Shadows on the wall of the Dell buyout. Photographer: Justin
Matt Levine is a Bloomberg View
columnist writing about Wall Street and the financial world.
Levine was previously an editor of Dealbreaker. He has worked as
an investment banker at Goldman Sachs and a mergers and
acquisitions lawyer at Wachtell, Lipton, Rosen & Katz. He spent
a year clerking for the U.S. Court of Appeals for the Third
Circuit and taught high school Latin. Levine has a bachelor's
degree in classics from Harvard University and a law degree from
Yale Law School. He lives in New York.
Banks Forgot Who Was Supposed to Own Dell Shares
Jul 14, 2015 1:37 PM EDT
are three stylized facts about stocks:
Nobody owns stock. What you own is an
entitlement to stock held for you by your broker. But your broker
doesn't own the stock either. What your broker owns is an
entitlement to stock held for it by Cede & Co., which is a nominee
of the Depository Trust Company, which is a company that is in the
business of owning everyone's stock for them. This system sounds
convoluted but actually makes it easy to keep track of things: If I
sell stock to you, I don't have to courier over a paper share
certificate, or call up the company and have it change its
shareholder register. Our brokers just change some electronic
entries at their DTC accounts and everything is cool.1
If you own stock in a company that
gets acquired for cash, you can ask a court to second-guess the
merger price and give you the fair value of your stock in cash. A
court will "appraise" your stock and order the surviving company in
the merger to pay you what it's worth (plus interest), which may be
more or less than the deal price. But to get the appraisal, under
you need to follow some procedures. In particular, you have to
demand appraisal in writing from the company before the
shareholder vote, you have to vote against the merger (or abstain),
and you have to own the stock continuously from the time you demand
appraisal until the merger closes.
Every time Fact 1 and Fact 2
interact, the result is invariably nonsense.
instance, Merion Capital objected to the 2012 buyout of Ancestry.com
by Permira Advisors and demanded appraisal.3
But Merion was not an aggrieved long-term shareholder. It was an
"appraisal arbitrage" investor, in the business of seeking appraisal,
and it started buying Ancestry.com stock four days after the
record date for the shareholder vote. (The vote was held on Dec. 27,
2012, but you needed to own the stock as of Nov. 30 to vote.4)
Merion met most of the requirements for appraisal: It demanded
appraisal before the shareholder vote, didn't vote for the merger
(since it couldn't vote),5
and owned the stock continuously from demand until closing. But it
couldn't prove that its shares hadn't been voted in favor of
the merger: It had bought the shares in anonymous public transactions,
so for all it knew the people who owned those shares as of the record
date had voted in favor of the merger.
Ancestry.com argued that Merion should have to prove
that its shares hadn't been voted for the merger, which would have
sunk its appraisal demand since that would be more or less impossible
to prove. But the
Delaware court said no.
Remember Fact 1: Merion never owned Ancestry.com stock, and neither
did the people who sold the stock. The only owner was Cede & Co. And
Cede & Co. voted against the deal. Of course Cede & Co. also
voted for the deal -- it "held 29 million shares of
Ancestry.com, of which about 10 million either voted 'no' or
abstained," meaning that the rest voted yes -- but enough of its
shares voted no to "cover" Merion.6
level goofier: T. Rowe Price vocally and consistently objected to the
2013 buyout of Dell, sought appraisal for its Dell shares, and then
found out that it had actually
voted in favor of the buyout.
Like, by accident. It just forgot, or something; it's very weird, and
not rendered less weird by T. Rowe's statement that it was "aware of a
discrepancy in the communication of our voting instruction on the Dell
buyout." Oops! From Fact 2, you would think that this would foreclose
T. Rowe's appraisal efforts, since unlike Merion it had demonstrably
voted in favor of the deal, and the appraisal rules say that that
for Fact 1: T. Rowe Price never owned any shares, and so it never
voted any shares. Its ownership, its voting, everything were as
shadows flickering on the wall of a cave. Everything that any
shareholder thinks it does, Cede & Co. actually does. And, again, Cede
voted (enough of) its shares against the deal, so Cede could get
appraisal. Here's T. Rowe's lawyer:
"I think the case law is rock solid and the only thing that counts
is how the record holder votes its shared," Grant said in an
interview. "To me it is cut-and-dried that all of the stock
holders who sought appraisal will be entitled to appraisal."
