Just posted an interesting interview with Wayne Elowe and Michael Hollingsworth of Kilpatrick Stockton regarding trends in middle market M&A.

For example, they observe that indemnity survival periods may be somewhat shorter these days, but still tend to cover one or two audit cycles; baskets have been ranging between 1/2-1% of transaction value and caps in the 10% to 50% range. Representations and warranties, if anything, have become more targeted on specific aspects of the seller’s business. With the requirements of Sarbanes-Oxley, buyers are also including representations targeting specific compliance issues. More trends are covered in the interview…

Last Tuesday, it was reported that a proposed – and controversial – transaction by Sovereign Bancorp has been amended so that the NYSE would allow it to proceed without a shareholder vote. Some of Sovereign’s largest shareholders had protested the lack of a shareholder vote (and I had criticized some of Sovereign’s other governance practices in this blog). Sovereign seeks to sell a stake in itself to Banco Santander, a Spanish bank – so that Sovereign can raise the funds to acquire another bank.

In this article, the WSJ reported that the NYSE advised Sovereign how to change the deal to get it through without a shareholder vote and quoted Richard Ketchum, head of NYSE Regulation: “We called it the way we saw it, …. Not everyone will be happy [but] what’s left is a transformed transaction that complies with our standards.” The WSJ article also noted: “Shareholders and corporate-governance experts viewed the NYSE’s decision on the matter as a test of how much regulatory muscle it would flex in a time of increased shareholder activism.”

According to reports, the transaction was revised to eliminate:

(i) Santander’s veto on the termination of Sovereign’s CEO and the requirement that any new CEO be reasonably acceptable to Santander;

(ii) provisions for Sovereign directors to remain on the board for an additional 10 years if Sovereign was bought outright by Santander; and

(iii) Santander’s obligation to vote its Sovereign shares in favor of Sovereign’s board nominees.

The revised deal also includes a “fiduciary out” to the no-shop provisions that otherwise prevent Sovereign from responding to acquisition proposals from third parties and a $200 million breakup fee.

Dissecting the Shareholder Approval Issue

Unless familiar with the views of the NYSE from prior dealings, many reading the NYSE’s rules would not have thought that the NYSE could interpret them to require Sovereign to obtain shareholder approval in connection with the issuance of shares representing less than 20% of its outstanding common stock to Banco Santander.

On their face, the NYSE’s shareholder approval requirements would not seem to require shareholder approval of Sovereign’s proposed transaction with Santander:

– Sections 312.03(a) and (b) don’t apply as they relate to equity compensation and related party transactions;

– Section 312.03(c) doesn’t appear to apply because the proposed transaction doesn’t involve the issuance of shares representing 20% of Sovereign’s outstanding common stock; and

– Section 312.03(d) shouldn’t apply because, notwithstanding the board representation and veto and other rights being granted Santander, the transaction doesn’t fit the normal concept of a “change in control” (e.g., in a “Revlon” sense).

Nevertheless, Sovereign’s unhappy shareholders at least partially succeeded in making a case that the proposed transaction triggered the shareholder approval requirement of 312.03(d) because it would result in a “change in control.” According to this WSJ article, these shareholders are unhappy with the NYSE’s decision and are considering an appeal to the SEC or banking regulators.

The NYSE’s Trap for the Unwary?

This situation highlights a potential trap for the unwary under the NYSE’s shareholder approval rules for transactions resulting in a purported change of control. In the Sovereign deal, we’re not talking true control (e.g., majority ownership) or even effective control (e.g., presumably somewhere north of 35% or 40% ownership, since that will often convey control given the percentage of shares typically voted at shareholder meetings) – but something much less – even below 20% – with a couple of directors and some veto rights.

I certainly agree with the outcome here (and even think the NYSE should have required a shareholder vote) as Sovereign’s governance practices are among the worst I have seen – but, as a matter of public policy, the NYSE should file proposed amendments to its rules with the SEC, solicit comments and obtain SEC approval rather than foster controversy by unilaterally interpreting “change of control” so broadly. I’m not a big fan of stealth regulation and, at a minimum, more formal guidance would seem appropriate. This would only help the NYSE as then it would be more difficult for folks to cry “foul” when they make determinations like this.

The Use of Treasury Shares or Cash to Avoid Shareholder Approval

It’s also worth noting that no one seems to blink an eye when parties structure transactions to avoid the shareholder approval requirements of 312.03(c) by using treasury shares (which are already listed) or cash to avoid having to list shares that would constitute 20% or more of the issuer’s outstanding common stock. Sometimes the amount of cash or treasury shares used as transaction consideration is just enough to cause the newly issued and listed shares to fall below 20% of the issuer’s outstanding shares. As noted in his blog, Professor Sjostrom notes that form prevails over substance in these circumstances.

