Duty Of Disclosure: Delaware Chancellor Further Limits Availability of Damages
From Travis Laster: Last week, Delaware Chancellor Chandler - in In re Transkaryotic Therapies, Inc. - granted summary judgment in favor of three directors who were alleged to have breached their fiduciary duties by supporting and voting in favor of the acquisition of Transkaryotic Therapies by Shire Pharmaceuticals. Here is a copy of the opinion.
Much of the opinion consists of the Chancellor's rulings on the plaintiffs' allegations of bad faith and disloyalty. From a doctrinal and practitioner perspective, the more important discussion focuses on the duty of disclosure (pages 17-28).
In summary, the Chancellor characterizes the duty of disclosure as a doctrine designed for pre-vote adjudication, leaving very little room for any post-closing remedy. In his words, "the Court grants injunctive relief to prevent a vote from taking place where there is a credible threat that shareholders will be asked to vote without such complete and accurate information. The corollary to this point, however, is that once this irreparable harm has occurred --i.e. when shareholders have voted without complete and accurate information--it is, by definition, too late to remedy the harm" (page 25).
Based on this principle, the Chancellor granted summary judgment for the defendant directors: "I hold that this Court cannot grant monetary or injunctive relief for disclosure violations in connection with a proxy solicitation in favor of a merger three years after that merger has been consummated and where there is no evidence of a breach of the duty of loyalty or good faith by the directors who authorized the disclosures" (page 27).
As a practical matter, the Transkaryotic decision obviously favors defendant directors, and it should increase their settlement leverage in cases where plaintiffs primarily assert disclosure claims but do not pursue injunctive relief. In other words, the cost of a post-deal clean-up settlement involving disclosure claims should go down. The logical response from the plaintiffs' bar, however, should be to pursue more pre-closing disclosure-based injunction applications, since that is now the only real avenue available for a meaningful disclosure remedy and a commensurate fee award. In the long run, therefore, the Transkaryotic decision may result in more injunction applications and more disclosure litigation.
Two other points deserve brief mention. First, the Chancellor granted summary judgment on the claim that a director breached his fiduciary duties by soliciting so-called "empty votes" from stockholders who owned shares on the record date then sold them. The Court found that the director's efforts to support the merger was "consistent with - rather than at odds with - his fiduciary duties" (page 39).
Second, the Chancellor permitted the plaintiffs to proceed with a challenge to the statutory validity of the merger, based on their assertion that the merger had not received sufficient votes. This challenge rested in part on testimony to the effect that the inspectors of election tallied the vote very quickly, yet the plaintiffs produced evidence of over-vote situations that would have taken additional time to resolve. Notwithstanding the passage of three years since the merger closed, the Court permitted the challenge to go forward. This holding emphasizes the need for care when tallying merger votes and counsels in favor of hiring a reputable outside firm, such as IVS, to act as the inspector for close votes.
I've been saying that companies should hire independent inspectors for a long time - and since you sometimes don't know if your vote will be close until the last minute - you need to line up the inspector well in advance because they are in short supply!
Shareholder Rights Plans: Adding Derivatives to "Beneficial Ownership"
As noted in this WSJ article, at least two companies - Louisiana-Pacific Corp. (see related Form 8-K) and Micrel Inc. (see related Form 8-K) - have changed their shareholder-rights plans in recent months to include derivatives when calculating levels of "beneficial ownership" that would trigger their poison pill. The companies likely took this action to thwart the use of derivatives in activist plays.
A Different Perspective on CSX/TCI: Should Courts Reject a Private Right of Action Under Section 13(d)?
In the Harvard Law School Corporate Governance Blog, Phillip Goldstein of Bulldog Investors provides a viewpoint different from those coming from management's perspective. It's interesting to read a different viewpoint from the management one.
We have been posting oodles of law firm memos about the case in our "Schedule 13D" Practice Area.
