Legal News

Responding to Activist Investors, Companies Give Poison Pill More Punch

By Dan Slater

Last week, we noted a strongly worded opinion by NY district judge Lewis Kaplan that reprimanded two hedge-funds for the way they used derivatives to obscure their takeover plans for railroad CSX.

Today, the WSJ’s Mara Lemos-Stein reports on a novel move by companies to take the matter into their own hands by “redefining stock ownership to thwart the use of derivatives in activist plays.” Louisiana-Pacific Corp. and Micrel Inc. have reportedly changed their shareholder-rights plans — the formal name of the “poison pill” — to include derivatives, or swaps, when calculating levels of “beneficial ownership” that would trigger their poison pill.

First things first: What’s a swap? In a swap, one party (typically, a brokerage) promises to pay the other (say, a hedge fund) all the economic rewards of owning a stock, while the fund promises to compensate the firm if the stock loses value. Swaps give the holder no voting rights and, in the view of the funds, mean they don’t need to comply with disclosure rules because, under securities laws, only “beneficial ownership” — meaning both voting rights and economic benefits — must be disclosed. In the CSX flap, Judge Kaplan found that the two hedge-fund-defendants had used swaps to build a position in CSX while delaying disclosure to the broader market. Kaplan thought that, since the funds have easy access to the underlying shares, they should have to report them.

Under Louisiana-Pacific’s new poison pill, if an investor increases his or her stake to 15%, the company will issue rights convertible into stock to all other holders, hence diluting the ownership of the major stakeholder. The 15% threshold hasn’t changed from the company’s previous shareholder rights plan, but the definition of ownership has. Micrel’s new pill, which includes derivatives exposure, is similar.

Mike Kinney, the director of investment relations for Louisiana-Pacific, told Hedge Fund Trades,
“The only difference is just the fact that the derivatives or any synthetic arrangement that’s defined in there would be included in the 15%; that’s the piece that’s new compared to our last shareholder’s rights plan.”

According to Stanford law prof Ronald Gilson, “In the original pill answer, [companies] were afraid [activists] would vote enough shares that would allow them to influence control. In the present structure, they’re not concerned about how many votes that particular party has, they are concerned about the economic stake, because what the hedge fund is doing is not so much winning by holding votes, but they’re winning by influencing other shareholders.”

Photo: iStockPhoto

Full post as published by Law Blog - WSJ.com on June 18, 2008 (boomark / email).