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Monday, June 17, 2013

Protecting Minority Stockholder Rights: On Perelman’s Conflict of Interest at Revlon

The principle of majority rule is a staple of democratic theory. Typically the victor of a close election is quick to proclaim that “the people” have spoken. That “the people” corresponds to 51% of those who voted is beside the point. What about the 49% who voted against the victor? What about the minority’s rights? In the U.S. Senate, the fact that it takes 60 out of 100 votes to end a filibuster means that a large minority can halt a majority’s bill. In the European Council, the qualified majority rule means that for a bill to pass, the states in the majority must be at least 55% of the total number of states and must have at least 55% of the E.U.’s population between them.  A large minority can therefore stop a small majority. In both of these “intergovernmental” bodies, the implication is that 51% of a vote is not as significant as the principle of majority rule suggests. What about the rights of a minority of shares of stock in corporate governance? When a majority stockholder has control of management, the interests of the minority stockholders can be shirked. This is particularly true when a majority stockholder proposes a going-private transaction with the aid of management.

“Going-private transactions create opportunities for shareholder abuse and can have coercive effects on minority shareholders,” Antonia Chion, a director in the S.E.C.’s enforcement division insists. A majority shareholder can propose a buy-out that is unfair to other stockholders, and a collusive management can keep those shareholders in the dark concerning independent assessments. This is not the case of a CEO who is controlling the board at stockholder expense; rather, the majority stockholder uses the management to circumvent the board and other stockholders at their expense and even that of the company.

On June 13, 2013, Revlon “agreed to pay an $850,000 penalty to settle accusations that it deceived shareholders and its independent directors in connection with” Ronald Perelman’s attempt to get the other stockholders to convert their common stock to preferred in what is called an exchange transaction.[1] As in the case of Perelman’s earlier attempt to take the company private, an independent assessment found that the other stockholders as well as the company would lose out in the deal. Perhaps because the other stockholders had had access to the information to reject the first proposal, Revlon, undoubtedly at Perelman’s urging, “went to great lengths to hide” the bad news of the assessment on the exchange transaction from the minority stockholders.[2] In fact among “other deceitful maneuvers,” Revlon “altered the agreement with the trustee to ensure that the trustee would not share the advisor’s opinion with” the minority stockholders.[3] In its filings with the S.E.C., the management lied that the board’s process had been “full, fair and complete.”[4] In actuality, the company’s board was “unable to fairly evaluate the adequacy of the exchange offer.”[5] The controlling stockholder, Ronald Perelman, had used the management of the company to go against the company’s own interest! That is, the company was acting against its own best interest simply because doing so was in the controlling stockholder’s interest. Surely this suggests that the majority stockholder had too much influence. Given the conflict of interest, having such influence at the expense of other stockholders and the board can be regarded as unethical.

Perhaps it could be argued that because Perelman’s investment firm, MacAndrews & Forbes, controlled about three-quarters of Revlon’s shares at the time, the company’s management had a fiduciary duty to act in Perelman’s interest even if it was not in the company’s interest. Stockholders are the owners, after all.

However, Perelman’s investment firm did not control all of the stock. It cannot be assumed that the interests of the other stockholders mirrored that of the stock Perelman owned or controlled. Furthermore, that the exchange transaction would have helped Revlon pay off a loan to Perelman’s investment firm only added to the majority stockholder’s conflict of interest. According to the New York Times, because “Perelman stood on both sides of the deal, there was a question about the transaction’s fairness.”[6] This is the reason the company asked its independent board members to assess the exchange transaction in the first place. For the company to turn around and require the independent assessor to hide the findings from the board is utterly contradictory, as well as unfair to the independent directors (as well as the other stockholders).

Therefore, even if the principle of majority rule applied to corporate governance supports Perelman’s influencing the management to the benefit of the stock that he controls, the conflict of interest suggests that the principle should not completely shut down the property rights of the other stockholders. Interestingly, not even the U.S. Senate’s 60 votes or the European Council’s qualified majority voting applied to corporate governance could have stopped the 75% of the shares that Perelman controlled at the time from directing the company’s management. Because the independent directors are designed to be free of pressure from management, they could be controlled by a majority stockholder in such a case.

Perhaps independent directors ought to be tasked with not only checking the corporation’s management, but also protecting the interests of the minority stockholders when those interests differ from that of the majority. At the very least, a majority stockholder should not be permitted to be situated in a conflict of interest with regard to the company. Merely being so situated can be argued to be unethical because even having the opportunity to exploit a conflict of interest causes harm (e.g., anxiety) to those who would be harmed financially. Additionally, the temptation is just too great, given the influence that the majority stockholder has over the company’s management. Even in terms of democracy, majority rule is not an absolute.

1. Peter Lattman, “To Perelman’s Failed Revlon Deal, Add Rebuke From S.E.C.,” The New York Times, June 14, 2013.
2. Ibid.
3. Ibid.
4. Ibid.
5. Ibid.
6. Ibid.