On Friday, Chancellor Chandler of the Delaware Court of Chancery again enjoined Caremark from proceeding with its meeting of stockholders to vote on its proposed merger with CVS. The Chancellor granted the injunction based on two disclosure issues, one regarding investment banker compensation, the other regarding the triggering of appraisal rights under Delaware law. We have posted a copy of the opinion in our “M&A Litigation” Portal.
Here is some analysis of the case from Travis Laster of Abrams & Laster: There are several key points in the opinion for M&A practitioners. First, the Chancellor criticized the combination of deal protection measures in the Caremark-CVS merger-of-equals. The combination is one that many M&A practitioners would regard as relatively standard: an approximately 3% breakup fee, a no shop with a superior proposal out, and a 5-day last-look matching right for CVS. The Chancellor rejected the view that these provisions are beyond question because they are a “customary set of devices.” (p. 11 n.10).
He instead cautioned that any analysis of deal protection devices must depend on the facts: “[A] court focuses upon ‘the real world risks and prospects confronting [directors] when they agreed to the deal protections.’ That analysis will, by necessity, require the Court to consider a number of factors, including without limitation: the overall size of the termination fee, as well as its percentage value; the benefit to shareholders, including a premium (if any) that directors seek to protect; the absolute size of the transaction, as well as the relative size of the partners to the merger; the degree to which a counterparty found such protections to be crucial to the deal, bearing in mind differences in bargaining power; and the preclusiveness or coercive power of all deal protections included in a transaction, taken as a whole. The inquiry, by its very nature fact intensive, cannot be reduced to a mathematical equation. Though a ‘3% rule’ for termination fees might be convenient for transaction planners, it is simply too blunt an instrument, too subject to abuse, for this Court to bless as a blanket rule.” Id. (citation omitted).
The Chancellor did not in fact rule on the deal-protection measures because, in his words, “I conclude that plaintiffs are not subject to any irreparable harm so long as shareholders are given the opportunity to exercise a fully-informed vote.” This, of course, necessarily means that the Chancellor did not find the combination of measures to be coercive or preclusive: If he had, the measures would interfere with the stockholder vote.
In light of this holding and the lack of any definitive guidance in the opinion, the Chancellor’s comments may well be a rhetorical effort to restrain the customary level of termination fees, which started years back at 1-2%, climbed to 2-3%, and now rests in the 3-4% range. It also remains to be seen whether the Court’s language will have any impact on the ability of defendants to obtain dismissals of complaints challenging what previously would have been seen as garden-variety combinations of defensive measures. I predict it will not.
Second, the Chancellor held that the disclosures regarding the Caremark investment bankers’ $35 million fee were materially misleading because they did not make clear that the bulk of the investment bankers’ fees, as a practical matter, were contingent upon their opining in favor of a Caremark-CVS deal. Caremark’s two bankers stood to receive $1.5 million each if they issued opinions as to the advisability of the Caremark/CVS merger, regardless of the conclusion. Upon the consummation of the transaction, each would receive an additional $17.5 million.
The bankers also would receive their additional $17.5 million if, after the announcement of the merger, Caremark completed a similar transaction within nine months. The Chancellor noted that as a technical matter, the $35 million was contingent upon opining in favor of the merger, because the bankers had no ability to receive their full fee if they did not. The Chancellor found the proxy to be materially misleading because it failed to explain adequately the contingent nature of the $35 million, which gave the bankers an incentive to approve the deal.
Third, the Chancellor found that Caremark and CVS’s agreement to issue a special dividend in connection with the merger triggered appraisal rights in what otherwise was a stock-for-stock merger to which appraisal rights would not have applied. Concluding that the Caremark $6 special dividend “is fundamentally cash consideration paid to Caremark shareholders on behalf of CVS,” the Chancellor held that this constituted consideration other than publicly traded stock of the acquirer and hence gave rise to appraisal rights.
The Chancellor rejected an argument that the dividend had independent legal significance and was therefore not merger consideration triggering appraisal rights. This holding has significant implications for transactional planners in stock-for-stock deals: bumps in an exchange ratio will not trigger appraisal rights, but bumps in the form of cash, whether by dividend or directly in the merger, will trigger appraisal rights.
Fourth, the Chancellor noted in the footnote the distinction between (i) a merger agreement provision that maintains the existing indemnification rights of officers and directors under a corporation’s charter and bylaws and (ii) a provision that provides additional, direct contractual indemnification rights from the acquirer. See p. 30 n.33.
The former are clearly limited by the scope of Section 145 of the General Corporation Law; the latter arguably are not. (In what would seem to be a typographical error, the Chancellor refers to Section 102(b)(7), rather than to Section 145). In my experience, practitioners who do not deal regularly with indemnification rights often are unaware of or do not focus on this important distinction.
