Friday, September 14, 2012

Will Emmis Communications be Allowed to Strip Its Preferred Stock of Voting Rights and Dividends?

I saw this outrageous story "Taking the Preferences Out of Preferred Stock" in the New York Times. Emmis Communications has a 6.25% cumulative preferred (EMMSP) that was issued in 1999. In December 2008, the company suspended the quarterly dividend on the preferred stock, which by its terms continued to accrue. The preferred was also putable at par ($50) plus accrued  in the event of a takeover.

By this summer, the preferred had accrued about $12 per share in dividends, for a total of $178.6 million in par plus accrued that would be due in the event of a takeover. The preferred holders were preventing management from taking over the company - they refused a 2010 offer of $30 in debt in lieu of the $50 plus accrued interest that they were owed.

So, the company borrowed money to do derivatives transactions with some of the preferred holders, such that the company had economic interest and voting interest in the shares but the shares were still "outstanding". (If they had simply been bought by the company, the company would not have been able to vote them, since company securities that are repurchased are considered cancelled and can never be voted.) It also established an employee retention plan and issued 400,000 shares of preferred stock to it so that it could "vote" those too.

With these votes, the company had the 2/3 majority needed to amend the terms of the preferred shares. Last week, after winning an initial Indiana court battle, the company voted its shares and amended the shares to eliminate the cumulative provision, the right of preferred shareholders to appoint two directors, and to redeem the preferreds in the event of an acquisition. The value of the preferred immediately dropped by 40 percent.

The reasoning in the ORDER DENYING PLAINTIFFS’ MOTION FOR PRELIMINARY INJUNCTION by federal judge Sarah Evans Barker (Reagan appointee!) is appalling. One of the key issues is whether or not shares of preferred stock were still "outstanding" after the company synthetically acquired all economic and voting interest in them.

The court’s task here is [to determine whether], regardless of the label given to the transaction, the manner in which Defendants structured the transactions to ensure the shares remain outstanding is permissible under Indiana law. [...A]lthough we concede that it is difficult to articulate what concrete value remains with mere record ownership, it is not meaningless under Indiana law.
I think that if you tried to do a transaction like this with the purpose of minimizing taxes, a court would call it a sham transaction. In fact, rather than selling securities and realizing capital gains, why don't people simply do swap transactions that transfer all of their economic and voting interest? By this reasoning, capital gains could be deferred forever by everyone!

The outcome would be perverse, just as it is in this case. How can a company be allowed to behave this way (assuming the account is true)?:
"[A] portfolio manager with Corre who was not one of the ten Preferred Shareholders approached by Defendants, but who contacted Emmis in November 2011, after learning that Defendants were acquiring shares from some of the Preferred Shareholders [testified] that he spoke with Pat Walsh, Emmis’s Vice-President, COO/CFO, who advised him that Corre should sell its Preferred Stock because Emmis was trying to acquire two-thirds of the Preferred Stock in order to amend the terms and 'if that happened, [Corre] didn’t want to be in the preferred.' [He] further testified that Mr. Walsh had said to him 'you’re in a prisoner’s dilemma' and 'you don’t want to be the last guy to act because there might not be room for [Emmis] to buy your shares.'
I can't believe that this will be allowed to stand. Ben Graham writes at length about preferred stocks in Security Analysis, with special emphasis on the necessity of cumulative provisions.

Should a company ever be allowed to remove the cumulative feature from a preferred over the objections of a holder? Ben Graham wrote that the lack of a cumulative feature is "so patently inequitable that new security buyers (who will stand for almost anything) object to noncumulative issues, and for many years new offerings of straight preferred stocks have almost invariably had the cumulative feature."


CP said...

U.S. District Judge Sarah Evans Barker on Friday issued an injunction blocking Indiana's new immigration law, saying the state overstepped its boundaries in the controversial statute that was to take effect July 1.

CP said...

U.S. District Judge Sarah Evans Barker ordered the surrender of the church, its school and parsonages to satisfy a lien of $6 million in back taxes, penalties and interest.

Integrated Solutions said...

I like to say that preferred stock is the fixed dividend that may pay on a monthly or quarterly basis.

Best Dividend Stocks

Allan Folz said...

Effing incumbent judges. What is she 25, 30 yrs on the bench. Get over yourself, lady.

The single biggest mistake in the constitution is a lack of term limits applicable to all 3 branches of govt. Judges should have to be at least 50 yrs old, allowed to serve 10 yrs, then required to retire from law with a 50% of salary pension.

Senators are 2 and done, Rep's are 4 and done. Presidents are 1 7yrs and done.

Allan Folz said...

BTW, the GM bankruptcy was the all clear signal that shareholders and bondholders are sheep to be fleeced when and as necessary. MF Global and Peregrine Financial are further reminders for anyone that happens to be a little slow on the uptake.

CP said...

So now that the cumulative feature has been stripped, there's no reason for the preferred to ever get any payments. The company was able to render it worthless. Doesn't that suggest that their actions were improper?

lawndale1 said...

I am hopeful the plaintiffs will continue to take this case through to its rightful reversal, potentially up at the state supreme court level. These actions were a clear abrogation of a director's fiduciary duties. Interestingly, with one of the defense arguments being the company would have to file bankruptcy, those fiduciary duties to preferred shareholders and creditors may even be enhanced by being in the 'zone of insolvency." Furthermore, I think the stripping of already accrued dividends may be a legally prohibited taking of property and may also have some constitutional protection violations to be asserted as well.

CP said...

It's outrageous. It renders the preferreds practically worthless if the changes stand.

I'm sure they will appeal. There is so much money at stake.