“In their complaint the plaintiffs purport to set forth a Denny’s buffet of disclosure claims…. The first disclosure claim the plaintiffs press involves the failure of the proxy statement to disclose one of the various DCF models run by JPMorgan during its work leading up to its issuance of a fairness opinion…the proxy statement informs shareholders that the more optimistic assessment based on the [disclosed] July 2006 Plan figures resulted in a range of values between $35.90 and $45.50 per share, a range that was materially higher than the $28.59 to $38.41 span contained in the undisclosed model.
But the plaintiffs quibble because the proxy statement fails to disclose a DCF model prepared by a JP Morgan analyst early in the morning on February 1. That model used modestly more aggressive assumptions than those that formed the basis for the DCF model used in JPMorgan’s final fairness presentation. Although this model was simply the first of eight drafts circulated before a final presentation was given to the Lear board later that day, the plaintiffs say that the omission of this iteration is material….
From the record before me, it appears that the proxy statement fairly discloses the Lear management’s best estimate of the corporation’s future cash flows and the DCF model using those estimates that JPMorgan believed to be most reliable. The only evidence in the record about the iteration the plaintiffs say should be disclosed suggests that it was just one of many cases being prepared in Sinatra time by a no-doubt extremely-bright, extremely-overworked young analyst, who was charged with providing input to the senior bankers. As the plaintiffs admitted, they did not undertake in depositions to demonstrate the reliability of this iteration, much less that it somehow represented JPMorgan’s actual best effort at valuing Lear’s future cash flows.” I added the emphasis…
Some analysis from Davis Polk (copies of both opinions are in our “M&A Litigation” Portal): In back-to-back decisions late last week, the Delaware Chancery Court enjoined both The Topps Company and Lear Corporation from proceeding with shareholder votes on separate going-private transactions pending additional disclosure of material information to shareholders. While the more significant legal ruling, In re The Topps Company S’holders Litig., also grants substantive relief on a Revlon claim (which we discuss in detail below), the decisions punctuate a recent trend in the Delaware courts towards issuing disclosure injunctions. This trend underscores what appears to be heightened sensitivity in the Delaware courts to alleged conflicts of interest and the corresponding concern that stockholders be presented with full and detailed disclosure of all material facts surrounding any possible conflicts before being asked to approve an LBO or otherwise controversial transaction.
The plaintiffs in Topps (comprising both shareholder plaintiffs and a slighted bidder, Upper Deck) alleged that the Topps board of directors had breached their Revlon duties to maximize value in a sale of control transaction. The substance of the allegation was that the Topps board had unfairly favored a deal with a private equity consortium led by Michael Eisner over a competing offer from rival Upper Deck because they perceived Eisner as a friendly suitor who had pledged to retain management.
As an initial matter, the Court found no fault in the board’s decision to negotiate an exclusive deal with Eisner rather than run an auction, observing that Topps had previously conducted a failed auction for its confectionary business and that it was reasonable for its directors to conclude that another failed auction risked damage to the company. In this respect, the decision should provide great comfort to M&A participants by reaffirming that, notwithstanding the recent Netsmart decision and despite having received another indication of interest, a company may conduct exclusive merger negotiations with one party in a going-private transaction, provided it has left itself “reasonable room for an effective post-signing market check.” In this case, the most significant deal protection terms reviewed and blessed by the Court were:
– a 40-day post-signing go-shop period (“For 40 days, the Topps board could shop like Paris Hilton.”);
– a matching right (While “a useful deal protection” for buyers, they have “frequently been overcome in other real-world situations.”); and
– a 4.3% termination fee (While “a bit high in percentage terms,” the break-up fee was reasonable since it included Eisner’s expenses and “can be explained by the relatively small size of the deal.”)