Except! Here's an
even goofier thing from
A Delaware judge on Monday found that because owners of 922,975
Dell shares failed to continuously hold their stock during the
buyout process, they forfeited their rights to challenge the deal
price. He blamed legal precedent and quirks of the country’s
arcane stock-management system, and expressed frustration at his
those owners was a T. Rowe Price fund. Oops again! (The others were
portfolios at Northwestern Mutual and Manulife, and the Milliken and
Curtiss-Wright retirement plans. Most of the T. Rowe funds that voted
in favor of the deal don't seem to be affected.)
story -- from
yesterday's opinion -- is a
little bonkers, although each individual step just about makes sense.
When shareholders demand appraisal, DTC separates out their shares
from the rest of the shares that it holds. That way, when the merger
closes, DTC can surrender the non-objecting shares, get the merger
consideration, and distribute it to the shareholders who didn't want
appraisal, while keeping separate the shares that did ask for
the way that DTC separates out the shares is by getting a separate
paper stock certificate for each holder seeking appraisal:
DTC does this by causing the issuer's transfer agent to issue a
paper stock certificate for the number of shares held by the
beneficial owner. The paper certificate is issued in Cede's name,
so the same record holder continues to hold the shares for
purposes of the Continuous Holder Requirement.
a little weird, but fine. Now you've got a paper certificate in Cede's
name. What do you do with it?
As a matter of course, DTC does not act as a custodian of paper
stock certificates for its participants, even if those
certificates are issued in Cede's name. A participant can pay to
have a vault at DTC for its certificates, but that is a separate
service. Unless a participant has arranged for a vault, DTC will
contact the participant and deliver the paper certificate to the
participant for safekeeping.
now we are moving pretty far away from the efficiency benefits of DTC,
but whatever. Just courier over the paper certificates to the
objecting investors' brokers.
But here another back-office procedure kicked in. For various
understandable business reasons (insurance requirements,
recordkeeping for internal audit, mitigating risk of theft, etc.),
some banks and brokers only hold stock certificates that are
issued in the names of their own nominees.
JP Morgan's and BONY's internal policies do not permit them to
hold paper certificates unless the shares are titled in the names
of their own nominees. The custodial banks therefore instructed
Cede to authorize the shares to be re-titled in the names of their
On August 5, 2014, Cede endorsed the Funds' certificates to the
custodial banks. Over the next three weeks, the custodial banks
arranged for the Transfer Agent to reissue the shares in the names
of their nominees. The Transfer Agent reissued the shares held for
Milliken and Manulife in the name of Hare & Co. and the shares
held for Curtiss-Wright in the name of Mac & Co., which are BONY‘s
nominees. The Transfer Agent reissued the shares held for T. Rowe
Price in the name of Kane & Co. and the shares held for
Northwestern in the name of Cudd & Co., which are JP Morgan's
is a lot going on here, not least of which is that apparently every
custodial bank has an assortment of adorably named monosyllabic
partnerships that serve as its share-ownership nominees.7 (Also
there is a meaningful typo: I'm pretty sure that August 5 was in 2013,
when the rest of this happened, not 2014.)
you see the problem? In normal terms, T. Rowe owned its shares on June
12, 2013, when it demanded appraisal,8 and
it owned them on Aug. 5, and it owned them continuously until the
merger closed on Oct. 29,
2013. "There is no dispute that the Funds continuously held their
shares as beneficial owners through the effective date of the merger,"
says the court.
the goofball alternate universe of legal ownership, of which the
normal everyday "ownership" is merely a shadow, T. Rowe never owned
the stock, and on Aug. 5, the ownership
There is no dispute that on Dell's records as maintained by the
Transfer Agent, legal ownership of Funds' shares changed from Cede
to the four current nominees: Mac & Co., Kane & Co., Hare & Co.,
and Cudd & Co.
that had nothing to do with the T. Rowe fund or the rest of these
investors, but it was enough to sink their appraisal claims: "When the
shares were re-titled, the Funds lost their appraisal rights." To get
appraisal, a shareholder needs to own shares continuously through
closing, and the shareholder -- Cede & Co. -- sold these shares in
August. So: no appraisal.
