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Source: Bloomberg View, February 17, 2017 commentary






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.


Wall Street

Dole Food Had Too Many Shares

Feb 17, 2017 10:00 AM EST

By Matt Levine

In 2013, tropical-fruit tycoon David Murdock, who was the chairman, chief executive officer and biggest shareholder of Dole Food Co., took it private for $13.50 a share. A lot of shareholders felt that that price was way too low, and that Murdock had sandbagged the shareholders by driving down the value of the company so he could buy it cheaply for himself. So they sued, and they won. In 2015, the Delaware Chancery Court ordered Murdock to pay shareholders another $2.74 a share, plus interest. There was a class action on behalf of shareholders, covering 36,793,758 shares, and after the court ruled in their favor, the class lawyers informed the shareholders and asked them to submit a form to claim their $2.74 a share.[1]

They got back claims from 4,662 shareholders for a total of 49,164,415 shares. "That figure substantially exceeded the 36,793,758 shares in the class," Delaware Vice Chancellor Travis Laster drily noted in an opinion Wednesday. Oops! Somehow shareholders owned 33 percent more Dole Food shares than there were Dole Food shares.

Huh. So. The simple explanation would be "a quarter of those people were lying," but nope. Almost all the claims were valid,[2] or at least, "facially eligible." So the lawyers sheepishly went back to Vice Chancellor Laster to explain what happened and ask what to do about it.

What happened? Two things. The first one is just a pure pointless mess. Essentially the way everyone owns stock is:

1.   Cede & Co., a nominee of the Depository Trust Co., owns all the stock in all the companies.

2.   DTC keeps a list of its "participants" -- banks and brokers -- who "really" own that stock, and how much each of them own.

3.   The participants, in turn, keep lists of "beneficial owners" -- people and funds -- who really really own the stock, and how much each of them own.

So if you own stock, what you really have is an entry in your broker's database, and your broker in turn has an entry in DTC's database, and DTC (well, Cede) has an entry in the company's database of shareholders of record. If you sell the stock, your broker takes it out of your account (at your broker), and DTC takes it out of your broker's account (at DTC), and DTC adds it to the buyer's broker's account (at DTC), and the buyer's broker adds it to the buyer's account (at the buyer's broker). As far as the company is concerned, Cede owned the stock the whole time.

If this all makes your head hurt, you are not alone. Sometimes it makes DTC's head hurt too, and it needs to lie down for a while in a dark room and listen to soothing music. DTC calls this a "chill." I am not kidding.[3] So when there's a merger that's about to close, it's too crazy for DTC to both keep track of trades and deal with getting the merger payment to shareholders. So DTC will place a chill on the stock, and just not record trades for the three days leading up to the closing. From Wednesday's opinion[4]:

DTC placed “chills” on its records for its participants’ positions in Dole common stock as of the close of business on November 1. A “chill” restricts a participant’s ability to deposit or withdraw the security. Once DTC initiated the chills, the participants’ positions in Dole common stock were locked in and could not change.

Nov. 1, 2013, was the closing date,[5] but the chill effectively covered the three previous days:

DTC’s centralized ledger did not reflect all of the trades in Dole common stock on the day of the merger or during the two days preceding it. Under the current standard of T+3 for clearing trades, DTC did not receive information about all of the transactions that took place on October 30, October 31, or November 1.

This doesn't actually mean that you couldn't trade Dole stock in the three days leading up to the merger closing. You could, and lots of people did. About 32 million shares traded in those last three days.[6] It just means that DTC doesn't want to hear about it. DTC was chilling. Instead:

The DTC participants who facilitated transactions that had not yet cleared when the merger closed were responsible for properly allocating the merger consideration among the parties to the transactions.

As far as DTC was concerned, whoever owned shares as of the close on Oct. 29 owned the shares at the time the merger closed. If you sold your shares after that time, your broker and the buyer's broker -- the DTC participants -- had to sort that out themselves.

