From a Cleary Gottlieb memo regarding the Sulzer no-action letter: Rule 14e-5 generally prohibits any person that has announced a tender offer for equity securities (and certain related persons, advisors, agents and others acting in concert with them) from directly or indirectly purchasing or arranging to purchase the securities subject to the tender offer (or other securities convertible into, or exchangeable or exercisable for, the subject securities) outside of the tender offer. While there are clear policy reasons for this Rule (including ensuring that the offeror treat all shareholders of the subject company equally), many other jurisdictions, notably the United Kingdom, allow purchases by the offeror outside of the tender offer so long as, among other conditions, the offeror raises the tender offer price to match the highest price paid to any shareholder outside the tender offer.
In this way, the offeror is able to benefit from lower market prices that often exist prior to the expiration of the tender offer and to more quickly approach satisfaction of the tender offer’s minimum acceptance condition. Moreover, those shareholders that do not wish to wait until the close of the tender offer to sell their shares will have another source of liquidity in the market allowing them to do so. Given the potential cost savings and strategic benefits to the offeror, making such purchases is sometimes viewed as an important part of the offeror’s strategy in non-US acquisitions.
The SEC recognized this conflict when, in late 1999, it adopted a broad set of rules designed to encourage bidders to extend tender and exchange offers to US securityholders of foreign private issuers. Under these rules, an offer that qualified for “Tier I” relief was expressly exempt from the Rule 14e-5 prohibitions on purchases outside the tender offer (subject to limited conditions). Until very recently, however, no-action relief from the SEC was required on a case-by-case basis to permit a bidder to make such purchases in connection with offers for foreign private issuers that did not qualify for Tier I relief. The SEC was requested to, and did, grant such case-by-case relief in a fairly long line of noaction letters.
As part of its continuing efforts to harmonize US and foreign rules, the SEC has recently decided that Rule 14e-5’s prohibition on purchases that are permitted under the rules of a target’s home jurisdiction is not fully consistent with the SEC’s policy of encouraging bidders to extend tender and exchange offers to US securityholders. In a letter dated March 2, 2007, the SEC granted class-wide exemptive relief under Rule 14e-5 to offerors that wish to purchase shares of a foreign private issuer target outside of the tender offer in certain prescribed circumstances. To qualify for this relief, the offeror must reasonably intend to rely on “Tier II” exemptive relief under Rule 14d-1(d) of the Exchange Act, which means essentially that the target must be a foreign private issuer with no more than 40% of the subject class of securities held by US residents.
Additionally, the laws of the target’s “home jurisdiction” (i.e., both the jurisdiction of the target’s incorporation and the principal non-US market in which the target’s securities are listed or quoted, if different) must permit purchases outside of the tender offer and provide that the tender offer price be increased to match any consideration paid outside of the tender offer that is higher than the tender offer price. The SEC and the home jurisdiction(s) must be parties to a bilateral or multilateral memorandum of understanding regarding consultation and cooperation in the administration and enforcement of securities laws, and the US offering materials must prominently disclose the possibility of purchases being made outside the tender offer. (Here is a list of the countries with which the SEC has bilateral MOUs.)
Significantly, no such purchases may be made in the United States. Finally, there are a number of other requirements regarding disclosure of purchases to the public and the SEC.
In sum, the SEC continues to encourage bidders in cross-border tender offers for the securities of foreign private issuers to extend those offers to US securityholders. Where this latest class-wide relief is not available, we understand that the SEC will continue to consider requests for relief on a case-by-case basis and may provide such relief in appropriate circumstances.
Deal Protection: The Latest Developments
We have posted the transcript from our recent webcast: “Deal Protection: The Latest Developments.”
We have just sent our March-April issue of our new newsletter – Deal Lawyers – to the printer. Join the many others that have discovered how Deal Lawyers provides the same rewarding experience as reading The Corporate Counsel. To illustrate this point, we have posted the March-April issue of the Deal Lawyers print newsletter for you to check out at no charge. Feel free to share it with your deal-minded brethren.
