Monthly Archives: April 2011

April 29, 2011

Chandler Retirement Spurs Replacement Speculation

Here are the latest rumors from this article in the “Delaware Business Court Insider”:

The Delaware legal community is abuzz with speculation about a replacement for Chancellor William B. Chandler III, who announced his retirement earlier this week. Six possible candidates have emerged, with Samuel Glasscock III and Mary Johnston as the likely favorites, according to sources familiar with the situation. The other credible candidates include Joel Friedlander, Patricia Enerio, Kevin Brady and Elizabeth McGeever, all Wilmington litigators. However, Glasscock, the current Chancery Court master, and Johnston, a Superior Court judge, are seen as the favorites because of the fact that they are both Republicans with ties to Sussex County.

Delaware’s constitution mandates that the position must be filled by a Republican to maintain the state’s political balance requirement for the judiciary. The constitution has no geographic requirement, but it is a respected tradition that the governor usually selects someone from the same county. Glasscock confirmed his interest in Chandler’s seat, telling the DBCI, “Its flattering to be mentioned for this position and I am considering it, but it is still early.” A secretary at Johnston’s chambers said, “She does not speak to the press.”

Two names that have generated buzz, Enerio and McGeever, have denied interest. McGeever, a director at Prickett Jones & Elliott, said, “I am not pursuing this.” Meanwhile, Enerio, a partner at Proctor Heyman, said she was out of the running because she is a Democrat. “I have definitely considered it. I have the utmost respect for the chancellor’s office,” Enerio told the DBCI. “But I would have to switch political parties due to the political balance requirement. I don’t plan on switching parties. It would be an unimaginable honor, but, again, I don’t plan on switching parties.” Brady, a partner at Connolly Bove Lodge & Hutz, has also been rumored.

Friedlander, a partner at Bouchard Margules & Friedlander, confirmed to the DBCI that he will submit an application for the position. Friedlander and Johnston were the finalists for the last Chancery Court opening in 2009, which ultimately went to Travis Laster. However, both Brady and Friedlander may face obstacles because they have no obvious ties to Sussex County. One lawyer familiar with the region emphasized that Sussex County is a tight-knit legal community. “It would be a mistake to pick someone who is solely associated with Wilmington. Even if a person volunteers to move down there for this position, it would be difficult,” the lawyer said.

Glasscock and Johnston would not face such impediments. Glasscock is already based in Georgetown because of his existing position with the Chancery Court. Meanwhile, Johnston is based in Wilmington, but also has a house in Bethany Beach. Andre Bouchard, a partner at Bouchard Margules & Friedlander, is chairman of the Judicial Nominee Committee, which has the job of providing a candidate list for Gov. Jack Markell. Bouchard confirmed that the official posting for the position will go out later this week with an application deadline of May 13. Although Bouchard declined to name possible applicants, he did say the committee is looking for someone “with first-rate intellect and [who] is knowledgeable and experienced in matters handled by the Chancery Court. We are looking for someone who displays the best attributes of the Delaware bar and the Delaware bench.”

Chandler’s replacement is expected to be named within the next 60 days. After an extensive interview process, the nominee committee is expected to send a short list to Markell, who has the responsibility to pick a replacement. The nomination would then proceed to the Delaware Senate for approval.

One likely scenario that has been rumored is the possibility of Vice Chancellor Leo Strine moving into the chancellor’s role. The new appointee would then move into Strine’s position. When Chandler’s retirement becomes effective, Strine will become the longest tenured member of the Chancery Court, serving since 1988.

Although Chandler’s replacement will not be known until mid-summer, he or she is likely to have several key attributes, including corporate litigation experience. “It is a fair bet that whoever is selected will be a seasoned corporate litigator,” added one lawyer. “Even if they are currently not in private practice, but have previous private practice corporate litigation experience.”

It is also expected that the lead candidate will have the calm judicial temperament as Chandler, who was often praised for fairness and intelligence. “There are plenty of qualified candidates out there,” said the lawyer. “The question is: Who is interested?”

April 28, 2011

More Boards Moving Toward Annual Elections?

Here is something interesting pulled from this Cooley memo, repeated below:

You might be interested in this recent Wall Street Journal article regarding the trend toward declassifying boards. The author contends that, this year, “an unusually high proportion of companies have accepted activists’ demands that all board members stand for annual elections by shareholders, replacing staggered terms for directors that typically last three years.” Classified boards are typically put in place to deter hostile takeovers because they make it more difficult to quickly change the board’s composition. Annual elections have been promoted by some activist shareholders on the basis that they will increase board accountability.

