Don’t Eat the Poison Pill By Mistake

(Bloomberg Opinion) -- Poison pills.

We talked yesterday about the “poison pill” stockholder rights plan that Papa John’s International Inc. put in place against its former chairman and dad, John Schnatter. The pill “will prohibit Schnatter from acquiring more than 31 percent of the stock,” I wrote, but I was cheating. That was a shorthand description. That’s not how poison pills actually work. It’s not like you go to the stock exchange and put in an order for 100 shares and it bounces back with an error message saying “that would put you over 31 percent.”

Instead, the way poison pills work is … just sort of unbelievable. Basically, if anyone triggers the pill—if they go over 10 or 20 or 31 percent of the stock or whatever the trigger is—then every other shareholder of the company gets offered the right to buy a ton of the company’s stock at a big discount. If people exercise these rights—and they should because they offer the chance to buy stock at a big discount—then many more shares are issued and the triggering shareholder is massively diluted.

It just sort of seems like this shouldn’t be allowed, that companies shouldn’t be able to give massively discounted shares to all of their shareholders except the one they don’t like. But it is allowed; there is a famous case. I used to work at Wachtell, Lipton, Rosen & Katz, the law firm that invented the poison pill, and the pill document—here is Papa John’s, if you want to read one—is sort of scripture at that firm. I remember having this distinct sense that we had collectively gotten away with something, that we were all living off of some deep black magic that the firm’s elders had done back in the ‘80s, that somewhere in a basement closet the notion of shareholder ownership was being tortured as the price for our success.  

A big rights issue is a big corporate event, and exercising the rights requires cash, and if this happened a lot you could imagine an industry springing up around it. There’d be poison-pill arbitrageurs who’d buy poison-pill rights to get the new shares, and prime brokers would finance the purchase price, and it’d be a whole thing. But it isn’t, because poison pills are never triggered. The point of a poison pill is not to do this stuff; doing it would be super annoying and complicated. The point of the poison pill is that it convincingly threatens an acquirer with massive dilution, so potential acquirers are deterred from triggering poison pills. And it works.

Modern pills have a simpler alternative to the rights-exercise stuff, by the way, which is that the company can just give each shareholder (other than the triggering shareholder) one extra share of common stock for each share they already own. (See section 24 of the Papa John’s pill, if you’re curious.) This also dilutes the triggering shareholder—basically everyone else has twice as many shares, and the triggering shareholder doesn’t—but doesn’t require the rest of the shareholders to come up with money or, um, figure out what is going on. It’s just a 2-for-1 stock split, but a selective stock split that excludes the triggering shareholder. Again it just seems like that shouldn’t be a thing, but once you’re on board with the general idea of a poison pill, why not?

Anyway, like I said, the deterrence mostly works. But the whole thing is so unbelievable that, toward the bottom end of the market, people sometimes don’t believe it. If your deterrence is too complicated, and if your enemies aren’t really detail people, then they won’t be deterred. Here’s a press release:

Tix Corporation ("Tix" or the "Company") (OTCQX:TIXC), shareholder Haren Bhakta,  has notified the Company's officers, directors and key employees on private and public forums that he (through his own fund HSB Capital Partners, LP) and his group, (mostly comprised of family members) have, according to his determination, exceeded the ownership limitations set forth in the Company's Shareholder Rights Plan, (also referred to as a poison pill).  The Company is alarmed by the illogical comments made by Mr. Bhakta, including:  "I have intentionally triggered your poison pill"; "I/we dare you to proceed with the poison pill"; and, "if my estimates are correct, CEO Mitch Francis, you will dilute yourself out of control."


Mr. Bhakta's correspondence clearly demonstrates no comprehension of how a shareholder rights plan operates and which shareholders risk having their ownership diluted.  Under the Shareholder Rights Plan, every shareholder EXCEPT the acquiring person and its "group" has the right to purchase a significant number of new shares at a very low price.  As a result, all shareholders who exercise their rights will protect and increase their proportionate ownership of the Company, while the acquiring person and his "group" would have their ownership percentage effectively wiped out.  The issuance of so many new shares would also ensure that the acquiring person, in this case Mr. Bhakta and his group, would suffer significant financial losses on their investment.

It is important to note that the effect of a company activating a shareholder rights plan and issuing shares is so financially devastating to the acquiring person, that it has never been done in us history.  No shareholder would ever deliberately trip a poison pill because their entire investment could be virtually wiped out.

