By Elizabeth Lash, Esq.
It’s a tale as old as time – or at least as old as a 1982 Keith Haring work: a multi-million dollar proxy fight between an incumbent board of directors and activist shareholders, battled through poison letters and poison pills. (Ed. Note: see Sources and Explanations for definitions of various corporate law terms). In this instance, the tale revolved around Sotheby’s auction house, which, as a publicly held company, will, at the end of the day, have had to expend more than $15 million on this past year’s proxy fight with its activist shareholders.
For those who normally ignore shareholder elections, the fight for control over Sotheby’s was one to which it was worth paying attention. Beginning in May 2013, several large, activist hedge funds began buying up shares in Sotheby’s: Third Point (run by Daniel Loeb), Marcato Capital Management (run by Richard (“Mick”) McGuire), and Trian Fund Management (run by Nelson Peltz). Not only did the funds begin requesting private meetings with Sotheby’s management to discuss Sotheby’s future direction, but at least one (Marcato) announced in its 13D filing that it would discuss “various strategic alternatives.”
But then the tone changed dramatically: in October 2013, Daniel Loeb declared open season on the Board by publicly publishing a letter (as part of an amended Schedule 13D) addressed to William Ruprecht, CEO, President, and Chairman of Sotheby’s, in which Loeb listed all of the ways in which Ruprecht and the rest of his Board were overpaid and underperforming.
Not only did Sotheby’s board take umbrage at its publicly-disclosed potential valuation (a bit of irony in its reaction, considering Sotheby’s itself is in the business of valuing prized possessions for investors), but such a declaration spurred Sotheby’s to action in view of a perceived hostile take-over, or at least a bitter proxy fight: not long after the filing of Loeb’s “poison pen” letter, Sotheby’s created a shareholder rights plan that would allow only passive investors to purchase more than 10% in Sotheby’s. (13G filers could purchase up to 20% of Sotheby’s shares, but 13D filers could not.)
A shareholder rights plan, or “poison pill,” is just one of the tools which companies may use to defend themselves from the threat of take-overs from apparently hostile outsiders. Shareholder rights plans (i.e., seemingly a bit of a misnomer, since they are actually created and enforced by a board of directors), which became popular in the 1980’s as a tool to stave off hostile take-overs, are legal and enforceable in Delaware, as long as a board of directors has investigated the threat of such a take-over and has instituted a plan that is reasonable in relation to the perceived threat to the company. A shareholder rights plan can be used to defend a company from unsolicited bids by severely diluting the position of any shareholder acquiring more than a specified proportion of a target company’s shares (in this case, 10%) without the prior approval of the company’s board. Such a plan obviously encourages outside bidders to negotiate with the board, since only the board can redeem the rights plan if it approves of the offer.
In the spring of 2014, Loeb sought a waiver from the 10% threshold to purchase a greater number of shares, but the Board declined to do so, instead offering, at various points, Loeb or one of his nominees a seat on the Board. Loeb, however, rejected the attempted settlements because appointment to one seat on the Board would have given Loeb only nominal control over the Board, and would have left him with little ability to influence the company’s direction.
Thus, discussions between the parties broke down in March 2014, and Loeb, along with several pension fund shareholders, brought suit to preliminarily enjoin Sotheby’s from holding its annual shareholder vote until the Delaware Chancery Court could rule on whether (a) the shareholder rights plan and (b) the Board’s refusal to grant a waiver from this plan were being used to unfairly benefit the incumbent Board in the upcoming shareholder election.
The final decision, just issued by Vice Chancellor Donald F. Parsons, Jr. of the Delaware Chancery Court in early May 2014, held that the Board acted reasonably when it created the plan, and when it enforced the plan (i.e., refused to grant a waiver from the plan to Loeb), in the face of the perceived threat in the form of a proxy fight by several of its largest shareholders. Interestingly, although it appeared the Vice Chancellor saw the creation of a shareholder rights plan as being well within the Board’s rights, he found that the Board’s later refusal to grant a waiver was precipitously balanced on the edge of permissible behavior.
