35 Press Release, International Working Group of Sovereign Wealth Funds, International Working Group of Sovereign Wealth Funds Reaches a Preliminary Agreement on Draft Set Generally Accepted Principles and Practices—“Santiago Principles” (Sept. 2, 2008).
36 International Working Group of Sovereign Wealth Funds, Sovereign Wealth Funds: Generally Accepted Principles And Practices—“Santiago Principles,” app. I (2008).
37 Ibid., 7.
38 50 U.S.C. § 2170(d) (2008).
39 Enforcement of United States Rights under Trade Agreements and Responses to Foreign Trade Practices, Pub. L. No. 100-418, 102 Stat. 1107 §§ 1305-07 (1988). For a history of the Exon-Florio Amendment and the Fairchild incident, see Jose E. Alvarez, “Political Protectionism and United States Investment Obligations in Conflict: The Hazards of Exon-Florio,” 30 Virginia Journal of International Law 1, 56-86 (1989); Matthew R. Byrne, “Note, Protecting National Security and Promoting Foreign Investment: Maintaining the Exon-Florio Balance,” 67 Ohio State Law Journal 849, 856-870 (2006).
40 Foreign Investment and National Security Act of 2007, Pub. L. No. 110-49, 121 Stat. 246 (2007).
41 Regulations Pertaining to Mergers, Acquisitions, and Takeovers by Foreign Persons, 31 C.F.R. 800 (2008).
42 The Bureau of Economic Analysis in the Department of Commerce administers a reporting requirement for all foreign acquisitions of 10 percent or greater interests in U.S. corporate entities.
43 See Chip Cummins, “World News: Nations Seek Aid from Gulf, but May Come Up Dry,” Wall Street Journal, Oct. 29, 2008, A10.
44 Moreover, a status quo solution appears to be more appropriate at this point in time than other proposals to address sovereign wealth funds. One proposal by Professors Milhaupt and Gilson would require that sovereign wealth fund investments be deprived of any voting power while held by the fund. See Ronald J. Gilson and Curtis J. Milhaupt, “Sovereign Wealth Funds and Corporate Governance: A Minimalist Response to the New Merchantilism,” 60 Stanford Law Review 1345 (2009). This proposal, however, does not deal with the monitoring function of any regulatory scheme, nor does it deal with the fact that most sovereign fund investment is currently nonvoting to begin with. A second proposal by Victor Fleischer would place a Pigouvian tax on these funds. Victor Fleischer, “A Theory of Taxing Sovereign Wealth,” 63-66 (draft dated Aug. 12, 2008). This type of tax would be imposed because these funds have a lower hurdle rate for investment and can unduly compete and crowd out nonsovereign investment. The tax would restore a level playing field. Currently, sovereign wealth funds do not pay a dividend or any other tax in the United States because they are owned by a sovereign and are largely passive investments. Fleischer’s proposal would repeal this tax exemption. This latter point appears to be a salient one, at least on a reciprocal basis. The United States should eliminate a tax benefit received by sovereigns who do not provide the same benefit to U.S. funds investing in their country. Nonetheless, a leveling tax at this point seems inappropriate, again because there has been no real harm shown yet, and secondarily because many U.S. government entities such as pension plans and endowments have similar cost of capital advantages over regular investors. See also Paul Rose, “Sovereigns as Shareholders,” 87 North Carolina Law Review 83 (2008). Paul Rose agrees with my analysis that the current U.S. regulatory apparatus is sufficient but rightly notes that there is still a need to monitor sovereign wealth fund investment in other countries to the extent it affects U.S. interests.
45 Thomson Reuters Database.
46 Dealogic Database.
47 See David E. Sanger, “Under Pressure, Dubai Company Drops Port Deal,” New York Times, Mar. 10, 2006, A1. For a history of the Dubai Ports saga, see Deborah M. Mostaghel, “Dubai Ports World under Exon-Florio: A Threat to National Security or a Tempest in a Seaport?” 70 Albany Law Review 583 (2007).