On numerous occasions, I believe the NYSE has confirmed that the use of treasury shares works under these types of circumstances, as the NYSE rule only applies if you want to newly list shares that represent 20% or more of the issuer’s outstanding shares. For example, if someone can use treasury shares equal to 2% of the outstanding combined with newly listed 19%, they don’t need to obtain shareholder approval even though the reality is that they are issuing 21% of the outstanding.

[Loyal readers of The Corporate Counsel will recall that using treasury shares doesn’t work on Nasdaq. The Nasdaq’s rules generally require shareholder approval whenever shares representing 20% of the current outstanding are to be issued, whether or not they are treasury shares. So the approach described above wouldn’t work on Nasdaq.]

With respect to cash, take a look at SBC’s recent acquisition of AT&T. By effectively paying $1 billion in cash (through an AT&T special dividend), SBC reduced the number of shares it would have had to issue in an “all stock” deal to slightly below 20%. This seems to have allowed SBC to avoid the need for an SBC shareholder vote on a fairly material transaction that seems to have diluted the rights and interests of existing shareholders.

A Final Thought on State Law vs. SRO Regulation

One final thought: The real shareholder claim here appears to be that the Sovereign board is breaching its fiduciary duties by taking extraordinary actions to entrench itself (to the potential detriment of Sovereign shareholders) rather than engaging in a transaction effecting a change in control in breach of NYSE regulations.

So it is under state law – rather than the rules of an SRO that apply to only a small percentage of companies – that seems like the more appropriate avenue to address concerns regarding the lack of shareholder suffrage for transactions of this nature. Delaware law – and the laws of many other states – generally require shareholder approval only for statutory mergers and similar business combinations and sales of all (or substantially all) of a corporation’s assets not for investments representing less than 20% of a company’s outstanding common stock.

However, it is tough to win a breach of fiduciary duty lawsuit, so the large shareholders likely decided that appealing to the NYSE had a higher likelihood of success (and was perhaps quicker than going to court) – and they can always pursue a state law claim later.

Many thanks to Kevin Miller of Alston & Bird for his contributions to this lengthy blog!

It looks like Washington Redskins owner Dan Snyder has prevailed in his attempt to wrest three board seats from Six Flags, giving him a mandate to take control of the company. Snyder claims that 57% of Six Flags’ shares supported the Snyder-led plan by written consent to remove three of the company’s seven board members, including its CEO and chairman. Barring dissent from the remaining board members, Snyder is expected to assume the chairman’s role, with former ESPN executive Mark Shapiro becoming the CEO.

The kicker for me is that I started blogging about Snyder’s inclination towards taking control over a year ago, when he first filed a Schedule 13D! I shoulda bought some Six Flags stock – but I just have no faith in my stock picking abilities. The curse of being a lawyer…

In a recent speech, the FTC’s General Counsel, William Blumenthal, provided his perspective on certain gun jumping issues. While reiterating that merging firms are separate entities and may not engage in collective actions that adversely affect competition, Blumenthal expressed concern “that we may have been too successful [in educating the public about violations and discouraging similar conduct] – that our message may have been heard by some in our audience to prohibit conduct beyond what we intended.” In particular, he recognized that due diligence and transition planning “are necessary and, within appropriate limits, unobjectionable from an antitrust enforcement perspective.”

Under Section 1 of the Sherman Act, premerger coordination to protect a transaction is subject to a reasonableness analysis, balancing the potential adverse effects against the justification for the conduct, taking into account available alternatives. Certain types of conduct (e.g., coordination on pricing) will rarely, if ever, be reasonably necessary to protect a transaction.

Under Section 7A, the test is different – whether the arrangement shifts beneficial ownership (from an antitrust perspective, not in a narrower 13D sense) – though he suggested that the analysis yields consistent conclusions. While recognizing that it is common for merger agreements to transfer certain indicia of beneficial ownership (e.g., risk of loss and benefit of gain) through purchase price and capital adjustment provisions as well as limitations on investment discretion, Blumenthal concluded that:

“I don’t mean to suggest that these commonplace provisions, together or in isolation, are problematic – they’re not. Nor are they or other factors dispositive of the Section 7A analysis. My point is that the typical merger begins at the time of the agreement by shifting a number of pebbles on the scale of beneficial ownership. At a certain point, if too many other pebbles have accumulated on the buyer’s tray through indicia such as access to confidential information and control over key decisions, one can reasonably find that the scale has tipped in the direction of the buyer.”

