New takeover rules to save investors from getting squeezed

For years, Canada’s securities regulators claimed to regulate takeover bids in the interests of target shareholders. But only now, with the Canadian Securtities Administrators’ new enforcement policy proposal, have they given shareholders, not boards, the free ability to “just say no” to a hostile bid.

During a hostile bid, shareholders are faced with a simple problem. Some shareholders will like the bid and want to tender their shares to the bidder. Other shareholders will not. Shareholders who fail to tender, however, risk being left with a much less valuable investment if a majority of shareholders tender into the bid. At worst, they risk being left with an illiquid minority stake, but, depending on the deal, they could also be faced with lower or less desirable compensation for their shares or a delay in receiving compensation for their investment. At best, minority shareholders could engage in post-takeover litigation or an appraisal proceeding, an expensive and uncertain outcome.

Therefore, without some sort of takeover defense, shareholders who don’t want to tender into a hostile bid may face significant, coercive pressure to tender due to the costs of being left in a minority position. To combat this pressure, boards enact takeover defenses – most famously shareholder rights plans, or “poison pills” – in order to block the acquirer. The power to block a deal not only protects shareholders from coercion, but also gives the board leverage to negotiate a better price.

Of course, strong takeover defenses are not without their attendant risks. Mostly, the risk is that the board will be less interested in selling the company than shareholders because the board receives non-monetary benefits from management, like the prestige of running a large company.

A major part of the old policy, National Policy 62-202, was cease-trading poison pills after a brief period, usually 90 days. As the trope goes, there was no “just say no” pill in Canada. NP 62-202 was designed to combat the risk of boards blocking deals for self-serving reasons, by giving shareholders the final say in a hostile bid. Instead of supporting shareholders, this policy exposed shareholders to coercion and stripped boards of negotiating leverage. With the new rules, Canada’s securities regulators have proposed a system that truly gives shareholders control over the fate of their investment.

Where the enforcement of NP 62-202 failed was that it did not adequately address the coercion problem. For example, in both the 2010 Lion’s Gate decision and in the recent hostile bid by HudBay Minerals Inc. for Augusta Resource Corp., regulators cease-traded poison pills that were approved by shareholders during the takeover bid. Shareholders wanted the protection of the poison pill, they recognized that the consideration for their shares was insufficient, and they wanted the board to negotiate the transaction on their behalf. By cease-trading the pill, the Ontario Securities Commission put them back in a coercive situation that they had explicitly voted to avoid. Likewise, during the Augusta/HudBay negotiations, the OSC set a cease-trade deadline for a pill despite HudBay having waived terms designed to mitigate the coercion problem when its bid was rejected by a group of shareholders. In addition to raising the threat of coercion, this decision damaged Augusta’s leverage in its ability to negotiate a friendly deal with HudBay.

One strong proponent of shareholder choice, Harvard law professor Lucien Bebchuk, proposed a solution to the coercion problem. It involves a two-step shareholder vote. First, shareholders vote if they want to tender into a transaction; second, if they voted “no” on the first step, they vote on whether they want to tender if a majority of shareholders voted “yes” on the first step. This solves the coercion problem as disapproval of the transaction does not risk leaving shareholders in a minority position. Elegantly, it also lets dissenting shareholders choose a minority position in order to retain appraisal rights if they think that the consideration for their shares is truly insufficient.

The new CSA policy adopts a version of the Bebchuk proposal. Under the new rules, hostile bids must remain open for 120 days, with a board option to decrease the period to 35 days if there are multiple bids, after which the bid will be subject to a minimum tender condition of 50 per cent of disinterested shareholders. If 50 per cent of shareholders tender into the bid, the bid will remain open for a further 10 days, to give non-tendering shareholders the ability to tender. Because minority shareholders are guaranteed the option to tender into the bid if they don’t tender during the initial tender period, there is no coercive pressure to tender into a bid for fear of being left in a minority position or receiving insufficient consideration.

Similarly, the proposal gives boards additional negotiating leverage on behalf of shareholders. Boards now have the opportunity to convince shareholders that a bid offers insufficient consideration for their investment. Instead of pitting shareholders against shareholders and shareholders against boards like the old regime did, the new regime aligns incentives. Shareholders can coordinate to defeat an insufficient bid by banding together without fear that their fellow shareholders will tender and damage their investments. Boards can only preserve their positions by convincing shareholders that the deal isn’t a good one, not by arbitrarily thwarting shareholders’ wishes.

This is progress. While I might wish for a system that gives boards more leeway in the exercise of their fiduciary duties and allows shareholders and boards to custom tailor poison pills for each company, and while I do think that a pure majority voting system gives undue influence to merger arbitrageurs who don’t have the long term interests of a company or the Canadian economy in mind, these are relatively minor quibbles. This proposal represents an easy and effective solution to a problem that has proven to be very difficult to solve.

Canadian shareholders may finally get the free and fair opportunity to say “no” to a bad deal, and boards may get the negotiating leverage they need to get shareholders a better deal. To this “just say no” policy, I say yes.