However, the Court criticized Topps for failing to exercise its right to continue negotiations with Upper Deck after the go-shop period, which it could have done by declaring Upper Deck to be an “Excluded Party” that was likely to submit a “Superior Proposal.” The Court found that Upper Deck was likely to succeed on its claims that the Topps board had breached its fiduciary duties by failing to try to negotiate a better deal with Upper Deck and by failing to release Upper Deck from a standstill agreement to allow it to proceed with a tender offer for all shares and communicate directly with Topps stockholders about its version of events. The Court therefore ordered substantive relief requiring Topps to grant Upper Deck a waiver of the standstill for these purposes.
On the disclosure side, the Court further enjoined the Topps shareholder vote until Topps discloses material facts regarding a valuation presentation by Topps’s financial adviser that casts doubt on the fairness of the merger consideration, discloses certain facts about Upper Deck’s bid (i.e., its willingness to bear all antitrust risk in the transaction), and most importantly, discloses Eisner’s assurances to Topps management.
In a similar vein, the Lear Court enjoined the Lear Corporation from proceeding with a stockholder vote on a proposed $5.3 billion acquisition by Carl Icahn’s American Real Estate Partners pending supplemental disclosure of facts indicating that the CEO had “material economic motivations that differed from [the stockholders] that could have influenced his negotiating posture with Icahn.”
The Chancery Court’s readiness in these cases to delay transactions over deemed disclosure deficiencies should serve as a cautionary reminder that clearing the SEC is not the limit of the disclosure considerations on a public company transaction. Topps and Lear are the latest in a series of injunctions issued by the Court over the last three months in going-private or otherwise controversial transactions, which seem to reflect greater effort to shine a spotlight on a perceived conflict of interest or to equalize the playing field between competing bidders. Such injunctions can result in critical time delays and radically alter the landscape for a transaction (which can be particularly important in a competitive bidding situations), as well as raise the price tag of settlement negotiations with the plaintiffs bar.
The Art of the Cross-Border Deal
We have posted the transcript from our recent webcast: “The Art of the Cross-Border Deal.”
Last week, Corp Fin’s Office of Mergers & Acquisitions issued a new 409A stock option repricing exchange offer no-action responses, designed to increase the exercise price of the options to avoid the tax penalty and compensate option holders with cash for the resulting increase in the exercise price. The no-action letter is to HCC Insurance Holdings. Officer and directors are excluded from the offer – as the Staff prefers.
The novel or unique aspect that I can see is that the SEC Staff is permitting a longer than usual period for the payment of the cash consideration. This is the first time the Staff has allowed issuers to time payment of the cash offered in a 409A repricing offer to the vesting of the related options. Previously, the Staff required issuers in a 409A option repricing to make any cash payments shortly after January 1, 2008.
Under the terms of this letter, however, it appears that the Staff is allowing some additional time (i.e., until the end of the year or quarter) for the cash payment to be made. The key is that employees have a right to receive the cash once the option vests-although the cash will be paid quarterly. So in this situation, for all options vesting prior to January 1, 2008, the cash payment is earned at the date of exchange. So, if the exchange occurs in June, my options vest in October, I am fired in December of ’07, I still get the cash in January. After January, it becomes tied to vesting.
In doing so, the issuer is conditioning issuance of the cash payment on the option actually vesting and the employee still being employed with the company at the end of the period. So there is a retention element that – up to this point – for which relief had not been granted by the Staff.
Remember that the Chordiant Software letter was global exemptive relief granted by the Staff; this new HCC Insurance Holdings letter is not – and it should not relied upon by anyone else. If someone wants the HCC -type of relief, they need to approach the Staff first. My guess is that if a couple of letters do come in, the Staff may turn one of them into a global relief letter. Thanks to Jim Moloney for his help on this one!
