5 DePaul Bus. & Com. L.J. 427
DePaul Business & Commercial Law Journal
Spring 2007
Article
*427 GREEN WITH ENVY? GREENMAIL IS GOOD! RATIONAL ECONOMIC RESPONSES TO
GREENMAIL IN A COMPETITIVE MARKET FOR CAPITAL AND MANAGERS
Eric Engle [FNa1]
Copyright © 2007 DePaul Business & Commercial Law Journal; Eric Engle
Abstract'Greenmail'
denotes the decision by a corporation's board of directors to
repurchase its shares that are held by a corporate raider, often at a
significant premium, thereby keeping the board of directors in office.
It may represent a conflict of interest between the corporation's
shareholders and the board of directors. While greenmail is legal, 50%
of greenmail gains are subject to taxation. This Article argues that
greenmail has a healthy role in a
competitive market economy.
I. IntroductionA
corporate raider purchases a significant number of shares of a stock on
the public market, driving the price of the stock upward. The raider
then offers the company the chance to buy back his shares at an even
higher price--or face the prospect of a hostile takeover, sale of
assets, and new management. Management buys back the raider's shares at
a higher value than on the public market. The raider sells their
shares. The price of the stock on the open then market falls. Is there
anything wrong in this scenario? Before you answer--what if management
did not buy back the raider's shares? Suppose that the raider then
tried to take over the company driving the public price of the shares
even higher. Is there still something wrong? What if the raider fails
to take over the company? What if the raider succeeds? When we see all
the different basic scenarios, the impossibility of a quick clear
answer becomes apparent: here, one more variable, what if the company
is poorly managed?
This
practice of forcing a choice between a premium share repurchase and the
threat of a takeover is called 'greenmail,' a term used to contrast the
subtsance of the transaction from 'blackmail,' or illegal
*428
extortion. What exactly is greenmail? Is it wrong? Is it legal? What
are its effects on the market? What responses are there to greenmail?
This
Article takes the position that greenmail essentially represents a
healthy aspect of competition to keep entrenched corporate management
honest. Rather than introducing economic distortions, greenmail serves
as an important market signal of an unhealthy company. Greenmail should
not be prohibited and greenmail income should be taxed at the standard
tax rate for ordinary gains.
A. History of Corporate Take-Overs
Greenmail
arose as a natural evolution of corporate takeovers. Prior to the
1960's, raiders sought to take over companies by proxy fights.
[FN1] A proxy fight occurs when a raider tries to convince shareholders to vote in favor of the takeover.
[FN2] Proxy fights are subject to the Securities Exchange Act of 1934.
[FN3]
The 1934 Act requires disclosure of the 'identity and background of the
purchaser, the source of funds to be used for the purchase, the
purchaser's plans to liquidate, merge, or make other major changes to
the target company, and the number of shares owned and sought' to the
Securities and Exchange Commission ("SEC") and to the issuer of
securities.
[FN4] Trading
target shares for raider securities is another route to accomplishing
the same end, with this transaction being controlled by the Securities
Act of 1933.
[FN5] Tender offerings by raiders of cash for targeted stock became popular in the 1960's and are covered by the Williams Act,
[FN6] which requires disclosure of tender offer information to the SEC and to the target
company. In the 1980's, raiders realized that they
could obtain cash payouts from management without even taking control
of the target company. 'Greenmail' describes this practice of inflating
a stock's price by purchasing it on the open market and initiating a
takeover bid while giving management the option to repurchase its
shares from the raider above the already inflated price. This leads to
an important question: Is greenmail just an elaborate form of pump and
dump? The quick answer is 'no.' To answer that question fully we need
an exact definition of greenmail.
*429 B. Definition of Greenmail
Greenmail
occurs when a shareholder acquires a significant amount of a company's
stock and then threatens to take over the company unless the
purchaser's shares are bought back by the company at a premium.
[FN7] Greenmail payments represent a repurchase premium.
[FN8]
Not all premium rate stock repurchases are considered suspect. For
example, the decision to repurchase the shares of a company's founder
or those shares held by a 'white knight' are not consdiered inherently
suspect.
[FN9] Should premium
repurchases be prohibited generally? Founders already have stock
options and, possibly, watered stock. Why should premium repurchases be
allowed to 'white knights,' traders who are friendly to management, and
not for raiders? The interests of the shareholders, not those of
management, should control and,
thus, if premium share repurchases are allowed as
to founders or white knights, then they should also be allowed as to
ordinary shareholders. To determine whether premium share repurchases
should be allowed, we must consider the economic effects and
theoretical justifications/critiques of greenmail.
