Dole Class Action Ruling: Short-Selling Clawback Next?
June 10, 2016 By
brokerage and bank operations and compliance managers will soon have
to face an onerous back-office and legal challenge — figuring out how
they to make short sellers pay back $2.74 plus interest for each share
of Dole Foods shorted more than three years ago. That money would be
used to compensate beneficial investors who are considered the
legitimate beneficiaries of a class action suit against Dole Foods.
administrative nightmare is a new decision from Delaware Chancery Court Vice
Chancellor J. Travis Laster. He has ruled that US national securities depository
Depository Trust Company (DTC) and its participants will have to work out among
themselves how beneficial shareholders of Dole Food receive their fair piece of
the $115.7 million pie in the class action settled in December 2015. The lawsuit
accused Dole’s officers of fraudulently pushing down the company’s stock price
before selling it into private ownership for US$1.6 billion in 2013. The
privatization was structured as a merger agreement.
Delaware is a
popular state for companies to incorporate and the Chancery Court is the place
to go to resolve disputes between Delaware corporations and their shareholders.
The Dole settlement awarded an additional $2.74 a share plus interest to
investors who could prove they were beneficial owners or recordholders during
the eligible claims period. The eligibility period was June 11, 2013 to November
1, 2013, the day Dole’s privatization took effect and when DTC put a “chill” on
Dole Foods stock. That meant that a participant could not deposit or withdraw
its shares. Once the “chill” happened, positions in Dole’s common stock were
locked in and could not change.
Laster didn’t offer any explicit directions for how his decision would work out
in operational terms. However, Stuart Grant, a partner with the law firm of
Grant & Eisenhofer in Wilmington, Delaware who represented the class-action
plaintiffs, says it comes down to the short-sellers compensating other
rightful investors is no longer Dole’s legal problem. Dole has already handed
over the $115.7 million to the claims administrator. Nor is it the problem of
the Milwaukee-headquartered settlement administrator A.B. Data which received
“facially eligible” claims for about 49.2 million shares. Members of the
eligible affected class held only 36.8 million, according to Judge Laster.
attorneys as well as Grant who commented to FinOps Report regarding the case,
any additional money needed to pay the rightful investors would have to be put
up by the short-sellers.
Whether banks and
broker-dealers will be able to obtain this money is the topic of plenty of
debate among Wall Street operations executives. It all depends on how the
contractual agreements between the banks and broker-dealers and their
short-seller clients are interpreted, say legal experts. It could take a quite a
bit of time to review past records to locate and then notify the short-sellers.
Whatever the agreements said back in 2013, the short-seller — often a hedge fund
— could have since gone out of business or closed its account with its bank or
broker-dealer. Even if located, the short seller could simply refuse to pay up.
If they don’t get
the money back from the short-sellers, the banks and broker-dealers will likely
decide to take it out of their own pockets, predicts Grant. If they don’t, they
risk lawsuits from the disgruntled investors who lent the shares. Of course, the
banks and broker-dealers could try to sue the short-sellers for the money. The
short-sellers could then argue they are under no legal obligation to refund what
they consider to be fairly-earned profits.
Bottom line: in
trying to solve one legal issue, Vice Chancellor Laster may have opened a
Pandora’s box of others. Any liability will be shifted from Dole to the bank and
broker-dealer participants of DTC. Judges in other state courtrooms could soon
be faced with untangling new and even more convoluted lawsuits.
apparently, he couldn’t see any other way to solve the dilemma of who is
entitled to the payout. “The journey down the rabbit hole would require mapping
the whole warren,” argued Vice Chancellor Laster. Here is why: beneficial
investors hold shares in the name of their financial intermediary. The financial
intermediary, in turn, holds the shares in book-entry form at DTC. The US
depository, in turn, holds shares on the books of a company in the name of Cede
Typically in a class
action securities settlement, far fewer claimants ask for their compensation
from the claims administrator than the number entitled to the compensation.
Therefore, there is more money to divide among fewer shareholders. Even if short
selling had occurred in those cases, it it was unlikely to result in a huge
difference between the number of claimants asking for compensation and the
Not so with Dole
Foods. There was so much short selling in the days leading up to Dole’s
privatization — 2.9 million shares shorted as of October 13, 2013 — that a large
discrepancy emerged between the number of “facially eligible” shares whose
investors asked for compensation and the number of shares registered on the
books of DTC. Because the US has a three-day settlement cycle, the depository’s
ledger did not reflect all of the trades in Dole common stock on November 1, the
day of the merger, or the two days preceding it.
Borrowers Plus Lenders
resulted in additional beneficial owners who received the merger consideration
who fell within the technical language of the class definition and who could
claim the settlement consideration,” explained Vice Chancellor Laster.
“Meanwhile, the lenders of the shares, not knowing that their shares were lent,
also could claim the settlement consideration.” It is common practice for banks
and broker-dealers to lend shares without the beneficial owners’ knowledge.
What about just
pretending the claims class is comprised of holders of 49,164, 415 shares and
just compensate everyone pro-rata? Sounds a lot easier, administratively
speaking. That approach would be “unjust,” said Vice Chancellor Laster. “It
would result in 25 percent of the consideration going to holders who should not
receive it. As a consequence, the true holders of shares would receive only 75
percent of the settlement consideration.”
Laster’s decision does have some legal basis. Short sellers are considered
borrowers of the stock and as such are not entitled to compensation from a
corporate action which takes place during the three days between the day the
trade is executed and its settlement. The lenders are entitled to the
compensation. Apparently, he has interpreted the class action settlement as the
equivalent of a corporate action, say operations managers. If so, that would be
a corporate action announced after the fact.
detailed records about the millions of trades that took place during the three
days leading up to the closing [November 1, 2013] it is impossible to determine
who owned the shares as of closing. And obtaining those records is not
realistically achievable,” said Vice Chancellor Laster.
Why not? A.B. Data
would need records from over 800 DTC participant brokers and custodian banks and
all of the individual clients. It can’t force them to hand them over and even if
every single record were produced, a separate forensic audit “of herculean
proportions” would have to be undertaken, said Vice Chancellor Laster.
What could have
prevented the Dole scenario from taking place? In one footnote to his ruling,
Vice Chancellor Laster suggested that the problem with compensating investors is
an “unintended consequence” of the top-down federal solution to the paperwork
crisis that threatened Wall Street in the 1970s. That paperwork crisis —
thousands of stock certificates having to move between buyers and sellers — led
to the creation of DTC and the book-entry system of securities ownership as we
know it today.
Laster’s suggested solution to the overall problem should make blockchain
afficionados happy. In another footnote to his ruling, he said that distributed
ledger technology offers a potential solution by maintaining multiple current
copies of a single and comprehensive stock ownership ledger. What does that mean
in practical terms? Blockchain experts say that short-sellers would likely be
identifiable in a jiffy. However, that still doesn’t guarantee that a bank or
broker-dealer could force them to give up $2.74 plus interest for each share
they borrowed over three years ago.
meantime, Vice Chancellor Laster’s ruling should be a warning bell to all
short-sellers: you could be asked to give over your trading profit to other
investors years later. For operations and compliance managers, it’s also a
warning bell. You’re going to be the ones cleaning up the administrative mess.