CBS v. Redstone.
If you own 79 percent of the stock—or of the voting stock, anyway—of a public company, then it is conventional to say that you control that company. That is a somewhat loose usage. Your control is not immediate or absolute. If you owned 79 percent of the stock of CBS Corp., for instance, you couldn’t just write yourself into every episode of “MacGyver.” There is a chain of command. If you wanted a “MacGyver” role, you could tell the board of directors, and they could tell the chief executive officer, and he could tell the head of programming, and he could tell the show’s executive producers, and they could tell the writers to fit you in somehow. Any of those people could say no, but if they did, the people above them in the hierarchy could fire them.
And at the top of the hierarchy, if the board refused your whimsical requests, you could fire them too. With your 79 percent of the vote, you could vote them out of office at the next annual meeting, and you could probably (depending on the exact provisions of the corporate charter) vote them out instantly, by calling a special meeting or by written consent, without bothering to wait for the annual meeting. Given that power, they will probably do what you want—not only because resistance would cost them their directorships, but also because resistance would be pointless; if you fired them you could replace them with new directors who would say yes. (Also you probably put them on the board in the first place and they are probably your friends.)
But this is not always true. In particular, the directors have fiduciary duties to all of the shareholders. If you came to them and demanded that they sell you the entire company for $0.01—getting rid of the 21 percent minority holders for free—then they would say no. You could fire them and put in new directors, but the new directors would also say no, since if they said yes the minority shareholders would certainly sue them and almost certainly win. (Also, as a controlling shareholder, you probably have fiduciary duties to the other shareholders.) Naked power or asset grabs by controlling shareholders are not, generally, okay. When controlling shareholders do make demands—say to combine the company with some other company they own, or to increase their own voting power—then the board will generally appoint a special committee of independent directors, and hire advisers, and demand safeguards and process and a fully negotiated price, and sometimes even say no.
That is usually as far as the resistance goes, but it does at least show that resistance is possible. The controlling shareholder doesn’t control the company, not really. The company is a complex entity; it is controlled in different ways by different people at different times. Possession often matters as much as the formal hierarchy. The night watchman controls the company, sort of, if he can change the locks overnight and not let the managers and directors and shareholders in the door the next morning.
That is a fanciful example, but on the other hand last week I would have thought it was pretty fanciful to say “the board of directors controls the company and if they don’t like the controlling shareholder they can issue new shares to everyone else to dilute her before she has time to fire them,” and here we are!
CBS and a special committee of independent directors sued Ms. [Shari] Redstone, her father, Sumner Redstone, and their National Amusements Inc. holding company, saying they are seeking to prevent them from breaching their fiduciary duties and causing irreparable harm by forcing a merger of CBS and Viacom, among other issues. National Amusements controls almost 80% of the voting stock in both companies, giving it power to decide shareholder votes and elect board members. …
CBS said it is seeking a temporary restraining order to prevent Ms. Redstone, president of National Amusements and vice chairman of both CBS and Viacom, from replacing CBS board members and forcing through a merger. … The restraining order would buy time for CBS’s board to consider a proposed dividend that would issue new Class A voting shares to all stockholders, reducing National Amusements’ voting power to 17% from almost 80%. The dividend wouldn’t reduce any shareholder’s economic interest, including that of National Amusements. CBS’s board is set to meet Thursday, ahead of the company’s Friday annual meeting. A hearing on the restraining order is expected Wednesday.
Here is the lawsuit. The theory of it is that Shari Redstone and National Amusements are trying to force through a merger with Viacom Inc. that is not in the interests of CBS shareholders, over the objections of the CBS special committee; National Amusements “strongly refutes its characterization of recent events.” The traditional remedy to this problem would be that the special committee, and the board of directors, would say no. National Amusements could then fire the board—it owns 79 percent of the voting stock, though only about 10 percent of the economic interest in the company—and replace it with a more compliant board to try to force through the merger, but that is not a good look, and would raise a pretty substantial risk that a court would block the merger anyway.
But CBS’s board is not limiting itself to the traditional remedy. Instead here is its plan:
The five members of CBS’s Special Committee, all independent directors of the Company, unanimously believe that the CBS Board has a fiduciary duty to act now to protect all stockholders and prevent Ms. Redstone from continuing to misuse her power as a controller, in breach of her fiduciary duties. To that end, at the Special Committee’s request, and with the support of the other independent directors, CBS has scheduled a meeting of the full CBS Board for this Thursday, May 17, 2018 (the “Special Board Meeting”) to consider potential responses to Ms. Redstone’s conduct, including the issuance of a dividend of voting Class A shares to all stockholders — both Class A and Class B. The contemplated dividend would have the effect of reducing the Redstones’ and NAI’s voting power — from 80% to approximately 17% — but would not dilute the economic ownership interests of any CBS stockholders, including NAI. This dividend is expressly permitted by the Company’s charter.