Half of Sovereign-Wealth Fund Deals Involve Majority Stakes
As noted in this recent WSJ article, according to a recent Monitor Group study, half of the investments by sovereign wealth funds since 2000 involved a more than 50% interest. 37% involved stakes between 10% and 50% and only 13% involved investments of less than 10%.
There were 420 deals during this eight-year period - only 14 of them in wealthy nations, worth abut $9.4 billion, involved majority stakes in companies in such politically sensitive areas as energy, utilities, information technology, telecommunications and financial services.
Here is a copy of the study - and here is a quote from this Reuters article: "Heightened national security concerns over strategic investing by sovereign wealth funds appear to be overblown, a new study released on Friday found. The study, conducted by consulting firm Monitor Group, found that the bulk of SWF investing appears to be aimed at furthering the economic development of a host or allied country, not acquiring sensitive strategic or economic assets to advance political aims of a state."
Winning the World Series: Cubs Worth More? Or Less?
Here is a recent WSJ.com interview with an economist about how much more the Chicago Cubs would be worth if they won the World Series this year (they are red hot and it's been 100 years since they last won).
The interview is short and perhaps not complete - but in my opinion, the Cubs would be worth less in the long run if they won. Part of their national mystique is that they are perennial losers. "Maybe next year" is their mantra. As someone who grew up down the street from Wrigley Field at a time when they "had it in the bag" - the late '60s/early '70s - I don't want to see the streak end...
Closing Time: When the Founder is Ready to Sell
We have posted the transcript for the webcast: "Closing Time: When the Founder is Ready to Sell."
Corp Fin's No-Action Letter: Partial Tender Offers Under US and Israeli Law
Here is some analysis from Jim Moloney of Gibson Dunn: This recent no-action letter - Elron Electronics Industries - is unusual in that it relates to a partial tender offer being done under U.S. and Israeli law. Here you have a situation where an Israeli bidder is is making an all-cash tender offer for up to 5% of the outstanding ordinary shares and ADRs in a single offer. It is somewhat more typical to see a dual-offer structure. According to the bidder, a recent record holder list shows a relatively high percentage of shares held by U.S. persons -- approximately 63%. However, the bidder believes the U.S. ownership of the subject company is really closer to 52%.
The Israeli Companies Law requires a 4-day extension of the tender offer period, without a corresponding extension of withdrawal rights (a "subsequent offering period"), once all conditions to the offer have been satisfied. Payment of the tender offer consideration is expected four or more days after the expiration of the subsequent offering period which is apparently permitted under Israeli law.
For reasons not clearly articulated in the letter, the "subsequent offer period" that is permitted under U.S. law (Rule 14d-11) does not work here. Presumably that is because the offer is "partial" and Rule 14d-11 requires that the offer be for "all outstanding" securities of the class sought and the bidder must "accept and promptly pay for all securities" tendered during the initial offering period upon the close of the initial offering period. Therefore, the bidder requested relief from the prompt payment rule (Rule 14e-1(c)) and the rule requiring withdrawal rights (Rule 14d-7(a)(1)), which the staff granted.
The CSX Opinion is In!
Yesterday, in CSX Corp. v. The Children's Investment Fund Management, Judge Lewis Kaplan of US District Court (SDNY) delivered his anxiously awaited opinion finding that the two plaintiff activist funds violated the securities laws by not disclosing their positions and intentions many months before they did.
However, Judge Kaplan also ruled that there was nothing effective that he could do and he didn't bar the funds from voting their shares at CSX's upcoming annual meeting. And in his fine analysis, Professor Steven Davidoff notes that its unlikely the SEC will pursue an enforcement action given the letter submitted to the court from Corp Fin. Here is a NY Times article - and here is a WSJ article.
Here is an additional tidbit - the NY Times' Andrew Ross Sorkin wrote his column Tuesday about how CSX is a case study in how not to respond to a proxy fight...
