Here’s an American Banker article written by Donald Mullineaux, Chair of the Federal Home Loan Bank of Cincinnati:

What’s the relationship between increased financial regulation and industry consolidation? In his March 31 commentary in American Banker, J.V. Rizzi contends that there is none. Contrary to the evidence provided in a recent Harvard Kennedy School working paper, Mr. Rizzi suggests that the Dodd-Frank Act — and regulation in general — does not underpin merger and acquisition activity. Rather, he says, banking acquisitions are primarily driven by economies of scale. This is a bit like arguing that cigarette smoking does not cause cancer, since we have evidence that exposure to the sun and other forms of radiation are cancer-causing agents. Just as there are many causes of cancer, banks have multiple motivations for mergers.

Empirical studies of the link between regulation and mergers must try to account for all of the relevant causal factors, which is quite a difficult exercise. As researchers love to say, more work needs to be done to unravel the relationship between regulation and M&A. But there is no case for ruling out regulation as a prospective driver. Mr. Rizzi also fails to appreciate that the imposition of new regulations like those engendered by Dodd-Frank can actually be a source of economies of scale. The reason why is that some of the costs associated with regulatory compliance are fixed costs, meaning that they do not vary with the activity level or size of the bank. Spreading fixed costs across a larger asset base is a common rationale for the existence of scale economies.

Federal Reserve governor Daniel Tarullo recognized this point explicitly in a May 2014 speech at the Federal Reserve Bank of Chicago. “Any regulatory requirement is likely to be disproportionately costly for community banks, since the fixed costs associated with compliance must be spread over a smaller base of assets,” he said. Governor Tarullo has been equally vocal about the economic costs associated with the potential demise of community banks, stating in the same speech that “community banks are of special significance to local economies” and that “the disappearance of community banks could augur a permanent falloff in this kind of credit [small-business loans], at least a portion of which may not be maintained in the more standardized approach to lending, characteristic of larger banks.”

Much ink has been spilled in academic journals trying to explain the phenomenon of “merger waves,” in which M&A activity clusters during well-defined time periods, only to erode at later dates. Once again, there are multiple possible explanations for this occurrence. But a leading candidate for the cause of waves is an “industry shock.” Such a shock can be defined as an unanticipated development or event that significantly alters the cost and or revenue structure in a particular industry. The most frequently mentioned shocks in the literature relate to technology, regulation, and deregulation.

It’s hard to argue that Dodd-Frank was anything other than an unforeseen banking industry shock. Therefore, the law contains the potential to continue producing a substantial volume of new mergers.

The battle over whether to shorten the Schedule 13D filing window has been long and drawn out. For example, as noted in this blog, SEC Commissioner Gallagher said last Fall that we shouldn’t expect changes to the 13D window “this year or next.” As noted in this Cooley blog, several public watchdog organizations have weighed in with this letter to the Senate Banking & House Financial Services Committees urging that Congress take action to shorten the 10-day filing period applicable to Schedule 13D. Also see this WSJ article…

This podcast of Travis Laster with Peter Ladig & Kyle Evans Gay of Morris James is interesting. Morris James has kicked off a new series of podcasts on Delaware law developments by the way…

Here’s news from Chris Cernich and Cristiano Guerra in ISS’s Special Situations Research:

Thus far, 2015 is on track to be a record year for the number of U.S. proxy contests going to a vote, according to an analysis by ISS’ Special Situations Research team. Last year, ISS tracked 11 contests that went to a vote in May – the heart of the U.S. annual meeting season – and 17, in all, through June 30. For the full year 2014, a total of 33 contests went to a vote. By comparison, ISS is tracking 13 contested elections for meetings slated prior to May 1, and 22 more in the month of May alone – bringing the total to 35 in the first five months of the year. While some of them will most likely settle, ISS’ Special Situations Research team expects at least 30 to go to vote, based on conversations with participants in the contest.

Contest Size Increases

When looking at the size of target companies in the U.S., the sweet spot for activism is generally less than $1 billion in market cap. The median in 2009 was $94 million, and, even in that high-water-mark year for contested elections, only 9 percent of contests – four of them – had targets with a market cap of greater than $1 billion; the next year there were zero. The median size has grown over the past few years, though, from $41 million in 2012 to $191 million the next year to $260 million in 2014. The median for 2015 won’t be official for another eight months, until all the data is in, but the median for the contests expected in first half of 2015 is $623 million. That compares to a median of $255 million for the first half of last year.