You can see why this would be a problem for the current Dole lawsuit. If you owned a share of Dole stock as of Oct. 30, DTC thinks you owned it at closing. If you sold the share to me on Oct. 31, my broker (and your broker) thinks that I owned it at closing. It's just one share, but it has turned into two shares as far as "facially eligible" claims go.[7] This is a weird problem: If you owned the stock on Oct. 30, and then sold it before the closing, you're kind of a jerk for submitting a claim pretending that you owned the stock at closing.[8] But this all happened a pretty long time ago and maybe you forgot.

Fortunately this problem is solvable. The solution is simultaneously trivial and extremely difficult. The key thing to realize is that those trades in the last three days happened, and somehow the original merger consideration -- the $13.50 a share paid on Nov. 4, 2013 -- found its way to the people who really owned the stock at the end of Nov. 1. DTC might not have had a complete and up-to-date list of them, but DTC's participants had mechanisms to get the money to the right place. (Intuitively: If Broker A sold shares to Broker B on Oct. 31, DTC would send the merger money to Broker A on Nov. 4, and Broker A would pass it along to Broker B, etc.) Whatever voodoo they did back then, they could probably do again. The problem of distributing the $2.74 can be reduced to a previously solved problem, the problem of distributing the $13.50. So it is trivial.

It's also kind of hard, in that the brokers have to go back and figure out who actually owned the shares at the time, but that's their problem. The Delaware vice chancellor concludes that for him to figure out who actually owned the shares, or for the lawyers to figure it out, "would be lengthy, arduous, cumbersome, expensive, and fundamentally uncertain," and "functionally impossible" to do "in a practical or cost-effective manner." That sounds hard! So the lawyers suggested, and the judge approved, letting the brokers figure it out instead:

Under this method, it will be up to the DTC participants and their client institutions to resolve in the first instance any issues over who should receive the settlement consideration. Shifting the burden to them is efficient because they already had to address these issues for purposes of allocating the merger consideration. If new issues arise, the DTC participants and their client institutions have access to their own records, and they have visibility into the terms of their contractual relationships, such as the terms on which shares are borrowed. Any ensuing disputes are between the beneficial owners and their custodial banks and brokers. Those disputes should be resolved pursuant to the contractual mechanisms in the governing agreements or, if necessary, through a judicial proceeding limited to the parties.

There might be lots of issues, but they won't be the court's problem. Good solution.

But there is another problem that created extra Dole shares. This is also a mess, but not a pointless one. It's a real economic issue, and also one that people seem to get emotional about. It is: short-selling.

Some quick background. The way short-selling works is:

1.      Mr. A owns a share of stock.

2.      Mr. B borrows Mr. A's share of stock.

3.      Mr. B sells the share to Mr. C.

But now Mr. A and Mr. C each own one share of stock. Where there was only one share, now there are two. A "phantom share" has been created. Well, not really. The trick to balancing the books is to remember that Mr. B owes Mr. A a share of stock. So Mr. B now owns negative one share of stock. There's a total of one share: one for A, and one for C, and negative one for B. One plus one minus one is one. It's no problem.[9]

"But what if ...," you start to ask, and I reply: Shh, shh. It just works. What if the company pays a dividend? Well, Mr C. physically possesses the share -- don't think too hard about that metaphor -- so the company pays the dividend to Mr. C. But Mr. A also owns the share, and he wants the dividend too. But it's OK, because Mr. B owns negative one share, so he has to pay a dividend. So he pays the dividend to Mr. A.[10] In practice, this is all intermediated through brokers, and Mr. A is unlikely to ever find out that his share was borrowed or that he got his dividend from Mr. B. For Mr. A, the whole thing just works quietly and seamlessly. It's magic.

What if the company is acquired in a management buyout for $13.50 in cash? Same thing. The company sends $13.50 to Mr. C. Mr. B sends the $13.50 to Mr. A. The two owners of the one share of stock each get the full $13.50 merger price for that one share of stock. Mr. B, who is short one share of stock, pays one merger price. Everything works.[11] It just works. It's still magic.

What if the company is acquired in a management buyout for $13.50 in cash and then, three years later, a court adds another $2.74 in cash to the merger price? Same ... wait. I have no idea. The magic might break down here. As the court points out:

The shorting 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. Meanwhile, the lenders of the shares, not knowing that the shares were lent, also could claim the settlement consideration. This is another means by which two different claimants could submit facially valid claims for the same underlying shares.

