By Liz Hoffman
Poison pills just got a shot in the arm.
Long used by companies to thwart hostile acquirers, these
arrangements are finding favor among companies seeking protection
from activist investors. Last week, these new types of "pills," as
they are known on Wall Street, got the thumbs up from the Delaware
courts, a big win for companies lately getting creative in fights
against activists.
On Friday, Vice Chancellor Donald Parsons of the Delaware Court
of Chancery ruled that auction house Sotheby's acted reasonably
when it adopted, and later maintained, a poison pill aimed squarely
at activist hedge funds circling the company's stock last fall. The
plan limited these investors, including Daniel Loeb's Third Point
LLC, to under a 10% stake but let passive investors--thought to be
friendlier to management--buy twice as much.
Mr. Parsons found credible the concerns of Sotheby's board that
Mr. Loeb, who was seeking board seats, would gain "effective
control" over the company without having paid a premium. Mr. Loeb
and Sotheby's reached a settlement Monday.
The decision affirms the legality of a new generation of poison
pills, which are being adopted more frequently by companies in
hedge funds' cross hairs.
"It's a Good Housekeeping seal of approval," said lawyer Gardner
Davis. "If I'm the general counsel of a public company and I'm
worried about an activist investor--and these days, everybody is
worried--this is...a nice tool to have on the shelf."
Christopher Davis, a lawyer who represents activists, called the
decision troubling and "unduly deferential to underperforming
directors." He said any pill designed to affect the outcome of a
shareholder vote is a misuse of the mechanism.
Poison pills, which discourage unwanted suitors by threatening
to dilute their stakes, emerged in the 1980s to thwart hostile
corporate takeovers. An early version helped General American Oil
fend off Texas oil man T. Boone Pickens in 1982; Airgas Inc. used
one to stiff-arm a bid from rival Air Products & Chemicals Inc.
in 2010.
But over the past year or so, they have been revamped and
redeployed, not against corporate suitors buying up shares to force
a merger but against investors like Mr. Loeb, who use smaller
positions to push for changes from within.
The new crop of pills typically cap investors at about a 10%
stake in the company; limit their ability to work together; and
count shares held through swaps and options, which activists often
use to amass stakes without ringing alarm bells.
They also distinguish between investors who rattle the cage and
those who don't. The Sotheby's pill capped Mr. Loeb and other
activists under 10% of shares, while allowing passive investors to
own up to 20%, using a regulatory filing as a litmus test.
Investors who seek to influence companies must report their stakes
to the Securities and Exchange Commission on 13D forms, while
passive holders use 13G forms.
About 15% of companies adopting a poison pill last year had
exemptions for investors who identify their stakes as passive, up
from 5.5% in 2008, according to FactSet.
Among them were Air Products & Chemicals, after William
Ackman surfaced last July with a stake, and Hologic Inc., after
Carl Icahn took a large position last fall. Both companies have
settled with the activists.
Third Point's lawsuit was the first to challenge the legality of
these two-tiered pills. It argued that Sotheby's pill unfairly
tilted the board contest in favor of management and that upholding
it would "open the door to future efforts to squash outspoken
stockholders in boardrooms across the country."
Delaware law doesn't ban a board from taking actions that
interfere with a stockholder vote but requires the actions to be
proportionate to the perceived threat. Mr. Loeb's lawsuit asked: Is
a minority investor, seeking a minority voice in the boardroom,
such a threat?
The answer is "clearly yes," said lawyer Michael O'Bryan. "Here,
the court has acknowledged that activism by itself can justify
board action."
Mr. Parsons, one of five judges on Delaware's corporate-law
court, said he was "not unsympathetic" to Third Point's claims,
which he said "raise important policy concerns." But on balance, he
said, the board's response was proportionate to the threat it
perceived.
The ruling didn't inoculate Sotheby's. In a settlement struck
Monday, Sotheby's gave Third Point most of what it had sought,
including director seats for Mr. Loeb and two allies. The agreement
also guarantees Mr. Loeb a central role as Sotheby's undertakes a
strategic review of its business.
And, in fact, Mr. Loeb's lawsuit, while technically a legal
loss, likely helped his cause by airing emails among Sotheby's
directors showing they shared many of his concerns about the
company. Those emails were a catalyst for the settlement, Sotheby's
director Domenico De Sole said Tuesday.
But as activists continue to ramp up attacks, the Sotheby's
ruling delivered a big win for one of corporate America's oldest
defenses.
"The poison pill continues to be resilient," said lawyer Paul
Scrivano. "People keep challenging it, and it keeps on
surviving."
Write to Liz Hoffman at liz.hoffman@wsj.com
Subscribe to WSJ: http://online.wsj.com?mod=djnwires