48 H.R. Res. 556, 110th Cong. (2007) (enacted).
49 Dealogic Database;Thomson Reuters Database.
50 See Mark E. Plotkin and David N. Fagan, The Revised National Security Review Process for FDI in the US, Columbia FDI Perspectives, No. 2, Jan. 7, 2009, 3.
51 See Russell Gold, “Chevron Purchase of Unocal Is Clinched in Shareholder Vote,” Wall Street Journal, Aug. 11, 2005, A2.
52 See Eduardo Lachica, “Bush Orders Chinese Firm to Sell Stake in Mamco, a Seattle Maker of Plane Parts,” Wall Street Journal, Feb. 5, 1990, A7.
53 See Hasan Jafri and Phillip Day, “Hutchison Whampoa Pulls Out of Bidding for Global Crossing—Security Concerns by U.S. Leaves Singapore Partner Alone in Purchase Attempt,” Wall Street Journal, May 1, 2003, B4.
54 See “Buy-out of 3Com Is Up for Vote Despite Concerns,” Wall Street Journal, Mar. 20, 2008, B4; Steven M. Davidoff, “3Com: A Failure to Communicate,” New York Times DealBook, Feb. 20, 2008.
55 Agreement and Plan of Merger by and among Diamond II Holdings, Inc., Diamond II Acquisition Corp. and 3COM Corporation, dated as of September 28, 2007, at § 8.1(g), filed as an exhibit to 3COM Corporation Amended Current Report (Form 8-K), filed on Sept. 28, 2007.
56 See Stephanie Kirchgaessner, “‘You Have to Figure How to Manage the Process,’” Financial Times, Apr. 25, 2008, 7.
57 See 3Com Press Release, Apr. 29, 2008.
58 See Paul Betts, “Danone Loses Its Taste for Economic Patriotism,” Financial Times, July 4, 2007, 22.
59 Dealogic Database.
Chapter 6: Bear Stearns and the Moral Hazard Principle
1 The figure was obtained by searching the Capital IQ database for private or public offerings made by firms in the Financials (primary) sector between December 1, 2007, and March 1, 2008.
2 See Scott G. Alvarez, General Counsel, Federal Reserve Board, Sovereign Wealth Funds, Testimony before the Subcommittee on Domestic and International Monetary Policy, Trade, and Technology, and the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, Committee on Financial Services, U.S. House of Representatives (Mar. 5, 2008).
3 For accounts of the collapse of these hedge funds and the state of Bear Stearns at the time, see Gretchen Morgenson, “Bear Stearns Says Battered Hedge Funds Are Worth Little,” New York Times, July 18, 2007, C; Randall Smith, “Credit Crunch: Holders in Two Funds Want to Replace Bear,” Wall Street Journal, Sept. 5, 2007, C2; Kate Kelly, “Cayne to Step Down as Bear Stearns CEO—Executive, under Fire, to Remain Chairman; ‘Time to Pass the Baton,’” Wall Street Journal, Jan. 8, 2008, A1.
4 It was exactly 32.8:1. The Bear Stearns Companies, Inc., Annual Report (Form 10-K), ex. 13, filed Jan. 29, 2008. This was actually down from almost 44:1 back in August 2008. See William D. Cohan, House of Cards: A Tale of Hubris and Wretched Excess on Wall Street (2009), 382.
5 Kelly, “Cayne to Step Down.”
6 See Roddy Boyd, “The Last Days of Bear Stearns,” Fortune, Mar. 31, 2008.
7 See Boyd, “The Last Days of Bear Stearns.”
8 See Brett Philbin and Rob Curran, “Boeing Rides Higher, But Bear Struggles—S&P Report Lifts Mood of Investors; Fannie, Freddie Up,” Wall Street Journal, Mar. 14, 2008, C5. See also Kate Kelly, “Fear, Rumors Touched Off Fatal Run on Bear Stearns,” Wall Street Journal, May 28, 2008, A1.