The Chancellor concludes by enjoining Caremark from proceeding with the meeting for a period of 20 days after the issuance of supplemental disclosures, which he notes corresponds to the notice period required by the appraisal statute.
In addition to these highlights, the opinion contains a number of other comments that give flavor to the decision. A full read is necessary to infer how the Court viewed the transaction and the related process.
Here is an article from Sunday’s NY Times: When hedge funds buy shares of a company and start agitating for changes in the way it is being managed, they may seem to be gunning for a quick killing at the expense of longer-term shareholders.
But, in fact, the evidence shows that for the most part, buy-and-hold investors ought to cheer when hedge funds jump aggressively into a stock, according to a new study. Titled “Hedge Fund Activism, Corporate Governance and Firm Performance,” it was written by Alon Brav, a finance professor at Duke; Wei Jiang, an associate professor of finance and economics at Columbia; Frank Partnoy, a law professor at the University of San Diego; and Randall S. Thomas, a professor of law and business at Vanderbilt. The study has been circulating in academic circles since the fall.
The authors examined nearly 900 instances from 2001 through 2005 of what they call hedge fund activism. The professors compiled their database in large part from the reports that hedge funds must file with the Securities and Exchange Commission whenever they acquire at least 5 percent of a company’s outstanding shares and intend to get involved in running the company.
Though the professors concede that they have no way to know whether their sample included every instance over this five-year period of hedge funds trying to change a company’s behavior, they write that they believe the sample “includes all the important events.” Included in the professors’ database are not only aggressively hostile actions like threats of lawsuits, proxy fights and takeovers, but also offers to help management enact policies intended to bolster the company’s stock price. Inherent in such cases, Professor Brav said, is an implied threat of hostile actions if management rebuffs those offers.
The professors found that the stock of the average company singled out by a hedge fund outperformed the overall market by 7 percentage points over a four-week period: the two weeks before and the two weeks after the hedge fund’s public acknowledgment that it was aiming at the company. Why would a stock start moving two weeks before the public announcement? One possible factor, Professor Brav said, is heavy buying by the hedge funds. After all, hedge funds have two weeks after obtaining a 5 percent stake in a company to report their ownership stake in a public filing.
If hedge funds did nothing to improve the target company’s profitability, this short-term boost to its stock price would be temporary, and the stock would fall back. But that is not what the professors found.
In the year after that initial month of market-beating performance, the average target company’s stock kept pace with the overall market. And over the subsequent two years, the professors also found, the operating performance of the target companies improved markedly.
As an example, Professor Brav referred to the continuing efforts of Pirate Capital, a hedge fund, to raise the stock price of Walter Industries, a widely diversified industrial company. In May 2005, Pirate Capital indicated in a public filing that it had acquired more than 5 percent of the company’s shares. In a letter sent that month to Walter Industries’ management, Pirate Capital made a number of proposals that it said would bolster the company’s stock, like spinning off certain of its divisions. The hedge fund indicated that, if management refused to act on the proposals, it would try to elect new directors at the next shareholder meeting. In the nearly two years since then, the management of Walters Industries has put into effect many of Pirate Capital’s proposals, and the stock price has outperformed that of the average stock in its industry.
In finding that the market’s reaction to this type of activism was the rule, not the exception, the professors concluded that the average long-term investor in companies singled out by hedge funds has benefited significantly. Because only a little over a year has passed since the end of his sample period, Professor Brav conceded that it was theoretically possible that the companies singled out by hedge funds would be worse off over the longer term. But he asserted that the data compiled for the study provided little support for this possibility, and that he thought it was unlikely.
The professors also examined whether hedge funds that try to change corporate behavior typically focus more on the short term or the long term. They found that in nearly half the cases they studied, the hedge fund still owned a large stake in the target company in October 2006. And in those cases when the hedge fund had sold its stake, the average holding period was close to one year. From this evidence, the professors conclude that “activist hedge funds are not excessively short term in focus.”
“Hedge funds provide an example of effective shareholder activism,” Professor Brav says. He noted that “when other institutional investors engage in activism — such as pension funds or mutual funds — they typically have not been effective in improving firm performance.”
Given this new research, it makes sense for investors to pay close attention to the holdings of activist hedge funds. One approach, of course, would be to buy stock of a target company immediately after a hedge fund notifies the S.E.C. that it has acquired at least a 5 percent stake, with the intention of getting involved in running the company. Professor Brav cautions that such a stock will have already begun to outperform the market by the time an investor buys it. But if the pattern in the study holds, that stock should also continue outperforming for at least a couple of more weeks.
As more investors jump into the target companies, however, beating the market this way could become more challenging.
