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?)


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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