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Absurdity of The Poison Pill

The poison pill prevents any shareholder, or a group of shareholders acting in concert, from owning more than a certain percentage of a company by allowing all other shareholders to purchase shares at a lower price in the event one chooses to cross the ownership line (typically 15%) without prior permission from the company. This effectively kills the value of their investment – hence the name, "poison pill." Public companies refer to a poison pill as a "shareholder rights plan." Does anyone else find that amusing? If anything, it undermines shareholder rights rather than supporting them.

Initially approved by the Delaware court in 1985 under Moran vs. Household International, over 1,500 American companies have a poison pill, and it can be put in place and removed by the directors as they please whenever they please without a shareholder vote. Typically directors feel comfortable in knowing that no single shareholder or group of shareholders will have more than 15% of the vote during a proxy fight.

To show how ridiculous the pill is, consider this analogy. If you are one of several partners that own a horse and the horse does well, and you agree to purchase another partners interest, would you allow the trainer to threaten to punish you  by diluting your partnership interest to almost no value if you dare to do this? It sounds absurd but this is what happens in corporate America. 

A poison pill creates an unmitigated ban on acquiring more than a certain percentage of stock. A purchaser who desires to buy and the seller who wishes to sell are simply out of luck. Board members should not be allowed to hide behind a poison pill indefinitely.

In other countries, poison pills operate through a more rational system.

In Canada, shareholders are generally given the opportunity to determine whether they would like to accept an offer on their company irrespective of the existence of a poison pill.  Specifically, a poison pill is allowed to remain outstanding long enough to permit the target company to seek a better offer from the bidder or a third party but after a certain period of time (usually between 45 and 60 days), regulators will strike down the poison pill and allow the shareholders to decide whether to sell their shares.  In addition, in the United Kingdom, director's fiduciary duties generally require compelling justification for any action that would frustrate the liquidity of shares making the adoption of poison pills without shareholder approval difficult, if not impossible.  As a result, poison pills and other defensive tactics that frustrate the liquidity of shares are poorly received by both regulators and investors and are rarely employed in the United Kingdom.

There is a myriad of solutions that could be legislatively enacted short of absolute prohibition on poison pills. These solutions should create a balance between the rights of shareholders to buy and sell shares and the desire of management to have meaningful input in a change of control situation. Two propositions:

  • After the commencement of a tender offer, the board members would have 90 days to explain to shareholders why it’s inadvisable to tender their shares or to present to shareholders an alternative proposal. After 90 days the poison pill would not apply to purchases in that tender offer.
  • If, in an any and all tender offer, the bidder would end up with more than 50% of the company’s stock, the poison pill would not apply to purchases in that tender offer.

Comments

Congrats on the new blog, Carl. Thought I'd try to be the person to post a comment.
I have several thoughts.
1. The poison pill is absurd, and even more so if enacted after a tender offer has been made.
2. How about some type of limited liability to the board members if they knowingly act in a way that does not represent the interests of the shareholders. Others, such as investment managers, have this type of liability if tehy act in their own best interest in blatant disregard to their investors. I am not a fan of more litigation, but if done correctly, this proposal might help.

Have you ever heard of a company having a poison pill like that you describe in your #2 scenario, whereby it is only in place from 15%-49%? It's a great idea.

Have you ever seen directors be personally responsible for shareholder neglect? What about not covered by insurance where they actually have to reach in to their pockets for several million dollars. If so, have they acted better with this personal liability.

Blogs off to a great start. I'll be checking it out daily.

Kenny



While this is a really insightful overview of the Poison Pill, I believe your reasoning is flawed. Poison Pills exist so that outsiders cannot take over the company and ruin it by drastically changing its direction or selling it for profit. True investors buy into a company because they believe in it, not so they can make a quick profit. These true investors do benefit from a Poison Pill because it gives them assurance that no one can swoop in with a hostile takeover. The problem with the “Wall Street” mentality is that a company’s success is looked at quarterly, forcing it to sacrifice the future for short term gain. We need a more disciplined Wall Street that understands the value of investing in a company for future success of that company, understanding that some quarters may not be as great as it builds out infrastructure and the like.



