March 17, 2008
Bear Stearns' Decision to Sell
Posted by Gordon Smith

Wow! Bear Stearns is being sold at $2/share to JP Morgan. Below is the stock chart for Bear Stearns over the past year ... as of Friday. Notice that it ended on $30/share. Shave $28/share off of that price, and be happy about it, says JP Morgan. The W$J quoted an anonymous source on the negotiations: "At the end of the day, what Bear Stearns was looking at was either taking $2 a share or going bust. Those were the only options." (Hmm. Did this anonymous source work for JP Morgan by any chance?)

Bear_stearns

Remember just last week when Bear Stearns was assuring the market that it could weather this storm? If I were an equity holder in Bear Stearns, I would be pretty miffed right now. Apparently, the Fed carried a big stick at the negotiations:

The deal already is prompting howls of protest from Bear Stearns shareholders, since the New York company last week indicated that its book value was still close to its reported level of about $84 share at the end of the fiscal year. "Why is this better for shareholders of Bear Stearns than a Chapter 11 filing?" one Bear shareholder asked J.P. Morgan executives in a conference call last night.

J.P. Morgan referred the question to Bear Stearns executives, who weren't on the conference call. In a statement, Bear Stearns Chief Executive Alan Schwartz said the deal "represents the best outcome for all of our constituencies based upon the current circumstances."

One person familiar with the sale process said federal officials delivered a decisive prod to the firm's directors. "The government said you have to do a deal today," this person said. "We may not be there tomorrow to back you up."

The Fed, according to a person familiar with the matter, didn't care so much about the equity holders and was trying to prevent a bankruptcy filing that could have sent shock waves through the markets.

"Best outcome for all of our constituencies"? Bear Stearns is a Delaware corporation, and when the directors of a Delaware corporation are deciding whether to sell the company, generally speaking they are charged with a very narrow decision rule: get the "best value reasonably available to the stockholders."

In this instance, the invocation of "constituencies" suggests that Bear Stearns is positioning this as a decision made "in the vicinity of insolvency," where the scope of director duties is often said to expand to include creditors. (Larry and Steve have argued that this misperceives the nature of director duties in the zone of insolvency, and while I tend toward this view myself, here I am merely commenting on Schwartz's choice of words.)

The Bear Stearns decision is faintly reminiscent of the decision at the heart of Odyssey Partners, L.P. v. Fleming Companies, Inc., 735 A.2d 386 (Del. Ch. 1999), in which minority shareholders argued that the majority shareholder should have pursued bankruptcy rather than foreclosure. Vice Chancellor Lamb offered several reasons for rejecting this claim, including the following:

In arguing that the defendant directors' failure to file for bankruptcy law protection was a violation of the board's fiduciary duties to the stockholders, plaintiffs overlook that the board was obligated to consider and protect interests other than those of the stockholders. When bankruptcy and foreclosure are compared, and the effects of both on the shareholders, creditors and other corporate constituencies balanced, the decision to proceed with the foreclosure cannot be said to have been made in bad faith or a manner that was disloyal ..., taken as a whole. Moreover, the record is clear that the directors, with the possible exception of Banks, reasonably believed that a bankruptcy filing would produce negative returns for all of the ... constituencies, including [the] stockholders.

In the case of Bear Stearns, there is no hint of self-dealing, which means that the director action would be evaluated under the business judgment rule. Equity holders will be upset, but Delaware corporate law will not come to the rescue.

One last thing: the story quoted above reported that the Fed wanted Bear Stearns to avoid a "bankruptcy filing that could have sent shock waves through the markets." Perhaps this purchase by JP Morgan will provide some assurance to the markets, but based on the trading in Asia at this hour, the shock waves are reverberating.

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Comments (12)

1. Posted by jkhjh on March 17, 2008 @ 6:42 | Permalink

It would be interesting to see a shareholder suit on this, since it'd be interesting to see how the Delaware courts factor in the fact that all parties (1) had a gun to their head (the fed) and (2) were trying to avoid a financial contagion. Given the contagion problem, I can't imagine the Delaware courts finding Bear Stearns' directors liable.


2. Posted by Fred Tung on March 17, 2008 @ 7:05 | Permalink

Gordon, last year in the Gheewalla case, the Delaware Supreme Court rejected Credit Lyonnais "vicinity of insolvency" fiduciary duties, while reaffirming the longstanding duty shift to creditors when a firm is actually insolvent. See my post: http://www.theconglomerate.org/2007/05/zoning_in_on_th.html. Under the circumstances, it would seem difficult to argue that the firm was insolvent.

Also see my recently posted paper that addresses these issues: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1031242.


3. Posted by Gordon Smith on March 17, 2008 @ 8:22 | Permalink

Thanks for the link to your paper, Fred. Sorry to have omitted that from my post.

I know about Gheewalla, of course, but it's not clear to me how this would play out in a Bear Stearns case. The Gheewalla Court rejected direct claims by creditors in the ZOI, but the question in a case like Bear Stearns would be whether the equity holders could sue the directors for breach of fiduciary duty on the ground that the directors considered the interests of the creditors.

Until reading your linked post, I would have said that the directors still have more room for play in the ZOI, but I forgot how definitive this sentence from Gheewalla sounded: "When a solvent corporation is navigating in the zone of insolvency, the focus for Delaware directors does not change: directors must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation for the benefit of its shareholder owners."

Any speculation how a Bear Stearns-type case would turn out?


