From a recent Wachtell Lipton memo: “Last Thursday, President Bush signed into law the Pension Protection Act of 2006. The Act makes it easier for hedge funds to attract capital from benefit plan investors and will facilitate non-control investments by private equity and venture capital funds, in each case without the funds’ underlying assets being subjected to the fiduciary and prohibited transaction rules of ERISA and the Internal Revenue Code.
The assets of a fund whose investors include employee benefit plans that are subject to ERISA may be considered to be “plan assets” that are also subject to ERISA, which means that the actions of the manager must comply with exacting fiduciary standards of ERISA. These requirements are not acceptable to most hedge funds and private equity and venture capital funds, which seek to exempt themselves from the rules by:
– qualifying as venture capital operating companies (“VCOC”) or real estate operating companies (“REOC”), which requires an investor, among other things, to have “management rights” with respect to its initial investment and at least a majority of its investments, valued at cost, thereafter; or
– limiting ownership of their equity ownership by “benefit plan investors,” which includes foreign and governmental plans as well as ERISA-regulated private pension plans, to 25% of the funds’ equity interests.
Because qualifying as a VCOC or REOC requires funds to have management rights with respect to certain investments, it is well-suited to private equity and venture capital funds, which typically make long-term investments and obtain management rights. Hedge funds, which typically make short-term investments and therefore do not obtain such rights, largely elect to comply with the rules by limiting ownership of their equity by benefit plan investors.
The New Rules: The approach taken by most hedge funds has economic limitations because “benefit plan investors” include many of the major sources of investment capital. The Act makes this approach more practical by liberalizing the 25% test in two ways:
– The definition of “benefit plan investors” will now exclude foreign and governmental plans; and
– Where benefit plan investors own equity in a fund that invests in a fund of funds, the proportion of the benefit plan investors’ equity ownership in the fund of funds will now be determined based on the benefit plan investors’ proportionate interest in the fund of funds, whereas the existing regulations treated an investment of a fund that flunked the 25% test as 100% held by benefit plan investors.
Impact on M&A: Hedge funds will welcome changes to the plan asset rules, which will provide them with increased capacity to accept additional capital from benefit plan investors and governmental and foreign plans without running afoul of the 25% test. Moreover, because plan money tends to be “stickier” than other forms of capital, hedge funds could have the ability to pursue more longer-term investments than in the past. The increased size of hedge funds, combined with their potential to pursue longer-term strategies, could both fuel more activism by hedge funds and provide them with increased ability to pursue large scale acquisitions.
In addition, some private equity and venture capital funds that have been avoiding treatment as ERISA fiduciaries by qualifying as VCOCs and REOCs will likely consider whether they can meet the liberalized 25% test so that they have more freedom to structure their investments. This could lead such funds to act more like hedge funds than private equity funds have historically acted.
The convergence of these investment strategies and the capacity for multi-faceted approaches by activists who can either agitate or finance an acquisition could pose significant challenges for corporations. We continue to advise corporations to engage in the same kind of preparation for attacks from fund activists as from hostile takeover bids. Careful planning and a proactive approach are critical.”
From the ISS “Corporate Governance Blog“: A controversial takeover battle between two of Japan’s largest paper manufacturers may prompt a legal ruling on how and when Japanese companies can deploy poison pill defenses.
The use of pills has grown exponentially in Japan over the past 18 months, but the legality of their use in some circumstances remains questionable, leaving both issuers and shareholders searching for guidance from Japan’s judiciary. A recent takeover attempt pitting bidder Oji Paper against rival Hokuetsu Paper Mills has invited judicial scrutiny because of the target’s adoption of a pill without shareholder approval and subsequent issue of warrants to a “white knight” investor, legal experts say.
The pill, which would remain in effect until the next annual shareholder meeting when it would be put to a shareholder vote, is relatively standard for Japan. The terms include a 20 percent trigger, the establishment of an independent but non-board level committee (composed of three non-executive statutory auditors) to review the terms of any takeover offer and present a non-binding recommendation on whether to deploy the pill, and a commitment to reduce board terms to one year.