In coming to his decision, the Vice Chancellor struggled with conflicting Board minutes and Board member testimony, along with some evidence of animus between Ruprecht and Loeb (putting aside that Loeb appears to be a difficult person to work with anyway). For instance, while Sotheby’s Board minutes (drafted by the Board’s attorneys), appeared to show how the shareholder rights plan and its refusal to grant a waiver fit exactly under prevailing precedent (even using the exact language of prior decisions relating to acceptable shareholder rights plans), deposition testimony by one Board member tended to indicate otherwise: that the refusal to grant a waiver may have been motivated more in maintaining control over the current Board than in protecting Sotheby’s from predatory behavior by outside hedge funds. While the latter was perfectly acceptable as a reason for creating and enforcing a shareholder rights plan, the former would have been impermissible.
So what really weighed in favor of the Board and in the court’s rejection of Loeb’s request for a preliminary injunction of Sotheby’s annual shareholder elections? The Vice Chancellor primarily discusses what he sees as relevant facts, namely, the effort to prevent “creeping control” of Sotheby’s without payment of a control premium; “collusive” ownership purchases by the outside funds; and the Board being made up of mainly independent directors.
Beyond the obvious (i.e., what the Vice Chancellor highlights), other factors appear equally important in the Vice Chancellor’s decision, even if they do not figure as prominently in the final analysis. For instance, the Board’s attempts to settle with Loeb by giving him or others connected with him one or more seats on the Board appeared to persuade the Vice Chancellor that the Board had acted reasonably, despite distaste for Loeb and his methods.
As well, an important factor in the decision (and this is where smart counsel and financial advisors really count) is that the shareholder rights plan still permitted outsiders bidders to make an all-cash, all-shares tender offer. Some Delaware courts have found that a refusal to make such an exception in a shareholder rights plan is unreasonable. Thus, this factor may have also weighed heavily in favor of the Board when the Vice Chancellor found that the Board’s primary motivation in enforcing the shareholder rights plan was not to maintain control (even if, as indicated in deposition testimony, that may have actually been the case).
In the end, as others have already observed, the Board may have won the battle, but lost the war. Although Sotheby’s Board claimed that its concern in fighting off activist shareholders was to keep Sotheby’s from wasting money it did not have, as well as protecting shareholders from coercive or unfair takeover tactics, the auction house in fact spent $5.7 million fighting Loeb and his compatriots, and will be reimbursing Loeb about $10 million for his troubles. Moreover, the Board felt that it had to award three seats to Loeb and his nominees, most likely as a result, not only of early reports and preliminary votes indicating that Loeb would win, but in heeding Vice Chancellor Parsons’ apparent warning that the Board’s refusal to grant a waiver was a very close call. On the other hand, Ruprecht has remained the Chairman of the Board, and Third Point has agreed to cap its holdings at 15 percent.
So what does this mean for the future of shareholder rights plans within and outside the art law domain? It means that shareholder rights plans are alive and well, particularly when well designed—even in the face of shareholder activism, rather than the threat of outright acquisitions. But it also means that boards should be careful about their internal discussions of such activist funds, and should institute thoughtful consideration of what, exactly, they perceive the threat to the company could be (at least before breaking the bank on their legal and financial costs). But for now, Loeb and his nominees are a part of the Board, and spring auctions are in full swing.
Sources and Explanations:
- The shareholder rights plan, also known as the “poison pill,” was developed in 1982. Frank Aquila, “Suddenly, Poison Pills Are Relevant Again,” Bloomberg Business Week: Markets & Finance, February 23, 2011, available at http://www.businessweek.com/investor/content/feb2011/pi20110223_426064.htm.
