Another gem from Mark Borges’ Blog: Following my post last month concerning the difference between the estimated total compensation that an executive will receive when he or she leaves a company (the so-called “walk away” number) and what’s required by Item 402(j), I found Ira Kay and Mike Kesner’s presentation at the “4th Annual Executive Compensation Conference” (the panel on “Fixing Post-Retirement and Severance Arrangements”) to be quite interesting.
As I pointed out, most of the estimated payment and benefit amounts that are being reported in proxy statements only show severance and accelerated equity award numbers. They leave out vested equity awards, SERP’s and other retirement benefits, and accumulated deferred compensation amounts (since the rules don’t ask for amounts that were payable to a named executive officer whether he or she terminated employment or not).
Ira and Mike presented a couple of helpful charts that demonstrate how the true “walk away” number can be calculated. These charts also can serve as a template for constructing a severance and change-in-control table for purposes of Item 402(j) (as we now know, while tabular disclosure of estimated payments and benefits isn’t required under Item 402(j), the Staff has expressed a strong preference for this form of disclosure). So if you’re thinking about enhancing this disclosure in 2008, their materials (which are available on CompensationStandards.com) would be a good place to start.
One last point: I’ve seen a number of compensation committees begin to rethink their severance and change-in-control arrangements (or, at least, the policies that will govern future arrangements) once they’ve developed an appreciation for the magnitude of the amounts potentially payable to their executives. In this vein, Ira Kay has put together a helpful list of recommendations to consider when restructuring outstanding agreements or updating severance policies that you should consider (for example: adding a “sunset” provision to severance agreements). This can also be found in the materials from his session.
Geoffrey Parnass gives us the following thoughts from his blog – “PrivateEquityLawReview.com” – about the Cerberus/United Rentals spat:
Does Cerberus have the unilateral right to walk away from its deal with United Rental and limit its exposure to a break up fee of $100 million? Or does United Rentals have the right to specifically enforce the merger agreement? That’s the issue at the heart of lawsuits currently pending in Delaware and New York arising out of this failed acquisition.
Cerberus had this to say about United Rental’s Delaware action for specific performance in a press release issued November 19th:
“We believe that United Rentals has been less than forthright in its legal filings and its communications concerning those filings. The fact is that RAM negotiated for and obtained the right to withdraw from the Merger Agreement of July 22, 2007 and instead make a one-time payment in the aggregate amount of US $100 million. This ability to walk away from the transaction with this limited exposure was specifically bargained for, is clearly and unambiguously stated in the Merger Agreement and related documentation, and is not in any way conditional on the occurrence of a material adverse change, the termination of the Merger Agreement by United Rentals or any other event.”
Also, according to Bloomberg, Cerberus started its own lawsuit in New York Supreme Court seeking a declaration that its maximum exposure to United Rentals is $100 million. In the suit, Cerberus says United Rentals has no remedy other than the right to pursue the $100 million break-up fee, which serves as a cap for any or all losses or damages relating to or arising out of the merger agreement.
Let’s see where that clear and unambiguous statement appears in the merger agreement. Section 8.2(c) of the agreement says:
“In the event that this Agreement is terminated by [United Rentals] pursuant to Section 8.1(d)(i) or Section 8.1(d)(ii), then [Cerberus] shall pay $100,000,000 to [United Rentals] as promptly as reasonably practicable (and, in any event, within two business days following such termination), payable by wire transfer of same day funds.”
OK then. Section 8.1(d)(i) says that United Rental can terminate the agreement upon certain breaches by Cerberus of the merger agreement, and Section 8.1(d)(ii) says that United Rental can terminate the agreement if the merger isn’t completed by a certain date. Neither of these things has happened, and United Rentals isn’t seeking the fee.
Later on, in Section 8.2(e), there is a clause limiting liability for termination events to $100 million. It says that United Rental’s right to terminate the merger agreement under Sections 8.1(d)(i) or (ii) and receive the $100 million fee under Section 8.2(c) is the “sole and exclusive remedy” of United Rentals against Cerberus for “any and all loss or damage suffered as a result thereof” and Cerberus shall not have “any further liability or obligation of any kind or nature relating to or arising out of this Agreement or the transactions contemplated by this Agreement as a result of such termination.” This fee is “the sole and exclusive remedy for recovery” in the event of “the termination of this Agreement by [United Rentals] in compliance with the provisions of Section 8.1(d)(i) or (ii).”