Currently, Hokuetsu’s board has no outsiders (nor does Oji’s), and the terms of the pill do not obligate the board of directors to accept the committee’s recommendation, should the committee favor the takeover offer and thus recommend against deploying the pill. Hokuetsu’s independent committee on Aug. 8 recommended to the board that the pill be deployed.
The committee’s independence is one issue the courts will focus on, experts say. The role of the [independent committee] is “to fairly and impartially determine whether the takeover bid will increase the value of the target company,” notes Waseda University’s Tatsuo Uemura in comments made to the Nihon Keizai Shimbun.
Without shareholder approval of the pill, however, Hokuetsu runs the risk of skeptical judicial scrutiny. According to ISS data, at least 60 other Japanese companies have adopted pills without shareholder approval this year, but few have done so in the face of a takeover bid.
A precedent-setting decision last year by the Tokyo District Court, upheld by the Supreme Court, forced process control equipment maker Nireco to withdraw a poison pill passed by the board of directors without shareholder approval. A Ministry of Economy Trade and Industry and Ministry of Justice white paper published in May 2005 appeared to endorse so-called advance warning takeover defenses. However, while prescribing pill-like defense mechanisms, the paper warned that regulations should not permit poison pills to be used simply to hold off a hostile bid or to entrench management.
Moreover, shareholder opposition of poison pills and other takeover-related defenses is on the rise. Influential pension fund associations have adopted more stringent proxy voting policies against such proposals, including the Pension Fund Association’s policy of voting against directors of companies adopting poison pills that are “structured such that the deployment is left to the discretion of the board of directors,” according to a June 29 Nihon Keizai Shimbun article.
A recent survey by the Japan Securities Investment Advisers Association indicated that 50 percent of respondents either voted against or abstained on management proposals, an increase of 11 percent over the previous year. Those proposals typically resulting in a negative vote or abstentions were executive retirement bonus plans and anti-takeover proposals, the Nihon Keizai Shimbun reported.
Hokuetsu’s white knight tactic may compound the risk of a negative judicial ruling. Two days after announcing its implementation of the pill, Hokuetsu’s board entered into an alliance with Mitsubishi Corp. that included the issuance of shares at a discount to the market price, allowing Mitsubishi to acquire up to a 24 percent stake in Hokuetsu.
One issue being debated in legal circles is disclosure. The Knight Ridder wire service reported that the Tokyo Stock Exchange (TSE) was considering disciplinary action against Hokuetsu for its failure to disclose Oji’s bid when discussing with the TSE its intent to adopt a poison pill ahead of the public announcement. The company also failed to disclose Oji’s offer to the market, as it worked out the deal with Mitsubishi.
In the face of a white knight defense, Oji could seek injunctive relief from the courts, although it has not yet made a move in that direction. Last year, Internet marketer Livedoor’s attempted takeover of Nippon Television led the target’s cross-shareholding partner, Fuji Television, to issue a flood of warrants to dilute Livedoor’s stake. The court issued an injunction to block the issue of the warrants. Should a deal go through, the combination of Oji and Hokuetsu would form the world’s fifth-largest paper company.
