Micro..hoo: A New Twist

This new development on the international M&A front is worth briefly noting on this blog.

We had all expected to see a highly-contested battle for control of Yahoo! panning out over the next few months. A hostile bid by Microsoft was keenly on the cards. But, it all ended last weekend turning out to be a damp squib, with CEO Steve Ballmer announcing Microsoft intention of withdrawing from the deal in a letter to Yahoo! CEO Jerry Yang. The main reason cited in the letter is Yahoo’s threat to outsource search to Google, which deterred Microsoft from launching a hostile bid.

There are differing viewpoints held by some about why Microsoft may have adopted such a strategy rather than move ahead aggressively with a hostile bid on Yahoo! Others even argue that this episode hardly denotes the end of the takeover saga – it is only a ploy by Microsoft to beat the share price of Yahoo! down (and also incite indignant shareholders to initiate action against the Yahoo! board) and thereby enhance its negotiating leverage on the deal. Overall, from a legal standpoint, it appears that challenges to Microsoft withdrawal or even to Yahoo’s uncompromising stand (that led to the withdrawal) in courts in the US are not likely to be sustained based on past precedent. Following are links to some of the discussion on this issue.

1. BusinessAssociations Blog discusses the effectiveness of a defense used by Yahoo! to ward off a hostile bid threat by Microsoft. This relates to the use of a strategic partnership (in this case with Google) as a takeover defense – perhaps as some sort of a “poison pill”.

2. The Deal Professor suspects that Microsoft has had to withdraw due to a slow strategy it adopted thus far. He says:

“I’ve always thought that the problem with this strategy Microsoft has adopted thus far — slow and easy — is that it missed a maneuver from Larry Ellison’s tried-and-true playbook. In Larry’s world, you launch your full hostile as soon as possible in order to begin the time-clock running on your required antitrust regulatory clearances. Thus, when the target (Peoplesoft, etc.) finally agrees to negotiate provided you raise your bid, you don’t have to worry about closing risk. By that time, you’ve already obtained the necessary antitrust and other regulatory clearances. You put a few more dollars on the table and close in the next few weeks.

Microsoft has not followed this route. Thus, in any negotiation with Yahoo now, Yahoo has bargaining leverage to demand a “hell or high water” provision which would require Microsoft to make assets dispositions, license technology or other actions to satisfy the demands of antitrust regulators. Remember, Microsoft has never been on the good side of regulators – the Department of Justice would love to have the benefit of this provision.”

3. Ideoblog offers some thoughts including the possibility of success (or otherwise) of any shareholder suits against Yahoo! in connection with the failure of Micorsoft’s takeover attempt, and consequent fall in price of Yahoo! shares. Larry Ribstein, the author of the blog says:

“First, would the suit against Yahoo’s “poison pill” work? I doubt it. Time is on Yahoo's side – it was still negotiating to increase shareholder value and had not sold control.

Second, if Yahoo stock does take a beating and Ballmer does come back, could he and MS be sued for securities fraud – making a deliberately false threat to produce this result? Possibly under 14(e) and 10b-5, but very hard to prove.”

4. Finally, this also gives rise to some corporate governance issues. For instance, Yahoo! shareholders may possibly contend that the board did not act in the interest of the shareholders by placing undue resistance to the Microsoft bid that resulted in its failure, and that Yahoo’s actions were driven by sentimental reasons (to preserve the positions of the incumbents, such as the founder). Even here, it may be a difficult case for shareholders challenging the actions as Yahoo! was always ready to complete a deal, but at a higher price.

(Update – May 7, 2008: Law.com credits Yahoo’s lawyers with a clever strategy they used to ward off Microsoft’s maneuvers)

Revised Limited Liability Partnership Bill on the Horizon

A revised bill on Limited Liability Partnerships (LLPs) has been approved by the Union Cabinet, reports The Economic Times. The LLP Bill is set to be introduced in Parliament soon. The establishment of LLPs would enable professional services firms, such as those constituted by chartered accountants and lawyers, to carry on their activities without risk of personal liability of partners (beyond their share of capital in the firm). This would bring the Indian legal position on par with other developed jurisdictions where LLPs have been permitted for professional services firms. The new Bill replaces the previous Bill of 2006 as it takes into account suggestions given by the Standing Committee

As with many other laws and regulations that seek to establish new types of entities, the tax position regarding LLPs is yet unclear. However, it is expected that necessary changes will be brought about through amendments to the Income Tax Act to clarify the position regarding taxation of LLPs. A thornier issue relates to the payment of stamp duty when companies (mostly private limited) or other entities convert themselves into LLPs. When such conversion occurs, there is notionally a transfer of property of the erstwhile company or other entity to the LLP thereby resulting in a conveyance that is subject to stamp duty. Conversions to LLPs become prohibitively expensive if the stamp duty implications are severe. This scenario gets further complicated because stamp duty on conveyances fall within the state subject, and the Centre cannot legislate on the same. Hence, it becomes virtually impossible to convince all relevant states to impose less rates of stamp duty on conveyances arising out of conversion to LLPs or even to seek an exemption for such transaction. That could impose a hindrance on cost-effective implementation of conversions to LLPs.

These and other implications can be reviewed further once the Bill is introduced in Parliament and its detailed provisions are known.