From Travis Laster: Last Friday, Vice Chancellor Strine of the Delaware Chancery Court issued a limited, disclosure-only injunction in In re Lear Corporation Shareholders Litigation, C.A. No. 2728-VCS. The injunction directs Lear to issue a supplemental disclosure regarding the Lear’s CEO’s request to the Lear board in late 2006, prior to negotiating on an exclusive basis an all-cash going-private transaction with Carl Icahn in January and February 2007, that the board take steps to secure the CEO’s retirement benefits. Like the recent decision in Topps, Lear contains many practical lessons for private equity deals and go-shop processes. Here are some highlights from the 55-page opinion:
1. VC Strine criticized the decision by the Lear Special Committee to permit Lear’s CEO to conduct negotiations over the merger price without any direct involvement by the Special Committee or the Company’s investment banker. VC Strine nevertheless found no evidence that this decision adversely affected the overall sale process. The Court determined that the Special Committee’s general approach to obtaining the best price was reasonable because a formal pre-agreement auction presented the risk of losing Icahn’s bid, the absence of any serious interest by a third party in acquiring Lear prior to the Icahn proposal, and the go-shop process after the Icahn merger agreement secured the opportunity for Lear to solicit a higher bid.
2. Despite his concern about the CEO’s role, VC Strine found that the Special Committee proceeded reasonably in relying on a post-agreement market check. VC Strine concluded that the market was fully aware of Lear’s willingness to consider alternative transactions in light of (i) the Lear board’s redemption of its poison pill in 2004, (ii) Icahn’s purchase of a significant stake in Lear in early 2006, (iii) Icahn’s purchase of an additional $200 million of Lear stock in October 2006, which took his stake to 24%, and (iv) an aggressive post-agreement market check during which Lear’s financial advisors contacted 41 potential buyers, including both financial sponsors and strategic acquirers. VC Strine explicitly distinguished Netsmart as involving a micro-cap company without similar market dynamics.
3. The Icahn merger agreement incorporated a two-tier termination fee, with a lower fee payable during a 45-day go-shop period. After the 45 days, Lear became subject to a more traditional no-shop provision and a somewhat higher termination fee. The lower fee only would be payable, however, if the Lear board terminated the Icahn deal and entered into a topping merger before the end of the 45-day period. Icahn had a 10-day match right prior to termination. Given this timeline, VC Strine analyzed the reasonableness of the termination fee using only the higher, post go-shop figure because he concluded that the 45-day go-shop period was too short for a bidder to conduct adequate due diligence, present a topping bid, and have the Lear board make the required decision, wait out the 10-day match, and then accept the bid. He noted
that a go-shop period could be structured differently to give a lower fee to a bidder who entered the process in a meaningful way during the go-shop period, for example by signing a confidentiality agreement or making an initial proposal.
4. The post-go-shop period fee was 3.5% of equity value and 2.4% of enterprise value. VC Strine found these fees to be reasonable, noting that “[f]or purposes of considering the preclusive effect of a termination fee on a rival bidder, it is arguably more important to look at the enterprise value metric because, as is the case with Lear, most acquisitions require the buyer to pay for the company’s equity and refinance all of its debt.”
5. VC Strine commented favorably on the Lear board’s securing Icahn’s agreement to vote his shares in favor of any topping bid that the board recommended, “thus signaling Icahn’s own willingness to be a seller at the right price.”
6. VC Strine rejected all but one of the “Denny’s buffet of disclosure claims” raised by the plaintiffs. In one noteworthy ruling, he held that Lear did not have to disclose an interim version of its DCF model that generated marginally higher values: “The only evidence in the record about the iteration … suggests that it was just one of many cases being prepared in Sinatra time by a no-doubt extremely-bright, extremely-overworked young analyst….” He did, however, hold that the CEO’s interest in securing his retirement benefits in Fall 2006 required disclosure given that it created a potential incentive for the CEO to
pursue a going-private deal that was not shared with Lear’s public stockholders.
