This Skadden memo reviews current trends in shareholder activism, including the growth in M&A activism, the merging of private equity & activism, and the rise of global activism. We’ve covered these topics in prior blogs, but one that I don’t think we’ve talked about is what the memo calls “reluctivism”:
Over the last few years, there has been a rise in so-called “reluctivists,” or traditionally long-only institutional investors who are engaging increasingly in activist campaigns. Recent examples, such as Wellington Management’s public opposition to Bristol-Myers Squibb’s acquisition of Celgene and Neuberger Berman’s nomination of directors to Verint’s board, display a willingness of traditional asset managers to engage in activist tactics with the goal of increasing the value of their investment.
The use of activist tactics has become a more accepted way to effect change as part of a broader transition to a shareholder-centric model of corporate governance. Under this model, there is no monopoly on good ideas, and any investor with a clear agenda, sufficient resources and the support of a wide shareholder base can “become an activist.” Thus, large institutional investors with significant ownership stakes in public companies are becoming more integral to the success of activist campaigns and companies’ responses to them.
Traditionally passive institutional shareholders are providing support to activist campaigns more frequently — generally behind the scenes, but sometimes in the open. In some cases, the shareholder-centric model has empowered institutional investors themselves to bring about change through tactics traditionally employed only by activists. The result has been the creation of an environment where even large, well-performing companies can become targets of activist campaigns launched by a variety of constituents.
I’ve previously blogged about situations in which a fund’s entanglement in its portfolio company’s operations have resulted in some pretty significant liability exposure. This Ropes & Gray memo discusses a recently settled False Claims Act lawsuit in which the DOJ sought to hold a PE fund liable for its role in an alleged kickback scheme involving a prescription pain cream. This excerpt provides some background on the case and how the fund came to be caught up in it:
The allegations in Medrano v. Diabetic Care Rx, LLC d/b/a Patient Care America et al. (S.D. Fla. No. 15-62617-civ) stem from the defendants’ decision to enter the compound pain cream business in early 2014. According to DOJ, TRICARE reimbursement rates for topical pain creams were known to be unusually high at the time, which allegedly prompted Patient Care America to enter into a scheme with three marketing companies to target and refer TRICARE beneficiaries to PCA for pain cream prescriptions. The government alleged that the resulting prescriptions were medically unnecessary and that PCA’s commission payments to the marketing firms amounted to illegal kickbacks under the Anti-Kickback Statute (“AKS”), which resulted in PCA’s submission of false claims to TRICARE.
The government’s February 2018 Complaint in Intervention also includes allegations that the marketers paid kickbacks to patients by covering patient copayments regardless of financial need, and that the marketers paid telemedicine physicians to write prescriptions without proper consent or a legitimate prescriber-patient relationship. Finally, the government included two common law claims for payment by mistake and unjust enrichment based on the same alleged misconduct.
With respect to private equity owner Riordan Lewis & Hayden, the government claimed that the firm played a leading role in promoting PCA’s alleged misconduct. Two RLH partners served as directors of the portfolio company and allegedly encouraged its pursuit of the pain cream business to generate a “quick and dramatic payment” on the fund’s investment. According to the government, RLH knew and approved of PCA’s May 2014 decision to use independent contractors rather than employed sales staff to generate prescriptions for topical pain creams.
Further, the Complaint in Intervention alleged that RLH knew based on the advice of counsel that paying commissions to marketers could violate the AKS and that compliance with the AKS was a material requirement for reimbursements from TRICARE. Based on this advice and on RLH’s experience investing in the health care industry, the government argued that the private equity firm knew or should have known that PCA’s practices violated federal health care laws.
After some legal maneuvering, the parties settled with the DOJ for $21 million without an admission or determination of liability. The memo notes, however, that prior to the settlement, a federal magistrate ruled that the DOJ had adequately pled knowledge & causation on the part of the PE fund with respect to one of the alleged schemes involving the portfolio company’s payment of third-party commissions.
The memo says that the key takeaways for PE funds with portfolio companies in the healthcare industry are the need for close monitoring of their involvement with those companies’ operations, the importance of portfolio company compliance programs, and the need to be on the look-out for “red flags” – such as a decision to disregard legal advice.
