How Wall Street takeovers should be curbed. Tough new restrictions may be in store after the Boesky affair
THE Dow is up, but there is no joy in Wall Street. Mighty Ivan Boesky, the all-star of arbitrageurs, has struck out and been banned from the game for insider trading. Drexel Burnham, the pioneer of junk bonds, is under subpoena by the Securities and Exchange Commission. Heard on the Street is the persistent rumor that others may be implicated, since Mr. Boesky, facing a criminal charge, has turned informant and has been ``wired for sound.''
The question being asked is: ``What did they know and when did they know it?''
The risk arbitrage divisions of the ``respectable'' houses have been losing a ton since takeovers, the mother's milk of arbitrageurs, have slowed. And junk bonds, which have financed many takeovers, are coming to be suspect in the eyes of bankers and investors.
The White House has a task force to consider more-stringent restrictions against insider trading. And Congress, no doubt, will hold well-publicized hearings.
The Street fears that these investigations are bound to lead to increased regulation of takeovers. And it is the proliferation of takeovers, along with the increments of insider information and junk bonds, which has resulted in inordinate profits, not only to corporate raiders, but also to many investment bankers.
But the chairman of a leading company is quoted in a congressional report: ``Maybe there is something wrong with our system when companies line up large amounts of money in order to purchase stock when it doesn't help build one new factory, buy one more piece of equipment, or provide even one more job.''
This is perhaps too sweeping an indictment of the takeover game. There are takeovers that do achieve desirable results, takeovers that break up inefficient conglomerates full of inept managers. But all too many takeovers are merely contests for control of management, good or bad. Many of them involve unsavory devices, bordering on illegality; these takeovers proceed without regard to the interests of shareholders and the public. Information about takeovers tempts many into insider trading, and many takeovers can be financed only by high-interest, high-risk junk bonds.
In 1983 at the request of the House Banking Committee, I became a public member of the SEC Advisory Committee on Tender Offers. With all respect to the committee members, I found that a majority of them were tied to Wall Street. Their recommendations were, in my view, largely cosmetic and did not reach the nub of the problem.
I filed a separate statement in the committee's report; in effect, a dissent. The suggestions I made for reforms in tender offers are even more timely now.
Takeovers, as I have said, may or may not benefit shareholders of either the target company or the company making the offer. But shareholders have no way to judge the fairness of a tender offer, except by the market, which is more often than not unreliable in the long term.
One of the greatest abuses in takeover situations is the golden parachute. Golden parachutes typically provide for exorbitant sums, in addition to handsome salaries and fringe benefits, to be paid to managers of a target company in anticipation of a takeover. They are basically designed either to frustrate a takeover attempt or to ``feather the nest'' of existing corporate executives who may be fired in a takeover.
Golden parachutes have created great cynicism among shareholders, workers, and the public about the integrity of our corporate system. Every wage earner, white collar or blue, is worthy of his hire. But golden parachutes transcend adequate compensation. They are an integral part of the takeover game - and they should be made illegal. ANOTHER egregious abuse is ``greenmail.'' This device is the purchase by the target company of a substantial block of the stock of a corporate raider, making a tender offer at a premium price not available to other shareholders. But greenmail is nothing more than tribute paid to ward off a takeover attack and to perpetuate existing management. It is immoral and injurious to innocent shareholders.
The argument advanced in support of greenmail is that an attempted takeover, though unsuccessful, teaches management to mend its ways. This argument does not wash. Companies or corporate raiders attempting takeovers are not corporate reformers. They are basically profit-motivated, whatever their views of the managements of target firms.
I agree with the deputy secretary of the Treasury, Richard G. Darman, that some corporate managers are inept and some changes desirable. But takeovers are generally not the answer. More-alert and independent directors, bankers, and shareholders possess the ``muscle'' to change incompetent managers.
Another troublesome device is the sale of ``crown jewels'' - a corporation's most attractive assets - during or in anticipation of a tender offer. It should be prohibited. Such sales are designed to frustrate a tender offer by making the target company less desirable. This is not to say that a corporation should be prevented from conducting its ordinary business during a tender offer but simply that a target company be prevented from disposing of significant assets as a defensive tactic to make a tender offer less attractive, often at the expense of the target company.