This issue includes pieces on:
– Private Equity Clubs: Seller Beware? Latest Developments and Practice Tips
– Falling into the “Going Private” Trap: A Cautionary Tale for Private Equity Fund Buyers
– In Vogue: The “Entire Fairness” Doctrine
– The Practice Corner: Special Committees
– The “Sample Language” Corner: Providing for a California Fairness Hearing
– An M&A Conversation with Chief Justice Myron Steele
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From Travis Laster: Last week, Vice Chancellor Strine of the Delaware Court of Chancery issued an opinion – In re: Netsmart Technologies – enjoining the cash sale of a small public corporation to a private equity firm until the directors (i) supplemented the disclosures regarding the sale process and (ii) disclosed their investment bankers’ projections. Vice Chancellor Strine was quite critical of the sale process used in the case, which he described as “a microcosm of a current dynamic in the mergers and acquisitions market.” Here are some high points from the 75-page opinion (ed. note: we have posted memos analyzing the opinion in the “Auctions” Practice Area):
1. VC Strine found that the Board and Special Committee did not act reasonably in failing to contact strategic buyers. The defendants attempted to justify this refusal based on sporadic contacts with strategic buyers over the half-decade preceding the deal. VC Strine held that “[t]he record, as it currently stands, manifests no reasonable, factual basis for the board’s conclusion that strategic buyers in 2006 would not have been interested in Netsmart as it existed at that time.” In later discussion, he carefully distinguished such informal contacts from a targeted, private sales effort in which authorized representatives seek out a buyer. He viewed the record evidence regarding prior contacts as “more indicative of an after-the-fact justification for a decision already made, than of a genuine and reasonably-informed evaluation of whether a targeted search might bear fruit.”
2. VC Strine rejected a post-agreement market check involving a standard window-shop and 3% termination fee as a viable method for maximizing value for a micro-cap company. He noted that such an approach has “little basis in an actual consideration of the M&A market dynamics relevant to the situation Netsmart faced” and would not have attracted topping bids “in the same manner it has worked … in large-cap strategic deals.”
3. VC Strine was quite critical of the lack of minutes for key board and Special Committee meetings, as well as the fact that most of the minutes were prepared in omnibus fashion after the litigation was filed.
4. VC Strine criticized the Special Committee for permitting management to conduct the due diligence process without supervision. “In easily imagined circumstances, this approach to due diligence could be highly problematic. If management had an incentive to favor a particular bidder (or type of bidder), it could use the due diligence process to its advantage, by using different body language and different verbal emphasis with different bidders. ‘She’s fine’ can mean different things depending on how it is said.” The Vice Chancellor ultimately found no harm, no foul on this issue because management did not have a favored PE backer and there was no evidence that they tilted the process in favor of any participant.
5. VC Strine found that the proxy’s disclosures regarding the company’s process and its reasons for not pursuing strategic buyers had no basis in fact. Adhering to his opinion in Pure Resources, he also found that the latest management projections relied on by the Special Committee and their financial advisor in its fairness opinion needed to be disclosed.
Each of these issues underscores the benefits of bringing Delaware counsel into the transactional process early, both for purposes of structuring the exploration of alternatives and reviewing the proxy statement. The issues that VC Strine addresses in his opinion are frequent subjects of counseling by Delaware practitioners. Although this is the first opinion to bring many of them to judicial light, all have been on the radar screen for some time. There are many other nuggets to be gleaned from this important decision, particularly for those of us currently involved in processes with PE players (and in this market, who isn’t?).
Regarding the latest Caremark decision, there seems to be a fair amount of confusion regarding the structure of the fees payable to Caremark’s investment bankers leading the Delaware Chancery Court to believe that additional, corrective disclosure is required and, in part, justified injunctive relief. In an attempt to resolve such confusion, a more detailed discussion and analysis/explanation of the fee arrangements seems appropriate (albeit by someone not involved in the transaction and without access to the actual engagement letters):
According to the decision: “By their terms, both the UBS and JP Morgan agreements require an opinion as to the advisability of the Caremark/CVS merger in the first instance. Such an opinion, regardless of the conclusion reached therein, triggers the payment of $1.5 million to each advisor. Upon the consummation of the transaction (the Caremark/CVS merger) or alternative transaction (i.e., a merger with a third party) within a specified time period, an additional $17.5 million becomes payable to each company. As a technical matter, the financial advisors must approve the CVS/Caremark merger to trigger their respective $17.5 million fees. Both the UBS and JP Morgan agreements state that “in the event that, following the public announcement of a Transaction with the Counterparty [CVS], the Company pursues a transaction structured in a manner contemplated by the definition of “Transaction” herein, with a third party other than the Counterparty (an “Alternative Transaction”)…with nine months,” the $17.5 million fee becomes payable.”
