We’ve previously blogged about the growing importance of cybersecurity due diligence in M&A. The UK Information Commissioner’s Office brought home some of the risks of inadequate diligence in this area when it announced its intention to impose a £99 Million fine on Marriott for GDPR violations associated with a data breach at Starwood Hotels, which Marriott acquired in 2016.
The press release announcing the fine specifically said that the ICO’s investigation “found that Marriott failed to undertake sufficient due diligence when it bought Starwood and should also have done more to secure its systems.” This excerpt from a recent Debevoise memo says that the ICO’s reference to inadequate diligence was unprecedented:
The proposed Marriott fine is the first major regulatory action anywhere to specifically call out a company for purportedly inadequate cyber due diligence in connection with an M&A deal. The proposed fine comes hot on the heels of the ICO’s notice of intent to fine British Airways £183 million. That proposed fine relates to British Airways’ 2018 data breach affecting approximately 500,000 customers.
The ICO has not yet published the details of Marriott’s alleged GDPR violations. Hence it remains to be seen exactly what more the ICO thinks Marriott could or should have done to identify and remediate the Starwood breach, whether pre- or post-closing of the acquisition.
The Starwood data breach apparently occurred in 2014, but the resulting exposure of customer data wasn’t discovered until 2018. The memo notes that approximately 339 million people across the world were affected by the breach, including 7 million in the UK.
After the Supreme Court’s decision in Aruba Networks, most lawyers probably thought that Vice Chancellor Laster’s “unaffected market price” approach to appraisal valuation was dead & buried. Last week, Vice Chancellor Slights issued a 144-page opinion in In re: Appraisal of Jarden Corporation, (Del. Ch.; 7/19) that says the doctrine still has some life left in it.
The Jarden decision is intriguing in many respects. Not only did the Vice Chancellor reject the valuation approach that the Delaware Supreme Court so recently endorsed & adopt the exact approach that it strongly rejected, but he also waded into the subjective mire of DCF analysis to an extent that most post-Dell opinions have tried to avoid.
First, VC Slights decided that the deal price minus synergies approach endorsed in Aruba Networks was inappropriate due to flaws in the sale process that may have put an artificial cap on the price & significant uncertainties regarding the value of anticipated synergies. Instead, as this Cleary Gottlieb blog notes, the Vice Chancellor returned to the unaffected market price approach rejected by the Supreme Court:
The Court first found that the market for Jarden’s stock was efficient based on testimony by the company’s expert, who looked at factors such as Jarden’s market capitalization, trading volume, bid-ask spread, number of analysts, and event studies. The Court rejected the petitioners’ argument that the unaffected market price was unreliable because the market was unaware of material facts about Jarden’s standalone prospects.
Notably, the Court dismissed the materiality of the projections Jarden’s management prepared in connection with the merger, which were not disclosed until after the deal was announced (in Jarden’s proxy), largely based on an event study by the company’s expert showing that the buyer’s stock declined when such projections were disclosed (noting it should have climbed if the market believed those projections showed Jarden had previously been undervalued, as petitioners claimed).
And although there was a gap between the date on which the unaffected price was calculated and the closing (which is the valuation date for purposes of a statutory appraisal), the Court found that, if anything, Jarden’s fair value was declining in that period.
What about discounted cash flow analysis? Well, VC Slights took a deep dive into that valuation approach as well. Not surprisingly, the competing DCF analyses put forward by the plaintiff & defendant were “fantastically divergent,” so the Vice Chancellor conducted his own DCF analysis that supported a conclusion that the unaffected market price of Jarden’s stock represented its “fair value.”
So, for now at least, it looks like reports of the demise of the unaffected market price approach to valuation are greatly exaggerated. Over the longer term, it will be up to the Delaware Supreme Court to determine whether it’s actually alive – or just a dead man walking.
This July-August issue of the Deal Lawyers print newsletter was just posted – & also mailed – and includes articles on:
– RSI Holdco: Delaware Chancery Court Upholds Seller’s Privilege Claim
– Important State & Local Tax Considerations in M&A
– Revlon Lives: Delaware Chancery Declines to Apply Corwin Doctrine
– Delaware Appraisal: The Road to Aruba Networks
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Subscription credit facilities, which provide a debt financing source for PE funds secured by investors’ capital commitments, can be a useful tool to address liquidity needs & provide short-term bridge financing in advance of a capital call. This recent Prequin report surveys the state of the market for these credit facilities. Here’s an excerpt from a segment written by Fitch’s Meghan Neenan that lays out some of the potential issues associated with a fund manager’s decision to draw on a subscription facility:
Subscription facilities can also accelerate the recognition of incentive income for the manager in an upside scenario, as LP capital calls can be delayed and investment returns can be generated on borrowed money, leading to higher IRRs which can put fund returns over high-water marks sooner in the fund life. Earlier investment ‘wins’ may lead some investment managers to realize incentive income sooner in the fund life, increasing the risk that those returns could be clawed back (returned to LPs) at a later date if fund investments ultimately underperform expectations. Additionally, there is a borrowing cost on the subscription facilities (albeit modest) that is borne by the funds which can make mediocre fund returns look modestly worse.