Yesterday, Chancellor Chandler of the Delaware Court of Chancery enjoined any stockholder vote on the pending merger between Caremark and Express Scripts until not earlier than March 9th. The Chancellor issued his decision because of the materiality of supplemental disclosures made by Caremark on February 12th, just 8 days before the stockholder vote scheduled for February 20th. We have posted a copy of the opinion in the “M&A Litigation” Portal.
Here is some analysis from Travis Laster of Abrams & Laster: The 8 days provided by Caremark was definitely towards the short end of the spectrum for supplemental disclosures, but it was not unprecedented. The Chancellor instead appears to have been influenced by the combination of the brief time period and the his view of the significance of the disclosures, which included “the revelation that Caremark has considered, on at least three separate occasions, potential transactions with Express Scripts.”
The Chancellor juxtaposed this disclosure with the Caremark board’s “present protestations that antitrust difficulties loom so large as to prevent the board of directors from even discussing an offer with an admittedly higher dollar value.” (Emphasis in original). The Chancellor also noted the materiality of Caremark’s disclosure that the CVS merger would extinguish stockholder standing to pursue derivative litigation regarding claims for stock option backdating. This statement comes on the heals of the Chancellor’s two recent and quite strong decisions criticizing stock option practices.
At 2 typed pages, the opinion is quite short and worth a first-hand read, particularly for deal counsel and litigators who frequently must consider whether – and when – to make supplemental disclosures.
From ISS’ Friday Report: This year, individual shareholders are taking the lead in filing proposals that target takeover defenses, such as classified boards, “poison pill” plans, supermajority voting rules, and requirements for holding special meetings.
Proposals to declassify corporate boards will be well represented this proxy season. As of Feb. 5, ISS was tracking more than 40 such proposals. Labor pension funds submitted seven resolutions, including a third-time proposal filed at Peabody Energy by the AFL-CIO. Peabody says the proposal was intended to “pressure the company into adopting policies being promoted by union officials that would be detrimental” to the firm, shareholders, and employees.
The Amalgamated Bank’s LongView fund has withdrawn a declassification proposal at Martek Biosciences after the company adopted the proposal. New York City’s pension funds have also filed proposals to declassify boards, as have a number of individual shareholders. In recent years, U.S. companies have become increasingly receptive to this governance reform. A majority of S&P 500 firms now allow for the annual election of all directors, according to an ISS study on boards at S&P “Super 1,500” companies.
Several issuers that have begun the process of declassifying their boards or plan to put the matter to a shareholder vote have asked for “no-action” letters from the Securities and Exchange Commission on the grounds that the proposals have been “substantially implemented.” These companies include Avista, Lear, Piper Jaffrey, and Visteon. Three other proposals to declassify boards have been withdrawn in the face of no-action challenges.
Individual shareholders thus far appear to be the only proponents who have submitted resolutions to limit poison pills, according to ISS records, with a total of 18 filed. Hewlett-Packard sought to exclude a poison pill bylaw proposal filed by investor Nick Rossi, but the SEC staff rejected that request on Dec. 21. Boeing, Home Depot, and Honeywell have asked the SEC for permission to exclude similar proposals. Honeywell argued that it has “substantially implemented” the proposal by adopting a new pill policy in December.
At Walt Disney’s annual meeting on March 8, investors will vote on a bylaw proposal by Harvard Law Professor Lucian Bebchuk that calls for a 75 percent vote by directors to adopt or amend a poison pill plan and would impose a one-year limit on pills that are not ratified by shareholders. Management opposes the proposal, arguing that it would limit the board’s ability to respond to hostile takeover offers and may not be enforceable under Delaware law. The media-and-entertainment company also warns that the 75 percent threshold would allow “a small group of directors” (such as representatives of an acquirer) “to block action that other directors believe is in the best interests of shareholders.”
A similar Bebchuk bylaw proposal received 48.5 percent support at CA last year and prompted the business software company to modify its pill and agree to put the defense to a shareholder vote.
Members of the Chevedden, Rossi, and Steiner families have filed 20 proposals this year seeking to strengthen shareholder rights to call special meetings. The proposal calls for boards to amend bylaws to give “holders of 10 percent of outstanding common stock the power to call a special shareholder meeting.”
Shareholder activist Evelyn Y. Davis has submitted at least 14 proposals calling for cumulative voting. Her targets this year include Aetna, General Electric, IBM, Safeway, and Bank of New York. Other individual investors have filed another 10 proposals. Last season, ISS tracked 23 proposals calling on companies to allow for cumulative voting that went to a vote between Jan. 1, and June 30, 2006. Average support for those proposals amounted to 39.8 percent.