This September-October issue of the Deal Lawyers print newsletter was just posted – & also mailed – and includes articles on:
– Five Observations on Recent Use of Universal Proxies
– Delaware Chancery Upholds Waiver of Appraisal Rights
– Does Your Acquisition Agreement Trigger a Form 8-K?
– Disclosure of Projections: Will Delaware’s Approach Still Rule the Roost?
Right now, you can subscribe to the Deal Lawyers print newsletter with a “Free for Rest of ‘19” no-risk trial. And remember that – as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers print newsletter – we are making all issues of the Deal Lawyers print newsletter available online. There is a big blue tab called “Back Issues” near the top of DealLawyers.com – 2nd from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.
And a bonus is that even if only one person in your firm is a subscriber to the Deal Lawyers print newsletter, anyone who has access to DealLawyers.com will be able to gain access to the Deal Lawyers print newsletter. For example, if your firm has a firmwide license to DealLawyers.com – and only one person subscribes to the print newsletter – everybody in your firm will be able to access the online issues of the print newsletter. That is real value. Here are FAQs about the Deal Lawyers print newsletter including how to access the issues online.
Last weekend marked the 50th anniversary of the debut of “Monty Python’s Flying Circus.” As anyone who reads my blogs regularly knows, I’m a big fan of the Pythons, so I followed the celebrations with great interest. I was particularly intrigued by the efforts described in this Reuters article to set the “Guiness World Record for the Largest Gathering of People Dressed Like Gumbys.”
For the uninitiated, “Gumbys” were recurring characters on the show who wore sweater vests, knotted handkerchiefs on their heads, rolled up trousers and Wellington boots, and, as the article put it, were noted for “their ape-like posture, habit of speaking loudly and slowly, and the catchphrase ‘my brain hurts’.”
Anyway, speaking of Her Majesty’s Government, the UK appears to be well on its way to careening out of the EU at the end of this month. If a no-deal Brexit actually does come to pass, there are going to be a lot of issues created under UK & EU competition laws. This Cleary Gottlieb memo provides a brief overview of the impact of a no-deal Brexit on merger control, antitrust investigations, private damage actions and other competition law-related matters. Here are the highlights:
A no-deal Brexit would have significant and immediate effects on UK competition law enforcement:
– Parallel investigation of mergers, cartels, and dominance cases by the UK Competition and Markets Authority (“CMA”) and European Commission (“EC”);
– Possible delay to transactions notified to the EC but not cleared by Brexit day;
– A significant increase in the CMA’s caseload, stretching its resources;
– New challenges for claimants bringing EU follow-on damages cases in the UK courts
In other words, while people may be making a big deal about the potentially grave consequences of a no-deal Brexit, when it comes to competition law, John Cleese’s Black Knight would likely shrug it all off as “just a flesh wound. . .”
Controlling shareholders can get a little grabby when it comes to stock issuances – and Delaware courts recognize that, in some circumstances, issuances that increase their ownership stake and dilute minority shareholders may breach the controller’s fiduciary duties. But Vice Chancellor McCormick’s recent order in Daugherty v. Dondero, (Del. Ch.; 10/19), is a reminder that this isn’t always the case.
The plaintiff challenged two stock offerings by NextBank Capital that were completed in 2016 & 2017. The plaintiff alleged that the company’s board and its affiliates constituted a control group, and that they breached their fiduciary duties by using the offerings to dilute the plaintiff’s ownership interest. The plaintiff alleged that the offerings were made at a discount, and that while the offerings were open to all shareholders, only the company’s directors and officers (including members of the control group) were offered the opportunity to obtain loans from the company to facilitate their participation.
The plaintiff relied on the Delaware Supreme Court’s decision in Gentile v. Rossette, (Del.; 2006), in which the Court held that minority shareholders potentially had both direct & derivative claims in connection with transactions where “a controlling stockholder, with sufficient power to manipulate the corporate processes, engineers a dilutive transaction whereby that stockholder receives an exclusive benefit of increased equity ownership and voting power for inadequate consideration.”