Disclosure of Internal Financial Projections
From guest blogger Steve Haas of Hunton & Williams:
A hot M&A issue of late has been the need to disclose internal financial projections under Delaware law. In 2002, the Court of Chancery in Pure Resources directed a target corporation to disclose substantive portions of its investment banker's work in responding to a controlling stockholder's tender offer. Many practitioners assumed that Pure Resources was distinguishable from third-party negotiated transactions because, as that court observed, the transaction involved a controlling stockholder who presumably had more knowledge about the company than did the minority stockholders.
But that rationale was implicitly called into question last year in Netsmart, where the court ordered disclosure of management's financial projections in connection with a go-private deal with a private equity fund. Subsequent Delaware decisions, however, including CheckFree and Globis Partners, made clear that there is no bright-line common law rule requiring disclosure of management's projections.
It's not clear how to reconcile all of these decisions, and practitioners are left with generalized standards that require disclosure of all "material information" and a "fair summary" of the target's financial analysis, but the required disclosures do not need to enable stockholders to perform their own independent valuation. In assessing these disclosure obligations, the accuracy and reliability of the projections and the extent to which they were relied upon by the target board and its investment bankers seem to be the most important factors.
One Delaware jurist also suggested recently that the presence of target insiders on the buy-side would help tilt the court's analysis in favor of disclosure, since those insiders likely prepared the projections and understand their utility. That rationale supports the positions taken in Pure Resources and Netsmart. Mike Tumas and Michael Reilly at Potter, Anderson & Corroon recently put together a very helpful analysis of these issues in this memo, which originally appeared in Deal Points.
Unsealed: Yahoo's Tin Parachute
The media has had a field day ever since Delaware Chancery Court's Chancellor Chandler unsealed this amended complaint filed against Yahoo, particularly because Carl Icahn is involved as he pressures Yahoo to sell; see this DealBook post which includes Icahn's latest demand letter. The lawsuit charges that Yahoo's directors breached their fiduciary duties by their actions, including failing to negotiate a deal with Microsoft and enacting a broad employee severance plan.
Professor Steven Davidoff describes the tin parachute plan in quite some detail - and analyzes the arrangement, plus links to two other blogs that do the same - in his "DealBook" blog. Here is an excerpt from his blog:
The plan provides that if an employee with Yahoo is terminated by Yahoo without “cause” or by the employee for “good reason” within two years after Microsoft acquires a controlling interest in Yahoo, the employee will receive (among other things):(1) his or her annual base salary over a designated number of months ranging from four months to 24 months, depending on the employee’s job level; and
(2) accelerated vesting of all stock options, restricted stock units and any other equity-based awards previously granted.
Under the plan, good reason means any “substantial adverse alteration” in an employee’s duties or responsibilities during the two years following the change of control.
As a measure of the market, the argument that this plan is “egregious” seems primarily related to the cash severance component, not the equity acceleration. The latter feature is quite common even on a single-trigger basis (in which the equity is accelerated immediately upon a change of control or on a modified basis, permitting the executive to leave the company after one year and benefit from this provision).
But single-trigger provisions are becoming much less common. And under the Yahoo plan, both these payments have a double trigger: There must be an acquisition by Microsoft and then a subsequent termination of the employee. This is what you would expect for a tin parachute — slang for a change-in-control plan that covers all employees.
Still, it is less common to permit rank-and-file employees to benefit under the plan if they decide to leave the company for “good reason.” Typically, they only get a benefit if they are terminated without “cause.” But here, the definition of “good reason” is narrower than you would typically see for a corporate executive, though it still gives some rights to the employees to walk away. This is the part of the plan that is most aggressive. And the complaint is right that the definition of good reason could provide substantial leeway for Yahoo’s employees to walk.