So far, it looks as though United Rentals has the winning position, as this language pretty clearly says that the $100 million payment is the sole remedy only in the situation where United Rentals has terminated the merger agreement due to a misrepresentation or failed deadline. Up until now, there isn’t any absolute cap on liability if Cerberus breaches the agreement and walks away.
But keep reading. At the very end of Section 8.2(e), comes the provision that finally supports Cerberus:
“In no event, whether or not this Agreement has been terminated pursuant to any provision hereof, shall [Cerberus], either individually or in the aggregate, be subject to any liability in excess of [$100 million] for any or all losses or damages relating to or arising out of this Agreement or the transactions contemplated by this Agreement, including breaches by [Cerberus] of any representations, warranties, covenants or agreements contained in this Agreement, and in no event shall [United Rentals] seek equitable relief or seek to recover any money damages in excess of such amount from [Cerberus].”
That’s pretty clear. Although there is plenty of language in the agreement that appears to support United Rentals’ position, this one sentence appearing at the end of Section 8.2(e) seems to cap Cerberus’ exposure at $100 million. The stock market seems to agree as well.
Today, the SEC announced that Brian Breheny has been promoted to be Corp Fin’s Deputy Director for Legal and Regulatory Policy (which was Marty Dunn’s former job). Brian has been Chief of Corp Fin’s Office of Mergers and Acquisitions since 2003. A new Chief of OMA will be forthcoming, but not likely for at least several months.
Corp Fin also announced that Wayne Carnall will rejoin the SEC to serve as the Division’s Chief Accountant (a job that has been vacant for six months since Carol Stacey left). Wayne has been working in the National Office of PricewaterhouseCoopers since he left the SEC in 1997.
On the “D&O Diary Blog,” Kevin LaCroix fleshes out a recent NY Times article on how buyout firms are walking away from deals. And yesterday, United Rentals sued in Delaware to compel Cerberus Capital Management to complete their deal (see this WSJ article).
Compensation Arrangements for Private Equity Deals
We have posted the transcript from our recent webcast: “Compensation Arrangements for Private Equity Deals.”
Last Thursday, the SEC adopted amendments to Rule 145 that eliminate the “presumptive underwriter doctrine” under Rule 145(c), except for transactions involving blank check or shell companies. Under this doctrine, persons who are parties to, or affiliates of parties to, a Rule 145(a) business combination transaction (other than the issuer) were deemed to be underwriters with respect to public sales of shares received in a Rule 145(a) transaction. As a result, even if the acquiring company in a Rule 145(a) transaction registers the issuance of its shares, affiliates of the target company would not be able to publicly sell the shares they receive unless they are sold pursuant to a resale registration statement or in compliance with certain provisions of Rule 144.
Once the amendments to Rule 145 become effective – which will be 60 days after the amended rule is published in the Federal Register – affiliates of the target company will generally no longer be subject to these resale restrictions. Other amendments also conform the Rule 145(d) resale restrictions to certain of the approved amendments to Rule 144 that were also adopted.
From Gibson Dunn’s memo on the rule change: “The amendments to Rule 144 will increase the liquidity of restricted securities by significantly reducing the restrictions on resales, shortening the holding periods and eliminating manner of sale requirements, such as the volume limitations. As a result, the amendments will likely decrease the cost of capital for issuers of restricted securities by reducing the liquidity discount typically imposed on such securities, and by reducing the need for issuers to agree to file and maintain the effectiveness of resale registration statements for the benefit of investors who purchase restricted securities. The amendments to Rules 144 and 145 and the resulting greater access to capital are also likely to enhance the attractiveness of restricted securities as a form of acquisition currency.”
From Mark Borges’ blog on CompensationStandards.com: As I’m beginning to prepare to help clients with their upcoming Compensation Discussion and Analyses, I’ve been looking at some of the CD&As that have been filed during the past month to see how companies are addressing the “more analysis” dictate of the Staff comment letters and October report. While I’m seeing some differences from the CD&As that were filed earlier in the year, the shift is probably going to be the biggest challenge that most companies face (alongside dealing with performance targets) in preparing their 2008 disclosures.