9 Press Release, Bear Stearns Companies Inc., dated Mar. 10, 2008.
10 See Boyd, “The Last Days of Bear Stearns.”
11 Ibid.
12 Interview by David Faber with Alan Schwartz, CEO and president, Bear Stearns Co. Inc., CNBC (Mar. 12, 2008).
13 See Cohan, House of Cards, 41.
14 Ibid. at 52.
15 See Gregory Zuckerman, “Hedge Funds, Once a Windfall, Contribute to Bear’s Downfall,” Wall Street Journal, Mar. 17, 2008.
16 See The Bear Stearns Companies, Inc. Current Report (Form 8-K), filed on Mar. 19, 2008.
17 Cohan, House of Cards, 81.
18 See Kate Kelly, “Bear Stearns Neared Collapse Twice in Frenzied Last Days,” Wall Street Journal, May 29, 2008, A1; Stephen Labaton, “Bear Stearns in the Committee
Room,” New York Times, Apr. 4, 2008, C1.
19 Two explanations have been proffered. First, that the guarantee had failed to convince lenders to again provide short-term repo financing and forestall Bear’s clients from withdrawing funds and that Bear was going to default on the JPMorgan loan on Monday. By forcing Bear into a transaction, the Fed was protecting its guarantee and preventing any monetary loss. This is the story put forth by the New York Federal Reserve. See Timothy F. Geithner, President and Chief Executive Officer New York Fed, Actions by the New York Fed in Response to Liquidity Pressures in Financial Markets, Testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs, Washington, D.C. (Apr. 3, 2008). The second reason offered is a political one—the Treasury Department, particularly Secretary Paulson, did not want to be seen as bailing out Bear Stearns and facilitating future moral hazard. Given that the threat to the financial system remained if Bear Stearns collapsed, it also remains unclear whether the government would have fulfilled its threat to cut off Bear Stearns if it did not find such a transaction. See Kelly, “Bear Stearn Neared Collapse.”
20 Ibid. See also Cohan, House of Cards, 88.
21 See Robert Steel, Under Secretary for Domestic Finance of the Treasury, Actions by the New York Fed in Response to Liquidity Pressures in Financial Markets, Testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs,Washington, D.C. (Apr. 3, 2008).
22 See John Brooks, The Go-Go Years (1973), 329-333.
23 Agreement and Plan of Merger by and between The Bear Stearns Companies, Inc. and JP Morgan Chase & Co., dated Mar. 16, 2008, at § 5.1, filed as an exhibit to The Bear Stearns Companies, Inc. Current Report (Form 8-K), filed on Mar. 20, 2008 (hereinafter Bear Stearns Acquisition Agreement).
24 Ibid. at §§ 6.10 and 8.1.
25 Ibid. at § 6.11.
26 For details of the Dynegy option and the failed combination of Enron and Dynegy. See Bethany McLean and Peter Elkind, Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (2003).
27 Bear Stearns Acquisition Agreement, § 6.11.
28 See Stock Option Agreement by and between The Bear Stearns Companies, Inc. and JP Morgan Chase & Co., dated Mar. 16, 2008, at 1, filed as an exhibit to The Bear Stearns Companies, Inc. Current Report (Form 8-K), filed on Mar. 20, 2008.
29 QVC Network Inc. v. Paramount Commc’n Inc., 637 A.2d 34 (Del. 1993).
30 Del. Gen. Corp. Law § 262 (2009).
31 Bear Stearns Acquisition Agreement.
32 Landon Thomas Jr. and Eric Dash, “At Bear Stearns, Meet the New Boss,” New York Times, Mar. 20, 2008.
33 See David A. Skeel Jr., “Governance in the Ruin,” 122 Harvard Law Review 696, 737 n. 155 (2008). See also Cohan, House of Cards, 103-108.