M&A practitioners will notice some familiar themes in Lear, such as the need for independent directors to be more involved in a sale process and the importance of chaperoning management. Practitioners who have followed the stapled-debt financing debate will be glad to see VC Strine’s reference to JPMorgan’s offer of stapled debt financing as part of the post-agreement market check. VC Strine cited the staple in rejecting of criticisms of the process by TACO, an Indian bidder who failed to come forward with a topping bid. Although the opinion is not explicit on this point, it seems clear from the context that VC Strine viewed the availability of the staple in this scenario as process-enhancing. It bears noting that in conjunction with giving JPMorgan the go ahead to provide the staple, the Lear board shifted control over the go-shop to Evercore to avoid creating any appearance of a potentially conflicted banker.
Lear is also the first Delaware decision to give some indication regarding when enterprise value as opposed to equity value is the more relevant metric for evaluating a termination fee. VC Strine first noted the potential use of the two metrics in the Pennaco case, but did not comment on when one would be preferable to another. Lear indicates that enterprise value should be preferred when the debt will need to be refinanced and the whole transaction is at issue, such as in an analysis of preclusiveness under Unocal or, one would expect, when a fee is structured as a liquidated damages provision. Although Lear does not say this explicitly, the converse inference is that equity value would be more relevant if the debt does not need to be refinanced or in a voting coercion analysis, where the principal issue is the impact of a no-vote on stockholders equity.
As widely reported, Senators Baucus (D-MT) and Grassley (R-IA) introduced a bill last Thursday that would significantly change the taxation of publicly traded private equity firms structured as partnerships. This legislation, if passed, would cause publicly traded private equity firms to be taxed as corporations. As such, these firms generally would be subject to an entity-level corporate tax (with no preference for capital gains, including carried interest) and the owners of these firms would be subject to tax on distributions received from the firms. Here is a related NY Times article.
Rep. Charles Rangel, Chairman of the House Ways and Means Committee, praised the bill and said his committee would examine the legislation. If passed, the bill would be immediately effective for any firm that has not yet filed an IPO registration statement with the SEC. For firms that have done so, namely the Blackstone Group, the bill would not be effective until 2012.
From Travis Laster: On Thursday, Vice Chancellor Strine of the Delaware Chancery Court issued an opinion in which he enjoined The Topps Company from proceeding with a meeting of stockholders to vote on a merger with The Tornante Company (controlled by Michael Eisner). The injunction required (i) supplemental disclosure regarding Eisner’s assurances that he would retain existing management and (ii) that Topps release Upper Deck, a second bidder, from a standstill agreement so that Upper Deck could communicate with Topps stockholders and launch a topping tender offer. The Vice Chancellor concluded that Topps improperly failed to waive the standstill, used Upper Deck’s status as a competitor as a “pretext,” and that the evidence “regrettably suggests that the Topps Incumbent Directors favored Eisner, who they perceived as a friendly suitor who had pledged to retain management….”
This decision is a must-read for M&A practitioners. Here are some highlights from the 67-page opinion:
1. The court validated Topps’s decision to negotiate privately with Eisner and not to conduct an auction. VC Strine observed that (a) Topps conducted a failed auction in 2005 for its confectionary business and (b) the directors engaged in a “spirited debate” on the subject. He also noted that a recent proxy contest had put potential buyers on notice: “the pot was stirred and ravenous capitalists should have been able to smell the possibility of a deal.”
2. The court recognized the value of obtaining a binding bid from Eisner (the “proverbial bird in hand”) and found that the board left itself “reasonable room for an effective post-signing market check” through the use of a go-shop provision (“For 40 days, the Topps board could shop like Paris Hilton”).
3. VC Strine validated the customary deal protection measures used by Topps – a termination fee and matching right. He observed that while matching rights are “a useful deal protection” for buyers, they have “frequently been overcome in other real-world situations.” He considered the 4.3% post-go-shop termination fee “a bit high in percentage terms” but deemed it reasonable since it included Eisner’s expenses and “can be explained by the relatively small size of the deal.” “At 42 cents a share, the termination fee (including expenses)
is not of the magnitude that I believe was likely to have deterred a bidder with an interest in materially outbidding Eisner.”