That’s not quite right; a poison pill was triggered once, in 2009. It was a huge mess, and trading in the company’s stock was suspended for a month while the company figured out how to actually do the thing it had threatened to do. But the gist is correct: Triggering a poison pill is a dumb thing to do, one that in theory harms only the shareholder who triggers it. (In practice—to the extent there is “practice”—it is a big headache for other shareholders and the company, too, but the triggering shareholder is the one who loses money.) So almost no one ever does it. But if you don’t quite read, or understand, or believe the poison pill, you might stumble into triggering it. “Wait, the poison was for me?,” you might ask, as you swallow it.

Meanwhile in Papa John’s news, Schnatter and the company were feuding even before Schnatter used a racial slur on his racial-sensitivity conference call:

People close to the company said Mr. Schnatter is to blame for poor sales and that his NFL criticism sent revenues on a downward trajectory from which it still hasn’t recovered. As the face of the brand, they said, he drove away customers with his comments. “We had at least four third-party companies tell us that John was the Achilles’ heel of the organization,” said one of the people.

Papa John was Papa John’s Achilles’ heel! It is a downright Oedipal struggle.

Insider trading.

To recap, my eight not-to-be-taken-too-seriously-and-certainly-not-as-legal-advice Laws of Insider Trading are:

  1. Don’t do it.
  2. Don’t do it by buying short-dated out-of-the-money call options on merger targets.
  3. Don’t text or email about it.
  4. Don’t do it in your mother’s account.
  5. Don’t do it by planting bombs at a company and shorting its stock.
  6. Don’t do it while employed at the Securities and Exchange Commission.
  7. Don’t Google “how to insider trade without getting caught” before doing it.
  8. If you didn’t insider trade, don’t forget and accidentally confess to insider trading.

Some of these come up more often than others. Number 2 comes up all the time. I suppose there is a mirror image of it, which is, don’t insider trade by buying short-dated out-of-the money put options on companies that are about to announce bad earnings. That one comes up occasionally, but is not as salient as the calls on merger targets. But definitely—call it Law 2A I guess—don’t insider trade by buying short-dated out-of-the-money put options on your own company just before it announces bad earnings. Don’t buy put options on your own company at all! It’s not a good look. If you’re going around betting against your own company’s stock, the SEC is going to make some inquiries. When it makes those inquiries, you don’t want it to find stuff like this:

On March 2, 2016, Matthew Brunstrum demonstrated his knowledge and understanding of the trading blackout period restrictions when he communicated by text with a friend that he intended to purchase Stericycle put options.

• Matthew Brunstrum’s friend responded via text: “that doesn’t seem legal.”

• Matthew Brunstrum responded: “How so? I’m just an analyst. As long as I don’t do it during our Earnings Blackout dates its fine.”

• Matthew Brunstrum’s friend responded: “I mean if you profited big money off of puts on your company, the sec would be knocking on your door quickly.”

• Matthew Brunstrum replied: “What I’m saying is the SEC doesn’t look at analysts. Itd [sic] only VPs and above.”

Nope! That is from—obviously—an SEC enforcement action against Matthew Brunstrum, a former analyst in the mergers and acquisitions department of Stericycle Inc. accused of selling his Stericycle stock, and buying short-dated out-of-the-money puts on Stericycle, because he knew about upcoming bad earnings. (When the earnings were announced, the stock fell 22 percent and he made almost $160,000.) This is not a law of insider trading exactly, but a basic rule of life and law enforcement and dramatic irony: If you brag in a permanently preserved electronic communication about how the cops will never catch you, then, when the cops do catch you, your bragging will feature prominently in the charging document. 

Anyway if you are keeping score, Brunstrum is accused of violating rules 1, 2A, 3, and also, sort of, 4: He allegedly told his mother about the bad earnings, and she bought a bunch of put options too. 

Elsewhere in insider trading, here’s another case that the SEC settled yesterday:

The SEC’s order finds that Yao Li, as Vice President of Technology at Alliance Fiber Optic Products, Inc. (AFOP), learned during regular meetings with AFOP’s senior executives that the company was likely going to miss its revenue guidance in three different quarters during 2014 and 2015.  According to the SEC’s order, Li traded on this inside information by short selling AFOP shares for profits as well as selling AFOP shares he already owned to avoid losses before these announcements. 

He was caught by “the SEC Market Abuse Unit’s Analysis and Detection Center, which uses data analysis tools to detect suspicious patterns such as improbably successful trading in advance of earnings announcements over time.” 

“Our agency’s ever-evolving data analytics enabled us to detect Li’s otherwise inconspicuous trading as an overall pattern to profit off multiple earnings announcements,” said Jina Choi, Director of the SEC’s San Francisco Regional Office.