I was reading through Adaptec’s proxy statement, and liked what I saw in the company’s discussion of its change in control arrangements (page 21 of the CD&A):
“We believe these change of control arrangements, the value of which are contingent on the value obtained in a change of control transaction, effectively create incentives for our executive team to build stockholder value and to obtain the highest value possible should we be acquired in the future, despite the risk of losing employment and potentially not having the opportunity to otherwise vest in equity awards which comprise a significant component of each executive’s compensation. These arrangements are intended to attract and retain qualified executives that could have other job alternatives that may appear to them to be less risky absent these arrangements, particularly given the significant level of acquisition activity in the technology sector. Except for a portion of the grants to our executive officers, as described above, our change of control arrangements for our executive officers are “double trigger,” meaning that acceleration of vesting is not awarded upon a change of control unless the executive’s employment is terminated involuntarily (other than for cause) within 12 months following the transaction. We believe this structure strikes a balance between the incentives and the executive hiring and retention effects described above, without providing these benefits to executives who continue to enjoy employment with an acquiring company in the event of a change of control transaction. We also believe this structure is more attractive to potential acquiring companies, who may place significant value on retaining members of our executive team and who may perceive this goal to be undermined if executives receive significant acceleration payments in connection with such a transaction and are no longer required to continue employment to earn the remainder of their equity awards.”
This explanation not only addresses why the company provides its executives compensation in the event of a change in control, but also explains the reasons behind the primary design feature (the “double trigger”) of the arrangements. I believe that this is type of discussion that the SEC is looking for in the CD&A with respect to each individual compensation element as well as the named executive officers’ total compensation packages.
– The Demise of the Broadly Written MAC: Will the Plain Language Standard Replace the Reasonable Acquiror Standard?
– Full “Walk-Away” Values at Termination and Change in Control
– How to Calculate the Full Walk-Away Value
– Merging Qualified Plans: Five Steps to Eliminate Post-Closing Headaches
– Due Diligence Review of Internal Controls: Focusing Beyond the Numbers
As all subscriptions are on a calendar year basis, it is time for you to renew your subscription. If you are missing these critical issues, try a 2008 no-risk trial to get a non-blurred version of this issue for free.
This year has been a tale of two M&A markets. Before the credit crunch of August, U.S. investors demonstrated a greater willingness this year to oppose going-private transactions and other deals. During the first half of 2007, companies announced a record $2.5 trillion in transactions, including $616 billion in purchases by private equity firms, according to Bloomberg News. The availability of inexpensive and abundant credit allowed private equity firms to pursue bigger targets, including First Data, Equity Office Properties Trust, and TXU–the largest-ever U.S. leveraged buyout.
Facing pressure from hedge funds, boards at Acxiom, Applebee’s, and other companies agreed to put their firms up for sale. After watching more boards approve private equity sales, investors became more skeptical of the fairness of initial offers and more willing to hold out for a better price.
Traditionally, target company shareholders have rarely turned down transactions. This year, however, investors rejected buyouts at Cornell Cos., Eddie Bauer, Lear, and Cablevision. The vote at Eddie Bauer in February was particularly noteworthy because no dissident investor had filed a Schedule 13D to publicly oppose the $9.25-per-share deal. In January, Cornell shareholders turned down an $18.25-per-share offer from Veritas Capital. The votes at Cornell and Eddie Bauer were among the first signs this year of an investor backlash against private equity buyouts.
In late October, ClearBridge, Gamco Investors, and other Cablevision investors rejected a $10.6 billion buyout by the firm’s founding Dolan family, which owns a 20 percent stake and has tried unsuccessfully twice before to take the cable television firm private. While the tighter credit markets have reduced the likelihood of other offers, the Cablevision shareholders argued that the Dolan family’s $36.26 per share bid undervalued the company.
In several cases this year, companies repeatedly delayed transaction votes while they tried to build sufficient support from shareholders. One prominent example is Clear Channel Communications, where the investor vote on a buyout by Thomas H. Lee Partners and Bain Capital Partners was delayed four times amid opposition from Fidelity Management and Highfields Capital Management. The buyout firms eventually raised their bid from $37.60 to $39.20 per share and won 98 percent support.
Other examples of delayed transaction votes include OSI Partners and Genesis Healthcare. In June, Inter-Tel postponed a vote on its sale to Mitel Networks amid fears that investors would reject the deal. Inter-Tel shareholders approved the sale in August after the company posted disappointing second-quarter results.
