HP Lawsuit a Test of Investors’ Power

WILMINGTON, Del. —  In a showdown that could have far-reaching effects on the power of shareholders to stand up to corporate executives, Hewlett-Packard Co. begins a court battle today over its bitterly contested plan to acquire Compaq Computer Corp.

“This is potentially a historic event,” said Rob Enderle, an analyst with Giga Information Group. “Investors all over the country are looking closely at this case,” with an eye toward reining in corporate managers who in recent years have become used to operating with near impunity.

HP declared victory last week in the shareholder vote to approve what would be the largest technology merger in history at $19 billion. But that outcome has been challenged by dissident company director Walter Hewlett, a major shareholder and son of late company co-founder William Hewlett. He claims HP officers bought votes and lied about the risks and benefits of the merger plan.

If HP loses in court, the vote could be invalidated--an outcome that experts said could lead to a substantial shift in the balance of power between shareholders and corporate managers. An HP defeat, Enderle said, “would establish new standards for corporate conduct, and you can expect the [Securities and Exchange Commission] to drive those standards hard.”

The trial, expected to last three days, is taking place before William Chandler III, chief judge of Delaware’s Court of Chancery. The court is a primary venue for resolving business disputes because more than half of Fortune 500 companies are incorporated in Delaware.

Historically, the Chancery Court has strongly supported management rights but recently has been moderating that stance, said Charles Elson, director of the Center for Corporate Governance at the University of Delaware.

“Chandler strikes a very good balance between management prerogatives and shareholder prerogatives,” he said, adding that the HP case “could draw a clear line between persuasion and coercion” in proxy fights.

In the post-Enron environment, legal authorities are carefully scrutinizing corporate behavior considered routine only a few months ago. Even relatively modest accounting or reporting irregularities are receiving close attention by courts and regulators.

Last week, the SEC and the U.S. attorney’s office for New York’s southern district opened investigations into Palo Alto-based HP’s actions during the Compaq merger effort. Legal experts said that the probe by the U.S. attorney strongly suggests a criminal investigation--a chilling prospect for corporate managers. If those investigations end in sanctions against HP or its officers, it could embolden shareholders of other firms to challenge powerful executives.

“Despite the fact that we know most mergers fail there’s been a lack of shareholder activism in questioning the logic of these mergers,” said David Yoffie, a professor at Harvard Law School. “This case is really precedent-setting about the ability of shareholders to question senior management.”

The Hewlett lawsuit, filed March 28, charges that HP management “used HP corporate assets to entice and coerce certain financial institutions” to vote in favor of merging.

An egregious vote-buying incident, according to the lawsuit, occurred shortly before the March 19 voting deadline, when HP announced that a $4-billion line of credit would be co-arranged by Deutsche Bank. Almost immediately after, Deutsche Asset Management, the bank’s investment unit, switched 17 million votes to favor the merger. The U.S. attorney is looking into this case, as well as the votes of Northern Trust Corp., another large shareholder.

HP, Deutsche Bank and Northern Trust have denied wrongdoing.

The preliminary vote count, expected to be finalized in the next week, shows the merger winning by some 45 million votes, or about 3% of the total. That margin would more than offset the Deutsche Bank ballots if they are thrown out by the court.

But Hewlett also accuses HP managers of making false and inflated claims about the smoothness of the integration process and about projected profit for the combined companies. He also charges that HP dramatically underestimated the number of employees who would be fired once the merger is consummated. If Chandler agrees that false claims influenced the voting, he could invalidate the vote.

Further ammunition was added to an already raging battle when a voicemail message from Carly Fiorina, HP’s chief executive and architect of the merger, to Chief Financial Officer Robert Wayman was somehow forwarded to a newspaper reporter two weeks ago.

“We may have to do something extraordinary for [Deutsche Bank and Northern Trust] to bring them over the line,” Fiorina said.

HP later confirmed the message’s authenticity, but strongly denied that it implied any improper actions. Fiorina, the first woman to head one of the 30 companies that make up the Dow Jones industrial average, will probably be called to testify during the trial.

HP’s handling of the process leading up to the vote may have made the legal battle inevitable.

“This whole sequence of events began with them going after [Hewlett] personally,” suggesting that he was a dilettante in a public relations campaign widely estimated at costing upward of $150 million, Enderle said. Later, the HP board voted not to renominate Hewlett for a board seat--his term ends this week.

“They drove him to this. If they had taken a less aggressive path, we likely would not be going through this today,” Enderle said.

Other observers pointed out that the high-priced campaign to tear down Hewlett’s arguments was surprisingly ineffective, because the opposition to the merger was well founded.

“This guy is not a kook,” the University of Delaware’s Elson said. “He got half the vote.”

Investment analysts say that HP--whose shares dropped 42 cents Monday to $18.27 in New York Stock Exchange trading--may be due for a protracted period of business uncertainty.

Michael Murphy, an investment fund manager and editor of the California Technology Stock Letter, predicts that HP will prevail in court. But he sold all his shares in the company last week.

“You don’t want to own it during the consolidation phase.... That’s very difficult for any company and HP doesn’t have a lot of experience at acquisitions,” he said.