Amazing! Maybe … maybe don’t write the charter that way? If you own a majority of the voting stock of a public company, but have given the board of directors the power to take that majority away from you, then, sure, in a sense you control the company, but in another sense your control is quite precarious. You go on one long vacation out of cell-phone coverage and, bam, you’re out.
Also amazing is that the complaint says that the Special Committee “finally determined that a CBS/Viacom merger is not in the best interests of CBS stockholders (other than NAI)” over the weekend; it filed the lawsuit on Monday—apparently before actually rejecting the deal—because “the Special Committee believes that once Ms. Redstone learns of this determination, she could assert her power, as she did at Viacom, to immediately replace members of the Board and use the new directors to force through the merger on terms favorable to herself and NAI but harmful to CBS.” So it tried to get the jump on her. But she is herself the vice-chair of the CBS board, so it can’t actually hold the board meeting to dilute her without giving her advance notice and losing the element of surprise. So it asked the court to help:
Given her reported threats and her history at Viacom, there is a significant risk that Ms. Redstone will seek to preempt the Board from having the opportunity to consider whether to take these actions, by replacing the independent directors in the three days before Thursday’s Special Board Meeting. Therefore, Plaintiffs are seeking a temporary restraining order to prevent Ms. Redstone, Mr. Redstone, or NAI from taking such inequitable action and preventing those parties from interfering with the effectiveness of the decisions to be made at the Special Board Meeting.
The special committee wants the court to prohibit Shari Redstone from firing them all as directors before they can meet on Thursday to fire her as a controlling shareholder.
It is a lot of drama! One assumes it is a bit of a bluff. For the board of directors to take away a shareholder’s control of a public company is a drastic move; to take away that control because of a hypothetical worry that she might fire them and push through a bad merger seems like ludicrous overkill. Presumably the special committee has hauled out this bazooka to try to force a negotiated solution that it really wants—something along the lines of a standstill on the Viacom deal and some guarantees of board independence. (“For Viacom, a CBS merger is undoubtedly the best-case scenario and now, probably, the least likely,” notes my Bloomberg Opinion colleague Tara Lachapelle. “CBS may or may not have better options.”)
Still don’t you kind of want them to actually do it? Or at least, litigate it? There are real debates in corporate governance about whether the board or the shareholders ought to control the company. These debates tend to come up in proxy fights and hostile takeovers, and concern issues like whether the board should adopt a poison pill to fend off takeovers that command majority support, or whether the directors should be elected on a staggered schedule to reduce short-term shareholder influence. That all seems kind of trivial compared to this! You don’t usually see a board of directors try to take away a shareholder’s shares to prevent her from firing them. That’s the real stuff right there.
The basic idea of the Volcker Rule is that banks should not be allowed to do proprietary trading (speculating on securities for their own account) but should be allowed to do market making (buying and selling securities from and to customers in order to facilitate those customers’ trading demand). There is a risk rationale for this—proprietary trading is risky while market-making is safe—that is mostly incoherent, but there is also a social-engineering rationale—banks should be in the business of serving society rather than just making bets for their own profit—that makes a lot of sense.
The basic problem with writing the rule is that market making is proprietary trading. I mean: People at banks use the terms “market making” and “proprietary trading” to mean different things, and they did so long before the Volcker Rule, and it’s mostly not that hard to know what they’re talking about. But in a strict literal sense market making consists of buying and selling securities for the bank’s own account, profiting when you can sell the securities for more than you paid for them and losing when you can’t. A market maker, said a federal court of appeals earlier this month, “seeks to profit from transactions in the securities by buying low and selling high,” just like a proprietary trader or, you know, anyone else.
So it took some subtlety to actually write the Volcker Rule, to come up with a set of characteristics that would distinguish the bad proprietary trading from the good market making. My impression is generally that the quite complex 880-ish-page rule does a decent job of drawing those lines in a sensible and intuitive way: If you run a desk that regularly buys at the bid and sells at the offer and keeps around enough inventory to respond to near-term customer demand, that is probably market making; if you run a desk that regularly crosses the spread to buy securities without considering customer demand and that pays its traders for market appreciation rather than flow, that is proprietary trading. There will always be some arbitrary lines; in particular, the Volcker Rule does not apply to positions held for more than 60 days. But basically it all seems reasonable. There is just a lot of it though. If you are a bank there are a lot of hoops to jump through to confirm that you are doing the good market making instead of the bad prop. “We are going to have to have a lawyer, compliance officer, doctor to see what their testosterone levels are, and a shrink, what is your intent,” as Jamie Dimon once put it, and while that is exaggerated, there are at least a lot of compliance officers.
But now the rule may flip:
In a much anticipated overhaul of Volcker, the Federal Reserve and other regulators are planning to drop an assumption written into the original rule that positions held by banks for less than 60 days are speculative — and therefore banned, the people said. Instead, banks would have leeway to conclude that their trades comply with the rule, putting the onus on regulators to challenge such judgments, the people said.