The same prohibition should be applied to the ``scorched earth'' tactic, the ``poison pill'' device, ``two-tier offers,'' and the sheer absurdity of the Pac-Man defense, best illustrated by the Bendix and Martin Marietta fiasco. These tactics would seem to be more suitable to a video game than to making massive changes in our corporate system.
We justifiably take pride in the fact that shares in our publicly held companies are widely held and actively traded. About 45 million Americans hold shares in these companies. Many Americans hold shares in small amounts, which, nevertheless, represent significant investments and, in aggregate, are substantial. Small shareholders do not have access to competent and readily available independent advice in evaluating tender offers, pro and con. Institutional investors, unlike small shareholders, do resort to professional and expert advice, which small investors cannot afford.
SEC filings do not, under present regulations, indicate whether a tender offer is good or bad from a shareholder's perspective. SEC filings are disclosure statements in a form geared to professional investors. They are as esoteric to a small shareholder as Form 1040 is to an average taxpayer. In both cases professional advice is virtually a necessity. The SEC should be empowered to appoint an objective and disinterested evaluator to appraise the fairness of a tender offer. British law so provides, without injury to its free market.
There should also be a freeze period during a tender offer, to permit adequate time so that competing offers can be made and other measures employed. British law, regulation, and practice provide for a six-month freeze. Perhaps, under our system, a shorter period may suffice. The period should be sufficient, however, to permit competing tender offers and to allow the Department of Justice and the Federal Trade Commission to make a determination of possible antitrust implications which is more adequate than under the limited 30-day period prescribed by existing law. It would also afford time for an independent evaluation and give shareholders the opportunity to consider such an evaluation. A reasonable freeze period, it seems to me, would be 120 days.
Before a tender offer is made, it should be approved by shareholders of the suitor company. Before it is accepted or rejected, it should be approved by the shareholders of the target company. This requirement is simply an application of corporate democracy. After all, shareholders, not management, own corporations. They risk their capital, and consequently they are entitled to make the ultimate decision on matters directly affecting their investments.
``Super majority'' provisions in charters and bylaws of corporations, in various states, which are overly friendly to corporate managers, are nothing more than a shield for their job security. These provisions require votes by more than a simple majority for a takeover to be approved or defeated. THEIR use is a recent development in defensive strategy. They run contrary to the concept of corporate democracy.
One person, one vote, the Supreme Court has decreed. But with corporations, the shareholder has neither voice nor vote in takeovers. Prohibition of super-majority provisions, moreover, is consistent with federal regulations designed to correct abuses in corporate governance and securities regulation. Super-majority provisions are plainly a device to perpetuate existing management.
The abuses in the tender situation, insider trading, junk bonds, and takeovers are substantial, serious, and continuing. They cannot be treated with Band-Aids. Nor can they be swept under the rug. The abuses cast a shadow on our system of corporate governance. It is clear that additional regulation by congressional enactment is overdue and essential to the public interest.
Neither the SEC, our stock exchanges, nor the current antitrust division of the US Justice Department, which appears to have repealed the Sherman and Clayton Acts, has the power or the will to call a halt to and curb the excesses that now exist. Therefore legislation is required.
The Wall Street argument that the free market will provide the remedy is disproved by the record.
The same argument was made in the '30s in the Pecora investigation, which led to the enactment of the Securities Exchange Act of 1934 and the establishment of the SEC. The argument of these special interests was rejected because unregulated speculation was a major contributing factor to our economic collapse, which was a disaster, not only to the Street, but to the public at large.
The need for public airing of the takeover game is even more evident than in the '30s. The securities markets have undergone profound changes. The growth and impact of the market on our economy are infinitely greater than during the depression, and abuses, unless corrected, can have an even more far-reaching effect. Credibility is the touchstone of our capital markets, as it is of our political system. If the confidence of investors is impaired, a debacle is not impossible.
Wall Street should invite rather than resist necessary reforms. If the Street does not cooperate, it will likely be faced with far more rigorous restrictions than those I have suggested.
Arthur J. Goldberg is a former associate justice of the Supreme Court of the United States.