4. VC Strine sharply criticized the Topps board for having little basis on which to terminate negotiations with Upper Deck when the go-shop expired (which was permitted if Upper Deck was deemed to be an “Excluded Party”): “Upper Deck was offering a substantially higher price…. [and] the Topps board chose to tie its hands by failing to declare Upper Deck an Excluded Party in a situation where it would have cost Topps nothing to do so.”
5. Most importantly, VC Strine came down hard on Topps’s refusal to waive a standstill agreement which prevented Upper Deck from making public statements or proceeding with a premium hostile tender offer: “That refusal not only keeps the stockholders from having the chance to accept a potentially more attractive higher priced deal, it keeps them in the dark about Upper Deck’s version of important events, and it keeps Upper Deck from obtaining antitrust clearance, because it cannot begin the process without either a signed merger agreement or a formal tender offer.”
6. The court ordered supplemental disclosures to make clear that, even though management had not negotiated retention agreements, Eisner had already made clear that he planned to retain “substantially all” of Topps’s “senior management and key employees.” The court also ordered supplemental disclosures of Upper Deck’s “he-double-hockey-sticks or high water” offer to divest itself of assets to obtain antitrust approval, which the court deemed relevant since Topps cited antitrust concerns in its decision to terminate discussions. The court also chastised Topps’s financial advisors for adjusting cost of capital assumptions and shortening management’s projections from five to three years-apparently in an attempt to support Eisner’s offer. The court ordered supplemental disclosures that reflected the original and full projections.
Practitioners should note that unlike other recent decisions, such as Caremark-Express and Netsmart, Topps is not solely a disclosure injunction. VC Strine granted substantive relief regarding the standstill. Practitioners also should note (not surprisingly) that the plaintiff who obtained that relief was the topping bidder, not a stockholder plaintiff. VC Strine expressly noted that the arguments made by the stockholder plaintiffs would not have supported a Revlon injunction. Topps thus does not increase deal risk absent the presence of a meaningful topping bid.
Topps‘ ruling on the standstill provision is frankly a welcome precedent. The questions created by aggressive standstill agreements and subsequent waivers have been part of the Delaware counseling mix for some time. Without any meaningful decisions on the issue, however, concerns regarding potential fiduciary duty issues were often given short-shrift. Topps confirms that the use of standstill agreements and reliance on them to foreclose subsequent bids are areas that must be approached with particular care.
From FEI’s “Financial Reporting” Blog: Yesterday, FASB voted to change a prior decision in its Bus Comb project, and voted today to simplify the standard by requiring that all noncontractual contingencies not recognized at the acquisition date (those that do not meet the more likely than not recognition threshold at the acquisition date) be accounted for post acquisition in accordance with FAS 5.
However, a majority of the board (4 of the seven board members) voted to retain a Fair Value (FV) measurement requirement for initial and subsequent measurement for all contractual contingencies and those noncontractual contingencies that meet the more likely than notrecognition threshold at the acquisition date. In response to comments about lack of cost-benefit in remeasuring these contingencies at FV, the board will conduct field trials during the period between issuance of the final Bus Comb standard – with staff suggesting a pre-ballot draft may be circulated by June 30 – and the implementation date of 2009.
Separately, some board members expressed concern with requiring this new (non-FAS 5) subsequent valuation at FV for contingencies just for Bus Comb, and FASB Chairman Bob Herz said there were other matters in the Bus Comb standard he would personally give subsequent FV treatment to which the other board members did not, such as acquired IPR&D. But, all Board members agreed FAS 5 needs to be amended, and Herz asked the staff come back to the board at a subsequent meeting with a proposed agenda decision to embark on a project to amend FAS 5, and to begin preparing an ED on it. The IASB is working on an amendment to IAS 37 on contingencies and the boards will talk about convergence issues. Further information on this and other issues addressed at today’s board meeting can be found in the FASB board handout.
After several extensions, the NASD has finally filed an amendment to its fairness opinion proposal. This Amendment is No. 4 because several of the others were merely extensions of the comment period.
