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Revealing Motives for NOL Poison Pill Adoption

In August of 2018, the Harvard Law School Forum on Corporate Governance and Financial Regulation published an article discussing the differences between traditional poison pills and poison pills adopted to protect net operating loss (NOL) carryforwards, referred to as NOL poison pills. After reading this article, I decided to take a closer look at U.S. companies that have adopted NOL poison pills.

Net operating losses are a valuable asset for companies that apply a loss carryforward to future net income to reduce tax liability. However, Section 382 of the Internal Revenue Code of 1986 limits the use of NOL carryforwards in the event of an “ownership change”. According to Section 382, an ownership change occurs when one or more shareholders owning at least 5 percent of the company increase their ownership by more than fifty basis points within a rolling 3-year period.
Some companies seek to protect their NOL carryforwards against ownership changes by using a NOL poison pill. The key differentiator between NOL poison pills and traditional poison pills guarding against hostile takeovers is that NOL poison pills have a triggering ownership threshold under 5 percent, which is far lower than a traditional poison pill. Some NOL poison pills also give the company’s board discretion to approve ownership changes over 5 percent and terminate the pill once NOLs have been fully used to reduce tax liabilities.

To get started, I identified NOL poison pills using the FactSet Corporate Governance DataFeed by isolating active poison pills with an ownership trigger threshold under 5 percent. Currently, 75 U.S. companies across all RBICS sectors have active NOL poison pills.

In theory, NOL poison pills are adopted solely to protect NOL carryforwards and not to thwart hostile takeovers. Beyond a lower triggering ownership percent, NOL poison pills typically have a longer duration than typical poison pills and often include a sunset provision that is tied to NOLs. A sunset provision provides that the poison pill will lapse if not ratified in a pre-determined amount of years.

Using the granular characteristics included in DataFeed, we can capture important differences between each poison pill that support whether the poison pill is intended to protect NOL carryforwards. One such field, in_play_text, provides textual context for pills that are adopted “in play” to prevent an unsolicited takeover offer or protect a friendly merger, among other scenarios, so it is interesting to see cases where poison pills with an ownership trigger under 5 percent were adopted “in play.”

The graph below allows us to visualize the number of poison pills that were adopted “in play” for each poison pill duration length. The following plots give a sense for when poison pills were adopted and are set to expire.

Of the 75 active NOL poison pills, 10 were adopted in play. We can get a better sense of why the pill was adopted by using the in_play_text field. In some cases, this field helps us reaffirm that the company adopted the poison pill to protect NOLs. In other cases, such as Safeguard Scientifics, Inc., this text suggests there were other motives for adopting the poison pill.

From here, it would be interesting to use the DataFeed to identify trends in the types of provisions tied to NOL poison pills compared to traditional poison pills, which may inform shareholder voting decisions.

To learn more about the FactSet Corporate Governance DataFeed, please visit the FactSet Corporate Governance page on the Open:FactSet Marketplace.