Poison Pills (Shareholder Rights Plans)Stock purchase rights plans or shareholder rights plans, otherwise known as poison pills, have enjoyed widespread adoption since their inception in 1983. Poison pills are the most prevalent takeover defense among S&P 500 companies. They also enjoy support among other large companies. According to ISS data, about 800 companies in the S&P 1500 have poison pills, including 239 firms in the S&P 500. The vast majority of pills were instituted after November 1985, when the Delaware Supreme Court upheld a company's right to adopt a poison pill without shareholder approval in Moran v. Household International. Poison pills are corporate-sponsored financial devices that, when triggered by potential acquirers, do one or more of the following: (1) dilute the acquirer's equity holdings in the target company; (2) dilute the acquirer's voting interests in the target company; or (3) dilute the acquirer's equity holdings in the post-merger company. Generally, poison pills accomplish these tasks by issuing rights or warrants to shareholders that are essentially worthless unless triggered by a hostile acquisition attempt. The two most common poison pills in practice today are the flip-over plan and a variation of the flip-over plan that contains an ownership flip-in provision. A flip-over plan distributes rights to shareholders to purchase discounted shares of the acquirer's holdings in the post-merger company (usually at 50 percent of fair market value). Such significant dilution to the equity holdings of the potential acquirer's stake makes the merger prohibitively expensive. However, the acquirer may still exercise control over the target firm without actually merging with it, simply by acquiring a majority position and controlling the election of directors and other matters submitted for shareholder approval. Although the inability to merge may result in operating inefficiencies, added regulatory costs, and licensing restrictions, a change in control could still be managed without triggering the poison pill. The flip-in provision, which is a common part of many modern flip-over poison pills, penalizes the acquiring party even if it does not effect a merger with the target company. Originally designed to prevent the self-dealing transfer of a target's assets to the acquirer, the flip-in provision has been extended in many cases to cover simple ownership. Under a pill containing an ownership flip-in provision, shareholders of the target are given the right to purchase, at a discount, shares of their own company should the acquirer surpass a specified ownership threshold (usually between 20 percent and 50 percent of outstanding shares). The acquirer is excluded from this sale of discounted shares, and thus may see its equity position in the target shrink dramatically. When combined with the flip-over provision, the flip-in condition makes any type of hostile control share purchase very costly. Other less common but restrictive poison pills include back-end rights plans and voting plans. Back-end rights plans give shareholders a redeemable right that can be exchanged for cash and securities worth more than the stock's then-current price. Typically, back-end prices exceed market prices by between 8 percent and 92 percent on the date of issuance.[1] Again, an acquirer is prohibited from participating in the exchange, which results in the acquirer suffering significant dilution to its equity holdings in the target company. Voting plans issue preferred stock with superior voting rights to common shareholders in the event an acquirer surpasses a specific ownership threshold. Thus, even if an acquirer were to own far more than 50 percent of the target company, it would not be able to exercise control over its purchase. For instance, under one such voting plan adopted by ASARCO Inc., the holder of 99 percent of the company's common stock would only have 16.5 percent of the company's total voting power.[2] Proponents of poison pills argue that, because pills force would-be acquirers to negotiate with the target company's board, they protect shareholders from coercive tactics such as two-tiered, back-end offers. Moreover, pills enhance shareholder value because such negotiations lead to higher premiums in the event of a purchase. Opponents, on the other hand, believe poison pills lead to management entrenchment and discourage legitimate tender offers. Even if the premium paid to companies with poison pills is higher than that offered to unprotected firms, a company's chances of receiving a takeover offer in the first place may be reduced by the presence of a pill. Misuse of pills has certainly entailed costs to shareholders in several instances. For example, shareholders at Pennzoil Co. and Circon Corp. lost hundreds of millions of dollars in value when rights plans precluded them from accepting attractive tender offers. Under such circumstances, a determined buyer's only recourse for dismantling the pill is to wrest control of the board via a proxy contest-and only then if the target firm has an unclassified board. Vote FOR shareholder proposals requesting that the company submit its poison pill to a shareholder vote or redeem it UNLESS the company has: (1) A shareholder approved poison pill in place; or (2) The company has adopted a policy concerning the adoption of a pill in the future specifying that the board will only adopt a shareholder rights plan if either:
A poison pill adopted under this fiduciary out will be put to a shareholder ratification vote within 12 months of adoption or expire. If the pill is not approved by a majority of the votes cast on this issue, the plan will immediately terminate. In addition, ISS recommends that poison pill policies include a provision in the fiduciary out clause stipulating that a pill adopted under such circumstances be approved only by the directors that are attested to be independent of management. This would decrease the influence of those most likely to benefit from the management entrenchment inherent in a poison pill. Vote FOR shareholder proposals calling for poison pills to be put to a vote within a time period of less than one year after adoption. If the company has no non-shareholder approved poison pill in place and has adopted a policy with the provisions outlined above, vote AGAINST the proposal. If these conditions are not met, vote FOR the proposal, but with the caveat that a vote within twelve months would be considered sufficient. Vote CASE-by-CASE on management proposals on poison pill ratification, focusing on the features of the shareholder rights plan. Rights plans should contain the following attributes:
'Dead Hand' Variations and 'Chewable' PillsWith the proliferation of proxy fights, companies have embraced new counteroffensives in the form of "dead-hand" and "no-hand" pills.[3] Dead-hand or "continuing director" provisions stymie hostile suitors from taking control of a company's board in order to remove a pill. With a dead hand, only the incumbent or "dead" directors may amend or redeem the rights plan. The more onerous “no-hand” variant precludes any board, continuing or new, from doing so. This prevents a hostile acquirer from effecting a merger, even if it gains board control, until the pill elapses. Slow-hand pills have “delayed redemption” features that limit their duration. A new board would not be able to redeem the pill for a specified period of time, which can range from 90 days to a year, though most commonly it is 180 days. Many issuers are reluctant to tie the hands of a future board. Over the last couple years, more than a dozen firms adopted policies containing a “fiduciary out,” whereby any new pill would be put to a shareholder vote, if not at the time of adoption, then by the following annual meeting or within a year. Shareholders should have the right to vote on shareholder rights plans. It is understandable, that, under certain circumstances, a board adopts a pill without shareholder approval to ensure negotiations with a potential acquirer take place. However, even pills adopted under these circumstances should be put to a vote within a reasonable period of time. Less than a twelve-month period may require the board to incur additional costs by calling a special meeting just for this purpose or force a vote while the board may still be in delicate negotiations with the acquirer. To strike a balance of power, some activists have advocated pills with "chewable" attributes. Typically, these take the form of a qualifying offer clause requiring the pill to be redeemed, either automatically or by shareholder vote, if a bid is made for the company that meets certain criteria. Such criteria generally include premium pricing, full financing, and a grace period during which the board is accorded time to explore other options. Guy Wyser-Pratte pioneered the first chewable pill in 1996 at Wallace Computer Services Inc., which has since been refined both by himself and other activists such as State of Wisconsin Investment Board (SWIB).[4] Few companies voluntarily embed such progressive features in their rights plans. Some firms have chosen to enhance their existing pills with a “three-year independent director evaluation” (TIDE) provision, under which a committee of directors who are not employees or affiliates of the company will review the pill at least every three years and decide on its continuation or revocation. This is often done as a preemptive strike against a shareholder pill proposal, however. Although most firms resist shareholder attempts to eradicate pills, some companies have found pills difficult to remove. Sealed Air Corp., which inherited its rights plan from predecessor W.R. Grace & Co., tried in vain several times to remove its pill before finally generating sufficient voter turnout to meet the 80 percent shareholder approval threshold. In the aftermath, CEO T.J. Dermot Dunphy remarked that rights plans "are designed like fishhooks--easy to get in, but tough to pull out of." Performance, on the other hand, "is the greatest defense against getting taken over."[5] Legal History"Since making its legal debut in 1985, the story of the poison pill has been a work in progress, with each variation and innovation generating new litigation and occasions for judicial opinion writing." --Jack Jacobs, Vice Chancellor, Delaware Chancery Court.