They Don’t Really Own Dell Shares
STEVEN DAVIDOFF SOLOMON
turns out that
mutual funds may not be that
great at keeping track of the stocks they own. The latest evidence
comes from a legal battle over the $24.9 billion management-led buyout
the Dell deal was made in 2013, about 2.7 percent of shareholders
objected to the purchase price of $13.75 a share, exercising
what are called appraisal rights.
The shareholders filed suit in a Delaware court, arguing that the
buyout price was too low and asking the court to determine the fair
value of Dell shares.
last stalwarts of the Dell buyout opponents included funds advised by
T. Rowe Price and Morgan Stanley.
Most other shareholders, including Carl C. Icahn, who threatened to
exercise appraisal rights, folded and took the $13.75 for each of
their shares. Who can blame them? Appraisal involves a convoluted
court proceeding and all the costs that go with it.
the problems with appraisal rights the fact that the United States
system of share ownership is even more bizarre. Five funds holding
922,975 shares that dissented from the Dell buyout, including T. Rowe
Price’s fund, found this out last week when their case was dismissed.
his opinion, Vice Chancellor J.
Travis Laster of the Delaware Chancery Court gave a startling reason:
The five funds didn’t really own their shares the way they thought
could a mutual fund lose track of its ownership?
answer is that in the United States, most people who think they own
shares actually do not.
Instead, in the United States most shares are held through a nominee
system. Shareholders are what we call beneficial owners — they have a
right of ownership, but one that is not reflected in the actual legal
title of the shares.
Individuals buy stock through brokers like Charles Schwab. The brokers
then purchase the stock on the investor’s behalf. But the brokers that
hold these shares do not actually own them. Instead, the shares are
held by a superentity called Cede & Company in an arrangement
administered by the Depositary Trust and Clearing Corporation. More
than 800 brokers and other institutions that hold stock are members of
the D.T.C.C. and hold shares at Cede.
bottom line is that when you look at your brokerage statement, the
shares listed are most likely owned by Cede on your behalf.
system was set up after the back-office brokerage and paperwork crisis
of the 1960s, when brokerage houses could not keep up with an
ever-increasing number of trades. Back then, anytime a trade occurred,
it needed to be recorded with the company and a new stock certificate
issued. The brokers could not keep up, and a number of them folded
because of faulty record-keeping.
keep up with the increasing ownership, the system was overhauled.
Today, when a trade occurs, there is no need to issue a new stock
certificate. Instead, an entry is simply made by the brokerage house
internally and at Depositary Trust and Cede. If you think about it,
this is the only way the system can handle billions of shares a day.
everything, though, this system of share ownership is imperfect.
is what these five Dell shareholders found out when they exercised
appraisal rights and encountered the law’s very particular
Delaware appraisal law requires that dissenters own their shares from
the time of dissenting until the completion of the deal. In other
words, there must be continuous ownership.
the rule assumes a world in which people directly hold certificates.
This is not surprising, since the rule was adopted well before the
Depositary Trust system was set up.
is where the problem occurred. The fund holders thought they owned
their shares throughout this time period. They did not.
Instead, when the funds exercised their appraisal rights, Cede
transferred the shares held by the funds to new nominees at the
brokers (including JPMorgan Chase and Bank of New York Mellon)
representing these funds. While beneficial ownership remained, actual
ownership changed — a violation of the continuous ownership
did this occur? It’s not clear, but it was most likely a result of
simple back-office errors.
Matt Levine of Bloomberg View
cast blame on JPMorgan Chase and Bank of New York Mellon, writing,
“Getting this wrong, and costing customers their appraisal claims,
seems almost deliberately perverse ”
Unfortunately for the funds, Vice Chancellor Laster held that this
transfer disqualified them from exercising appraisal rights. While
they were beneficial owners of the shares, title changed, violating
the continuous ownership requirement.
judge recognized that this was unfair, but he stated that his hands
were tied by Delaware law, which recognized only the actual holder of
record as the owner of shares.
only remedy now is for the funds to go to the Delaware Supreme Court,
the higher state court, and persuade it to change the rules, something
Vice Chancellor Laster seemed to want.
almost so arcane you could cry. But it raises bigger issues about both
share ownership and appraisal rights that are being swept under the
most shareholders do not actually hold title to their shares is for
the most part a meaningless technicality. But it still raises all
sorts of issues as people try to track these shares.
example, the system of voting shares is a mess because of this
ownership problem. T. Rowe Price mistakenly voted yes for the Dell
deal when it meant to vote no. And in the battles between hedge funds
and companies to elect directors, the voting system still cannot allow
for a universal ballot, one where all the nominees of each side are on
one card, since people cannot track all the information needed down to
the share tracking issue, there is perhaps a bigger point about
last few years, more and more shareholders have tried to exercise
appraisal rights. Many of them are hedge funds that buy shares
specifically to take their chances in court. But others are
shareholders like T. Rowe Price that think they deserve a better deal.
was always the purpose behind appraisal rights — to allow shareholders
that thought they had received a bad deal to go to court and get the
fair value for their shares.
that appraisal rights are being exercised regularly, however,
companies are fighting back, trying to find every technicality to
throw out these suits.
proposal before the Delaware Legislature to cut back these cases by
barring people with less than $1 million in shares from exercising
appraisal rights, among other steps, did not succeed in part because
many companies felt it did not go far enough in halting the tide of
appraisal rights cases.
the Dell case is a warning. Appraisal rights are there to protect
shareholders from underpriced deals. Instead of wrangling about
technicalities or rewriting the statute to cut back on these actions,
Delaware should perhaps write an appraisal statute that works with the
share ownership rules.
could blame the T. Rowe Price fund and the others for this fiasco. Yet
they are really the victims here, tripped up by an unnecessarily
arcane system of shareholding in the United States. The lesson here
is: Don’t hate the player. Hate the game.
Steven Davidoff Solomon is
a professor of law at the University of California, Berkeley. His
columns can be found at nytimes.com/dealbook.
A version of
this article appears in print on July 22, 2015, on page B5 of the New
York edition with the headline: Funds Challenging Dell Bid Find Shares
Aren’t Really Theirs.
The New York Times Company