The FTC’s efforts to stop Microsoft’s pending acquisition of Activision/Blizzard can now be added to the agency’s loss column. Last week, a California federal district court denied the FTC’s bid to stop the deal, and the 9th Circuit quickly affirmed that decision. While the FTC’s lawsuit remains pending, this excerpt from Davis Polk’s memo on the case indicates that the agency has a mountain to climb if it wants to continue efforts to unwind the deal after closing, because the district court found that it was unlikely to succeed on the merits of its case:
Although it was “sharply dispute[d]” between the parties, Judge Corley found that the “likelihood of ultimate success” meant “the likelihood of the FTC’s success on the merits in the underlying administrative proceedings, as opposed to success following a Commission hearing, the development of an administrative record, and appeal before an unspecified Court of Appeals.”
The FTC argued that post-transaction, the combined Microsoft/Activision firm “may deprive rivals—primarily Sony —of a fair opportunity to compete . . . by foreclosing an essential supply—Call of Duty.” Citing the Commission’s decision in the Ilumina/Grail matter, the FTC argued that “it need only show the transaction is ‘likely to increase the ability and/or incentive of the merged firm to foreclose rivals.’” The court rejected that position, writing, “Illumina . . . provides no authority for this proposition, nor could it . . . . If there is no incentive to foreclose, then there is no probability of foreclosure and the alleged concomitant anticompetitive effect. Likewise, if there is no ability [to foreclose], then a party’s incentive to foreclose is irrelevant.”
The court likewise rejected the FTC’s claim that “it need only show the combined firm would have a greater ability and incentive to foreclose Call of Duty from its rivals than an independent Activision.” Judge Corley reasoned that this standard is inconsistent with Section 7 of the Clayton Act, which requires a substantial lessening of competition.
The district court concluded that to establish a likelihood of success on its ability and incentive foreclosure theory, the FTC must show that the combined firm has the ability and incentive to withhold Call of Duty from its rivals, and that competition would probably be substantially lessened as a result of the withholding. The court then found that while the combined firm would have the ability to foreclose competitive access to Call of Duty post-merger, it would not have the incentive to do so.
As a result of these federal court decisions, UK antitrust regulators represent the only remaining impediment to the deal’s closing, and recent media reports suggest that Microsoft may be able to satisfy their objections through a restructured deal more quickly than originally expected.
A recent Reuters article says that the antitrust agencies are struggling to get courts to see things their way when it comes to merger challenges. It points out that the agencies won approximately 65% of their litigated merger challenges between 2001 and 2020, while under the Biden administration the FTC & DOJ have won only 30% of its cases.
Here’s an interesting development on books & records requests that John blogged about last week on TheCorporateCounsel.net:
The Delaware Chancery Court recently dismissed a books & records action against The Walt Disney Company premised on alleged breaches of fiduciary duty by the company’s board arising out of its decision to publicly oppose Florida’s “Don’t Say Gay” legislation. The plaintiffs’ contended that the directors breached their duty of loyalty by placing their personal beliefs ahead of the company’s interest by taking positions that impaired its value.
This excerpt from a recent Wilson Sonsini memo on the decision summarizes Vice Chancellor Will’s reasoning:
The court conducted a trial on a paper record, and that record reflected an appropriately engaged and deliberative board. As the controversy first flared, the Disney board convened a special meeting and, shortly thereafter, held a regularly scheduled meeting to discuss the issues. Board minutes captured the board’s engagement. The record showed that Disney leadership took an increasingly public stance in the face of intensifying criticism from its employees and creative partners. Accordingly, the court noted, the board’s decision did not come “at the expense of stockholders.” Rather, the board was motivated by an understanding that “a positive relationship with employees and creative partners is crucial to Disney’s success.”
As such, the court determined that “[i]t is not for this court to question rational judgments about how promoting non-stockholder interests—be it through making a charitable contribution, paying employees higher salaries and benefits, or more general norms like promoting a particular corporate culture—ultimately promote stockholder value.” Meanwhile, no evidence supported the plaintiff’s allegation that the directors’ personal beliefs or their support of organizations that opposed HB 1557 swayed them to act contrary to the interests of the company and its stockholders.
Based on her analysis, Vice Chancellor Will ultimately concluded that the plaintiff did not establish a proper purpose for inspection because it did not sufficiently allege potential wrongdoing by the board. In an era where companies increasingly find themselves caught in the crossfire of contentious social issues, boards and their advisors are likely to find this excerpt from the Vice Chancellor’s opinion on the latitude that directors have under Delaware law exercise their business judgment to be of some comfort:
Delaware law vests directors with significant discretion to guide corporate strategy—including on social and political issues. Given the diversity of viewpoints held by directors, management, stockholders, and other stakeholders, corporate speech on external policy matters brings both risks and opportunities. The board is empowered to weigh these competing considerations and decide whether it is in the corporation’s best interest to act (or not act).
