Earlier this week, the SEC brought an enforcement action against a hedge fund sponsor for alleged violations of Section 13(d)’s beneficial ownership reporting provisions. Here’s an excerpt from this Steve Quinlivan blog describing the proceeding:
The hedge fund had a senior managing director and portfolio manager that became a candidate for a board seat on a public company and began acting as a de facto board member. On October 28, 2014, the portfolio manager and a financial analyst emailed a list of recommended changes to the public company’s lead outside director and Chief Executive Officer. The e-mail noted “operations are a mess” and that “[i]nvestors don’t have unlimited patience.”
On November 6, 2014, the public company, at the suggestion of the portfolio manager, formed a special sub-committee of the top three officers and the independent directors. Thereafter, the special sub-committee held regular discussions with management of the public company, including the consideration of proposals for cost cutting, capital allocation, oil well development, and changes to the tone at the top. The portfolio manager participated in these discussions even though he was not yet appointed to the public company board.
The hedge fund had reported its ownership interest in the company on a Schedule 13G, which allows certain large investors to report their position without complying with the more extensive disclosure obligations imposed under Schedule 13D. However, only those persons who qualify as “passive investors” are eligible to use Schedule 13G. Persons who may seek to exercise or influence control over the issuer can’t use 13G – and they have to promptly file a Schedule 13D once they’re no longer eligible for the short-form filing.
The hedge fund ultimately filed a 13D once its designee was elected to the Company’s board. The Division of Enforcement said that was too late – it alleged that the hedge fund’s actions prior to that time involved “substantial steps in furtherance of a plan, which was ultimately successful,” to place its designee on the board. Accordingly, it incurred an obligation to file a Schedule 13D in advance of the designee’s election. The parties consented to the entry of a cease & desist order and $260,000 in civil monetary penalties without admitting or denying the SEC’s allegations.
Much to the chagrin of activist targets, the SEC hasn’t brought a lot of Section 13(d) enforcement proceedings against activists, but as we blogged at the time, it did bring one last year against a group of activists for alleged disclosure shortcomings during the course of a campaign.
Last week, Reuters reported that the SEC has shelved its proposal to implement a “universal proxy”. Despite Reuters’ report, there’s been no official word from the SEC indicating that the proposal has assumed room temperature. If it is gone, we’re kind of sad to see it go. It’s not that we’re pro or con – it’s just that universal proxy’s been such fertile “blog-fodder” for us!
We’ve previously blogged about the potential impact on activism of an SEC decision to adopt – or not adopt – the proposal. We’ve also discussed Pershing Square’s unsuccessful efforts to persuade ADP to use a universal proxy card – and, more recently, SandRidge Energy’s decision to become the first company to use a universal proxy card in a proxy contest.
This recent blog from Cooley’s Cydney Posner provides some history on the universal proxy proposal. If the SEC’s proposal truly is on the shelf, it will be interesting to see if there’s a move toward more aggressive private ordering when it comes to the use of a universal ballot.
Tune in tomorrow for the webcast – “Retaining Key Employees in a Deal” – to hear Morgan Lewis’ Jeanie Cogill, Hunton Andrews Kurth’s Tony Eppert, & Proskauer’s Josh Miller discuss the latest developments on compensation strategies to retain key employees in M&A transactions.
– Finders & Unregistered Broker-Dealers
– Governance Perils Involved in Financing Transactions by Emerging Companies
– Impact of the European GDPR on M&A
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Litigation challenging deals has long been a fact of life, but this recent blog from Kevin LaCroix says the cost of that litigation has soared in recent years:
As reported in a July 10, 2018 press release from Chubb, the average total cost associated with a settled merger-objection lawsuit increased 63% in the four year period between 2012 and 2016. The total cost includes attorneys’ fees and cash settlement amounts. In 2012, this figure was $2.8 million. By 2016, the figure had grown to $4.5 million. The average amount for the four year period from 2012 to 2016 was $3.6 million. Of these costs, only about 39% represented amounts going to shareholders. 61% of these amounts went to plaintiffs’ and defense attorneys in the form of fees and expenses.
