– Two Recent Delaware Decisions Provide Practical Transaction Guidance
– Antitrust Merger Review: The Worst Case is Worse Than You Think
– Cross-Border Carve-Out Transactions: Due Diligence and Purchase & Sale
– Shareholder Activism: Nine Lessons Learned
– The Couple in the Conference Room
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It’s hard to imagine a concept that’s gotten more traction in corporate law in recent years than the magical power of a fully informed shareholder vote to cure all a deal’s flaws. But a new study says that – when it comes to M&A at least – the shareholder vote is more sacred cow than sacred right. Here’s an excerpt from the abstract:
We provide strong empirical support based on a sample of 852 merger deals from 2000 to 2015 that there is a very large thumb on the scale that pushes all deals toward approval, regardless of any allegations of wrongdoing. We observe substantial ownership changes at target corporations, sometimes as high as 40 to 50% of their stock, from long-term investors to hedge funds upon the announcement of a deal and before the consummation of the transaction with a shareholder vote. This change reflects the merger arbitrageurs’ actions. We further show that this change in ownership has a positive and statistically significant impact on the likelihood of merger deals garnering the required shareholder approval.
We conclude that the Delaware courts need to rethink their obsession with the shareholder vote, renounce the current doctrinal trends that are taking them in the wrong direction, and return to their historic role of evaluating whether directors have satisfied their fiduciary duties in M&A transactions.
I’ll make a bold prediction that although there may be a lot of merit to this critique, it’s going to go nowhere. Sure, it might increase board accountability in M&A, but it has broader implications that a lot of people aren’t going to like.
That’s because the study’s recognition of the implications of the real-world fluidity of a shareholder base undermines today’s prevailing theory of good corporate governance – the idea that shareholders should be regarded as the true “owners” of the corporation, and that anything that enhances their power in comparison to the board’s is the embodiment of virtuous conduct. Too many people have too much invested in that paradigm to let it be eroded.
Here’s an interesting new study that compares the valuations of deals initiated by sellers to those initiated by buyers. It turns out that who makes the approach matters a lot when it comes to the value that the target’s shareholders receive. Here’s the abstract:
We investigate the effects of target initiation in mergers and acquisitions. We find target-initiated deals are common and that important motives for these deals are target economic weakness, financial constraints, and negative economy-wide shocks. We determine that average takeover premia, target abnormal returns around merger announcements, and deal value to EBITDA multiples are significantly lower in target-initiated deals.
This gap is not explained by weak target financial conditions. Adjusting for self-selection, we conclude that target managers’ private information is a major driver of lower premia in target-initiated deals. This gap widens as information asymmetry between merger partners rises.
The authors contend that when a target initiates a deal, potential buyers become more skeptical about valuation, because companies with stocks that are undervalued prefer to remain independent – while overvalued targets are happy to pursue a sale before the roof caves in.
We’ve previously blogged about Emulex v. Varjabedian – one of this term’s most watched SCOTUS securities cases. The case was prompted by a split among the circuits as to whether negligence or scienter was required to impose liability under Section 14(e) of the 1934 Act. That’s the Williams Act’s general antifraud provision, and it prohibits misstatements or omissions in connection with tender offers.
Shortly after cert was granted, the U.S. Chamber of Commerce upped the ante by filing an amicus brief arguing that the Court should hold that no private right of action exists under Section 14(e). Recently, the Solicitor General weighed in with an amicus brief on behalf of the U.S. government, which endorsed the conclusion that there is no private right of action under Section 14(e).