In the Clear Channel transaction, the private equity acquirers sought to win over skeptical investors by offering the opportunity to obtain up to a 30 percent “stub equity” stake, so they could share in the future profits of the privatized company. Similarly, the acquirers of Harman International Industries offered a 27 percent stake to Harman’s investors. Investors became more interested in stub equity transactions after watching private equity firms take companies private and then reap substantial profits a few years later through a public offering. While these stub equity stakes generally have limited liquidity and governance rights, the Clear Channel investors have negotiated certain governance rights, including the right to elect two of the new company’s 12 board seats.
In the Clear Channel, Lear, and Topps transactions, companies were ordered by Delaware judges to delay votes after shareholders filed lawsuits alleging that directors had breached their fiduciary duties. In the Lear case, a judge ordered the company to provide more information to investors on negotiations over the CEO’s severance package. In the Topps case, the court delayed the vote on a buyout by Madison Dearborn Partners and Tornante after concluding that the board failed to act in good faith to consider a competing offer from rival UpperDeck. The Topps ruling also is notable because the court decided to keep jurisdiction over the case, even though investors sued earlier in New York state court. The case illustrates that Delaware judges want to maintain their important role in overseeing transaction disputes between companies and investors.
Several companies bypassed a shareholder vote by agreeing to a friendly tender offer. One example was Laureate Education, which agreed to a $62-per-share offer from a private equity consortium in June after shareholders–including T. Rowe Price and Select Equity Group–objected to a $60.50-per-share bid. Friendly tender offers had been all but extinct until 2006 when the Securities and Exchange Commission amended its “best price” rule to exclude employment agreement payments to insiders. Tender offers can be more advantageous to acquirers because the transactions can close more quickly and there are no record dates to contend with. Also in June, the private equity purchasers of Biomet replaced a $44-per-share buyout with a $46-per-share tender offer.
Among the most contentious deals of the year was CVS’s acquisition of Caremark Rx, a Tennessee-based pharmacy benefits manager. Facing opposition from CtW Investment Group and other Caremark investors and a hostile bid from Express Scripts, CVS eventually increased its offer by $7.50 per share. Caremark investors, who received an additional $3.3 billion in value, approved the deal in March after a Delaware judge delayed the vote twice and ordered the company to provide more disclosure on investment bank fees and investors’ appraisal rights.
Another development this year was the greater activism by large mutual fund companies, which historically have taken a passive role. For instance, OppenheimerFunds helped lead a successful investor revolt in March at video game maker Take-Two Interactive, where the company’s former CEO had pleaded guilty to stock option backdating. Fidelity opposed the Clear Channel buyout, while T. Rowe Price made 13D filings to challenge Laureate Education’s buyout and Diversa’s going-private transaction.
After the Credit Crunch
The M&A climate has changed significantly after problems in the subprime mortgage market led to a wider corporate credit crisis in August. As credit tightened, banks tried to get out of their financing obligations by urging private equity firms to walk away from transactions. Shareholders at target companies almost overnight became less aggressive in agitating for better terms, realizing that in most cases the terms negotiated by their board earlier this year would not be bettered, at least in the near term. One notable example of this change was the mid-August decision by hedge fund Pershing Square to drop its opposition to a $5.3 billion buyout of Ceridian, a human resources firm.
Since August, some buyers have tried to back out of deals by either paying a reverse break fee (e.g., at Acxiom) or more commonly, by citing the “MAC” clause in the transaction contract, a clause that allows buyers to walk if there has been a “material adverse change” to the target’s business after the contract’s execution. The prospective acquirers of Harman International, Sallie Mae, and Genesco all have invoked these clauses to try to get out of those transactions.
With the relatively novel but now ubiquitous reverse break fee acting as a cheap option that caps a buyer’s ultimate liability, the mere threat of MAC litigation may force sellers to agree to reduced terms, regardless of the strength of the sellers’ legal arguments. The dearth of legal precedent in the Delaware courts on MAC clauses only compounds the dilemma for sellers.