Proposals to eliminate supermajority vote requirements also will be well represented this season, according to ISS records. Thirty such proposals were filed prior to Jan. 1, with slightly more than half by members of the California-based Rossi family. The California Public Employees’ Retirement System also intends to file proposals on the issue, fund officials tell ISS. Proponents intend to capitalize on strong support for such proposals in recent years. Last year, resolutions to eliminate supermajority requirements averaged 67.8 percent support for 19 proposals that came to a vote between Jan. 1 and June 30, according to ISS records.
While labor funds are less focused this year on takeover defense-related measures, they continue to file at companies that have failed to act on past majority votes on shareholder proposals. This year, union funds will be filing proposals asking companies to create committees to respond to cases where a majority of shareholders supported a resolution and the company failed to act.
The International Brotherhood of Electrical Workers (IBEW) filed such a proposal at Genzyme (where an IBEW-filed golden parachute proposal won 57.9 percent of votes cast last year) and at OfficeMax, where a similar IBEW proposal received 53 percent support in 2006.
Companies Take Action
Meanwhile, a number of companies have acted to dismantle takeover defenses. Last year, at least seven firms, including Amgen, Hilton Hotels, Motorola, and Newell Rubbermaid, terminated their poison pills following majority votes for shareholder proposals requesting the redemption or submission for investor approval of any pill.
Last month, the board of McKesson, a San Francisco-based healthcare services firm, amended the company’s poison pill to let it expire on Jan. 31. The board also agreed to ask shareholders to vote to institute annual elections for all directors.
“These actions demonstrate our board’s continuing commitment to strong, stockholder-focused, contemporary corporate governance practices, which we believe are consistent with our goal of creating long-term, sustainable value for McKesson stockholders,” John H. Hammergren, the company’s chairman and chief executive officer, said in a statement.
In December, Schering-Plough said it will rescind its poison pill and accelerate the declassification of its board from 2008 to this year’s annual meeting. The New Jersey-based pharmaceutical company also plans to recommend that shareholders vote to reduce the 80 percent supermajority requirement to simple majority approval for the removal of directors, and for mergers and acquisitions.
Marathon Oil and IBM recently said in regulatory filings that they will ask for shareholder approval at their 2007 annual meetings to eliminate supermajority voting rules. 3M, FedEx, and Lockheed Martin are among other companies that recently lowered their vote requirements, according to The Wall Street Journal.
From today’s WSJ, which includes this blurb from Breakingviews.com: ‘Go shop” provisions have become a common feature of the LBO landscape. These clauses are meant to sound shareholder-friendly because they lock in a bidder while allowing a board to beat the bushes for others. So how to explain the extra $3 billion that EOP extracted for shareholders after agreeing to a “no shop” with Blackstone in November?
As the jargon implies, a “no shop” limits boards from soliciting rival offers. So “go shops” must be better for shareholders, right? Not so fast. Two of the biggest buyouts of the past year, of hospital chain HCA and chip maker Freescale, included “go shop” clauses. And in neither case did competitors emerge.
This is partly why investors regard “go shops” with suspicion. They see it as a form of legal cover for independent directors worried they will be perceived as favoring managers buying out the companies they run on the cheap. But that leaves the question of how EOP, despite a “no shop,” got such a robust battle going between Blackstone and Vornado.
Rather more critical to the outcome was the size of the fee that anyone wanting to top Blackstone’s first bid would have had to pay. At the outset, EOP insisted on just a 1% break fee, well below the industry standard of 3%. As a carrot to Blackstone, EOP ratcheted that up as the private-equity firm raised its offer.
This suggests that what’s more important than the shopping label is the intent of directors to seek the highest price. And an extra low break fee is a better signal that directors are looking out for shareholders.
Travis Laster reports: Here is a case is one that may slip under the radar but which has implications for proxy contests for minority board seats. In FGC Holdings Ltd. v. Teltronics, C.A. No. 883 (Del. Ch. Jan. 22, 2007), Vice Chancellor Parsons held that a director was NOT entitled to indemnification for fees and expenses incurred enforcing his entitlement to be seated as a director. Vice Chancellor Parsons held that for purposes of Section 145(a) and (b) of the General Corporation Law, the plaintiff could not meet the “is or was a director” requirement because he was not yet a director at the time he incurred the fees and expenses.
Vice Chancellor Parsons also denied the request for mandatory indemnification under Section 145(c) for a proceeding in which the director had been “successful on the merits or otherwise” because mandatory indemnification also requires that the individual meet the covered capacity requirements of Section 145(a) and (b).
FGC Holdings was issued in connection with an attempt to enforce the right of a preferred stockholder to seat a director to which they were entitled under a certificate of designations. The same analysis, however, should apply to seated directors’ efforts to obtain indemnification for expenses incurred in successful proxy contests for minority board seats. It will not affect successful proxy contests for board majorities, who can simply vote to reimburse themselves their expenses.