Draft Report on Commodity Futures

One of the reasons ascribed to the recent price rise in India is the introduction and expansion of the commodities futures markets. This has, however, been partly put to rest if one were to go by the observations contained in the draft report of the Expert Committee on Commodity Futures Trading headed by Prof. Abhijit Sen. The Committee, which issued its draft report recently, failed to find a clear causation between commodity futures and the price rise in agricultural commodities. The report states:

“The fact that agricultural price inflation accelerated during the post futures period does not, however, necessarily mean that this was caused by futures trading. One reason for the acceleration of price increase in the post futures period was that the immediate pre-futures period had been one of relatively low agricultural prices, reflecting an international downturn in commodity prices. A part of the acceleration in the post futures period may be due to rebound/recovery of the past trend.

A study of supply fundamentals (production, changes in inventory and international trade) show that changes in these also contributed to higher inflation during the period under consideration. Nonetheless, recent behaviour of food grains prices does not appear to be explained completely by supply shortfalls, and, in particular, contribution of international price movements to domestic price outcomes appears to have increased substantially. Claims that futures trading were a cause of the inflation in sensitive commodities needs to be viewed in this context.”

On the other hand, the Committee is not entirely pleased with the present functioning of the futures markets. For instance, it found that futures and hedging have failed to result in proper price discovery or an effective mechanism of risk management, which have in fact become poorer. The report makes a call to upgrade the quality of regulation both by the Forward Markets Commission and the commodity exchanges in order to prevent manipulation and abuse by speculators and arbitrageurs.

Spot markets have also been found to require large-scale reforms. Here are some excerpts:

“Reforming spot markets should be given top priority. There is a need to give thrust to encourage all state governments to pass Model APMC Act. In fact, the model APMC Act is going to revolutionize agriculture marketing in the country. Further, in order to promote integrated national markets, the Central Government should take active steps to bring inter-state spot trade under the regulation of a central authority rather than leave it to highly scattered APMCs. Entry 33 in concurrent list of 7th Schedule of the Constitution seems to provide such a jurisdiction. The setting up of National Spot Electronic Exchanges by the National Commodity Exchanges is an attempt to create a national integrated market.”

From this, it is possible to glean mixed conclusions. On the one hand, there is no evidence of the commodity futures markets exacerbating the inflation of essential commodity prices. On the other hand, there is still a lot of work to be done in improving the regulations relating to commodity futures and the exchanges on which these futures are traded. Spot markets also require a complete overhaul.

A Weak Start to Short Selling

Although short sales were allowed to commence last week (on April 21, 2008), the response thus far has been lukewarm. Various reasons have been offered for this result. The Hindu Business Line reports that market players attributed the poor response to bad timing, to relatively higher margin requirements for securities lending and borrowing (SLB) as compared to the future and options (F&O) segment of trade, and to the lack of operational readiness on the part of institutions. On the other hand, an The Economic Times report states that foreign institutional investors (FIIs) (who hold the key to the success of short selling) continue to use the participatory notes (PNs) route for shorting on Indian securities rather than to go through the mechanism established by SEBI. From these, it appears that there are several loose ends to be tied before the short selling mechanism can be implemented on a large scale.

In the meanwhile, there are more fundamental questions being raised about the desirability of short selling. Knowledge@Wharton carries an article that notes:

“When Bear Stearns collapsed in March, some insiders argued it was wrong to blame the firm’s risky bets on mortgaged-backed securities. They had another culprit: malevolent traders working together in the upside-down world of short sales – making money by knocking down Bear’s stock.

No one openly admits to conducting a “bear raid,” since deliberately manipulating stock prices is illegal. But Wall Street has long believed bear raids can and do take place. There has, however, been little academic research to explain the forces at work. Now two finance experts have shed some light on the process. “We basically describe a theory of how bear raid manipulation works,” says Wharton finance professor Itay Goldstein. He and Alexander Guembel of the Said Business School and Lincoln College at the University of Oxford describe the procedure in their paper titled, “Manipulation and the Allocational Role of Prices.”

Their key finding illuminates the interplay between a firm’s real economic value and its stock price, showing how traders who deliberately drive the share price down can undermine the firm’s health, causing the share price to fall further in a vicious cycle.”

Apart from this, short selling may also induce a tendency towards price manipulation. For instance, the Securities and Exchange Commission (SEC) recently issued a press release where it charged a Wall Street trader with fraud for spreading false rumours. The release states:

“The U.S. Securities and Exchange Commission today filed a settled civil action in the United States District Court for the Southern District of New York, charging Paul S. Berliner, a Wall Street trader formerly associated with Schottenfeld Group, LLC, with securities fraud and market manipulation for intentionally disseminating a false rumor concerning The Blackstone Group's acquisition of Alliance Data Systems Corp. The Commission's complaint alleges that on November 29, 2007 — approximately six months after Blackstone entered into an agreement to acquire ADS at $81.75 per share — Berliner drafted and disseminated a false rumor that ADS's board of directors was meeting to consider a revised proposal from Blackstone to acquire ADS at a significantly lower price of $70 per share. The Commission alleges that this false rumor caused the price of ADS stock to plummet, and that Berliner profited by short selling ADS stock and covering those sales as the false rumor caused the price of ADS stock to fall.”

While short selling has begun in the Indian markets, the regulators ought to be watchful of such situations. Vigilance and monitoring of market activity is crucial. The SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 do contain detailed provisions prohibiting fraudulent and manipulative trading, and these regulations can potentially be used to curb such activity.