Thanks to Kevin Miller of Alston & Bird, below is a summary of the comments submitted to the SEC on proposed NASD Rule 2290 regarding fairness opinions (Release No. 34-53598, April 4, 2006):
1. Association of the Bar of the City of New York
– 2290(b)(3) – strongly believes that it is ill advised (and inconsistent with the approach taken in balance of the rule) to require that members have processes to evaluate whether the amount and nature of the compensation from the transaction underlying the fairness opinion benefiting any individual officers, directors or employees or class of such persons relative to the benefits to shareholders of the company is a factor in reaching a fairness determination and suggests that if the SEC and NASD nevertheless determine to adopt such a requirement, that they incorporate a safe harbor for differential benefits approved by a committee of independent directors (along the lines of the safe harbor in recently proposed amendments to Rule 14d-10) or not exceeding a de minimus value threshold;
– 2290(a)(3) – would not support an amendment to expand disclosure of material relationships to include affiliates of companies involved in the transaction underlying the fairness opinion because of (A)the
difficulty in obtaining information in the tight time frame many fairness opinions are prepared; (B) would necessitate conveying information across internal informational barriers erected in part to avoid conflicts; and (C) would unnecessarily risk inaccuracies, particularly in light of duplicative information (at least with respect to the member’s client and its affiliates) required by Item 1015 of Regulation M-A;
– 2290(a)(1), (2) and (3) – would not support an amendment to require that fee
disclosures be quantified, though would support additional disclosure if such amounts exceeded 5% of the member’s revenue, assets or market capitalization;
– would not support an amendment to require that contingent fees or other relationships be characterized as conflicts of interest;
– believes it unnecessary and inappropriate to consider expanding required disclosure to cover material relationships between parties to the transaction underlying the fairness opinion and affiliates of the member providing the opinion because of the difficulty in obtaining such information due to (A) the complex nature of large, diverse, global financial services companies of which many members are a part; (B) the existence of informational barriers addressing important legal and regulatory issues; and (C) privacy laws that may exist in certain jurisdictions – also notes that it may be counterproductive to require members to inform themselves of material relationships that could pose a conflict when they might otherwise have remained unaware of the relationship with the member’s affiliate;
– in response to query regarding a possible requirement that members disclose the type of verification they undertook with respect to information provided by their client that formed a substantial basis for the member’s fairness opinion, notes that the current practice is for members to disclose in their opinions that they do not independently verify any information and assume the accuracy and completeness of all information they are provided or rely upon – would not oppose a rule requiring disclosure of the current practice whether as a general matter or with respect to each category of information that provided a substantial basis for the opinion;
– continues to believe it impractical and inappropriate, and would not support an amendment requiring members, to verify or obtain verification for information provided by their client that formed a substantial basis for the member’s fairness opinion – members often don’t have adequate familiarity, time or expertise to verify information and much of the information on which they rely is inherently unverifiable;
– does not believe it necessary to disclose the procedures utilized in the fairness opinion; and
– a variety of technical comments seeking clarification and addressing wording issues. Otherwise generally supportive of proposed rule as currently drafted
2. Houlihan Lokey Howard & Zukin Capital
– supports quantification of fee disclosures required by 2290(a)(1), (2) and (3), including disclosure of the amount of the fee for rendering a fairness opinion and the amount of the overall fee contingent on completion of the transaction;
– supports disclosure of “material” or “significant” relationships rather than “conflicts of interest”;
– does not support requirement that members describe the type of verification they undertook with respect to information that formed a
substantial basis of their opinion and does not support requirement that they obtain independent verification; and
– supports rule requiring procedures designed to ensure appropriate internal review of fairness opinions but does not believe additional disclosure regarding such procedures is necessary, as other rules and current proxy disclosure requirements are adequate.