Honestly though short selling your own company’s stock ahead of earnings is pretty conspicuous. Don’t do that; that’s like Rule 2A’.

Still elsewhere in insider trading, remember yesterday when I said that I had set up a website called where you could email me material nonpublic information and I could either insider trade on it or turn you in to the authorities? That was a joke. I didn’t actually set up that website. But after I made the joke, it became true, and someone did register that site. Now it redirects to the web page of the SEC Division of Enforcement. That’s good, actually; it cuts out the middleman; just send your tips straight to them.

Securities fraud.

Remember Billy McFarland, the Fyre Festival guy? He tricked a bunch of people into spending a lot of money to go to a luxury music festival in the Bahamas but forgot to actually put on the festival; he also tricked a bunch of people into investing a lot of money in his music-booking company based on lies and fake financial statements. He pleaded guilty to wire fraud earlier this year, and yesterday he and some of his accomplices also settled related securities-fraud charges with the SEC. Those charges mostly aren’t about the festival—which was just a regular fraud, not a securities fraud, since people were buying festival tickets, not securities—but rather about McFarland’s music-booking company. The gist is that McFarland and his buddies raised money for the company by lying about how well it was doing, and that the lying was not so much “creative accounting and fudging of numbers” as it was “just entirely making stuff up”:

McFarland provided Simon with detailed instructions concerning how to manipulate the data contained in the offer report, including to:

• “Make sure 35% [of the locations are] international cities;”

• “[S]prinkle in a couple of higher offer amounts;” and

• “[S]how $30.1 mm total bookings in January with strong repeat buyer percentages.”

You know, just writing a spreadsheet that shows that you made lots of money is a shortcut; it is much easier to write a spreadsheet about your sales than to go out and make the sales. But I find it weirdly exhausting to read this. Like, that poor guy—Daniel Simon, a contractor for McFarland’s businesses, who went to high school with him and who also settled with the SEC—was slaving away over that spreadsheet, trying to make sure that it looked like a good business, that they had a good mix of revenues and a nice balance of new customers and repeat buyers. Sure it’s less work than having to actually find the buyers, but it is still a surprising amount of work.

Ethereum Ponzi innovation.

I don’t know, this just made me smile:

Fomo3d is simple in concept. You buy a “key,” which is kind of like a token, and that key adds 30 seconds to a timer. Part of the eth you paid for the key goes to a pot, which currently has some 28,000 eth ($13 million). Part of it goes in “dividends” to those that bought a key before you.

If the timer goes to zero, whoever bought that last key takes all the money.

It’s a good idea! Like the way a Ponzi scheme works is that if you get in early enough you make a profit (from the people who came in later and whose money was used to pay you off), but if you get in too late you lose your money (because it all goes to pay off the earlier “investors”). That’s fine, lots of people do Ponzis, and some people even knowingly do Ponzis. “Some greater fool will come in and bail me out” is a common and perfectly rational thought process that often turns out to be correct. But there is eventually an inflection point where a sensible informed investor won’t want to get into a Ponzi because it is probably too late.

But this thing adds the twist that if you’re the very last person to invest in the scheme, you make a giant profit. If you’re the second-to-last person (or third-to-last, etc. etc., anyone who is late but not last), you lose all your money. (If you’re early you make a normal Ponzi profit from the “dividends.”) Your incentive to put more money in, if you are second-to-last, is strong. So the scheme can, in its horrible way, sustain itself, I suppose until eventually someone hacks it and steals the pot. I like it! I approve. Not as an investment idea—good lord, not that—and certainly not as legal advice, but just as an amusing addition to the number of things in the world. “If you just see gambling, lulz & games you are missing the bigger picture. Live experimentation of interesting economics,” says an Ethereum developer, which … I mean, no, it is mostly live experimentation in gambling, lulz & games, but, sure, the games are interesting, and they are economics games.

Things happen.

“The truth of the Main Street Investors Coalition is that it is an organization aimed at preventing investment firms from raising issues like climate change.” C.E.O. Activism Has Become the New Normal. The Big Business of Being Gwyneth Paltrow. Insurers Pull Billions From Hedge Funds. “Millennials think cash is the best long-term investment.” Silicon Valley to Big Oil: We Can Manage Your Data Better Than You. When Airline CEOs Try the Cheap Seats. How the Fleece Vest Became the New Corporate Uniform. 'I can't feel my body right now': Goldman Sachs held its annual Wiffle ball tournament and it got a little competitive. Good dog photos.

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

Matt Levine is a Bloomberg Opinion columnist covering finance. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz, and a clerk for the U.S. Court of Appeals for the 3rd Circuit.

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