In an update to a prior alert (thanks to past John circa five years ago for this blog title!), Venable recently released a detailed memo providing an overview of when a person is acting as a so-called finder. As the memo notes, the term “finder” is not defined in federal securities laws but is limited by activities a person cannot perform lest they be deemed a “broker” or “dealer” and therefore subject to registration. As John noted, this is a murky and complex area, and it remains so even with the greater certainty provided by the recent legislative exemption for M&A brokers, which unfortunately is somewhat more limited than the withdrawn 2014 no-action letter that previously provided an exemption.
For anyone needing a summary of the legal issues, parameters of available exemptions and pitfalls of being classified as an unregistered broker, this is an excellent resource. Here’s an excerpt with an important reminder that, notwithstanding a federal exemption, state laws and regulations continue to apply:
Both the M&A Brokers No-Action Letter and the Federal Exemption do not affect state laws and regulations on the matter. While the Federal Exemption may motivate states to adopt corresponding exemptions, Congress’s decision not to preempt state law leaves unresolved the potential for conflicting requirements that would impair the usefulness of the Federal Exemption.
In response to the M&A Brokers No-Action Letter, the North American Securities Administrators Association adopted a uniform state model rule designed to provide an exemption for M&A Brokers from registration as brokers, dealers, and agents under state law. However, the model rule is not self-executing and must be adopted by a state before it becomes effective in a specific jurisdiction.
As a result, state-level broker registration remains an important consideration for M&A Brokers, even if an exemption exists at the federal level. Interestingly, New York has recently proposed, then failed to adopt, a state regulatory regime of business finders. Certain states, including California, Texas, and Michigan, have some form of a registration exemption for M&A Brokers. Therefore, finders should consult the applicable state broker-dealer regulations prior to engaging in activities in the particular state.
In light of the federal legislative exemption, states may be taking action on this front. Keith Bishop points out on his blog that Nevada recently announced updates to the Nevada Administrative Code, which include a new exemption for certain M&A brokers that is similar, but not exactly the same as, NASAA’s model exemption.
In the first week of July, Nasdaq published four FAQs focused on SPACs. The FAQs address the following topics:
– When a SPAC falls below the Publicly Held Shares, Market Value of Publicly Held Shares, Market Value of Listed Securities and/or the Shareholder requirements due to shareholder redemptions
– Information required when a SPAC holds a meeting to extend its deadline to complete a business combination
– How Nasdaq determines compliance with the price-based listing requirements in a de-SPAC where the target is publicly traded
– Whether SPACs must hold annual meetings
This Loeb & Loeb blog notes that one of the new FAQs will complicate transactions involving OTC-quoted target companies looking to use a SPAC to move to Nasdaq. Here’s the full FAQ (#1863):
How does Nasdaq determine compliance with the price-based listing requirements in the case of a SPAC business combination where the target company is a publicly traded company?
In the case of a transaction where a SPAC acquires 100% of a publicly-traded target company or is acquired by a publicly-traded target company, Nasdaq generally relies on the trading price of the publicly-traded target company (adjusted for any applicable exchange ratio and for the additional cash provided by the SPAC) to determine compliance with the price-based listing requirements.
The blog goes on to provide the following example and takeaway:
For example, under this FAQ, if a target’s stock is trading at $1.00 per share and it will be converted into the SPAC’s stock on a one-for-one basis, Nasdaq will assume that the trading price of the post de-SPAC company’s stock is $1.00 per share, regardless of valuation of the target, fairness opinions, or the trading price of the SPAC’s stock. In the scenario I just gave, the company would not be able to meet the minimum share price requirement under Nasdaq’s initial listing rules.
Companies looking to do a de-SPAC involving a publicly traded company will need to ensure that conversion ratios for the publicly traded company’s stock will result in the combined company meeting Nasdaq’s initial listing requirements.
In late June, I blogged about the significant changes proposed by the FTC and DOJ to the Hart-Scott-Rodino (HSR) Premerger Notification and Report Form. For more information on the substance of the proposal, this Mintz post excerpted below succinctly describes the changes:
The key proposed changes include expanded and new requirements to submit the following:
Transaction Information
– Details about transaction rationale and details surrounding investment vehicles or corporate relationships.
– Detailed transaction timeline.
– Existing agreements between the parties (including those that were in effect within the previous one year).