That's basically true of the original merger consideration, too. There, brokers would owe merger consideration to people who owned more shares than actually existed, and they'd go get that extra consideration from the short sellers. Everything balanced out. Maybe that will happen here too. But it's harder. If you were short Dole Food stock on Nov. 1, 2013, you were doing it in an account with a broker. You posted collateral in that account. When it came time to collect the $13.50 from you, the broker had no problem collecting it. But that was three years ago. If the broker comes back to you now for the extra $2.74, you might feel entirely within your rights to reply "new phone who dis?" You might not have an account with that broker any more. You might not even exist any more. (People die; hedge funds close.) You certainly haven't been posting collateral against your Dole Food short position for the last three years. That position was closed out ages ago.

Anyway this could account for millions of the phantom shares:

As of October 31, 2013, traders had shorted approximately 2.9 million shares of Dole common stock. Because the price of Dole common stock traded above the merger price through closing, it is likely that traders shorted additional shares on November 1, resulting in even more shares in short positions as of closing.

So that's a fun one! I don't know how the brokers will deal with this problem, but I will just quote the court and say: "Any ensuing disputes are between the beneficial owners and their custodial banks and brokers." Let us wash our hands of them.

Isn't this such a delightful muck? As Vice Chancellor Laster writes:

This problem is an unintended consequence of the top-down federal solution to the paperwork crisis that threatened Wall Street in the 1970s. Through the policy of share immobilization, Congress and the Securities and Exchange Commission addressed the crisis using the 1970s-era technologies of depository institutions, jumbo paper certificates, and a centralized ledger.

It's enough to drive even a sensible vice chancellor to talk about blockchains[12]:

Distributed ledger technology offers a potential technological solution by maintaining multiple, current copies of a single and comprehensive stock ownership ledger. The State of Delaware has announced its support for distributed ledger initiatives.

I want to push back on that a little. There are two problems in this case. One is mechanical: figuring out who actually owned Dole stock as of the closing date three years ago. A blockchain would presumably solve that problem, without requiring the court and the lawyers to embark on a "lengthy, arduous, cumbersome, expensive, and fundamentally uncertain" dive through the records to figure out who owns what. But the current system also solves the problem, without requiring the court and the lawyers to do anything arduous or expensive. They just send the problem off to the current ledgering system -- DTC and the custodian brokers and so forth -- and that system deals with it. It's like a blockchain, only it's made up of hundreds of humans and computer systems at dozens of banks, glued together in a way that somehow more or less works. It's not even expensive. "DTC advised class counsel that this process is feasible and requires payment of a base fee to DTC of $2,250, with the potential for additional consultation fees if difficulties arise."[13] That's like 0.002 percent of the amount being distributed. It does seem like a half-competent blockchain would be faster and cheaper and more transparent. But the idea that the current system can't solve this problem is wrong. The current system can solve it fine. Just not in a way that any individual human can see or understand. The solution is, let's say, distributed.

The other problem is economic: People owned more Dole shares than actually existed, because they bought them from short sellers, and now if you want to pay off all the owners, you have to track down the short sellers to make them pay up. That problem is hard, and it seems like the current system might have real problems with it: If the short sellers died, or went out of business, or closed their accounts, or just really don't want to pay some extra merger consideration three years after the fact and yell a lot when their brokers ask them to, then the brokers will have a hard time finding all the money. Would a blockchain fix this? I don't know. A blockchain would make it easy to identify the short sellers, three years later. (That's what blockchain immutability is good for.) But then what? They could still have died, or closed their accounts, or yell.

But, sure, Delaware, and Vice Chancellor Laster, are not wrong that a distributed ledger system to keep track of who owns what shares in real time would make all of this a lot easier.[14] And I can see why Delaware is thinking about it. This is not the first time we have talked about the antique goofiness of the current system, and how it messes with mergers. Dell Inc. also did a management buyout, and a Delaware court also found that its shareholders should have gotten paid more. But some of those shareholders who should have gotten paid more didn't, because of two separate failures to grapple with the convoluted registry system. (Some of them failed to own their shares the right way. Others failed to vote them the right way. Neither was entirely the investors' fault.) That system has worked pretty well for 40 years. But it is starting to show its age. There are little cracks that give us brief glimpses of the abyss below. Why not cover them up with a fresh, cool coat of blockchain?