In one case, a failed deal resulted in an extraordinary boardroom fight. On Oct. 31, Cerberus Capital withdrew from a management-led $6.1 billion buyout of Affiliated Computer Services, citing the poor credit market. The next day, ACS Chairman Darwin Deason, who was part of the buyout group, called for the ouster of five independent directors. Deason said the directors may have violated their fiduciary duties by failing to approve the deal before the credit crisis. The board members had sought to shop the company to other bidders and had urged Deason and Cerberus to drop an exclusivity provision. The directors agreed to resign, but they denounced Deason’s “bullying and thuggery.” The directors accused Deason of trying “to subvert the [sale] process in order to prevent superior alternatives to your proposal from being consummated.”
Notable Proxy Fights
As of mid-October, RiskMetrics Group had issued recommendations on 33 proxy contests that went to a vote, about the same number at this time last year. One notable difference this year has been the dramatic increase in the size of companies targeted by dissident campaigns. Three of these targets this year (Home Depot, Sprint Nextel and Motorola) have market caps above $40 billion. As the size of the targets increase, activist hedge funds have been forced to obtain the support of “mainstream” non-activist investors. Activists targeting $40 billion companies cannot simply form “wolf packs” of other hedge funds and expect to win a shareholder vote.
So far this year, it appears that activist hedge funds have been able to convince mainstream investors to support many of their activist campaigns. For example, Relational Investors was able to pressure Home Depot ($65 billion-plus market cap) into selling its supply business and forcing out high profile and controversial CEO Bob Nardelli in January. In October, Relational also successfully pushed Sprint ($50 billion-plus market cap) to force out CEO Gary Forsee.
In May, corporate raider-turned-activist Carl Icahn managed to capture 46 percent of the vote at Motorola ($40 billion-plus market cap), despite the fact that Icahn remains a polarizing figure in the investor community. Breeden Capital, led by former SEC chairman Richard Breeden, was able to capture an extraordinary 85 percent support at H&R Block ($7 billion market cap) in September.
The ability of activists to win support from mainstream investors has caused target companies to become increasingly willing to seek out settlements. As of early July, 32 potential proxy fights had settled, according to RiskMetrics Group data. Among the settlements were those reached at Comverse Technology, Southern Union, Pogo Producing, and Brinks. Most of the time, the accords are really target company capitulations that allow the board and management to save face. If one considers most settlements to be activist “wins,” then activists have easily won a majority of their engagements.
An open question for 2008 is what effect the credit crunch will have on the behavior of activist investors. Two of the most common demands by activist funds are to “sell the company” or to undertake a leveraged recapitalization. To the extent that there are fewer potential buyers, and target companies cannot tap into easy credit to complete recapitalizations, there may be fewer activist campaigns next year.
A few weeks ago, I blogged about the SEC finally blessed FINRA’s (formerly NASD) Rule 2290 on an accelerated basis. Today, FINRA issued its Notice to Members regarding Rule 2290, which states that the effective date of the rule change will be December 8th (ie. 30 days following the publication of the notice).
Join us on December 6th for a webcast – “The Latest on Fairness Opinions” – to learn how the new FINRA rules impact fairness opinion practices (and how a host of new cases address management conflicts), as well as learn how the dynamics – and processes – of preparing fairness opinions have been changing. Join these experts as they explore the latest trends and developments in this area:
– Kevin Miller, Partner, Alston & Bird LLP
– Dan Schleifman, Managing Director and Chairman of the Investment Banking Committee – Advisory, Credit Suisse Securities (USA) LLC
– Ben Buettell, Managing Director and Co-Head Fairness Opinion Practice, Houlihan Lokey Howard & Zukin
– Denise Cerasani, Partner, Dewey & LeBoeuf LLP
From Travis Laster: “Back on October 18th, Chancellor Chandler denied a motion for a preliminary injunction challenging a proposed merger between CheckFree Corporation and Fiserv, Inc. The one-page letter issued by Chancellor Chandler on that same day promised a fulsome explanation for his decision “in the near future.” The Chancellor delivered on his promise on November 1st, with an opinion – In Re: CheckFree Corp. Shareholders Litigation – which provides some helpful guidance regarding disclosure obligations. In the opinion, Chancellor Chandler addresses and rejects each of plaintiffs’ three arguments for injunctive relief based on allegedly insufficient disclosures:
First, plaintiffs argued that CheckFree’s proxy was required to but did not disclose management’s projections for the Company, on which the Goldman Sachs relied for its fairness opinion. Distinguishing Netsmart and relying on the framework established in In re Pure Resources, the Chancellor found that the definitive proxy statement “contains an adequate and fair summary of the work Goldman did to come to its fairness opinion” and that management’s projections did not have to be disclosed. Chancellor Chandler noted that the proxy’s description of Goldman’s work spans seven pages and contains significant explanation about the valuation methods and data used by Goldman. Chancellor Chandler also noted that the proxy “never purports to disclose [management’s] projections” and “explicitly warns that Goldman had to interview members of senior management to ascertain the risks that threatened the accuracy of those projections.” The Chancellor held that “[t]hese raw, admittedly incomplete projections are not material and may, in fact, be misleading.”