C. Theories of Greenmail
One theory, the 'management entrenchment' hypothesis, holds that management pays out greenmail to keep their own jobs.
[FN10]
This is likely the case as management has an obvious self-interest in
maintaining corporate control. Though management does have an interest
in keeping their jobs, this does not necessarily cause a conflict of
interest between management and ordinary shareholders. Therefore,
greenmail ought not to be prohibited on the basis of a possible
conflict of interest between shareholders and management. Shareholders
have internal governance mechanisms, as well as the option of not
buying into or selling out of companies with entrenched managers.
*430 Another theory is that management makes greenmail payments to defend the 'shareholder's interests.'
[FN11]
According to this second view, management has inside information that
is not reflected in the stock's price. Greenmail under this second view
is paid to protect the ordinary shareholders' interests. Another view
is that greenmail is paid to reduce the costs of litigation or
opposition to management strategies.
[FN12] Some economists
argue that greenmail is justifiable as it distributes costs of policing management.
[FN13]
The
obvious self-interest of management to keep their jobs makes the
management entrenchment hypothesis plausible. However, though greenmail
payouts reflect management's self-interest, they also represent an
ordinary function of competition in the marketplace for good managerial
teams. Greenmail payouts are a penalty for mismanagement and a market
signal. They are a healthy part of the creative destruction which is
the very nature of capitalist competition.
D. Economic Effects of Greenmail
What
are the economic effects of greenmail? Empirical studies of greenmail
on stock price and of managerial motivation in paying greenmail have
been mixed.
[FN14] Greenmail payments usually
[FN15]
lead to a decline in the publicly-traded price of the stock. This is
because management's opposition to takeovers is seen as a sign of
expected poor future performance.
[FN16] Some think that shows that greenmail is generally not in the shareholders' interests.
[FN17]
I disagree. Even if greenmail were not an important market signal and a
healthy competitive incentive for the capital market, greenmail does
not generally affect prudent investors in a targeted company.
Shareholders are heterogenous
*431
-- each is in a different position. When thee raider starts buying stock
in the target company, the stock's price will generally
rise. Some shareholders will sell and cash in on
a windfall profit. Still others will hold out and then gladly buy the
suddenly undervalued stock after the greenmail has been paid. In other
words, just as the economic studies yield mixed results, so too are the
effects of greenmail on individual shareholders unpredictable. Even if
takeover rumors always lead to inflation of a stock price, and even if
greenmail payments always lead to a reduction of the stock's
publicly-traded price, the market, including prudent investors, can
take all of that into account. Greenmail is just one more example of
self regulation of the market through competition. Further, if
greenmail weeds out bad management, which it likely does, then it is
good for the economy.
Greenmail weeds out bad management. '[F]irms paying greenmail have above-average management turnover in the following year.'
[FN18]
Moreover, greenmail is not effective as a tactic to prevent a hostile
takeover. For example, the St. Regis Co. paid greenmail twice; the
third takeover bid resulted in the sale to a white knight.
[FN19]
Though greenmail is not an effective tool for entrenching management,
and is unproblematic for that reason too, greenmail is an effective way
to threaten entrenched and inefficient managers. Greenmail isn't a
problem. It's a solution.
In
other words, greenmail is more than just an elaborate 'pump-and-dump'
scheme. True, the takeover bid generally increases the price of the
stock on the open market. Likewise, the greenmail payout generally
results in "falling
stock prices." So what? That's completely
normal--it's called the law of supply and demand. Even if that weren't
the case, regulators must remember: managment can always "just say no"
and refuse to pay greenmail. Raiders take on a significant risk in
hopes of a correspondingly significant reward; they aren't always
right. The good business with bad management may turn out to be a bad
business with good management capable of ferocious resistance for
little or no reward. Second, management, especially entrenched and
inefficient management, deserves to be threatened with a takeover when
it is ineffective. Greenmail is just one more instance of capitalist
competition leading to best performance.
*432 II. Responses to GreenmailTo
the extent that greenmail represents ordinary competition it does not
need a remedy. Responses to greenmail are essentially anticompetitive.
Because greenmail has a healthy function in the market, it is
unsurprising that greenmail is not considered to be the crime of
extortion, or any crime at all.
[FN20] Greenmail is not extortion because there is no unlawful obtention of property
[FN21] and because management does not have the right to be free from the threat of a hostile takeover.
[FN22] Courts recognize the competitive function of corporate raiding.
A. Corporate Responses
1. Greenmail Payments are Lawful and Subject to the Business Judgment Rule
The
decision of management to pay out greenmail is permitted as an instance
of business judgement. The 'business judgement rule' essentially holds
that courts will not second guess the lawful decisions of management by
allowing for various causes of actions, such as the tort of 'negligent
management.'