1.     I'm eliding some details here. The 2015 decision combined class action and appraisal claims for a class including all of the Dole shareholders other than Murdock and his affiliates. That was a total of about 54.1 million shares. "This decision likely renders the appraisal proceeding moot," the vice-chancellor found then. But the subsequent class-action settlement excluded the appraisal claimants, who had their own lawyers and took care of themselves separately. They had about 17.3 million shares. The other 36.8 million shares, covered by the class action, are what we're talking about here. Their payout comes to about $115.8 million, including interest (but before deducting attorneys' fees).

2.         They did kick out 48,758 shares after double-checking.

3.      I mean, I am about the lying down in a dark room with soothing music. But not about the "chill."

4.       Citation omitted.

5.       It was a Friday; the merger consideration was paid out on Monday, Nov. 4.

6.       Most of them in the last two days. By comparison, the average daily volume over the previous year was about 1.3 million shares.

7.       From the opinion:

For purpose of the settlement, multiple owners could submit claims for shares involved in trades that had not cleared. A DTC participant who continued to hold the shares as reflected on DTC’s records could submit a claim, but so could the beneficial owner who was a client of the DTC participant that acquired the shares and therefore owned them as of closing. Both claims could appear facially valid even though they involved the same underlying shares.

8.      Though I mean I see your point. Murdock paid $13.50 in cash in the merger; the court ultimately found that he should have paid $16.24. If I owned the stock at the closing, I got $13.50, and am now entitled to get the extra $2.74. But if I bought it from you the day before the closing, I paid you about $13.55 (the closing price on Oct. 31). The extra $2.74 (or $2.69) is kind of a windfall to me. You, on the other hand, might have been a long-term shareholder who thought Dole was destined for great things, who voted against the underpriced merger, and who finally sold in disgust the day before it closed. In a real sense Murdock's underpayment harmed you, not me. 

But, whatever, the deal is that the people who owned stock at closing are the ones who get the extra payment. And to be fair that was priced in: The stock closed at $13.55 the day before the merger closed, and a whopping $13.65 the Friday of the closing. And then the next Monday all those buyers got cashed out for $13.50, as they knew they would be. Presumably they only paid over the merger price because they thought they might get a second chance in court.

9.      People sometimes complain about "naked short selling" creating "phantom shares," which they demonstrate by pointing to the fact that people own more shares of Company XYZ than there are shares outstanding. But this is no problem at all, is true of every company,  and has nothing to do with naked short selling. "Naked" short selling means selling stock short without borrowing it. That is mostly illegal. It would indeed create "phantom shares." But so does regular, clothed short selling. Either way, the trick is that the person doing the short selling -- naked or otherwise -- now owns a negative number of shares, which precisely balances out the "phantom shares" that the short selling creates.

10.   This is covered by Section 8 of the Master Securities Loan Agreement. But for our purposes let's just pretend it happens by the operation of magic.

11.   This also seems to be covered by Section 8 of the MSLA, though ... less clearly? Everyone seems to think it works, though.

Again this all happens through DTC, brokers, etc. Like realistically what happens is:

1.       There are like 1000 shares outstanding.

2.       The company pays $13,500 to Cede & Co.

3.       DTC looks at its books and sees that Broker X owns 100 shares.

4.       Cede pays $1,350 to Broker X.

5.       Broker X looks at its books and sees that it has customers who own 150 shares, and other customers who are short 50 shares.

6.       Broker X bills those short customers for $675.

7.       Broker X takes that $675 from the shorts, and the $1,350 from Cede, and gives it to the long customers.

8.       Everything checks out.

12.   Albeit in a footnote.

13.   The lawyers "have budgeted $10,000 for additional consultations."

14.   To be fair, a centralized ledger to keep track of who owns what shares in real time would help a lot. Half of the problem here would go away if DTC just chilled out with the "chills" before mergers. (The move to T+2 settlement will help a little.) The key thing is updating the share registry in real time, not distributing it.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at

To contact the editor responsible for this story:
James Greiff at

©2017 Bloomberg L.P. All Rights Reserved 


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