We extend our prior work on how both supply (including the emergence of OTC equity derivatives and growth in share lending) and demand (including the growth of hedge funds) factors now facilitate the large-scale, low-cost decoupling of shareholder voting rights from shareholder economic interests. Both inside and outside shareholders, as well as corporations themselves, can engage in what we termed "empty voting"--voting while holding greater voting power than economic ownership. Shareholders can also have "hidden (morphable) ownership"--economic ownership, ostensibly without voting rights, which remains undisclosed under current disclosure rules, but can quickly morph to include voting ownership as well. These forms of decoupling pose important risks to the one-share-one-vote paradigm that underlies conventional models of corporate governance and shareholder voting.
We extend our prior work in five primary ways. First, we treat decoupling of voting rights from economic ownership of shares (empty voting and hidden ownership) as special instances of a more general pattern--investors, and corporations themselves, can unbundle the package of rights and obligations which have traditionally been associated with equity ("equity decoupling") as well as debt ("debt decoupling"). Second, we provide evidence that equity decoupling is an important worldwide phenomenon, which adds urgency to the need for disclosure and perhaps other reforms. Third, we go beyond decoupling by shareholders, examine decoupling strategies that corporations can use to fend off changes in control, and expand our integrated equity ownership disclosure proposal to address corporate decoupling. Fourth, we propose responses to empty voting which go beyond disclosure, including constrained corporate power to limit the voting rights of empty voters, condensing the period from record date to shareholder meeting date, and encouraging institutional investors to recall and vote lent shares. Fifth, we sketch several extensions of our decoupling framework to (a) the full range of shareholder rights and obligations, (b) debt decoupling, and (c) the possible revival of the "street sweep" takeover strategy.
INTRODUCTION I. SHAREHOLDER AND CORPORATE DECOUPLING A. Decoupling: Overall Picture B. Functional Elements and Terminology C. Shareholder Rights: Empty Voting 1. Hedge Funds and Other Shareholders 2. Soft Parking by the Corporation Itself 3. Employee Stock Ownership Plans; Restricted Stock Plans 4. Empty Voting of Another Company's Shares D. Shareholder Obligations: Avoiding Disclosure 1. Outside Shareholders 2. Insiders 3. The Corporation Itself II. REAL WORLD SIGNIFICANCE OF DECOUPLING A. Swiss Stealth Takeovers, 2005-2007 B. The Swiss Regulatory Response C. The Worldwide Scope of Decoupling III. UPDATING OUR OWNERSHIP DISCLOSURE PROPOSAL A. Our Integrated Ownership Disclosure Proposal 1. Current Rules and Our Disclosure Proposal 2. Regulatory Action to Date B. U.K. Experience with Disclosure Reform C. Extending Our Disclosure Reform Proposal to Corporate Decoupling 1. Current Disclosure Rules for Corporate Decoupling 2. Corporate Decoupling: Disclosure Proposal D. Reporting Shares Lent and Voted on Form 13F IV. RESPONSES TO EMPTY VOTING: BEYOND DISCLOSURE REFORM A. Overview B. Voting Rights 1. Direct Limits on Voting Rights 2. Voting with Negative Economic Ownership 3. Voting by Record Owners: Extension to OTC Equity Derivatives 4. Voting by Record Owners: Proportional Voting if No Instructions 5. Empty Voting by Insiders C. Strategies Affecting the Share Lending Market 1. The Importance of Share Lending and Recent Industry Developments 2. Safe Harbor for Voting Instead of Lending; Lending Disclosure 3. Lending to Empty Voters: Know-Your-Customer's-Purpose Rules 4. Recent Changes in Share Lending Practices D. Strategies Focused on Voting Architecture 1. Technical Changes 2. Direct Voting by Economic Owners 3. Minimizing the Gap Between Record Date and Meeting Date E. The Substance of Voting Procedure: Last-Minute Scrambles for Votes V. EXTENSIONS OF THE DECOUPLING FRAMEWORK A. Other Shareholder Rights and Obligations 1. Unbundling Shareholder Rights 2. Unbundling Shareholder Obligations B. Debt Decoupling and Empty Crediting C. The Reemergence of Street Sweep Takeover Bids CONCLUSION INTRODUCTION
Ownership of shares customarily conveys economic, voting, and other rights and disclosure and other obligations. Longstanding legal and economic theories of the public corporation assume that the elements of this package of rights and obligations cannot readily be decoupled--and in particular that voting rights cannot be decoupled from an economic interest in the corporation. The "one-share-one-vote" pattern, with voting rights held in proportion to economic interest, is a familiar instance of this assumption.