There are far fewer contests going to a vote at companies with a market cap of less than $10 million. And the number of targets greater than $1 billion market cap which actually go to a vote has grown substantially as well: in 2013, there were 13 of them, or 35 percent of total contests which went to a vote. Last year the number dipped down to 10 companies, but 10 is still a very big change from prior years when one or two a year was generally the max. For the first half of 2015, ISS anticipates that as many as 15 will go to a contested election; the corresponding period last year had seven.

The Biggest Contests for 2015

Beyond DuPont, two of the biggest 2015 contests on the slate so far are at mattress manufacturers. Select Comfort, which is $1.8 billion in market cap, is facing a contest from Blue Clay Capital at its May 22 meeting. And Tempur Sealy, which is $3.4 billion in size, is facing a Vote No from H Partners at its May 8 meeting. It’s not a traditional vote no, however – they want the CEO, the chair, and a third director ousted, after which they’re hoping the board will appoint an H Partner’s executive and one other nominee. Two more are being run by a new activist, called Land & Buildings, which formed after the financial crisis to invest specifically in real estate. REITs don’t usually have contests, but after Corvex succeeded in replacing the board at Commonwealth REIT last year it seems that’s about to change – and Land & Buildings is trying to lead the charge with a May 22 contest at Associated Estates Realty Corp., which is $1.4 billion in market cap. Land & Buildings is also running a contest at MGM Resorts International, a $10.4 billion company, which will go to a vote one week later, on May 28.

ISS is tracking several other meetings in the $1 billion plus category:
– Sandell, which won seats at Bob Evans last year, is looking for seats on the board of Brookdale Senior Living, a $7 billion firm; that shareholder meeting is likely to be in June.
– Shutterfly, a $1.4 billion Internet company, is facing a contest from Marathon Partners at its May 27 meeting.
– Rovi Corp, a $1.9 billion firm whose business is centered on discovery and personalization of digital entertainment, is looking at a contest from Engaged Capital at its May 13 meeting.
– GAMCO is back for the fifth year at $2.7 billion Telephone and Data Systems.
– Barington Capital is looking for seats at The Children’s Place, a $1.3 billion firm whose last proxy contest, half a decade ago, was led by the ousted founder.

Many are getting inquires about NOL pills now that a lot of companies have turned the corner. In 2014, the number of companies adopting NOL Rights Plans hit a three-year high and a tie for the most such adoptions in any year since 1998, the first year in which a US company adopted an NOL Rights Plan, according to FactSet SharkRepellent. Here’s a blog by Mintz Levin’s Matthew Gardella on the topic:

A company’s past NOLs can be used to offset taxable income in future years, subject to certain limitations. For companies that have operated at a significant loss and expect to turn a profit in the foreseeable future, the value of their NOL carryforward may be one of their most valuable assets on their balance sheet. Nowhere is this situation clearer than in the case of a publicly-traded life sciences company that has funded the clinical development of its product candidate(s) with rounds of capital-raising and now is on the verge of regulatory approval and product launch.

Yet the future use of these tax assets may be impaired if a company has had an “ownership change,” as defined in Section 382 of the Internal Revenue Code. This risk is especially a concern for publicly-traded companies whose ownership base is inherently fluid. Although the determination of whether an ownership change has occurred is fact specific and complex, one trigger is a change in the stock ownership of the company by more than 50% over a rolling three-year period. For determining whether such an ownership change has occurred, Section 382 focuses on the cumulative increases in the holdings of 5% or greater stockholders. [1] While highly technical rules and exemptions apply in construing these 5% or greater stockholders, which require the assistance of an experienced tax advisor, one thing should be self-evident to the board of directors of a publicly-traded company with significant NOL carryforwards: It is important to consider appropriate steps to protect and preserve these valuable tax assets from potentially being impaired by an “ownership change”.

For many companies, the answer has been to adopt a Section 382 Shareholder Rights Plan, or sometimes generically referred to as a Tax Benefits Preservation Plan (“NOL Rights Plan”). These companies have included well-known corporations such as AOL Inc., Ford Motor Company, J.C. Penney Corporation, Inc., Krispy Kreme Donuts, Inc. and American International Group, Inc. (AIG), as well as small-cap companies such as Onvia, Inc. and Nabi Biopharmaceuticals. In 2014, the number of publicly-traded companies adopting NOL Rights Plans hit a three-year high and a tie for the most such adoptions in any year since 1998, the first year in which a U.S. company adopted an NOL Rights Plan, according to FactSet SharkRepellent.

