Empty Voting and Hidden Ownership

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THENEWVOTEBUYING:EMPTYVOTINGANDHIDDEN(MORPHABLE)OWNERSIllPHENRYT.C.HU.BERNARDBLACKReprintedfromSOUTHERNCALIFORNIALAWREVIEWVolume79,May2006,Number4Copyright©200~byHenryT.C.Hu.AllRightsReserved~uscGOULDSCHOOLOFLAW THENEWVOTEBUYING:EMPTYVOTINGANDHIDDEN(MORPHABLE)OWNERSHIP*HENRYT.C.Hu**&BERNARDBLACK***ABSTRACTCorporatelawgenerallymakesvotingpowerproportionaltoeconomicownership.Thisservesseveralgoals.Economicownershipgivesshareholdersanincentivetoexercisevotingpowerwell.Thecouplingofvotesandsharesmakespossiblethemarketforcorporatecontrol.Thepowerofeconomicownerstoelectdirectorsisalsoacorebasisforthelegitimacyofmanagerialauthority.Boththeoryandevidencegenerallysupporttheimportanceoflinkingvotestoeconomicinterest.Yetthederivativesrevolutionandothercapitalmarketsdevelopmentsnowallowbothoutsideinvestorsandinsiderstoreadilydecoupleeconomicownershipofsharesfromvotingrights.Thisdecoupling,whichwecallthe*Copyright©2006byHenryT.C.Hu.Allrightsreserved.PermissionisherebygrantedfornoncommercialreproductionofthisArticleforclassroomuseonlyinnonprofitacademicinstitutions,subjecttotheconditionthatthenamesoftheauthors,acompletecitation,andthiscopyrightnoticeandgrantofpermissionbeincludedinthecopies.ThisArticleisalsoavailableathttp://ssrn.comlabstract=904004.**AllanShiversChairintheLawofBankingandFinance,UniversityofTexasLawSchool.WethankconferenceandworkshopparticipantsattheAmericanLawandEconomicsAssociationannualmeeting(May2005);theBoundariesofSECRegulationConference(FinancialEconomicsInstitute,ClaremontMcKennaCollege)(February2006);StanfordLawSchool(March2006);UniversityofTexas,McCombsSchoolofBusiness(April2006);theWeil,Gotshal&MangesRoundtableatYaleLawSchool(April2006);andtheCorporateLawRoundtableatUniversityofPennsylvaniaLawSchool(April2(06).Wealsothank!manAnabtawi,RichardCraswell,JeffreyGordon,LarryHarris,LindaHayman,GerardHertig,JenniferHill,BruceJohnsen,CharlesMcCallum,HaroldJ.Mulherin,JeffryNetter,IanRamsay,EdwardRock,RobertaRomano,DavidSkeel,LeoStrine,JanetKiholmSmith,andanonymouspeerreviewersofourcompanionarticlesforcommentsandsuggestions.WethankCatherineBellahandRyanMcCormickfortheirresearchassistance.***HaydenW.HeadRegentsChairforFacultyExcellence,UniversityofTexasLawSchool,andProfessorofFinance,UniversityofTexas,McCombsSchoolofBusiness.811 812SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811".-'"newvotebuying,"hasemergedasaworldwideissueinthepastseveralyears.Itislargelyhiddenfrompublicviewandmostlyuntouchedbycurrentregulation.Hedgefundshavebeenespeciallycreativeindecouplingvotingrightsfromeconomicownership.Sometimestheyholdmorevotesthaneconomicownership-apatternwecall"emptyvoting."Inanextremesituation,avoteholdercanhaveanegativeeconomicinterestand,thus,anincentivetovoteinwaysthatreducethecompany'sshareprice.Sometimesinvestorsholdmoreeconomicownershipthanvotes,thoughoftenwith"morphable"votingrights-thedefactoabilitytoacquirethevotesifneeded.Wecallthissituation"hidden(morphable)ownership"becausetheeconomicownershipand(defacto)votingownershipareoftennotdisclosed.ThisArticleanalyzesthenewvotebuyinganditspotentialbenefitsandcosts.Wesetoutthefunctionalelementsofthenewvotebuyinganddevelopataxonomyofdecouplingstrategies.Wealsoproposeanear-termdisclosure-basedresponseandoutlineamenuoflonger-termregulatorychoices.Ourdisclosureproposalwouldsimplifyandpartiallyintegratefiveexisting,inconsistentownershipdisclosureregimes,andisworthconsideringindependentofitsvaluewithrespecttodecoupling.Inthelongerterm,otherresponsesmaybeneeded:wediscussstrategiesfocusedonvotingrights,votingarchitecture,andsupplyanddemandforcesinthemarketsonwhichthenewvotebuyingrelies.TABLEOFCONTENTSI.INTRODUCTION814n.THETECHNOLOGYOFTHENEWVOTEBUYING823A.THEfuNCTIONALELEMENTSOFTHENEWVOTEBUYING823TABLEI827B.EMPTYVOTINGTHROUGHCOUPLEDASSETS8281.EmptyVotingThroughEquityDerivatives828a.Perry-My1anLaboratoriesandSimilarExamp1es828b.LibertyMedia-NewsCorporation830c.InsiderHedgingandEntrenchment8312.EmptyVotingThroughRecordDateCapture832C.HIDDEN(MORPHABLE)OWNERSHIP8361.MorphingfromdeFactotoFormalVotingRights836a.AccesstoDerivativesDealers'MatchedShares836b.AvoidingMandatoryBidRulesandOtherUses8392.ToeholdsandtheSocialVirtuesofStealth840 2006]NEWVOTEBUYING8133.SheddingVotingRights841D.RELATEDNON-HOSTASSETS8421.Mergers8422.IndirectHedges844E.INNOVATIONSUNDERLYINGlHENEWVOTEBUYING844F.THEEXTENTOFNEWVOTEBUYING846TABLE2848III.LEGALANDFINANCETHEORYANDEVIDENCE.850A.CLASSICTHEORYOFVOTINGRIGHTS:INTRODUCTION850B.LITERATUREREVIEW:THEORYANDIMPLICATIONSFORNEWVOTEBUYING8511.Theory851a.One-share-one-vote851b.TheValueofVotes:IndividualVersusCollectiveValue852c.EquilibriumVersusNonequilibriumModels8532.EmpiricalEvidence854a.DivergenceBetweenInsiders'VotingandEconomicOwnership854b.TheValueofVotingRights855c.MarketforCorporateControl856d.RecordDateCapture857C.ANALOGIESTOOlHERFORMSOFDECOUPLING8581.Dual-classCommonStock,Pyramids,andCircularControl..8582.Dual-classRecapitalizations8593.VotingbyRecordOwners860D.CLASSICALVOTEDOCTRINEANDDECOUPLING861E.TESTABLEHypOTHESES863IV.DISCLOSURE:CURRENTRULESANDREFORMPROPOSAL864A.GENERALCONSIDERATIONS864B.EXISTINGDISCLOSUREREQUIREMENTS864TABLE38661.LargeShareholderDisclosure(Schedules13Dand13G)867a.BasicRequirements867b.ApplicationtoHidden(Morphable)Ownership868c.ApplicationtoEmptyVoting8702.ReportingbyInstitutionalMoneyManagers(Form13F)8713.Insiderand10%ShareholderDisclosure(Section16)8734.MutualFundReporting875C.REFORMINGlHEDISCLOSURESYSTEM875 814SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811'!1.GeneralConsiderations875TABLE48812.LargeShareholderDisclosure(Schedules13Dand13G)8823.InstitutionalMoneyManagersandMutualFunds883D.DISCLOSUREOFLARGEEMPTYVOTINGPOSITIONS885E.SUMMARy886V.LONGERRUNRESPONSESTOEMPTYVOTING886A.GENERALCONSIDERATIONS886B.STRATEGIESFOCUSEDONVOTINGRIGHTS8881.DirectLimitsonVotingRights8882.VotingbyRecordOwners;ExtensiontoEquitySwaps8903.CorporationOpt-in8904.StateCorporateLaw893C.STRATEGIESFOCUSEDONVOTINGARCHITECTURE895D.STRATEGIESFOCUSEDONSUPPLYANDDEMANDFORCESINTHEMARKETSONWHICHTHENEWVOTEBUYINGRELIES8991.LimitingShareLendingandRequiringInstitutionalVoting8992.SafeHarborforVotingInsteadofLendingShares9013.ReducingtheAttractivenessofLendingSharesandProvidingEquityDerivatives9024.ImposingResponsibilitiesonShareLendersandDerivativesProviders9045.TheDemandSide:ExecutiveHedging906VI.CONCLUSION906I.INTRODUCTIONThevoteisthecoresourceofshareholderpower.Thestandardcontractariantheoryofthecorporationsupportsassigningvotingrightstocommonshareholdersinproportiontoshareownership.Doingsoplacesthepowertooverseecompanymanagersinthehandsofresidualowners,whohaveanincentivetoexercisethatpowertoincreaseftrmvalue;themoresharesowned,thegreatertheincentiveandthusthegreaterthenumberofvotes.1Linkingsharestovotesalsofacilitatestheoperationofthemarketforcorporatecontrol.Empiricalevidencesupportstheconcernwithadisparitybetweeninsiders'votingpowerandeconomicinterestby1.See.e.g.,FRANKH.EASTERBROOK&DANIELR.FISCHEL,THEECONOMICSTRUCfUREOFCORPORATELAW63,67(1991)("[W]hydoshareholdersalonehavevotingrights?...Thereasonisthatshareholdersaretheresidualclaimantstothefirm'sincome."). 2006]NEWVOTEBUYING815showingthatsuchadisparitypredictsreducedfirmvalue.2Beyondthisinstrumentalroleofvoting,shareholdervotingisacoreideologicalbasisformanagerialauthority,legitimatingmanagers'exerciseofauthorityoverpropertythemanagersdonotown.3Yetthederivativesrevolutioninfinance,especiallythegrowthinequityswapsandotherprivatelynegotiated("over-the-counter"or"OTe")equityderivatives,andrelatedgrowthinthesharelendingmarket,aremakingiteasierandcheapertodecoupleeconomicownershipfromvotingpower.4Hedgefundsandcompanyinsidersaretakingadvantageofthisnewopportunity.Sometimes,theyholdmorevotesthanshares-apatternwecall"emptyvoting"becausethevoteshavebeenemptiedofanaccompanyingeconomicstake.Inanextremecase,aninvestorcanvotedespitehavingnegativeeconomicownership,whichgivestheinvestoranincentivetovoteinwaysthatreducethecompany'sshareprice.Investorsorinsiderscanalsohaveeconomicownershipthatexceedstheirapparentvotingrights.Theinvestorsorinsidersoftenhaveinformalaccesstovotingrights,whichtheytypicallyexercisebyeitheracquiringformalvotingrightsfromanintermediary(usuallyaderivativesdealer)orinstructingtheintermediaryonhowtovotethecompany'sshares.Thisownershipistypicallynotdisclosedunderlargeshareholderdisclosurerules.5Theserulesfocusonvotingpowerratherthaneconomicinterest,anddonotclearlyrequiredisclosureoftheinformalvotingpowerthatoftenexists.Theinformal,"morphable"natureofthesevotingrightsallows2.See,e.g.,StijnClaessens,SimeonDjankov&LarryH.P.Lang,TheSeparationofOwnershipandControlinEastAsianCorporations,58J.FIN.BeON.81(2000);PaulA.Gompers,JoyIshii&AndrewMetrick,ExtremeGovernance:AnAnalysisofDual-classFirmsintheUnitedStates(RodneyL.WhiteCtr.forFin.Research,WorkingPaperNo.12-04,2006),availableathttp;llssrn.comlabstract=562511.3.See,e.g.,BlasiusIndus.v.AtlasCorp.,564A.2d651,659(Del.Ch.1988)(assertingthatvotingrightsare"criticaltothetheorythatlegitimatestheexerciseofpowerbysome(directorsandofficers)overvastaggregationsofpropertythattheydonotown").CfMMCos.v.liquidAudio,Inc.,813A.2d1118(Del.2003).4.Forbroaderdiscussionsofthechallengesthatderivativesandmodem[mancialinnovationsposetocorporategovernanceprinciples,see,forexample,HenryT.C.Hu,BehindtheCorporateHedge:InformationandtheLimitsof"ShareholderWealthMaximization,"J.APPLIEDCORP.FIN.,Fall1996,at39[hereinafterHu,BehindtheCorporateHedge],andHenryT.C.Hu,NewFinancialProducts,theModemProcessofFinancialInnovation,andthePuzzleofShareholderWelfare,69TEx.L.REV.1273(1991)[hereinafterHu,NewFinancialProducts].OnthedistinctionbetweenOTCandexchange-tradedderivatives,see,forexample,HenryT.C.Hu,MisunderstoodDerivatives:TheCausesofInformationalFailureandthePromiseofRegulatoryIncrementalism,102YALEL.J.1457(1993)[hereinafterHu,MisunderstoodDerivatives].5.WediscussthecurrentownershipdisclosurerulesinfrainPartIV.B. 816SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811investorstoplausiblydenythevotingpowerthatwouldtriggerdisclosure.Weusetheterm"hiddenownership"torefertotheundisclosedeconomic,.!ownership,andtheterm"hidden(morphable)ownerShip"torefertothecombinationofundisclosedeconomicownershipplusprobableinformalvotingpower.Werefertoemptyvotingandhidden(morphable)ownershiptogetheras"thenewvotebuying"orsimplyas"decoupling."Inthelastfewyears,thenewvotebuyinghasaffectedtakeoverbattlesandcontrolofpubliccompaniesin(atleast)Australia,Canada,Germany,HongKong,Italy,Japan,NewZealand,theUnitedKingdom,andtheUnitedStates.Thereareanumberofwaystodecouplevotesfromeconomicownership.Onemethodreliesonthesharelendingmarket,whichletsoneinvestor"borrow"sharesfromanother.Understandardlendingarrangements,theborrowerhasvotingrightsbutnoeconomicownership,whilethelenderhaseconomicownershipwithoutvotingrights.Asecondapproachemploysanequityswap,inwhichthepersonwiththelongequityside(the"equityleg")oftheswapacquireseconomicownershipofshares(butnotvotingrights)fromtheshortside(the"interestleg").Theshortsideoftenhedgesitseconomicriskbyholdingshares,thusendingupwithvotesbutnoneteconomicownership.Otherdecouplingstrategiesarealsopossible,suchasrelyingonputandcalloptionsor,wheretheyexist,single-stockfutures.Arecentpublicinstanceofemptyvotingillustratesthepotentialrisksfromemptyvoting.PerryCorp.,ahedgefund,owned7millionsharesofKingPharmaceuticals.6Inlate2004,MylanLaboratories.agreedtobuyKinginastock-for-stockmergeratasubstantialpremium,butMylan'ssharesdroppedsharplywhenthedealwasannounced.TohelpMylanobtainshareholderapprovalforthemerger,Perrybought9.9%ofMylan,becomingMylan'slargestshareholder.ButPerryfullyhedgedthemarketriskassociatedwithitsMylanshares.Perrythushad9.9%votingownershipandzeroeconomicownership.IncludingitspositioninKing,Perry'soveralleconomicinterestinMylanwasnegative.ThemoreMylan(over)paidforKing,themorePerrystoodtoprofit.Emptyvotingcanalsobeusedtomultiplythevotingpowerofanexistinglongownershipposition.Forexample,ashareholdercanborrowsharesjustbeforetherecorddateforashareholdervote,andthenreverse6.WediscussthisexampleandprovidecitationsinfrainPartII.B. 2006]NEWVOTEBUYING817thetransactionafterward.ThefIrstpubliclyreportedinstanceofthis"recorddatecapture"strategyoccurredintheUnitedKingdomin2002.7LaxeyPartners,ahedgefund,heldaboutI%ofthesharesofBritishLand,apropertycompany.Attheannualgeneralmeeting,Laxeyvotedover9%ofBritishLand'ssharestosupportaproposaltodismemberBritishLand.Justbeforetherecorddate,Laxeyhadborrowedalmost42millionshares.Emptyvotingbyinstitutionsisaclosecousintowidelyusedtechniques,suchaszero-costcollarsandvariableprepaidforwards,bywhichmanagersandcontrollingshareholdersretainformalownershipofshares,whilesheddingsomeormostoftheireconomicownership.8IntheUnitedStates,thesestrategiestypicallyhavebeendrivenbyinsiders'desiretoshedriskwhiledeferringtaxes,ratherthanbyvotebuyingmotives.Butinsiderscanreadilyuseemptyvotingtechniquestocementtheircontrol,anddosoinothercountries.Conversely,investorscanhavegreatereconomicownershipthanformalvotingrights,butalsohaveinformal,"morphable"votingrightsthatgivetheinvestorfullownershipasapracticalmatter.Perry'sstakeinaNewZealandcompany,RubiconLtd.,whichcametolightin2003,illustratesthispossibility.9Perryusedequityswapsprovidedbyderivativesdealerstoholda16%economicstakeinRubicon,withoutcomplyingwithNewZealand'slargeshareholderdisclosurerules,which,likesection13(d)("Section13(d)")oftheSecuritiesExchangeActof1934("ExchangeAct"),requiredisclosureby5%shareholders.loWhenanelectioncamealong,Perryreturnedtoitsdealers,unwoundtheswaps,acquiredthe"matchedshares"heldbythedealerstohedgetheswaps,andthusobtainedformalvotingrights.Perry'snondisclosurewasupheldunderNewZealandlaw.Morphablevotingrightscanalsobeusefulforreasonsunrelatedtodisclosure.II7.WediscussthisexampleandprovidecitationsinfrainPartII.B.8.See,e.g.,Donoghuev.CentilliumCommc'nsInc.,2006U.S.Dis!.LEXIS13221(S.D.N.Y.Mar.28,2006)(describingvariableprepaidforwardcontractsanddiscussinghowtheyareregulatedundersection16oftheExchangeAct);J.CarrBettis,JohnM.Bizjak&MichaelL.Lemmon,ManagerialOwnership,IncentiveContracting,andtheUseofZero-costCollarsandEquitySwapsbyCorporateInsiders,361.FIN.&QUANTITATNEANALYSIS345(2001)(discussingzero-costcollarsandequityswaps);RachelEmmaSilverman&JaneJ.Kim,IRSTargetsStrategyforWealthyExecutives,WALLST.J.,Feb.9,2006,atDI(describingvariableprepaidforwards).9.WediscussthisexampleandprovidecitationsinfrainPartII.C.10.CompareSecuritiesAmendmentAct1988,§26(N.Z.),withExchangeAct§13(d),15U.S.C.§78m(d)(2000).II.WediscussanumberofotherusesofmorphablevotingrightsinfrainPartII.C. 818SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811Thenewvotebuyingislargelyunregulatedandoftenunseen.Corporatecaselawgoverning"classic"votebuyingdoesnottouchit.Thatcaselawpresumesadirecttransferofvotingrightsfromavotesellertoavotebuyer;itthenassessesthebusinessjustificationfortheseller'stransferofvotingrights.IntheleadingDelawarecase,Schreiberv.Carney,votebuyingisdefinedas"avotingagreementsupportedbyconsiderationpersonaltothestockholder,wherebythestockholder...votesasdirectedbytheofferor.,,12Incontrast,thenewvotebuyingofteninvolvesnoidentifiable"seller"noranidentifiable"transfer"ofvotingrights.Thenewvotebuyercan,forinstance,followatwo-stepprocess.Itbuyssharesintheopenmarketandthenentersintoaderivativestransactionthatoffsetseconomicownershipoftheshares.Thevotebuyerisleftonlywithvotingownership.Ithasengagedintwoconventionaltransactions-purchasingsharesandusingaderivativeforhedgingpurposes-thatarenotindividuallysuspect.Forrecorddatecapture,thesaleofvotesoccursthroughsharelending-anordinaryactivitywithlegitimateusesunrelatedtovotebuying.Federalownershipdisclosurerulesscarcelytouchthenewvotebuyingeither.InstitutionalinvestorsmustdisclosetheirsharepositionsinpubliccompaniesonForm13FYButForm13Fdoesnotcovertransactionsthatoffseteitherthevotingrightsoreconomicinterestconveyedbythesepositions.NordoesitcovereconomicownershipacquiredbyholdingequityswapsorotherOTederivatives.TheSchedule13DandSchedule13Grequirementsfordisclosureby5%shareholdersaremoreextensive,butwithsomeattentiontolegalniceties,hidden(morphable)ownershipandemptyvotingpositionscanoftenbestructuredtoarguablyevade13DIl3Gdisclosure.14EveninPerry-Mylan,wherePerryfiledaSchedule13D,itmadeonlylimiteddisclosureofitshedgingagreements.15Disclosurebyinsidersand10%shareholdersundersection16oftheExchangeAct("Section16")focusesoneconomicownership.16Section16disclosurecapturesemptyvotingthroughhedging(sincehedgingaffects12.Schreiberv.Carney,447A.2d17,23(Del.Ch.1982).13.SECPonnI3P,InfonnationRequiredofInstitutionalInvestmentManagersPursuanttoSection13(f)oftheSecuritiesExchangeActof1934andRulesThereunder,17C.F.R.§249.325(2005)[hereinafterPonn13F].14.ScheduleI3D,17c.P.R.§240.l3d-IOI(2005)[hereinafterScheduleJ3D];ScheduleBG,17C.F.R.§240.Bd-I02(2005)[hereinafterScheduleBG].15.NewsreportssuggestthattheSecuritiesandExchangeCommission("SEC")isconsideringanenforcementactionagainstPerry,presumablyunderSectionJ3(d)rules.See.e.g.,IantheJeanneDugan,HedgeFundsDrawScrutinyoverMergerPlay,WALLST.J.,Jan.11,2006,atCI.16.ExchangeAct§16,15U.S.c.§78p(2000&Supp.2002). 2006]NEWVOTEBUYING819economicownership)butlikelydoesnotcaptureemptyvotingthroughshareborrowing(sinceeconomicownershipdoesnotchange).Becausethenewvotebuyingisseldomcapturedbydisclosurerules,itsscaleisunknown.Wedid,however,searchforandcompilealistofovertwentyconfIrmedorpubliclyrumoredexamples,almostallsince2002.Itisnoaccidentthatmostoftheseexamplesarerecent,northatmanyinvolvehedgefunds.Thetheoreticalpossibilityofdecouplingvotesfromeconomicownershipisnotnew.17Whatisnewisinvestorabilitytodosoonalargescale,decliningtransactioncostsduetofinancialinnovation,andatrilliondollar-pluspoolofsophisticated,lightlyregulated,hedgefunds,freefromconflictsofinterestandconcernswithadversepublicitythatmaydeterotherinstitutionalinvestorsfromusingdecouplingstrategies.Thecorporategovernanceriskposedbythenewvotebuyingisclear,buttheremedyisnot.Policymakersabroad-notablyinHongKongandtheUnitedKingdom-arebeginningtoconfrontthenewvotebuying.U.S.policymakerswillsoonneedtoaddressit.18Inourview,theneartermneedisforenhancedownershipdisclosure(craftedwithsensitivitytothecostsofdisclosure),toletregulatorsassesshowoftennewvotebuyingoccursandhowitaffectsshareholdervoteoutcomes.Ifdisclosuresaremadeonareal-timebasis(astepthatgoessomewhatbeyondourproposal),theinformationtheyprovidecanalsolettheDelawarecourts(themostlikelyvenue)addressvotingrightsonacaseby-casebasisundergeneralcorporatelawprinciples.Fourthemesmotivateourdisclosurereformrecommendations.Oneisthatdisclosurerulesshouldbeinternallyconsistent.Theyshouldtreatsubstantivelyidenticalpositionssimilarly,whichcurrentrulesdonot.Inparticular,giveninvestors'abilitytomorphfromeconomic-onlyownershiptoeconomic-plus-votingownership,therulesmustcoverbotheconomicandvotingownership.Second,thedisclosurerulesshouldbe"goodenough"toletregulatorsandinvestorsassesswhenandwherevotebuying17.Foranexampleofhowtohedgeasharepositionwithoptions,see,forexample,RICHARDA.BREALEY&STEWARTC.MYERS,PRINCIPLESOFCORPORATEFiNANCE546-52(8thed.2006).18.WediscussrecentregulatoryresponsestothenewvotebuyingintheUnitedKingdomandHongKonginfrainPartIV.C.TheonlypublicsectorrecognitionintheUnitedStatesthatweknowofisaJuly2005speechbyViceChancellorLeoStrine,wherehestatedthatwhatweterm"emptyvoting"and"relatedfactors"are"makingitdifficultforcorporatelawmakerstoavoidafundamentallook"atcorporatelaw.SeeDavidMarcus,ThinkingBigThoughts,CORP.CONTROLALERT,Aug.-Sept.2005,at6,6. 820SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811occurs,withoutimposinglargenewcostsoninvestors.Third,therulesshouldtreatlongandshortpositionssymmetrically.Fourth,theownershipdisclosurerulescanbemuchsimplifiedandbetterintegrated.Currently,therearefivedistinct,highlyidiosyncratic,complexSECownershipdisclosureregimes.Thesedisclosureregimesapplyrespectivelytolargeactiveshareholders(Schedule13D),largepassiveshareholders(Schedulel3G),institutionalinvestorsgenerally(Form13F),insidersand10%shareholders(Section16),andmutual19funds.Ourproposalswouldsignificantlysimplifythiscomplexscheme,andmovetowardanintegratedsystemforshareownershipdisclosurethatbuildsonexistingSection16andmutualfunddisclosurerules.Betterintegrated,moreconsistentownershipdisclosurerulescouldwellreducecompliancecostsandbeworthwhileonthisbasisalone,quiteapartfromtheirroleinaddressingthenewvotebuying.Inproposingdisclosurereforms,wetakeasgiventherougheconomicandpoliticallogicbehindthecurrentrules.Wedonotrevisitwhetherlargeshareholdersormajorinstitutionsshoulddisclosetheirsharepositions,northethresholdlevelsforthisdisclosure.Whiletheoptimalityofthesethresholdsiscontestable,webelievethattheyareatleastreasonable.Wealsobelievethatwhateverthethresholdsare,thedisclosurerulesshouldbeinternallyconsistent.Moreover,thepoliticalhistoryofdisclosure,intheUnitedStatesandelsewhere,suggeststhatourpoliticalsystemwillnottoleratehiddencontrolofmajorcompanies,norcontrolcontestswagedbehindcloseddoors.Sodisclosuretherewillbe.Ouraimistomakethatdisclosurecoherent,simple,andrelativelylow-cost.Asaregulatoryresponsetohidden(morphable)ownership,disclosurealonemaysuffice.Foremptyvoting,additionalresponsesmayalsobeneeded.Still,weconsideritprematuretogobeyonddisclosureatthispoint.Onereasonisthatemptyvotingcansometimesbebeneficialandsometimesnot,dependingonthecircumstances.Ontheproblematicside,emptyvotingbyinsidersislikelytofacilitateentrenchmentandundermineexternaloversight.Emptyvotingwithnegativeeconomicinterestisalsotroubling,asinthePerry-Mylanexample.Onthepositiveside,hedgefundscanuseemptyvotingtoinfluencegovernanceatunderperformingcorporations.Oversightofcompanymanagersbylargeshareholdersisoftenconsideredtobebeneficial,butis19.WediscusstheserulesinfrainPartIV. 2006]NEWVOTEBUYING821oftenineffective.2oEmptyvotingcouldletvotesmovefromlesstobetterinformedhandsand,thus,couldenhancetheeffectivenessofshareholderoversight.21Laxey'srecorddatecaptureatBritishLandprovidesapossibleexampleoftheefficiency-enhancinguseofdecoupling.Ofcourse,thosewhotakealessbenignviewofinvestoractivismandthemarketforcorporatecontrolwouldlikelydisagree.Forinstance,MartinLiptonhasclaimedthathedgefunds,institutionalinvestors,and"abusive"takeoverscausemanagerstofocustoomuchonshort-termresults.22Underthisview,decouplingbyoutsideinvestorswouldexacerbatethisproblem.Wedonotaddressheretheoptimallevelofshareholderoversightofcorporatemanagers;wemerelynotethatmanyobserversbelievethatmoreoversightwouldbebeneficialonbalance.Asecondproblemwithsomepotentialregulatoryresponsesisthatthevarietyofhedgingstrategiesandthesubstitutabilityofonestrategyforanothermakerestrictionsonemptyvotinghardtodraftandhardtoenforce.Enhanceddisclosuremayprovidetheinformationneededtowritesubstantiverulestolimitemptyvoting,butwearenotthereyet.Longerterm,severalfamiliesofstrategiescouldpotentiallyaddressemptyvoting.Onefamilyfocusesdirectlyonvotingrights.Thekeyquestionis:underwhichcircumstancesshouldthevotingrightsofanemptyvoterbelimitedordeniedaltogether?Oneincrementalstrategywouldletcorporationsamendtheircharterstolimitemptyvoting.Changesinfederalproxyrulesandstockexchangerequirementsmaybeneededtoallowthis.Midstreamcharteramendmentstoaddressemptyvotingcould20.See.e.g.•ROBERTA.G.MONKS&NELLMINOW,CORPORATEGoVERNANCE(2001);BernardS.Black,AgentsWatchingAgents:ThePromiseofInstitutionalInvestorVoice,39UCLAL.REv.811,830-49(1992).21.SeeSusanE.K.Christoffersen,ChristopherC.Geczy,DavidK.Musto&AdamV.Reed,VoteTradingandInformationAggregation(Jan.20,2(05)(unpublishedmanuscript),availableathttp://ssrn.com/abstract=686026.22.See.e.g.,MartinLipton&StevenA.Rosenblum.ANewSystemofCorporateGovernance:TheQuinquennialElectionofDirectors,58U.CHI.L.REv.187,210(1991)(arguingthatmanagersseekingtosatisfytheshort-termexpectationsofinstitutionalinvestorssacrificeinvestmentsforthefuture,suchasresearchanddevelopmentandcapitalexpenditures);MartinLipton,IsThistheEndofTakeovers?,WASH.POST,Nov.6,1988,atH2(referringto"abusive"takeoversas"forcing[Americancompanies]tofocusonshort-termstockmarketresults");MartinLiptonetal..Wachtel!,Lipton,Rosen&Katz,BePreparedforAttacksbyHedgeFunds(Dec.21,2005).http://www.realcorporatelawyer.com/pdfs/wlrk122205-02.pdf(referringtohedgefundattackersas"self-seeking,short-termspeculatorslookingforaquickprofitattheexpenseofthe.companyanditslong-termvalue").Foranearlydiscussionoftheshort-termismclaim(andtherelatedissueofconflictsamong"generations"ofshareholders),see.forexample,Hu,NewFinancialProducts,supranote4,at1278-87. 822SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811beproblematic,however.Companiesmightproposerulesthatallowemptyvotingstrategiesusedbyinsiders,whileblockingstrategiesusedbybothersomeoutsiders.Themechanicsofshareholdervoting-thevotingarchitecture-alsoneedrethinking.Thesemechanicsdonoteasilyaccommodatelarge-scalesharelendingprogramsinvolving,evenforasingleinstitutionalowner,diverselendingarrangementsandmultipledecisionmakers.Forexample,someinstitutionalinvestorswholentBritishLandsharestoLaxeywerenot23awaretheyweredoingso,includinggovernanceactivistHermes."Overvoting"ofshares(inwhich,ineffect,asharelenderandashareborrowerseektovotethesameshares)isanotherproblemarea.Athirdfamilyofstrategiesfocusesonsupplyanddemandforcesrelatingtothenewvotebuying.Onesimplestepwouldbeasafeharbortoallowpensionfundsandotherinstitutionstorecalllentsharesaroundvotingrecorddatesinordertovotetheirshares.Regulatorscouldalsopotentiallyrequireinstitutionalinvestorstorecalllentsharesandvoteinimportantelections,orotherwisetightenrulesgoverningsharelending.Changesincapitaladequacy,tax,andotherrulesrelatingtoequityderivativesandsharelendingcouldmaketheseactivitieslessattractive.ThisArticleproceedsasfollows.PartIIunpacksthefunctionalelementsofthenewvotebuyingandcollectsthepublicexampleswehavebeenabletolocate.PartIIIdescribesthetraditionalcontextsfortheanalysisofvotebuyingandreviewsthetheoreticalandempiricalliteraturethatbearsondecoupling.PartIVdiscussesthecurrentownershipdisclosurerulesandproposesasimpler,morecomprehensive,"integratedownershipdisclosure"regime.PartVoffersamenuoflonger-termresponsesthatgobeyonddisclosure.PartVIconcludes.ThisArticlehastwoshortercompanions.Oneisdirectedatanacademicfinanceaudience.24Thesecondisdirectedatlegalpractitioners23.SeeJennyDavey.LaxeyFacesDefeatinAttempttoBreakUpBritishLand,TIMES(London),July17,2002,at23(Business);MartinDickson.NotCityCricket,FIN.TIMES(London),Sept.28,2004,at22(Companies)(reportingonHermes).24.AninitialversionofourthreearticleswasfirstpresentedpubliclyinMay2005,attheannualmeetingoftheAmericanLawandEconomicsAssociation.SeeHenryT.C.Hu&BernardS.Black,EmptyVoting:ShareholderVotingRightsandCoupledAssets(2005)(unpublishedmanuscript,onfilewithauthors).SubsequentversionswerepostedonSSRN,beginningonJanuary6,2006.SeeHenryT.C.Hu&BernardS.Black,HedgeFunds.Insiders,andEmptyVoting:DecouplingofEconomicandVotingOwnershipinPublicCompanies(EuropeanCorp.GovernanceInst.,LawWorkingPaperNo.5612006,2006),availableathttp://ssm.comlabstract=874098[hereinafterHu&Black,HedgeFundsandEmptyVoting]. 2006]NEWVOTEBUYING823andregulators.25Asfarasweareaware,thisArticleanditscompanions~:arethefirstattempttosystematicallyaddressthenewvotebuyinganditscorporategovernanceimplications.26II.THETECHNOLOGYOFTHENEWVOTEBUYINGA.THEFuNCTIONALELEMENTSOFTHENEWVOTEBUYINGIntheirclassic1983articleonvotingincorporatelaw,FrankEasterbrookandDanielFischelstatedthat"[i]tisnotpossibletoseparatethevotingrightfromtheequityinterest"andthat"(s]omeonewhowantstobuyavotemustbuythestocktoo.'>27Thiswasanoversimplification,butonlyabit.Forthemostpart,votingrightswereinextricablylinkedtoshares.Withthenewvotebuying,incontrast,theeconomicreturnonsharescanbeseparatedfromtherelatedvotingrights.Thederivativesrevolutioninfinance,combinedwiththegrowthofthesharelendingmarket,ismakingthedecouplingofeconomicownershipfromvotingrightsevereasierandcheaper.28Moreover,withtheriseofhedgefundsandtheiradoptionofshareholderactivismasaninvestmentstrategy,decouplingmayhavefounditsmuse.Thevarietyofdecouplingstrategiescanbeoverwhelming.Wethereforebeginbyspecifyingthecorefunctionalelementsofthenewvotebuying.ThroughoutthisArticle,weassumeasimplecontext:apubliclyheldcorporationwithoneclassofcommonshares(eachsharecarryingonevote),anddiversifiedshareholderswithhomogeneouspreferencesandexpectations.Wefocusonshareholderwealthmaximizationasacorporate25.HenryT.C.Hu&BernardS.Black,EmptyVotingandHiddenOwnership:Taxonomy,Implications,andReforms,61Bus.LAW.(forthcoming2006),availableathttp://ssrn.comlabstract=887183.26.See,e.g.,DavidMarcus,HedgeFundVoting:TheDevilWeDon'tKnow,CORP.CONTROLALERT,Mar.-Apr.2006,at10.OtherarticlesorworkingdraftsinthelegalliteraturethathaveeitherdiscussedortouchedonthisissueincludeShaunMartin&FrankPartnoy,EncumberedShares,2005U.ILL.L.REv.775;DavidSkeel,BehindtheHedge,LEGALAFFAIRS,Nov.-Dec.2005,at28;MarcelKahan&EdwardB.Rock,HedgeFundsinCorporateGovernanceandCorporateControl(Apr.9,2006)(preliminarydraft,onfilewithauthors).27.FrankH.Easterbrook&DanielR.Fischel,VotinginCorporateLaw,26J.L.&EeON.395,410(1983).28.WediscussthesesupplyanddemandfactorsirifrainParts1I.EandV.D. 824SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811goalandleaveasidenonshareholderconstituencies.29Wesometimesrefertoanoutsideinvestorwhoengagesinnewvotebuyingasa"hedgefund,"andanofficer,director,orcontrollingshareholderwhodoessoasan"insider."Toproceedfurther,ithelpstodefineasetofterms.By''formalvotingrights,"wemeanthelegalrighttovotesharesundercompanylaw(assupplementedbyrulesgoverningvotingofsharesheldinstreetname),includingthelegalpowertoinstructsomeoneelsehowtovote.Thus,inthecommonsituationwhereabrokerholdssharesinstreetnameforacustomer,thecustomerhasformalvotingrightsbecauseithastherightunderstockexchangerulestoinstructthebrokerhowtovotethecustomer'sshares.By"votingrights"or"votingownership"ofshares,werefertoeitherformalorinformalrightstovoteshares,includingthedefactopowertoinstructsomeoneelsehowtovote.InPerry-Rubicon,Perryhadvotingrightsbecause,asapracticalmatter,ithadthepowertoreturntoitsderivativesdealersatanytime,unwinditsequityswaps,andobtainthevotingsharesfromthedealers.3oThecompanyatwhichvotingtakesplaceisthe"hostcompany."By"economicownership,"wemeantheeconomicreturnsassociatedwithshares.Thisownershipcanbeachieveddirectlybyholdingshares,orindirectlybyholdinga"conpledasset"thatconveysreturnsthatrelatedirectlytothoseontheshares.Economicownershipcanbeeitherpositive-thesamedirectionasthereturnonshares,ornegative-theoppositedirectionfromthereturnonshares.Someonewhoownsvotingshareshas''fnllownership,"consistingofvotingownershipplusdirecteconomicownership.Theseparationofvotingrightsfromeconomicownershipoftendependsoncombiningeconomicownershipofshareswithownershipofacoupledasset.Coupledassetsincludederivatives(suchasoptions,futures,andequityswaps)andotherfinancialproducts,aswellascontractualrights(suchasrightsunderashareloanagreement).Thecoupledassetcould29.Wealsogenerallyleaveasidethedistinctionsbetweenthewelfareofthecorporationandthewelfareoftheshareholder,betweenshareholderwelfareandshareholderwealth,conflictsinvolvingdifferentkindsofshareholders(forexample,diversifiedversusundiversified,hedgedversusunhedged,andholdersofgeneralcommonstockversusholdersoftrackingstockversusholdersofpreferredstock),andconflictsamongdifferent"generations"ofshareholders(forexample,shorttermversuslongterm).See,e.g.,Hu,BehindtheCorporateHedge,supranote4;HenryT.C.Hu,HedgingExpectations:"DerivativeReality"andtheLawandFinanceoftheCorporateObjective,73TEx.L.REv.985(1995)[hereinafterHu,HedgingExpectations].30.WediscussthePerry-RubiconexamplesuprainPartIandinfrainPartII.C. 2006]NEWVOTEBUYING825eitherincreaseordecreaseeconomicownership.Investorsmayalsohold"relatednon-hostassets"-assets,oftensecuritiesofanothercompany,whosevalueisrelatedtothevalueofthehostcompany'sshares.Forexample,ifthehostcompanyplanstoacquireatargetinashare-for-sharemergerwithafixedexchangeratio,thetarget'ssharesarearelatednonhostasset.By"neteconomicownership/~wemeanaperson'scombinedeconomicownershipofhostsharesandcoupledassets.Thisnetownershipcanbepositive,zero,ornegative.Wecharacterizeas"emptyvoters"anypersonswhosevotingrightssubstantiallyexceedtheirneteconomicownership.Thelevelofneteconomicownershipmaydependonshareprice.Suppose,forexample,thatacompany'ssharestradeat$50,andanexecutiveentersintoazero-costcollarthatcapsupsideat$60anddownsideat$45.Theexecutivewillretainpartialeconomicownership,whichwillbehigherforsharepriceswithinthe$45to$60rangethanoutsidethisrange.Thecombinedreturnfromhostshares,coupledassets,andrelatednon-hostassetsproduceswhatwecallan"overalleconomicinterest"intakingactionsthataffectfirmvalue,whichcanbepositive,zero,ornegative.InthePerry-Mylanexample,PerrycombinedfullownershipofMylanshareswithcoupledassets(equityswapsandotherhedges),whichoffsetitseconomicownership.Thisleftitwith9.9%votingownershipandzeroneteconomicownership:[9.9%fullownershipofshares]-[9.9%economicownership(throughcoupledassets)]=[9.9%votingownership+9.9%economicownership]-[9.9%economicownership]=[9.9%votingownership]Perryalsoheldarelatednon-hostasset-sharesofKingPharmaceuticals.Perrywasleftwithfullvotingrights,butanegativeoveralleconomicinterest-itwouldprofitifMylanoverpaidforKing,31Ifapersonhaseconomicownershipthatdisclosurerulesdonotcover(orcanreasonablybeinterpretedbythepersonasnotcovering),wecallthis''hiddenownership."Ifinpractice,thishiddenownershipincludes31.WediscussthisexampleandprovidecitationsinfrainPartI1.B. 826SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811informalvotingrights,wetermthis''hidden(morphable)ownership."These''morphablevotingrights"willgenerallynotbeverifiablebyoutsiders,anddependonmarketcustoms.Perry'shidden(morphable)ownershipofRubiconoffersanexample.Whateverformnewvotebuyingtransactionstake,onlythecompanycanalterthetotallevelofvotingrightsoreconomicownership.Ifoneinvestoracquiresmorevotingrightsthaneconomicownership,someoneelsemustholdmoreeconomicownershipthanvotingrights.Table1offerssomeillustrativeexamplesoftheprincipalformsofthenewvotebuying. 2006]NEWVOTEBUYING827TABLE1.SomeformsofnewvotebuyingExamplesofsomeformsofnewvotebuying.Theseexamplesareillustrativeonly.ThePerry-Mylan,Laxey-BritishLand,insiderhedging,andPerry-Rubiconexamplesarediscussedabove.Theotherexamplesarediscussedbelow.RelatedNetOverallVotingEconomicCoupledNon-ExampleEconomicEconomicOwnershipOwnershipAssethostOwnershipInterestAssetEmp/vVotin~EquityYesShareownershiphedgedwithYesDirectswaps,No(targetNegativeequityswap(Perry-MyIan)othersshares)ShareownershiphedgedwithShortcalloptions(ColesMyerproxyYesDirectZeroNoZero+longputfight)ShareownershiphedgedwithYesNotrelatednon-hostassetYesDirectPossibleNotknown(acquirerknown(MONY-AXA)bonds)Recorddatecapture(Laxey-YesDirectYesShareloanNoLowBritishLand)(high)(low)(low)RecorddatecapturefollowedShareloanbyshort-sale(HendersonYesNegative+shortNegativeNoNegativeInvestment)saleDirectEquityPositivePositiveInsiderhedgingYesNoI(lowered)derivatives(lowered)(lowered)PositiveDeutscheBoerse-LondonorYesStockExchange(forhedgenegative,YesDirectNoYes(targetfundsthatwerelongacquirerdependingshares)sharesandshorttargetshares)onstakeintargetHidden(Momhable)OwnershipInformalrightVotingrightsexercisedbytoacquireEquityYesNoHighacquiringshares(PerrysharesfromIndirectswapsRubicon)derivativesdealersInformalrighttodirectVotingrightsexercisedbyderivativesEquitydirectingvotesofothersIndirectYesNoHighdealers'swaps(Marks&Spencer)matchedsharesEliminatingvotingrights:DependedonmorphingbetweendefactosuccessofDirectShareloanYesNoHighandnovotingrightstakeoverbid(LivedoorlNippon) 828SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811B.EMPTYVOTINGTHROUGHCOUPLEDASSETSWeexamineinthissectiontoanexaminationofthemechanicsofemptyvotingachievedthroughcoupledassets.SectionCaddresseshiddenownership.SectionDaddressessomeextracomplexitiesintroducedbyrelatednon-hostassets.1.EmptyVotingThroughEquityDerivativesa.Perry-MylanLaboratoriesandSimilarExamplesAsoflate2004,PerryCorporationowned7millionsharesofKingPharmaceuticals,agenericdrugmaker.MylanLaboratoriesagreedtoacquireKingPharmaceuticalsinastock-for-stockmerger.Ifthemergerclosed,Perrywouldmakea$28millionprofit.Tocompletethemerger,however,MylanLabsneededshareholderapproval,andMylan'sshares32haddroppedsharplywhenthedealwasannounced.Perry,therefore,boughta9.9%stakeinMylan,whichitcouldvoteinfavorofthemerger,buthedgeditseconomicownershipthroughequityswapsandotherunspecifiedtransactions.Inanequityswap,the"long"sidereceivesfromthe"short"sideaneconomicreturnequivalenttothereturnontheunderlyingshares.PerrytookashortequityswappositioninMylan;thederivativesdealerslikelyhedgedtheirlongposition,perhapsbysellingMylansharesshort.Asecondhedgefund,Citadel,wasrumoredtohavefollowedthesamestrategyasPerry.33Carlkahn,amajorMylanshareholder,opposedtheacquisition.HesuedMylanandPerryunderfederalsecuritieslaw,includingSection13(d).34HeclaimedthatPerryandotherunnamedhedgefundshadacquired19%oftheMylanvotes,withnoeconomicownership.Ifso,Perry32.Insomecases,ourdescriptionsinthisArticleofnewvotebuyingexamplesrelyinpartonnewsreportsthatrefertomarketrumorsorothersourceswhichmaynotbeaccurate.OurdiscussionofthePerry-MylansituationisbasedonPerryCorp.,Schedule130astoMylanLaboratories,Inc.(Nov.19,2004);Complaint,HighRiverLtd.P'shipv.MylanLabs.,Inc.,353F.Supp.2d487(M.D.Pa.Dec.10,2004)(No.04-2677)[hereinafter,kahnComplaint];JesseEisinger,IcahnCriesFoulatPerry'sNo-riskPlayinTakeoverFight,WALLST.1.,Dec.15,2004,atCI;ChristopherFaille,PerryPlanstoSellStakeinMylan,HEDGEWORLDDAILYNEWS,Mar.23,2005;AndrewRossSorkin,IcahnAccusesaHedgeFundofStockManipulation,N.Y.TIMES,Dec.13,2004,atCI;AndrewRossSorkin,NothingVentured,EverythingGained,N.Y.TIMES,Dec.2,2004,atCI[hereinafterSorkin,NothingVentured].33.SeeAndrewRossSorkin,ForaTakeoverArtist,OneBluffTooMany?,N.Y.TIMES,Nov.28,2004,§3,at6;ScottStuart,Mylan,KingandMurphy'sLaw,CORP.CONTROLALERT,Apr.2005,at8.InFebruary2005,afterMylanabandoneditsacquisitionplans,Citadelsoldits4.4%stakeinMylan.BusinessBriefs,PITTSBURGHPOST-GAZETTE,Feb.15,2005,at08.34.SeeIcahnComplaint,supranote32. 2006]NEWVOTEBUYING829andkindredinvestorshadanegativeoveralleconomicinterestinMylan.TheywouldwantMylantocompletethedealevenifMylan'svaluesuffered.ThelawsuitbecamemootwhenMylanabandonedtheacquisitionbecauseofaccountingproblemsatKing.35Severalotheranecdotescanillustrateemptyvotingthroughhedgedsharepurchases.In2004,FrenchinsurerAXAenteredintoamergeragreementtoacquireMONY.Tofinancethebid,AXAissuedconvertiblebonds,whichwereconvertibleintoAXAsharesatadiscounttoAXA'spriceonlyifAX.AacquiredMONY.HoldersofAX.AbondsapparentlyacquiredMONYsharestovoteforthemerger,whileshortsellersofAXAbonds(includingtheHighfieldsCapitalhedgefund)acquiredMONYsharestoopposethemerger.BothgroupsmayhavehedgedtheirMONYpurchases;neithergroupvotedbasedonwhetherthemergerwasgoodforMONY.36Inthe2002proxyfightbetweenWalterHewlettandHewlettPackard("H-P")overH-P'sproposedmergerwithCompaqComputer,whichMr.Hewlettopposed,therewererumorsthatCompaqshareholdersacquiredhedgedH-Ppositionsinordertovoteforthemerger.37Emptyvotingmighthaveaffectedtheoutcomeofthisextremelyclosevote.Ina2002proxycontestatAustralianfirmColesMyer,investorSolomonLewheld3%ofColesMyer'sshares.Tosupporthisproxycampaign,heacquiredanother4%oftheshareswhilehedginghiseconomicownershipwith(shortcall,longput)optionspositions.38Thesestrategiesaretroubling.Manyacquisitionstumoutpoorlyfortheacquirer.39ThemajorU.S.stockexchangesrequiretheacquirer'sshareholderstoapprovealargestock-for-stockmerger.Yetinpractice,the35.TaraCroft,Mylan:KingDealDoomed,DAILYDEAL,Jan.12,2005.MylandroppeditsplanstoacquireKinginFebruary2005.InMay2005,PerrydisclosedthatithadsolditsMylanshares.SeeIcahn&Co.:IcahnDiscontinuesLitigationAgainstPerryCorp.andMylanLaboratories,PHYSICIANL.WKLY.,June29,2005,at9.36.SeeInreMaNYGroup,Inc.S'holderLitig.,853A.2d661(Del.Ch.2004);InreMaNYGroup,Inc.S'holderLitig.,852A.2d9(Del.Ch.2004).AXAissuedthebondstofinanceitsacquisitionofMaNY.37.SeekahnComplaint,supranote32,at4;Sorkin,NothingVentured,supranote32.38.SeeLouiseMcCoach,TheGlencoreDecision:ACaseforRefonn?