Hostile takeovers are a harsh reality of the world of publicly owned companies.  Well-capitalized, diversified insurers are attractive to an increasing number of foreign interests holding large amounts of cheap dollars, as well as to the Abust-up@ artists who think they can sell assets and obtain financing on what is left.  Poor performers, on the other hand, catch the interest of Abottom fishers,@ who believe that they can buy at a bargain and turn the company around.

While a larger and financially stronger company undoubtedly will be in a better position to prevent a takeover, the recent acquisition activity on Wall Street (the RJR Nabisco leveraged buyout in particular), makes clear that being Abig and strong@ will not, in and of itself, provide an insurmountable defense against a sophisticated and well-financed raider.  Unfortunately, no single technique can guarantee absolute protection against a raider, but if management employs proper advance planning and remains vigilant to the potential threat, it is likely that the insurer will remain independent for a long time to come.  The board of directors must act to protect the company from the abusive tactics of the corporate raider by ensuring that the proper legal precautions have been taken in advance of any approach by an unwanted suitor.

The foundation of the defense lies in the terms of the company=s governing documents!its articles of incorporation (or charter) and its bylaws.  Depending upon the law of the state where the company is incorporated, here are some of the measures the company may be permitted to take:

$  AStagger@ the terms of directors.  This will effectively prevent a dissident stockholder from seizing control of the corporation by electing his own slate of directors (and replacing all current directors) at any one annual meeting.  A Astaggered@ board typically divides the number of directors into three classes whose members are elected for terms of three years.  Thus, in any one year, only one-third of the board is up for election and subject to outside challenge.

$  Limit the ability of dissidents to remove incumbent directors.  Under the current bylaws of many companies, a majority vote at a special meeting of stockholders can effect the removal of a director, with or without cause.  This provision essentially negates the protection afforded by a staggered board since dissident stockholders may be able to call a special meeting with a small percentage of shares (sometimes as low as 10%) and vote out one or more directors.  By requiring a Asupermajority@ voting margin (one that is greater than a simple majority-and usually 75% to 80%) to call a special meeting with respect to this matter, by requiring a supermajority vote to remove a director, or by prohibiting removal of a director without cause altogether, the board will not be subject to a nonelection proxy contest.

A  SNEAK ATTACK

Similarly, bylaws that permit stockholders to act by majority vote without a meeting (that is, by means of a written consent) subject the corporation to a sneak attack which may be decided in the raider=s favor even before the board of directors knows that a vote solicitation is in progress.  If the bylaws are amended, the shareholder consent action may be successfully curtailed (by a supermajority requirement) or eliminated

$  Ensure that the rights of minority stockholders are protected in a proposed business combination.  In the past, corporate raiders have lured stockholders into the trap of the front-end-loaded or two-tier buyout where the raiders have paid a cash premium to the market price for a first come-first served percentage of the company=s stock.  Then, upon consummation of the acquisition (generally by means of a merger with the raider=s shell company), the raiders have given the remaining shareholders a less valuable form of consideration, usually subordinated debt or nonvoting preferred stock.

One way to prevent this is to adopt into the articles of incorporation a Afair price@ provision.  This provision requires that the proposed acquirer offer to all shareholders a similar price and form of consideration in a business combination that follows its acquisition of shares.  If the acquirer does not comply with these and other requirements that attempt to equalize the terms and conditions of the acquisition for all shareholders, a supermajority vote will be required to approve the proposed business combination.

$  Be certain that the corporation has a sufficient number of shares of authorized but unissued (voting) common stock and that the company=s articles of incorporation permit the board of directors to issue such shares without an additional vote by the stockholders.  Such authorized but unissued shares provide a means for the board of directors to manage hostile acquisitions by, for example, increasing the number of shares outstanding and making it more expensive for the acquirer to buy control.  Another technique is placing a large block of shares with a trusted investor (the White Knight), who has no intention of taking over the company but will vote in accordance with the board=s recommendation to block the raider. 

$  To achieve the same purpose, have the corporation=s stockholders approve a large number of shares of authorized but unissued preferred stock.  This will permit the board of directors to determine by resolution, and without further stockholder action, the rights of the preferred shares and when and in what quantity to issue such shares.  The preferred stock, commonly known as Ablank check preferred,@ may be given dividend, voting, redemption or even conversion (to common stock) rights by the board in a number of ways that could forestall the acquisition of the common stock and, at the very least, make it more complicated for the raider to acquire control of the corporation.

$  Consider changing the corporation=s domicile in order to take advantage of more liberal incorporation laws that would permit the inclusion of the above provisions in the articles of incorporation or bylaws and, possibly, to utilize certain antitakeover legislation.  It may be easier to accomplish this at the time of demutualization or with an upstream holding company than to attempt to obtain stockholder approval at a later date or to redomesticate the insurer.

Forty-seven states now have holding company statutes in place.  These statutes generally require that any person (other than an authorized insurer) intending to acquire control of a domestic insurer give prior written notice to the insurer and obtain the prior approval of the state insurance regulator.  The regulator must be satisfied that the acquirer, among other qualifications, is trustworthy and has the financial wherewithal to make the acquisition and that the acquisition is fair and will not lessen competition.  Recently, a U.S. District Court determined that the holding company statute in North Dakota was unconstitutional.