NOL Rights Plans are intended to deter a person from becoming a 5% or greater stockholder by providing that such a person would experience significant dilution by crossing that threshold (or, for existing 5% holders, acquiring additional shares) without approval of the board of directors.

The terms of an NOL Rights Plan are essentially identical to a traditional Rights Plan used to deter unwanted takeover attempts (a so-called “poison pill”), except that the NOL Rights Plan:

– uses a trigger that is set at a substantially lower level (4.99%) given its different purpose;
– has additional provisions in the definition of “beneficial ownership” to incorporate the definition used in the tax code; and
– typically contains more discretionary provisions enabling the company to exempt a persons who would otherwise trip the NOL Rights Plan if the company determines its NOL carryforward would not be materially affected.

An NOL Rights Plan can be implemented unilaterally by the board of directors subject to the directors’ fiduciary duties, and does not require stockholder approval (though see ISS discussion below). Even though adopted for a different purpose, the board of directors adopting an NOL Rights Plan must follow a similar fiduciary process as would be conducted when adopting a traditional poison pill. Delaware courts have consistently upheld such traditional Rights Plans when these fiduciary duties have been properly observed. In 2010, a Delaware Supreme Court case specifically addressing an NOL Rights Plan demonstrated that the judicial review of a board’s decision to adopt an NOL Rights Plan will follow the same principles as those established for reviewing a traditional Rights Plan.

Lastly, investor relations always play an important role in considering whether to adopt an NOL Rights Plan. How might the NOL Rights Plan’s low trigger (i) affect the company’s ability to raise additional capital, (ii) chill liquidity and/or (iii) impose monitoring costs on the company? Additionally, a company must consider Institutional Shareholder Services’ (ISS) policy towards Rights Plans generally and NOL Rights Plans specifically. While relatively few companies have put their NOL Rights Plan up for stockholder approval within 12 months of adoption as required by ISS, those that have done so have seen consistently good outcomes with the vote. Because companies adopt NOL Rights Plans to protect a significant asset, stockholders are generally supportive of the action. Accordingly, there appears to be little risk to companies adhering to ISS’s policy and submitting NOL Rights Plans for ratification by stockholders.

In conclusion, during and since the financial crisis starting in 2007/2008, many companies accumulated significant NOLs and as the economy and business conditions improve, many of those companies happily foresee themselves generating taxable income. The only question is whether they will have the NOL carryforwards that they thought they would to offset against that taxable income, or if they will have the unpleasant surprise of realizing that an “ownership change” has impaired those tax assets. It may be time for your company to start thinking about whether adopting an NOL Rights Plan today is right for you.

[1] An ownership change generally occurs if the percentage of the company’s shares owned by one or more 5% stockholders increases by more than 50 percentage points over the lowest percentage of stock owned by those stockholders at any time during the prior three-year period or, if more recent, since the date of the last ownership change. For Section 382 purposes, all of a company’s public stockholders (excluding any stockholders who are themselves 5% stockholders) at the beginning of the relevant 3-year period are viewed collectively as one 5% stockholder. Each time a company issues stock to the public, the purchasers of that stock are viewed separately from the existing public stockholders under a so-called “segregation” rule. This new public group is itself a 5% stockholder, so increases in its ownership (beginning with the stock issuance itself) count toward the Section 382 limitation. Any actual 5% stockholders are excluded from the new public group. Under a special rule, if a company issues stock to the public solely in exchange for cash, then a portion of that issuance is deemed to be purchased by the existing public group(s), and only the remaining portion is deemed to be purchased by the new public group. This is beneficial because it reduces the increase in the company’s ownership change percentage caused by the issuance. This rule is not available for issuances of stock to strategic partners. Section 382 contains detailed rules to trace the ownership of each public group. For example, when a 5% stockholder buys shares on the market, it is deemed to buy a pro rata portion of those shares from each existing public group.

In this blog, “The Activist Investor” pushes back against PwC’s recent report on activist investors…

Recently, a new Cornerstone Research report – entitled “Shareholder Litigation Involving Acquisitions of Public Companies” – was released. Perhaps the most significant finding was a significant increase in the percentage of transactions challenged in only one jurisdiction. The report attributed this shift away from multi-forum litigation to the increasingly widespread adoption of exclusive venue bylaws. According to the report, more than 300 companies adopted such provisions in 2013 and 2014. Other key trends include:

– Plaintiff attorneys filed more than 600 lawsuits challenging M&A deals announced in 2014 and valued over $100 million.

– The percentage of deals challenged in litigation remained high at 96% for deals valued over $1 billion, but declined for deals valued under $1 billion, from 94% in 2013 to 89% in 2014.