34 Bear Stearns Acquisition Agreement, § 8.1.
35 Ibid. See also Guarantee from JP Morgan Chase & Co., dated Mar. 16, 2008, filed as an exhibit to The Bear Stearns Companies, Inc. Current Report (Form 8-K), at §§ 1,2, and 3, filed on Mar. 20, 2008.
36 See Andrew Ross Sorkin, “JPMorgan in Negotiations to Raise Bear Stearns Bid,” New York Times, Mar. 24, 2008, A1.
37 See Kelly, “Bear Stearns Neared Collapse Twice,” 18.
38 Share Exchange Agreement by and between The Bear Stearns Companies, Inc. and JP Morgan Chase & Co., dated Mar. 24, 2008, 1-2, filed as an exhibit to The Bear Stearns Companies, Inc. Current Report (Form 8-K), filed on Mar. 24, 2008.
39 New York Stock Exchange, Listed Company Manual, §§312.01, 312.05 (2009).
40 JP Morgan Chase & Co., et al. (Schedule 13D),The Bear Stearns Companies, Inc., filed on Apr. 3, 2008.
41 Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003).
42 Ibid., 936.
43 Orman v. Cullman, 2004 Del. Ch. LEXIS 150 (Del. Ch. 2004).
44 Optima Int’l of Miami v. WCI Steel, Inc., C.A. No. 3833-VCL (Del. Ch. June 27, 2008).
45 See generally The Bear Stearns Companies Inc. Current Report (Form 8-K), filed on Mar. 24, 2008.
46 Kate Kelly, “Credit Crisis: Market Bounces: Bear Director Sells His Stock,” Wall Street Journal, Apr. 2, 2008, C2.
47 See Motion for Temporary Restraining Order, In re Bear Stearns Co. Inc. S’holder Litig., Civil Action 3643-VCP (Del. Ch. Mar. 25, 2008).
48 Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437 (Del. 1971).
49 Ibid., 439.
50 Blasius Indus., Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988).
51 Ibid., 661-662.
52 Commonwealth Assoc. v. Providence Health Care, Inc., 1993 WL 432779 (Del. Ch. 1993).
53 The case applying Blasius to a vote on a takeover was State of Wisconsin Inv’t Bd. v. Peerless Sys. Corp., No. 17637, 2000 Del. Ch. LEXIS 170 (Del. Ch. Dec. 4, 2000). In contrast, Vice Chancellor Strine in Mercier et al. v. Inter-Tel, Inc., 929 A.2d 786, 808-809 (Del. Ch. 2007), only applied the Blasius doctrine as an alternative holding, while Vice Chancellor Lamb held in In re Mony Group that “when the matter to be voted on does not touch on issues of directorial control, courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter and to thwart what appears to be the will of a majority of the stockholders.” In re MONY Group, Inc., 853 A.2d 661, 674 (Del. Ch. 2004).
54 Paramount Commc’n v. QVC Network, 637 A.2d 34, at 48 (Del. 1994).
55 Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1985).
56 McWane Cast Iron Pipe Corp. v. McDowell-Wellman Eng’g Co., 263 A.2d 281 (Del. 1970).
57 In re Bear Stearns Co. S’holder Litig., C.A. No. 3643-VCP, 2008 WL 959992, at ∗6 (Del.Ch., Apr. 9, 2008).
58 See Marcel Kahan and Edward B. Rock, “How to Prevent Hard Cases from-Making Bad Law: Bear Stearns, Delaware and the Strategic Use of Comity” 58 Emory Law Journal 714 (2009).
59 In re Bear Stearns Litigation, 600780/08 (N.Y. S. Ct. Dec. 4, 2008).
60 For a discussion of this variability, see Sean Griffith and Myron T. Steele, “On Corporate Federalism: Threatening the Thaumatrope,” 61 Business Law 1 (2005).
61 See Kate Kelly, “Bear CEO’s Handling of Crisis Raises Issues,” Wall Street Journal, Nov. 1, 2007.
62 See Stephen Labaton, “S.E.C. Concedes Oversight Flaws Fueled Collapse,” New York Times, Sept. 26, 2008. See also Securities and Exchange Commission, Chairman Cox Announces End of Consolidated Supervised Entities Program (Sept. 26, 2008).
