Tightening the Locks on Bear

April 7, 2008, 1:26 pm

James Dimon, JPMorgan Chase’s chief executive, must have been really angry about the problems in the terms of the first version of his deal to buy Bear Stearns — because he isn’t taking any chances this time around.

On Friday, JPMorgan filed a schedule 13D disclosing that on March 24, it acquired 11.5 million Bear Stearns shares in the open market, all of them at $12.2369 a share. This constitutes 8.91 percent of Bear.

The shares were acquired one day after JPMorgan and Bear agreed to recut their deal, raising the price from $2 to $10 in exchange for a number of new deal-protection measures. The principal new feature was a share exchange involving the issuance of 39.5 percent of Bear to JPMorgan, a side transaction that did not need approval from Bear’s shareholders.

That 39.5 percent stake would put JPMorgan close to the majority approval it needs to complete the deal.

Not surprisingly, the New York Stock Exchange has signed off on this issuance as of April 4. The issuance is now scheduled to occur on Tuesday (though JPMorgan and Bear use the phrase “on or about” in their press releases, so we wouldn’t put it past them if they tried to do the exchange early).

If the share exchange happens, JPMorgan will own approximately 48 percent of Bear altogether. And in its new 13D filing, JPMorgan stated that it intended to acquire up to 49.5 percent of Bear in the open market.

How is that for honoring the Omnicare decision under Delaware law, which requires that a deal cannot be entirely locked up? Does anyone really thinking that having 0.5 percent free to vote “no” is not locked up?

The new share acquisition raises a host of other questions, including:

1. JPMorgan was only granted early termination under the Hart-Scott-Rodino antitrust waiting period on April 1. How could it have legally acquired these shares before then?

2. Who exactly did JPMorgan acquire these shares from on the “open market”? The acquisition was all at one price, which suggests a single seller. Was it Joe Lewis? Mr. Lewis has yet to amend his 13D to reflect such a deal.

3. JPMorgan acquired these shares when the Bear directors had publicly “committed” to supporting this deal. Yet James Cayne, Bear’s chairman, has since sold his shares, and Paul A. Novelly, a Bear director, disclosed April 1 that he had also sold all his stock. Did JPMorgan intend to go over the 50 percent threshold with these shares, or were those commitments known to be hollow at the time given? Does it matter?

Of course, there is also the question of how the Bear directors justified not imposing a cap in the agreement on acquisitions above the 39.5 percent level. This kind of limit is almost always specified in merger agreements. Leaving it out in this deal appears to fit with the goal of JPMorgan and the Bear directors, as directed by the Federal Reserve, to jam this transaction through at all costs, no matter the rules.

Here, I do find it a bit unseemly and odd that Bear’s directors are selling their shares one by one in the open market at a price higher than the current bid. They increasingly have no stake in the company other than the director indemnification JPMorgan has agreed to provide them. This doesn’t particularly align them with the interests of their shareholders. And if there is indeed supposed to be punishment for the moral hazard here, why is the Fed (and JPMorgan) allowing them to take the extra profit?

Another question concerns the pending litigation. JPMorgan has supposedly put aside as much as $6 billion in reserves to cover litigation arising from this deal. If this is the case, where are the plaintiffs’ lawyers? Is this moolah waiting for a taker, or is it just good public relations for JPMorgan, allowing it to justify a lower price without actually paying the cost? The New York action, which thus far has only a May 6 injunction hearing and no temporary restraining order motion filed, is being handled by a grab-bag of mid-tier securities litigation firms led by Levi & Korsinsky. You would think the Bear employees would hire someone. And again, where is Mr. Lewis?

In any event, it appears that JPMorgan and its law firm, Wachtell, Lipton Rosen & Katz, are pushing things to the wall to get this deal cleared.

Will a New York or Delaware court challenge it?

Here, the New York action will not play out until May 6, unless the attorneys push things up. It will thus likely take place under the specter of JPMorgan owning 49.5 percent of Bear already. While the voting of those securities could be nullified, it doesn’t look good for Bear– despite the seemingly good legal case they have for establishing coerciveness or preclusiveness under Revlon or Unocal.

In addition, if a court analyzes the renegotiated deal in light of Bear’s improved position after Deal No. 1 was struck, it may also find an infringement upon the shareholder franchise, concluding there was no compelling justification under Blasius since the guarantee was already in place. This, of course, ignores the politics of the matter. I believe that the litigants’ only shot is that markets firm up enough that a lone New York Supreme Court judge has enough gumption to challenge these actions, rather than simply creating a Bear exception. What would you do? I suppose it all depends upon whether or not you think Deal No. 2 was necessary to save the markets. Should there be a rule of deference to the Fed and Treasury here, since they are in the best position to know?

And where is Delaware? It has been almost a week since the hearing before Vice Chancellor Donald F. Parsons. His failure to rule is not a good sign for the plaintiffs. Nor was the assignment of the case to him: Judge Parsons came to the bench only in 2003 and was an intellectual property expert before then. I am sure he is quite capable, but he is not the most experienced judge in these corporate law matters. Judicial assignments can be tricky things, but perhaps this had more meaning. In any case, the issue before Delaware right now is whether or not to defer to the New York proceedings. The New York action is before Judge Herman Cahn, and he came down strongly in the Topps decision last year for retaining New York cases against Delaware adjudication if they are first filed. Delaware will typically defer to first-filed cases under the McWane principle, which states that a Delaware court, when considering staying a case in deference to a first-filed action in another jurisdiction, should rule:

freely in favor of the stay […] in a court capable of doing prompt and complete justice, involving the same parties and the same issues; that, as a general rule, litigation should be confined to the forum in which it is first commenced, and a defendant should not be permitted to defeat the plaintiff’s choice of forum in a pending suit by commencing litigation involving the same cause of action in another jurisdiction of its own choosing; that these concepts are impelled by considerations of comity and the necessities of an orderly and efficient administration of justice. McWane Cast Iron Pipe Corp. v. McDowell-Wellman Engineering Co., 263 A.2d 281 (Del. 1970)

In normal times, the principle might not apply here because of the overwhelming issues of Delaware law. But by issuing the stay, Delaware can let New York handle this in a case that would not establish precedent in its courts. Again, given the apparent stretching of the law here, and the forces pushing towards upholding it, this may be something that Delaware and Vice Chancellor Parsons prefer. This leaves it all before Judge Cahn in New York court.

Here is one final question: What does JPMorgan’s purchase of these shares in the open market — rather than adding them into the share exchange — say about their March 24 assessment of the share exchange holding up in a court of law?