Competition Information
– Information and narratives related to products or services in both horizontal and non-horizontal business relationships such as supply agreements.
– More granular geographic information for certain overlaps.
– Expanded information on other acquisitions in the previous 10 years within the overlapping markets.
– Projected revenue streams.
Customer information.
– Document Submissions
– Expanded scope for “4c” and “4d” documents that analyze the competitive effects of the proposed transaction.
– Certain ordinary course documents.
Ultimate Parent and Controlled Entities Information
– Organizational charts for funds and limited partnerships.
– Identification of officers, directors, board observers, significant creditors, and holders of non-voting securities.
– Expanded minority shareholder information.
Labor Market Information
– Disclosure of information intended to identify labor market issues.
– Classification of employees by Standard Occupational Classification system categories.
– Workplace safety information.
Information on Subsidies from Foreign Governments or Entities of Concern
– Data required to fulfill the Merger Filing Fee Modernization Act of 2022.
We’re posting memos and other materials in our “Antitrust” Practice Area here on DealLawyers.com.
The DLA Piper Global Foreign Direct Investment team just released a 2023 edition of their Multi-jurisdiction Guide for Screening Foreign Investments. The intro to the guide explains that screening activities have expanded in many jurisdictions to cover considerations related to cybersecurity, consumer protection, data privacy, supply chain and strategic sectors, and governments are increasingly willing to intervene in offshore transactions on the basis of domestic impacts that are more indirect or limited. It gives the following examples:
The interagency Committee on Foreign Investment in the United States (CFIUS) has intensified its scrutiny of proposed transactions. The CFIUS has also expanded its retrospective reviews of consummated transactions in potentially sensitive sectors where the parties had not submitted a notification or declaration. The U.K. National Security and Investment Act 2021 (NSIA) took effect in January 2022, establishing new requirements for mandatory notification to the Investment Security Unit within the Department for Business, Energy and Industrial Strategy (BEIS) for certain acquisitions resulting in equity interests over 25% or material influence over businesses active in 17 specified sensitive sectors. In 2022 Canada also introduced a new National Security Review of Investments Modernization Act, which can substantially strengthen the existing national security review. And in the EU, Romania introduced its FDI regime in 2022 and new or enhanced regimes are expected in Belgium, Slovakia, Netherlands, Ireland, Estonia, Slovenia, Spain and Sweden in 2023.
The interactive guide reviews developments in foreign investment screening practices in 35 jurisdictions across the Americas, Europe, Africa, Asia, and Australia.
Last month, the SEC announced a settled enforcement action against Insight Venture Management LLC alleging that the fund advisor charged excess management fees & failed to disclose a conflict of interest relating to its fee calculations. This excerpt from the SEC’s press release describes its allegations:
According to the SEC’s order, Insight’s limited partnership agreements for certain funds it advised allowed it to charge management fees based on the funds’ invested capital in individual portfolio investments and required Insight to reduce the basis for these fees if Insight determined that one of these portfolio investments had suffered a permanent impairment. The order finds that, from August 2017 through April 2021, Insight charged excess management fees by inaccurately calculating management fees based on aggregated invested capital at the portfolio company level instead of at the individual portfolio investment security level, as required by the applicable limited partnership agreements.
Further, the SEC’s order finds that Insight failed to disclose to investors a conflict of interest in connection with its permanent impairment criteria. Because Insight did not disclose its permanent impairment criteria, investors were unaware that the criteria Insight used were narrow and subjective, making them difficult to satisfy. Therefore, the order finds that Insight’s investors were unaware that Insight’s permanent impairment criteria granted Insight significant latitude to determine whether an asset would be considered permanently impaired so as to reduce the basis used to calculate Insight’s management fees.
Without admitting or denying the SEC’s allegations, the fund advisor consented to an order finding that it had violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rules 206(4)-7 and 206(4)-8 thereunder. It also agreed to a cease-and-desist order and censure and to pay a $1.5 million penalty and $864,958 in disgorgement and prejudgment interest.
A recent Weil blog on the enforcement action offers some recommendations to PE fund advisors to avoid finding themselves in a similar situation:
In response to this enforcement action, advisers should (i) review, and carefully adhere to, (a) any implemented impairment or write-down policies, especially with respect to fee reduction practices, and (b) the relevant provisions set forth in their fund documentation, including any distinctions between “investments” and “portfolio companies” and any interplay with write-downs and, if applicable, (ii) disclose to investors (a) all relevant criteria used in the impairment analysis and (b) the fact that the adviser has a conflict of interest in applying any subjective impairment criteria, as an impairment may reduce management fees and/or impact a fund’s carried interest waterfall.