– The average number of lawsuits per deal declined from 5.2 in 2013 to 4.5 in 2014, the lowest annual rate since 2009.

– The number of deals with more than 10 filings decreased, from 14 in 2013 to nine in 2014.

– The percentage of lawsuits resolved before M&A deals closed in 2014 slid to the lowest level since 2008. In 2014, only 59% of litigation was resolved before the deals were concluded, compared with 74% in 2013.

– Only one M&A case in the data went to trial in 2014; it resulted in a $76 million damages award.

– Lawsuits challenging M&A deals were filed more slowly in 2014. The first lawsuit was filed an average of 14 days after the deal announcement, compared with 11 days in both 2012 and 2013.

– Similar to prior years, almost 80% of settlements reached in 2014 provided only additional disclosures. Just six settlements involved payments to shareholders.

Here are a few pieces with notes from the recent M&A conference at Tulane:

– WSJ’s “Two Pieces of Good News for Activists from Tulane M&A Confab”
– Fortune’s “As deals rise, bankers warn of ‘bumpitrage'”
– Cleary’s “Appraisal arbitrage”
– Cleary’s “Forum selection bylaws”
– Cleary’s “Fee-shifting bylaws”

As noted in this memo, a few months ago, NASAA requested comments on a proposed uniform state model rule regarding the exemption of certain M&A Brokers from state registration requirements. This proposal has key differences from a Corp Fin no-action letter issued on the same topic last year. Here’s an excerpt from the memo:

There are some important differences between the Model Rule and the SEC No-Action Letter. First, as noted above, the Model Rule would impose limitations on the size of the acquired privately held company (either $25 million in earnings or $250 million in gross revenues), whereas the SEC No-Action Letter allows M&A Brokers to effect securities transactions without regard to the size of the privately held company. Second, the Model Rule would only require that the M&A Broker have a reasonable belief that the buyer of the privately held company will control and be actively involved in its management. By contrast, the SEC No-Action Letter requires that the buyer must actually control and actively operate the privately held company. Third, the requisite “control” of a privately held company under the Model Rule means at least a 20% voting interest in the company, whereas the SEC No-Action Letter raises the “control” threshold to at least a 25% voting interest.

Here’s a blog by Stinson Leonard Street’s Steve Quinlivan:

The Board of Governors of the Federal Reserve Board has modified its Small Bank Holding Company Policy Statement to facilitate the sale of smaller community banks.

Under the final rule, a holding company with less than $1 billion in total consolidated assets may qualify under the policy statement, provided it also complies with the qualitative requirements. This new asset limit is set by statute.

Previously, only bank holding companies with less than $500 million in total consolidated assets that complied with the qualitative requirements could qualify under the policy statement.

The quantitative requirements are the bank holding company:

– was not engaged in significant nonbanking activities either directly or through a nonbank subsidiary;
– did not conduct significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; and
– did not have a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the Securities and Exchange Commission.

Under the policy statement, holding companies that meet the qualitative requirements may use debt to finance up to 75 percent of the purchase price of an acquisition (that is, they may have a debt-to-equity ratio of up to 3.0:1), but are subject to a number of ongoing requirements. The principal ongoing requirements are that a qualifying holding company:

– reduce its parent company debt in such a manner that all debt is retired within 25 years of being incurred;
– reduce its debt-to equity ratio to .30:1 or less within 12 years of the debt being incurred;
– ensure that each of its subsidiary insured depository institutions is well capitalized; and
– refrain from paying dividends until such time as it reduces its debt-to-equity ratio to 1.0:1 or less.

The policy statement also specifically provides that a qualifying bank holding company may not use the expedited procedures for obtaining approval of acquisition proposals or obtaining a waiver of the stock redemption filing requirements applicable to bank holding companies under the Regulation Y unless the bank holding company has a pro forma debt-to-equity ratio of 1.0:1 or less.

The Fed has generally discouraged the use of debt by bank holding companies to finance the acquisition of banks or other companies because high levels of debt can impair the ability of the holding company to serve as a source of strength to its subsidiary banks. The Fed has recognized, however, that small bank holding companies have less access to equity financing than larger bank holding companies and that the transfer of ownership of small banks often requires the use of acquisition debt. Accordingly, the Fed adopted the policy statement to permit the formation and expansion of small bank holding companies with debt levels that are higher than typically permitted for larger bank holding companies.

Consistent with the proposed rule, the final rule applies the revised policy statement to savings and loan holding companies.