The article notes that the “Florida State Board of Administration and the Nathan Cummings Foundation, advised by Harvard law professor Lucian Bebchuk [through American Corporate Governance Institute LLC, a new research and advisory group headed by Prof. Bebchuk], recently dropped half of 28 resolutions seeking yearly elections after 14 of the big companies they targeted agreed–ahead of a vote–to support the change at 2011 or 2012 annual meetings….Investors rarely withdraw annual-election resolutions because the company decides to endorse their idea. Fewer than 25% of such proposals offered by stockholders between 2005 and 2010 failed to reach a vote for any reason, including negotiated settlements, according to ISS, a proxy-advisory firm.” According to ISS, nonbinding proposals to implement annual elections “garnered majority support, on average, every year since 2000…. The number of Standard & Poor’s 500 companies with classified boards has fallen to 139 from 303 in 1998, according to research firm FactSet SharkRepellent.”

The author suggests that “now, some companies are embracing annual elections without the impetus of a vote on a shareholder proposal, partly because board members already feel vulnerable: Many major corporations recently adopted rules requiring, for instance, that directors in uncontested elections win a majority of votes cast.” The article reports that, while some companies immediately signed on when presented with the shareholder proposal for annual elections (even after having previously rejected declassification), in other cases, there were lengthy negotiations before endorsing the proposal or ultimately rejection of the proposal.

April 26, 2011

Delaware Chancellor Chandler Retires

In his “Delaware Corporate & Commercial Litigation” Blog, Francis Pileggi notes that Delaware Chancellor William Chandler has retired before the completion of his term and explains the process by which a replacement will be chosen. Francis also notes the importance of not having a full bench of five members of the Delaware Court of Chancery.

April 14, 2011

California Court Holds No Duty To Include a “Fiduciary Out” in Extraordinary Transaction

Here’s news culled from this memo by Edward Herlihy and David Shapiro of Wachtell Lipton:

On March 30th, the California Court of Appeals affirmed a long standing principle of California law that boards of directors of California companies can lawfully bind themselves to complete an extra-ordinary corporate transaction such as a merger or recapitalization without the need for a “fiduciary out” and without an independent shareholder vote. Monty v. Leis, No. B225646 (Cal. Ct. App. March 30, 2011).

Pacific Capital Bancorp (“PCB”), parent of Pacific Capital Bank, suffered losses in the real estate loan market that resulted in a write-down of its assets and was met with a series of banking regulatory orders which required that PCB raise capital. After seeking additional capital from numerous sources, PCB entered into an exclusive investment agreement with the Ford Financial Fund, LP (“Ford”) a fund affiliated with renowned bank investor Gerald Ford. Ford agreed pursuant to the investment agreement to inject $500 million of capital into the bank to allow it to meet regulatory requirements and grow its business. As a result, Ford would own over 80% of PCB’s common stock. PCB relied on the “financial distress” exception to the NASDAQ shareholder vote requirements to issue common and convertible preferred shares to Ford. After issuance, Ford voted the common shares it held to amend the articles of incorporation to authorize additional shares to be used to satisfy the conversion feature in the preferred stock. Two shareholders filed suit seeking to enjoin the transaction on a number of grounds and the trial court denied the injunction.

After examining the issues raised, the appeals court determined that the investment agreement did not contain improper defensive mechanisms. Specifically, the appeals court rejected the argument that the PCB board breached its duties by failing to include a “fiduciary out” provision enabling PCB to back out of the transaction for a better deal. In doing so, the appeals court specifically declined to follow the Omnicare case, noting that that case had been criticized even by the Delaware courts. Rather, the court opined that a board of directors may lawfully bind itself in a merger or investment agreement from negotiating or accepting competing offers. The Court specifically found that the board had “no duty” to include a “fiduciary out.”

The PCB case is an important recognition of the proper role of a board of directors in a regulated business. In the PCB case, the directors were faced with the immediate and pressing need to raise a significant amount of capital in a short period of time or risk further bank regulatory action. They made an informed and correct decision to commit themselves to a transaction with a sophisticated investor that could provide capital, prevent the company from more aggressive regulatory sanctions and preserve some value for shareholders.