For merger objection lawsuits that were dismissed rather than settled, the percentage increases over the four year period are even greater. In the four year period between 2012 and 2016, the average total cost increased 162%, from $880,000 in 2012 to $2.3 million in 2016. The average total cost associated with dismissed merger objection lawsuits during the period 2012 to 2016 was about $912,000.
Since the data ends in 2016, it doesn’t fully reflect the impact of recent Delaware decisions like Trulia & Corwin, which have led at least one prominent member of the Delaware plaintiffs’ bar to throw in the towel. But the net effect of Delaware’s actions hasn’t been to lower the volume of merger objection litigation – it’s just migrated to friendlier jurisdictions. Kevin notes that federal courts are becoming a particular favorite among the plaintiffs’ bar, with merger cases accounting for more than 40% of securities class action filings during 2018.
Earlier this week, in Morrison v. Berry (Del. 7/18), the Delaware Supreme Court reversed an earlier Chancery Court decision & held that “partial and elliptical” disclosures provided to shareholders were insufficient to insulate the seller’s board from fiduciary duty claims under the Corwin doctrine.
The challenged disclosures related to the relationship between the company’s founder & the PE firm that ultimately acquired the company, together with other matters relating to his role and actions in the board’s sale process. The Court concluded that the plaintiffs had raised significant questions concerning whether the disclosures relating to these matters were misleading, and overruled the Chancery Court’s decision to dismiss their complaint.
This Morris James blog says the decision provides insights into Corwin’s “fully-informed” shareholder approval requirement:
Corwin holds that approval of a transaction by a fully-informed, uncoerced majority of the disinterested stockholders invokes the deferential business judgment standard of review for a post-closing damages action, making the transaction almost certainly immune from further judicial scrutiny.
This is an important decision for its discussion of the “informed” approval prerequisite to a Corwin defense. This aspect of Corwin turns on thoroughly-developed standards under Delaware law regarding what is or is not material to the stockholders’ decision-making. In that way, the decision is not novel. Yet, because a disclosure violation may prevent what would otherwise be an early dismissal of a breach of fiduciary duty action against directors for damages, the issue is of heightened importance post-Corwin.
In the Court’s own words, this case “offers a cautionary reminder to directors and the attorneys who help them craft their disclosures: ‘partial and elliptical disclosures’ cannot facilitate the protection of the business judgment rule under the Corwin doctrine.” Here, the material undisclosed facts concerned a founder’s early dealings with the private equity buyer, pressure on the board, and the degree that this influence may have impacted the sale process structure.
The blog also highlights the role that a pre-suit books & records demand played in bolstering the plaintiffs’ arguments – and points out that this is “another area of increased importance post-Corwin, given the unavailability of a Corwin defense in that setting and the ability to obtain documents that might help one plead around a later Corwin defense.”
Cases like In re Dow Chemical stand for the proposition that Delaware courts generally apply the business judgment rule to a board’s decision to acquire another entity. But this Hunton Andrews Kurth memo says that the Chancery Court’s recent decisions in the Oracle & Tesla cases are a reminder to dealmakers that this isn’t always the case. This excerpt points out that controlling shareholder conflicts of interest may muddy the waters:
In most cases, like Dow Chemical, the acquiror’s board of directors will be protected by the business judgment rule, which is a presumption that the directors acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. Dow Chemical also makes clear that the business judgment rule should protect “buy-side” decisions regardless of whether they relate to a relatively small acquisition or a “ ‘bet the company’ transformational transaction”—“Delaware law simply does not support [a] distinction” based on the size of an acquisition.