[6] The only state court to have ruled on binding bylaws proposed by shareholders is Oklahoma. In the International Brotherhood of Teamsters v. Fleming Cos., the state’s supreme court upheld the Teamsters' right to propose a binding bylaw amendment that would require majority shareholder approval of any rights plan adopted or maintained by the company. Legal experts are torn on the relevance of the decision to other jurisdictions. At least 25 states have laws expressly giving boards the right to create poison pills, with Oklahoma, Delaware, and California being notable exceptions. [7] Delaware, where the vast majority of companies are incorporated, has only gone so far as to strike down dead-hand pills. In James Carmody v. Toll Brothers Inc. (1998), the Chancery Court ruled that such mechanisms interfere with a future board's ability to manage the corporation. Just months later, the court ruled against limiting the duration of a dead-hand pill in Mentor Graphics Corp. v. Quickturn Design Systems Inc. The Delaware rulings have led to a rash of resident companies eliminating their dead-hand provisions. On the other hand, more protectionist states such as Pennsylvania, Georgia, and Maryland have validated and even embraced dead hands and similar delayed redemption pills.[8] Poison pills are unique among takeover defenses in that they may be approved by boards without shareholder approval. Enhancing this power is the fact that a number of states have passed poison pill endorsement legislation that removes courts from the position of challenging abusive pills. However, the degree that a rights plan may promote or diminish shareholder value clearly depends on circumstances specific to the individual company. Given their potential role in determining the future of a company, ISS believes shareholders should have the right to vote on all new pills and any material changes to old pills. ISS advocates supporting proposals requesting boards to either submit their pills to a shareholder vote or redeem them. When given the opportunity to vote on pills, shareholders should evaluate the plans on a case-by-case basis. Ideally, plans should embody the following attributes: Board redemption feature : A board should have sufficient flexibility to maximize shareholder wealth when employing a poison pill in negotiations. A redemption clause allows the board to rescind or redeem a pill even after a potential acquirer has surpassed the ownership threshold. Some pills only allow the board to redeem them before an acquirer has reached this ownership position. Prohibiting a board from repealing a pill once a bidder has acquired an arbitrary percentage of stock greatly reduces the board's flexibility in negotiating with the bidder. By the same token, dead-hand/no-hand pills and their progeny pose severe restraints on a future board's ability to manage the company's affairs. Such provisions should be excluded from pills. Flip-in level : A growing number of companies are providing their boards with carte blanche authority to lower their flip-in thresholds to 10 percent under specific circumstances, such as the determination that an individual is an "adverse person." This is a major shift from the late 1980s and early 1990s, when 20 percent triggers were de rigueur and 10 percent triggers were rare. Pills should not discourage potential bidders from accumulating a meaningful stake in the company or cause a large shareholder to inadvertently trigger the rights. ISS advocates a fixed flip-in level of 20 percent or higher. Sunset provision : Because pills are often adopted without shareholder approval, shareholders should have the opportunity to ratify or reject them at least every three years. So-called "sunset" provisions permit shareholders to reaffirm or redeem a pill based on how the company's board has used it in the past, market conditions, or the firm's performance. Qualifying offer clause : Shareholders should also look for a qualifying offer clause, which gives them the ability to redeem a poison pill when faced with a bona fide takeover offer. In many cases, boards have refused to withdraw pills even when a majority of shareholders have indicated their desire to sell the company. Such imperious actions impede market forces by denying company owners the right to decide on offers for themselves. Corporations and shareholders alike have been testing a variety of chewable provisions, and no single version works effectively for all companies. Therefore, ISS supports a simplified shareholder redemption feature: if a board refuses to redeem a pill 90 days after an offer is announced, 10 percent of the shares should be able to call a special meeting or seek a written consent to vote on rescinding the rights plan. In summation, consider supporting a poison pill only if the following factors are present:
Because there are no estimable qualities to dead-hand or no-hand provisions, ISS separately advocates withholding votes from board members who adopt poison pills with these continuing director features. Table 3-3. Case in Point: Adaptive Broadband Poison Pill
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