Instead of the banks having to demonstrate that everything that their market-making desks do is market making, their market-making desks will be presumed to be doing market making, and regulators will have to demonstrate that anything they object to is not market making.
You can sort of imagine three categories of bank activity:
- Straightforward market making to satisfy obvious near-term customer demand.
- Running a proprietary trading desk that is set up to make large bets on the direction of the market.
- A trader on the market-making desk leaning into a few directional bets here and there.
Number 1, everyone agrees, is permitted. Number 2, everyone agrees, is not. Number 3 could go either way, but loosely speaking it seems fair to say that it was restricted by the old Volcker Rule and will be much less restricted by the new one. This seems fine to me? It depends on what you are going for. If you do not want banks to take any market risk in their trading operations, then you will be sad about Number 3, but if that’s really what you want then you’ll be sad about Number 1 too. You’ll be sad about banking, honestly; banks are in the business of taking risk. If on the other hand your worry about proprietary trading is that it created a bank culture in which every trader aspired to be an outsized risk-taker with a $100 million pay package, and in which trading managers aspired to set up shadowy hedge funds rather than to meet customer demand, then getting rid of the actual prop trading desks pretty much solves the problem, and giving the market-making traders a bit more flexibility to do their own risk management and decide on their own positions is probably fine.
Andrew Ross Sorkin proposes that banks and investors who don’t like guns should team up to run bankrupt gun manufacturer Remington Outdoor as a gun company for people who don’t like guns:
What if the big banks that have provided financing to Remington during its bankruptcy were to back — and partner with — one or more of the big private equity firms in an effort to transform the company into the most advanced and responsible gun manufacturer in the country?
After all, virtually all the banks have a “social impact” unit or at least an initiative meant to “do good.” And so do many private equity firms, like TPG and Bain Capital.
And they would not be out to kill the business; quite the opposite: They could create a profitable model for the rest of the industry using technology and sound sales policies to reinvent the modern-gun manufacturer.
This strikes me as a little implausible—“our social-impact fund will be investing in gun manufacturing,” sure—but really no more implausible than a lot of what reluctant gun-company shareholders actually get up to so, you know, fine.
What I like about this proposal, though, is its model for postmodern shareholder capitalism. The basic idea of shareholder capitalism, say, circa 1976 through 2016 or whatever, was that companies should make as much money as possible for shareholders. The traditional way to do this is to build products that customers want and sell those products to the customers who want them. There is an obvious conflict of interest between shareholders and customers—shareholders want to sell the products for a lot of money, customers want to buy them cheap—but also a deep alignment of interests; the happier you make the customers, the more money you make for the shareholders, and the happier they are too.
Or are they? Does money make shareholders happy, or do they want some deeper sense of fulfillment? Well, I mean, come on; there are a lot of shareholders, and they have different and conflicting desires and values, and money is an easy way to measure and commensurate what you are doing for them. You can’t worry about what each shareholder actually wants, about each one’s deepest hopes and dreams; you just worry about the thing that is easy to measure and common to all of them: money.
But at some point if public markets become sufficiently dominated by a few large aggregators of capital, then companies could just give shareholders what they actually want: Like, they could call up Larry Fink or whoever and say “Larry what are your feelings on guns?” and he could say “well I don’t like them but if you are going to make them maybe put fingerprint sensors into them” and they could say “anything for you Larry.” There are still commercial considerations here—presumably the aggregators of capital need to appeal to their own end users, and presumably the most broadly applicable way to do that is by providing good investment returns—but they’re filtered through the personal sensibilities of the capital aggregators. And you could easily imagine those sensibilities conflicting with the desires of a company’s customers, and the sensibilities of the shareholders winning out. If there is a shareholder class that is culturally distinct from the customer class, then it is not obvious that companies should optimize for making as much money as possible by giving customers what they want. Because it is not obvious that more money is what the shareholders want.
Terrific, just terrific: The Robin Hood Foundation, the charitable foundation that is funded by lots of big hedge-fund managers, has “sent millions of dollars to groups participating in anti-hedge-fund activist campaigns such as the Hedge Clippers and Strong Economy For All.” So when protesters show up at Dan Loeb’s Hamptons estate in chartered buses to protest against his activities, he is helping to pay for those buses. Robin Hood isn’t even mad:
Robin Hood’s chief program officer, Emary Aronson, said the charity became aware of its connection to some protest groups several years ago, and decided to continue funding. “There’s no thermometer that we use to say we are going one way or the other because of something that’s in the news or how it affects the hedge-fund community,” Ms. Aronson said.
That seems right. My view is that if you have gotten rich by running a hedge fund then you really ought to appreciate financial ingenuity. If someone, say, puts a clever credit-default-swap trade past you, the proper reaction is to tip your hat and say “well played old chap.” You can afford to have a sense of humor about it, you know? It seems to me that if anti-hedge-fund protesters find a way to raise money from hedge funds, then when they show up to protest, the hedge-fund managers should greet them with champagne and high-fives.
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