Antitrust regulators have made it clear that they intend to take a hard look at potential violations of Section 8 of the Clayton Act, which prohibits director interlocks, and that private equity firms may find themselves in the crosshairs of these actions. But this WilmerHale memo says that any DOJ or FTC enforcement push will have to address a number of unanswered questions about the statute – and that the agencies are almost certain to take a hard line. This excerpt addresses three key unresolved definitional issues:
Person: Even the most basic premise of Section 8—that a “person” cannot, in principle, serve on the board of competing corporations—is fraught with uncertainty. Does “person” mean “individual,” such that two separate designees of the same corporation could serve on competing boards without violating the statute? Or does “person” refer to the parent entity that has designated the two individuals, such that the interlock is captured by Section 8? The U.S. antitrust agencies have long favored the latter position, but the question remains unresolved in the courts.
Competition: Section 8 captures interlocks between corporations that are in competition with each other, but the definition of what constitutes competition remains a gray area. Some courts rely on the market definition analysis used by the Sherman and Clayton Acts generally, which would consider cross-elasticity of demand and whether the products are interchangeable. Other courts perform a broader analysis and analyze (1) the extent to which the industry and its customers recognize the products as separate or competing; (2) the extent to which production techniques for the products are similar; and (3) the extent to which the products can be said to have distinctive customers.
Corporations: Section 8 prohibits interlocks between “two corporations.” Does this mean that the same person could serve on the board of competing entities, if at least one of them is an unincorporated entity (such as an LLC)? It appears so. The Supreme Court in BankAmerica Corp. v. United States suggested that Congress deliberately chose statutory language that “selectively regulates interlocks with respect to … different classes of business organizations.” Other antitrust laws in close subject matter proximity to Section 8 also distinguish corporations from unincorporated entities. Nonetheless, an aggressive DOJ or Federal Trade Commission might attempt to use Section 8 to challenge interlocks involving non-corporate entities, such as LLC.
The memo recommends a number of actions that companies should in light of regulators likely aggressive enforcement approach. These include reviewing existing board memberships by company employees and reviewing board service policies – and assuming that a very broad definition of the term “competitor” will apply when conducting that analysis.
Some days it isn’t easy to come up with content for this blog, and today is one of those days. It looks like my choices have come down to either blogging about another one of Vice Chancellor Laster’s 100+ page opinions or biting the bullet & blogging about Elon Musk and Twitter. Despite my reluctance to blog about the preliminaries in this significant but goofy case, the fact that Chancellor McCormick’s opinion resolving a privilege dispute between Musk & Twitter was only19 pages long has made my decision a relatively easy one.
The case involved one of many discovery disputes between the parties. This one arose because Musk apparently used email accounts at SpaceX and Tesla to communicate about the Twitter deal. Twitter wanted those emails, and Musk responded by asserting that they were subject to attorney-client privilege. Twitter moved to compel production, and Chancellor McCormick ultimately denied that motion.
In reaching that conclusion, she first observed that in order to support a claim of attorney-client privilege, Musk had to demonstrate that he had an objectively reasonable expectation of confidentiality in the SpaceX and Tesla emails. This requirement created a problem for Musk, because as Twitter pointed out in its motion, both companies had email policies that made it clear that that employees have no privacy interest in their work emails and warn that the companies reserve the right to monitor those emails.
Now – as Mel Brooks once pointed out in a famous scene from his film “History of the World, Part I” – “It’s good to be da King!” With that in mind, it’s not surprising to learn that Musk was able to produce affidavits from his IT managers at SpaceX and Tesla attesting to Musk’s ‘unrestricted’ personal use of those accounts and the sharply limited the access that others had to them.