3. Securities Industry Association
– Scope of 2290 – overbroad and vague – should only apply to opinions “reasonably likely to be included or summarized or referred to in disclosure documents required to be filed with the SEC;
– 2290(a)(1) – technical suggestion modifying language of rule to apply to “financial advisor to any company that is a party to the transaction” rather than “financial advisor to any transaction”;
– 2290(a)(2) – generally supportive of requirement that members be required to disclose fees or payments contingent on consummation of transaction but requests clarification that such requirement only apply to fees or payments from parties to a transaction and that the proposed rule not require members to collect information over internal informational barriers established for regulatory purposes; not supportive of any requirement that fees be quantified or that contingent fees or prior relationships be characterized as conflicts;
– 2290(a)(3) – suggests limiting required disclosure of material relationships between member and parties to the subject transaction to financial advisory services, underwritings and capital markets services, lending and financing arrangements, and merchant banking or private equity relationships involving direct equity investments in parties to the subject transaction, but not market making, asset management or research coverage; believes extending disclosure requirement to material relationships between parties to the transaction and affiliates of the member would be difficult unless limited to affiliates that are consolidated subsidiaries of the member or its parent holding company;
– 2290(a)(4) – not supportive of a requirement that members independently verify information supplied by its client that formed a substantial basis for the fairness opinion or obtain independent verification of such information;
– 2290(a)(5) – supports requirement that fairness opinions disclose whether the opinion was approved or issued by a fairness committee;
– 2290(b)(1) – generally supportive of requirement that members have procedures addressing the process by which fairness opinions are approved provided rule clarified to permit members of fairness committee to “advise” deal team with respect to appropriate negotiating strategies, etc. in the ordinary course;
– 2290(b)(2) – supports requirement that members have procedures that address the process by which fairness opinions are approved, including the process to determine whether the valuation analyses were
– 2290(b)(3) – believes it inappropriate to require members to adopt policies or procedures to evaluate the amount and nature of compensation that individual officers, directors or employees will receive from the underlying transaction relative to other parties.
4. Council of Institutional Investors
– Supports proposed Rule 2290 and encourages SEC to work with other exchanges to ensure adoption of similar rules.
5. Sutter Securities
– Supports the required disclosures and procedures in the proposed rule but suggests rule be augmented to require procedures to (i) determine the circumstances under which an opinion should be updated and (ii) address, prior to public distribution of a fairness opinion in a proxy statement or similar document whether the opinion should be reaffirmed or withdrawn. Also suggests that if the date of an opinion in a proxy statement is not proximate to the date of the proxy statement, the member should be required to disclose the basis on which it determined not to update its opinion. [Note: not clear how the latter is to be accomplished as the member does not control the content or date of the proxy statement or whether its client desires/requests a bring-down opinion]
6. Donna Hitscherich, Columbia University Graduate School of Business
– References co-authored research paper entitled “Banker Fees and Acquisition Premia for Targets in Cash Tender Offers: Challenges to the Popular Wisdom on Banker Conflicts” which concludes that there is no evidence that a higher proportion of contingent fees or previous work for acquirors have an adverse impact on acquisition premia.
7. Michael Kane, President and CEO, Kane & Company
– Supports quantification of compensation arrangements where disclosure of such arrangements is required by proposed Rule 2290 and supports requirement that members state that a conflict may exist and describing the impact of such conflict on the fairness opinion, including a description of the compensation structure (whether or not contingent) and the amounts at stake;
– Supports a disclosure requirement covering material relationships between the parties to the transaction and affiliates of the member providing the fairness opinion;
– Does not support a potential requirement that members verify information or obtain independent verification; and
– Does not support a potential requirement that members disclose the procedures utilized in fairness opinions – current proxy disclosure is adequate.
News from GovernanceMetrics International’s “In Focus”: The European Commission has been busy trying to quash “golden share” veto takeover powers currently used by several EU member countries to protect key companies. The commission is seeking to open up markets and reduce government control of business. The EC has filed suit against Italy for maintaining golden shares at privatized companies that were formerly state-owned monopolies such as oil company Eni, power utility Enel and telephone utility Telecom Italia. Hungary is also the subject of likely suits, as it has yet to repeal the golden shares it holds over 31 companies in various industries, a repeal it promised to enact before joining the EU in 2004.
EU regulators are also eyeing Germany for its restrictions on the sale of Bankgesellschaft Berlin, the former state-owned German bank which was bailed out by the EU. Germany is restricting the use of the bank’s valuable “Sparkasse” trade name by any potential buyer, but the EC insists that the brand is a key asset of the company and must be offered as part of a sale. Bankgesellschaft Berlin is scheduled to be sold to a non-government buyer during 2007. Throughout Europe, the EC has been arguing that government protections must be limited to only specific areas, such as defense and security.