Deconstructing Duff & Phelps

In his dissent in Jordan v. Duff & Phelps Judge Posner, who this year is celebrating his 25th anniversary on the bench, showed why he is regarded as among the keenest of our federal judges. This article shows why Posner gets the better of the arguments in this classic corporate law chestnut taught in most law school corporate law classes. In addition, it offers some new perspectives on Duff & Phelps in light of the developments in case law and corporate and securities practice in the decades since the opinion was written. First, it sets forth a new theory about the interplay between tag-along rights and disclosure. The employee in this case, Jordan, didn't bargain for "tag-along" rights (commonly negotiated elements of shareholder agreements in closely held firms that allow minority shareholders to share control premia) when he bought his shares in Duff & Phelps, but the court allows him to recover as if he did. This paper shows why courts should be reluctant to give sophisticated and informed parties, like Jordan, that actually dicker over terms, rights they didn't want to pay for. The implication of Jordan's refusal to bargain for these rights, and therefore the majority's ability to keep the control premium for itself, goes to disclosure: the more likely it is that the firm can exclude Jordan from participating in any change-of-control premium, the less valuable any disclosure of inchoate merger plans would be to him. The court's conclusion that disclosure was valuable to Jordan is undermined by the fact that nothing in law or fact suggested that Jordan had a right to share in the spoils of the merger. Second, the paper shows why the structure of the shareholder agreement Jordan signed amounted to a waiver of his rights to bring the suit he filed and won. Jordan effectively consented to being traded against by those with inside information (that is, the firm). By agreeing when he bought the shares to take book value for them at some time in the future, Jordan was in effect consenting to trades with the firm at a set price in cases in which one or both parties would know that the fair value of the shares deviated from book value. This looks like the modern "big boy" letter, which provides a basis for much over-the-counter securities practice: two sophisticated parties on opposite sides of a securities deal agree to not bring securities fraud claims in the future based on the fact that they are "big boys" and know the other might have inside information. Big boy letters are widely used and are being accepted by courts as de facto waivers of certain securities law claims; a recent development that Posner implicitly suggests in his dissent. Finally, the paper shows why applying theories of insider trading in cases involving options at the time of the exercise of the option is inappropriate. Although a party to an option contract - Jordan effectively sold a call and bought a put - may be engaged in insider trading at the time the derivative contract is executed, finding liability for asymmetric information at the time of exercise defeats the entire justification for entering into the contract in the first place. The Duff & Phelps rule effectively disables the options for parties that have information that makes the options valuable in the first place.