Chancellor McCormick noted that in determining whether an employee has a reasonable expectation of privacy in his or her emails, Delaware has looked to a four-factor test established in In re Asia Global Crossing (S.D.N.Y. BKR 2005). That test looks primarily to whether “company policies and historical practices made it reasonable for employees to expect privacy in company-sponsored email.” Although acknowledging that the Chancery Court had compelled production of emails under a nearly identical policy in the WeWork litigation, she concluded that two mitigating factors mandated a different conclusion in this case. The first mitigating factor was the fact that both Tesla and SpaceX had policies limiting the grounds for monitoring employee emails, while the second mitigating factor was the existence of Musk-specific rules:
As the second and perhaps most forceful mitigating consideration, Defendants argue that the “default” policies of SpaceX and Tesla do not apply to Musk, and that each company adopted “Musk-specific” rules. For this, Defendants rely exclusively on the affidavits of Musk, IT managers from SpaceX and Tesla, and the head of Tesla’s legal department. Those affidavits state, unequivocally, that Musk had “unrestricted” personal use of his Tesla email account, that “no one” at Tesla can access those emails without Musk’s consent except “to the extent legally necessary,” and that “nobody” at SpaceX can access his email account without Musk’s express consent.
Chancellor McCormick acknowledged that a cynic might doubt that these Musk-specific policies really exist, considering that they are supported only by the affidavits of Musk & his employees and that no corporate records support their existence. Yet she concluded that the evidence “rings true”:
The court has little doubt that neither SpaceX nor Tesla view him as on par with other employees, that he has the power to direct operational decisions, and that nobody at either company would access his information without first obtaining his approval. One can debate whether this corporate reality makes for good “corporate hygiene,” but it is difficult to discredit the recitation of the facts.
In other words, when it comes to protecting personal emails on corporate accounts from discovery, “It’s good to be da King!”
The bursting of the SPAC bubble has left quite a few companies that went public via a de-SPAC looking for an exit. The depressed valuations of these companies might make them tempting acquisition targets, but this Freshfields blog says that potential buyers of a recently de-SPACed business need to recognize that they come with a lot of baggage that needs to be addressed during the acquisition process. The memo lays out some of these issues. This excerpt discusses some of the challenges created by the legacy SPAC capital structure:
As part of a de-SPAC transaction, de-SPACed companies typically inherit “public warrants,” which were issued to the public investors in the SPAC IPO, and “private placement warrants,” which were issued to the SPAC sponsor, as well as potentially PIPE investors, in putting together the financing for the deal. The terms of the public warrants and private placement warrants are usually identical, except that the de-SPACed company may redeem the public warrants if its stock price reaches or exceeds certain levels, whereas the private placement warrants are not redeemable.
Both public and private placement warrants may contain provisions that provide that in the case of a merger or other business combination transaction, the warrants become exercisable for the merger consideration. This means that the buyer cannot unilaterally take them out (subject to the redemption provisions of the public warrants based on the deal price) and—if some warrant holders do not exercise their warrants right away—may have ongoing obligations to pay the merger consideration for the life of the warrants.
As a separate matter, in a deal that involves less than a specified percentage (usually 70%) of listed stock as the deal consideration, the warrants often provide that the exercise price will be adjusted if the warrant is exercised within a specified period of time after the closing of the deal (usually 30 days) such that the warrant holder will be entitled to receive upon exercise, on a net basis, the Black-Scholes value of the warrant (calculated as of immediately prior to closing, based on certain assumptions specified in the warrant agreement).
This creates an added complication in that a buyer may not know the exact amount of consideration to be paid for the de-SPACed warrants at the time of signing. Buyers should, therefore, consider whether the warrant agreement terms may be amended and whether it would be feasible or desirable for the buyer to enter into agreements with the warrant holders that lock in the treatment of their warrants at the time of signing.
The memo points out that de-SPACed companies may also have inherited legacy target securities which may have bespoke provisions and may further complicate cleaning up the company’s capital structure post-acquisition. The memo also covers the implications of fiduciary duty issues for the de-SPACed company’s board, the potential concentration of voting power, and the potentially divergent interests of its shareholders.
Less than a week after an FTC administrative judge dismissed the agency’s challenge to Illumina’s acquisition of Grail, the EC rode to the FTC’s rescue and blocked the deal. The FTC’s challenge focused on the fact that the deal involved the purchase of a nascent competitor, and that caught the EC’s eye as well. Here’s an excerpt from this WilmerHale memo on the implications of both regulators’ efforts to stop the transaction: EC’s decision:
The Illumina/Grail saga, at both the EC and the FTC, is a striking example of competition authorities’ intensive focus on both vertical transactions and on preserving nascent competition. Parties contemplating a potentially controversial transaction are well-advised to adopt a multi-jurisdictional approach and carefully account for the risk of a prohibition when negotiating contractual terms.