Disclosing Swaps: SEC Staff Takes a Position in CSX Lawsuit
As the conclusion of one of the more closely-watched cases in recent years in the M&A area draws near (see this IR Magazine article for background), a number of amicus curiae filings were made available last week, including a letter from Corp Fin Deputy Director Brian Breheny (as transmitted by the SEC's General Counsel; this is not a Commission amicus brief). We have posted them in the "M&A Litigation Portal" on DealLawyers.com, as follows:
- SEC General Counsel's Brian Cartwright Transmittal Letter
- SEC Corp Fin Deputy Director's Brian Breheny Letter
- Prof. Bernard Black's Response to SEC Staff Letter
- ISDA/SIFMA Amicus Curiae Brief
Here is some analysis from Cliff Neimeth of Greenberg Traurig: In a pending litigation being watched closely by the public M&A bar, institutional activists and target issuers alike, this past Wednesday, in correspondence submitted by Corp Fin Deputy Director Brian Breheny to U.S. District Court (SDNY) Judge Lewis Kaplan, Brian endorsed the view of activist hedge funds - The Children's Investment Fund ("TCIF") and 3G Capital Partners ("3G") - that they were not required under Regulations 13G or 14A to disclose their approximate 12% economic stake in Jacksonville, Florida-based railroad operator CSX Corp. until months after they entered into these arrangements. The hedge fund defendants previously announced their intention and presently intend to elect a short-slate of their five nominees at CSX' annual meeting scheduled for later this month.
At issue, among many other aspects of the litigation, is the fact that TCIF and 3G were parties to elaborate "swap" and cash-settle derivative arrangements with investment bank counterparties, and that the nature of these contracts did (and do) not confer upon TCIF and 3G any shared or sole voting power over the underlying equity securities. Accordingly, in their view, such arrangements fall outside of the ambit of Section 13(d) and Regulation 13D thereunder until such time as these arrangements are converted into beneficial voting positions.
Although TCIF and 3G, on numerous occassions, announced to the investment community and to CSX directly that they were parties to the swaps and, in fact, made H-S-R (pre-merger notification) filings with the FTC, the absence of a detailed Schedule 13D filing (and subsequent amendments) allegedly enabled them to conduct (over a period of months) a broad range of "coordinating activities" with other institutional holders of CSX, to execute various plans, arrangements and understandings relating to control of CSX, and to otherwise engage in undisclosed "group" activities.
Brian Breheny (expressing the Staff's position of the appropriate interpretive legal standard and not the position of the SEC's Commissioners) stated in his letter to Judge Kaplan that "the presence of economic or business incentives that the [swap counterparty] may have to vote the shares as the other party wishes" is insufficient to create the beneficial acquisition of voting power in respect of such shares.
If Judge Kaplan agrees with TCIF's and 3G's (and indirectly, Breheny's amicus) interpretation of the legal standard for disclosure, this would have significant implications for hedge fund activist transaction planners and target companies. If he rules in this direction, it is not unlikely that this may prompt the SEC to accelerate its current assesment of whether Regulation 13D should be amended to broaden its reach to cover these cash-settled (synthetic) arrangements that have become more commonplace over the past several years.
Coupled with the SEC's e-proxy regime, the current slowdown in traditional economic M&A activity, and the recent Delaware Supreme Court and Delaware Chancery Court decisions in Openwave-Harbinger Capital, Jana Partners-CNET, Levitt Corp.-Office Depot and TravelCenters-Brog (with respect to the efficacy of the advance notice by-laws in those cases), this continues to help fuel an unprecedented level of institutional activism and control contest activity for the forseeable future. This also underscores the need for corporate issuers to examine their "shark repellents" and defensive arsenal.
Obama's "Incorporation Transparency Act" and The Shape of Things to Come
From guest blogger J.W. Verret, Assistant Professor, George Mason University School of Law:
The Senate Permanent Investigations Subcommittee is considering a bill introduced a few weeks ago by Senators Barack Obama, Norm Coleman, and Carl Levin, the "Incorporation Transparency and Law Enforcement Assistance Act," requiring states to determine the beneficial ownership of business entities formed under their jurisdiction and make that information available to their the federal government through subpoena.
