Notes Going Private In January 1973, the Dow Jones Industrial Average, the tradition- al index of stock market performance, broke 1000 for the first time. By the end of 1974, it had collapsed beneath 600,' and has only recent- ly climbed higher. Since in most cases the collapse has not been the result of reduced corporate earnings, stocks are now selling at far lower price/earnings ratios and multiples of book value than at any time in the recent past." In an effort to capitalize on this collapse in the value of their stock, many publicly held corporations-especially those that first went public during the bull market era of the late 1960's 3-have attempted to reacquire from investors all the publicly held common stock in their firms.4 This procedure leaves only that group of insiders who direct the corporate reacquisition programs (usually the very ones who took the companies public originally) as the surviving shareholders in a now privately held enterprise. Such a program of share reacquisition is known as "going private." 5 1. A chart plotting the course of the Dow Jones Industrial Average over the last 12 years can be found in the N.Y. Times, Dec. 7, 1974, at 39, col. 5. Other indexes tell a similar story. The unweighted average of common stocks on the New York Stock Ex- change, for example, had lost 69 percent of its value from 1968 to the summer of 1974, BARRON'S, Aug. 26, 1974, at 11, and the value of total stock holdings of individuals (in- cluding private trust funds) had declined from $914.3 billion at year end 1972 to $565.3 billion on June 30, 1974, id. at 1. 2. The Dow Jones Industrials, for example, are now selling at their lowest price/ earnings ratio since World War II. See BUSINESS WEEK, Dec. 21, 1974, at 103 (chart of price/earnings ratios since 1945). 3. From 1967 to 1972, some 3,000 corporations filed registration statements with the SEC for the first time. Sommer "Going Private": A Lesson in Corporate Responsibility, BNA SEC. REG. 9. L. REP. No. 278, at D-1 (Nov. 20, 1974). 4. On the causal link between current securities market conditions and going private, see, e.g., Knapp, Going Private-Wall Street's Latest, O-T-C MARKEr CHRONICLE, MAR. 7, 1974, at 1, col. 1. 5. Because going private has only recently become a matter of frequent practice, and hence general interest, most commentary to date has appeared in the financial press. See, e.g., Freeman, Going Private: Corporate Insiders Move to Eliminate Outside Shareholders, Wall St. J., Oct. 18, 1974, at 1, col. 6; Hershman, Going Private-Or How to Squeeze In- vestors, DUN'S REv., Jan. 1975, at 37; Knapp, supra note 4; Lee, Why Companies Want to Go Private, N.Y. Times, Sept. 15, 1974, § 3, at 14, col. 1; Pacey, More Firms Are Turning Their Backs on Wall Street, BARRON'S, Mar. 4, 1974, at 3. See also Kerr, Tender Offers and Going Private-EndingPublic Shareholding an Issue, N.Y.L.J., Dec. 16, 1974, at 25; Special Report: Six Years After the Great Bull Market, The Tables Are Turned-Going Private Is "In," SEC. REC. & TRANSFER REP., Oct. 7, 1974, at 3. * As used in this Note, "going private" will refer only to transactions whose ultimate goal is the return of a corporation to a privately held status. Thus programs of share repurchase 903 The Yale Law Journal Vol. 84: 903, 1975 Companies going private have one broad objective in mind: the elimination of sufficient numbers of shareholders to enable the cor- poration to remove its shares from registration with the Securities and Exchange Commission (SEC) under § 12 of the Securities Ex- change Act,0 and also to achieve the lesser benefits of de-listing from the exchange on which they are traded.7 De-registration can be ef- fected by reducing the total number of shareholders in a publicly held corporation to below 300.8 It enables a corporation, among other advantages, to avoid sending to its shareholders proxy state- ments and annual reports disclosing information required by the SEC, and it relieves insiders from being subject to such provisions as § 16(b) of the Exchange Act. Rarely before have companies, however unhappy they were with their role as publicly held enterprises, been afforded the opportunity to buy their way back to private status at such a modest cost. 10 As a result, going private has become, of late, a popular course of cor- porate action. Nevertheless, going private raises numerous legal prob- aimed at obtaining some, but not all, of the publicly held shares of a corporation's stock are not considered. Also excluded is one class of transaction similar in ultimate results to reacquisitions by the corporation itself: a direct tender offer by a corporation's