Illumina/Grail is also a reminder that potentially controversial non-notified transactions – which have long faced a risk of investigation by the U.S. antitrust authorities and the UK Competition and Markets Authority – now face a risk at the EC under Article 22 as well. That risk – particularly acute when a deal is not reportable because the target has little if any revenue, but the deal nonetheless could raise competition concerns – will increase if there are any complaints from customers, competitors, or disappointed competing bidders for the target that an authority deems plausible.
Since the deal already closed, the EC is pondering what to do next, and the memo says that the possibility of ordering the transaction unwound is on the table.
Wachtell Lipton recently published the 2022 edition of its Going Private Guide. The 85-page guide is full of insights into all aspects of the going private process. For example, here’s an excerpt addressing why a tender offer might be preferrable to a one-step merger when it comes to managing dissident stockholders attempting to play games with a deal:
Another potential advantage of the tender offer structure is its relative favorability in most circumstances in dealing with dissident stockholder attempts to “hold up” friendly merger transactions. The tender offer structure may be advantageous in overcoming hold-up obstacles because:
– Tender offers do not suffer from the so-called “dead-vote” problem that arises in contested merger transactions when the holders of a substantial number of shares sell after the record date and then either do not vote or change an outdated vote.
– ISS and other proxy advisory services only occasionally make recommendations or other commentary with respect to tender offers because there is no specific voting or proxy decision, making it more likely for stockholders to tender based on their economic interests rather than to vote based on ISS’s views (which may reflect non-price factors).
– Recent experience indicates that dissident stockholders may be less likely to try to “game” a tender offer than a merger vote, and therefore, the risk of a “no” vote (i.e., a less-than-50% tender) may be lower than for a traditional voted-upon merger.
Topics addressed in the guide include preliminary planning issues, transaction structures, state corporate law standards, federal disclosure requirements, dealing with competing offers, partnering with other investors & financing the transaction.
Artificial Intelligence is becoming an increasingly important tool for many businesses. But like any emerging technology, the use of AI in a target’s business raises a bunch of issues that buyers need to address during the due diligence process. This Norton Rose Fulbright blog provides an overview of the data, cybersecurity & privacy, and intellectual property issues associated with AI that buyers should keep in mind. This excerpt addresses the risks associated with the input data used to train an AI system:
The risks associated with the input data used to train the AI system are a key consideration when conducting due diligence on AI. These risks often vary based on the nature and sensitivity of the data, and raise the following issues, among others. To assist with understanding the AI and gain comfort on the aforementioned risks, a few considerations are as follows:
– Accessibility: Acquirers should confirm that the target obtained their data legally to ensure there will be no issues using the data after acquisition. Problematic data may jeopardize the AI model’s ability to generate predictive solutions, and prevent the AI system from operating as intended.
– Bias: Input data may contain racial, gender, disability and other biases, which could result in an AI system that is susceptible to errors (which, in some instances, could raise ethical concerns). To reduce the risk of acquiring problematic data, buyers should ensure that the target has systems in place to identify and eliminate biases in the AI system, and that the target prioritizes data ethics.
Last week, in In Re Match Group Inc. Derivative Litigation, (Del. Ch.; 9/22), the Chancery Court held that IAC/InterActive’s 2019 reverse spinoff of its Match.com dating business satisfied the MFW framework and was subject to review under the business judgment standard.
The spin-off was accomplished through a series of transactions through which IAC/InterActive (“Old IAC”) separated its dating businesses and certain debt obligations from its other businesses. Under the terms of the agreement governing the deal, Old IAC formed a new subsidiary (“New IAC”) and spun its other businesses to New IAC. That left Old IAC holding certain debt obligations and a stake in Match.com (“Old Match”). Old IAC then reclassified its high & low vote classes of stock into a single class of common stock and changed its name to Match Group, Inc. (“New Match”). Old Match then merged into a New Match merger sub, and the minority Old Match stockholders received stock in New Match.