The Solicitor General’s brief acknowledged that the SEC argued in favor of an implied right of action in Piper v. Chris-Craft Industries – the last case in which the SCOTUS considered implied rights of action under 14(e). But it noted that Court’s approach to implied rights of action since then has changed, and that its “current approach to private rights of action forecloses inferring such a right under Section 14(e).” Here’s an excerpt from the brief:
Beginning with Piper, however, where this Court rejected an implied private right of action for unsuccessful tender offerors, 430 U.S. at 24-42 & n.28, the Court has substantially altered its approach. It has declined to infer new causes of action unless the statute at issue demonstrates an intent to create both a right and a remedy. For example, the Court refused to infer a private right of action under Section 17(a) of the Exchange Act, 15 U.S.C. 78q(a), because the statute “does not, by its terms, purport to create a private cause of action in favor of anyone.” Touche Ross & Co. v. Redington, 442 U.S. 560, 568-570 (1979). The Court likewise refused to infer a private right of action under Section 206 of the Investment Advisers Act of 1940, 15 U.S.C. 80b-6, because that statute does not “mention an intended private action.” Transamerica Mortg. Advisors, Inc. v. Lewis, 444 U.S. 11, 19-24 (1979) (citation omitted).
In a variety of contexts, the Court has since treated the absence of affirmative textual support as a bar to inferring new private rights of action. See Johnson v. Interstate Mgmt. Co., 849 F.3d 1093, 1097 (D.C. Cir.2017) (Kavanaugh, J.) (collecting cases). And in 2001, the Court acknowledged that it had “abandoned” its previous approach. Sandoval, 532 U.S. at 286-289. The Court now requires that, “[l]ike substantive federal law itself, private rights of action to enforce federal law must be created by Congress.” Id. at 286. In the absence of apparent “[s]tatutory intent” to create a cause of action, “courts may not create one, no matter how desirable that might be as a policy matter, or how compatible with the statute.” Id. at 286-287.
The absence of an implied private right of action under Section 14(e) would leave the government as the only party that could enforce the statute. Since that’s the case, it’s not surprising that the Solicitor General argues that negligence, not scienter, should be the standard for imposing liability under it. Check out this Alison Frankel blog for more details on this and other briefs filed in the case.
A decision by the Court that there’s no private right of action under 14(e) won’t necessarily leave investors without a federal remedy to address tender offer shenanigans. As the Solicitor General’s brief notes, investors still could potentially recover damages in private suits under Section 10(b) and Rule 10b-5, and Section 11 and other 1933 Act remedies would be available in the event of an exchange offer involving the issuance of securities as consideration.
Tune in tomorrow for the webcast – “Activist Profiles & Playbooks” – to hear Anne Chapman of Joele Frank, Bruce Goldfarb of Okapi Partners, Tom Johnson of Abernathy MacGregor and Damien Park of Spotlight Advisors identify who the activists are – and what makes them tick.
This recent blog from Steve Quinlivan says that FASB has issued a proposed ASU addressing the treatment of post-acquisition deferred revenue:
The proposed ASU clarifies when acquiring organizations should recognize a contract liability in a business combination. In the proposal, an organization should recognize deferred revenue from acquiring another organization if there is an unsatisfied performance obligation for which the acquired organization has been paid by the customer.
Deferred revenue represents prepayments received for goods or services. GAAP requires the revenue related to these prepayments not to be recognized until the goods are shipped or the services are rendered. Deferred revenue can be kind of a hot mess in an M&A transaction because, as this Skoda Minotti blog points out, it has a disturbing tendency to disappear:
In an acquisition, deferred revenue is typically adjusted down from its originally recorded amount to its “fair value,” which is based on the cost to deliver the related product or service (not the amount of cash collected prior to the related revenue being recognized). Because of the reduction in the deferred revenue balance to “fair value,” there is a portion of revenue (for which cash has been received) that never gets recorded on the company’s pre- or post-transaction books. Poof!
That revenue basically disappears and never gets recognized. For companies that receive meaningful prepayments, this can have a material impact on the amount of revenue that is recorded post-acquisition when the deferred revenue is reversed and recognized as revenue.
The FASB proposal doesn’t propose to change the fair value approach – but it does suggest the possibility that there may be some tinkering with the costs to be included in a fair value measurement.