- Sotheby’s, which was originally formed in 1774, and became a public company in 1977, has almost 70 million shares outstanding. Sotheby’s currently trades at around $40 a share. “About Sotheby’s: History,” Sotheby’s, available at http://www.sothebys.com/en/inside/about-us.html; “Sotheby’s Shares Outstanding,” Macroaxis Investment Management Service, available at http://www.macroaxis.com/invest/ratio/BID–Shares_Outstanding, last accessed May 9, 2014; “Sotheby’s BID Key Statistics,” Market Watch – Wall Street Journal, available at http://www.marketwatch.com/investing/stock/bid/profile, last accessed May 9, 2014.
- Alexandra Stevenson, “Sotheby’s to Reimburse Loeb $10 Million,” New York Times, May 7, 2014, available at http://dealbook.nytimes.com/2014/05/07/sothebys-to-reimburse-loeb-10-million/?_php=true&_type=blogs&_r=0; Charlotte Burns, “Loeb battle costs Sotheby’s $15.7m,” The Art Newspaper, Frieze New York Daily Edition 8-9 May 2014, available at http://www.theartnewspaper.com/fairs/Frieze-New-York/2014/1.pdf.
- “Dan Loeb’s Third Point Boosts Sotheby’s Stake: 13D Filing,” Market Folly blog, August 27, 2013, available at http://www.marketfolly.com/2013/08/dan-loebs-third-point-boosts-sothebys.html.
- A Schedule 13D is a report filed with the Securities and Exchange Commission when a person or group of persons acquires beneficial ownership of more than 5% of a voting class of a company’s equity securities registered under Section 12 of the Securities Exchange Act of 1934. “Schedule 13D,” Securities and Exchange Commission, available at https://www.sec.gov/answers/sched13.htm
- Third Point LLC v. William F. Ruprecht and Sotheby’s, Docket No. C.A. No. 9469-VCP, consolidated with The Employees Retirement System of the city of St. Louis, on behalf of itself and all other similarly situated shareholders of Sotheby’s v. William F. Ruprecht and Sotheby’s, C.A. No. 9497-VCP, **6-10 (Del. Ch. Ct., May 2, 2014), available at http://courts.delaware.gov/opinions/download.aspx?ID=205180.
- Third Point LLC, at **19-20; “Sotheby’s Form SC 13D/A Amended General Statement of Beneficial Ownership,” October 2, 2013, available at http://investor.shareholder.com/bid/secfiling.cfm?filingID=1193125-13-388165&CIK=823094.
- Third Point LLC, at **19, 22, 43.
- A schedule 13G is similar to a 13D (i.e., it must be filed when a person acquires beneficial ownership of more than 5% of publicly held securities), but may only be filed by passive investors, qualified institutional investors, and exempt investors. David Mittelman, Reed Smith, LLP, “When To File Schedule 13D Vs. Schedule 13G,” Law360.com, available at http://www.law360.com/articles/501953/when-to-file-schedule-13d-vs-schedule-13g; Brian Schaffer, Prosek Partners, “Another Difference Between ‘D’ and ‘G’ Is More Than Just The Obvious,” Unboxed Thoughts Blog, http://www.unboxedthoughts.com/2011/08/11/another-difference-between-%E2%80%98d%E2%80%99-and-%E2%80%98g%E2%80%99-is-more-than-just-the-obvious/.
- See Moran v. Household Int’l, 500 A.2d 1346 (Del. 1985); Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985); Anthony Augliera, “Shareholder Rights Plans: Saying No to Inadequate Tender Offers,” 57 Fordham L. Rev. 803, 1989, available at http://ir.lawnet.fordham.edu/flr/vol57/iss5/6.
- Aquila, “Suddenly, Poison Pills Are Relevant Again,” Bloomberg, 2011.