Chapter 7: Jana Partners, Children’s Investment Fund, and Hedge Fund Activist Investing
1 For one of the numerous optimistic views at the time, see, e.g., Gary E. Siegel, “In Brief: NABE: U.S. Will Come Close, but Avoid Recession,” Bond Buyer (Feb. 26, 2008), 4.
2 Some activist shareholders also claim that the executive compensation problem was a driving cause of the financial crisis. See, e.g., Robert Kropp, “Executive Pay Comes under Fire from Activist Shareholders for Contributing to Financial Crisis,” Institutional Shareowner, Oct. 28, 2008.
3 David Ellis, “Mortgage Mess CEOs Defend Pay,” CNN Money, Mar. 7, 2008.
4 See “In Defence of the Indefensible, Is Showering the Boss with Perks Good for Shareholders?” Economist, Dec. 2, 2004. For an argument that perks encourage less employee saving and, therefore, decreased employee shirking due to a need to obtain later salary, see M. Todd Henderson and James C. Spindler, “Corporate Heroin: A Defense of Perks, Executive Loans, and Conspicuous Consumption,” 93 Georgetown Law Journal 1885 (2005).
5 See Geraldine Fabrikant, “A Family Affair at Adelphia Communications,” New York Times, Apr. 1, 2002.
6 Calculated using adjusted stock price from Jan. 1, 2007 to Dec. 31, 2008.
7 Salary information calculated from Ford Motor Co. Definitive Proxy Statement (Schedule 14A), for years 2001-2006.
8 See Bernard S. Black and John C. Coffee Jr., “Hail Britannia? Institutional Investor Behavior under L
imited Regulation,” 82 Michigan Law Review 1997 (1994).
9 See Marc Lifsher, “At CalPERS, Change in Style, Not Focus,” Los Angeles Times, Jul. 25, 2005, C1.
10 See Joe Nocera, “From Raider to Activist, but Still Icahn,” New York Times, Feb. 3, 2007, C1.
11 FactSet SharkWatch Database.
12 Ibid.
13 See Deepak Gopinath, “Hedge-Fund Rabble-Rouser,” Bloomberg Markets (Oct. 2005). In another juicy letter, Loeb wrote in June 2006 upon Third Point taking a 9.5 percent position in Nabi Biopharmaceuticals, that “you [management] hide your heads in the nearest warm aperture in an apparent ‘ostrich defense’ and ignore your shareholders (the top three now owning over 28 percent of your shares in aggregate) in the hope that the Company’s owners will go away before your next annual meeting.” See Third Point LLC, Amendment No. 2, Letter Attached (Schedule 13D), Nabi Biopharmaceuticals, Inc., filed on June 15, 2006.
14 Alon Brav et al., “Hedge Fund Activism, Corporate Governance, and Firm Performance,” 63 Journal of Finance 1729, 5 (forthcoming draft dated May 2008).
15 Ibid., 16.
16 FactSet SharkWatch Database.
17 Brav, “Hedge Fund Activism,” 5.
18 Ibid., 3.
19 The results of these studies generally indicate that corporations that have been the target of activist hedge funds experienced higher stock returns and increases in firm operating performance than comparable control firms in the study. The studies identified several factors contributing to excess returns, including divestiture of unnecessary assets, reduction of excess cash, and changes in corporate governance. See inter alia Christopher Clifford, “Value Creation or Destruction? Hedge Funds as Shareholder Activists” (draft dated June 11, 2007); Nicole Boyson and Robert M. Moradian, “Hedge Funds as Shareholder Activists from 1994-2005” (draft dated July 31, 2007); April Klein and Emanual Zur,“Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors” (draft dated June 24, 2008).
20 See Brav, “Hedge Fund Activism,” 31.
21 Barclay Hedge, Event Driven Hedge Fund—Assets under Management.
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