Nobody, including the judge who decided the case, is happy about this.
Because it is nonsense! Cede & Co.! Mac & Co.! Kane & Co.! Hare & Co.!
Cudd & Co.! Come on! These are not real things. Anyone involved in the
Dell deal would be baffled if you told him that the controlling
shareholder was Cede & Co., and that Cede had sold a block of stock to
Mac & Co. Cede and Mac and Cudd and friends exist in a parallel
universe whose intersections with the actual economic world tend to be
creepy and uncomfortable.
do you blame for this? I mean, the judge blamed Delaware law, and that
is fair enough.9 As
he notes, "Federal law looks through Cede and recognizes the custodial
banks and brokers as record holders"; if Delaware did the same -- or
looked through all the way to beneficial owners -- it would have saved
the appraisal claims here. (On the other hand, looking through to real
owners might doom appraisal arbitrage strategies like Merion's.)
would also be reasonable to put some blame on JPMorgan and Bank of New
York Mellon, the custody banks who changed the ownership. They are two
of the three
biggest custodian banks in the
world, and they had one job! All they had to do was not cross out
the name "Cede & Co." and write some other silly name on some stock
certificates. (Or, if the temptation was too great: Pay for a
vault at DTC.) Presumably JPMorgan and BoNY will find a way to avoid
re-titling appraisal shares in the future, but it's a little
embarrassing they hadn't done so already. Yesterday's decision may be
a bit of a surprise, but it is not, like, a secret that appraisal
procedures are finicky and that continuous ownership is an important
requirement. Getting this wrong, and costing customers their appraisal
claims, seems almost deliberately perverse.
I'm sure it wasn't deliberate.10 The
financial system is built up in layers of abstraction over some vast
and unwieldy machinery. The machinery is complicated in part in order
to make the abstraction simple: You can buy stock with a click of a
mouse because armies of people devote their careers to the legal
niceties and operational maintenance and integration of all this
back-office apparatus. Sometimes the machinery pokes out a bit through
the fabric of the abstraction, and someone has to file it back down to
make things smooth again. Really, though, considering how complicated
the machinery is, it's amazing that this doesn't happen more often.
This column does
not necessarily reflect the opinion of the editorial board or
Bloomberg LP and its owners.
Obviously this oversimplifies.
own stock directly, though it is not the norm for public shareholders
of public companies. Also DTC (the Depository Trust Company) is itself
a subsidiary of
DTCC (the Depository Trust &
Clearing Corporation). The weirdest thing is Cede & Co., which is a
partnership nominee of DTC, and whose existence has always been a bit
mysterious to me. (Here's
All of this is well summarized in pages 1-2 of
yesterday's Chancery opinion:
DTC's place in the ownership structure results from the federal
response to a paperwork crisis on Wall Street during the late
1960s and early 1970s. Increased trading volume in the securities
markets overwhelmed the back offices of brokerage firms and the
capabilities of transfer agents. No one could cope with the
burdens of documenting stock trades using paper certificates. The
markets were forced to declare trading holidays so administrators
could catch up. With trading volumes continuing to climb, it was
obvious that reform was needed. Congress directed the SEC to
evaluate alternatives that would facilitate trading.