Second, plaintiffs argued that the proxy should have disclosed that the merger would likely extinguish a pending derivative action and that, by extinguishing the derivative action, one of CheckFree’s directors would be free from potential liability. The Chancellor found that plaintiffs’ likelihood of success on this disclosure claim was “far from strong” because (i) directors do not have to provide investors with legal advice and (ii) only one director had an ulterior motive in approving the merger, yet the merger was recommended by a unanimous vote of CheckFree’s directors.
Finally, plaintiffs argued that the proxy’s description of the merger’s background “lacks sufficient detail.” Plaintiffs only support for their argument was that “the background section spans less than two full pages.” Chancellor Chandler observed that “[t]his Court … does not evaluate the adequacy of disclosure by counting words” and found that, without additional support for this claim, plaintiffs failed to meet the requirements for injunctive relief.
In my view, practitoners should be cautious about viewing the Chancellor’s holding as a green light to leave projections out of proxy statements. The case law here is still developing, and there are enough precedents in favor of disclosure to create injunction risk. The better course will remain to include projections, at least until we receive further guidance from the Supreme Court.
Equally important, caution is warranted on the lack of a disclosure violation based on the extinguishment of a derivatve action. The derivative claims here only affected one director and had been preliminarily rejected by a federal court. Stronger claims affecting a majority or a significant portion of the board could well give rise to a disclosure claim. Facially more significant claims implicating a majority of the board and involving a high profile issue like stock option backdating could well be viewed differently.”
In the wake of last week’s webcast – “Compensation Arrangements for Private Equity Deals” – we received a question about the considerations of negotiating management’s deal before – or after – the LBO dealed is finalized. There are interesting cross currents ranging from fiduciary duty appearances to deal certainty to ability to disclose fully what the interested party interests are compared to the generic “we plan to make arrangements” disclosure.
Jeremy Goldstein of Wachtell Lipton notes: There may be advantages to waiting to negotiate management’s deal until after an MBO is finalized as follows:
1. Directors may wish to keep management as neutral as they can in the sale process so that they don’t “pick a horse” during the pre-signing due diligence process.
2. If management develops a closer relationship with certain bidders, the relationship could advantage those bidders by skewing the diligence process in their favor. Third, as a simple matter of process, some may view negotiating management’s deal before having agreement on price and other key terms as an issue of “putting the cart before the horse.”
3. If pre-signing discussions between management and a PE group go too far, the SEC may treat the deal as a “going private” transaction in which heightened disclosure obligations and liability exposure of Rule 13e-3 will apply. This may complicate the proxy process and make shareholder litigation more difficult to resolve. That being said, how to appropriately pursue a private equity transaction is an art, not a science, and the informed exercise of judgment by the directors is inescapable.
And Stan Keller of Edwards Angell Palmer & Dodge notes these other considerations:
1. The financial buyers often want to be assured of management continuity and having this certainty can maximize deal value.
2. From the perspective of management, they have maximum leverage before a deal is finalized and, indeed, if they are in a position to influence whether a deal should happen (not which deal), their comfort can facilitate that decision.
3. Shareholders may be best served when management’s deal is set in a way that can be disclosed so shareholders can evaluate the fairness and attractiveness of the deal with knowledge of management’s interest (this can also be accomplished by locking in the terms before the proxy statement/tender document goes out). This also can enhance the opportunity for a market check because a potential bidder knows what is the complete deal terms it needs to work with. Ideally, the way to accomplish most of the foregoing objectives is to move in parallel in an orchestrated way, so that deal pricing and choice of buyer is not affected but management and the selected buyer can move quickly before finalization of the agreement to establish their deal.