This foundational assumption can no longer be relied on. In prior work, we explored the implications of decoupling of voting rights from economic ownership and the resulting gaps in disclosure rules (collectively, Decoupling I). (1) We explored why decoupling of voting rights from economic interest is increasingly a matter of choice. The emergence of equity swaps and other over-the-counter (OTC) equity derivatives, the growth of lightly regulated hedge funds, related growth in the share lending market, and other factors now permit decoupling of voting rights from economic interest to occur quickly, at low cost, on a large scale, and often hidden from view. Investors can have greater voting than economic ownership, a pattern we termed "empty voting." Conversely, investors can have greater economic than voting ownership, which under current rules often allows them to avoid public disclosure of their ownership. Often, this hidden economic ownership can be quickly transformed to include voting ownership as well, a combination we termed "hidden (morphable) ownership." We referred to empty voting and hidden (morphable) ownership together as the "new vote buying." We set out the functional elements of these two forms of decoupling, provided a taxonomy of decoupling strategies, described the legal and regulatory environment, proposed enhanced shareholder disclosure of both economic and voting ownership, and sketched possible additional responses to empty voting.
In this Article, we reexamine and extend our prior work in light of new developments, which show the real-world significance of these decoupling strategies, illustrate uses beyond those we had anticipated, and confirm the urgency of a disclosure-based response. We also propose additional regulatory responses to empty voting.
This Article is organized as follows. Part I offers an overview of decoupling strategies and uses. We embed empty voting and hidden (morphable) ownership in a new general framework, in which the separation of economic and voting rights is one instance of the broader ability of investors to unbundle much of the package of rights and obligations customarily associated with share ownership. In our prior work, we focused on decoupling by shareholders. Here, we also add decoupling by corporations to an overall family of "equity decoupling" strategies. The firm cannot vote its own shares. But the firm's managers can often use decoupling strategies to arrange for friendly shareholders to hold votes but limited or no economic rights, where the shareholders are expected to support management, and have incentives to do so, or at least no incentives to vote against management. In one recent takeover battle, for example, a Hungarian firm repurchased 40% of its own shares and lent the shares to friendly banks (thus transferring voting rights but not economic risk). One might call the strategy "soft parking" of shares (we define this term more carefully below). OTC equity derivatives offer other options for the firm to place votes but little or no economic risk with friendly third parties. Employee stock ownership plans (ESOPs) and restricted stock plans place votes, with only limited economic ownership, in friendly hands. And acquirers can be empty voters of target shares, or vice versa. We also develop the uses of decoupling to avoid a number of regulatory requirements, not just ownership disclosure.
A recurring response to Decoupling I from U.S. readers was, "This is interesting, but is it important?" Part II provides fresh evidence. We can now say unequivocally that equity decoupling is an important worldwide phenomenon. Some recent examples have been dramatic, including stealth takeover attempts relying on hidden (morphable) ownership strategies. The managers and shareholders of major firms have woken up one morning to learn that their company suddenly has a new 30% or 40% shareholder.
In Switzerland, decoupling has been the stuff of front page headlines, involving the acquisition of controlling stakes in several leading Swiss firms, the resignation of the CEO of a major Swiss bank for facilitating this hidden ownership, and rapid government responses. Nothing in current U.S. rules prevents similar stealth bids here. Poison pills may do so, but their existence in perhaps half of our major public firms will not help the other half, nor justify regulatory complacency.
More broadly, our list of decoupling examples worldwide (see Part II and Table 1, infra) has grown--from 21 in 2006 to over 80 today, in over 20 countries. Some of the new examples are disquieting. Moreover, our prior examples primarily involved hedge funds and other outside shareholders. A number of the new examples involve corporate decoupling. These examples confirm the importance of insider and corporate decoupling.
In Part III, we refine our earlier integrated ownership disclosure reform proposal to respond to the newly emerging forms of decoupling, especially corporate decoupling, and to expand disclosure of share lending. We also argue that the emergence of sneak takeover attacks in Europe, which could be...