In support of this bill, the Senators cite a handful of cases investigated by federal agencies that were later dropped because of difficulty determining beneficial ownership in the investigated entities. A proper analysis of the effects, costs, and likely constitutional challenges facing this bill reveals it as little more than a red herring - an empty gesture by a Presidential aspirant and Senators from contested districts meant to generate the appearance of being tough on corporate crime.
Other Alternatives
Legitimate prosecution of business entities engaging in activities that represent a threat to national security or violate tax, banking, or securities laws is a vital element of the federal government's law enforcement mandate. This does not mean that the state governments should be enlisted as subsidiaries of the Department of Justice merely because federal prosecutors find their work difficult or expensive.
There are other ways for the DOJ to determine the beneficial ownership of corporations. For instance, in Delaware, the home to more than half of all business entities, and 60% of the Fortune 500, nearly 2,000 cases are filed annually in Delaware's Court of Chancery against business entities. Delaware's plaintiffs bar skillfully uses the legal discovery process to determine beneficial ownership of those defendants.
Learning from Delaware - and the Costs
Perhaps federal prosecutors could learn something from Delaware lawyers in that regard. Legal discovery is an expensive and difficult process, but the fact that a handful of federal prosecutions have not resulted in successful convictions does not justify the federal government drafting the states into the service of federal agencies.
Indeed, the Constitution prohibits such an approach. In Printz v. U.S., the U.S. Supreme Court invalidated provisions of the Brady Bill that imposed mandatory regulatory requirements on local law enforcement. Justice Scalia articulated the Court's interpretation of state sovereignty succinctly: "The Federal Government may not compel the States to enact or administer a federal regulatory program."
The realities of business ownership, with its complex holding arrangements, make the costs of this bill prohibitive. Holdings are often structured with a network of ownership using flow through entities as well as powerful contractual rights held by non-shareholders. This is done for legitimate tax efficiency planning purposes as well as to sell specific interests to groups of investors or secure specific assets to interested creditors. The ownership structure of the Carlyle group or a typical grocery store franchise share that quality. This bill holds criminally liable any business failing to keep an accurate listing of its "beneficial owners" with the state in which it is registered, thus subjecting the two million businesses that form every year to unreasonable liability for a number of open questions of what being a "beneficial owner" really means in today's business environment.
Impact on Small Business
Professor Bainbridge of UCLA Law School has also observed that this bill will harm the millions of small businesses exempt from SEC registration trading on the pink sheets. Though the bill exempts entities registered with the SEC, recognizing that when shareholders trade in an active market an accurate list of their beneficial owners would be nearly impossible to maintain, it ignores that the same issue will be worse for smaller firms exempt from SEC registration.
The overriding drawback to this scheme is that only law-abiding businesses will feel its effects. Registrants of business entities used to cover illicit activities, such as money laundering or terrorism financing, would certainly lie on any form the states send them requesting beneficial ownership information. Unreasonable administrative costs are then imposed on state governments and small businesses with little effect on the exceedingly small percentage of businesses actually engaging in illicit activities.
The formation of over two million businesses each year is not something to be maligned by politicians hoping to spin momentary political hay. It is a result of a regulatory environment that has created a business entity formation system envied by developing markets around the world. If economic benefits of small business entities are to be protected, regulatory proposals should be subject to a sincere cost-benefit analysis.
What to Do Now
Most entities are formed in jurisdictions, such as Delaware, that have developed a specialized business court and corporate code to assure directors and officers maintain strict adherence of their fiduciary duty to their shareholders. The Obama/Levin/Coleman Act puts the success of this system in jeopardy.
Corporate counsel involved in the creation of LLC, LLPs, and corporations would be advised to inform their clients about this impending change, as well as the potential liability they face for failing to fully report their "beneficial owners" to the state's that chartered them.