Free Riders
Which merger deals draw lawsuits? The ones that are sure to generate big fees, of course.
Daniel Fisher, 02.14.05
A Florida judge once likened lawyers in a securities class action to "squeegee boys," those urban entrepreneurs who splash soapy water on a driver's windshield and then demand money to wipe it off.
Now a detailed study of lawsuits in Delaware Chancery Court suggests the judge was onto something--at least when it comes to the lucrative practice of suing over the terms of mergers and acquisitions. Lawyers tend to file such suits as soon as a deal is announced and then wait to see if the price rises. If it does, they claim credit and demand a fee. If it doesn't, they quietly drop the suit.
The pattern led the study's authors, University of Arizona law professor Elliott Weiss and New York University economist Lawrence White, to conclude that in many cases lawyers are "exploiting their ‘license to litigate' primarily to enrich themselves."
Weiss and White looked at 564 mergers of publicly traded Delaware companies between 1999 and 2001. All of the deals were worth $100 million or more, but the 104 that drew lawsuits had a striking pattern: They were among the largest, often involved all-cash offers and in more than half the cases the acquiring company owned stock in the firm it was buying.
Why do these deals attract so much litigation? Delaware law subjects cash takeovers and buyouts by controlling shareholders to much tougher scrutiny than most stock-swap mergers. The target company must prove the deal is fair to all shareholders. The best way to prove fairness is to appoint a special committee of independent directors to review the offer and negotiate a better deal. Knowing this, acquirers make their initial bid a little lower to leave room for a higher final price.
A typical recent example is the announcement last August that Cox Enterprises would buy the 38% of Cox Communications it didn't already own. Lawyers had lobbed six suits at the $7 billion deal by noon of the day it was announced, saying it was unfair and coercive. Never mind that Cox had agreed, in advance, to let a special committee negotiate the final price, which ultimately rose from $32 a share to $34.75 a share. The lawyers claimed that they, not the special committee, drove the price up, and are seeking a $5 million slice of the increase. Franklin Mutual Advisors has sued to block the fee, saying the lawyers had "little if any impact."
Weiss found that plaintiff lawyers, supposedly the zealous representatives of shareholders, didn't challenge a single renegotiated price. Nonetheless, according to the study, they sought and got fees averaging $1,800 an hour in the cases where the price rose. Fees in the 48 settled cases ranged from $25,000 to $14.9 million for a total of $93 million.
Securities lawyers argue they keep the process honest. Answers White: "Talented men and women on both sides of the legal table--there's got to be something more valuable for them to do with their time."
forbes.com |
