July 22, 2020

M&A Disclosure: 3rd Cir. Says Proxy “Risk Factors” Require Specifics

Last month, in Jaroslawicz v. M&T Bank Corp., (3rd Cir; 6/20), the 3rd Circuit vacated the dismissal of a Section 14(a) claim premised on allegedly inadequate risk factor disclosure in a merger proxy statement. The plaintiff challenged the adequacy of disclosures of risks relating to M&T’s anti-money-laundering deficiencies and consumer checking practices contained in its proxy statement for the acquisition of Hudson City Bancorp.

M&T’s compliance shortcomings in these areas resulted in an extended regulatory approval process & a CFPB enforcement action, and ultimately delayed the deal’s closing by more than two years.  Shortly before closing, the plaintiff filed a class action lawsuit alleging that, because the proxy didn’t address M&T’s compliance issues, it failed to disclose material risk factors facing the merger, as required by Item 105 of Reg S-K. In turn, that failure allegedly resulted in violations of Section 14(a) of the Exchange Act and Rule 14a-9.

As this excerpt from Cahill’s recent memo on the decision points out, the Court focused its analysis on the line-item requirements of Item 105 of Reg S-K:

The Third Circuit found that plaintiffs’ complaint plausibly alleged that the anti-money-laundering deficiencies and consumer checking practices were known to M&T, and posed significant risks to the merger, before issuance of the proxy. The Court commented, “[i]n short, while Item 105 seeks a ‘concise’ discussion, free of generic and generally applicable risks, it requires more than a short and cursory overview and instead asks for a full discussion of the relevant factors. That, as we will see, is where the Joint Proxy fell, in a word, short.”

The Third Circuit began its discussion of Item 105 by highlighting guidance from the SEC and other circuits that it found illuminating.  In the SEC’s Legal Bulletin on the subject, under the section titled “Risk Factor Guidance,” the SEC explains that “issuers should not present risks that could apply to any issuer or any offering.” The SEC guidance continues that Item 105 risk factors fall into three broad categories: (i) industry risks, which companies face by virtue of the industry in which they operate; (ii) company risks, which are specific to the company; and (iii) investment risks, which are specifically tied to the security that is the subject of the disclosure document. SEC Legal Bulletin No. 7, 1999 WL 34984247, at *5-6. “When drafting risk factors, [companies must] be sure to specifically link each risk to [the] industry, company, or investment, as applicable.”

After reviewing precedent from other circuits, the Court concluded that the plaintiffs had adequately pled the existence of shortcomings in the proxy disclosures. In particular, the Court emphasized M&T’s awareness that its compliance program would be subject to close scrutiny and that failure to satisfy regulators could end its merger plans. It concluded that this knowledge was enough to impose a duty to provide more specific disclosures about the impending regulatory scrutiny. The Court reached a similar conclusion about M&T’s consumer checking issues.

Despite its finding on the risk factors, the Court rejected plaintiffs’ claims that M&T’s failure to discuss these allegedly non-compliant practices rendered M&T’s opinion statements about regulatory compliance and the prospects for prompt regulatory approval misleading under the Omnicare standard.

The Jaroslawicz case provides an example of something that most M&A and capital markets lawyers already know – when it comes to “risk factor” disclosure, boilerplate won’t cut the mustard. But those lawyers also know that it is often a lot easier to identify the most significant threats to a deal with the benefit of hindsight than it is to call them out in advance.

John Jenkins