The plaintiffs alleged that the Old Match board and Old IAC, as Old Match’s controlling stockholder, breached their fiduciary duties by inappropriately diverting cash to New IAC and by inappropriately allocating assets & liabilities between the entities. The defendants moved to dismiss the plaintiffs’ complaint, contending that the complied with the MFW framework. The plaintiffs responded that the special committee formed to negotiate the transaction was not independent and not empowered to say “no” to the deal. They also alleged that the special committee did not satisfy its duty of care and that the Old Match stockholders’ vote wasn’t fully informed.
Vice Chancellor Zurn rejected the plaintiffs’ allegations. While she found that one member of the special committee was not independent due to his previous employment relationship with Old IAC, she concluded that the plaintiffs’ failed to allege that he “controlled the information flow to his fellow directors, undermined the committee’s process, or exerted any undue influence or control over” the other committee members. She found that the special committee was empowered to reject a transaction, and rejected the duty of care claims, including those relating to the committee’s retention of its financial advisor.
The Vice Chancellor also rejected challenges to the adequacy of Old Match’s proxy disclosures. The most interesting of these was a claim that the proxy statement was misleading because it didn’t disclose that the “real” reason for certain governance changes was to protect New IAC from adverse tax consequences, not to protect New Match’s stockholders. Noting that the proxy described the board’s reasons for structuring the transaction as it did and described the governance changes as being “defensive anti-takeover measures to prevent a change of control,” VC Zurn rejected the plaintiffs’ claim that further disclosure about the board’s motivation for implementing them was required:
This Court has long rejected arguments that disclosures are materially misleading because “they fail to disclose [the] real reason” behind board action because “as a general rule, proxy materials are not required to state ‘opinions or possibilities, legal theories or plaintiff’s characterization of the facts.’” “[D]isclosures relating to the Board’s subjective motivation or opinions are not per se material, as long as the Board fully and accurately discloses the facts material to the transaction.” “Put more simply, asking ‘why’ does not state a meritorious disclosure claim under our law.”
Over the past several weeks, there’s been a lot of interesting commentary on some of the implications of the SEC’s universal proxy rules. Here are some of the highlights:
– Should you amend your bylaws to address universal proxy? This Hunton Andrews Kurth memo says the answer is “yes” and provides details on what companies should consider addressing. Here’s an excerpt from the intro:
Companies should consider whether to amend their bylaws in connection with the SEC’s new universal proxy rule, which will be effective for shareholder meetings to be held after August 31, 2022. Although new Rule 14a-19 contains certain requirements for a dissident shareholder to conduct a proxy contest, the rule also reinforces the importance of complying with the corporation’s organizational documents.
In addition, most commentators expect that the universal proxy rule will lead to more proxy contests both from traditional activist hedge funds and potentially a new breed of activists who have not previously pursued board representation. It will be important, therefore, for public companies to maintain state-of-the-art advance notice bylaws to ensure an orderly nomination and election process, and to make sure that a dissident’s interests are fully disclosed to the corporation and its other stockholders
– Why did the Staff issue a CDI (#139.01) clarifying that a dissident couldn’t include the names of more nominees than it intended to run in its Rule 14a-19(b) notice? This Gibson Dunn blog provides the answer:
We understand the Staff’s guidance on this issue is primarily directed at the frowned-upon practice engaged in by certain dissident shareholders who list more nominees than there are open seats for election. In such cases the dissident shareholders place brackets around the names of all their nominees at the early stages, only to finalize their list of nominees (with brackets removed) when filing a definitive proxy statement. This interpretive guidance is intended to restrict such gamesmanship engaged in by dissidents.
– Sidley recently launched its own “Universal Proxy Card Resource Center” that provides links to the SEC’s adopting release, guidance and related materials, as well as selected comment letters and other resource materials. Sidley appears to be the first law firm that’s put together something like this, but I doubt it will be the last. Don’t forget Michael Levin’s UniversalProxyCard.com if you’re looking for universal proxy resources.
– I recently blogged about what ISS had to say on universal proxy. Now, Glass Lewis has weighed in via its blog. Here’s an excerpt:
For our part, we do not expect our overall approach in evaluating proxy contests to change under the universal proxy card system. We would also note that these are not entirely uncharted waters – universal proxy cards are utilized in certain markets outside the United States, including limited use in North America in the past.
