DealLawyers.com Blog

Below are some thoughts from William Newman of Sullivan & Worcester on the regulatory regimen in the US for inbound M&A deals – often a significant factor in determining whether a deal will be completed or not – that he recently posted on his firm’s blog:

A lawsuit that could have determined whether a filing made with CFIUS can be considered customary has ended. In May 2009, husband and wife Joseph and Judy Ehrenreich sued 3Com Corporation for damages they allegedly suffered from the loss in value of their 3Com shares. The case was brought under the provision of the federal securities laws that enables purchasers of stock to recover losses arising out of incorrect or incomplete statements made by the issuer of the shares. 3Com is a Massachusetts-based enterprise networking solutions provider.

The Ehrenreichs claimed that the cause of their loss was 3Com’s failure to specify that CFIUS review of its proposed merger with affiliates of Bain Capital was a significant risk. 3Com had published a press release announcing the proposed merger on September 28, 2007. The press release stated that the merger was subject to “customary regulatory approvals.” CFIUS review was not mentioned. The plaintiffs purchased 13,000 shares of 3Com stock after the announcement of the proposed merger.

The basis of the plaintiff’s case was that the proposed merger did truly raise serious national security concerns and that, as a result, CFIUS review was not customary. The plaintiffs interpreted “customary” to mean perfunctory or ministerial. The aspect of the merger that triggered CFIUS review was that, as part of the transaction, affiliates of China’s largest network equipment company, Huawei Technologies, were to acquire an interest in 3Com. Press reports associated Huawei with China’s military and possible links to Chinese cyber warfare efforts against the U.S. and the U.S. military.

Although 3Com disclosed on October 4, 2007 that it intended to make a CFIUS filing, the plaintiffs contended that 3Com’s announcement omitted the reasons for seeking the review and downplayed the risk that CFIUS could block the transaction. Five months later, 3Com withdrew its CFIUS filing. One month later, the parties terminated their merger. The announced reason was that CFIUS intended to prohibit the deal. The price of 3Com stock plummeted from its level at the time of the original announcement.

The complaint claims that the peculiar structure of FINSA – its voluntary and not mandatory filing requirement — gives parties an incentive not to mention the possibility of CFIUS review. It suggests that parties might try to “fly under the radar screen” and not provoke public reaction to a deal.

We will not know from this case whether 3Com’s initial failure to specify CFIUS review and the basis on which CFIUS could review the transaction was an incorrect or incomplete statement. The plaintiffs voluntarily withdrew on June 30, dismissing their case with prejudice. A settlement may have occurred. Even if abandoned at this stage, the case stands as a warning to parties contemplating a CFIUS filing. When communicating to the markets, it’s best to say more about the likelihood of a CFIUS review rather than less. Parties now are on notice that CFIUS review may be more than perfunctory. It’s safer to make that clear if the review leads to an unexpected end to the deal.