After studying the issue, the SEC adopted a national policy of
share immobilization. To carry out its policy, the SEC placed a
new entity—the depository institution—at the bottom the ownership
chain. DTC emerged as the only domestic depository. Over 800
custodial banks and brokers are participating members of DTC and
maintain accounts with that institution. DTC holds shares on their
behalf in fungible bulk, meaning that none of the shares are
issued in the names of DTC‘s participants. Instead, all of the
shares are issued in the name of Cede. Through a Fast Automated
Securities Transfer account (the "FAST Account"), DTC uses an
electronic book entry system to track the number of shares of
stock that each participant holds.
By adding DTC to the bottom of the ownership chain, the SEC
eliminated the need for the overwhelming majority of legal
transfers. Before share immobilization, custodial banks and
brokers held shares through their own nominees, so new
certificates had to be issued frequently when shares traded. With
share immobilization, legal title remains with Cede. No new
certificates are required.
Delaware is of course where most public companies
are incorporated. This is a summary of
Delaware General Corporation Law section
262(a) and (d)(1).
facts here are drawn from
this Wall Street Journal article
the Chancery Court opinion in
the Ancestry.com case.
that if you owned the stock on November 30, and sold it on December 1,
you could still vote on December 27. The long lag between record and
voting dates is ... kind of an old-fashioned artifact, honestly?
didn't vote against, either, but
the requirement is that you
"neither voted in favor of the merger or consolidation nor consented
thereto in writing."
I find that: (1) Cede, the record owner, made demand as required
by Section 262(a); (2) consistent with Transkaryotic, Cede had at
least as many shares not voted in favor of the merger as the
number for which demand was made; and (3) in exercise of its
rights under Section 262(e), the beneficial owner, Merion, filed
its petition in its own name. Under the unambiguous language of
subsection (a), Merion has standing to pursue appraisal here.
said at the time:
This is cool, no? Part of the purpose -- really the main purpose
-- of DTC/Cede is to make administration easier, so no one else
has to keep track of who owns stock. But DTC also adds value by
this sort of value-maximizing abstraction. Some 10 million shares
were voted against the deal. Each of those shares now has a
valuable appraisal option. Some of the disgruntled no voters will
let that option expire worthless, rather than going through the
trouble of seeking appraisal. Or they would, if they owned their
shares directly. But because they own them in a big pot, that pot
can maximize the value of the option by basically giving it to
anyone who wants to make something of it. That's good,
collectively, for the shareholders, though obviously annoying for
In Ancestry.com the option didn't turn out to be worth that much: The
appraised it at $32 per share,
the same as the deal price, though that comes with two-plus years of
above-market interest. But in
general, by pooling shares in Cede & Co., shareholders collectively
ensure that they can profit from their appraisal rights by selling
them on to appraisal arbitrageurs, as long as some shareholders vote
against the deal.
I said in footnote 1, Cede & Co. is a mystery to me, but Cudd & Co. is
a mystery wrapped in an enigma wrapped in a depository.
in normal terms it probably demanded appraisal before that, but (from
Because they owned their shares in street name through their
custodial banks, the Funds caused Cede to demand appraisal on
their behalf. On July 12, 2013, before the vote on the merger,
Cede made appraisal demands for the Funds.
The original record date for the Dell merger
was June 3, and the vote was
scheduled for July 18, though
both were later pushed back as
Dell struggled to round up votes.
Much of the opinion is actually a critique of the
development of Delaware caselaw, not the statute, but that is a bit
afield of our purposes.
evidence for that conclusion is the fact that BoNY messed it up
There was an additional hiccough at BONY. Shortly after the
Transfer Agent reissued the shares, BONY conducted a routine
weekly sweep of its vault. BONY found the stock certificates for
the shares beneficially owned by Manulife and Milliken and
redeposited them with DTC in the FAST Account.
On September 12, 2013, a majority of Dell‘s shares voted in favor
of the merger. A few weeks later, on October 4, BONY realized that
the shares beneficially owned by Manulife and Milliken had been
re-deposited in the FAST Account. BONY withdrew them from DTC and
had new certificates issued in the name of Hare & Co.
contact the author on this story:
Matt Levine at
contact the editor on this story:
Philip Gray at
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