(Nov.2005)(unpublishedmanuscript,onfilewithauthors)[hereinafterMcCoach2005];LouiseMcCoach,TheGlencoreDecision:ACaseforRefonn?AnUpdate(Mar.2006)(unpublishedmanuscript,onfilewithauthors)[hereinafterMcCoach2006](discussingColesMyerandotherAustraliannewvotebuyinginstances).39.See,e.g.,ROBERTF.BRUNER,DEALSFROMHELL:M&ALESSONSTHATRISEABOVETHEASHES(2005);RONALDJ.GILSON&BERNARDS.BLACK,THELAWANDFiNANCEOFCORPORATEACQUISITIONS363-97(2ded.1995);SaraB.Moeller,FrederikP.Schlingemann&ReneM.Stulz,WealthDestructiononaMassiveScale?AStudyofAcquiring-firmReturnsintheRecentMergerWave,60J.FiN.757(2005). 830SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811acquirer'sshareholdersrarelyvotedownevenanapparentlyoverpricedmerger.Emptyvotingontheacquirer'ssidebythetarget'sshareholders,employedifthevoteislikelytobeclose,couldreducewhateverconstraintthevoterequirementnowinstillsontheacquiringfirm.Moreover,emptyvotingcanreadilybeextendedtoproxyfightsforcontrol.Neithersidecanbecountedontoplayfairandsimplysolicitshareholdervotes.Thetemptationtobuyvotesquietlywillbestrong,especiallyiftheothersidemaybedoingso.Clevernessinvotebuying-acharacteristicnotnecessarilyassociatedwiththeabilitytorunthecompanywell-maybecomecentraltoproxyfightsuccess.b.LibertyMedia-NewsCorporationMoresubtledecouplingcanalsoplayaroleincorporategovernance,asshownbyLibertyMedia'sacquisitionofalargestakeinRupertMurdoch'sNewsCorporation("NewsCorp.").InJanuary2004,LibertyMediafIledaSchedule13Dstatingthatithadrecentlybought125millionvotingNewsCorp.shares.4oAfterthesepurchases,LibertyMediaowned192million(9.1%)ofNewsCorp.'svotingshares,secondonlytotheMurdochfamily's30%.LibertyMediaalreadyowned843millionnonvotingshares,foracombinedholdingof"approximately17.4%oftheoutstandingequity.,,41LibertyMediaalsodisclosedthatithadenteredintoaforwardcontracttosell152millionvotingsharestoCitibankinthree40.OurdiscussionofthisexampleisbasedonLibertyMediaCorp.,Schedule13DastoNewsCorporationLimited(Jan.20,2004)[hereinafterLibertyMedia,January200413D];LibertyMediaCorp.,ScheduleI3D/A(AmendmentNo.I)astoNewsCorporationLimited(Nov.3,2004);TimBurt,PrincePledgestoAidMurdoch,FiN.TIMES(London),Nov.18,2004,at32(Companies);GeraldineFabrikant,lnSurprise,LibertyMediaFattensStakeinNewsCorp.,N.Y.TIMES,Jan.22,2004,atCI;GeraldineFabrikant,LibertyMediaFuelsSpeculationbyAddingtoNewsCorp.Stake,N.Y.TIMES,Jan.23,2004,atC3;MikeFarrell,WhyLibertyHaltedIts"Forward"Pass,MULTICHANNELNEWS,Sept.26,2005,at65;MartinPeers,NewsCorp.'sNetIncreasesby27%onTVStrength,WALLST.J.,Nov.4,2004,atB3;MartinPeers,NewsCorp.OffersAbout$5.7BilliontoBuyRestofFox,WALLST.J.,Jan.II,2005,atC4;RobertBennettetal.,LibertyMediaGroup,ConferenceCallonQ32004LibertyMediaGroupEarnings(Nov.9,2004),inFD(FAIRDISCLOSURE)WIRE,Nov.2004;LibertyMediaCorporationAnnouncesEarlyTerminationofTotalReturnSwapwithMerrillLynch,PRNEWSWIRE,Dec.20,2004,http://www.pmewswire.comlcgi-bin/stories.pl?ACCT=I04&STORY=/www/story/1220-2004/0002669843&EDATE=[hereinafterEarlyTermination].41.Technically,LibertyMediaheldtwokindsofAmericanDepositoryReceipts("ADRs").OneADRrepresentedfour"OrdinaryShares"-shareswithfullvotingrights.WerefertoOrdinarySharessimplyas"votingshares."TheotherADRrepresentedfour"PreferredLimitedVotingShares"-shareswithlimitedvotingrights.Werefertothesesharessimplyas"nonvotingshares."SeeLibertyMedia,January200413D,supranote40,at2.InNovember2004,NewsCorp.reincorporatedinDelawareanditsnew"classA"(nonvoting)sharesand"classB"(voting)sharesbegantradingontheNewYorkStockExchange.NewsCorp.,Form8-K,Exhibit99.1(Nov.12,2004)("NewsCorporationCompletesReincorporationtoUnitedStates."). 2006]NEWVOTEBUYING831tranchesbeginningin2008forafixedprice,thushedgingmostofitseconomicinterestinthevotingshares.Yet,inourterminology,LibertyMediawasnotanemptyvoterbecauseitsoveralleconomicownership42exceededitsvotinginterest.LibertyMediahassincecontinuedtomodulateitseconomicandvotingownershipofNewsCOrp.43c.InsiderHedgingandEntrenchmentCorporateexecutivesandcontrollingshareholdersareoftenilldiversified.Theseinsidersoftenwanttoreducetheireconomicexposuretothefirm'sshares-hopefullywithoutcausingpublicconcernthatinsidersarebailingout,triggeringataxbill,or,forcontrollingshareholders,givingupcontrol.Highlevelsofinsiderownershiparereasonablycommon.OnesurveyofNewYorkStockExchange("NYSE")-listedcompanieswith2001revenuesbetween$250millionand$1.5billionfoundthatmorethanoneintenhadchiefexecutiveofficerswhoownedmorethan10%oftheirshares.44Inabouthalfofthosecompanies,insidersheldmorethan50%oftheshares.Thislackofdiversificationwilloftencauseinsiderstobemoreaversetofirm-specificriskthandiversifiedoutsideshareholders.45Investmentbanks,forasuitablefee,havedevelopedanumberofstrategiestoaccommodateinsiders'desiretohedgetheireconomicexposure.Onepopularstrategy,knownasazero-costcollar,involvesbuyingaputoption(tolimitdownsideloss)whilesimultaneouslysellinga42.LibertyMediahadnotpreviouslydiscloseditsownershipofnonvotingshares.Thus,inourterminology,ithadhiddenownership.Thisownershipmighthavebeenmorphableaswell,perhapsbyswappingnonvotingsharesforvotingshares,asUbertyMediainfactdidlaterin2004.Seeinfranote43.43.InNovember2004,UbertyMediaenteredintoandpubliclydisclosedanequityswapwithMerrillLynchunderwhich,uponreceivingcertaingovernmentapprovals,LibertyMediawouldacquireabout8%oftheNewsCorp.votingsharesinexchangefornonvotingshares;its17%votinginterestwouldthenroughlycorrespondtoitseconomicinterest.InDecember2004,UbertyMediaannounceditwouldterminatetheswapearlyandacquirethevotingshares.EarlyTermination,supranote40.InSeptember2005,oneanalystassertedthatUbertyMediahadhedgeson7%ofitsNewsCorp.votingsharesand19%ofitsnonvotingshares.Farrell,supranote40.44.DennisSimon,InSplittingLeadership,LookatCEOOwnership,DIRECTORS&BOARDS,Winter2004,at24,25.45.Whilecorporateexecutiveswillgenerallyprefertotakelessriskthandiversifiedshareholderswouldconsideroptimal,theoppositemaybetrueincertaincircumstances.Forfurtherdiscussionofthisandrelatedissuessuchaswhenpubliccorporationsshouldhedgeagainstrisksee,for.example,Hu,HedgingExpectations,supranote29,at1024-27,1033-40;Hu,MisunderstoodDerivatives,supranote4,at1492-94;HenryT.C.Hu,Risk.Time,andFiduciaryPrinciplesinCorporateInvestment,38UCLAL.REv.277,287-95,314-32,365--66,385-86(1990). 832SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811calloption(thusreducingpotentialgain).46Suchacollarpreservesvotingrightsbutsharplyreduceseconomicownership.A2001studyreportsthatonaverage,seniorexecutivesinU.S.publiccompaniesusedcollarsfor36%oftheirholdings,andtherebyreducedtheireconomicownershipby25%.47Inthepastfiveyears,executivehedgingappearstohaveincreaseddramatically.48Inshort,theimpactofinsiderdecouplingismixed.Ontheonehand,insiderhedgingmaymitigatetherisk-takingconflictbetweenmanagersanddiversifiedshareholders.Butthesametechnologycouldallowinsiderstoboosttheirvotingcontrolatlittleeconomicrisk,thusweakeningthemarketforcorporatecontrolasadiscipliningmechanism.Tobesure,thereareotherwaysforinsiderstoretaincontrolwhilesheddingeconomicownership,includingdual-classcommonstockandpyramidalownershipstructures.WediscussthesealternativesinPartIII.2.EmptyVotingThroughRecordDateCaptureBeforeashareholdermeeting,acompany'sboardofdirectorsestablishesavotingrecorddate.49Shareholderswhoholdsharesatthecloseofbusinessontherecorddatehavetherighttovoteatthemeeting,whichistypicallyamonthorsoaftertherecorddate.Onewaytoholdvoteswithouteconomicownershipistoholdsharesbuthedgethroughcoupledassets.Asecondwayisrecorddatecapture-borrowingsharesinthesharelendingmarketforalimitedperiodaroundtherecorddate.Sofarasthecompanyisconcerned,theborrowerownstheshares(andtheassociatedvotes).Inatypicalloan,theborrowercontractswiththe46.Ifthecompanypaysnodividendsandtheputandcalloptionshavethesameexercisepriceandexpirationdate,thistransactioniseconomicallyequivalenttosellingshares.Morecommonly,thecalloptionexercisepriceissomewhatabovetheputoptionexerciseprice,hencetheterm"collar"(becauseeconomicexposureislimitedtotherangebetweenthecallexercisepriceandtheputexerciseprice).Inthezero-costversionofthecollartransaction,theproceedsfromthesaleofthecallequalthecostoftheput,sotheinsiderpaysnonetamounttoinitiatethecollar.47.Bettisetal.,supranote8,at346.Anecdotalevidenceisconsistentwiththepervasivenessofsuchhedging.Oneobservernotedin2001thatthedemandforequityderivativesbyAmericanclientshad"exploded."AdamGreen,PeterHolland&CorneliaSpring,WhyWealthyClientsUseEquityDerivatives,RISK,Dec.2001,atSii.PaulAllen,cofounderofMicrosoft,avoidedlosingapproximately$970millionon76millionMicrosoftsharesthroughtheuseofcollars.CompensationResources,REpORTONSALARYSURVEYS,Feb.2001,at8.RobertBelfer,adirectorofEnron,usedcollarstolockinfloorpricesbetween$55and$66forabout1millionEnronshares.CassellBryan-Low,EnronDirectorHedgedBets,WALLST.J.,Feb.20,2002,atC20.48.SeeRonaldFink,Overexposed,CFOMAG.,Apr.2006,at85.49.See.e.g.,DEL.CODEANN.tit.8,§213(a)(2005). 2006]NEWVOTEBUYING833sharelenderto(I)returnthesharestothelenderatanytimeattheelectionofeitherside,and(2)paytothelenderanamountequaltoanydividendsorotherdistributionstheborrowerreceivesontheshares.50TheloanissecuredwithcashorTreasurysecurities.Taxesaside,thisloancontract(acoupledassetinourterminology)leavestheborrowerholdingvoteswithouteconomicownership,whilethelenderhaseconomicownershipwithoutvotes.Atraditionaluseofshareborrowingistofacilitateshort-seIling.51Theborrowersellstheborrowedsharesinthemarket,endingupwithnovotesandnegativeeconomicownership.Later,theshort-sellerclosesouttheshortpositionbybuyingsharesinthemarketanddeliveringthesesharesbacktothesharelender.Butomittheshortsale,andshareborrowingbecomesaneasyroutetoemptyvoting.ThesharesofmostpubliclytradedstocksintheUnitedStatescanbeborrowed.Arecentstudyofwhichshareswereavailableforborrowingfromasinglelargefinancialinstitutionfoundthatstocksthatcouldnotbeborrowedaccountedforlessthan1%ofmarketcapitalization.52Borrowedsharesareusuallycheap--onestudyfindsthatthetypicalcostisaboutfifteenbasispointsperyear.53Thenumberofborrowablesharesisoften50.Foradiscussionofcustomarysharelendingpractices,see,forexample,BONDMKT.ASS'N,MASTERSECURITIESLoANAGREEMENT(2000)(underU.S.law);INT'LSEC.&LENDINGASS'N,GWBALMASTERSECURITIESLENDINGAGREEMENT(2000)(underU.K.law);GeneD'Avolio,TheMarketforBorrowingStock,661.FIN.EcON.271(2002);DarrellDuffie,NicolaeGarleanu&LasseHejePedersen,SecuritiesLending,Shorting,andPricing,66J.FiN.EcoN.307(2002).Fordescriptionsofthesharelendingmarket,seeJeffCohen,DavidHaushalter&AdamV.Reed,MechanicsoftheEquityLendingMarket,inSHORTSELLING:STRATEGIES,RISKS,ANDREWARDS9(FrankJ.Fabozzied.,2004);MarkC.Faulkner,AnIntroductiontoSecuritiesLending,inSECURITIESFiNANCE:SECURITIESLENDINGANDREpURCHASEAGREEMENTS3(FrankJ.Fabozzi&StevenV.Manneds.,2005)[hereinafterSECURITIESFiNANCE&LENDING].Onthehistoryofsharelending,seeKevinBurke&GeorgeMartello,TheEvolutionofSecuritiesLending,inSECURITIESLENDINGANDREpURCHASEAGREEMENTS1(FrankJ.Fabozzied.,1997).51.ByadoptingRegulationSHOin2004,theSECsoughttolimit"nakedshorting,"thepracticeofsellingsharesshortwithoutborrowingthenecessaryshares,thuscreatingtheriskoffailingtodeliversharestothebuyer.SECShortSalesRule,ExchangeActReleaseNo.34-50103,69Fed.Reg.48,008(Aug.6,2004)(amendingoradoptingSecuritiesActRules105,200-203,17C.F.R.§239.105,.200.203(2005))[hereinafterShortSales,ExchangeActReleaseNo.34-50103].Thisefforthasnotbeentotallysuccessful.SeeAaronLucchetti&KaraScannell,DespiteSECRules,aSmallAmountofNakedShortingAppearstoPersist,WALLST.J.,Apr.13,2006,atC1.52.D'Avolio,supranote50,at273.53.SeeChristoffersenetaI.,supranote21.D'Avolio,supranote50,reportsthattheborrowingcostwaslessthan1%peryearfor91%ofthecompaniesinhissample.Borrowingmaybecheaponaverage,butnotineverysituation.Inonerecentcase,CharterCommunicationstooktheunusualstepofissuing150millionsharesinapublicoffering,supposedlytoaccommodatehedgefundsfrustratedbyborrowingcosts.CharterShareIssueApprovedbytheSEC,WALLST.J.,July19,2005,atC3;PeterGrant,SECIsSlowtoApproveCharter'sOddStockSale,WALLST.J.,June24,2005,atC3. 834SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811large---duringsomerecentcorporatebattles,upto20%ofthecompany'sshareswereheldbyborrowers.54TheLaxeyPartners-BritishLandincident,discussedinPartI,offersanexampleofrecorddatecapture.55LaxeysoughtabreakupofBritishLandandopposedthereelectionofBritishLand'schairman.BritishLand'schairmanwasratherdispleasedwithwhathecalledLaxey's"rent-a-vote"strategy.56Therewasironyallaround.BritishLandsawLaxeyasabusingthevotingsystem,whileLaxeyperceiveditselfascallingweakmanagementtoaccount.Meanwhile,fundmanagerHermes,oneoftheCity'schampionsofgoodcorporategovernance,was(unknowingly)oneofthelenders.Hermesdidapologize.Inearly2006,afarmorequestionableuseofrecorddatecaptureappearstohaveoccurredinHongKong.HendersonLandofferedtobuythe25%minorityinterestinHendersonInvestment,apubliclyheldaffiliate.57Mostminorityshareholdersfavoredthebuyout,andHendersonInvestment'ssharepriceincreasedsubstantially.UnderHongKonglaw,however,thebuyoutcouldbeblockedbyanegativevoteof10%ofthe"freefloating"shares-inthiscaseabout2.5%oftheoutstandingshares.Toeverybody'ssurprise,2.7%oftheshareswerevotedagainstthebuyout.HendersonInvestmentssharesfell17%thedayafterthevotingoutcomewasannounced.Whathappened?ItappearsthatoneormorehedgefundsborrowedHendersonInvestmentsharesbeforetherecorddate,votedagainstthe54.SeeKateBurgess&JamesDrummond,TransparencyFindsaHigh-levelChampion:ACaptainofIndustryCallsonInvestorstoLeadbyExampleonAccountability,FIN.TIMEs(London),Apr.22,2005,at22(Companies).55.OurdiscussionoftheLaxeyPartners-BritishLandsituationisbasedonRorianGimbel,TheBigPicture:UneasyBedfellowswithMoneyinMind:DoesInvestinginHedgeFundsCompromisePensionFunds'CorporateGovernanceActivity?,FIN.TIMES(London),Apr.19,2004,at3(FTReport);JimPiccitto,LaunderingMoneyintheFreeWorld,GLOBALINVESTOR,Dec.1,2004,atSS36;JohnRitblat,LettertotheEditor,BritishLandBuy-backWellUnderWay,FIN.TIMES(London),Jan.13,2003,at18;SimonTargett,TopPensionFundsPlanSecuritiesLendingCode,FIN.TIMES(London),June14,2004,at1(FfReport);JohnWaples,RitblatHitsatCSFBandLaxeyforVote"Conspiracy,"SUNDAYTIMES(London),July21,2002,atI(Business).Gimbel,supra,suggeststhatLaxeyacquiredvotingpowerthroughacombinationofrecorddatecaptureandotherstrategies.56.SeeRitblat,supranote55.57.OurdiscussionoftheHendersonInvestmentsituationreliesonAsianHedgeFundsUndermineLending,INT'LSEC.FIN.,Mar.I,2006,at10(1);PatriciaCheng,HedgeFundsFindLoopholeinH.K.,INT'LHERALDTRm.,Feb.16,2006,at18;FrancescoGuerrera&RorianGimbel,HendersonStockLendingFears,FIN.TIMES(Asiaed.),Feb.1,2006;AlexFrewMcMillan,HongKongStudyingVotingIssuesonBorrowedShares,lNFovEsT21NEWS,Jan.25,2006.Thenewsreportsdonotnamethehedgefundthatmayhavesingle-handedlyblockedthebuyout. 2006]NEWVOTEBUYING835buyout,andthensoldthosesharesshort,thusprofitingfromitsprivateknowledgethatthebuyoutwouldbedefeated.Onehedgefundalonemayhaveheldenoughsharestodefeatthebuyout.HendersonInvestmentinvolveselementsredolentofbothLaxeyBritishLandandPerry-Mylan.AswithLaxey-BritishLand,hedgefundsusedrecorddatecapturetoobtainvotes.AswithPerry-Mylan,oneormorehedgefundsheldanegativeoveralleconomicinterest-~)fmoreprecisely,wouldhavenegativeeconomicownershipbythetimethevotingoutcomewasknown.Thesehedgefundshareholdersapparentlyblockedadealthatwouldbenefitothershareholders.Considernextavariantonrecorddatecapture.Ifsharescannotbeborrowed,analternativevotecapturetechniqueisavailablethatpromisesnearlyemptyvoting.Aninvestorcanbuysharesjustbeforetherecorddateandsellthemsoonthereafter.Theinvestorincursround-triptransactioncosts,buthaseconomicownershipforonlyashortperiodoftime.Theinvestorcanhedgethislimitedriskfullybybuyingputoptionsontheshares(acoupledasset),orpartiallybyshortingabroadshareindexoranindustryindex(arelatednon-hostasset).Short-termownershipplussuchahedgeentailsfullyorsubstantiallyemptyvoting.Thetimingofthislimitedownershipfurtherattenuatesthelinkbetweeneconomicownershipandvotingrights.Therecorddateiswellbeforethedateatwhichvotesarecast.Thereisnoreasontoexpectcompany-specificnewsontherecorddate.Bythetimethevotingoutcomeisknown,theinvestorwillhaveshedanyeconomicexposure,andwillsuffernoilleffectsfromvotinginwaysthatreducefirmvalue;indeed,asinHendersonInvestments,theinvestorcouldevengainfromdoingso.58WediscussinPartVtheeffortsbypensionfundsandothersharelendersintheUnitedKingdomtorespondtorecorddatecapture.58.WethusdisagreewithEasterbrookandFischel,whoignorethedifferencebetweentherecorddateandthevotingdate.Theyclaimthatapersonwhobuysshares"thedaybeforetheelection,votesthem,andsellsthedayaftertheelection"willbear"thegainsorlossesattributabletotheelection."Easterbrook&Fischel,supranote27,at411nAI.Thisissimplynotso. 836SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811C.HIDDEN(MORPHABLE)OWNERSHIP1.MorphingfromdeFactotoFormalVotingRightsa.AccesstoDerivativesDealers'MatchedSharesEquityderivativescanalsobeusedtoavoiddisclosingeconomicownershipunderdisclosurerulesthattumlargelyonvotingrightsratherthaneconomicownership.Perryhasusedequityderivativesforthispurpose,aswell.59Inearly2001,PerrywasamajorholderofRubiconLtd.,aNewZealandpubliccompany.NewZealandhasrulesrequiringdisclosureof5%ownershippositionsinpubliccompanies,similartoSection13(d).6oInJune2001,Perrygavenoticethatithadceasedtobea5%holderinRubicon.Ayearlater,toeveryone'ssurprise,Perrydisclosedthatitheld16%ofRubicon,havingbought31millionsharesfromDeutscheBankandUBSWarburgjustintimetovoteatRubicon's2002annualgeneralmeeting.WhathappenedduringtheperiodwhenPerryapparentlywasnotasubstantialholderofRubiconshares?InMay2001,Perrysheditsvotingrights,butnotitseconomicinterest.Itsold31millionsharestotwoderivativesdealersandsimultaneouslytookthelongsideofequityswapsfor31millionshares.Perry's16%economicownershipdidnotchange,butitceasedreportingbecause,itclaimed,theequityswapsfelloutsidetheNewZealanddisclosurerules.WhenPerryneededthevotingrights,itterminatedtheswapsandboughtthesharesbackfromthedealers.AlawsuitbyanothermajorRubiconshareholder,challengingPerry'srighttovote,ensued.Thetrialcourt,inrulingagainstPerry,notedinpassingthatPerryhadenteredinto"hundredsofequityswaptransactions.,,61Onappeal,Perry'spositionwasupheld.62InMylan,PerrycoupledthepurchaseofMylanshareswithashortequityswappositiontoachievevotingrightswithnoneteconomicownership.WithRubicon,PerryheldlongequityswapsinRubiconsharestoachieveeconomicownershipwithoutformalvotingpower,whichwould59.OurdiscussionofthePerry-RubiconsituationisbasedonIthaca(Custodians)Ltd.v.PerryCorp.•[2003]2N.Z.L.R.216(H.C.),rev'd,[2004]1N.Z.L.R.731(C.A.);[2004]2N.z.L.R.182(C.A.)(refusingconditionalleavetoappeal).60.Seesupranote10andaccompanyingtext.61.Ithaca(Custodians)Ltd.,2N.z.L.R.216.'j{232.62.Ithaca(Custodians)Ltd.•1N.Z.L.R.731,'j{9. 2006]NEWVOTEBUYING837havetriggereddisclosure.Atthesametime,PerryretaineddefactovotingrightsexercisableatPerry'sdiscretion,becauseitcouldreturntotheinvestmentbanksatanytimeandunwindtheswap.Putanotherway,Perryheld"morphable"votingrights-whichwoulddisappearwhenPerrywantedtohideitsstake,onlytoreappearwhenPerrywantedtovote.HowdidPerryknowthatithadaccesstotheshares?ThedealersneededtohedgetheirexposurefromextendingtheequityswapstoPerry.PerrycouldexpectthemtodosobyholdingthesharestheyhadboughtfromPerry.Anothermeansofhedgingwasunlikely,giventhethinmarketforRubiconsharesandtheneedtoincurtransactioncoststohedgeinanotherway.PerrycouldalsoexpectthebankstohappilysellthesharesbacktoPerrywhenPerrychosetounwindtheequityswaps.EventheNewZealandCourtofAppeal,whichruledinPerry'sfavor,stated:[I]twasalmostcertainthattheshareswouldbesoldtoPerryCorporationupontheterminationoftheswapsifPerryCorporationwishedtobuy,providedthecounterpartiesheldtheshares(...