[FN23] However
the business judgement rule is modified in the law of Delaware, New
York, and California to take into account the conflict of interest
between managers and shareholders.
[FN24] Each of those states require management to prove there is some rationale justifying its decision.
[FN25] California requires the inherent fairness of the transaction to be shown.
[FN26] New York requires the justification be not merely arguable, but also plausible.
[FN27] Delaware requires that the transaction be arguably in the shareholders' interest.
[FN28] Delaware permits greenmail payments provided the purpose of management is not self-entrenchment;
[FN29]
however, in doing so, it requires an enhanced business judgement
inquiry. Some 'factors that the board of directors should analyze
include: the inadequacy of the price offered, the nature and timing of
the offer, questions on illegality, the impact
*433
on constituencies other than shareholders, the risk of nonconsummation,
and the quality of securities being offered in the exchange. '
[FN30]
2. Charter/By-Law Amendment
Within
the logic of capitalist competition and freedom of contract it is clear
that the principal response to greenmail should be made by the company
and not the state. Shareholders can and do amend corporate charters to
prohibit greenmail. Amendments to corporate charters, unlike greenmail
payments, do not result in a decline in stock prices.
[FN31]
International Minerals & Chemicals, Perkin-Elmer, Mobil Oil, and
many other companies have written anti-greenmail provisions into their
charters or bylaws.
[FN32] Thus, there is little reason for state intervention to prevent greenmail.
[FN33] Government regulation of corporation charters reduces shareholders' investment choices.
[FN34]
B. State Responses
1. Disgorgement
Another
response to greenmail is disgorgement statutes which require remittance
of greenmail payments. Critics point out that disgorgement reduces
competition, diminishes shareholder participation, and depresses stock
values.
[FN35] I would argue they also represent a restraint on trade and a form of protectionism subject to antitrust law.
2. Anti-Takeover Laws
Some
states have introduced anti-takeover statutes. State anti-takeover
statutes have been challenged as unconstitutional on the basis of both
the
supremacy clause, alleging inconsistency with the Williams Act,
[FN36] and the dormant commerce clause
[FN37] with mixed results.
[FN38] The
*434 Williams Act
[FN39]
requires disclosure to the SEC and the target company when a
shareholder acquires more than 5% of a company. A state anti-takeover
statute cannot conflict with the Williams act.
[FN40]
That is, the state anti-takeover statute must be consistent with
federal law. State anti-takeover laws have also been made for reasons
of protectionism,
[FN41]
which raises the question of their compliance with the WTO. Competition
among states may be the best way to determine the best regulatory
response to greenmail and hostile takeovers.
C. Federal Responses
1. Taxation
In 1987,
Public Law Number 100-203, Sec. 10228(c) established Internal Revenue Code Chapter 54, Section 5881, entitled 'Greenmail'.
[FN42] Title 26 of the United States Code, Section 5881 (
I.R.C. § 5881) imposes a 50% tax on greenmail payments.
[FN43] Greenmail payments can be in any form, or 'consideration.'
[FN44] Greenmailed shares must have been held for less than two years.
[FN45] The sale of stock must be in connection with a public tender offer.
[FN46] As well, the greenmail payment must be differential, that is it must be made on terms other than are available to all other
shareholders.
[FN47]
Public tender offers are those offers to purchase stock or assets which
would be required to be filed or registered with federal or state
regulatory agencies.
[FN48] The tax applies whether or not gain is recognized.
[FN49]
The
SEC permits greenmail payments because greenmail payments are taxed at
a higher rate than other income. Coupled with the possibility to amend
the corporate charter, the SEC sees no reason for federal intervention.
[FN50]
*435 2. RICO/Hobbs Act (Extortion)
Critics
of greenmail sometimes propose that it should be covered by the federal
Racketeering Influenced and Corrupt Organizations Act (RICO) or by the
Hobbs Act. To obtain a civil RICO remedy under Section 1962 of the
United States Code, plaintiffs must prove: '(1) a person (2) through a
pattern (3) of racketeering activity (4) directly or indirectly (a)
invested in, (b) acquired or maintained an interest in, (c) or
participated in (5) an enterprise (6) that affects or engages in
interstate commerce and (7) causes injury thereby. '
[FN51]
Proving wrongful injury, of course, is not really possible. Stock
prices are always speculative. Management and ordinary shareholders
have a conflict of interest. Likewise the Hobbs Act does not seem
applicable. The Hobbs Act
[FN52] has two elements: obstruction of interstate commerce and robbery or extortion.