In contrast, Oracle and Tesla reveal vulnerabilities in the business judgment rule armor. In particular, where a court finds that the board lacks sufficient independence from a conflict of interest, demand may be excused. This is especially true where a dominant executive personality exercises control over the board’s decision-making process, and that process leads the company to engage in a transaction that directly benefits that dominant personality. Delaware courts have also increased their scrutiny in recent years of overlapping business relationships in the technology industry and in venture capital circles (see, e.g., Sandys v. Pincus).
The memo goes on to provide practical suggestions that a buyer’s directors should take to satisfy their fiduciary obligations, including identifying & addressing potential conflicts involving the buyer’s directors & officers and the target.
We’ve previously blogged about advice from PwC on preparing carve-out financial statements in connection with spin-offs or other divestitures. Now, they’re back with this memo offering more advice on a specific component of those financials – the tax provision. As with just about everything else involved with carve-out financials, the process of determining the tax provision is complicated. Here’s an excerpt discussing the SEC’s preferred approach:
ASC 740-10-30-27 requires that the current and deferred tax expense for a group that files a consolidated return be allocated among the group members when those members issue separate financial statements. While ASC 740 does not require the use of any particular allocation method, it does require the method to be systematic, rational, and consistent with the broad principles of ASC 740. It goes on to indicate that the separate return method meets those criteria. In addition, the SEC staff has stated that it believes the separate return method is the preferred method.
Under the separate return method, the carve-out entity calculates its tax provision as if it were filing its own separate tax return based on the pre-tax accounts included in the carve-out entity. This can result in perceived inconsistencies between the tax provision of the carve-out entity and the tax provision of the consolidated group. This is acceptable, as ASC 740 acknowledges that if the separate return method is used, the sum of the amounts allocated to individual members of the group may not equal the consolidated amount.
The memo notes that the separate return method isn’t mandatory, and that another method may be acceptable as long as it’s systematic, rational, and consistent with the broad principles of ASC 740. The memo goes on to review one of those alternatives – the separate company method as modified for benefit or loss – and discusses a number of additional issues that need to be addressed in determining the appropriate tax provision & financial statement disclosure.
SPACs have increased in popularity among private equity funds in recent years, with major PE sponsors raising SPACs or selling portfolio companies to them. As SPACs have gained credibility among PE sponsors, they’ve become a more viable option when considering a public market exit strategy for PE fund portfolio companies.
This Weil blog discusses the SPAC alternative and provides a chart setting forth the similarities & differences between taking a company public through a traditional IPO vs. through a SPAC. This excerpt summarizes some of the pros & cons of the two alternatives:
There can be significant advantages to structuring a public market exit for a portfolio company through a SPAC rather than a traditional IPO, including being able to customize the terms of the exit so that the selling sponsor can share in the founder shares and warrants received by the SPAC sponsor in connection with the formation of the SPAC and structuring the sale as an all cash deal or some combination of cash and stock. On the flip side, there is market risk in closing the SPAC transaction due to the redemption rights of the SPAC stockholders (although there is also market risk with an IPO obviously).
Tech, media & telecom companies typically harvest vast amounts of online customer data. This Debevoise memo provides guidance on developing a cybersecurity & data privacy due diligence checklist for deals involving targets in these sectors. Here’s the intro:
Companies in the technology, media and telecommunications (“TMT”) sectors typically are online-dependent and collect a great detail of valuable information from and about their customers. For these and other reasons, TMT companies are among the most attractive targets for all sorts of cyber breaches, including denial of service attacks, viruses, ransomware and other forms of malware. When considering the acquisition of a business in the TMT sector, diligence requires paying close attention to these cybersecurity, data protection and privacy issues.
Acquirers should explore four key areas, using tools including document review, interviews with the target’s personnel, and questionnaires:
– When and to what extent the target collects, stores, processes and transfers personal information
– The target’s information security resources, practices and procedures
– The target’s data security and privacy compliance history
– Where applicable, particular sector-specific requirements
The memo provides guidance about the specific diligence issues that should be addressed in each of these key areas.