The intent of poison pill is to prevent corporate raiders, who, majority of the times are asset strippers that have seen some intrinsic value in a company that is not reflected in the balance sheets or in its share prices.
Those corporate raiders will come, strip the asset, cash it and move on and have no concern for the well being of any other stake holders in the enterprise (other shareholders, employees, customers). Also, these people will have in depth knowledge on regulations and litigations and will be able to maneuver all hurdles. These corporate raiders often end up as billioniers doing charitable deeds in later years of their life.
Most of the day traders cling to these people and follow them where ever they go to make a killing when the opportunity comes.
This is only one side of the coin.
Some times, very good companies that have great potential to grow and bring value to their investors might unfortunately end up having a bunch of clowns that got on to its board by sheer luck and are clinging to their positions running the company in wrong direction.
This board scuttles take over efforts by any value investor group that knows how to turn the company around and make it sustainable.
That is where the poison pill hurts most. It gives protection to any and all boards with out distinction and that needs to be changed.
The proposal to give 90 days time to explain its position and alternatives to shareholders looks like a viable option, it might work in this internet age, as the exchange and media have a bigger role in influencing the shareholder decision by providing transparency in information and bring out any hidden interests of parties involved into light. But again, it will be known how that clause will be exploited by either party only after it is legislated.



Management of small and medium size mutual insurance companies are less accountable to policyholders then is the management of publicly traded companies. Policyholders do not even know that they have the ability to vote for or against management. Is there some way to inform policyholders of their rights - maybe a United Policyholder Organization?



Ladies and Gentlemen,

I am not a highly educated man (no BA), although I have a clear understanding of the "So Called" hows and whys of corporate greed and hunger for overbearing power. I want to title my following script as:

The Untouchables???

These companies have perfect seats; "It’s Our Way Only, Period... Or Else..."
The poison pill clearly acts as unregulated insurance directed (and/or deployed) by the Insured (The Company) to protect the interests of the board and management of a company.

The poison pill seems to be nothing more than a CEO and Board of Directors sitting upon the great company throne with guns and weapons immediately prepared for deployment on any stockholder who they feel may become a danger to their current power structure. This way they can keep the good ole boys, just that, The Good Ole Boys!

As with publicly owned and traded company, you should be able to buy as many shares as you wish without harassment. With such an investment, this should not in any way guarantee a board seat. Though a shareholder with 100 shares should have the same opportunity to have his/her voice heard in the decision making of that company, just as one should have if he/she holds 250K shares. ALL SHAREHOLDERS should be INCLUDED in board meetings (if only by conference call) and have their concerns regarding the company be made known. This would create confidence between shareholders and management. These board members of these companies are compensated well, so they should have no problem setting aside 1hr./60min. at a BM to allow these people to voice their concerns.

Boards are only people and should not be immune to pitfalls caused by their poor judgment, and the failure of a CEO to perform is the boards responsibility.
This is the case for a CEO not to belong on a Board of Directors. Just as you would if you were on a municipal council or public elected position, you could not hold any position within the business that requires management of personnel and/or operations management in any other way. That situation would constitute a direct conflict of interest. That is ILLEGAL!!!
--Something about ethics laws.?.?.?--

Just an opinion,

Robby



Okay, the defenders of poison pills: can you give us one, single, example of a poison pill resolution which has benefited shareholders? Feel free to define benefit, and shareholders, as narrowly or broadly as you wish.

My guess is you'll be out of luck. These should be banned as disadvantageous to minority stakeholders.

Dean



One step forward....ten steps back. As a market participant who fervently believes that the unaccountability of Boards and Executives are the root cause of a majority of our problems, i just about threw up. This is sick.


SELECTICA AMENDS PREFERRED STOCK PURCHASE RIGHTS PLAN
TO LOWER BENEFICIAL OWNERSHIP PERCENTAGE FROM 15% TO 4.99%
SAN JOSE, CA, November 17, 2008 — Selectica, Inc. (Nasdaq: SLTC) today announced that its board of directors has amended the terms of the company’s preferred stock purchase rights plan initially distributed to holders of its outstanding common stock in 2003. The rights have been amended in order to protect the interests of all stockholders by helping preserve the value of the company's net operating loss carryforwards and tax credits. The amended rights plan is similar to shareholder rights plans adopted by several other public companies with significant net operating loss carryforwards. Existing stockholders will not be required to divest any shares of the company’s common stock acquired before the amendment becomes effective.
In addition to protecting the company’s net operating loss carryforwards and tax credits, the amended rights plan is designed to assure that all stockholders of the company receive fair and equal treatment in the event of any proposed takeover of the company, to guard against two-tier or partial tender offers, open market accumulations and other tactics designed to gain control of the company without paying all stockholders a fair price, and to enhance the board’s ability to negotiate with a prospective acquirer.
The amendment was not adopted in response to any effort to acquire control of Selectica. However, the rights plan may also have an anti-takeover effect and will be an impediment to a proposed takeover which is not approved by Selectica’s board of directors.



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