4. Posted by Lawrence Cunningham on March 17, 2008 @ 8:34 | Permalink

Federal securities law, not state corporate law, likely poses greater difficulties for persons who were making reassuring statements about Bear Stearns during the week before this stunning turnabout.

On Tuesday, March 11, its CEO announced publicly that the company's finances are “strong” and ``there is absolutely no truth to the rumors of liquidity problems.” These statements were repeated or echoed by both the Chairman of the SEC, Chris Cox, on Tuesday, and one of its Commissioners, Paul Atkins, on Friday.

All these statements were materially false and misleading. Whether they were made with scienter or out of foolish ignorance remains to be determined. Perhaps no prudent investor would rely on statmeents of SEC officials; but one should be able to rely on what the CEO says.


5. Posted by Gordon Smith on March 17, 2008 @ 10:44 | Permalink

Larry,

When all is said and done, I wonder whether the CEO of Bear was telling the truth. Look at the market's reaction to this news: JP Morgan is up almost 9% at last glance! This on a day when the other investment banks are going the opposite direction. Did Morgan just steal one?

I agree with you that the CEO could have some federal securities law problems, but I am more intrigued by the board's decision to sell in the face of pressure by the Fed. Is sacrificing your equity holders on the altar of broader economic concerns a breach of fiduciary duty?

By the way, Larry Ribstein has an interesting take on all of this under which Bear Stearns might get to have its cake and eat it, too. Follow the Trackback link.


6. Posted by Lawrence Cunningham on March 17, 2008 @ 14:39 | Permalink

Gordon,

Maybe the CEO believed it. And leaders of highly-leveraged corporations in the money business during a credit crisis may need to advertise confidence. It is delicate balancing. Assuring people of solvency can reinforce doubt and exacerbate the problem. The environment certainly can change quickly. Maybe that’s what happened in three days time.

I remain skeptical. Warnings have existed since August, at least. Is it likely that the environment changed so rapidly to justify the confident assertions Tuesday citing a strong book value of $84 per share when the company was functionally insolvent on Friday?

And corporate cheerleaders aside, what in the world are the Chairman and a Commissioner of the SEC doing telling the market that all’s well at Bear Stearns when, at a minimum, there is at least some doubt whether that is true?

On the fiduciary duty point, it is hard for me to imagine a respectable state court rebuking directors for making a decision under extraordinary federal regulatory pressure at the center of a serious global financial crisis.

--Larry


7. Posted by Lawrence Cunningham on March 17, 2008 @ 14:39 | Permalink

Gordon,

Maybe the CEO believed it. And leaders of highly-leveraged corporations in the money business during a credit crisis may need to advertise confidence. It is delicate balancing. Assuring people of solvency can reinforce doubt and exacerbate the problem. The environment certainly can change quickly. Maybe that’s what happened in three days time.

I remain skeptical. Warnings have existed since August, at least. Is it likely that the environment changed so rapidly to justify the confident assertions Tuesday citing a strong book value of $84 per share when the company was functionally insolvent on Friday?

And corporate cheerleaders aside, what in the world are the Chairman and a Commissioner of the SEC doing telling the market that all’s well at Bear Stearns when, at a minimum, there is at least some doubt whether that is true?

On the fiduciary duty point, it is hard for me to imagine a respectable state court rebuking directors for making a decision under extraordinary federal regulatory pressure at the center of a serious global financial crisis.

--Larry


8. Posted by Fred Tung on March 17, 2008 @ 14:56 | Permalink

Hi Gordon and Larry:

Though at this point, I'm sympathetic with Larry's view that it would seem hard to fault the board under these circumstances, I don't want to prejudge without more facts. Larry Ribstein's post (as Gordon said, follow the TrackBack) offers some damning tidbits. Two bucks a share on Monday is a pretty spectacular fall from last Friday. OTOH, if collapse was imminent, then quien sabe?

Maybe Bear shareholders vote the deal down after the markets calm down, and everyone wins. Bear is back in business, the deal gets done at a higher price, and Bear's board is off the hook for the $2 deal.


9. Posted by Bobby Bartlett on March 17, 2008 @ 16:27 | Permalink

For those interested in seeing the merger agreement before the 8-k is filed, an execution copy can be found on Bear Stearns’ website at http://bearstearns.com/includes/pdfs/investor_relations/merger.pdf

I'm sure Davidoff at Dealbook will provide his usual insightful analysis, but until then, even a cursory look at the agreement reveals some interesting provisions. The shark repellent is especially noteworthy: Section 6.9 provides a no-shop with topping rights; Section 6.11 gives JP Morgan an asset option on 383 Madison Ave. for $1.1 billion (less liabilities); and Section 6.10 gives JP Morgan the right to restructure the transaction if the shareholders vote it down. Plus, there’s this little gem in Section 5.2: "[Starting today] Parent shall be entitled to direct the business, operations and management of the Company and its Subsidiaries in its reasonable discretion."

Also noteworthy is Section 6.6: Bear Stearns' executive officers and directors get a six-year tail on D&O coverage plus full indemnification by JP Morgan. It’s been a while since I’ve negotiated a public company acquisition, but six years is the longest tail I think I’ve seen. Given the stakes of this transaction (and especially when compared to what the directors and officers would probably get in bankruptcy), it will be interesting to see if any shareholders contend that this provision creates a conflicted board. It would be a stretch, but folks who went long on Friday at $30 have to be really miffed!


10. Posted by Jake on March 17, 2008 @ 20:01 | Permalink

There's got to be a huge tax play buried in this deal.

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