The Vice Chancellor rejected the plaintiff’s contention that Gentile should apply to either offering. As to the 2016 transaction, she noted that the control group itself was diluted, so Gentile simply didn’t apply. While the 2017 transaction was dilutive to minority shareholders, she also concluded that it was inappropriate to apply Gentile to that transaction:
The Complaint also fails to state a claim under Gentile as to the 2017 Stock Offering, even though it resulted in a marginal increase to the Controlling Stockholders net equity and voting positions. This is so because Gentile and its progeny require that the expropriated benefit inure exclusively to the controllers.
Cases interpreting this exclusivity requirement have found it lacking where all stockholders are equally eligible to participate in the challenged transaction. Daugherty concedes that he and all other minority stockholders had the opportunity to participate in the Stock Offerings. Accordingly, Gentile does not apply.
VC McCormick also held that the insider loan program didn’t alter this analysis. While the plaintiff contended that the loan program was part and parcel of a scheme to benefit the control group, the Vice Chancellor observed that it extended to all of NextBank’s directors and officers, not just the members of the control group. Since that was the case, it didn’t extend an “exclusive benefit” to the control group.
SEC Chair Jay Clayton is on record as wanting to find ways to expand the ability of retail investors to access private markets – including private equity funds. This Ropes & Gray memo reviews some of the challenges & opportunities associated with expanding retail access to private funds, as well as some of the alternative ways that retail participation might be accomplished. Here’s an excerpt from the intro:
Over the past several years, regulators and market participants increasingly have called for the expansion of investment opportunities for retail investors and retirees. These calls for expanded opportunities have cited market structure changes, the looming retirement crisis and basic fairness to retail investors and retirees who do not meet existing regulatory proxies for investor “sophistication.” SEC Chairman Jay Clayton, for example, observed that, in 2018, more capital was raised in the private markets than in the public markets, and that retail investors should (but currently do not) have access to those opportunities.
From 1996 to 2018, according to the World Bank, the number of exchange-listed U.S. companies decreased by approximately half, from 8,090 to 4,397. Consistent with the declining number of U.S. publicly traded companies, many large investors that had previously invested exclusively in public markets are now investing in private markets as well, seeing them as necessary for diversified exposure to global growth. Because retail investors are generally limited to investments in public companies, these market trends suggest that the investment opportunities available to retail investors have correspondingly decreased.
Calls for expansion of retail investment opportunities have also noted that lack of access to investments in private funds is contributing negatively to the retirement savings of many U.S. workers. In 2018, for example, the largest investors in private funds were government and private “defined benefit” retirement plans. However, most private-sector American workers save for retirement through “defined contribution” plans, such as 401(k) plans. For reasons discussed in Section II below, participants in defined contribution plans, both public and private, historically have had very limited access to private funds. Studies suggest that, over the last 25 to 30 years, access to private market investments is contributing to the relative outperformance of defined benefit plans over defined contribution plans.
Expanding retail access to private equity investments, in particular, has drawn support from academics and other nongovernment commenters in recent months. For example, a November 2018 report published by the Committee on Capital Markets Regulation cited studies demonstrating that private equity buyout funds consistently outperform public market alternatives, and argued that this performance, which appears uncorrelated with the performance of the public securities markets, justifies expanding retail investor access to private equity fund opportunities.
The memo says that while there may be a strong case for expanding retail access to private funds, current provisions of the securities laws and ERISA “essentially foreclose” most retail investors from participating. It discusses the issues associated with alternatives for providing retail access to private funds through direct investment, investment through a “registered fund of private funds,” & investment through a feeder fund advised by a registered investment adviser.
I recently blogged about the FTC’s increasing focus on non-competes in its merger review process. Earlier this week, the FTC underscored the point that these arrangements are on the front burner by blogging guidance on their use in M&A transactions. The FTC emphasized that in reviewing ancillary provisions like these, it will assess whether “they are ‘reasonably necessary’ for the deal & whether they are ‘narrowly tailored’ to the circumstances surrounding the transaction.” Here’s what the FTC had to say about what it thinks “narrowly tailored” means:
What one means by narrowly tailored depends on the competition that is restrained by the agreement and how it relates to a legitimate business concern. If you are selling three gas stations in Los Angeles but the non-compete bars the seller from operating gas stations in California for seven years, such a provision is unduly broad and would raise significant antitrust concerns, due both to its geographic scope and its term.