[which]washighlylikely).Weconsiderthatthismarketrealitywouldhavebeenobvioustoanyreasonablyinformedmarketparticipant.Mr.Rosen,headtraderatPerryCorporation,saidinevidencethathehadalwaysthoughtitlikelythattheshareswouldbeheldbythecounterpartiesasahedge.Healsosaidhehadthoughtthat,ifhewantedtoterminatetheswapsandpurchasetheshares,itwouldbecommerciallysoundforthe...counterpartiestosellhimthoseshares.63OnereasontheCourtofAppealconcludedthatdisclosurewasnotrequiredwasthatitbelievedsimilardisclosurewouldnotberequiredinAustralia,theUnitedStates,ortheUnitedKingdom.64Thereareavarietyofwaysforaderivativesdealerholdingtheshortsideofanequityswaptohedgeitsexposure,butholdingmatchedsharesisacommonmeans.65Especiallywhentheequityswapinvolvesalargenumberofsharesinathinlytradedcompany,alternativehedgingstrategiesmaybelimited.Whenthederivativesdealerhedgesanequityswapwithmatchedshares,amarketpracticemaywellbeemerginginwhichbothsidesexpectthatthedealer,ifasked,willeitherunwindtheswapandsellthesharestoitsclient,asPerry'sdealersdid,orvotethematchedsharesas63.!d.'JI66.64.!d.'][77.65.See,e.g.,MichaelD.Dayan&GlenA.Rae,aTeEquityDerivatives:HedgingTransactionsandEquitySwaps,inPRACTICINGLAWINST.,SWAPS&OTHERDERNATIVESIN2004,at284(Edward1.Rosened.2004)(diagramminganequityswapanditshedging). 838SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811itsclientwants.Thecommercialpracticebetweenderivativesdealersandsomeclientsmayextendtothemannerinwhichthedealershedge.66Holdingmatchedsharestohedgeanequityswapmaybeapreferredstrategywhentheclientisconcernedwithgovernance,preciselybecausedoingsolendsitselftovotemorphing.Asevidenceofthesecustoms,theCodeCommitteeoftheUnitedKingdom'sPanelonTakeoversandMergersrecentlystatedthatitis"frequentlytheexpectation"ofalongequityswapholderthatthederivativesdealerwould"ensure"thatanequivalentnumberofsharesareavailabletobevotedbyitscustomerand/orsoldtothecustomeronclosingoutthecontract.67Ifthedealerdidnotholdmatchingsharesandhedgedinanotherway,theholderwould"normallyexpect"thedealertoacquiretheshares,evenifthisresultedincosttothedealer.68Asexamplesofmarketexpectations,thecommitteepointedtothebehaviorofhedgefundsandderivativesdealersin2004inconnectionwithBAeSystems'bidforAlvisandPhilipGreen'sbidforMarks&Spencer.69BAeSystemsobtainedcommitmentstosupportitsofferfromanumberofhedgefundsthathadenteredintoequityswaps70astoAlvisshares.SomefundsagreedtorequestphysicalsettlementoftheswapsandthensupporttheBAeoffer.Forotherhedgefunds,thederivativesdealer(withthefund'sconsent)committedtoaccepttheofferastothedealers'matchedshares,?lSimilarly,PhilipGreenannouncedthatitsbidforMarks&66.Foracontraryexample,whereanunhappycustomersuedCitibankforchangingthewayithedgedequityswapsandotherequityderivatives,seeCaiolav.Citibank,N.A.,295F.3d312(2dCir.2002).67.SeeCODECOMM.,U.K.PANELONTAKEOVERS&MERGERS,DEALINGSINDERIVATIVESANDOPTIONS:OUTLINEPROPOSALSRELATINGTOAMENDMENTSPROPOSEDTOBEMADETOTHETAKEOVERCODEANDTHESARs§3.3(Jan.2005)[hereinafterU.K.TAKEOVERPANEL,JANUARY2005PROPOSAL].68.ld.§3.4.69.OurdiscussionofBAeSystems-Alvisisbasedonid.;KateBurgess,PanelPlansChangestoDisclosureRules,FIN.TIMES(London),Jan.8,2005,at2(Companies).OurdiscussionofPhilipGreenMaIks&SpencerisbasedonU.K.TAKEOVERPANEL,JANUARY2005PROPOSAL,supranote67,§3.4(b);JeremyWarner,Outlook:UnchartedWaters,INDEPENDENT(London),July14,2004,at39(Business).70.Theu.K.instrumentcorrespondingtoaU.S.equityswapisknownasa"contractfordifferences"or"CFD."Inthisarticle,weusethetenn"equityswap"torefertobothinstruments.71.InitscommentstotheCodeCommittee,theInternationalSwapsandDerivativesAssociationdidnotchallengetheCommittee'sdescriptionofmarketexpectations.ItmildlydisputedtheCommittee'sdiscussionofthederivativesdealers'interestsinvoting(oracceptingatakeoverbid)inaccordancewiththeirclients'preferences,explainingthattheCommittee'sdescriptionwas"somewhatsimplistic."LetterfromRichardMetcalfe,Int'lSwaps&DerivativesAssoc.,toPanelonTakeovers&Mergers5(Feb.28,2005)(onfilewithauthors). 2006]NEWVOTEBUYING839Spencerwassupportedbyinvestmentbankswhoheld8.3%ofMarks&Spencer'ssharesasmatchedsharestohedgeequityswaps.Thissupportwaspresumablyatthedirectionofthehedgefundswhoheldthelongsidesoftheseswaps.Marketexpectationthatadealerwillunwindaswapisnotaguarantee,asillustratedbya2006buyoutofferbySearsHoldingsfortheminoritysharesinitsSearsCanadasubsidiary.72AhedgefundhadpreviouslyacquiredequityswapsinSearsCanadafromScotiabank.Scotiabanklaterbecamethedealer-managerforSearsHoldings'buyoutoffer.TheofferrequiredapprovalbyamajorityoftheSearsCanadaminorityshareholders.SearsCanada'sindependentdirectorsopposedthebid;sodidmanySearsCanadashareholders.ThehedgefundaskedScotiabanktounwindtheswapsoitcouldvoteagainsttheoffer.Scotiabanknotonlyrefused,butalsocommittedtovoteitsSearsCanadasharesfortheoffer.Scotiabankthusbecameanemptyvoter;perhapswithnegativeeconomicinterestbecauseitwasanagentforSearsHoldings.ThehedgefundcomplainedaboutScotiabank'sfailuretoobserveswapmarketconventionsandsaiditwas"lookingforwardtoregulatoryandlegalscrutinyofthistransaction.'mb.AvoidingMandatoryBidRulesandOtherUsesHidden(morphable)ownershipcanbeusedforotherpurposes,besidesavoidingdisclosure.Oneuseinvolvesavoidingmandatorybidrules.Inmanycountries,ashareholderwhoexceedsathresholdpercentageofshareownershipmustoffertobuyallremainingsharesataformulaprice.Holdingswapsinsteadofsharescanletashareholderavoidtheserules.In2005,forexample,theAgnellifamily,whichcontrolledFiat,enteredintoequityswapsforFiatshareswithMerrillLynchwithoutpubliclydisclosingthisfact,74ThefamilywantedtoretaincontrolofFiatafteraforthcomingdebt-for-equityswap,whichwoulddilutetheAgnellis'72.OurdiscussionofSearsCanadaisbasedonJesseEisinger.InCanada.aFace-offoverSears,WALLST.J.,Apr.12,2006,atCl.73.Id.74.OurdiscussionoftheAgnelli-FiattransactionsisbasedonIFIL-ExorInvestigationMerrillLynchMilanHQSearched,ILSOLE24ORE(Italy),Mar.10,2006(IFIListheAgnellifamilyvehiclethatacquiredtheswapposition);IFILReceivesConsobEquitySwapReport,ILSOLE24ORE(Italy),Feb.23,2006;JohannaIivonen,ItalianStockMarketRegulatorRulesAgainstIFILinFiatCase,WORLDMARKETSANALYSIS,Feb.23,2006;Italy'sConsobRulesIFILNotObligedtoBidforFiat,butSwapDealProbed,AFXINT'LFocus,Feb.8,2006;StillintheDrivingSeat-ItalianFinance,EcONOMIST,Oct.15,2005;ThreeInvestigatedinIFIL-ExorEquitySwapAffair,ILSOLE24ORE(Italy),Feb.25,2006. 840SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811stake.IftheyhadboughtFiatsharesdirectly,theywouldhavecrossed30%ownership,thustriggeringItaly'smandatorybidrule.TheAgnellisalsowouldhavehadtodisclosetheirpurchases,whichcouldhaveaffectedFiat'sshareprice.AfterFiatcompleteditsdebt-equityswap,theAgnellisunwoundtheirequityswapsandobtainedtheswapdealer'smatchedFiatshares.TheItaliansecuritiescommissionruledthattheAgnellisdidnotviolatethemandatorybidrule;itisstillinvestigatingtheproprietyofnondisclosure.ThegoalofacquiringsharesmorecheaplyalsoemergedinAustraliaduringthe2005takeoverbidbyCentennialforAustralCoal.75RivalGlencoreacquireda"blockingposition"(sufficienttopreventCentennialfromreaching90%ownershipandsqueezingoutremainingshareholders)throughacombinationofsharesandequityswaps(whichthederivativesdealershedgedwithmatchedshares).GlencoreclaimeditsswappositiondidnotneedtobedisclosedunderAustralia'slargeshareholderdisclosurerules,whicharetriggeredby5%shareownership.Itdiscloseditscombinedpositiononlyaftercrossing10%.TheAustralianTakeoversPanelheldthatGlencoreshouldhavediscloseditscombinedpositionwhenitseconomicownershipcrossed5%.ThePanel'sdecision,however,wasreversedonappealbytheAustraliancourtS.76Thegoalofavoidingamandatorybidrulealsounderliestheearliestpubliclyknownexampleofdecouplingweareawareof.In1997,BrierleyInvestmentsusedequityswapstoincreaseitsstakeinJohnFairfaxHoldingsfrom19.98%to25%.77Directownershipof20%ormorewouldhavetriggeredAustralia'smandatorybidrule.Brierleydiscloseditsswapposition;itmerelysought(successfully)toevadethemandatorybidrules.2.ToeholdsandtheSocialVirtuesofStealthHidden(morphable)ownershipmaynotalwaysbesociallyundesirable.Onepotentialbenefitinvolvesanunresolvedpuzzleinfinance:whydomoretakeoverbiddersnotacquiretoeholds,eventhough75.OurdiscussionofAustralCoalisbasedonGlencoreInt'lAGv.TakeoversPanel(2006)F.c.A.274[hereinafterGlencoreInt'lAG];McCoach2005,supranote38;McCoach2006,supranote38;NigelMorris,Director,TakeoversPanel,AustralCoalLtd.02-DecisionandReviewApplication(JulyI,2005),http://www.takeovers.gov.auJdisplay.asp?ContentID=956[hereinafterAustralCoalTakeoversPanelDecision].76.GlencoreInt'lAG,supranote75.77.OurdiscussionofBrierley-FairfaxHoldingsisbasedonMcCoach2005,supranote38;McCoach2006,supranote38. 2006]NEWVOTEBUYING841doingsowouldappeartobehighlyprofitable?78Themostplausibleexplanationsareconcernsaboutpromptingapricerun-up,whichcouldincreasetheoverallcostoftheacquisition;andthatthetoeholdmay79increasethelikelihoodofbidderresistance.Anequityswapoffersaquiettoeholdthatneednotbepubliclydisclosed.8oNondisclosuremightreducemarketimpactcost.Evenifitdoesnot,reducingbidderresistancecouldenhancethemarketforcorporatecontrol.Proponentsofanactivecorporatecontrolmarketmightthereforeconsidernondisclosureoftoeholds,uptosomelevel,tobesociallydesirable.AnAustralianexampleillustrates.In2004,BHPBilliton,beforeannouncingabidforWMC,acquireda4.3%toeholdthroughequityswaps.81BHPdiscloseditstoeholdbeforecrossingthe5%thresholdfordisclosingadirectshareposition.Itsreasonsforacquiringswapsratherthansharesarenotknown.Perhapsitwantedtohavetheoptionofkeepingitsstakehiddenoracquiringmorethan5%beforedisclosingitsposition.3.SheddingVotingRightsTheforegoingusesofvotemorphinginvolveacqumngsharesorinformalvotingrights.Atwistonthevotemorphingconceptinvolvessheddingvotingrightsunderspecifiedconditions-morphingfromhavingformalorinformalvotingrightstonothavingthem.Japan'sfirst-everhostiletakeoverbid,the2005bidbyLivedoorforNipponBroadcasting,illustrates.InFebruary2005,Livedoorannouncedthatithadacquireda8235%stakeinNippon.LivedoorwantedtoacquireNipponinorderto78.See,e.g.,ArturoBris,Toeholds,TakeoverPremium,andtheProbabilityofBeingAcquired,81.CORP.FiN.227,227-28(2002);SandraBetton,B.EspenEckbo&KarinS.Thorburn,TheToeholdPuzzle(EuropeanCorp.Governancemst.,FinanceWorkingPaperNo.8512005,2005),availableathttp://ssrn.comlabstract=71560I.79.SeeSandraBetton&B.EspenEckbo,Toeholds,BidJumps,andExpectedPayoffsinTakeovers,13REv.FiN.STUD.841,878-81(2000).80.Bris,supranote78,at244.8!.BryanFrith,CunningPredatorsHideBehindSwaps,AUSTRALIAN,Mar.II,2005,at18;AndrewTrounson,BHPBidfortheLongHaul-XstrataOutgunnedinShowdownforWMCResources,AUSTRALIAN,Mar.9,2005,at35.82.OurdiscussionofLivedoor-NipponBroadcastingisbasedonMichiyoNakamoto,InvestmentBanking:HistoricBattleEstablishesCombatRules,FIN.TIMES(London),June27,2005,at5(FTReport);DavidPilling,WhiteKnightNewVillainofFujiTVSaga,FiN.TIMES(London),Mar.28,2005,at21(Companies);SoftbanktoReturnFujiShares,DAILYYOMIURI(Tokyo),Apr.23,2005,at8;MartinFoster,LivedoorSuffersBlowinBid,THEDEAL.COM,Mar.24,2005,http://www.thedeal.comlNASApp/cslCS?pagename=TheDeallTDDArticle/StandardArticle&bn=NULL&c=TDDArticle&cid=1I11624424202;KyodoNewsService,SoftbankInvestmentbecomesFujiTV'sLargestShareholder, 842SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811influenceFujiTV,inwhichNipponhada22.5%stake.NipponrespondedbyenteringintomultiyearagreementstolenditsFujiTVsharestoSoftbankInvestmentandDaiwaSecurities.Nipponretainedeconomicownership.Unlikeacustomaryshareloan,however,ithadnocontractualrighttorescindtheloans.IfNipponwonthetakeoverbattle,therewasatleastapossibility,andperhapsaninformalunderstanding,thattheborrowerswouldunwindtheloanagreementsandreturntheFujiTVshares.IfLivedoorwon,itfacedasubstantialriskthatSoftbankandDaiwawouldrefusetounwindtheloans,thusdenyingLivedoorwhatitreallywanted-votingrightsfortheFujiTVshares.Thedefensewassuccessful.LivedoorandFujiTVagreedtoapartnership,andLivedoorendeditsefforttoacquireNippon.SoftbankpromptlyreturnedtheFujisharestoNippon.83Here,morphablevotingrightswerenotusedtolettheholderobtaindefactovotingrightsandyetavoiddisclosingthoserights.Instead,NipponapparentlyusedvotemorphingtodenyvotingrightstoLivedoorwhileretainingaccesstothevotesifthetakeoverthreatdisappeared.Asubstantivepurposewasinvolved,notadisclosureone.·D.RELATEDNON-HOSTASSETSWeconsiderheresomecomplexitiesintroducedbythepossibilitythatrelatednon-hostassetsmaycontributeimportantlytoashareholder'soveralleconomicinterest.1.MergersOnerecurringsituationinwhichrelatednon-hostassetsareimportantinvolvesastock-for-stockmerger.InthePerry-Mylansituation,PerryhadvotingownerShip,butzeroeconomicownership.Itsrelatednon-hostasset(sharesinthetarget,King)madeitsoveralleconomicinterestnegative.Buttherecanalsobesituationsinwhichrelatednon-hostassetscanincreaseashareholder'soveralleconomicinterest.ActionsbyhedgefundsinvolvingFORBES.COM,Mar.24,2005,hnp://www.forbes.comlinfoimaging/feeds/infoimaging/2005/03/24/infoimagingcomtex_2005_03_24_ky_OOOO-5439-.industrytopstories.merg.html.83.SeeNipponBroadcasting,SoftbankInvestmentEndFujiTVStockwanDeal,AFXNEWS,June30,2005;SoftbanktoReturnFujiShares,supranote82.WewereunabletofindnewsreportsonwhathappenedtothesharesthatNipponloanedtoDaiwa. 2006]NEWVOTEBUYING843DeutscheBoerse'sproposedacquisitionoftheLondonStockExchange("LSE")illustrate.84InDecember2004,DeutscheBoerseproposedbuyingtheLSE.InJanuary2005,twohedgefunds,Children'sInvestmentFundandAtticusCapital,togetherholding8%ofDeutscheBoerse'sshares,publiclyopposedthebidasagainstshareholderinterests.ewecannotresistnoting85thattheheadofChildren'sInvestmentFundisaPerryCorp.alumnus.)Theacquisitionwasopposedbyothermajorshareholdersandwaseventuallyabandoned.Whatconnectsthisstorytovotebuyingisthatcertainhedgefunds-perhapsthesameones-shortedasignificantnumberofLSEsharessoonaftertheoppositionwasannounced.AssumingthatsomehedgefundswerebothlongDeutscheBoerseandshortLSE,theywerebettingthattheacquisitionwouldfail,inwhichcaseDeutscheBoerseshareswouldriseandLSEshareswouldfall.Thesehedgefunds'overalleconomicinterestindefeatingthemergerwaslargerthaniftheyheldonlyDeutscheBoerseshares.ThiswouldtendtooffsettheusualcollectiveactionproblemthatanyoneDeutscheBoerseshareholderwouldbearmuchofthecostofopposingthemerger,butwouldbenefitonlyinproportiontoitsfractionalDeutscheBoersestake.AshortsaleofLSEsharesmightprovidesufficientadditionalincentivesforlargeshareholderstoundertakethecostofthispotentiallybeneficialactivity.Variantsonthesamecoupled-assetposition,however,couldhavetheoppositeeffect.Ifaninvestor'sshortpositioninLSEwerelargerelativetoitslongpositioninDeutscheBoerse,itwouldbemoreinterestedinLSEsharesdroppinginpricethaninDeutscheBoersesharesrising.TheinvestorwouldhaveanincentivetoopposeanacquisitionthatwouldbenefitDeutscheBoerse,orindeedbothcompaniescombined.Conversely,mergerarbitrageurswhofollowthecommonstrategyofgoinglongtarget,shortacquirerwouldhaveincentivestosupportthemergerregardlessofits84.OurdiscussionoftheDeutscheBoerse-LSEsituationisbasedonSilviaAscarelli.AMarketMarriageinEurope?;DeutscheBoerse'sCourtshipofLondonExchangeMayElicitaRival,WALLST.J.,Dec.14,2004,atCI8;NormaCohen,InvestorsWarnDBorseBoard,FIN.TIMES(London),Feb.22,2005,at21(Companies&Markets);NormaCohen&PatrickJenkins,DBorseActstoHealTCIRift,FIN.TIMES(London),Apr.21,2005,at25(Companies);WilliamHutchings,DeutscheBorseBowsToHedgeFundPressure,FIN.NEWSONLINE,Feb.1,2005;Seifert'SSecondProposal,EcONOMIST,Dec.18,2004;WinnersandLosers:CEOWernerSeifertShedsSomelightontheReasonsWhyDeutscheBorseDecidedtoDropItsLI.3BillionBidfortheLondonStockExchange,GUARDIAN(U.K.),Mar.14,2005,atII.85.SeeJasonSinger,IvyLeave:YalePartsWayswithHedgeFund,WALLST.J.,Mar.29,2006,atCI. 844SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811merits.Thus,thenewvotebuyingcouldbothempowerChildren'sInvestmentFundandAtticustopressureDeutscheBoersetomakea"good"decision,andempowerothers,suchasclassicmergerarbitrageurs,tosupportmisguidedmergers.Wehavealreadydiscussedaboveanumberofothermergersituationswherethevotingoutcomemayhavebeenaffectedbynewvotebuying.Itisnotmuchofastretchtoimagineasubterraneanbattleforvotesbetweenhedgefundsandotherinvestorswithdifferingoveralleconomicinterests.Insuchabattle,itmightbelittlemorethanhappenstanceifthevotingoutcomecorrespondedtotheacquisition'svaluetotheacquirer,ortobothcompaniestogether.2.IndirectHedgesOtherplausiblerelatednon-hostassetscanexist,inadditiontopositionsintheotherpartytoatakeoverbid.Theessentialcharacteristicofarelatednon-hostassetisthatitsvaluecorrelateswiththevalueofhostshares.Thus,anexecutiveatFordwhoisconcernedaboutthefutureofAmericancarcompanies,butisreluctanttobuyputoptionsonFordstock,86andmighttriggershort-swingprofitrecaptureunderSection16.TheexecutivecouldinsteadbuyputsonsharesofGeneralMotorsoraFordsupplier.ThecorrelationbetweenthereturnsonFordsharesandthoseonGeneralMotorsoraFordsuppliermaybehighenoughforthe8executive'spurposes.?E.INNOVATIONSUNDERLYINGTHENEWVOTEBUYINGSupplyanddemandconsiderationssuggestthatthenewvotebuyingislikelytocontinuetogrow.Threefactorsstandout.First,continuedimprovementsinfinancialtechnologyarelikelytodrivedowntransactioncosts.EquityswapsandotherOTCequityderivativesonindividualsecuritieswerenotinventeduntilthelate1980s.88Bytheendof2004,theworldwidemarketforOTCequityderivativeswasover$4trillion,up50%86.Asidefrompossiblyinfuriatingsuperiorsandshareholders,thetransactioncouldpotentiallybeconsideredadeemedsaleofFordsharesandtriggershort-swingprofitrecaptureunderSection16.87.Ontherelatedquestionofwhetherexecutivescanusesuchsubstituteswithoutrunningafoulofinsidertradinglaws,seeIanAyres&JoeBankman,SubstitutesforInsiderTrading,54STAN.L.REv.235(2001).88.SeeJoanneM.Hill,TheHistoryofEquityDerivatives,inTHEHANDBOOKOFEQUITYDERIVATNES33-48(JackClarkFrancis,WilliamW.Toy&J.GreggWhittakereds.,1995). 2006]NEWVOTEBUYING845overthepreviousyear.89Thisgrowthpresumablybothreflectsandspurslowertransactioncostsandincreasedqualityandvarietyofproducts.9o9Second,sharelendinghasgrownrapidlyoverthepastdecade.)IntheUnitedKingdom,sharelendinginlate2004wasapproximately£80billion,comparedwithjust£3.5billionin1996.92IntheUnitedStates,thesecuritieslendingmarket,includingequityanddebt,roseto$1.3trillioninrnid-2004fromabout$940billionayearearlier.93Thedrivingforceshavebeengrowthinthederivativesmarketandtheriseofhedgefunds,whosetradingstrategiesoftenincludeshort-selling.Largeinstitutionalinvestors,suchaspensionfunds,publicretirementfunds,andmutualfundslendtheirsharesinavarietyofways.Somelendersusespecializedthird-partylendingagents.Often,thecustodianbankswhichclearandholdtheirpositionsactaslendingagents.Afewlargelendersdirectlycontractwithborrowers.Forinstance,theCaliforniaPublicEmployeesRetirementSystemlendssharesthroughanauctionsystem.Broker-dealersalsolendsharesthattheyholdonbehalfofmargincustomers(keepingtherevenue)andencourageretailinvestorstosignmarginaccountstofacilitatethisprofitablebusiness.94Ontheborrowingside,afewlargeborrowersborrowontheirown,butmostborrowindirectlythroughbroker-dealers,partlybecausethebrokeragefirmismorecreditworthy,andpartlytohidetheborrower'sidentity.Broker-dealersalsoborrowfortheirownaccountstofacilitatemarket-makingandhedgingtherisksonderivativesthattheyenterintowithcustomers.95Third,hedgefundshavegrownrapidlyinthelastdecadeandarenowestimatedtonowhaveover$1trillionininvestorassets;theirimpactis89.SeeInternationalSwapsandDerivativesAssociation,SummaryofRecentSurveyResults,http://www.isda.orglstatisticslrecent.html(lastvisitedMay8,2006).90.Foradiscussionofthemodemprocessoffinancialinnovationanddifficultiesinframingregulatoryresponses,see,forexample,Hu,MisunderstoodDerivatives,supranote4.91.See,e.g.,HeatherMcKenzie,SecuritiesLendingGrowsUp,FiN.NEWSONLINE,Oct.2,2000;GenePicone&RichardWame,AComingofAge,PENSIONSMGMf.,Sept.I,2003.Seealsosupranote50(sourcesonthesharelendingmarketandthehistoryofsharelending).92.SeeKateBurgess,JamesDrummond&AlexSkorecki,UKStockLendingMoreThanDoubles,FiN.TIMES(London),Nov.17,2004,at22(Companies)(reportingestimatesbyCrestco,theU.K.sharetradingsettlementagency).93.SeePhyllisPlitch,Funds'LendingSparks"Short"Debate,WALLST.J.,May25,2005,atB2(citingdatatrackedbytheAstecConsultingGroup).94.Standardmarginaccountagreementsallowbrokerstolendcustomershares.Seeinfratextaccompanyingnote266.95.SeeFaulkner,supranote50,at17. 846SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811..compoundedbymanyfunds'useofleverage.96Hedgefundmanagerstypicallyhavewidediscretionastotradingstrategies.Unlikemutualfundsandpensionfunds,hedgefundsfacefewregulatorylimits.Moreover,manyhedgefundmanagersarecomfortableusingequityderivativesandothersophisticatedfinancialtools.Recently,manyhaveadoptedcorporategovernanceactivismasaninvestmentstrategy.97Hedgefundsusuallyhavefewerconflictsofinterestthanotherinstitutionalinvestors,andlessconcernwithadversepublicity,sotheycanbemoreaggressiveinpursuingtheseopportunities.F.THEEXTENTOFNEWVOTEBUYINGSincemuchnewvotebuyingisundisclosed,itsextentisnecessarilyunknown.Butthereisvalueincollectingtheknowninstancesinoneplace.Table2lists,inroughreversechronologicalorder,thepubliclydisclosedorrumoredexamplesofnewvotebuyingthatwewereabletofind.Thelistissurelypartial.Still,thenumberofexamplesandtheirdiversenaturesuggestthescaleofthenewvotebuying,whilethedatessuggestitsrecentadvent.Othersourcesalsosuggestthatnewvotebuyingisreasonablycommon.Theseinclude:regulatorychangesinHongKong(2003)andtheUnitedKingdom(2005)torequiredisclosureofeconomicownership,andselfregulatoryeffortsintheUnitedKingdomtolimitrecorddatecapture;98theexistingmarketcustomsonunwindingofswapsandvotingofmatchedsharesbyderivativesdealers;99statementsbylawyersatmajorfirmsastowhetherhiddenownershippositionsmustbedisclosed.Theseincludepartnersat:96.Thereisnoreliabledataonthenumberofhedgefundsortheirassetsundermanagement.SeeSEC,IMPLICATIONSOFTHEGROWfHOFHEDGEFuNDS-STAFFREpORTTOTHEUNITEDSTATESSECURITIESANDEXCHANGECOMMISSIONIn.2(2003)[hereinafterSEC,HEDGEFuNDREpORT].Forthe$1trillionestimateinmid-2005,seeAtDeadline;CalSTRSBoostsEmerging,PENSIONS&INVESTMENTS,Aug.8,2005,atI(reportinganestimatebyTremontCapital).Itisclear,however,thattheindustryhasgrownrapidly.TheHennesseeGroupestimatesthathedgefundassetsgrewfrom$50billionin1993to$592billionin2003.SEC,HEDGEFuNDREpORT,supra,atInA.97.See.e.g.,RivaD.Atlas,SomeFundsTakingRoleFarBeyondJustInvestor,N.Y.TIMEs,Aug.16,2005,atCI;LinaSaigol,HedgeFundsAreVeryKeentoFlexTheirSecretiveShareholdingMuscle,FIN.TIMES(London),Aug.9,2005,at19(Companies);HennySender,HedgeFunds:TheNewCorporateActivists,WALLST.J.,May13,2005,atCl.98.WediscussthesereformssuprainPartsIV.CandV.D.99.WediscussthesemarketconventionssuprainPartII.C. 2006]NEWVOTEBUYING847oFreehillsinAustralia;100oAllen&OveryintheUnitedKingdom(theprimaryoutsidecounselfortheInternationalSwapsandDerivativesAssociation),statingthatdisclosureisnotrequiredforcash-settledU.S.Equityderivatives;101oClearyGottliebintheUnitedStates(statingthat"alongpositionunderanequityswapwouldgenerallynotbetreatedasbeneficialownership"underSECrules);102LawsuitsintheUnitedStates(involvingPerry-Mylan),Australia(involvingGlencore-AustralCoal),andNewZealand(involvingPerry-Rubicon).103Quantitativeevidencerelatedtodecouplingincludestheevidencediscussedabovethatexecutivehedging(withvotebuyingeffects,evenifvotebuyingisnottheprincipalgoal)iscommon,104andtheevidence,discussedbelow,onrecorddatecapture.105100.SeeNeilPathak&WeyinmiPopo.Cash-settledEquitySwapsinTakeovers,FREEHILLS,June30,2005,http://www.freehills.com/publications/publications_5108.asp.101.Chin-chongLiew,DisclosureRequirementsforPurelyCash-settledDerivatives,H.K.LAW.,June2000,at59.102.2EDWARDF.GREENEETAL.U.SREGULATIONOFTHEINTERNATIONALSECURITIESANDDERIVATIVESMARKETS§13.02(2)n.25(7thed.2004).103.WediscussPerry-MylansuprainPartII.B,andPerry-RubiconandGlencore-AustralCoalsuprainPartn.c.104.SeeBettiseta,supranote8,andourdiscussionofinsiderhedgingsuprainPartII.B.105.SeeChristoffersenetal.,supranote21,andourdiscussionofthisresearchinfrainPartm.B. 848SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811TABLE2.DeconplingexamplesThistablelists,inroughreversechronologicalorder,theknownorpubliclyrumoredinstancesofnewvotebuyingthatwewereabletocollect.Thelistissurelypartial;ifreadersknowofinstancesnotonthislist,wewouldbegratefultolearnofthem.CoupledorHiddenHostEmptyRelatedDateCountryVoteBuyer(Morphable)DescriptionCompanyVotingNon-hostOwnershipAssetHedgefund(BillXXSears2006CanadaAckman)and(by(byAckman,EquityswapSeePartlI.CCanadaScotiabankScotiabank)unsuccessful)XShareHendersonHong2006Hedgefund(s)X(shortborrowing+SeePartII.BInvestmentKongposition)shortsale2005FiatItalyAgnellifamilyXIEQuityswapsSeePartII.C2005AustralCoalAustraliaGlencoreXIEQuitvswaDSSeePartII.CNipponShare2005FujiTVJapanXSeePartII.CBroadcastinglendingDeutscheShortsaleof2005GermanyHedgefundsXSeePartII.DBoersetargetsharesSenecaheld9%economicinterestinPortmanSeneca(hedge2005AustraliaXEquityswapsPortmanthroughMiningfund)equityswapsprovided106byCSFB.2004WMCAustraliaBHPBillitonXEquityswapsSeePartlI.C2005ResourcesPerryCorp.XEquityswapSeePartII.B2004Mylan(hedgefund)U.S.2005LaboratoriesCitadel(hedgeXUnknownSeePartII.Bfund)(Dossible)PolygonsoughttoinfluenceDFSdespiteowningonlyonesharePolygon2004DFSU.K.XEquityswapofstock(ithad3%(hedgefund)economicownershipthroughe~3~tyswaps).Hedgefunds(helpingBAe2004AlvisU.K.XEquityswapsSeePartII.CSystemstoacquireAlvis)106.SeeBryanFrith,PonmanTradingShouldBeReviewed,AUSTRAI.lAN,Mar.4,2005,at22.107.SeeRichardFletcher,USHedgeFundBuildsUpLargeStakeinDFS,SUNDAYTIMES(London),Aug.22,2004,at2. 2006]NEWVOTEBUYING849CoupledorHiddenHostEmptyRelatedDateCountryVoteBuyer(Morphable)DescriptionCompanyVotingNon-hostOwnershipAssetHedgefunds(helpingPhilipMarks&2oo4U.K.GreentoacquireXEquityswapsSeePartII.CSpencerMarks&Spencer)"Songbird"DerivativesdealercOIl5ortiumUBSheld7.7%of2oo4CanaryU.K.(seekingtoXEquityswapsCanaryasmatchedWharfacquireCanarysharestosupportWharf)108equityswaps.HoldersandshortAcquirer'sMONYsellersofAXA(AXA)2oo4U.S.XSeePartII.BGroupconvertibleconvertiblebondsbondsHidden:yesAustraliaForward2oo4NewsCorp.LibertyMediaXMorphable:SeePartII.B&U.S.contractmaybeP&OshareholderswhofavoredInvestors(favorP&OShareCarnival'sbid2oo2UKCarnivalbidforXMaybePrincessborrowingreportedlyborrowedP&OPrincess)sharesinordertovote109foracceptance.HoldersofHewlett-Compaqshares2oo2U.S.XTargetsharesSeePartII.BPackard(targetofH-Pmergerbid)SolomonLew2oo2ColesMyerAustralia(proxyXNoOptionsSeePartII.Bcontestant)Share2oo2BritishLandU.K.LaxeyPartnersXSeePartII.BborrowingNew2oo1RubiconPerryCorp.XEquityswapsSeePartII.CZealandJohnFairfaxBrierley1997AustraliaEquityswapsSeePartII.CHoldingsInvestments108.See,e.g.,MartinDickson,TheSecretCityBattleoverCanaryWhaif:RoleofDerivativesinTakeoverBattles,FIN.TIMES(London),Apr.24,2004,at2(Companies);LinaSaigol,UBSWinsTakeoverPanelAppealoverCanaryVote,FIN.TIMES(London),Apr.24,2004,at2(Companies).109.SeeBankofEngland,StockLendingandRepoCommittee,SummaryofMeetingHeldattheBankofEngland(Dec.11,2002),http://www.bankofengland.co.uk/markets/giltslslrcdec02.pdf. 850SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811III.LEGALANDFINANCETHEORYANDEVIDENCEA.CLASSICTHEORYOFVOTINGRIGHTS:INTRODUCTIONWhydocommonshareholders(andonlycommonshareholders)havevotingrights?Theconventionalcontractariananswerflowsfromtheshareholders'statusasresidualclaimantstothefirm'svalue.Thisgivesthemincentivestomonitormanagement.Theeffectivenessofvotingrightsislimitedbycollectiveactionproblems,butthemarketforcorporatecontroloffersaresponse-shareholderscanselltheirsharesandassociatedvotingrightstoanacquirer.IIOMakingvotingrightsproportionaltoone'sshareinthefirm'sresidualvaluereducesagencycostsbymatchingeconomicincentiveswithvotingpower.ll1Corporatelawpermitscorporationstodeviatefromone-share-one-votebasedontheusualclaimthatinformedpartiescanchooseoptimalarrangementsontheirown.112MostU.S.publiccompanies,however,retainaone-share-one-votestructure,likelyreflectingtheoptimalityofthisstructureformostfirms.TheDelawarecourts,meanwhile,celebrateshareholdervoting,viewingitasthe"ideologicalunderpinninguponwhichthelegitimacyofdirectorialpowerrests."l13Theusuallaxbusinessjudgmentruledoesnotapplytocompanyactionsthatundermineshareholdervotingrights.Instead,phraseslike"compellingjustification"coursethroughtheopinions.114Thejudgesseethemselvesaspreventingthe"wrongfulsubversionofcorporatedemocracybymanipulationofthecorporatemachinery."ll5TheDelawarecourtsalsoaccordgreatdeferencetoshareholdervotes.Forexample,acentralthemeofDelawaretakeoverlawistodistrustmarketdecisionsbyshareholders(sellingsharesintenderoffers)andfavorvotingdecisions.I16110.See,e.g.,ROBERTCHARLESCLARK.CORPORATELAW93-95,389-400(1986);Easterbrook&Fischel,supranote27,at403-06,408-10.Ill.SeeCLARK,supranote110,at390;Easterbrook&Fischel,supranote27,at408-10.112.See,e.g.,RonaldJ.Gilson,EvaluatingDualClassCommonStock:TheRelevanceofSubstitutes,73VA.L.REv.807,808-09(1987).113.BlasiusIndus.v.AtlasCorp.,564A.2d651,659(Del.Ch.1988).114.[d.at661.SeealsoMMCos.v.liquidAudio,Inc.,813A.2d1118,1121,1131(Del.2003).115.MMCos.,813A.2dat1127(quotingGiuricichv.EmtrolCorp.,449A.2d232,239(Del.1982».116.RonaldJ.Gilson&AlanSchwartz,SalesandElectionsasMethodsforTransferringCorporateControl,2THEORETICALINQUIRIESINLAW783(2001). 2006]NEWVOTEBUYING851Thenewvotebuyingthusstrikesdirectlyatboththeeconomicandlegallogicbehindshareholdervotingrights.InPartIILB,wetakeacloserlookatthefinance-theoreticargumentsandempiricalevidencerelatingtothelinkbetweeneconomicownershipandvotingrights.InPartIILe,weaddresstherelevanceofothercircumstancesinwhichvotingandeconomicownershipcandiverge.PartIILDconsiderspastlegalresponsestotheseparationofvotesfromeconomicownership.PartIILEdiscussessomepotentiallytestableempiricalimplicationsofthenewvotebuying.B.LITERATUREREVIEw:THEORYANDIMPLICATIONSFORNEWVOTEBUYING1.Theorya.One-share-one-voteSeveralstrandsoftheoreticalliteraturedevelopthebasiccontractarianargumentfavoringaone-share-one-votecapitalstructure.Onestrandderivesfromthehostiletakeoversofthe1980sandfocusesontheroleofaone-share-one-voteregimeinenhancingthefunctioningofthemarketforcorporatecontrol117andthepoweroflargeshareholderstoinfluencemanagement.118Amorerecentstrandderivesfromthecross-countrylaw-and-financeliterature,inwhichamajorconcernistheabilityofcontrollingshareholdersto''tunnel''awaymorethantheirshareoffirmvalue.Here,highereconomicownershipbyinsiderspredictslowertunneling.119Theintuitionissimple.Assumetunnelingiscostlybecauseitreducesfirmvalue.Thehighertheinsiders'economicownership,thegreatertheshareofthiscosttheybear,and,hence,thelesstunnelingtheyengagein.Alargegapbetweeninsiders'votingrightsandeconomicownershipcanalsodistortthefirm'sinvestmentdecisions.117.SeeOLNERHART,FIRMS,CONTRACTS,ANDFINANCIALSTRUCTURE95-125(1995);SanfordJ.Grossman&OliverD.Hart,OneShare-OneVoteandtheMarketforCorporateControl,20J.FIN.EcON.175(1988);MiltonHarris&ArturRaviv,CorporateGovernance:VotingRightsandMajorityRules,20J.EcON.FIN.203,226-28(1988).118.SeeAndreiShleifer&RobertW.Vishny,LargeShareholdersandCorporateControl,94J.POL.EcON.461,463(1986).119.SeeLucianAryeBebchuk,ReinierKraakman&GeorgeG.Triantis,StockPyramids,Crossownership,andDualClassEquity:TheMechanismsandAgencyCostsofSeparatingControlfromCash-flowRights,inCONCENTRATEDCORPORATEOWNERSHIP295(RandallK.Moreked.,2000);ArtDurnev&E.HanKim,ToStealorNottoSteal:FirmAttributes.LegalEnvironment,andValuation,60J.FIN.1461(2005). 852SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811Althoughdisparitybetweeneconomicandvotingownershipencouragestunneling,itcouldserveothergoals.Assume,forexample,thatinsidersareunwillingtorelinquishcontrol.Greaterabilitytohedgeeconomicownershipcouldmakeinsiderslessaversetofum-specificrisk,and,hence,morelikelytoapproveriskypositivenetpresentvalueinvestmentprojectsandlesslikelytoengageinvalue-reducinghedgingwithinthefum.120Votebuyingbyoutsideshareholderscanalsoreducefreeriderobstaclesthatlimittheeffectivenessofshareholdervotingasaconstraintonmanagers,assomeoftheexamplesinPartIIsuggest.Thus,thenewvotebuyingisnotnecessarilyefficiency-reducing.Afinalstrandofanalysisfocusesnotontheimpactofdecouplingatthefumlevel,butinsteadonlegalchoicesmadebyentirenations.Forexample,ifpoliticalinfluencedependsonwhatonecontrols,alegalregimethatpermitsdisparitybetweenvotingpowerandeconomicownershipcanletasinglefamilycontrolalargerindustrialempire.Thiscanfosteraneconomicallyandpoliticallypowerfulelitethatinanextremecasecan"capturethestate."l21Conversely,adisparitybetweeninsidercontrolandeconomicownershipmayariseinresponsetostatepower,asprivateactorsseekcountervailinginfluence.122Inthisapproach,thedisparitybetweeninsidereconomicownershipandcontrol,andotheraspectsofinvestorprotectionareendogenoustoothercountry-levelinstitutions.123b.TheValueofVotes:IndividualVersusCollectiveValueAcoreconcernwithdecouplingderivesfromtherelatedobservationsthatforoutsideinvestors,voteshavelimitedindividualvalue,butcanhavesubstantialcollectivevalue;andthatinmostcircumstances,thevalueofavoteisasmallfractionofthevalueofashare.Imaginethattherewereanexplicitmarketforvotes,decoupledfromshares,andthatsomeonewasinterestedinacquiringamajorityofthevotes.Thevotebuyercouldmakeatwo-tieroffer:priceXuntilitgetsamajority,zerothereafter.Muchasinatwo-tiertenderofferforshares,shareholderswouldfacepressuretosellvotesatanypricegreaterthanthebackendprice(here,zero),lesttheyend120.Seesupranote45.121.JoelS.Hellman,GeraintJones&DanielKaufmann,SeizetheState,SeizetheDay:StateCaptureandInfluenceinTransitionEconomies,31J.COMPARATIVEEeON.751(2003);RandallMorek,DanielWolfenzon&BernardYeung,CorporateGovernance,EconomicEntrenchment,andGrowth,43J.ECON.LITERATURE655,655-57(2005).122.Curtis1.Milhaupt,PropertyRightsinFirms,84VA.L.REV.1145(1998).123.MarcoPagano&PaoloF.Volpin,ThePoliticalEconomyo/CorporateGovernance,95AM.BeaN.REv.1005,1007--D8,1027(2005). 2006]NEWVOTEBUYING853upwiththeback-endprice.Moreover,atpresent,thevotebuyercanconductarollingtwo-tiertenderofferwithoutrules.Shareholderswillthusfacetimepressuretosellfast,lestotherssellfirst.Thelimitedvalueofindividualvotescanbeformalizedusing"oceanic"Shapleyvalues,whichmeasurethelikelihoodthatavoterwillbepivotal.TheShapleyvalueofasmall"oceanic"shareholderdependsontheholdingsofsignificantshareholders.124Ifafirmhasnoutstandingshares,onesignificantshareholderholdingafractionxofthesharesandmanyoceanicshareholders,thesignificantshareholder'sShapleyvalueis{x/(l•x)}ifthesignificantshareholderholdslessthanhalftheshares(x<0.5);andIifthesignificantshareholderholdsamajority(x2:0.5).TheoceanicshareholdershavecombinedShapleyvaluesof{I-(thesignificantshareholder'svalue)},andthusShapleyvaluepershareof{(I-2x)/n(lxiforx<0.5;and0forx2:O.S}.Thisper-shareShapleyvalue,andthusthevalueoftheirvotes,dropssharplyasthesignificantshareholderapproachesabsolutecontrol(x=0.5)anddisappearsoncecontrolisachieved.Moreover,intenderoffersforshares,thepoolofbiddersisconstrainedbecausethefront-endoffermustexceedthecurrentmarketpricetoattracttakers.Thus,unlesslarge-scalelootingisfeasible,thetenderofferwillbeprofitableonlyifthenewcontrollercanrunthefirmatleastaswellastheoldcontrollers.Avotebuyerdoesnotfacesimilarconstraints.Ifthepriceofvotesapproacheszero,thenevensmallprivatebenefitsofcontrolcanjustifytheefforttoacquirecontrol.c.EquilibriumVersusNonequilibriumModelsTheeconomicsliteratureincludessometheoreticalmodelsinwhichexplicitcompetitionbetweenincumbentsandraidersforvotes,decoupledfromshares,operatessimilarlytoamarketforcoupledsharesandvotes.125Thesemodelssuggestthatifinsiderscanbepreventedfromusingamarketforvotestolockupcontrolbeforearaiderappears,acontrolcontestfor124.SeeJ.S.Milnor&LloydS.Shapley,ValueofLargeGamesII:OceanicGames,3MATHEMATICSOFOPERATIONSREsEARCH290(1978);N.Z.Shapiro&LloydS.Shapley,ValueatLargeGamesI:AlimitTheorem,3MATHEMATICSOFOPERATIONSREsEARCHI(1978).CfJeffreyZwiebel,BlockInvestmentandPartialBenefitsofCorporateControl,62REv.BeON.STUD.161(1995)(applyingtheconcepttoblockholdingsinfirms).125.See,e.g.,DouglasH.Blair,DevraL.Golbe&JamesM.Gerard,UnbundlingtheVotingRightsandProfitClaimsofCommonShares,97J.POL.BeON.420(1989);ZvikaNeemanandGerhardO.Orosel,OntheEfficiencyofVoteBuyingWhenVotersHaveCommonInterests,INT'LREv.OFL.&BeoN.(forthcoming2007). 854SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811votescouldhave(minor)efficiencyadvantagescomparedtoacontestforshares.Themodels,however,are"extremelystylized,,126andnonequilibriuminnature,inwaysthatgivethemlimitedrelevancetothecontextsinwhichnewvotebuyingislikelytoarise.Mostcentrally,themodelsassumethatvotebuyingoccursonlyduringalimitedperiod.Theincumbentsandtheraidercompetethroughfullydisclosedoffersforvotes,whichexpireatthesametime.Themodelsthuspresumeacompetitionforvotesthatistightlyconstrainedintimeandtransparenttoallparticipants.Amorerealisticmodel,stilltobedeveloped,islikelytoleadtodifferentconclusions.Whatisneededisanequilibriummodelinwhich(1)theinsiderscanquietlyacquirevotesatanytime,beforearaideremerges;(2)onceacquired,votescanbeheldindefinitely;and(3)ifinsidersdonotkeepcontrol,araidercanquietlyacquirevotesatanytime.Whilesuchamodelisbeyondthescopeofthisproject,wesuspectthatinequilibrium,insiderswillkeepcontrol,ifonlytowardoffraidsbyoutsidersseekingtoextractprivatebenefits.Ifinsidersdidnotkeepcontrolinsuchaworld,raiderswouldhaveanincentivetomake"Saturdaynightspecial"offerstobuyvotes-timedtoputmaximumpressureonshareholderstosell,andtonotgivetheinsiderstimetorespond.127Thoseofferswouldlikelyproducearegulatoryresponse,muchasshort-fusetenderoffersforshareshelpedgiverisetoour128currenttenderofferrules.2.EmpiricalEvidencea.DivergenceBetweenInsiders'VotingandEconomicOwnershipThetheoreticalworkwhichpredictsadversevalueeffectswheninsiderscanseparateeconomicownershipandvotingrightsissupportedbyareasonablysolidbodyofempiricalevidence,bothintheUnitedStatesandinternationally.Thereareseveralstrandsofrelevantresearch.Oneevaluatesthestockpriceeffectsofdual-classrecapitalizationsintheUnited126.BlairetaI.,supranote125,at423.127.RonaldJ.Gilson,TheCaseAgainstSharkRepellentAmendments:StructuralLimitationsontheEnablingConcept,34STAN.L.REv.775,775n.2(1982)(discussing"Saturdaynightspecials"andothertenderofferterminology).128.FrankH.Easterbrook&DanielR.Fischel,TheProperRoleofaTarget'sManagementinRespondingtoaTenderOffer,94HARV.L.REv.1161,1162---Q3(1981)(discussingthehistoryoftenderofferregulation). 2006]NEWVOTEBUYING855States,atakeoverdefensepopularduringthe1980s.129Theannouncementofadual-classrecapitalizationsignificantlyreducesshareprice.130Asecondbodyofempiricalworkcorrespondstotheconcernwithtunnelingbycontrollingshareholders.Inmanycountries,foundingfamiliesoftenmaintaincontrolbyholdinghighervotingthaneconomicownership,throughhighvotingsharesorcircularorpyramidalgroupholding131structures.IntheUnitedStates,PaulGompers,JoyIshii,andAndrewMetrickofferevidencethatadisparityor"wedge"betweeneconomicandvotingownershipcreatedthroughdual-classcommonsharesadverselyaffectsshareprices.Tobin's"q"(acommonmeasureoffirmvalue)decreaseswithinsiders'votingrights(holdingeconomicownershipconstant)uptoabout45%,arangewhichcoversmostofthefirmsintheirsample.132Awedgebetweenvotingrightsandeconomicownershippredictslowersharepricesinothercountries,aswell.133Thesestudiesarebasedonthetradingpricesofnoncontrollingshares.Thus,itispossiblethatthelowervalueofminoritysharesisoffsetbythehighervalueofcontrollingshares,whichdonottrade,sotheirvaluecannotbeobserved.Thereissomeevidence,however,thatalargerwedgepredictslowerfirmprofitability.134b.TheValueofVotingRightsEmpiricalworkhasalsobeendoneseekingtodirectlyassessthevalueofvotingrights.Thisliteratureoffersasenseforhowmuchofafirm'svalueisatstakeinnewvotebuying.Therearetwobasicwaystomeasure129.WediscusstheserecapitalizationsinfrainPartm.c.130.See,e.g.,LarryY.Dann&HarryDeAngelo,CorporateFinancialPolicyandCorporateControl:AStudyofDefensiveAdjustmentsinAssetandOwnershipStructure,20J.FIN.EcON.87(1988);JeffreyN.Gordon,TiesThatBond:DualClassCommonStockandtheProblemofShareholderChoice,76CAL.L.REv.I(1988);GreggA.Jarrell&AnnetteB.Poulsen,Dual-classRecapitalizationsasAntitakeoverMechanisms,20J.FIN.ECON.129(1988).ButseeM.MeganPartch,TheCreationofaClassofLimitedVotingCommonStockandShareholderWealth,18J.FIN.ECON.313(1987)(fmdingnosignificanteffect).131.SeeClaessensetaI.,supranote2,at82-83,11O.132.GompersetaI.,supranote2.133.SeeStijnClaessens,SimeonDjankov,JosephFan&LarryLang,DisentanglingtheIncentiveandEntrenchmentEffectsoflArgeShareholdings,571.FIN.2741(2002);KarlV.Lins,EquityOwnershipandFirmValueinEmergingMarkets,38J.FIN.