[FN53] However, greenmail is not extortion; thus, the Hobbs Act cannot apply. Again, even if there was a problem, this really isn't
an appropriate remedy.
III. ConclusionCorporate
takeovers ensure competition among managers to be efficient and
effective businessmen. Greenmail is one incentive for managerial
competition. Thus, greenmail is not itself problematic; it is just one
more mechanism of efficiency through competition. Greenmail is not an
effective tool for managerial self-entrenchment. However, the
speculative impact of greenmail is good for the economy since it
highlights companies which are poorly managed and overvalued on the
public market. By threatening bad managers of good companies, and by
reallocating capital to efficient actors, greenmail strengthens the
economy. Thus, most of the responses to greenmail are attempts to
remedy a non-problem.
The
most effective remedies, consistent with the capitalist logic of
competition and individualism, are at the corporate level. A prudent
corporation can foresee the possibility of a hostile takeover and amend
its articles of incorporation and bylaws to protect itself. Improvident
corporate managers probably deserve the risk of takeover that they
incur by using shoddy 'off the shelf' charters and bylaws. 'Mom and
pop' organizations must eventually grow up or sell out to more
efficient operations. Further, the individual remedy is also effective
*436 at the shareholder level. Selling
stock when there is a takeover rumor and buying
the now (supposedly) undervalued stock in the aftermath of the payout
are rational investor actions that require no inside information. SEC
reporting requirements and shareholder diligence remove the risk of
insider trading.
Individual
and corporate responses are adequate and best. Mercifully, state
neo-mercantilist efforts at regulating takeovers are constrained by
regulatory competition and federal supremacy. Thus many state
anti-takeover statutes have been stricken as illegal.
And
the federal response? The federal government imposes a heavy tax on
greenmail, but taxes of 70% were once common. A 50% tax is onerous
enough to discourage speculative greenmail, but not so great as to
prevent raiders from threatening takeovers assuring management
competition. In the interest of preventing econmic distortion, it would
be wiser to reduce the greenmail tax to the maximum corporate rate,
allow greenmail payments to be characterized as ordinary and necessary
business expenses (that are to be deducted from taxable income), and
allow the greenmail payout to be treated as ordinary income, and thus
able to be offset by any losses. Such minor tax reforms will occur to
the extent that takeovers become correctly perceived as one more
instrument of economic competition ensuring efficient markets and good
economic performance.
[FNa1]. Eric Engle, JD St. Louis, DEA Paris X, DEA Paris II, LLM Bremen,
Dr.Jur. Bremen.
[FN1]. Mark E. Crain, Disgorgement of Greenmail Profits: Examining a New Weapon in State Anti-Takeover Arsenals, 28 Houston L. Rev. 867, 871-72 (1991).
[FN2]. Lucian Arye Bebchuk & Marcel Kahan, A Framework for Analyzing Legal Policy Towards Proxy Contests, 78 Cal. L. Rev. 1073, 1074, 1078 (1990).
[FN3]. See 15 U.S.C. § 78n(a)-(e) (2006).
[FN4]. Crain, supra note 1, at 872.
[FN5]. See 15 U.S.C. §§ 77a-77kk (2006).
[FN6]. Williams Act, Pub. L. No. 90-439, 82 Stat. 454 (1968) (codified as 15 U.S.C. §§ 78m(d)-(e), 78n (d)-(f) (2006)).
[FN7]. William W. Bratton, The New Dividend Puzzle, 93 Geo. L.J. 845, 850 n. 16 (2005).
[FN8]. David Manry & David Stangeland, Greenmail: A Brief History, 6
Stan. J. L. Bus. & Fin. 217, 225 (2001).
[FN9]. 'When a significant
block of shares is repurchased from a particular (targeted) shareholder
not as part of an announced repurchase program for general corporate
purposes, the repurchase may occur at a substantial premium over the
then-current market price. The premium thus represents beneficial terms
not available to shareholders generally. Some premium targeted
repurchases, such as those from heirs of firm founders, or from white
knights who hold shares to protect a valued corporate partner from
outside takeover interest, arouse little attention from
nonparticipating shareholders.' Id. at 220 (citations omitted).
[FN10]. Note, Greenmail: Target Stock Repurchases and the Management-Entrenchment Hypothesis, 98 Harv. L. Rev. 1045 (1985).
[FN11]. Christopher J. Bellini, The Evolution of Greenmail: A Lawyer's Dilemma in Corporate Representation, 2 Geo. J. Legal Ethics 533, 535-36 (1988).
[FN12]. 'According to the
'management entrenchment' hypothesis, the management of a firm resorts
to greenmail as a takeover defense principally to save their own jobs.