- In March 2014, Loeb requested, via letter, that the Board amend the shareholder rights plan to provide a limited waiver of the 10% trigger of the poison pill for investors planning to engage in a proxy contest, so that Loeb would be permitted to acquire shares of Common Stock up to the 20% trigger of the poison pill already permitted for 13G investors, without being deemed an Acquiring Person and triggering the poison pill. “Schedule 13D, Amendment No. 4,” Securities and Exchange Commission EDGAR database, available at https://www.sec.gov/Archives/edgar/data/823094/000119312514116267/d698590dsc13da.htm.
- Loeb filed suit late March 2014 alleging that the Board had breached its fiduciary duties by adopting the shareholder rights plan (“Rights Agreement”) and enforcing it against Third Point, and requesting that (a) the Rights Agreement be declared unenforceable and (b) Sotheby’s Board redeem the Rights Agreement in its entirety; or (c) enjoin Sotheby’s from enforcing the Rights Agreement against Third Point; or (d) order Sotheby’s to amend the Rights Agreement to allow Third Point to acquire up to 20% of the Company’s outstanding Common Stock without triggering the Rights Agreement. Third Point also filed a motion requesting that the Court of Chancery hold a trial in advance of the May 6, 2014 annual meeting of the Company’s stockholders. http://archive.fast-edgar.com//20140326/A62ZE22DZC2R32ZU222G2MXPH3QRZZ22Z862/.
- Third Point LLC, at **49-53.
- Third Point LLC, at **42-44.
- Third Point LLC, at **28-31, 42-43.
- Third Point LLC, at *43.
- See Moran, 500 A.2d 1346; Unocal Corp., 493 A.2d 946; Augliera, 57 Fordham L. Rev. 803.
- Augliera, 57 Fordham L. Rev. 803.
- Third Point LLC, at *42.
- Third Point LLC, at *9.
- Katya Kazakina, “Sotheby’s Ends Fight With Third Point as Loeb Joins Board,” Bloomberg, May 5, 2014, available at http://www.bloomberg.com/news/2014-05-05/sotheby-s-agrees-to-add-third-point-s-loeb-to-board.html
- Stevenson, “Sotheby’s to Reimburse Loeb $10 Million,” New York Times, 2014; Burns, “Loeb battle costs Sotheby’s $15.7m,” The Art Newspaper, 2014.
- Svea Herbst-Bayliss, “ISS recommends votes for two Loeb nominees to Sotheby’s board,” Reuters, April 24, 2014, available at http://www.reuters.com/article/2014/04/24/us-sothebys-idUSBREA3N17X20140424; Michael J. De La Merced and Alexandra Stevenson, “Sotheby’s Yields to Hedge Fund Mogul and Allies,” May 5, 2014, available at http://dealbook.nytimes.com/2014/05/05/sothebys-and-loeb-end-fight-over-board/.
- Agustino Fonteveccia, “Truce! Dan Loeb’s Third Point Gets 3 Board Seats, But Sotheby’s CEO Bill Ruprecht Stays On Board,” Forbes.com, May 5, 2014, available at http://www.forbes.com/sites/afontevecchia/2014/05/05/truce-dan-loebs-third-point-gets-3-board-seats-but-sothebys-ceo-bill-ruprecht-stays-on-board/. According to Fonteveccia:
- Third Point, run by Loeb, won a partial victory, securing three board spots and the removal of a poison pill that will allow it to raise its stake in the company to 15%, yet he didn’t manage to force embattled CEO Bill Ruprecht to ease his grip on the company, as he’s manage [sic] to hold on to his job while remaining president and chairman of the board of directors. Loeb, along with former investment banker and jeweler Olivier Reza and restructuring expert Harry Wilson, will be included in Sotheby’s slate of nominees, while the board will be expanded to 15 from the current 13 members. Interestingly, the Third Point nominees will work with Ruprecht and his team.
About the Author: Elizabeth R. Lash, Esq., is currently with Lash & Associates, LLC, where she works as a consultant on commodities consulting and regulatory issues. She also provides IP and corporate governance advising in her capacity as a sole practitioner.
Disclaimer: This article is intended as general information, not legal advice, and is no substitute for seeking representation.