At the end of the speech, Blumenthal focused on three specific areas of concern:

1. Ways to minimize the antitrust issues that will often arise in the context of ordinary due diligence and transition planning – which may include discussions regarding post merger matters including prices, marketing, assignment of customers and accounts to their formerly-separate sales forces, narrowing of product lines, strategy, identity and branding, and capital and investment decisions;

2. Types of questions the staff of the FTC will often ask in assessing the appropriateness of coordinating extraordinary planning decisions that parties often wish to make during the premerger period – e.g., the decision whether or not a party to a merger should proceed with a significant capital project which will not be required if the merger is consummated; and

3. While the joint marketing of products involving the coordination of pricing or allocation of customers or accounts, is not permissible, this prohibition does not generally apply to the joint marketing of the underlying transaction through joint advertisements and press releases.

Here are some background materials that describe six gunjumping cases brought by the FTC alleging excessive coordination. We have posted some law firm memos on this development in our “Antitrust” Practice Area. Thanks to Kevin Miller of Alston & Bird!

Lots of interest in this upcoming DealLawyers.com – “Going Private and Going Dark.” As this article suggests, a surprising number of companies are “going dark” and I believe that the article even understates how many have done so in the past few years. During the webcast, the lawyers and banker on the panel will debunk some of the common myths about going dark.

If you can’t wait for the webcast, we have created a new “Going Dark” Practice Area, which has some articles on going dark – and a partial list of companies that have recently done so.

On the heels of the recent Congressional bill that would require shareholder approval of any golden parachute payments – “The Protection Against Executive Compensation Abuse Act” – CalPERS has voted unanimously to oppose the proposed $8.1 billion merger of UnitedHealth Group and PacifiCare Health Systems Inc., unless the companies bring back the $345 million in executive bonuses that would be paid as a result of the transaction for a separate shareholder vote.

CalPERS said in a press release that its decision came after the release of PacifiCare’s proxy statement that shows the company’s management started merger discussions with UnitedHealth almost six months before PacifiCare’s shareholders were asked to approve “a very favorable compensation package” for management and the board in the event of a change in control of the company. In comparison, ISS has a contrary view on the golden parachutes due to the different way it analyzes parachute payments – see this article on its analysis of the merger.

Word to the wise: excessive golden parachutes can tank a deal these days – and what is considered excessive these days is less than what it used to be. A similar message was delivered by former DuPont CEO Ed Woolard (and current Chair of the NYSE compensation committee) in this 10-minute video on CompensationStandards.com – essentially, Mr. Woolard doesn’t believe that any CEO should receive any different severance arrangement than any other employee in the company. Learn more about the original purpose of severance payments in this recent issue of The Corporate Counsel.

To learn more about the recent Congressional bill noted above, go to Monday’s entry on the TheCorporateCounsel.net blog (in fact, if this is your first visit to this blog, you should check out TheCorporateCounsel.net blog as well).

An important – and largely unresolved – question in the antitrust law has been answered: whether the acquisition of a partial, non-controlling, ownership interest in a competitor raises serious issues under the Clayton Act. On October 25th, the US Court of Appeals for the Sixth Circuit held in United States v. Dairy Farmers of America, Docket No. 04-6318, that such partial acquisitions may raise substantial antitrust issues. Read more about this case in our “Antitrust” Practice Area.

At last week’s PLI Securities Regulation panel on public company mergers, Brian Breheny, the Chief of the Office of M&A at the SEC indicated that:

1. The Office of M&A’s number one priority is fixing the problems created by the split in the circuits regarding 14d-10. Brian said not to expect the SEC to adopt a brightline test – but reminded the audience that the SEC has consistently taken the view that bona fide compensation arrangements should not raise 14d-10 issues. However, it wasn’t clear how the SEC will propose to solve the problem other than that it has now concluded that a rule amendment is necessary.

2. The SEC is closely studying the NASD’s rule proposal regarding fairness opinions and is also reviewing its own fairness opinion disclosure rules.

Some of you will recall the 2004 decision in Consolidated Edison v. Northeast Utilities by the US District Court for the SDNY holding that former shareholders of the target could bring an action for a lost merger premium as a result of the buyer’s wrongful repudiation of the merger agreement. Because such claim was vested in shareholders as of the date of the repudiation – and not the target or transferees of their shares – the target could not settle such claims (e.g., by amending or revising the terms of the original merger agreement).

Thankfully, the 2nd Circuit has overturned the decision on appeal concluding that, under the terms of the merger agreement between Consolidated Edison and Northeast Utilities, target stockholders become third party beneficiaries – with the right to enforce the buyer’s obligation to pay the contracted merger consideration, only upon consummation of the merger.

This important decision confirms that claims of wrongful repudiation of a typically constructed merger agreement will not deprive the principal parties of the ability to amend – or otherwise settle disputes – by vesting claims in the hands of target shareholders at the time of the breach. Thanks to Kevin Miller of Alston & Bird for the heads up!

The Convergence of Hedge Funds and Its Impact on M&A

We have posted the transcript for the popular webcast: “The Convergence of Hedge Funds and Its Impact on M&A.”