If, on the other hand, the non-compete applied to a one or two-mile radius around each station for a couple of years, this appears more tailored to address the potential concerns about loss in value by the buyer. But Staff would still have to evaluate the provision, even though the more limited term and scope evidence an intent to narrowly tailor the effect of the non-compete. The same approach applies to non-solicitation clauses: restrictions on soliciting employees must be narrowly tailored to protect the value to the business of the personnel at issue; they should not act as a de facto no-poach agreement.
In crafting non-solicits & non-competes, the FTC advises parties to focus on what they are trying to guard against, why that protection is needed, and the scope of the protection that is needed – as opposed to “wanted” – given the value invested in the deal.
Don’t look now, but the Delaware Chancery Court just upheld another Caremark claim in the face of a motion to dismiss. In his 50-page opinion in In re Clovis Oncology Derivative Litigation, (Del. Ch.; 10/19), Vice Chancellor Slights held that the plaintiffs had adequately pled that the board breached its fiduciary duties by failing to oversee a clinical trial for the company’s experimental lung cancer drug and then allowing the company to mislead the market regarding the drug’s efficacy.
In declining to dismiss the case, the Vice Chancellor observed that Delaware courts are more likely to find liability under Caremark for oversight failures involving compliance obligations under regulatory mandates than for those involving oversight of ordinary business risks:
Caremark rests on the presumption that corporate fiduciaries are afforded “great discretion to design context- and industry-specific approaches tailored to their companies’ businesses and resources.” Indeed, “[b]usiness decision-makers must operate in the real world, with imperfect information, limited resources, and uncertain future. To impose liability on directors for making a ‘wrong’ business decision would cripple their ability to earn returns for investors by taking business risks.”
But, as fiduciaries, corporate managers must be informed of, and oversee compliance with, the regulatory environments in which their businesses operate. In this regard, as relates to Caremark liability, it is appropriate to distinguish the board’s oversight of the company’s management of business risk that is inherent in its business plan from the board’s oversight of the company’s compliance with positive law—including regulatory mandates.
As this Court recently noted, “[t]he legal academy has observed that Delaware courts are more inclined to find Caremark oversight liability at the board level when the company operates in the midst of obligations imposed upon it by positive law yet fails to implement compliance systems, or fails to monitor existing compliance systems, such that a violation of law, and resulting liability, occurs.”
VC Slights cited the Delaware Supreme Court’s recent decision in Marchand v. Barnhill, and noted that that case “underscores the importance of the board’s oversight function when the company is operating in the midst of ‘mission critical’ regulatory compliance risk.”
Caremark requires a plaintiff to establish that the board either “completely fail[ed] to implement any reporting or information system or controls” or failed to adequately monitor that system by ignoring “red flags” of non-compliance. While the board’s governance committee was responsible for overseeing compliance with regulatory requirements applicable to the clinical trial, the Vice Chancellor held that the plaintiff adequately pled that it knowingly ignored red flags indicating that the company was not complying with those requirements. Accordingly, he declined to dismiss the case.
Ann Lipton has some interesting perspectives on VC Slights’ distinction between business & legal compliance risks over on her Twitter feed. Check it out.
Caremark still may be, as former Chancellor Allen put it, “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” But after decades of routinely dismissing Caremark claims at the pleading stage, this marks the second time this year that the Delaware courts have declined to do so – and it’s the third case in the last two years in which they’ve characterized a Caremark claim as “viable.”
Is Caremark becoming a more viable theory of liability, or is board’s conduct in these cases just more egregious than in prior cases? It’s hard to say based on the limited evidence we have. For now, maybe the ’60s band Buffalo Springfield put it best – “There’s something happening here. What it is ain’t exactly clear. . .”
Financial buyers used to insist on financing conditions in their acquisition agreements. They learned long ago that a financing condition usually ramped up their offer’s uncertainty beyond what public company boards were willing to stomach. In order to remain competitive with strategic buyers, they abandoned the financing condition and opted to instead offer up a reverse termination fee that would come into play if they couldn’t finance the deal. But the terms of those deals made it clear that, as far as the seller was concerned, that reverse termination fee was all they were going to get.