According to this “Institutional Investor” article, the largest group of PE fund investors wants more oversight from the SEC when it comes to fund sponsors:
Sure, they have billions of dollars invested and spend millions in consulting and advisory fees. But now, some of the world’s largest private equity investors, along with an industry group, are demanding oversight over the industry they’re largely funding.
On Tuesday, the Institutional Limited Partners Association and 35 of its member institutions sent a letter to the Securities and Exchange Commission pushing for stronger regulations on private equity advisory firms. The letter is in response to a call for feedback from the regulator on how it administers the Investment Advisers Act of 1940.
“This is a culmination of our efforts on this issue,” Chris Hayes, senior policy counsel at ILPA, said by phone Tuesday.
ILPA and the institutions that signed its letter are asking the SEC to enforce tougher standards for private equity fund advisers by requiring clearer standards for disclosures of conflicts of interest, according to the letter.
The letter was signed by some pretty heavy hitting PE investors – including CalPERS, CalSTRS, & the New York City and State retirement systems, among others.
Lawyers love to control the pen – and we all think that being in charge of drafting a deal’s documentation will provide our clients with an advantage over the other side in deal negotiations. But is that really true? Over on his website, UCLA’s Stephen Bainbridge recently flagged a new study that sheds some light on this topic. Here’s the abstract:
Does the party that provides the first draft of a merger agreement get better terms as a result? There is considerable lore among transactional lawyers on this question, yet it has never been examined empirically. In this Article, we develop a novel dataset of drafting practices in large M&A transactions involving U.S. public-company targets. We find, first, that acquirers and sellers prepare the first draft of the merger agreement with roughly equal frequency, contrary to the conventional wisdom that acquirers virtually always draft first.
Second, we find that there is little or no advantage to providing the first draft with respect to the most monetizable merger agreement terms, such as merger breakup fees. Third, and notwithstanding, we do find an association between drafting first and a more favorable outcome for terms that are harder to monetize, more complex, and that tend to be negotiated exclusively by counsel, such as the material adverse change (MAC) clause. These findings are consistent with the view that the negotiation process generates frictions and agency costs, which can affect the final deal terms and result in a limited first-drafter advantage.
The article is 84 pages long. If you don’t feel you can muscle through that but still want some more details on the study, the authors recently summarized their article over on the HLS Governance Blog.
According to this Cornerstone Research report, Delaware appraisal actions declined in 2018 for the second year in a row. This excerpt from Kevin LaCroix’s recent “D&O Diary” blog summarizes the study’s findings & gives some insight as to the likely reasons for the decline:
According to the report, the number of Delaware appraisal petitions rose steadily after 2009, peaking at 76 in 2016. As discussed in the Cornerstone Research report, the increase in the number of petitions followed the recent rise of appraisal arbitrage, in which investors purchased shares in the target company after the deal announcement and then contested the deal price in a subsequent transaction.
As detailed elsewhere, among the attractions to investors in pursuing this strategy for much of this period is the relatively advantageous statutory interest rate; in 2016, the Delaware legislature amended the law to allow defendants to pre-pay anticipated amounts due as a way to cut-off the accrual of statutory interest.
However, the number of appraisal petitions declined to 60 in 2017 (a decrease of 21 percent), and declined again in 2018 to only 26 (a further decrease of 57 percent. The number of merger transactions that attracted at least one appraisal petition peaked at 47 in 2016, but decreased to 34 in 2017 (a decline of 28 percent), and decreased further to 22 in 2018 (a further decrease of 35 percent). The decline follows two recent Delaware Supreme Court decisions emphasizing that greater weight should be given in appraisal actions to the deal price (as well as the changes concerning the accrual of pre-judgment interest).
This year may see further interesting developments regarding appraisal actions – the Delaware Supreme Court has scheduled oral arguments on the appeal of Vice Chancellor Laster’s decision in the Aruba Networks case for the end of next month.