(Bloomberg) -- It would have been a pretty standard corporate dispute for Wall Street to bet on, if it weren’t for the meme stock crowd.
A court’s approval of an AMC Entertainment Holdings Inc. stock conversion plan last week ended a long legal tug-of-war between the movie theater chain and a small army of retail investors, who fiercely opposed the plan and helped delay it by months.
The involvement of these investors, who turned beaten-down stocks like AMC and GameStop Corp. into viral memes and winners for a time, injected extra uncertainty into the situation. And it gave Wall Street traders — who were wagering on whether the proposed conversion plan would pass legal muster, and looking to profit from the outcome — a vexing new factor to consider.
“Retail investors on their own have very little influence over corporate actions,” said Campbell Harvey, a professor at Duke University’s Fuqua School of Business. “However, when they band together and act as one, they can attain the influence of a large institutional investor or a hedge fund. The meme investor social network makes it much easier to launch a legal attack.”
An AMC theater in New York City.
Friday’s decision by Delaware Chancery Judge Morgan Zurn capped a bitter legal battle over AMC preferred equity units, or APEs, which pitted the company’s top executives against that retail investor base.
Zurn had surprised the market last month by rejecting an earlier version of the settlement, which she found waived too many potential claims against the company. The disclosure of the first settlement drew more than 3,500 communications from about 2,850 shareholders, prompting Zurn to appoint a special master to handle the flood, further delaying the process.
Chris Colpitts, director of event-driven strategies at TD Cowen, says the attention the case got may have ultimately pushed the judge to be more of a stickler for procedure.
“Normally in class action settlements nobody comments, nobody objects,” Colpitts said. “In AMC there was so much interest and attention that she may have been more focused on ensuring the correct procedural steps were taken.”
In her July opinion, Zurn said the objections themselves didn’t inform her decision to reject the settlement. But she called AMC’s shareholder base “extraordinary” and said it included “a great number of human owners who care passionately about their stock ownership and the company,” calling the reaction to the notice of settlement “unprecedented.”
For the arbitragers betting on the conversion, the prolonged legal saga has turned seemingly easy money into a high-risk proposition. They set up the trade through stocks and options, and the twists and turns forced them to hold their wagers longer than they planned, eating into any profits.
The small investors “overloaded” the court with their objections, said Julian Klymochko, chief executive officer of Accelerate Financial Technologies, which has an arbitrage-focused fund.
“Many only have, like, a very, very, very small monetary stake” but used it to cause “hundreds of millions of dollars of economic damage to arbitragers,” Klymochko said. He added that it was “irrational that some retail investors were trying to prevent this conversion deal, which, if it hadn’t gone through, the company would’ve gone bankrupt and their shares would’ve been zero.”
The delay was especially perilous since many were borrowing the stock to short it and had to pay hefty daily financing costs to maintain their positions, plus face the risk of a short squeeze. Some could lose more than 250% on the trade, according to analysis from data firm S3 Partners.
The stock has taken a wild ride as hedge funds and other traders bought APE positions and went short the common shares. They were betting on pocketing the price difference between the two once the conversion went through and narrowed the gap. Zurn’s rejection of the plan in July forced some to start unwinding that bet to limit their risk, sending the common shares soaring. Her approval on Friday sank them.
“The thing that has been kind of really crazy about this case is the meme stock investors that hold the common stock, some of them are like, ‘We don’t want to settle at all — we just want to stick it to everyone,’” said Eric Talley, a corporate law expert at Columbia Law School.
The dispute started in February when the Allegheny County Employees’ Retirement System sued AMC, alleging it was using complex corporate engineering to sideline small investors. The pension fund claimed AMC was empowering holders of the APEs at retail investors’ expense — for example, by selling almost 30% of the units to hedge fund Antara Capital LP to win its support for the share conversion plan.
The meme crowd was so incensed that the court even took additional security measures for a hearing on the deal in Wilmington in late June. Two extra rooms with a live feed from the courtroom were reserved.
In the end only a handful of the two dozen objectors scheduled to testify showed up. They included a man who said he had driven 10 hours from Tennessee to speak in public for the first time and a US Air Force veteran who delivered a wide-ranging, emotional broadside on Wall Street corruption.
“Anytime an arbitrage position intersects with a meme stock,” TD Cowen’s Colpitts said, “caution is warranted.”
The case is AMC Entertainment Holdings Inc. Shareholder Litigation, 2023-2015, Delaware Chancery Court (Wilmington).
--With assistance from Jennifer Kay and Michael Leonard.