Alternatively, the 'shareholders' interests' hypothesis defends greenmail; the management of a firm
presumably possesses private information concerning underlying values
which the new investors have uncovered through costly investigation.
Greenmail may then represent the rejection by management of an
inadequate offer. Another view is that management may be ridding the
firm of disruptive shareholders, ending costly litigation, or reducing
dissident opposition to management strategies.' Manry & Stangeland,
supra note 8, at 220.
[FN13]. Note, supra note 10, at 1055.
[FN14]. Bellini, supra note 11, at 540.
[FN15]. For a history of empirical studies on greenmails effect on stock prices, see Manry & Stangeland, supra note 8, at 222.
[FN16]. Id. at 224.
[FN17]. 'When news of a
greenmail payment is announced, however, the stock price typically
falls. The price declines are generally interpreted as evidence that
these repurchases are inconsistent with shareholders' interests.' Id.
at 221 (citations omitted).
[FN18]. Id. at 223.
[FN19]. Bellini, supra note 11, at 539.
[FN20]. Stuart P. Green, Theft by Coercion: Extortion, Blackmail, and Hard Bargaining, 44 Washburn L.J. 553, 577 (2005).
[FN21]. Viacom Int'l, Inc. v. Icahn, 747 F. Supp. 205 (S.D.N.Y. 1990).
[FN22]. Id. at 213-14; Chock Full O'Nuts Corp. v. Finkelstein, 548 F. Supp. 212 (S.D.N.Y. 1982). See also Dan River, Inc. v. Icahn, 701 F.2d 278 (4th Cir. 1983).
[FN23]. Bellini, supra note 11, at 546.
[FN24]. Id. at 552.
[FN25]. Id. at 552-53.
[FN26]. Id. at 553.
[FN27]. Id.
[FN28]. Bellini, supra note 11, at 553.
[FN29]. Id. at 546.
[FN30]. Id. at 547.
[FN31]. David Manry & David Stangeland, Greenmail: A Brief History, 6 Stan. J. L. Bus. & Fin. 217, 223 (2001).
[FN32]. Christopher J. Bellini, The Evolution of Greenmail: A Lawyer's Dilemma in Corporate Representation, 2 Geo. J. Legal Ethics 533, 537-38 (1988).
[FN33]. Subcommittee on Annual Review, Annual Review of Federal Securities Regulation, 40 Bus. Law. 997, 1020 n. 70. (1985).
[FN34]. Bellini, supra note 32, at 539.
[FN35]. Mark E. Crain, Disgorgement of Greenmail Profits: Examining a New
Weapon in State Anti-Takeover Arsenals, 28 Houston L. Rev. 867, 869 (1991).
[FN36]. The Williams Act, 15 U.S.C. §§ 78m(d)-(e), 78n(d)-(f) (2006),
requires disclosure of stock purchases greater than 5% of a given class
of stock. A state statute in conflict with the Williams act would be
invalid due to the supremacy of federal law.
[FN37]. See CTS Corp. v. Dynamics Corp. of Am., 481 U.S. 69, 87-88 (1987).
[FN38]. Compare id. at 87-94 (holding an anti-takeover statute was valid) with Edgar v. MITE Corp., 457 U.S. 624, 631-40 (1982) (plurality opinion) (holding an anti-takeover statute was invalid).
[FN39]. 15 U.S.C. §§ 78m(d)-(e), 78n(d)-(f) (2006).
[FN40]. See Edgar, 457 U.S. at 631-32.
[FN41]. Marleen A. O'Connor, Restructuring
the Corporation's Nexus of Contracts: Recognizing a Fiduciary Duty to
Protect Displaced Workers, 69 N.C. L. Rev. 1189 (1991).
[FN42]. David Manry & David Stangeland, Greenmail: A Brief History, 6 Stan. J. L. Bus. & Fin. 217, 227-28 (2001). Section 5881 was further modified in 1988. Id.
[FN43]. I.R.C. § 5881(a) (2006).
[FN44]. Id. § 5881(b).
[FN45]. Id. § 5881(b)(1).
[FN46]. Id. § 5881(b)(2).
[FN47]. Id. § 5881(b)(2)(C).
[FN48]. I.R.C. § 5881 (c)(1) (2006).
[FN49]. Id. § 5881 (d).
[FN50]. Bellini, supra note 32, at 555.
[FN51]. Tracy Greer, The Hobbs Act and RICO: A Remedy for Greenmail?, 66 Tex. L. Rev. 647, 653 (1988).
[FN52]. 18 U.S.C. § 1951(a) (2006).
[FN53]. Greer, supra note 51, at 662.
END OF DOCUMENT