Woodruff Sawyer recently published its 2023 Guide to Representations & Warranties Insurance, which provides an overview of current market conditions, policy terms and considerations for potential purchasers of RWI. In light of commentary suggesting a tightening claims environment, I thought what the report had to say on claims was pretty interesting. Here’s an excerpt:
Halfway through 2023, we’ve found the rate of claims has been relatively consistent with previous years, while the number of claims has increased. This increase is largely attributable to the surge of M&A activity in 2021. However, we have seen interesting shifts emerging in the timing of claims noticed, types of claims filed, and areas insurers will expect heightened diligence in the future.
Timing of Claims Noticed – Historically, most claims have been noticed within the first year after binding. However, in 2022–2023, an increasing number of claims were noticed between 12 to 18 months post-close.
Types of Claims Filed – First-party, or indemnification, claims (where the insured brings a claim directly to the carrier) remain more common than third-party claims. However, third-party claims are on the rise for 2023 and will likely continue to uptick. Of the most frequently cited first-party claims, breaches of the financial and material contracts reps continue to involve the greatest potential for loss and are the claims most likely to exceed the self-insured retention (SIR), which is the portion of cost the insured must bear before the R&W policy responds.
Heightened Diligence – Data security/privacy breaches are hot on the heels of financial statements and material contracts. Carriers are increasingly concerned about the adequacy of cyber coverage, and buyers should expect this to be an area of heightened diligence. It is crucial that buyers understand the far-reaching implications of insurance diligence. In the haste of M&A deal flow, buyers can neglect to conduct adequate insurance diligence on the target company. Likewise, many purchase agreements lack clear and concise insurance representations by the sellers.
The Guide also discusses the frequency of the breaches reported in RWI claims, and notes that reps & warranties concerning financial statements, data security & privacy, employee benefits and employment top the list.
Last week, in Coster v. UIP Companies, (Del.; 6/23), the Delaware Supreme Court affirmed Chancellor McCormick’s earlier decision holding that the company’s board had a “compelling justification” for authorizing a dilutive share issuance to resolve a stockholder deadlock. The decision marks the lawsuit’s second trip to Delaware’s highest court. The first time around, the Supreme Court overruled an earlier Chancery Court decision and held that the Chancellor must address the argument that the board interfered with the plaintiff’s voting rights and leverage as an equal stockholder without a compelling reason to do so.
Two precedents featured prominently in the Supreme Court’s initial decision overruling the Chancery Court. The first, Schnell v. Chris-Craft Industries, stands for the proposition that actions taken by an interested board with the intent of interfering with a stockholder’s voting rights are a breach of the directors’ fiduciary duty. The second, Blasius v. Atlas Industries, holds that even good faith actions by the board that have the effect of interfering with voting rights require a “compelling justification.”
On remand, Chancellor McCormick determined that the board acted in good faith and established the compelling justification required to support its decision to issue the shares, and the Supreme Court affirmed her decision. In reaching that conclusion, the Supreme Court conducted an extensive review of Delaware case law interpreting Schnell and Blasius and concluded that the standards “have been and can be folded into Unocal review to accomplish the same ends – enhanced judicial scrutiny of board action that interferes with a corporate election or a stockholder’s voting rights in contests for control.” It then summarized what courts must do when confronted with claims that board action interferes with voting rights:
When a stockholder challenges board action that interferes with the election of directors or a stockholder vote in a contest for corporate control, the board bears the burden of proof. First, the court should review whether the board faced a threat “to an important corporate interest or to the achievement of a significant corporate benefit.” The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal. As Chancellor Allen stated long ago, the threat cannot be justified on the grounds that the board knows what is in the best interest of the stockholders.
Second, the court should review whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise. To guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control, a board that is properly motivated and has identified a legitimate threat must tailor its response to only what is necessary to counter the threat. The board’s response to the threat cannot deprive the stockholders of a vote or coerce the stockholders to vote a particular way.
Applying this standard to the Chancellor’s decision, the Supreme Court upheld her findings that the company’s board was properly motivated in responding to the existential threat posed by the stockholder deadlock. It also upheld Chancellor McCormick’s conclusion that the board’s actions in authorizing the share issuance were reasonable and proportionate to the existential threat posed by the potential stockholder deadlock and that its response was not preclusive or coercive.
Ultimately, it looks like the key takeaway from this decision is that Blasius is officially gone as an independent standard of review, and is instead subsumed into the Unocal standard – just as then-Vice Chancellor Strine advocated more than 15 years ago. For more in-depth discussion of the potential implications of this doctrinal shift, be sure to check out the commentary on this decision from Prof. Stephen Bainbridge and Prof. Ann Lipton.