Some areas of our financial markets can be prone to abuse and manipulation: investing in penny stocks, for example, or buying illiquid shares of companies over the Pink Sheets. Those two qualities don't automatically qualify a stock as fraudulent, but they do significantly raise the chances that something fishy may occur. There's one aspect of our markets, however, that I can unequivocally urge investors to avoid: the mini-tender offer.
Last week, investors in shares of pharmaceutical giant Wyeth
Not all tender offers are the same
A tender offer is a proposal that one company makes to shareholders of another company to acquire their shares, in order to take control of the shareholders' company. In most cases, a tender offer includes some sort of premium; otherwise, shareholders of the company being acquired have little incentive to surrender their shares.
Additionally, a company making a tender offer must follow strict rules established by the U.S. Securities and Exchange Commission (SEC) to ensure that all shareholders are treated fairly. They must have the opportunity to withdraw from the tender offer if, for instance, another, better offer comes along. These rules, though, don't apply to mini-tender offers; that's what makes the mini-tender so dangerous for investors.
A mini-tender offer is an offer to buy shares of a given stock, so long as the total amount purchased is less than 5% of a company's total shares. It's analogous to a regular tender offer, but since it's below that 5% threshold, it's not subject to the SEC's rules on tender offers.
Why make a mini-tender offer?
If the goal of a tender offer is to take control of another corporation, why on earth would any company ever make a mini-tender offer? It would seem so much easier to buy shares on the open market if a firm wanted to acquire less than 5% of another company. But by eluding the SEC's rules on tender offers, mini-tender offers are subject to all sorts of potential fraud and abuse. They're being used to dupe unwary stockholders out of their shares.
Nearly all mini-tender offers are made at less than the market value of the company's share price. Thus, they obviously provide shareholders little incentive to sell. In this most recent case with Wyeth, the firm making the mini-tender offered Wyeth shareholders $47 a share; even shares of Wyeth were trading at $48.68 on the day the offer was made. (The stock is even higher now.) Shareholders in the know would have zero incentive to sell their shares in the mini-tender offer.
The firms making the mini-tender proposals know that some shareholders don't understand the stock market so well, though. They may blindly assume that the mini-tender offer is at a premium to the share's market value or perhaps think that they're obligated to give up their shares. After getting shareholders to give up their shares at a below-market price, the company that made the mini-tender offer immediately sells those shares in the open market, profiting from the difference in prices.Bad deal for shareholders
Mini-tender offers aren't just deceptive -- they're also open to all sorts of other abuses and misdeeds. Shareholders have zero chance of coming out ahead in such an offer; if the share price of the stock falls below the mini-tender offer price before the offer closes, the offering firm is allowed to cancel the offer or reduce the offer price again. In many cases following such a price drop, shareholders who agreed to the previous offer have to actively withdraw their shares; they won't be withdrawn automatically. If your broker fails to mail you a copy of the newly reduced offer, or if you forget to withdraw your shares, you're stuck selling your holdings at the even lower share price.
Some companies making mini-tender offers will offer a small share-price premium to shareholders of the target company -- but hold the offer open for weeks or months. Once shareholders agree to offer their shares in a mini-tender, they're often not allowed to withdraw their shares from the offer unless the price changes. Thus, the offering company hopes that in the coming weeks or months, the share price will rise above the small premium it has bid for the shares, and the small premium shareholders thought they were getting for their shares will disappear.
Even worse, the bidding firm can continually keep extending the offer's closing date in hopes that the share price will drop below the tender offer. This is another no-lose situation for the offering firm; if shares don't rise above the offer price in the months after it was made, the firm will simply withdraw the offer entirely.
Mini-tender offers can be initiated for any public company, so long as they involve less than 5% of outstanding shares. In recent years, hundreds of these offers have been made with the hopes of luring in unsuspecting shareholders. They're a zero-sum game, and individual investors who fall prey to them are guaranteed to lose.Other losers from mini-tenders
Investors aren't the only losers. Companies whose shares are subject to the tender offer have to waste time preparing press releases declaring their opposition to the mini-tender offer, and explaining the offer's nature to some of their more uninformed shareholders. In fact, all stockholders lose in these situations, since these often deceptive -- and sometimes fraudulent -- rip-offs diminish investors' confidence in the markets. The SEC does give some tips to investors whose stocks have been subject to a mini-tender offer. But I'd greatly prefer it if the commission took a harder look at mini-tender offers and revised some of the rules that govern them.
Don't be suckered in by bad market mojo. Protect yourself with financial savvy from any of our Foolish newsletters. Try a no-strings-attached 30-day trial, absolutely free.