Published in the September 2010 issue of Lexpert magazine as part of Barry Reiter's regular column.
Some say the 863 million offered in exchange for Frank Stronach's multiple-voting hares as outrageous." hat, however, is matter best left to shareholders
A proposal by Magna International Inc. to reorga-nize its capital structure and eliminate a class of multiple-voting shares has raised a fuss. It also raises interesting governance issues.
The Magna share structure gives holders of Class A subordinate shares one vote, while holders of Class B shares receive 300 votes per share. As a result, with only 0.6 per cent of Magna's total equity, Stronach Trust (controlled by Chairman Frank Stronach and his family) holds 66 per cent of Magna's votes.
This kind of capital structure has become unusual in Canada.
In 1987, the TSX required companies intending to list dual- class structures to attach "coattail" provisions to the superior class. Coattails prevent the controlling shareholder from receiving a premium for the superior shares by requiring that any take- over bid made for the superior class be made contemporaneously for the subordinate shares as well.
The Magna Class B shares, dating from 1978, have no coat- tails. They also have no "sunset provisions," which in the 1990s became a common way to limit the impact of dual share classes by eliminating superiority in specified circumstances (e.g., aft er the passage of time, after equity ownership of the holders falls below some threshold, upon transfer of the superior shares).
The value of the Magna Class A shares has always been thought to be subject to a "Stronach discount" on the basis that control of the company could be achieved by acquisition of the Class B shares only, and that the timing of liquidity for Mag-na shareholders would be fully at the discretion of the Class B shareholders (namely, the Stronach family).
In March 2010, Magna management approached Stronach to try to interest him in eliminating Magna's multiple-voting structure. After about a month of discussion, management informed Magna's board about the initiative and the board established an independent directors' committee to address a proposal that had emerged. Th e committee conducted a review process and held one (and apparently only one) negotiating session with Stronach, in the context of a "final take-it-or-leave-it offer."
Stronach Trust agreed to sell its Class B shares to Magna for a rich deal: Magna would deliver Class A shares and cash (valuing Class B shares at a premium of some 1,800 per cent over Class A shares), plus a five-year consulting contract for Frank Stronach and equity and voting interests in an electric car partnership between Magna and Stronach Trust. Th e deal, all in, was widely reported to be costing Magna $863 million.
In May, the board determined to put this offer to a share- holder vote, requiring approval by a simple majority of the Class A votes, structuring the transaction as a plan of arrangement (which would therefore require court approval), and making no voting recommendation to shareholders. While the board had obtained advice from its financial advisor, CIBC, it had not obtained a fairness opinion: CIBC said it was unable to provide one because the dilution associated with the deal was unprecedented and the benefit to shareholders would depend on the future trading value of Magna's shares.
When the proposal was announced on May 6, the price of Magna's Class A shares jumped significantly, and institutional shareholders and their advisor groups quickly came down on different sides. RiskMetrics recommended that its clients vote in favour because of the potential benefits of the "one share, one vote" structure, including elimination of the trading discount, enhanced accountability of the directors, greater access to capital and the removal of an impediment to potential take-over interest. RiskMetrics thought that these benefits outweighed the high price and "corporate governance concerns."
Meanwhile, Glass Lewis & Co., a proxy advisor and wholly owned subsidiary of the Ontario Teachers' Pension Plan, recommended its clients vote against the deal. Teachers was concerned that Stronach was being permitted to extract "outrageous" premiums from Magna under the guise of normalizing its governance structure, and that better disclosure and guidance to shareholders were necessary to maintain the integrity of capital markets.
At the end of May, Magna issued its proxy circular, providing some background and urging shareholders to vote. It described the special committee's involvement and presented its conclusion that the proposal should be put to a shareholder vote with- out any committee recommendation. The Magna board made no voting recommendation. The circular did not include presentations that had been prepared by CIBC for the special committee (deal analysis) or by PricewaterhouseCoopers (estimated fair market value of Magna's vehicle-electrification business).
Intense debate ensued. Eventually, Ontario Securities Commission staff decided to intervene on the basis that the proxy circular had not contained adequate disclosure, the board had not provided useful recommendations, and the approval and review process followed by the board had been inadequate. The OSC held an expedited hearing and issued a short statement in support of its conclusions, with more detailed reasons to follow.
The Commission determined that a transaction such as this would not be abusive of shareholders or Ontario's capital markets "simply because the price proposed to be paid is considered by certain investors to be outrageous." On the evidence before it, the OSC was unable to come to a view as to whether or not the proposed transaction was unfair. The OSC concluded that the best way to determine fairness would be to simply allow shareholders of Magna to either approve or reject the deal: this was ultimately a business and financial decision for those shareholders.
However, the OSC did have significant concerns about the governance process and the disclosure made to shareholders. Under Ontario securities law, the proxy circular must describe the substance of matters to be voted on in sufficient detail to enable the shareholder to form a reasoned judgment about how to vote. In the circumstances of this case – a complex, related-party transaction with no voting recommendation, no fairness opinion and consideration that was hard to evaluate – the OSC felt that shareholders were inadequately informed.
The OSC also felt that, in a situation of this sort, the disclosure in the circular must, to the extent reasonably possible, provide shareholders with substantially the same information and analysis that the special committee received. It listed a dozen items that it felt should be better disclosed in the circular, including detail on the review and approval process of the special committee, disclosure of the CIBC and PwC reports, clarity as to how CIBC assessed the proposed transaction and a reasoning as to why CIBC could not issue a fairness opinion.
The OSC noted that, while there was no legal requirement for a voting recommendation or a fairness opinion, the fact that neither was provided had implications for the disclosure required. The OSC also had "some concerns with the process followed by the board, the special committee and management in reviewing and deciding to submit the proposed transaction to shareholders for approval." Accordingly, the OSC issued an order preventing the shareholder vote from proceeding until Magna delivered an amended circular complying with these requirements.
A Measured Response
There appears to be much to commend both in the OSC's decision and in the reasoning it has provided so far. The Commission declined the opportunity to interfere in a substantive way, for instance, by deciding that the consideration proposed was unfairly expensive when compared with what shareholders were to receive — this, the OSC concluded, was a matter to be determined by the shareholders.
That being said, shareholders needed to be in a position to understand and assess their interests, and they needed to be well represented in negotiations on the deal put before them. On the first point, the OSC was clear that, particularly in the context of directors who were making no recommendation, the shareholders had to be given effectively the same information as had been given to the directors, so that they could form their views on an informed basis.
On the second point, the OSC appeared to be critical of management, which had largely driven the discussions with Stronach before involving the board, and of the special committee, which it appears to regard as not having pressed Stronach hard enough to provide confidence that the deal put to the shareholders was the best that could have been extracted. In expressing these views, the OSC is following a long line of decisions of the leading US corporate court (Delaware Chancery) in emphasizing the need for a special committee of disinterested directors to exercise leadership, and to have documented evidence to prove that it is doing so.
Further independent criticism of the board has argued that shareholders were entitled to a recommendation one way or another from the directors, who had engaged in a detailed review of a complex deal that management was supporting strongly. The amended circular that Magna filed expressed a special committee view that the deal will be fair and reasonable if shareholders approve it and the court subsequently approves the plan of arrangement. And special committee members have said that, as individual shareholders, they are in favour.
On July 23, a few weeks before this column went to press, Magna shareholders voted 75.3 per cent in favour of the deal, which would end Stronach's control over Magna. But at least some investors have vowed to carry on the fight in court (at the arrangement hearing). Whatever the ultimate outcome, directors are well-advised to consider the lessons of Magna as they approach related-party matters in the future.
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