April 13, 2011

Delaware Court of Chancery Addresses Multi-Forum Deal Litigation

Here’s news culled from this memo by Ted Mirvis, William Savitt and Ryan McLeod of Wachtell Lipton:

That litigation follows in the wake of a deal’s announcement is nothing new. But participants in the M&A markets are still grappling with the increasingly prevalent trend of multiple shareholder actions challenging the same deal in different courts. The Delaware Court of Chancery recently endorsed a pragmatic solution to this endemic problem. In re Allion Healthcare Inc. S’holders Litig., C.A. No. 5022-CC (Del. Ch. Mar. 29, 2011).

The case involved a going-private transaction in which Allion Healthcare’s controlling shareholders, in concert with a private investment firm, bought out the company’s unaffiliated shareholders. As has become customary, multiple lawsuits challenging the deal were filed in Delaware (Allion’s state of incorporation) and New York (Allion’s principal place of business). The various plaintiffs declined to coordinate their efforts and the actions proceeded in both jurisdictions. Preliminary injunction proceedings were scheduled in both jurisdictions and then resolved through supplemental disclosures in Allion’s proxy statement. Following the close of the transaction, both sets of plaintiffs filed amended complaints and the defendants engaged in settlement discussions with the Delaware plaintiffs, which ultimately yielded a settlement based on an increase in the merger consideration. The settlement, including an award of fees for the plaintiffs’ lawyers, was then approved in the Delaware court over the objection of the New York plaintiffs. When the Delaware and New York plaintiffs’ groups were unable to agree on an allocation of fees, the Court was forced to resolve the issue.

In so doing, Chancellor Chandler observed the “increasingly problematic” “fallout” of multi-forum deal litigation–a trend we have warned of before. The Chancellor recognized the unfairness of forcing defendants “to litigate the same case–often identical claims–in multiple courts,” noted the resulting waste of judicial resources, and cautioned of the potential confusion and full faith and credit problems that could stem from different outcomes in different jurisdictions. The Chancellor made clear that his “preferred approach” is an innovation this Firm developed several years ago in response to the multi-forum litigation problem: identical motions simultaneously filed in each venue “asking the judges in each jurisdiction to confer with one another and agree upon where the case should go forward.” The Chancellor explained that this method “has worked for [him] in every instance when it was tried.”

In Allion, the Chancellor awarded the New York plaintiffs half the fees associated with the supplemental disclosures, but no fees in connection with the price bump obtained in the settlement, signaling his view that obstructionist behavior will not be rewarded. More broadly, Allion indicates that the Delaware courts will apply their practical wisdom to combat the untenable burdens imposed by multi-forum deal litigation and remain receptive to new approaches to harmonize conflicting and duplicative merger litigation.

April 11, 2011

Activists Target Companies With Market Caps Over $50 Billion

From this memo by Marty Lipton of Wachtell Lipton:

In a speech to the Council of Institutional Investors last Monday, Nelson Peltz, one of the most successful of the activist investors, said the recent changes in corporate governance would enable him to make investments in the heretofore “untouchables”–companies with market capitalizations over $50 billion. Mr. Peltz noted that the new governance rules give activists more tools with which to pressure companies, noting that larger companies provide bigger profit opportunities than smaller companies.

Activist investors with significant records of success will be able to use the new governance rules to convince institutional investors, like the members of the Council of Institutional Investors, to join them in pressuring companies to change their business strategies to those advocated by the activists, whether or not they are in the best interests of the long-term success of the companies and their long-term investors.

There has been a notable increase in hostile takeover and activist investor activity this year. If the present favorable market conditions for this activity continue, there will be a further increase. There is also little doubt that Mr. Peltz’s prediction that the targets will be among the largest companies is also correct.

All companies, even the very largest, should have up-to-date plans for dealing with activists and strategies to avoid inviting the notice of activists.

April 6, 2011

PCAOB Focuses on Audits of Chinese Reverse Merger Companies

Here’s news culled from this Troutman Sanders memo:

On March 14th, the Public Company Accounting Oversight Board issued a Research Note focusing on the audits of reverse merger companies from the China region. The Research Note, titled “Activity Summary and Audit Implications for Reverse Mergers Involving Companies from the China Region: January 1, 2007 through March 31, 2010,” is the first such paper to be issued by the PCAOB, and follows its July 2010 Staff Audit Practice Alert No. 6 which raised concerns about compliance with standards for audits of companies with substantially all their operations outside the U.S. These two pronouncements show that the PCAOB is highly concerned about practices in this area, has narrowed its scope to focus on audits of companies from the China region, and may investigate and impose sanctions against accounting firms to raise awareness of these issues.