&QUANTITATIVEANALYSIS159(2003);BernardBlack,HasungJang&WoochanKim,DoesCorporateGovernancePredictFirms'MarketValues?EvidencefromKorea,22J.L.ECON.&ORG.(forthcoming2006),availableathttp://ssrn.com!abstract=311275.134.GompersetaI.,supranote2;SungWookJoh,CorporateGovernanceandFirmProfitability:EvidencefromKoreaBeforetheEconomicCrisis,681.FIN.ECON.287,290(2003). 856SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811thevalueofvotes:Thefirstmeasuresthevalueofcontrolasafractionoffirmvalue.Thesecondmeasuresthepremiumvalueofhigh-voterelativetolow-voteshares.Thus,AlexanderDyckandLuigiZingalescomparethepricepaidtoacquireacontrolblockwiththecontemporaneousvalueofnoncontrollingshares.135TatianaNenovaexaminesdifferencesbetweenthetradingpricesofseparateclassesofvotingstoCk.136Bothstudiesfindwidevariationacrosscountriesinthevalueofcontrol,withthisvalueoftenequaltoasubstantialfractionoffirmvalue.137IntheUnitedStates,themeanvalueofcontrolisrelativelylow,around2%-4%offirmvalue.138Thisvaluecanbemuchlarger,however,foraparticularcompanythatisundergoingachangeincontrol.I39Turningtothepremiumaccordedtohigh-votesharesrelativetolow-voteshares,single-countryestimatesrangefrom5%-10%intheUnitedStatesl40to82%inItaly.141c.MarketforCorporateControlInsiderentrenchmentthroughnewvotebuyingcouldhaveaneffectsimilartostrongtakeoverdefenses.Gompers,Ishii,andMetrickreportevidencethatU.S.firmswithstrongtakeoverdefenseshavelowerTobin'sqthanfirmswithweakdefenses.142MartijnCremersandVinayNairreportevidenceofabnormalreturnstoaportfoliooffirmswithweaktakeover135.AlexanderDyck&LuigiZingales,PrivateBenefitsofControl:AnInternationalComparison,59J.FIN.537(2004).136.TatianaNenova,TheValueofCorporateVotingRightsandControl:ACross-countryAnalysis,68J.FIN.BeON.325(2003).137.Inadditiontothesecross-countrystudies,othersinglecountryestimatesofthevalueofcontrolasapercentageoffinnvalueinclude3%-8%inSweden,seeKristianRydqvist,TakeoverBidsandtheRelativePricesofSharesThatDifferinTheirVotingRights,20J.BANKING&FiN.1407,1419-20(1996);and30%inItaly,seeLuigiZingales,TheValueoftheVotingRight:AStudyoftheMilanStockExchangeExperience,7REV.FIN.STUD.125(1994).138.SeeMichaelJ.Barclay&CliffordG.Holderness,PrivateBenefitsfromControlofPublicCorporations,251.FIN.BeON.371,394(1989)(discussingvaluedifferencebasedonlargeblocktrades);Nenova,supranote136.139.SeeHarryDeAngelo&lindaDeAngelo,ManagerialOwnershipofVotingRights:AStudyofPublicCorporationswithDualClassesofCommonStock,14JFIN.ECON.33(1985);LuigiZingales,WhatDeterminestheValueofCorporateVotes?,110Q.J.ECON.1047,1049-52(1995).140.SeeRonaldC.Lease,JohnJ.McConnell&WayneH.Mikkelson,TheMarketValueofControlinPublicly-tradedCorporations,11J.FIN.ECON.439,469(1983);Zingales,supranote139,at1047.141.SeeZingales,supranote137,at126(alsocollectingothersinglecountryestimates,including6.5%inSweden,13%intheUnitedKingdom,23%inCanada,27%inSwitzerland,and45%inIsrael).142.SeePaulGompers,JoyIshii&AndrewMetrick,CorporateGovernanceandEquityPrices,118Q.J.ECON.107(2003). 2006]NEWVOTEBUYING857defenses,butonlyinthepresenceofoutsideblockholders.143Atthesametime,abidder'sabilitytousehiddenownershiptoamassatoeholdstakecanfacilitatetakeoverbids.d.RecordDateCaptureOnerecentworkingpaperprovidesevidenceonrecorddatecapture.SusanChristoffersen,ChristopherGeczy,DavidMusto,andAdamReed,usingproprietarydataonloansofU.S.sharesbyacustodianbankin1999andbyabroker-dealerfrom1996to2001,reportthatloansspikeontherecorddate,increasingonaveragefrom0.21%to0.26%ofoutstandingshares.l44Thespikeinborrowingontherecorddatestronglysupportstheexistenceofsomerecorddatecapture.Thespikeishigherforfirmswithpoorerperformance,forvotesthatturnouttobeclose,andforvotesthatproducehighersupportforshareholderproposalsoroppositiontomanagementproposals.Christoffersenandhercolleaguesofferevidencethatborrowingsharesaroundarecorddatecostsnomorethanborrowingatanothertimearoundfifteenbasispointsperyear.Tothem,thissuggeststhataninformationaggregationprocessisatwork,inwhichill-informedlendersconsciouslyyieldtheirsharestobetter-informedborrowers,whocanvotewisely,toeveryone'sbenefit.Theirdataoffersclearevidencethatrecorddatecaptureoccurs,butwearenotpersuadedbythis"activelending"interpretationoftheirfindings.First,weconsideritunlikelythatlendersoftenconsciouslyyieldsharesforvotingpurposes.AswediscussinPartV.C,mostlendersseektoearnaprofitfromlendingingeneral,paylittleattentiontorecorddatesorwhichcompanies'sharestheyarelending,andoftenoutsourcetheprocesstoalendingagent.145Tous,itseemsmorelikelythatshareborrowersaretheactiveagents.Second,thebenefitsfrominformationaggregationwillariseonlyifborrowershaveapositiveeconomicinterest.Thisissometimesnotthecase,assituationssuchasPerry-MylanandHendersonInvestmentsillustrate.Theyalsolackdataonwhoisborrowing.Third,theyassumethatoutsideinvestorsareborrowing,buttheirresultsareconsistentwithinsiderssometimesanticipatingaclosevoteandborrowingtoensurevictory.143.K.J.MartijnCremers&VinayB.Nair,GovernanceMechanismsandEquityPrices,60J.FIN.2859(2005).144.ChristoffersenetaI.,supranote21.145.WediscusssharelendingpracticessuprainPartII.EandinfrainPartV.C. 858SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811C.ANALOGIESTOOTHERFORMSOFDECOUPLING1.Dual-classCommonStock,Pyramids,andCircularControlMuchofthepotentialuseofthenewvotebuyingwilllikelycomefrominsidersandfromoutsidersseekingcontrol(whowillbecomeinsidersiftheysucceed).Forinsiders,newvotebuyingisonlyoneofanumberoftechniquesfordecouplingeconomicandvotingownership.Otherstrategiesincludedual-classcommonstock,pyramidalownershipstructures(withinsiderscontrollingthetopcompanyinthepyramid),andcircularownershipstructures(withinsiderscontrollingapivotalcompany).Forinsidersthen,newvotebuyingisanewtool,butnotafundamentallynewopportunity.Itisworthconsidering,then,thedifferencesbetweennewvotebuyingandtheseolderdecouplingtechniques.Onecentraldifferenceisthat,withdual-classcapitalstructures,pyramids,andcircularcontrol,outsideinvestorsknowwhattheyaregetting.Thus,insiderspayamarketpenaltywhen,say,companiesissuelower-votingshares.ThispenaltyisthemostlikelyreasonwhyahighpercentageofU.S.initialpublicofferingsinvolvecompanieswithaoneshare-one-votecapitalstructure.Boththetheoreticalworkdiscussedaboveandtheavailableevidenceontheeffectsofinsiderdecouplinginvolveadisclosedwedgebetweeneconomicownershipandvotingrights.Anundisclosedwedgeismoreproblematicthanadisclosedwedge.Considerafumwithacontrollingshareholder.Ifthewedgeisdisclosedandstableovertime,investorswillpresumablypayalowerpriceforsharesofafIrmwithalargewedge,whichreflectsthecontroller'sdistortedincentives.Supposeinsteadthatdecouplingishiddenandeasytochangeovertime.InvestorswillnotknowwhichfIrms'insidershavealargewedgebetweeneconomicandvotingownership.Investorsalsowillnotknowhowthiswedgefluctuatesovertime.Insidersmaybeabletocedecontroltothemarketforatime,butcheaplyreacquireitlater,perhapswhenathreattoday-to-daycontrolemerges.Someinsidersmaybeabletoapparentlycedecontrol,thusobtainingthemarketpricebenefItsofdoingso,whileactuallyretainingcontrol.Ingeneral,onewouldexpectinvestorstoreact,asinany 2006]NEWVOTEBUYING859adverseselectionsituation,bydiscountingthepricestheypayforsharesofallcompanies.Thiswillincreasethecostofpublicequitycapital.146Hidden,low-costdecouplingcouldalsocontributetoa"lemons"equilibriuminwhichdispersedownershipisunstableevenifitmaximizesfirmvalue,sothatmostfirmsretainconcentratedownership.Bebchukdevelopsamodelinwhich,inamarketwithhighprivatebenefitsofcontrol,dispersedownershipwouldbefirst-bestifitcouldbesustained,butisunstablebecauseanewcontrollercouldpayamarketpriceforsharesandthenprofitbyself-dealing.147EmpiricalstudiesprovideevidenceofthecollapseofinitiallydispersedownershipaftermassprivatizationintheCzechRepublicandBulgaria.1482.Dual-classRecapitalizationsDual-classrecapitalizations--effortsbycompanymanagerstocreateadual-classstructureafterthecompanyhassoldfull-votingsharestoinvestors--offerapossiblybetteranalogytothenewvotebuyingthandual-classstockorpyramidstructure.Dual-classrecapitalizationsbecamepopularintheUnitedStatesduringthehostiletakeoverwaveofthe1980s,aftertheNYSErelaxeditsone-share-one-voterule.Inatypicalrecapitalization,thecompanywouldproposeadual-classvotingstructureinwhichinsiderswouldacquirehigh-voteshares.Thelow-voteshareswouldhaveslightlysuperioreconomicrights,suchasaslightlyhigherdividend,perhapsfivecentspershareperyear.149Theserecapitalizationsletinsidersacquirecontrolwithoutpayingamarketpricefordoingso.Outsideshareholdersvotedtoapprovetherecapitalizationsbecausetheirvoteswereindividuallyworthlessthanthehigherdividend.150Consistentwithinsidersacquiringcontrolforalessthan-marketprice,theannouncementofadual-classrecapitalization146.SeeStewartC.Myers&NicholasS.Majluf,CorporateFinancingandInvestmentDecisionsWhenFirmsHaveInformationThatInvestorsDoNotHave,13J.FiN.EeON.187(1984).147.SeeLucianAryeBebchuk,ARent-protectionTheoryofCorporateOwnershipandControl(Nat'!BureauofEcon.Research,WorkingPaperNo.W7203,1999),availableathttp://ssrn.com!abstract=203110.148.EdwardGlaeser,SimonJohnson&AndreiShleifer,CoaseVersustheCoasians,116Q.J.BeON.853(2001);VladimirAtanasov,BernardBlack,ConradS.Ciccotello&StanleyB.Gyoshev,TheAnatomyofFinancialTunnelinginanEmergingMarlcet(May16,2006)(unpublishedmanuscript),availableathttp://ssm.com!abstract=902766.149.See.e.g.,Gordon,supranote130;JoelSeligman,EqualProtectioninShareholderVotingRights:TheOneCommonShare,OneVoteControversy,54GEO.WASH.L.REv.687(1986).150.SeeGilson,supranote112. 860SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811significantlyreducedshareprice.'51MostformsofmidstreamrecapitalizationswerethenbannedthroughjointactionbytheSECandthestockexchanges,preciselybecausetheyletinsidersamasscontrolwithoutpayingamarketpricefordoingSO.152Insomerespects,newvotebuyingisworsethanadual-classrecapitalization.Arecapitalizationatleastrequireddisclosureandashareholdervote;thenewvotebuyingrequiresneither.3.VotingbyRecordOwnersAnotheranalogyinvolvesthecommonpracticeinwhichinvestorsholdsharesin"streetname"ratherthanintheirownname.Theultimate"recordowner"isasecuritiesdepository(DepositoryTrustCompany("DTC")istheprincipaldepository),whichholdssharesfortheaccountsofitsmembers-banksandbroker-dealers-who,inturn,holdsharesfortheirclients.153Sometimeslargercustodianbanksorbrokersholdforsmallerones.Asamatterofformalcorporatelaw,DTC,throughitsnominee,Cede&Co.,isamajorityshareholderofalmosteverypubliclytradedU.S.company,yetithasnoeconomicownership.IfDTChadvotingdiscretion,thiswouldbeemptyvotingwithavengeance.However,awebofmarketpracticesandSECandstockexchangerulesensurethatvotingrights,havingbeenseparatedfromeconomicownership,arelargelyreunitedinpractice.DTCandotherdepositoriespassvotingauthoritytothebanksandbroker-dealersforwhichtheyholdshares.Thebanksandbroker-dealers,inturn,mustasktheirclientsforvotinginstructionsandfollowthoseinstructionsifprovided.Ifaclientdoesnotreturnvotinginstructions,NYSERule452allowsthebankorbroker-dealertovoteonroutinematters,butnotonmajormatters,suchasacontestedelectionofdirectorsoranacquisition.TheNYSEpublishesweeklyalistofupcomingelectionsandagendaitemsonwhichbroker-dealerscanvoteonlyifinstructedbyclients.154Thisisnot151.Seesourcescitedsupranote130.152.SeeBusinessRoundtablev.SEC,905F.2d406(D.c.Cir.1990)(invalidatingtheSEC'spriorefforttobandual-classrecapitalizations);StephenM.Bainbridge,TheShortLifeandResurrectionofSECRule19c4,69WASH.U.L.Q.565(1991);Gilson,supranote112.153.Onthecurrentsystemanditsorigins,see,forexample,IssuerRestrictionsorProhibitionsonOwnershipbySecuritiesIntermediaries,ExchangeActReleaseNo.34-50758,69Fed.Reg.70,852,70,852nn.I-2(Dec.7,2004);MICHAELT.REDDY,SECURITIESOPERATIONS127-M(2ded.1995).154.SeeNYSE,Inc.,Rule452(2002).OntheoriginsandstructureofRule452andsimilarNASDAQandAmericanStockExchangerules,seeBainbridge,supranote152;TaskForceonS'holderProposalsoftheCornm.onFed.RegulationofSec.,Am.BarAss'n,ReportonProposedChangesinProxyRulesandRegulationsRegardingProceduresfortheElectionofCotporateDirectors,59Bus.LAW.109(2003). 2006]NEWVOTEBUYING861toodissimilarfromthecurrentmarketpracticeunderlyinghidden(morphable)ownership.AswediscussedinPartII.C,derivativesdealersoftenholdmatchedsharestohedgelongequityswappositionstheyhaveprovidedtotheirclients.AtleastintheUnitedKingdom,thedealerswillusuallyagreetoconveyvotingrightsbacktotheclientsondemand,eitherbyunwindingtheswapsandsellingthematchedsharestotheirclients,orbyvotingthematchedsharesasdirectedbytheirclients.D.CLASSICALVOTEBUYINGDOCTRINEANDDECOUPLINGCorporatelawpolicestheconnectionbetweeneconomicinterestandvotingpowerthroughtheclassiccommonlawprohibitionon"votebuying,"definedasthesaleofashareholder'svotingrights,shornofeconomicinterest,toathirdparty.ISSTheoriginal1932RestatementofContractsmadesuchasaleillegal.I56NewYork'scorporatelawprohibitsshareholdersfromsellingorchangingtheirvotesformoney"oranythingofvalue.,,157Thecentralconcernwasthatvotebuyingwouldleadtoselfdealingbythosewhotherebygaincontrol.ThecurrentDelawareattitudetowardvotebuyingismoretolerant.Theleading1982caseofSchreiberv.CarneycenteredonaloanbyTexasInternationalAirlinestoacontrollingshareholderto'obtainthat158shareholder'ssupportforarestructuring.Thecourtfoundthatthiswasvotebuying,butexplainedthat"eacharrangementmustbeexaminedinlightofitsobjectorpurpose."159Votebuyingwaspermittedforaproper160purposeifitsatisfiedatestforintrinsicfairness.InSchreiber,thecourtfoundaproperpurpose-therestructuringwouldfurthertheinterestofall161TexasInternationalstockholders.Andthetermswereapparentlyfair,forwhichthebestevidencewasapprovalbyavoteofothershareholders.Ingeneral,thevotebuyingcasesareunlikelytoreachnewvotebuyingwithoutamajorchangeincurrentdoctrine.Schreiberdefinesvotebuyingasavotingagreementsupportedby"considerationpersonaltotheISS.See,e.g.,Chewv.InvernessMgmt.Corp.,352A.2d426(Del.Ch.1976);RobertCharlesClark,VoteBuyingandCorporateLaw,29CASEW.REs.L.REv.776(1979)(compilingcases);MichaelD.Schmitz,Comment,ShareholderVoteBuying-ARebuttablePresumptionofIllegality,1968WIS.L.REV.927.156.REsTATEMENTOFCONTRACTS§569(1932).157.N.Y.Bus.CORP.LAW§609(e)(McKinney2003).158.Schreiberv.Carney,447A.2d17(Del.Ch.1982).159.[d.at25.160.[d.at24.161.[d.at26. 862SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811stockholder,wherebythestockholderdivorceshisdiscretionaryvotingpowerandvotesasdirected.,,162Thefocusisonavotesellerwhotransfersthevotingrighttoavotebuyer.Thenewvotebuyingfallsoutsidethisdefinition.Forinstance,anewvotebuyercanacquirevotingrightsthroughatwo-stepprocessthatinvolvesneitheravotesalenoratransferofvotingrights:first,purchaseshares;andsecond,shedtheeconomicrightsassociatedwiththoseshares,leavingthesharepurchaserholdingonlythevotingrightsassociatedwiththeshares.ConsiderthePerry-MyIansituation.163PerrypurchasedMylanshares,andenteredintoequityswapswhichhedgeditseconomicownership.Neitherstepinvolvedeitheravoteselleroratransferofvotingrights.Instead,thesetransactionsinvolvedasharepurchaserandatransferofeconomicinterests.Indeed,bothwereperfectlyordinarymarkettransactions:asharepurchaseandahedgingtransaction.Similarly,insidersusingcollarsretainvotingrightswhilesheddingeconomicownership.Again,thedecouplingisachievedbytwonormalmarkettransactions-thepurchaseofsharesandthehedgingofeconomicrisk-ratherthanasinglesuspectpurchaseofvotes.Recorddatecapturealsofallsoutsidecurrentvotebuyingdoctrine.Theborrowedsharesconveyfulleconomicandvotingownership.Thisiscustomarilycoupledwiththerightofeithertheborrowerorthelendertoreversethetransactionondemandand,whiletheloanisoutstanding,theborrowerpayingtothelenderthecashreturnonthesharesplusanagreeduponborrowingcharge.Noindividualpieceofthisarrangementisproblematic.Votebuyingbyinsiders,however,remainssuspectbecauseofpossiblefiduciarydutyconstraints.InthebattleoverH-P'sacquisitionofCompaq,WalterHewlettaskedthecourttosetasidethevotesbyDeutscheBankongroundsofvotebuying,allegingthatDeutscheBank'svotewascoercedbythreatsfromH-Pmanagementthatthebank'sfuturebusiness164relationshipwithH-Pwouldsufferifthebankvotedagainstthemerger.Thecourtfoundnoevidenceofcoercion,butseemedtopresumethe162.Schreiber,447A.2dat23.163.WediscussthisexamplesuprainPart1I.B.164.Hewlettv.Hewlett-PackardCo.,No.Civ.A.19513-NC,2002WL818091,at*12(Del.Ch.Apr.30,2002). 2006]NEWVOTEBUYING863165illegitimacyofcoercion,haditoccurred.WereturntothisinsiderfiduciarydutylimitationinPartV.BA.E.TESTABLEHYPOTHESESSupposethatdisclosurerules,suchastheonesweproposebelow,providedgooddataontheextentofemptyvotingandhidden(morphable)ownership(whichwouldnolongerbehidden);botharereasonablywidespread;andthereisnochange,otherthandisclosure,incurrentrules.Whatresultsmightweexpect?Onesetofhypothesesinvolvesthemarketsonwhichthenewvotebuyingdepends.Aroundtherecorddateforacontestedvote,wewouldexpect(l)anincreaseindemandforshareborrowing;and(2)apossibledecreaseinthesupplyoflendableshares,becausesomelenderswillwanttovotetheirshares.Thisshouldincreasethecostofborrowingsharesorcreatingashortequityswapposition(forwhichthedealermayhedgebyborrowingsharesandsellingthemshort).Inanextremecase,thecostofborrowingsharesorobtainingshortequityswappositionsmightspikeasthecontestantsviewtoacquireenoughvotestocarrytheelection.Christoffersenandhercolleaguesreporthigherlendingvolumearoundrecorddateswithlittleapparentchangeinprice,166butthisseemsunlikelytobeanequilibriumoutcomeforcontestedelections.Cheaperdecouplingshouldincreasetheoveralllevelofdecoupling.Itmightbefeasibletoexploitcross-countryorcross-firmdifferencesintheavailabilityandcostofdecouplingtotestwhetherthesedifferencespredictdifferencesintheextentofdecoupling.Arelatedhypothesisinvolvestheminimumownershipthatinsidersneedtomaintaintoensurecontrol.Ownershipof30%-35%ofacompany'sshareshasgenerallybeenconsideredsufficientforcontrol.Ifinsiderscanmorereadilyreduceeconomicownershipwhilemaintainingvotingownership,andoutsiderscanacquirevotesatmodestcost,bothfactorsshouldleadcontrollingfamiliestomaintainhighervotingownership.165.Forfurtherdiscussionofvotebuying,seeThomasJ.Andre,Jr.,APreliminaryInquiryintotheUtilityofVoteBuyingintheMarketforCorporateControl,63s.CAL.L.REv.533(1990);Clark,supranote155;DouglasR.Cole,E-proxiesforSale?CorporateVote-buyingintheIntemetAge,76WASH.L.REV.793(2001).166.ChristoffersenetaI.,supranote21. 864SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811Afinalhypothesisinvolvestheequityswapmarket.Onepossiblereasonfortherapidgrowthinthismarketisthedesireofhedgefundsandotherinvestorstoconcealtheirownership.Ifso,moreeffectivedisclosurerulescouldreduceuseofequityswaps.Onceagain,cross-countryorcrossfirmtestsmightbefeasible.IV.DISCLOSURE:CURRENTRULESANDREFORMPROPOSALA.GENERALCONSIDERATIONSWeturnnowtohowdisclosurerulesrelatetothenewvotebuying.InPartIV.B,weaddresstheextenttowhichcurrentshareownershipdisclosurerulesreachemptyvotingorhidden(morphable)ownership.InPartsIV.CandIV.D,weofferan"integratedownershipdisclosure"reformproposalthatwouldbothensuredisclosureofmuchofthenewvotebuyingandsimplifycurrentownershipdisclosurerules.B.EXISTINGDISCLOSUREREQUIREMENTSWereviewherethecurrentdisclosurerequirementsthataffectthenewvotebuying.Toavoidclutterthatmightobscureourmainthemes,weglossoversomecomplexities.Thus,ourdiscussionshouldbeunderstoodasroughly,butnotwholly,accurate.Currently,therearefivediscreteownershipdisclosuresystems,for(1)active5%shareholdersonSchedule13D;167(2)passive5%shareholdersonSchedule13G;168(3)institutionalinvestors,includinghedgefunds,onForm13F;169(4)companyinsidersunderSection16;and(5)mutualfundspoThesesystems,takentogether,arebewilderinglycomplex.Differentrulesoftenapplyindeterminingwhattriggersthedisclosurerequirementsandwhatmustbedisclosedifdisclosureisrequired.Economicallyidenticalholdingsareoftendisclosedindifferentways,dependingonhowaninvestorachievesaparticularcombinationofvotingandeconomicownership.PositionsinvolvingOTCderivativesoftenescapedisclosure,whenasubstantivelyidenticalpositioninvolvingexchangetradedderivativeswouldbedisclosed.Ownershipofcalloptionsmay167.Schedule13D,supranote14.168.Schedule13G,supranote14.169.Form13F,supranote13.170.SeeinfraPartN.BA. 2006]NEWVOTEBUYING865requiredisclosure,but(thenearlyequivalent)saleofputoptionsmaynot.Andsoon.Aderivatives-savvyhedgefundcanoftenavoiddisclosure.Table3summarizesthecurrentdisclosurerequirements.Theircomplexityandillogicisimmediatelyapparent. 