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News February 5, 2007 Issue

Nothing Illegal About Empty Voting, Says Atkins

Following a series of academic articles by Professors Henry Hu and Bernard Black of the University of Texas Law School, there has been lots of press attention about so-called "empty voting" or "vote morphing." But the issue is not new: Last year this time, the SEC was close to bringing an enforcement action against a hedge fund manager for allegedly failing to disclose the true economic interest underlying its holdings.

In a bit of good news for hedge fund managers that engage in these practices, SEC Commissioner Paul Atkins recently provided some comfort about SEC scrutiny in this area: "As far as I can see, there is nothing illegal about the practice," he said.

However, added Atkins, when voting rights belong to someone who does not hold an economic interest, "it does add complexity to the corporate governance discussion, particularly because of the lack of transparency of the voting." He noted that in many cases, "the economic benefit to a shareholder of having a vote in a particular corporate decision may be outweighed by the economic benefits attainable through share lending — you cannot both lend your shares and vote them at the same time." He also pointed out that empty voting raises "interesting" fiduciary duty issues: "Should those of you who manage money on behalf of others be taking the most economically profitable course, even if that means foregoing a vote, if you do not have a great interest in the outcome of the vote?"

Last year this time, hedge fund manager Perry Corporation was weighing its response to a Wells notice it had received from the SEC, in which the agency reportedly asserted that the hedge fund manager violated disclosure rules by purchasing nearly 10 percent of Mylan Labs’ outstanding shares, and the attendant voting rights, while at the same time hedging that position using puts, calls, swaps, and other transactions, so that Perry did not actually acquire any economic interest or become exposed to any economic risk while holding the shares. D

etails of Perry’s activity were described in a suit filed by Carl Icahn, who wanted to thwart a merger involving Mylan. Perry had wanted the merger to go forward. Perry’s acquisition of Mylan stock was nothing more than a "vote-buying scheme," argued Icahn in his December 2004 complaint. "Perry and other arbitrageurs have perfected a technique of purchasing significant blocks of shareholder voting rights, without at the same time acquiring economic interests in the shares, by purchasing reciprocal market positions in which the exposure to the underlying security is fully hedged," he said. "In effect, such arbitrageurs set up sham transactions, whereby a large brokerage firm sells them stock and, at the same time, through put contracts or otherwise, agrees to repurchase the stock at the same price at a later date. In this manner, while the stock is registered in Perry’s name so that he can vote, he cannot lose (or gain) any money from the stock position no matter how the market moves." Icahn asserted that the "public has no way of knowing that these stock transfers are not true transfers but simply designed to manipulate the market."

Perry claimed it hadn’t done anything wrong. "There does not appear to be a single decision finding that the federal securities laws or state law prohibit the transactions challenged by [Icahn], nor does any federal statute or rule prohibit Perry Corp.’s conduct," said the firm. "Non-disclosure of information, even if material, does not give rise to liability where, as here, the defendant has no affirmative duty of disclosure." As a beneficial and record owner of Mylan common stock, said Perry, its funds were permitted to vote the shares held as of the record date, "regardless of Perry Corp.’s having engaged in routine transactions of the type executed by all professional investors to hedge the economic risk associated with owning Mylan stock."

While Icahn dropped the suit in May 2005, the SEC picked up on Icahn’s theme. Last year, a Perry spokesperson confirmed that the SEC staff had conducted an informal inquiry in connection with Perry Capital’s trading in Mylan securities. The spokesperson said that the SEC issued a Wells notice to the firm "inviting us to make a submission addressing concerns of the Staff as to whether activities in that regard violated certain provisions of the federal securities laws, including Sections 10(b) and 13(d) of the Securities Exchange Act of 1934." At the time, the Perry spokesperson said that the firm intended to submit a Wells filing and believed that it had strong defenses to the staff’s concerns. "We believe that we have acted properly at all times and with the advice of counsel," the spokesperson said.

In light of Atkins’ comments, it appears that the SEC has backed away. Calls to Perry Capital asking for an update on the status of the SEC’s inquiry were not returned by press time.