While it may not be exactly the way negotiations transpired, I believe the following story/mock negotiation explains the motives of the parties and why the UBS and JP Morgan fee structures reflect a rational fee structure intended to protect both sides and should not be assumed to be unique or unusual, much less suspect, in the MOE context.
First, from Caremark’s perspective, Caremark is engaging UBS and JP Morgan as its financial advisors with respect to a specific transaction – the proposed merger of equals with CVS. Caremark is not asking for advice on and, most importantly, does not want to pay UBS or JP Morgan a fee if it pursues a different transaction following the termination of negotiations with CVS. [Note: Caremark is not in Revlon mode and is not trying to sell itself to whomever is willing to pay the highest price. It has a specific long term value maximizing strategy in mind.] This fee structure is the most common structure in buyside engagement letters (where a buyer hires an advisor to help pursue a specific target) and consequently it should not be surprising that its structure has spilled over into MOE engagement letters which have elements of buyside and sellside.
Next, Caremark presumably proposes that it pay the agreed fee of $19 million to each advisor upon the consummation of the contemplated transaction. This ensures that Caremark will not be required to pay UBS and JP Morgan substantial fees if its discussions with CVS terminate or a deal with CVS doesn’t otherwise pan out. The contingent nature of the fee means that Caremark will only be required to pay its advisors if it consummates a transaction providing substantial benefits to its shareholders. [Note: In TCI, the same Chancellor questioned contingent fees for financial advisors to special committees but did not seem to question contingent fees payable to a company’s financial advisors. It is also worth noting that, if they could, bankers would love to be paid on a noncontingent basis.]
UBS and JP Morgan presumably raised two issues regarding Caremark’s fee proposal:
1. The financial advisors would point out that Caremark will likely request a fairness opinion in connection with the contemplated transaction with CVS and the financial advisors should receive a portion of their fees upon the rendering of any such opinion – after all such opinions aren’t without risk and shouldn’t be free. UBS and JP Morgan can’t request to be paid for rendering an opinion on any other transaction as they had not been engaged to advise on any other transaction.
They can only request an opinion fee for rendering a fairness opinion with respect to a transaction with CVS because that is the transaction on which they have been engaged to advise. Presumably, Caremark accepts this argument and agrees to pay a small portion of their financial advisors’ fees upon receipt of their fairness opinion, regardless of the conclusion reached therein. [Note: Caremark continues to insist that a substantial portion of the bankers’ fees be contingent on consummation of a transaction in order to avoid paying large sums to its advisors in the absence of a transaction providing substantial benefits to its shareholders.]
2. UBS and JP Morgan point out that, as a practical matter, the public announcement of a Transaction with CVS will likely put Caremark “in play”, susceptible to rival bids, etc. and it would not be fair for UBS and JP Morgan not to get paid if their hard work in assisting Caremark on the proposed CVS deal ultimately resulted in Caremark engaging in transaction providing even greater benefits to Caremark’s shareholders. [Note: this type of backstop/fee protection is common in sellside engagement letters where a target engages financial advisors with respect to a potential stock-for-stock strategic transaction with a specific buyer but recognizes that once a transaction is announced, anything can happen and they may end up being sold to a rival bidder.]