All that being said, in order to support any dissident nominee in a proxy contest, we still require the activist to make a compelling case for change and to nominate qualified, unconflicted director candidates who seem better suited to address deficiencies or to facilitate a superior outcome for shareholders. In short, the hurdles we believe an activist must clear in order to win board representation will not be lower under a universal proxy card system.
So what could change? The new rules will potentially make all incumbent directors on a board more vulnerable for replacement, whether they are specifically identified as a targeted director by the activist or not. In a non-classified board situation, this could mean more incumbent directors will need to be intimately involved in the situation, engaging with shareholders and other interested parties.
In addition to the law firm memos & other materials on the new rules available in our “Proxy Fights” Practice Area, we’ve also hosted a webcast on the new regime and, more recently, podcasts with Goodwin’s Sean Donahue and The Activist Investor’s Michael Levin. You can count on us to continue to keep close tabs on how the new rules are influencing activist campaigns and proxy contests and provide you with timely and practical resources to help you deal with what we expect will be a rapidly evolving environment. Subscribe today to access these materials & our other resources! You can subscribe online, by emailing sales@ccrcorp.com, or by calling (800) 737-1271.
It turns out that the 1% excise tax on buybacks isn’t the only provision of the Inflation Reduction Act that complicates things for dealmakers. This Wachtell memo discusses how the new “Book Minimum Tax” provisions – which impose a 15% minimum tax on corporations’ with “adjusted financial statement income” exceeding $1 billion over the preceding three years – may impact M&A transactions. This excerpt addresses the BMT’s implications for taxable asset purchases:
For income tax purposes, an acquisition structured as a taxable asset purchase (or deemed asset purchase by reason of a Section 338 election) typically results in a “step up” in the tax basis of the acquired assets, including goodwill, which is depreciable by the buyer. In contrast, an acquisition structured as a tax-free “reorganization” or as a taxable stock purchase does not result in a step up in the tax basis of the target’s assets.
Under U.S. GAAP, purchase accounting would result in the target’s assets being reflected at fair value regardless of the tax treatment of the acquisition. Because goodwill is not amortized under current U.S. GAAP, a taxable asset purchase (or deemed asset purchase) could give rise to adjusted financial statement income of the buyer that significantly exceeds its taxable income. In such a case, the BMT could reduce or eliminate the buyer tax benefits typically associated with a taxable asset purchase.
The memo also discusses the BMT’s implications for corporate divisions, such as spin-offs and split-offs, and notes that it may affect other situations in which income tax and GAAP treatment have diverged, including potential differences in the treatment and utilization of target NOLs and the treatment of deal-related expenses.
The FTC recently announced that it had adopted omnibus resolutions authorizing compulsory process in various antitrust investigations, including those related to non-HSR notified mergers and acquisitions. According to this Mintz memo on the FTC’s action, that means the FTC’s staff need only obtain the approval of a single commissioner to start an investigation into a transaction that wasn’t large enough to require an HSR filing. Previously, the staff had the ability to take such action only with respect to transactions in which an HSR filing had been made. This excerpt from the FTC’s press release summarizes the effect of its action:
The omnibus resolution governing proposed mergers, acquisitions, and transactions approved today will allow for quick investigations of all mergers, including those that fall below the value thresholds that require reporting to the antitrust agencies under the Hart-Scott-Rodino Act (HSR). The Commission’s 6(b) studyon non-HSR reported acquisitions by technology companies highlighted how some of the largest firms in our economy have made hundreds of acquisitions that are not being reported to the FTC or DOJ.
Commissioners Phillips and Wilson dissented from the FTC’s action and issued a statement in which they contended that the omnibus resolutions removed Commission oversight from investigations within their scope and “decreased accountability and created more room for mistakes, overreach, cost overruns, and even politically-motivated decision making.”
The Mintz memo characterized the FTC’s action as giving the staff a broad “hunting license,” under which non-reportable merger investigations can be more easily initiated in response to a market participant contacting the FTC—or even in response to a media report.