00TABLE3.Currentownershipdisclosurerequirementsrelatingtonewvotebuying0'10'1Thistablesummarizeshowlongandshortpositionsinsharesorequivalents,andstocklendingandborrowing,aretreatedundercurrentU.S.ownershipdisclosurerules.Thetableaddressesseparatelytheuseoflongandshortpositionsinsharesandequivalentstotriggerareportingobligation,andtheneedtodisclosethesepositionsifareportingobligationexists.StockLendingandLongPositionsShortPositionsBorrowinl!AsTriggerIfFilingRequiredAsTriggerIfFilingRequired~c::EquitySharesandEquitySharesandEquityEquityExchange-Exchange-ReportingReportingSwaps;Exchange-Swaps;Exchange-Swaps;ShortSwaps;Short~tradedtradedLendingBorrowingSchemeFrequencyOtherOTCtradedOtherOTCtradedOtherOTCDerivativesSalesotherOTCDerivativesSales~DerivativesDerivativesDerivativesDerivativesDerivativesDerivatives<::Ql3DCurrentGenerallynoYesPartialYesNoYesNoPartialYesPartialUnclearYest"-<::;;Yes(ifheldYes(ifheldYes(ifheldonon~13GAnnualGenerallynoNoYesNoNoNoYesNoNoonreportingreportingreportingdate)~date)date);l>:s;:l3FQuarterlyStatus-based:$100MinNoPartialStatus-based:$100Minl3FNoPartialNoNo::E13Fsecuritiessecurities~:$Section16Probablynottl(directororStatus-basedStatus-based::Eofficer)BannedBannedbybyProbablyYes(asCurrentYesYesSectionSectionnotrigger);Section16l6(c)l6(c)Probablyno(10%GenerallynoYesNo(inholder)disclosure)~No(exceptby-.IMutualQuarterlyYesYesYesYesimplicationfrom00Funds........disclosureofshortsales)~- 2006]NEWVOTEBUYING8671.LargeShareholderDisclosure(Schedules13Dand13G)a.BasicRequirementsAnypersonwho"directlyorindirectly"acquires"beneficialownership"ofmorethan5%ofapubliccompany'ssharesmustfileaSchedule13DwiththeSECwithintendaysaftercrossingthe5%threshold.l7lCertaintypesofinstitutionalinvestorswhoinvest"passively"(intheordinarycourseofbusinessandwithoutintenttoinfluencecontrol)caninsteadfileamoreabbreviatedSchedulel3G(generallyonFebruary15ofeachyear,reportingyear-endpositions).172Bothschedulesarepubliclyavailable.Disclosureisbasedon"beneficialownership"ofshares,asdefinedbyRule13d-3.Thefocusisonsoleorsharedvotingorinvestmentpower,whichcanbeheld"directlyorindirectly,throughanycontract,arrangement,understanding,relationship,orotherwise.,,173Beneficialownershipofsharesincludes"therighttoacquirebeneficialownership...withinsixtydays,including...throughtheexerciseofanyoption[or]warrant.,,174TheSECdiscouragesgamingbyprovidingthatanypersonwhousesany"contract,arrangement,ordevice"toevadethesereportingrequirementsisnonethelessdeemedtobeabeneficialowner.175Filersmustreportthenumberandpercentageofsharesbeneficiallyowned,andanypurchasesorsaleswithinthepastsixtydays.176Item6ofSchedule13D,whichhasnocounterpartinSchedule13G,alsorequiresdisclosureof"anycontracts,arrangements,understandingsorrelationships(legalorotherwise)"relatingtoanysecuritiesoftheissuer.177Item7requiresthefilingofcertainrelated"writtenagreements"asexhibits.178Shortpositions,whetherinsharesorderivatives,donottriggerdisclosure.Ifdisclosureistriggeredbyalargelongposition,somedisclosureisrequiredforpartiallyoffsettingshortpositions.171.SeeExchangeActRule13d-l,FilingofSchedules13Dand13G,17C.F.R.§240.13d-l(a),(i)(2005).172.SeeExchangeActRule13d-I(b),17C.F.R.§240.l3d-l(b)(2005).Whenownershipfirstexceeds10%,Schedule13Gmustbefiledbythetenthdayofthenextmonth.[d.173.ExchangeActRule13d-3(a),17C.F.R.§240.l3d-3(a)(2005).174.ExchangeActRule13d-3(d)(l)(i),17C.F.R.§240.l3d-3(d)(l)(i)(2005).175.ExchangeActRule13d-3(b),17C.F.R.§240.13d-3(b)(2005).176.Schedule13D,supranote14,atItem5;Schedule13G,supranote14,atItem4.177.Schedule13D,supranote14,atItem6.178.[d.atItem7. 868SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811HowSchedules13Dand13Gtreatsharelendingandborrowingisunclear.Borrowing(whichcomeswithvotingpower)wouldlikelybothcounttowardtriggeringdisclosureandbedisclosableonbothforms.Recorddatecapturewithoutacontrolintent,however,isunlikelytobecapturedbySchedule13Gbecausefewrecorddateswillfallaroundtheyear-endreportingdate.SharelendingmightbedisclosableonItem6ofSchedule13D,butisnotcapturedbySchedule13G.b.ApplicationtoHidden(Morphable)OwnershipWillthe13Dand13Grequirementscapturehidden(morphable)ownership?WewillusePerry-Rubiconasanexampley9Perryheldjustunder5%ofRubicon'sshares,plusequityswapsconveyinganadditional11%economicownership.Itsdirectholdingofshareswouldnottriggerdisclosure.Theequityswaps,bythemselves,wouldlikelynottriggerdisclosureeither.TheswapsinPerry-Rubiconwerecash-settledanddidnotconveytherighttoacquireshares.Perry'sequityswappositionmightbecaughtbythe"arrangement,understandingorrelationship(legalorotherwise)"language,ifithadasufficientlyfirmexpectationthatitcouldexchangeitsequityswappositionforsharesatanytime.ButthereisnoclearguidanceintheruleorinSECno-actionletters.PractitionersatlawfirmsprominentintheOTCderivativesmarketapparentlytakethepositionthatdisclosureofcash-settledequityswappositionsisnormallynotrequired.PartnersatAllen&Overy,theprimaryoutsidelawfrrmoftheInternationalSwapsandDerivativesAssociation(themaintradeassociationfortheOTCderivativesindustry),andatClearyGottliebhavebothtakenthisposition.I80Thenondisclosureofcash-settledequityswapscanbequestionedifonelooksbeyondthetermsoftheswapitselftotheeconomiccontext.Aderivativesdealerwhichtakesashortequityswappositionwillalmostsurelyhedgeitsexposure,oftenbyholdingmatchedshares.ThishedgingchoicewasadoptedinPerry-Rubicon.PerrysoldRubiconsharestoDeutscheBankandUBSWarburgconcurrentwithenteringtheequityswaps.TherewasaverygoodchancethatPerrycouldreturntoitsdealersandexchangeitsswappositionforshares,withoutanexplicitpriordiscussion.(Accesstothedealers'matchedsharesisnotalwaysacertainty;thehedgefundintheSearsCanadasituationwassurprisedtofinditsdealer179.WediscussthistransactionsuprainPartII.C.180.SeeGREENE,supranote102(bookbyClearyGottlieb);Liew,supranote101(articlebyAllen&Overypartner). 2006]NEWVOTEBUYING869lessaccommodatingthanithadexpected.181)Isthisexpectationasufficient"arrangement,understandingorrelationship(legalorotherwise),"takingintoaccounttheextensionofbeneficialownershiptoanypersonwhousesany"arrangementordevice"toevadereporting?PerryclaimednotunderNewZealand'srules,whicharesimilartoU.S.rules.Perrylostattrial,butwononappeal.Australiahasreachedasimilarresult,undersimilarlargeshareholderdisclosurerules.In2005,GlencoreInternational,whichheldjustbelow5%ofAustralCoal,enteredintoequityswapswithtwoderivativesdealers,therebyacquiringanother6.5%ineconomicownership,beforedisclosing82itsoverallposition.1TheAustralianTakeoversPanelheldthatGlencoreshouldhavediscloseditscombinedpositionassoonasitseconomicownershipcrossedthe5%threshold.183ThePanelfoundthatGlencoreexpectedthederivativesdealerstoacquirematchedsharestohedgetheequityswaps,andthatthedealers'incentivetoholdthematchedsharesgaveGlencore"arealdegreeofeffectivenegativecontrol"overdisposaloftheseshares.ThePanel'sdecision,however,wasreversedonappealbytheFederalCourtofAustralia.184Hidden(morphable)ownershipmightarguablybeanalogizedto"stockparking"fordisclosurepurposes.185Theargumentwouldbethattheshares"parked"withanotherpartyinconventionalparkingarrangementsaresimilartothe"matchedshares"heldbyaderivativesdealertohedgeanequityswapprovidedtoaclient.Inbothcases,thereislittleornomarketrisktothefinancialintermediaryandthetransactionmaybeusedtoavoiddisclosingownership.Therearematerialdistinctions,however,betweenthetwosituations.Parkinginvolvesanunderstandingthattheclientwillbuythestockbackatalaterdateandprotectitscounterpartyagainstloss.Withanequityswap,thereisnosuchunderstandingandthedealermustprotectitselfagainstloss.181.WediscusstheSearsCanadaincidentsuprainPartII.C.182.WediscusstheGlencore-AustralCoaltransactionsuprainPartII.C.183.SeeAustralCoalTakeoversPanelDecision,supranote75.TheTakeoversPanelbasedthisdecisiononthepolicyconcernsunderlyinglargeshareholderdisclosurerules,ratherthanonthespecificlanguageofthestatute.184.SeeGlencoreInt'lAG,supranote75.185.Thekeystockparkingcase,UnitedStatesv.Bilzerian,926F.2d1285(2dCir.1991),discussesparkingarrangements. 870SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811c.ApplicationtoEmptyVotingConsidernexthowSchedules13Dand13Gaffectemptyvoting,usingPerry-Mylanasanexample.Perryacquired9.9%ofMylan'sshares.HadSchedule13Gbeenavailable,nodisclosureofitshedgeswouldhavebeenneeded,nordisclosureofitspositionuntilFebruary15ofthenextyear.PerryinitiallytookthepositionthatSchedulel3Gwasavailable,andfiledaSchedule13DonlyafterCarl!eahnfiledaSchedule13DindicatinganintenttoacquireMylan,astepthatPerryopposed.I86Perry'sviewthatitsintenttoopposeMylan'smergerwithKingdidnotinvolveacontrolintentisdebatable.ButevenifaSchedule13Dfilingwasrequired,whatshouldPerrydiscloseaboutitshedges?Notmuch,orsoPerryjudged.Item6ofSchedule13Drequiresdisclosureof"anycontracts,arrangements,understandingsorrelationships"relatingtoMylanshares.Perrydulysaidthatithadengagedin"security-basedswapagreements"andthat"toexecutecertainhedgingtransactions,"ithadenteredintoshareloanI8transactionswithBearStearnsandGoldmanSachs.?Thisopaquedisclosurewaslikelynotaccidental.Considernextthecommonsituationinwhichaninvestorholdsastakeinbothacquirerandtarget,whichaffectseconomicinterestintheacquirer.Deutsche-Boerse-LSEandHewlett-Packard-Compaqofferexamplesofthisscenario.I88AssumethatahedgefundfilesaSchedule13D;mustitdiscloseitspositioninthetarget?Theanswerisno.Item6requiresdisclosureofcontractsorarrangementswithrespectto"anysecuritiesoftheissuer.,,189Insum,Schedules13Dand13Gprovideonlylimiteddisclosureoftheexistenceandnatureofthenewvotebuying.OnecanquibblewiththelevelofdetailthatPerryprovidedoritsfailuretoattachthehedgingagreementsasexhibits.I9oButfromapolicyperspective,pickingatthelanguageofdisclosurerulesthatwerenotwrittenwithemptyvotinginmindisbesidethepoint.Therealproblemisthatthe13Dand13Grules186.SeeNeilWhoriskey&BrandonW.Gardner,ArbitrageinanM&AContext-IssuesRaisedbytheMylanCase,M&ALAW.,Sept.2005,at15.187.PerryCorp.,Schedule13DastoMylanLaboratories,Inc.,atItems4,6(Nov.19,2004).188.WediscusstheseexamplessuprainPartsILBandII.D,respectively.189.Schedule13D,supranote14,atItem6(emphasisadded).190.Item7ofSchedule13Drequiresfilingof"allwrittenagreements,contracts,arrangements,understandings,plansorproposalsrelatingto...thetransferorvotingofthesecurities,finder'sfees,jointventures,options,puts,cans,guaranteesofloans,guaranteesagainstlossorofprofit,orthegivingorwithholdingofanyproxyasdisclosedinItem6."Id.atItem7.Perry'scounselpresumablydecidedthatitshedgeswerenoneofthese. 2006]NEWVOTEBUYING871werewritteninthe1970s,whenneitherswapsnoranyotherOTCderivativesexisted.1912.ReportingbyInstitutionalMoneyManagers(Form13F)Thethirdownershipdisclosureregimeappliestoinstitutionalmoneymanagers,includinghedgefunds,whomustdisclosetheirholdingsattheendofeachquarterbyfilingForm13FwiththeSEC.192Form13Fisfiledforty-fivedaysaftertheendofeachquarter.Withregardtothenewvotebuying,Form13Fofferslittlehelp.Itrequiresdisclosureofholdingsof"section13(f)securities"byevery"institutionalinvestmentmanager"whoholds$100millionormoreinthesesecurities.193Theterm"institutionalinvestmentmanager"isdefinedbroadlytoinclude(1)anyperson,otherthananaturalperson,whoinvestsinorbuysorsellsforitsownaccount;and(2)anyperson,whetherornotanaturalperson,whoexercisesinvestmentdiscretionwithrespecttotheaccountofanyotherperson.194Thiscaptureshedgefunds,whetherlocatedintheUnitedStatesoroffshore,butnothighnetworthindividuals,unlesstheyinvestfortheaccountsofothers.195TheSECpublishesan"OfficialListofSection13(f)Securities."Thislistislimitedtocommonsharesandexchange-tradedoptionsofU.S.publiccompanies.196Anythingnotonthelistneednotbedisclosed.Critically,Form13Frequiresnodisclosureforsecuritiesthatarenotpubliclytraded,eveniftheyareeconomicallyidenticaltodisclosablesecurities.Forexample,positionsinexchange-tradedoptionsaredisclosable,butsubstantivelyidenticalpositionsinOTCoptionsarenot.Moneymanagersneednotreportoptionstheyhavewrittenratherthan191.Swapswereintroducedinsecrecyinthelate1970sandbecamefull-fledged[mancialproductsonlyin1981,withthedisclosureofsomedetailsofacurrencyswapbetweenffiMandtheWorldBank.SeeHenryT.C.Hu,Swaps,theModemProcessofFinancialInnovationandtheVulnerabilityofaRegulatoryParadigm,138U.PA.L.REv.333,363(1989).192.Thefilingsarepubliclyavailable.Amanagermayrequestconfidentialtreatment,butonlyundernarrowcircumstances,andtheSECdoesnotoftengrantsuchrequests.SeeFormI3F,supranote13.193.SeeExchangeAct§13(f)(I),(f)(5)(A)(2000);15U.S.C.§78m(f)(I),(f)(5)(A)(2000);ExchangeActRuleI3f-l,17C.F.R.§240.13f-1(2005).194.SeeExchangeAct§13(f)(5)(A);15U.S.C.§78m(f)(5)(A).195.SeeExchangeActRuleI3f-l,17C.P.R.§24O.l3f-l(2005);SECDivisionofInvestmentManagement:FAQAboutFormI3F,Question4(May2005),http://www.sec.gov/divisions/investmentlI3ffaq.htm[hereinafterSECI3FFAQ].ForanexampleoftheuseofFormI3Finformationtotrackhedgefundtrading,seeMarkusK.Brunnermeier&StefanNagel,HedgeFundsandtheTechnologyBubble(BFAAnnualConferencePaperNo.446,2003),availableathttp:/ssm.com!abstract=423940.196.SeeExchangeActRule13f-l(c),17C.F.R.§240.l3f-l(c)(2005);SECI3FFAQ,supranote195,atQuestion7. 872SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811bought,evenifthewrittenpositioniseconomicallyequivalenttoadisclosablepurchasedposition.Longsharepositionsarereported;shortpositionsarenot.197Sharelendersreportignoringtheloan(thatis,thelenderreportsowningtheshares);shareborrowersreportnothing.198Evenforcoveredsecurities,Form13Frequiresquitelimitedinformation.The"InformationTable"atitsheartissimplyalistofeachsecurityowned,itsCUSIPnumber(astandardmeansforidentifyingpubliclytradedsecurities),itstype(forinstance,shares,puts,orcalls),andthenumberofsecuritiesheld.199Form13Frequiresreportingofsharesastowhichamanagerhasvotingpowerorinvestmentpower,whethersoleorshared.If,however,amanagerhasvotingauthorityover"routine"mattersandnoauthoritytovoteon"nonroutine"matters,themanagerreportsasifithadnovotingauthority.Nonroutinemattersincludea"contestedelectionofdirectors,amerger,asaleofsubstantiallyalltheassets,[and]achangeinthearticlesofincorporationaffectingtherightsofshareholders"whileroutinemattersincludeselectinganaccountant,uncontestedelectionofdirectors,andapprovalofanannualreport.2OOHidden(morphable)ownershippositionswillusuallyescape13Freporting.ThesepositionscommonlyrelyonOTCderivatives,whicharenotreported.Indeed,onereasonwhyhedgefundsholdequityswapsandotherOTCderivativesratherthansharesistohidetheirownershipfrompublicview.Form13Ffareslittlebetterforemptyvoting.Emptyvotingthroughshareborrowingwillneverbeseen.Ifaninvestorholdsshareswhilehedgingeconomicownership,thedirectownershipwillbereported;itsemptycharacterwillnot.Moreover,itisusuallyeasytohideavotingstakealtogether.Forexample,ahedgefundcould,ineffect,exchangeitssharesforeconomicallyequivalentswappositionsbeforequarterend,andthenunwindtheswapsandreacquiresharesfromthederivativesdealersimmediatelyafterwards.197.SECForm13FFAQ,supranote195,atQuestion41("YoushouldnotincludeshortpositionsonFormBEYoualsoshouldnotsubtractyourshortposition(s)inasecurityfromyourlongposition(s)inthatsamesecurity;reportonlythelongposition.").198.[d.atQuestion42.199.SeeForm13F,supranote13,atSpecialInstructionsfl9-12.200.[d.atSpecialInstructions'll12(b)(viii). 2006]NEWVOTEBUYING8733.Insiderand10%ShareholderDisclosure(Section16)ThefourthprincipalsourceofdisclosureisSection16,whichcovers201officers,directors,and10%shareholdersofU.S.publiccompanies.Outsideshareholdersusuallyavoidcrossingthe10%threshold,partlybecausedoingsotriggersrecaptureof"short-swingprofits"frombuyingandselling(orsellingandbuying)withinasix-monthperiod.Acquiringeconomicownershipwhileavoidingcoverageisstraightforward.The10%ownershipthresholdisbasedonbeneficialownershipintheSection13(d)sense,whichfocusesonvotingpowerratherthaneconomicinterest.202Ifacash-settledequityswapletsahedgefundavoiddisclosureunderSection13(d),thesameswapwillalsoletthefundavoidSection16disclosure.Ifdisclosureistriggered,however,thepositionstobedisclosedarebasedon''beneficialownership"intheseparateSection16sense,whichfocusesoneconomicownership.203Therelevantforms(Forms3,4,and5)requiredisclosureofmosteconomicinterests.204Aninitialfilingmustbe205madeonForm3withintendaysaftertheeventwhichtriggerscoverage.ChangesarereportedonForm4.Form5isanannualstatementofchanges.Allformsarepubliclyavailable.Section16beneficialownershipisdefinedbroadlytoincludeany"pecuniaryinterest.,,206Disclosablepositionsinclude"anyoption,warrant,convertiblesecurity,stockappreciationright,orsimilarrightwithanexerciseorconversionprivilegeatapricerelatedtoanequitysecurity,orsimilarsecuritieswithavaluederivedfromthevalueofanequitysecurity.,,207Thisdefinitionisquitebroad.Equityswapsandotherequityderivativesmustbedisclosed,whetherphysically-orcash-settled,and201.SeeExchangeActRules16a-l(a),16a-2,17C.F.R.§§240.l6a-l(a),16a-2(2005).202.17C.F.R.§240.16a-l(a).Registeredbroker-dealers,banks,andcertainotherentitiesandindividualsareexemptsolongastheyholdshareswithout"divestingsuchpersonofbeneficialownershipofasecurity"orenteringintoanarrangementthatwouldviolatetheantigamingprovisionsof17C.F.R.§240.l3d-3(b).Id.203.ExchangeActRule16a-2,17C.F.R.§240.16a-2(2005).Fornonexpertsinsecuritieslaw,yes,theSEChasindeeddefinedthesameterm-beneficialownership--intwodifferentways,onceunderSectionB(d)andonceunderSection16.204.Form3,InitialStatementofBeneficialOwnershipofSecurities,17C.F.R.§249.103(2005)[hereinafterForm3];Form4,StatementofChangesinBeneficialOwnershipofSecurities,17C.F.R.§249.104(2005)[hereinafterForm5];Form5,AnnualStatementofBeneficialOwnershipofSecurities,17c.F.R.§249.105(2005)[hereinafterForm5].205.ExchangeActRule16a-3,17C.F.R.§240.l6a-3(a)(2005);Form3,supranote204,atInstruction3.206.17c.F.R.§§240.l6a-2,.I6a-3,&.16a-4.207.ExchangeActRule16a-l(c),17C.F.R.§240.16a-l(c). 874SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811whetherexchange-tradedorOTe.Aderivative'svalueneednotpreciselytracksharevalue;thederivativemustbedisclosedifitsvalueis"derivedfromthevalueofanequitysecurity.,,208Thereisanexceptionfor"broadbased"indexoptions,futures,andmarketbasketsofstocks.Byimplication,derivativeswhosevalueisbasedonanarrowindexarecovered.Thus,Section16coverssomerelatednon-hostassets-albeitwithambiguityaboutwhichones.Theinformationrequiredforeachderivativeisalsoextensive,andincludesthe"title,exerciseorconversionprice,dateexercisable,expirationdate,andthetitleandamountofsecuritiesunderlyingthederivativesecurity.,,209Changesinownershiparereportedusingspecifictransactioncodes,including"s"(sale),"C"(conversion),"0"(exerciseofanout-of-the-moneyderivative),"X"(exerciseofanin-orat-the-moneysecurity),and"K"(anequityswaporsimilarsecurity).210Itseemslikelythatfew,ifany,Section16filersreportshare211borrowingorlending.ThereisnoexplicitSECrequirementtoreportshareborrowingorlending,thereisnorelevanttransactioncode,andwehavefoundnoSECorpractitionerguidanceevendiscussingthisquestion.Section16reportingfocusesoneconomicownership,whichlendingandborrowingdoesnotchangeinanysignificantway.Thelendercanrecallthelentsharesatanytimeandreceivesfromtheborrowerapaymenttocompensateforanydividendsorotherdistributionsduringtheperiodoftheloan.Theborrower'svotingrightsdonoteasilyfallwithintheterm"pecuniaryinterests"underSection16.Intheparallelsituationofavotingtrustwhichhasvotingpowerbutnoeconomicownership,thetrustdoesnotreportshareownership.212Forhidden(morphable)ownership,then,Section16disclosuredoesagoodjob.Foremptyvoting,disclosuremightdependonhowtheemptyvoteracquiresitsvotes.Shareshedgedwithderivativeswouldbedisclosed,butitlikelynotshareborrowing.208.