Amid ‘activist’ debate, Strine sides with hedge fund dogging SandRidge
Leo Strine, the Chancellor of Delaware Chancery Court, is no particular friend of the activist shareholder, as hedge funds and institutional investors who press corporate boards for change have become known. Strine is after all on record, in a November 2010 essay for the American Bar Association’s The Business Lawyer, arguing that short-term shareholder pressure impedes corporate boards from building long-term value. That’s a theme echoed loudly last week by a pair of gray eminences of corporate law, Martin Lipton of Wachtell, Lipton, Rosen & Katz and Ira Millstein of Weil, Gotshal & Manges, in warnings about the potentially deleterious effect of what Millstein called “newfound activism (with a) focus on short-term results.” Both Milstein’s relatively moderate opinion piece in Dealbook and Lipton’s bellicose client alert argued that hedge funds focused on quarterly results and shareholder returns are fundamental threats to U.S. corporations. Or, as Strine put it in his prescient 2010 essay, “It is increasingly the case that the agenda-setters in corporate policy discussions are highly leveraged hedge funds, with no long-term commitment to the corporations in which they invest.”
Nevertheless, when Strine had to take sides last week between an activist hedge fund and a self-interested corporate board in a showdown involving seats on the board of the oil and natural gas company SandRidge Energy, his choice was emphatic: SandRidge’s board, he ruled in a 38-page opinion, “failed to exercise its discretion in a reasonable manner” when it used the threat of a $4.3 billion “proxy put” bond buyback to try to sway shareholders against supporting an alternative slate of directors proposed by the hedge fund TPG-Axon. Strine granted a shareholder motion to enjoin SandRidge from continuing to use the maneuver (which I’ll explain in more detail below) in its campaign against the TPG slate.
As usual, Strine’s opinion is dense and fact-intensive, so I’m not suggesting that the chancellor has changed his message on short-term investors. In fact, shareholder counsel Stuart Grant of Grant & Eisenhofer told me that the SandRidge record and the opinion itself do not indicate that hedge fund backing for the alternative slate was a factor in Strine’s decision. Instead, Grant said, the chancellor’s focus was on the board’s interest in its own entrenchment. “Chancery Court bends over backward to give boards discretion as long as there’s no conflict,” he said. “If there’s a conflict, the court is going to look really, really hard at the board’s conduct.” And in this case, said Mark Lebovitch of Bernstein Litowitz Berger & Grossmann, who argued for shareholders at the March 7 injunction hearing, “the chancellor saw a board that was clearly behaving badly.” If there’s a broad message in the ruling, in other words, it’s that boards are not always in the right in Delaware, even when they’re fending off meddlesome hedge funds.
SandRidge, as Strine discusses (and as Reuters chronicled in investigative reports earlier this year), has had a spectacularly bad track record since July 2008, when its shares traded at a high of $68. They now trade at less than $6. Despite that plummet, CEO Tom Ward continues to be paid handsomely and accorded what Reuters called “wide latitude in personal oil and gas deals.” Frustrated with this state of affairs, one of SandRidge’s biggest shareholders, TPG, began agitating last November for Ward’s removal, new directors and a possible sale of the company.
After the board adopted a poison pill to counter the hedge fund, TPG announced a shareholder consent solicitation that would effectively replace the existing board with directors supported by the hedge fund. The day after TPG filed its preliminary statement, the company responded with a preliminary revocation statement warning shareholders that ouster of the board was a control change that would trigger proxy put provisions requiring the company to buy back $4.3 billion in debt. A SandRidge shareholder then sued the company, arguing that the board could avert the proxy put if it simply voted to approve the rival slate for a shareholder vote. With the vote on TPG’s consent solicitation about to kick off – and with the SandRidge board refusing to commit to approval of TPG’s slate for a vote – the shareholder asked for a preliminary injunction to require the SandRidge board to approve the rival slate for the purpose of averting the proxy put or to explain why it wouldn’t do so.
SandRidge’s board did itself no favors by first asserting to shareholders that the proxy put would present an “extreme, risky and unnecessary financial burden on your company,” but then, after Strine scheduled a preliminary injunction hearing, changing its story. The proxy put wouldn’t be a problem after all, SandRidge said, because its bonds were trading above par and the company could obtain financing to repurchase any notes that were tendered. That kind of strategic wriggling didn’t suit Strine.
“These are fundamentally inconsistent propositions put forward to justify the incumbents’ refusal to make an approval decision, one way or the other,” he wrote. “Regrettably, I am left with the impression that this condition of piquant ambiguity is one that the incumbent board, for tactical electoral reasons, finds of utility in its attempt to remain in power…. In this context where the importance of the stockholders’ right to choose is paramount, games-playing is not something our law takes lightly.”
At the hearing last Thursday, shareholder lawyer Lebovitch made a shrewd pitch, asking Strine to force SandRidge to permit shareholders to exercise their right to a fair vote on the board of their choice, without the cloud of doubt created by the incumbent board’s refusal to approve the TPG slate and avert the proxy put. (Strine’s 2010 essay on the danger of short-term thinking includes strong language on the importance of shareholder voting power.) After concluding that SandRidge hadn’t offered any good reason why the hedge fund slate was unqualified to stand for election – and brushing aside SandRidge’s concern that its shareholders would not understand the difference between approval for the purpose of avoiding the proxy put and an endorsement of the TPG slate – that’s what Strine did.
“Once again, the chancellor recognized the paramount importance of the shareholder franchise,” Lebovitch said.
William Phillips of Covington & Burling argued for SandRidge at the hearing last week. He did not return a call for comment. A SandRidge representative said Tuesday that in accordance with Strine’s ruling, the board has approved the TPG nominees only for the purpose of averting the proxy put trigger. He said the company continues to ask shareholders to support the incumbent board and declined additional comment.
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