Several states have recently enacted a Acontrol share acquisition@ statute, which generally provides that the person who has purchased a large block of stock (generally 20%, 33.33% or 50% of the shares outstanding) would be granted the voting rights to such shares only as approved by a majority vote of noninterested stockholders.

If the voting rights for the acquirer=s shares are not approved, the company may be permitted to purchase such shares at their Afair value.@  If voting rights are approved and the acquirer maintains a majority of the outstanding shares, all noninterested shareholders may be entitled to dissenters= rights, which would permit the company to purchase their shares at Afair value.@  Fair value is defined in the Indiana statute, for example, to mean a value not less than the highest price paid per share by the acquiring person in the control share acquisition.

SUPERMAJORITY VOTE

Other states have enacted Asupermajority vote!fair price@ provisions that are similar to the fair price provision for the articles of incorporation described above, while some states have promulgated a statute that requires a waiting period before the corporation can enter into a business combination with a large stockholder.  It should be noted that certain of these statutes, have come under legal attack by corporate raiders in the recent past.

Moreover, a protective statute recently passed in New York for newly demutualized life insures prohibits the acquisition of more than 5% of the outstanding voting shares of the new stock company within five years after the insurer=s demutualization without the prior approval of the New York Life Insurance and Companies Bureau.  If such acquisition occurs without the required approval, shares in excess of the 5% limitation are Asterilized@ and deemed to be Anonvoting securities.@

Other commonsense steps that may be taken to keep the wolf from the door involve becoming active with respect to the corporation=s stockholder base.  For example, attentive legal departments, or outside counsel, will advise their clients to identify and establish a relationship with the corporation=s market makers.  These firms know who is buying what and can be in a position to assist in identifying potential predators and stock accumulators.

Another prudent step would be to monitor the trading activity in the market and industry in general, and in the corporation=s stock in particular.  Sharp changes in the trading volume of the company=s stock for no apparent reason (such as when there has been no announcement of earnings) may be an indication that one or more parties are interested in the corporation.  Such fluctuations should be investigated immediately.

It is crucial to attempt to identify the corporation=s stockholders.  Don=t worry about the Amom and pop@ purchaser; but do attempt to obtain information about institutional investors.  Veteran AStreet@ people (like the market makers) know which institutions vote with or against management on certain issues.

In addition, obtain the Anames of the beneficial owners@ (NOBO) list from each street name holder or clearing agency, as currently permitted under proxy rules.  Use those lists to cross-check with the stock transfer books to find persons or entities that may slowly be accumulating shares under other identities.

Finally, establish a relationship with your stockholders.  Discuss the insurer=s results at the annual meeting of stockholders and encourage questions; meet with investment analysts; invite stockholders to tour the executive offices and speak with management.  (Be careful not to discuss nonpublic information.)  Find out what the stockholders want; explain how management is maximizing stockholder wealth.

More intricate legal measures may also be adopted, depending, of course, on the law of the state where the insurer or holding company is incorporated.  The most notorious of such devices is the Apoison pill.@  One form of poison pill is merely a plan adopted by the board of directors which provides to each stockholder the right to purchase the shares of the acquiring company at a discount.  (This is known as a Ashare purchase rights plan@ or a Aflip-over plan.@)

Such rights are triggered when the acquirer has purchased a specified percentage of the corporation=s stock (20%, for example) and may be redeemed by the corporation for a nominal amount (typically pennies).  Such a device therefore encourages raiders to negotiate with the board of directors and has, in the past, prevented undesired and uneconomical second-step merger acquisitions.

Another technique that recently has gained popularity is the use of employee stock ownership plans (ESOPs), which can put a substantial block of stock in the hands of the company=s employees.  Such plans are administered by an ESOP fiduciary, who must discharge his duties solely in the interest of the ESOP participants and for the exclusive purpose of providing benefits to the ESOP participants.  While the interests of employee-participants tend to be management-oriented, the legal requirement of fiduciary independence does not guarantee that the ESOP fiduciary will always side with management in a hostile situation.

Finally, the insurer has an obligation to protect its management against the insecurity that may result from a hostile acquisition attempt.  Consequently, properly drafted employment agreements, which provide for appropriate severance payments should a change in control of the corporation occur, have become commonplace.  These agreements generally state that the employee will serve the company in a particular capacity during the term of his or her agreement.

Should there be a change in control (generally defined as the purchase of approximately 25% of the company=s shares, or a major change in the composition of the board of directors, or the merger of the company or the sale of all of its assets), and if, thereafter, the officer=s job title, duties, compensation or benefits are downgraded, the officer would be entitled to a lump sum severance payment.

If each member of the top management team has such an agreement, it may dissuade the stock speculator who wants to take a Arun@ at the company.  Other compensation plans, such as accelerating options or retirement plans, may be used to insulate management from the anxiety of an attack so that the officers can focus on taking appropriate action for the benefit of all stockholders.

The board of directors, however, must never lose sight of the fact that it is obligated to act in accordance with proper business judgement and in the best interests of the company and its stockholders.  Therefore, the goal of achieving independence merely for its own sake cannot be justified.

The threat of aggression by outsiders looking to increase their personal wealth at the expense of the corporation and other stockholders cannot be minimized.  Strategic, long-range legal planning is imperative if a corporation is to be able to defend itself against a belligerent assault.

JEFFREY A. KOEPPEL is a partner in the Washington, D.C., law firm of Elias, Matz, Tiernan & Herrick.