While that combination of reverse termination fee and exclusive remedy provisions has become almost universal for deals involving private equity buyers, that’s not the case when it comes to strategic sellers. As this Cooley blog points out, not only do they rarely get maximum liability caps, but their ability to assert that the termination fee is an exclusive remedy is usually contingent on their compliance with other deal terms.
In the wake of the Delaware Chancery Court’s recent decision in Genuine Parts v. Essendant, the blog suggests that strategic parties would be wise to push for the kind of “clean break” that private equity buyers have been able to negotiate. Here’s an excerpt:
The Genuine Parts decision highlights why strategic parties would be wise to take a page out of the financial buyer’s exclusive remedies playbook. For a board of directors of the target company, the certainty of a clean break from a prior transaction is crucial and can raise questions that could factor into a board’s decision-making when evaluating competing bids.
Should the board discount the financial terms of a competing bid for the risk attendant to possible litigation above and beyond the payment of the termination fee? Will potential competing bidders be more reluctant to make competing offers if the potential cost is greater than the termination fee? Worst of all from the intervening buyer’s (and target company’s) perspective, when the payment and acceptance of the termination fee does not act as a bar to further claims, the intervening buyer essentially funds the aggrieved first buyer’s litigation case (which was never the intent of the termination fee).
The blog doesn’t suggest that a target’s failure to comply with a non-solicitation covenant should just be shrugged off – but it says that the better approach would be to require the jilted buyer to elect its remedies & either accept the termination fee or take its chances in court.
In situations where the buyer may not know whether the seller breached its obligations at the time it needs to make this decision, the blog says the appropriate alternative may be to sue the buyer for tortious interference. As I blogged over on “John Tales” a while back, there’s some very interesting case law on tortious interference with an acquisition agreement.
I’ve previously blogged about the rise of mootness fees as plaintiffs’ favorite post-Trulia method for extracting a quick buck in federal merger objection strike suits. Last summer, a Chicago federal court balked at signing off on a mootness fee, which the judge referred to as a “racket” promoting useless merger litigation.
It looks like that case may be the start of a trend. This Morris James blog highlights a Delaware federal court’s recent decision refusing to approve a mootness fee application on the basis that the additional disclosures provided conferred no benefit to shareholders. Here’s an excerpt from the blog:
The district court denied the plaintiffs’ fee applications because it found that the plaintiffs failed to carry their burden to show the supplemental disclosures provided a “substantial benefit” justifying a fee award. CitingWalgreens and Trulia, the court reasoned that the plaintiffs “must establish, as a factual predicate, that the supplemental information was material.”
First considering supplemental disclosures of unlevered free cash flow projections used in the target’s financial adviser’s discounted cash flow analysis, the court reasoned that past cases supporting that such information can be material in certain circumstances do not make it per se material. The court explained the plaintiffs did not “explain how the stockholders would have been misled” by the omission of this information in these circumstances, nor did they “cite evidence or expert opinion on the issue.”
The court held similarly with respect to supplemental disclosures about the adviser’s calculation of the discount rate, the terminal multiple and the perpetuity growth rate. Again, the plaintiffs cited no authority showing this information is per se material, only cases “where courts found, on better developed records, that certain omissions were material given the particular factual circumstances.” The court further explained “neither caselaw nor law review articles are evidence of materiality in this case.”
Finally, the court held similarly with respect to supplemental disclosures of the multiples for each comparable company or precedent transaction included in the adviser’s analyses, when prior disclosures had already provided the overall ranges of multiples used. Such disclosures were not per se required, and plaintiffs failed “to connect the supplemental information to the facts of this case such that I could conclude that the omissions were material to DST stockholders given the total mix of information available to them.”
The blog notes the Court’s references to Trulia and Walgreens, and suggests that one of the takeaways from the decision is that “requests for court approval of mootness fees may involve similar judicial scrutiny of the benefit achieved, even though mootness dismissals do not involve potentially problematic classwide releases.” Considering the fact that about 70% of merger objection lawsuits this year have been filed in the 3rd Circuit, this decision has the potential to put a real crimp in the mootness fee racket.