UBS and JP Morgan are not asking to be compensated if Caremark engages in an alternative transaction absent the public announcement of a transaction with CVS as they weren’t engaged to advise on such transaction and couldn’t argue that their work on the CVS transaction led to such alternative transaction since the CVS transaction was never publicly announced. UBS and JP Morgan only ask to get paid if its clear that their hard work on the proposed CVS transaction leads to a superior transaction with another party because the superior transaction was proposed after the public announcement of the CVS transaction effectively put Caremark into play. [Note: this is not dissimilar to many merger agreement breakup fees that are payable if target shareholders voted the originally proposed transaction down after public announcement of an alternative transaction and an alternative transaction is subsequently consummated but are not payable if target shareholders vote the originally proposed transaction down in the absence of an alternative transaction proposal.]
Caremark likely recognizes the logic of the bankers’ position but to ensure that the “alternative transaction” truly resulted from the hard work of UBS and JP Morgan insists that it only be obligated to pay them a transaction fee if the alternative transaction is pursued within nine months of the public announcement of the CVS deal.
Finally, as the court correctly noted, there is case law that “the contingent nature of an investment banker’s fee can be material.” [emphasis added]. It is not always the case and here, once Express Scripts came forward with its alternative transaction proposal, the bankers’ fairness opinions on the original CVS transaction became irrelevant. Caremark shareholders no longer care whether the original CVS transaction was fair or the bankers had improper incentives to render a fairness opinion on that proposal. They only care about the merits of the revised CVS transaction as compared to the proposed Express Scripts transaction. To the extent the bankers’ fee structure is material, it is because the bankers have no reason to favor one bidder over the other, they get paid whichever wins, and will consequently provide unbiased advice to the Caremark board.
From Travis Laster of Abrams & Laster: In a case decided last week – Ortsman v. Green – Vice Chancellor Stephen Lamb granted a motion to expedite, finding that the complaint stated colorable claims with respect to (i) the investment banker’s involvement in the transaction and (ii) certain disclosure claims, including disclosures relating to investment banker compensation. [Because the opinion refers by number to key paragraphs in the complaint, we have posted both the complaint and opinion in our “M&A Litigation” Portal.]
VC Lamb first held that the complaint stated a colorable claim sufficient to merit expedition with respect to the role of UBS in acting as the financial advisor to Adesa and leading the sale process. After commencing the sale process, “UBS advised Adesa that it wished to be able to offer debt financing to potential acquirers.” The plaintiffs alleged that this conflict affected the sale process “when UBS advised the Adesa board not to pursue an indication of interest from a strategic buyer that UBS believed would not be interested in a leveraged transaction and, thus, would not be a source for it of fees from debt financing.”
In the Toys-R-Us decision a few years ago, Vice Chancellor Strine criticized the practice of a sell-side banker asking to participate in financing on the buy side. Notwithstanding this criticism, we see such requests with relative frequency, and it regularly creates counseling problems. VC Lamb’s grant of expedition in Adesa is proof-positive of the types of litigation risks that this practice creates.
Second, Vice Chancellor Lamb held in Adesa that the complaint stated a series of colorable disclosure claims sufficient to merit expedition. Most notable was a claim related to investment banker compensation. After UBS assumed its dual role, Adesa hired Credit Suisse to provide a fairness opinion. The proxy disclosed only that Credit Suisse received “a customary fee” for its services. The Vice Chancellor noted that “a reader of the proxy statement is not told how much Credit Suisse was paid, whether it would have received the same payment even if it was unable to render a fairness opinion at $27.85, or how much Credit Suisse has earned in recent periods from Kelso or other members of the buyer group.” The Vice Chancellor ultimately found that the 8 issues identified in paragraph 50(viii) of the complaint raised colorable disclosure claims and merited expedited discovery. At a minimum, practitioners will want to review investment banker compensation disclosures in light of this decision.
At the top to the year, I blogged extensively about issues arising from tender offers for backdated options. One of the issues related to the “prompt payment” requirement in the tender offer rules (because new Section 409A of the Internal Revenue Code requires that any cash amounts paid in connection with an option repricing be paid in the year after the option repricing; a requirement which contravenes the SEC’s prompt payment rules).
Yesterday, Corp Fin’s Office of Merger & Acquisitions issued the first exemptive letter – to CNET Networks – relating to Section 409A and the tender offer prompt payment rules.