[d.209.Form3,supranote204.210.Form4,supranote204.211.Shareborrowingwould,however,clearlycounttowardtriggeringdisclosureby10%shareholders,whichisgovernedbytheseparateSectionl3(d)rules.212.See,e.g.,ARNOLDS.JACOBS,16ASECTION16OFTHESECURITIESEXCHANGEACT§7.31(2005).Weconcedethatthelender'seconomicpositiondoesnotremaincompletelythesame.Forinstance,therearetaxdifferencesbetweendividendsandpaymentsbytheborrowerinlieuofdividends,buttheseseemtoothinareedonwhichtohangadisclosureobligation,especiallysincethisdifferencehasbeensignificantonlysincethe2003reductioninthedividendtaxrate. 2006]NEWVOTEBUYING8754.MutualFundReportingThefinalsetofreportingobligationsappliestomutualfunds,whichmustreporttotheSECquarterlyontheirportfolioholdings(thefilingispublic)andprovideasummarylistsemiannuallytoinvestors.213Disclosurefocusesoneconomicownershipandcoversbothlongandshortpositions.Foroptions,disclosureincludesvalue,exerciseprice,andmaturitydate.TherearenorulesonwhatdetailstoreportforequityswapsandotherOTCderivatives,butaspotcheckofseveraldisclosurefilingssuggeststhatdisclosureofcounterpartiesandcertainnumericalinformationsuchasnotionalamountsiscommon.Thereisnorequirementtodisclosespecific24sharelendingornon-short-sale-relatedborrowingpositions.lThus,whilethedetailsaredifferent,mutualfundreportingissimilartoinsiderreportinginthatit(1)focusesoneconomicownership;(2)coversallpositions,bothlongandshort,whetherornottheyconveyvotingrights;(3)coversbothexchange-tradedandOTCderivativepositions;but(4)apparentlydoesnotcoversharelendingornon-short-sale-relatedborrowing.Bothsystemscoverhidden(morphable)ownershipreasonablywell,aswellassomeflavorsofemptyvoting.Mutualfunddisclosurecapturesonlyquarter-endpositions,however.C.REFORMINGTHEDISCLOSURESYSTEM1.GeneralConsiderationsAsTable3andPartIV.Bshow,thecurrentdisclosurerulesarehighlycomplex,treatsubstantivelyidenticalpositionsinconsistentlybothacross213.ThebasicformsformutualfunddisclosureareFormsN-1A,N-CSR,andN-Q.SeeSEC,ShareholderReportsandQuarterlyPortfolioDisclosureofRegisteredManagementInvestmentCompanies,SecuritiesActReleaseNo.33-8393,69Fed.Reg.11,244,11,254-57(Mar.9,2004);SECFormN-1A,RegistrationStatementUndertheSecuritiesActof1933,GeneralInstructions,'j[22(b}-•(c),availableathttp://www.sec.gov/aboutlforms/formn-la.pdf(discussingannualandsemiannualreports);SECFormN-CSR,CertifiedShareholderReportofRegisteredManagementInvestmentCompanies,GeneralInstructions,'j[6,availableathttp://www.sec.gov/aboutlforms/formn-csr.pdf;SECFormN-Q,QuarterlyScheduleofPortfolioHoldingsofRegisteredManagementInvestmentCompany,GeneralInstructions,availableathttp://sec.gov/aboutlforms/formn-q.pdf.214.Mutualfundstypicallylistthesecuritiesthattheyhavelentintheirscheduleofinvestmentswithafootnotestatingthat"[a]l1oraportionofthissecurityisonloan."SusanC.Peters,AccountingTreatmentofLoansofSecurities,inSECURITIESFINANCE&LENDING,supranote50,at205.Mutualfundbalancesheetsdisclosethetotalvalueofsecuritiesonloan.Id.Amutualfundwithashortpositionhasnegativeeconomicownershipwhichmustbedisclosed;implicitinthisdisclosureisthatthefundhadborrowedshares. 876SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811andwithindisclosureregimes,donoteffectivelyaddresseitheremptyvotingorhidden(morphable)ownership,andforthemostpartdonotcoversharelendingandborrowing.Inbigpicture,Schedules13Dand13Gfocusonvotingownership,whileSection16andmutualfunddisclosuresfocusoneconomicownership.Form13Fcoversonlyspecificpositionsinpubliclytradedsharesandexchange-tradedoptions.Someoftheseradicaldifferencesinfocusmayhaveoncemadesense.Someoftheomissionsmayoncehavebeenunimportant.Butinaworldofeasydecouplingofvotingandeconomicownership,plusamassiveaTederivativesmarket,greateruniformityandfeweromissionsarecalledfor.The"integratedownershipdisclosure"proposalthatwesetforthbelowwouldprovideimprovedthoughstillimperfectdisclosureofbothemptyvotingandhiddenownership,whilesubstantiallysimplifyingthecurrentownershipdisclosurerules.Ourproposalbuildsonexistingdisclosuretechnologyandrequiresonlyinformationreadilyaccessibletoinvestors.Inlargepart,theproposalsimplyextendsexistingdisclosurepracticesforinsidersandmutualfundstoabroaderclassofreportingpersons.Thus,additionalcompliancecostsshouldbelimited,andwillbeoffsetformanyreportingpersonsbyaddingasinglesetofrulesforwhatmustbereported.Weexpect,butcannotprove,thatoveralldisclosurecostswoulddecline.Weproposesimplifyingthedisclosurearchitectureby(l)movingtowardcommonstandardsfortriggeringdisclosureandfordisclosingpositionsoncedisclosureisrequired;(2)providingasinglesetofrulesforwhichownershippositionstodiscloseandhowtodisclosethem;(3)requiringdisclosureofallpositionsconveyingvotingoreconomicownership,arisingfromsharesorcoupledassets;and(4)requiringsymmetricdisclosureofpositiveandnegativeeconomicownership.Wedonotdirectlyaddressdisclosureofrelatednon-hostassets,butourproposalswouldoftenrequiredisclosureofholdingsinbothacquirersandtargets,whichareoneimportantcategoryofrelatednon-hostassets.Ourdisclosureproposalshouldcapturehidden(morphable)ownershipreasonablywellforcurrentSchedule13DandSection16filers,becausethesefilersmustreportownershipandchangesthereinpromptly.Disclosurewillbepatchierforotherfilersbecausetheymustreportonlyend-of-periodpositions.WereturntothisissueinPartIV.D,below.Weexpectthatthisnewinformationwillbeusefultoinvestors,aswellastocorporations,Delawarejudges,bankingandsecuritiesregulators,andlegislatorsastheycontemplatehowtorespondtonewvotebuying.But 2006]NEWVOTEBUYING877evenifthenewdisclosurehadnoothervalue,thesimplificationwepropose-largelyintegratingwhatarenowfivediscreteownershipdisclosuresystems-wouldlikelybeworthwhile.Inofferingthisproposal,wedonotreassessthecurrentdisclosurethresholds,disclosurefrequencies,anddelayperiods,nor,toanappreciableextent,whichinvestorsmustreporttheirpositions.Implicitly,then,weassumethatthereisrougheconomicorpoliticallogicsupportingthecurrentrules.Wealsobelieve,however,thatwhateverthethresholdsanddelayperiodsmaybe,thedisclosurerulesshouldbeinternallycoherent.Considerataxanalogy.Onecanbelievethatcurrenttaxratesaretoohigh,andstillpreferasystemwithfewloopholesoveraloophole-riddensystemthatproducesloweroveralltaxesbutfavorsthetax-cleverandproduceshorizontalinequity.Werecognizethatownershipdisclosurehasbothbenefitsandcosts.215Onthebenefitside,sharepricingwillbemoreefficientifinvestorsknowwhatmajorinvestorsaredoingandhaveadvancenoticeofpossiblechangesincontrol.Moreover,price-relevantinformationoftenhasgreaterprivatevaluethansocialvalue.Requiringdisclosurecanreducecostly,oftenduplicative,privatesearchforinformation.Onthecostside,privatesearchforinformationcanenhancesharepriceefficiency,andthecorporatecontrolmarketisanimatedinpartbyprivatereturnstosearch.Thus,outsideinvestorsmustreceivesomerewardforfindingmispricedsharesandmismanagedfirms.Real-timedisclosurewouldlikelyreducethereturntosearch.Thecurrentsystem,withnearreal-timedisclosurebyinsidersandlargeactiveshareholders(l3Dfilers),butdelayeddisclosurebyothershareholders,couldwellstrikeadecentbalanceamongthesecompetingconcerns.Inadditiontotheirpotentialeconomiclogic,largeshareholderdisclosurerulesrespondtotheintuitionthatinvestorsshouldknowwhoacompany'smajorshareholdersareandwhetherthoseshareholdersarebuyingorselling,andthatacompany'sinsidersshouldhaveanopportunitytorespondtoatakeoverattempts.Thehistoryofownershipdisclosuresuggeststhat,precisethresholdsanddelayperiodsaside,oursocietywillnottoleratehiddencontrolofmajorcompanies,norcontrolcontestswagedbehindcloseddoors.Sodisclosureofmajorpositionstherewillbe.Our215.WediscussthebenefitsandcostsofdisclosureinmoredetailinHu&Black,HedgeFundsandEmptyVoting,supranote24,atPart4. 878SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811aimistomakethatdisclosurecoherent,simple,andthereforerelativelylow-cost.OurproposeddisclosurereformsbuildlargelyontheSection16rulesandcurrentmutualfundpractice.Forderivativepositions,wewouldextendSection16-typedisclosurestoshareholderswhoreportonForm13FandSchedules13Dand13G.Shortpositionswouldbedisclosedinamannersimilartolongpositions,withapossibleexceptionfor"pureshortsales,"discussedbelow.WewouldmodestlyexpandtheinstitutionsthatmustreportonForm13Fbycountinganyeconomicownershipofshares,directlyorthroughderivatives,towardthe$100millionthreshold.WewouldcountonagrossbasisalllongandshortpositionstowardthetriggeringthresholdforSchedules13Dand13GandForm13F.Banks,broker-dealers,andotherswhoholdbothproprietaryandinvestmentadvisorypositions,wouldreporteachseparately,subjectperhapstolimitedexceptionsforshort-termpositionsheldinconnectionwithmarket-makingactivities.Wewouldalsorequiredisclosureofsharelending,shareborrowing,andvotingownership,evenifunaccompaniedbyeconomicownership.Lenderswouldreporttheirloans;borrowerswouldreporttheirborrowingsandwhethertheyretainedtheborrowedsharesorsoldthemshort.Moneymanagerswhohavevotingdiscretionforroutinemattersbutnotnonroutinematterswouldsoindicate.Weregardasaveryclosequestionwhetheralargepureshorteconomicposition,definedasnegativeeconomicownershipwithnoaccompanyingvotingownership,shouldrequiredisclosure.Ourproposalerrsonthesideofsimplicityandsymmetryinprovidingthatbothlongandshortpositionswouldbedisclosedandcountfortriggeringafilingrequirement.216RegulatorswillneedtodevelopguidelinesforreportingofderivativepositionsthatarenotaddressedbythecurrentSection16andmutualfund216.Theprincipalargumentsfordisclosurearethevalueofsimplicityandsymmetry,thepracticaldifficultyindraftinganexceptionthatislimitedtoashortpositionwithnoaccompanyingformalorinformalvotingrights,reducedgamingrisk,andthevaluetoinvestorsofmorecompleteknowledgeofotherinvestors'marketpositions.Theprincipalargumentsagainstdisclosurearethatshortsellingisavaluablepolicingmechanismforshareprices,ourmarketsandregulatorysystemsalreadyburdenshortsellersinvariousways,anddisclosurewouldaddtotheseburdens.ForadiscussionofhowU.S.taxandregulatoryrulesraisethecostofshortselling,and,thus,contributetomarketinefficiency,seeMichaelR.Powers,DavidM.Schizer&MartinShubik,MarketBubblesandWastefulAvoidance:TaxandRegulatoryConstraintsonShortSales,57TAXL.REv.233(2004). 2006]NEWVOTEBUYING879rules.Asalodestarprinciple,webelievethatreportingpersonsshoulddiscloseinformationsufficienttoletaderivativesdealer,withaccesstoinformationonvolatilityandotherpricingparameters,estimatethederivative'svalueanditsdelta(howthatvaluedependsonshareprice).Thereportingpersonneednotprovidethemodelitusestovaluethederivative(thatmaybeproprietary),onlytherawmaterial.Forinstance,foratypicalOTeputoption,thereportingpersonwouldsetoutthecorecontractualterms-principallythestrikeprice,theexpirationdate,thenumberofshares,thecounterparty,andwhethertheoptionwasEuropeanstyle(exercisableonlyatexpiration)orAmericanstyle(exercisableatanytime).Thisprinciples-basedapproachshouldbemorerobusttofinancialinnovationthanthe"cubbyhole"approachusedinthecurrent13Frules.217OurproposalsforenhanceddisclosureofeconomicownershiparegenerallyconsistentwithrecentregulatorychangesmadeintheUnitedKingdomandHongKonginresponsetocertainaspectsofthenewvotebuying.ill2005,theu.K.PanelonTakeoversandMergersextendedlargeshareholderreportingtopersonswitheithereconomicorvotingownership.218ill2003,HongKongsimilarlyextendedlargeshareholderdisclosurerequirementstopersonswithbothlongandshortequityderivativespositions.219The2006Hendersonillvestmentincidentmay22opromptHongKongtotakefurtheraction.Themostimportantdifference217.Foranalysesofhowfinancialinnovationsubvertstraditionalclassification-basedregulation,seeHu,MisunderstoodDerivatives,supranote4;Hu,supranote191;EdwardD.KIeinbard,EquityDerivativeProducts:FinancialInnovation'sNewestChallengetotheTaxSystem,69TEx.L.REv.1319(1991).218.SeeCODECOMM.,U.K.PANELONTAKEOVERS&MERGERS,DEALINGSINDERNATNESANDOPTIONS:DETAILEDPROPOSALSRELATINGTOAMENDMENTSPROPOSEDTOBEMADETOTHETAKEOVERCODE-PARTI:DISCLOSUREISSUES§§5.1-5.2(May2005);CODECOMM.,U.K.PANELONTAKEOVERS&MERGERS,DEALINGSINDERIVATIVESANDOPTIONS:STATEMENTBYTHECODECOMMmEEOFTHEPANELFOLLOWINGTHEEXTERNALCONSULTATIONPROCESSESONDISCLOSUREISSUESINPCP2005/1ANDPCP2005/2(Aug.2005);PANELEXECUTIVE,U.K.PANELONTAKEOVERS&MERGERS,SUMMARYOFCHANGESTOTHETAKEOVERCODE(Oct.2005).CfFin.Servs.Auth.(U.K.),HedgeFunds:ADiscussionofRiskandRegulatoryEngagement(Fin.Servs.Auth.,DiscussionPaperNo.05/4,2005).219.SeeHONGKONGSEC.&FuTURESCOMM'N,OUTLINEOFPARTXVOFTHESECURITIESANDFuTuRESORDINANCE(CAP.571)-DISCLOSUREOFINTERESTS(Aug.2003)[hereinafterHONGKONGSFC,PARTXVOUTLINE];HONGKONGSEC.&FUTURESCOMM'N,REVIEWOFTHEDISCLOSUREOFINTERESTSREGIMEUNDERPARTXVOFTHESECURITIESANDFUTURESORDINANCE(Jan.2005)[hereinafterHONGKONGSFC,REVIEW].Previously,insidershadreportedlymadeextensiveuseofOTCderivativestoreduceorincreasetheireconomicownershipintheirowncompanies,preciselybecauseofwhattheheadofequityderivativesatamajorinstitutioncalledthe"nondisclosurefactor."MelvynWestlake,RulesoftheGame,ASIARiSK,Apr.2002,availableathttp://www.asiarisk.com.hk/public/showPage.html?page=3206.220.See,e.g.,Cheng,supranote57. 880SOUTHERNCALIFORNIALAWREVIEW[Vol.79:811betweentheUnitedKingdomandHongKongapproachesisthatHongKongdoes(aswedo),whiletheUnitedKingdomdoesnot,requiredisclosureofapureshorteconomicposition.Disclosurerulesalsoneedtobeenforced.Atpresent,thereissomeenforcementofSection13(d)andSection16disclosure,butapparentlyminimalenforcementofForm13F.221Table4summarizesourintegratedownershipdisclosureproposal.ComparingTable4toTable3visuallyshowsthesimplificationofthecurrentrules.221.OnFOnTI13Fenforcement,seeJamesD.Cox&RandallS.Thomas,LettingBillionsSlipThroughYourFingers:EmpiricalEvidenceandLegalImplicationsoftheFailureofFinancialInstitutionstoParticipateinSecuritiesClassActionSettlements,58STAN.L.REV.411,446-48(2005). .__---L_tvooTABLE4.Proposalformoreintegratedownershipdisclosure~Thistablesummarizesthedisclosureruleswepropose,inaformatsimilartoTable3,whichsummarizescurrentownershiprules.Thetableaddressesseparatelytheuseoflongandshortpositionsinsharesandequivalentstotriggerareportingobligation.andthedutytodisclosethemoncethereportingobligationhasbeentriggered.Forstocklendingandborrowing.borrowingisrelevantbothfortriggeringdisclosure(exceptforstatus-basedfilers)andfordisclosureifafilingisrequired.LongPositions(Shares.EquityShortPositionsSwaps,otherOTCandExchange-ShareLendingandEmptytradedDerivatives)ReportingBorrowingVoting(overProposedDisclosureFrequencyAstriggerIffilingrequiredAstriggerIffilingrequiredThreshold(SameasLevel,suchRequirement~CurrentEquitySwaps,ShortEquitySwaps,ShortSalesLendingBorrowas0.5%of~Law)otherGTCandSalesotherGTCandingCompany'sExchange-tradedExchange-tradedShares~DerivativesDerivativest;!ti;:I130CurrentYesYesYesYesYesYesc::::Yes(ifheldonYes(ifheldonreportingYes(ifheldon~13GAnnualYesYesYesreportingdate)date)reportingdate)~Status-based:$IOOMinStatus-based:$100MineconomiceconomicownershipofI3FQuarterlyownershipofYesYesYesYesequitiesandequityequitiesandderivativesequityderivativesSection16(directororStatus-basedBannedBannedStatus-basedYesbybyofficer)CurrentYesYesYesSectionSectionSection16(10%16(c)16(c)YesYesholder)0000MutualFundsQuarterlyYesYesYesYesYesYes..... 882SOUTHERNCALIFORNIALAWREVIEW[Vol.79:8112.LargeShareholderDisclosure(Schedulesl3Dandl3G)Aswehaveseen,largeshareholderdisclosureunderSchedule13Dorl3Gfocusesonvotingownership.Ourproposedextensionissimple:votingandeconomicownershipshouldeachbereported,andshouldeachcounttowardtriggeringthereportingobligation.TheSection16conceptofeconomicownershipcanbecarriedovertoSchedulesl3Dandl3Gandexpandedtoincludeshareborrowingandlendingpositionswhichaffectvotingownership.EachpositionwouldbeseparatelydisclosedusingtransactioncodesadaptedfromSection16reporting.Schedulel3Dfilerswouldattachanycontractsthatconveyorrelatetotheireconomicorvotingownership.Wewouldalsomodestlymovethelinebetweenl3Dandl3Greporting,whichcurrentlyturnsoncontrolintent.Wewouldrequire13Dreportingifapositionisheldwithaviewtowardaffectingashareholdervote,evenifthevotedoesnotaffectcontrol.TakePerry'spositioninMylanasanexample.Perry,onceitcrossed5%ownershipofMylan,wouldreportonSchedulel3DbecauseithelditspositionwithaviewtowardaffectingtheMylanvoteonacquiringKing.Itwouldreporteachpositionconveyingpositiveornegativeeconomicorvotingownershipandattachitshedgingcontractsasexhibits.Schedulel3GreportingwouldbesimilartoSchedulel3Dreporting,butwithoutexhibits.Asatpresent,itwouldgenerallybedueannuallyandincludeonlyyear-endholdings.Thiswillletsomepositionsgounreported,butthelossofinformationshouldbemodestbecausemostinstitutionswillhavetoreporttheirpositionsquarterlyonForml3P.Indeterminingwhetherthe5%reportingthresholdhasbeencrossed,wewouldnotallownettingoflongandshortpositions.Anexamplecanshowwhy.Assumethatahedgefundtakesa10%netshortpositionandalsoentersintoanequityswapconveyinga6%longposition,sothatitsnetshortpositionis4%.Withnetting,nofilingwouldberequired.ButwewouldwantthehedgefundtofileaSchedule13Dor13G.Thehedgefund'soverallpositionisnetshort,yetitmaywellhaveaccessto6%votingrightsifashareholdervotearisesthatcanaffectcompanyvalue.Forsomederivativepositions,questionswillariseastohowtomeasureeffectiveeconomicexposure.Anequityswapconveyingtheeconomicreturnon1millionsharesshouldcountaseconomicownershipof1millionshares.Butwhataboutacalloption?Inderivativesterminology,8("delta")isthechangeinoptionvalueforasmallchangein 2006]NEWVOTEBUYING883thepriceoftheunderlyingasset.222Ifsharesgoupby$1,acalloptionwith0=0.4willincreaseinvalueby$0.40.Acalloption's0,however,changesassharepricechanges.Howshouldthispositionbereported?Webelievethatreportingthepreciseeconomicownershipforcalloptionsandotherderivativeswithdeltasthatvarywithsharepriceorotherfactorswouldaddunduecomplexityandcost.Weproposeinsteadacruderapproach.Currently,Rule13d-3providesasimpleruleforreportingcalloptions:onereportsthenumberofsharesthattheoptionrelatesto.223Thisisequivalenttoassuming0=1.Webelievethenumberofmatchedsharesforaderivativepositionshouldbecomputedinasimilarfashion.ThisisconsistentwiththerecentreformsinHongKong.2243.InstitutionalMoneyManagersandMutualFundsWeproposethat13FdisclosureofeconomicandvotingownershipshouldusethesameformatandcontaininformationaboutthesamepositionsasSchedules13Dand13G.Theprincipaldifferenceswouldbe:(1)thetriggerforreporting;and(2)Schedule13Dwouldcontinuetorequirereportingofchangesinposition,whileForm13FandSchedule13Gwouldrequireonlyperiod-endreporting.Thecurrentreportingthresholdisownershipof$100millioninsection13(f)securities.Wewouldchangethisto$100millionineconomicownershipofU.S.equitysecurities.Thiswillpreventaninstitutionfromavoidingdisclosurebyholdingprimarilyequityderivativesandkeepingitsdirectequityholdingsunder$100million.Currently,dataonsharelendingissparse.Eventheaggregatesizeofthemarketcanonlybeestimated.225Thelargestborrowersofstocksareprimebrokeragefirms;thelargestlendersaremajorinstitutions.Beyondthesefacts,andsomeindividualanecdotes,littleelseisknown.Simplyaggregatingthesharelendingandborrowingthatwouldbereportedby13F222.Moretechnically,deltaisthepartialderivativeoftheoptionpricewithrespecttothepriceoftheunderlyingasset.E.BRIYS,M.BELLALAH,H.M.MAl&F.DEVARENNE,OPTIONS,FuTuRESANDEXOTICDERNATNES124(1998).223.17C.F.R.§240.13d-3(2005).224.SeeHONGKONGSFC,PARTXVOurLINE,supranote219,§2.5(sectionentitled"HowmanysharesamItakentobeinterestedinifIholdequityderivatives?").225.Thus,onespecialist'sMay2005estimateofthesizeoftheUnitedStates'institutionalsecuritieslendingmarl