Although things can always change, my guess is that this Amendment will go “final as proposed” since the SEC Staff has already weighed in after seeing the comments. As noted in this firm memo, the NASD has pared back parts of the proposal in light of comments (both from the SEC Staff and the industry). We will continue to post analysis in our “Fairness Opinions” Practice Area.
Back in late March, the NY Times Dealbook had this gem: “The big investment banks are everywhere these days, underwriting public offerings, advising buyers and providing deal financing — often on behalf of the same company. This ubiquity has created some concern when a bank needs to be found to handle a “go shop” provision in a takeover agreement, which essentially creates a window during which the target tries to drum up better offers. The dilemma: Does the desire for a completely independent bank trump the desire for a bank with sufficient resources and relevant experience?
Vice Chancellor Leo E. Strine Jr., who often presides over big deal-related cases at Delaware’s Court of Chancery, offered his opinion on this hot-button issue. In a panel discussion Thursday at Tulane Law School’s Corporate Law Institute, Vice Chancellor Strine suggested that a conflict-free bank is not always the best choice.
“I question bringing in a Mickey-Mouse-size bank to respresent a go-shop,” he said on the panel. “I still err on the side of repeat players” — meaning banks that may already have an interest in a company or a deal — who “know the tricks of the game.”
A pure adviser, he suggested, can sometimes end up being a “purely ignorant adviser.” This line of discussion brought out what is likely to be one of the most memorable quotes of the event. It was spoken by panelist Robert Kindler, vice chairman of investment banking at Morgan Stanley. Referring to the universe of big banks such as his own, he said: “We are totally conflicted — get used to it.”
A couple of recent cases have highlighted situations where beneficial ownership reporting by hedge funds is called into question, in one instance with a particularly draconian result – potential imprisonment.
Last week, the U.S. Attorney for the Southern District of New York announced that the founder and manager of two hedge funds, pleaded guilty to three counts of violating federal securities laws arising from the activities of his funds in acquiring substantial positions in the securities of two public companies. In addition to defrauding the funds’ investors about transactions that resulted in losses of $88 million, the manager was charged with failing to file on Schedule 13D to report an interest of 5% or more of one company’s stock (he and his funds controlled over 80 percent of the stock), and failing to file a Form 3 to report his beneficial interest of more than 10% in another company (while falsely reporting ownership of under 10% in a Schedule 13D).
The SEC also commenced a civil action in this case back in 2005 that is still pending. Actions such as this one should come as no surprise to those who have heard the SEC Staff publicly express the point that compliance with the beneficial ownership reporting requirements has been – and will remain – a high priority.
While the failure to file accurate beneficial ownership reports was obviously important for the markets in the common stock of the companies involved, the lack of accurate beneficial ownership information was also crucial for the manager to carry out his fraudulent scheme, as any reporting of his interests would have informed his investors that he was not acting in accordance with the funds’ investment policies. Alan Dye has blogged more about this case on his Section16.net Blog.
And Another Schedule 13D/G Action…
Recently, the Delaware Chancery Court addressed the situation of a hedge fund that reported its “investment only” intent on Schedule 13G when it was potentially considering the nomination of a short slate of directors to the company’s board. While the case of Openwave Systems Inc v. Harbinger Capital Partners principally involved the hedge fund’s failure to timely nominate its director candidates under Openwave’s advance notice bylaw provisions, the court took particular note of the fund’s status as a Schedule 13G filer in assessing whether it was really in a position to nominate its own directors within the required timeframes of the advance notice bylaw provisions, as well as in rejecting the fund’s allegation that the board of Openwave reduced the number of directors in response to Harbinger’s potential “threat.”
Join us tomorrow for a webcast – “The Art of the Cross-Border Deal” – to hear Tina Chalk of the SEC, Frank Acquila of Sullivan & Cromwell, Greg Wolski of E&Y and Peter King of Shearman & Sterling analyze the latest M&A tactics in cross-border deals.