As context for the PCAOB’s concern regarding the audits of Chinese reverse merger companies (CRMs), the Research Note includes certain statistics: 159 CRMs accessed the U.S. capital markets during the period from January 2007 to March 2010; during that period private operating companies from the China region accessed U.S. capital markets more frequently by CRM transactions than by IPOs; CRMs tend to have relatively lower levels of revenue, assets and market capitalization; and the auditors of many CRMs are “triennial firms,” that is, firms inspected by the PCAOB once every three years (as opposed to annually) because they audit fewer than 100 public companies.
In both the Research Note and Practice Alert No. 6, the PCAOB identified factors that may have a negative effect on the audits of CRMs: language differences; use of third parties to perform audit work; added travel time and expense; and understanding of local business conditions.

The second factor – the use of third parties – appears to be of greatest concern to the PCAOB. In Practice Alert No. 6, the PCAOB cited examples of improper reliance on or coordination with third parties, including one case where a U.S. firm signed an audit report after using a China-based third party firm to perform substantially all the audit procedures on the issuer’s financial statements.

Accounting firms that audit U.S. public companies must comply with PCAOB standards, which include the AICPA’s Statement of Auditing Standards No. 1, Section 543, “Part of Audit Performed by Other Independent Auditors” (“AU 543”). AU 543 requires accountants to decide whether their participation in an audit is sufficient to justify serving as the principal auditor and author of the report on the financial statements. This decision becomes more difficult as more audit work is delegated to a third party, and AU 543 requires an accounting firm to consider various factors in this regard.
Reverse merger companies and their independent registered accounting firms should ensure that future audits are planned and performed in compliance with AU 543.

In addition, companies and accounting firms may want to assess whether prior audits have been conducted in compliance with AU 543, and whether documentation of such compliance exists in order to permit prompt cooperation with any PCAOB investigation. In planning future audits, or assessing prior audits, companies and accounting firms should involve legal counsel with relevant knowledge and experience.

April 4, 2011

Proxy Season Preview: Takeover Defenses

Here is analysis from ISS’s Ted Allen:

During the 2011 U.S. proxy season, investors again will see a significant number of shareholder proposals that address corporate takeover defenses, such as supermajority voting requirements, classified boards, and limits on shareholder-called special meetings.

Once again, most of these resolutions have been submitted by California shareholder activist John Chevedden and other affiliated investors. So far, shareholders have filed 166 proposals that target takeover defenses, which account for 43 percent of the 386 governance proposals tracked by ISS this year. By contrast, investors have submitted 120 proposals on board issues (such as majority voting and independent chairs), and just 55 resolutions on compensation topics.

So far, investors have filed 48 proposals that urge companies to allow investors holding a certain minimum stake (such as 10 percent) to call a special meeting. However, 12 companies have obtained permission from the Securities and Exchange Commission under Rule 14a-8(i)(9) to omit these proposals by offering their own management proposals with higher ownership thresholds (such as 25 or 40 percent) and other limits on special meetings. Allstate, FirstEnergy, and YUM! Brands are among the issuers that have successfully argued that shareholder proposals would conflict with their management resolutions. In addition, Mattel and Waste Management have told the SEC that they plan to add one-year net-long position requirements to their management proposals.

These companies assert that a higher ownership hurdle is necessary given the expense and distraction of holding a special meeting. While activists would prefer lower thresholds, 53.8 percent of S&P 500 firms do not provide the right to call special meetings, according to ISS GRId data. Another 14.4 percent have ownership thresholds under 25 percent, 14.8 percent require between a 25 and 49 percent stake, and 17 percent have a 50 percent or greater standard.

So far, special meeting proposals have survived no-action challenges on eligibility or other grounds at Honeywell, General Dynamics, AT&T, American Express, and Verizon Communications. As of March 9, 31 proposals on this topic were still pending. It remains to be seen whether these proposals will fare better than last year, when the average support fell to 43 percent, down from 50.1 percent in 2009.

Meanwhile, Chevedden and other retail investors again are filing a greater number of resolutions that urge companies to allow a majority of investors to act by written consent. ISS is tracking 40 proposals this year, up from 29 in 2010. So far this season, 16 companies have asked the SEC for permission to exclude these proposals, but just one request (from Bank of America) has been granted.