insiders. See, e.g., Pacey, supra, at 3 (offer to buy shares of Nardis of Dallas, Inc., by its 65 percent majority shareholders). Having acquired all of the corporation's publicly held shares, a majority shareholder could presumably reimburse himself for the cost of share acquisition through distributions from the corporate treasury. Thus, the difference between corporate and insider purchases, ih practical terms, may be simply the allocation of the risk of a not wholly successful effort to completely remove all equity participation by the public. Since the use of the corporation as the purchaser puts no financial burden on the inside share- holders assuming they need not advance funds, it can be expected that corporate re- acquisition programs will be the financially preferred method. 6. 15 U.S.C. § 782 (1970). See, e.g., Prospectus Pursuant to Exchange Offer of Wells, Rich, Greene, Inc., Nov. 4, 1974, at 16-17 [hereinafter cited as Wells, Rich Prospectus]. 7. Although every exchange does supervise the conduct of the corporations whose shares are traded on it-restricting, for example, the power of a company to issue non- voting classes of stock-most companies find SEC regulations and liabilities far more burdensome than exchange requirements, and therefore SEC de-registration rather than exchange delisting must be considered the ultimate goal of any going private transaction. Each exchange has its own standards for de-listing, but basically, all require a corpora-. tion's removal if its "float"-that is, the size of the pool of the corporation's securities held by the public-is reduced past a specified size. The New York Stock Exchange, for example, will de-list a corporation if it has fewer than 1200 outstanding shareholders with blocks of 100 or more shares, less than 600,000 publicly held shares, or an aggregate market value of publicly held shares below $5,000,000. N.Y.S.E. Rule 499, 2 CCH N.Y.S.E. GUIDE 2499, at 4235. A corporation can also be voluntarily de-listed if it so requests, and if 66. percent of the shareholders approve, while fewer than 10 percent object. N.Y.S.E. Rule 500, 2 CCH N.Y.S.E. GUIDE 2500, at 4239. 8. 15 U.S.C. § 781(g)(4) (1970). 9. Id. § 78d(b); Sommer, supra note 3, at D-2. 10. Barbara Lynn Stores, Inc., for example, originally offered its public shareholders an aggregate of S2,300,000 in its effort to go private, while it possessed cash and equiva- lent assets totalling some $4,400,000. See Proxy Statement of Barbara Lynn Stores, Inc., Oct. 8, 1974, at 4-5 [hereinafter cited as Barbara Lynn Statement]. It could thus afford to offer stockholders a substantial premium over market price and still go private without assuming an enormous debt burden to finance the venture. 904 Going Private lems, particularly of insider fiduciary obligations and self-dealing, which cannot be resolved by a simple recourse to precedent. This Note attempts to analyze these problems, to suggest standards for ju- dicial review of minority challenges to going private, and to outline certain means by which corporate counsel can reduce the possibility of litigation in future going private efforts."' I. Motives and Mechanics of Going Private A. Insider Motives The advantages of going private which accrue to a corporation's inside shareholders alone are patently clear, both to business writers and to dissident shareholders. Thus Merle Norman Cosmetics, Wells, Rich, Greene, Inc., and Barbara Lynn Stores, as well as their directors and controlling shareholders, have all been sued in connection with their attempts to go private, 2 while such journals as Business Week have editorialized against some efforts to go private.' 3 Running through all the criticism is a common argument that insiders who sold a por- tion of their equity interest when their company went public in the 1960's are now buying that interest back, through the use of the corporate mechanism, for a fraction of the earlier price, and that to do so is grossly unfair to the public, upon whom the shares were foisted at inflated values, and from whom they are now being repur- 4 chased at bargain prices.1 11. In analyzing these issues, the Note concentrates on the going private efforts of four corporations-Barbara Lynn Stores, Inc., Federated Development Company, Merle Norman Cosmetics, Inc., and Wells, Rich, Greene, Inc.-which represent a broad cross- section of recent going private transactions. These four companies were chosen because they are typical of current going private efforts. Barbara Lynn operates a chain of discount stores. Federated Development invests in real estate. Merle Norman retails, through its own outlets, a well known line of cosmetics.