The brouhaha over Freeport-McMoran Copper and Gold's recent acquisitions illustrates the sometimes unsatisfying way that corporate law deals with conflicts of interest.
Freeport's $9 billion deal to buy McMoran Exploration and Plains Exploration and Production has been greeted with almost universal derision. On a conference call after the announcement, Evy Hambro, the joint chief investment officer of the natural resources equity team at BlackRock, criticized the company.
Congratulations on making one of the worst teleconferences I've ever heard to justify a deal. Before I ask my question, would it be possible to find out if anybody on the call from your side is not conflicted in answering the question I want to ask?
The issue raised by Mr. Hambro is very real.
Freeport had previously spun off McMoran Exploration in 1994 but still held a 16.2 percent stake and has tight ties with the company. Six of McMoran Exploration's 11 directors serve on the board of Freeport. The chairman of Freeport is James Moffett, the chief executive and chairman of McMoran Exploration.
The board will be reward handsomely in the transaction. Freeport is paying a premium of 74 percent, and an estimated $130 million is flowing into the hands of those directors who sat on both boards. Not only that, but James Flores, the chief executive of Plains, is also a director of McMoran Exploration, and he is personally netting an estimated $12 million from the deal.
The conflicts would be problematic enoug h. But in an age where Wall Street hates conglomerates, investors have struggled to understand the strategic reasoning for the deal. Freeport is a mining company and McMoran Exploration and Plains Exploration are oil and gas companies. Investors are concerned that the acquisitions are adding little in the way of cost savings or synergies to Freeport.
As I wrote in an earlier article, Freeport has structured these acquisitions mostly in cash and is issuing less than 20 percent of its outstanding shares. Accordingly, no vote by Freeport shareholders is required under the rules of the New York Stock Exchange, where Freeport is listed.
Still, some Freeport shareholders claim tha t the conflicts are too great to justify this deal. Unfortunately, the investors are without a vote and unlikely to find solace in court. It's just the way that way the law in Delaware, the state where Freeport is incorporated, deals with these types of conflicts.
Freeport, of course, knew of these conflicts and so took the common route to address them. The company's board created an independent committee of directors with its own independent advisers. McMoran Exploration did the same. The idea is to purge the conflict by having those who are untainted by it make the decision.
Those efforts are driven by Delaware law.
Usually, transactions like this one â€" where the directors sat on both sides â€" could be cancelled by shareholders. As fiduciaries, courts held that directors should not be allowed to engage in conduct on behalf of the corporation that benefits themselves.
More recently, the law has changed and these conflicted transactions are permit ted if they are signed off by an independent force. Delaware law states that when there is a conflict, the transaction is not void solely because there were directors on both sides of it, if certain events take place. One, the transaction is approved by the disinterested directors after disclosure of the material facts. Two, the deal is approved by the shareholders after similar disclosure. Or three, the company can prove in a court of law that the transaction is fair.
Freeport-McMoran opted for Door No. 1. And the company's board elected to have the transaction disclosed and approved by the disinterested directors.
This does not end the matter. The question now is whether Freeport's independent directors had all of the material information before them and were not unduly influenced by the conflicted directors and executives.
If that is the case, then the Delaware courts will not interfere with the transaction. This means that in the pending litigation in Delaware challenging this acquisition, the plaintiffs lawyers will be hunting for some defect in the process.
Perhaps the most interesting statement of the conference call was made by Richard C. Adkerson, the chief executive and president of Freeport, who stated that once the board of Freeport decided on the strategy it then created a special committee of directors to consider the issue.
Plaintiffs lawyers will be asking if this unduly steered the process toward an acquisition. They will also be asking whether the independent directors were given all the information they needed and whether the investment banks were conflicted.
But make no mistake, even if a defect found, the deal will not necessarily be terminated. Instead, the court would still look to see whether the acquisition was fair.
We would need some rather bad facts for a Delaware court to find this acquisition unfair. Even then, the Delaware courts are loath to halt a transaction. Instead, monetary damages are more likely, something that would be paid in a settlement. In short, it would be an extraordinary act for the Delaware courts to actually step in and do something here, and even then it is unlikely to stop the transaction.
But it all raises the question: Do we need to take a harder look at these conflicts issues?
In Delaware, the test for director independence has been stated as whether “a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind.†Obviously, financial issues come into play, but it is unlikely that this will be an issue in the Freeport deal. That leaves softer ties like social and friendship. In other words, was this deal approved because of the independent directors wanted to accede to the will of t he Freeport executives, who just happened to be conflicted?
This is a big leap to take. And frankly, even if it comes out that the Freeport independent directors are close with the conflicted Freeport executives and directors, it is not likely to matter under Delaware law. Common social ties and the natural pressure that directors have to want to get along are generally not enough to destroy independence. This is the law, if for no other reason than most directors would be disqualified from being independent because boards are supposed to be collegial places.
Thus, assuming that the lawyers here were able to do their jobs, Freeport shareholders are unlikely to get far challenging this deal on conflict grounds. It's an unsatisfying answer. I know.