Last year, written consent proposals, which appeared on 2010 proxy statements after more than a decade absence, averaged a surprising 54 percent support, but these resolutions may not fare as well this season as some institutional investors have revised their voting guidelines to consider other governance factors, such as a company’s threshold for calling special meetings. About 30 percent of S&P 500 firms now allow investors to act by written consent, ISS data shows.

Supermajority Voting Rules

Investors also will see a significant number of proposals from retail activists that seek to repeal the supermajority (such as 80 or 66 percent) voting rules that some companies have for bylaws or other agenda items. ISS is tracking 35 of these proposals this year; but 20 face no-action challenges. This topic averaged more than 73 percent support, the highest support level for a shareholder measure in 2010, and had 70.5 percent approval in 2009. Notwithstanding these votes, supermajority rules remain common; 55 percent of S&P 500 companies have such rules, according to ISS GRId data.

In a new development since last spring, companies are successfully using Rule 14a-8(i)(9) to exclude these proposals. In most cases, management seeks to propose a majority-of shares-outstanding threshold, while the activists are asking the companies to adopt a majority-of-votes-cast standard. Del Monte Foods successfully used this argument to omit a supermajority proposal filed for its September 2010 meeting. Since then, Alcoa, Medco Health Solutions, Fluor, and three other issuers have used this approach to exclude 2011 proposals on this topic. Four other proposals have been omitted on other grounds. Prudential Financial sought to exclude this resolution based on insufficient proof of ownership, but was turned down. Twenty-two proposals remain pending.

Board Declassification

Another widely supported reform is board declassification, which averaged 58 percent support in 2010. So far, ISS is tracking 34 proposals for 2011. The Nathan Cummings Foundation has filed at least 11 of these resolutions that seek annual elections for all directors. Other proponents include the American Federation of State, County, and Municipal Employees (AFSCME); the Florida State Board of Administration; New York City’s pension funds; and retail investors affiliated with Chevedden.

So far, Allergan, Dun & Bradstreet, DirecTV, and three other issuers have obtained permission to exclude these resolutions by arguing that they had substantially implemented them. The Nathan Cummings Foundation has withdrawn five proposals, typically after the companies agreed to declassify. Meanwhile, KBR has sued Chevedden in federal court over a declassification proposal and contends that he failed to provide sufficient proof of ownership.

In addition, AFSCME has asked Ball Corp. and Wellpoint to reincorporate to Delaware from Indiana, where a 2009 state law requires staggered board terms unless a company’s board votes to opt out.

Oklahoma-incoporated firms may be a target of similar proposals in the future. In September, a new Oklahoma corporate law took effect that mandates classified boards; to opt out, a company would have to wait until 2015 and then obtain support from a majority of shares outstanding. John Keenan, a strategic analyst with AFSCME, said the union pension fund has no immediate plans to file reincorporation proposals at Oklahoma firms, but noted: “we’ll continue to evaluate the changes and overall corporate governance regime of Oklahoma law.”

Classified boards have received more attention in recent months after a trio of Delaware court decisions upheld poison pills at Airgas, Selectica, and Borders Group, which all had staggered board terms. In a recent Wall Street Journal commentary on the Airgas decision, Harvard Law Professor Lucian Bebchuk observed that a declassified board can be an “antidote” to a poison pill. “Despite the Delaware court’s decision, investors still have recourse–because a poison pill is powerful only as long as the directors supporting it remain in place,” Bebchuk wrote. “If, by contrast, a company’s shareholders could replace a majority of its board more quickly, the board’s power to block a takeover bid would be correspondingly weakened.”

Overall, U.S. companies have responded to shareholder demands for this reform in recent years. Within the S&P 500 index, 61.6 percent of companies now have declassified boards, and another 6.2 percent are in the process of eliminating their staggered board terms, according to ISS GRId data.

Investors also have filed a handful of proposals that address other takeover defenses. Retail investors have asked Ford Motor, Martha Stewart Living Omnimedia, Telephone & Data Systems, Constellation Brands, and Ingles Market to drop their dual-class equity structures, while Comcast was allowed to omit a recapitalization proposal on ownership grounds.

The Amalgamated Bank’s LongView Fund filled a proposal at J.C. Penney that asked for a shareholder vote on its poison pill, but that resolution was withdrawn after the retailer announced new board appointees. While activists no longer submit dozens of pill proposals each season, investors still care about this issue. In 2010, the failure to seek shareholder approval for a poison pill contributed to majority withhold votes against directors at least seven Russell 3000 companies.