Control Share Acquisition Provisions

Discussion

Control share acquisition statutes are a prevalent form of state-sponsored antitakeover legislation. Such statutes function by denying shares their voting rights when they contribute to ownership in excess of certain thresholds. Voting rights for those shares exceeding ownership limits may only be restored by approval of either a majority or supermajority of disinterested shares. Thus, control share acquisition statutes effectively require a hostile bidder to put its offer to a shareholder vote or risk voting disenfranchisement if the bidder continues buying up a large block of shares.

Although control share statutes vary among states, the basic mechanics of these antitakeover devices are similar:

• When an acquirer's shares exceed any of a number of threshold levels-normally 20 percent, 33 percent, or 50 percent-a disclosure statement must be filed with the target company. The disclosure statement often requires basic information about the acquirer, the number of shares directly or indirectly owned, and the dates and prices at which such shares were acquired.

• After the disclosure statement is filed, a special shareholder meeting is called (usually at the acquirer's expense) to determine whether voting rights should be restored to the control shares. In some states, if the acquirer fails to file a disclosure statement, the company may redeem the control shares at fair market value. Both notice of special meeting and a proxy statement describing the board's opinion regarding the restoration of voting rights are distributed to shareholders.

• Shareholders vote on whether to restore voting rights to the control shares. This typically requires approval of a majority of disinterested shares. Again, in some states, if shareholders do not approve restoration of voting rights, the company reserves the right to redeem the shares at fair market value. Alternatively, some states require presentation of the same proposal for a shareholder vote in successive annual meetings for up to three years.

At present, 27 states have control share acquisition statutes, which can be quite effective in blocking hostile tender offers. At the very least, the fact that a potential acquirer must receive shareholder approval each time an ownership threshold is crossed slows down the acquisition process and adds to the expenses of the acquirer. At its worst, and when successful, the control share acquisition statute gives management a proportionate increase in its voting power and further insulates directors and officers from shareholder influence.

While most control share acquisition statutes are quite similar, we have highlighted a few states with unusual features contained in their statutes. Tennessee has an opt-in statute, requiring a shareholder vote in order to be applicable to the company.[1] Hawaii's control share acquisition statute provides a high level of protection. There, a shareholder can have voting rights taken away when any of five different ownership thresholds is crossed. In addition, the shares that are eligible to decide whether or not to restore the voting rights of the control shares include those held by management. This magnifies the control management has over the situation, since its relative voting power increases as control shares are removed from consideration. Nebraska is another state that does not exclude management's shares from those that vote on the control share acquisition. All other states require at least a majority vote from those shares not owned by either the potential acquirer or the company and its employees.

Another common feature of some control share acquisition statutes is the provision that a majority of all shares, in addition to a majority of disinterested shares, must approve the purchase of control shares. While securing the votes of a majority of disinterested shares may be difficult enough to do, obtaining the votes of a majority of all shares could well be impossible to accomplish, especially when the purchased block of stock is small and management controls a significant portion of voting stock. States requiring the majority votes of both disinterested shares and all shares include Kansas, Michigan, Minnesota, Missouri, Oregon, Pennsylvania, South Dakota, and Wyoming.

Oklahoma's control share acquisition statute typifies this provision, with the exception that voting rights are restored to control shares three years after approval of the acquisition is first denied. Arizona's provision allows control shares to participate fully in election of directors, but not in other voting matters.

Wisconsin's control share acquisition statute imposes just one threshold of 20 percent of outstanding shares, and requires that all shares purchased by those having in excess of this ownership threshold carry one-tenth normal voting rights. A majority shareholder vote is necessary to restore full voting rights to the control shares. Although this statute allows some diluted voting power to accrue to control shares, even in the absence of shareholder approval, it effectively imposes a continuous ownership thresh-old after one surpasses the 20-percent level.

Conclusion

Control share acquisition statutes may harm long-term share value by effectively entrenching management. The ability to buy shares should not be constrained by requirements to secure approval of the purchase from other shareholders. Moreover, shareholders should reject provisions that require a supermajority shareholder vote to restore forfeited voting rights. Finally, denying certain shares their voting rights violates the "one share, one vote" principle of stock ownership.

While it would be unusual for shareholders to vote against a proposal to opt out of a control share acquisition, there may be cases in which discouraging a particularly harmful takeover does prove beneficial to shareholders. Therefore, evaluate proposals to opt out of control share acquisitions on a case-by-case basis.