A Surprise Witness on the Stand
from Winter 1999
by Peter Keating
“Not every lawyer feels the way I do about disclosing clients’ names, but I wouldn’t write a book,” says Martin Lipton, Esq. “There’s no memoir in the works, and there never will be.”
That’s too bad for those of us who don’t have Lipton on retainer. Clients get a monthly one-on-one phone call from him, full of typically pungent thoughts about recent legal events.
Such opinions are based on more than 40 years at Wachtell, Lipton, Rosen & Katz, during which he has stretched the limits of mergers and acquisitions law and redefined the rules of corporate governance. Along the way, Lipton has been a vocal defender of shareholder rights, pushing for myriad reforms in the ways companies are run.
He has long been an advocate of greater representation by outside directors. It’s surprising, therefore, to hear Lipton now call for a moratorium on this particular reform. Pushing further change, he says, would be counterproductive. “We have achieved a very good balance. It’s very important not to change that balance so that it is too heavily weighted toward outside directors,” he told Corporate Board Member. “If that happens, management will lose the initiative and entrepreneurship it should have.”
Equally surprising, Lipton weighs in against the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. The panel, set up by the New York Stock Exchange, the National Association of Securities Dealers, and the Securities and Exchange Commission in the wake of various cooked-book scandals, has proposed that audit committees consist only of persons who are independent from management and financially literate. It also wants to require audit committees to submit annual reports to shareholders stating that they believe their companies’ financial statements conform with generally accepted accounting principles.
The panel has achieved something of a sacred cow status among some reformers, but Lipton will have none of it. “Their report is very ill-considered and should not be adopted,” he says. “It seriously affects the relationship between management and the board of directors, and it creates serious liability problems for members of the audit committee.”
His basic point is simple: There is very little in what a typical audit committee does that would prevent the kind of financial disasters that have taken place at companies such as Cendant or Livent. Instead, Lipton suggests regulators go after “weak auditors applying ambiguous accounting rules,” not audit committees. Lipton thinks the SEC should ban auditors from having any other relationships with the company, such as management consulting.
Lipton’s views on governance are the product of a long and distinguished career that took him to both sides of many M&A wars. He began in M&A in the mid-1970s, representing Loews in its nasty (and successful) takeover of CNA Insurance. He switched to defending companies against hostile takeovers throughout the eighties, denigrating the damage done by corporate raiders and rejecting them as clients. He switched horses again in 1991, representing AT&T when it successfully went after NCR.
Lipton has spent much of his professional life going up against Joe Flom, a partner at the competing firm Skadden, Arps. The victories Lipton’s firm won over Flom’s include McGraw Hill’s rejection of American Express. Among Flom’s triumphs: Ronald Perelman’s takeover of Revlon.
Lipton was among the first to recognize that the takeover boom of the 1980s meant big changes in board responsibilities. Some academics and lawyers favored the “rule of passivity,” arguing that boards should not take any steps to defend a company from hostile bids. Lipton disagreed, saying that directors had a duty to fight takeovers that weren’t in the interest of their shareholders. The Delaware Supreme Court adopted this view in 1985. Most famously, Lipton developed the “poison pill” takeover defense, which simply makes it too expensive for a hostile bidder to buy stock in a target company.
Lipton’s legal work as well as his proselytizing deserves much credit for bringing to a close a period popularly characterized as a decade of greed. Not only did corporations adopt variants of his poison pill, Wachtell, Lipton also won court cases establishing the right of corporate boards to “just say no” to mergers. Recent beneficiaries of this ruling include Loewen Group, the world’s second-largest funeral company. In 1996, it successfully rejected a $2.9 billion offer from industry leader Service Corp, International.
Lipton argues that the United States paid an enormous price for letting the takeover craze go on as long as it did. “The 1980s were an era of two-tiered, front-end-loaded, bootstrap bust-up takeovers,” he says. “It was a period of financially motivated deals that took advantage of the anomaly of having stock prices that were substantially below asset values, plus high inflation. The combination of the leveraged buyout excesses and the junk bond excesses led to the savings and loan crisis, the trouble with banks, and a whole rash of bankruptcies, and we didn’t really recover from that until 1996.”
Long before then, M&A work had dried up, and Lipton was deprived of a time-honored target for his outrage. His signing up to help AT&T go after NCR delighted Lipton’s critics. “I guess what it really means is that Marty is a purist no longer,” one investment banker gleefully told the New York Times.
Lipton, of course, is not at a loss for words in explaining his new role. “Most deals today are true strategic deals, not financially motivated,” he says. “We still won’t do an offer where control is sought by one group while other shareholders are left holding the bag.”
Lipton’s firm is among the most profitable in the country. It reportedly charged Kraft $20 million for two weeks work in 1988—in a case he ultimately lost; Kraft went unwillingly into the arms of Philip Morris. In 1996, the firm ranked second in the nation with $1.4 million in profits per partner. Cravath, Swain & Moore came in first with $1.5 million per partner. Skadden, Arps partners averaged $999,000 each.
Lipton’s interest in boardroom issues followed naturally from his ongoing legal work. He began lecturing and writing on the topic of how corporate governance affects competitiveness. “Remember, at the beginning of the ’90s, we were in the S&L mess, and it looked like German and Japanese corporations were outcompeting us.”
At a session of the Washington-based Council on Competitiveness, Lipton encountered Harvard Business School Associate Dean Jay Lorsch. “I think that Jay thought I was something of a troglodyte and that I didn’t believe in boards of directors or corporate governance,” Lipton recalls. “But sharing a cab back to National Airport, we realized our ideas weren’t that far apart.” This insight led to their seminal Business Lawyer article, “A Modest Proposal for Improved Corporate Governance.” The two authors argued that boards were too big, too close to management, and insufficiently prepared to make critical decisions. “Directors may eventually act,” they wrote, “but their actions are often late, after the shareholders have lost value; employees, jobs; and the corporation, its competitive market position.”
Lipton and Lorsch recommended that companies limit their boards to no more than 10 directors, with at least two independent members for each insider. They suggested that boards meet more frequently and for longer periods of time, with directors spending at least 100 hours a year on their boardroom duties. They also wrote that boards should meet informally with their company’s top investors every year. And, most controversially, they recommended the appointment of a lead outside director who would oversee an independent annual review of the CEO and of corporate performance. “What’s the strategic plan, and is this management achieving that plan? That’s what counts,” says Lipton.
Even though these ideas sparked debate and criticism at the time they were published, a surprising number of large companies soon adopted the bulk of the recommendations. Indeed, the General Motors Board of Directors Corporate Governance Guidelines, a template for many corporations, draws heavily on the Lipton-Lorsch proposals.
As for the current surge of tech start-ups that seem to be popularizing the idea of founder-directors, Lipton sees continuity with, not a disjunction from, corporations of the past. “If you look at the history of a company like Standard Oil, Mr. Rockefeller and his partners constituted the executive committee, which we would call the board today,” he says. “Nowadays in high-tech, what you essentially have is the founders, together with the venture capitalists, constituting the boards. Then when they go public, they add three or four independent directors.”
Such mellow musings don’t last long with Lipton, who soon turns combative again—going after everybody’s whipping boy: overly litigious lawyers. He calls their product liability suits a most inefficient means of socializing the costs of an industrial society. “People get injured, cars don’t work just right, drugs don’t work just right. In large measure, a society has to insure against those contingencies and compensate the people who are hurt, but you don’t go crazy with punitive damages,” he says. “There’s no reason that a whole industry should exist where the lawyers siphon off two-thirds of what is spent on these problems.”