The report notes that if LPs don’t understand these cost & incentive dynamics, the fund sponsor’s reputation could suffer and may make it more difficult to raise capital in the future.
I confess that I haven’t spent a lot of time on the SEC’s rule proposal on M&A financial statement requirements, but I thought that there might be a few potential bombshells lurking in there. Sure enough, it looks like Wachtell Lipton found a big one. Here’s an excerpt from the firm’s recent memo:
Article 11 of Regulation S-X currently precludes inclusion of pro forma adjustments for the potential effects of post-acquisition actions expected to be taken by management. As explained in the SEC Division of Corporation Finance’s Financial Reporting Manual, “highly judgmental estimates of how historical management practices and operating decisions may or may not have changed as a result of that transaction” are “considered a projection and not an objective of S-X Article 11.”
The proposed amendments would replace the existing pro forma adjustment criteria with, among other things, “Management’s Adjustments” that would include “synergies and other effects of the transaction, such as closing facilities, discontinuing product lines, terminating employees, and executing new or modifying existing agreements, that are both reasonably estimable and have occurred or are reasonably expected to occur.” The proposed rules would require, for each Management’s Adjustment, “a description, including the material uncertainties, of the synergy or other transaction effects; disclosure of the underlying material assumptions, the method of calculation, and the estimated time frame for completion; qualitative information necessary to give a fair and balanced presentation of the pro forma financial information; and to the extent known, the reportable segments, products, services, and processes involved; the material resources required, if any; and the anticipated timing.”
For synergies and other transaction effects that are not reasonably estimable and will not be included in Management’s Adjustments, the proposed rules would require “that qualitative information necessary for a fair and balanced presentation of the pro forma financial information also be provided.”
What is it with everybody’s obsession with synergies these days? First the Delaware Supreme Court deducts them in appraisals and now the SEC wants them filed with your pro formas. The thing is, well, there’s usually a big problem with synergies, as another excerpt from Wachtell’s memo explains:
“Pro formas are an imperfect vehicle for communicating synergy predictions for many reasons, including the timing disconnect, the fact that synergies are not always a material element of transactions, and the practical reality that synergy targets identified upon transaction announcements are inherently uncertain and based on limited information exchanged during due diligence.”
In other words, even the best synergy estimates often include a fair amount of wishful thinking. That’s not a good place to be if the information in question is going to be included or incorporated by reference in a proxy statement or a 1933 Act filing.
Okay, maybe the title’s play on the famous line from John Huston’s “Treasure of the Sierra Madre” was click bait, but hey – you clicked, didn’t you? Anyway, in Europa Eyewear v. Kaizen Advisors, (D. Mass; 7/19), a Massachusetts federal court recently held that a non-signatory deal jumper was bound by a California choice of forum clause contained in the merger agreement negotiated by the two original parties to the deal.
The Court cited extensive precedent holding that a non-party may be bound by a forum selection clause if it is “closely related to the dispute such that it becomes foreseeable that it will be bound.” In this case, the jilted buyer filed a California action in which it sought damages and injunctive relief based on, among other things, the seller’s alleged contractual breaches and the deal jumper’s alleged tortious interference with that contract.
The Court ruled that since everything turned on interpretation of the underlying contract, the deal jumper’s alleged conduct was so closely related to the contractual relationship that the forum selection clause applied to it as well. The deal jumper objected on due process grounds, but the Court said that its decision to initiate the litigation by filing a declaratory judgment action was fatal to that objection:
The Court recognizes the significant due process considerations implicated where forum-selection clauses are applied to a non-signatory. In this case, however. . . Europa is the plaintiff seeking declaratory judgment not a defendant being haled into a forum with which it has no contacts. Accordingly, like all other plaintiffs, if it wishes to proceed with its claims, it must do so in the proper forum. Here, that is the Central District of California.
Check out this Ropes & Gray podcast featuring former Corp Fin Director Keith Higgins addressing the use of Rule 506(c) in the context of PE fundraising. Here’s an excerpt from an exchange between Keith & his colleague Peter Laybourn on the ability of a sponsor to flip from relying on Rule 506(b) to Rule 506(c):
Peter Laybourn: I’m sure that every fund formation lawyer out there has had instances where a client calls them up with a particular general solicitation question. I certainly know that I have had that happen multiple times.
Keith Higgins: We’ve talked about it before.
Peter Laybourn: Exactly, many times. For example, one called me up very recently and said, “Hey, we’ve just been approached by a reporter and we’d like to respond to him or her and share the details about our fund. Can we do that?” And I then have to be the bad guy and say, “No, you can’t because you’re relying on 506(b).” So Keith, do you have any advice for sponsors that find themselves in that position and who want to talk to the press?
Keith Higgins: Sure. You want to talk to the press about that specific offering and about that fund, you can flip the offering to a 506(c). In fact, unless you’ve made your first sale, you haven’t filed your Form D anyway, so you haven’t had to check the box as to whether you’re doing it under B or C, you just decide you’re going to move forward on 506(c). And the Commission staff did provide guidance that said it’s okay to flip from a B to a C – that’s good to go.
The other piece of advice on that, if you want to talk to reporters, is you have to engage in that “fencing on an electronic tightrope” where you’re talking about the general strategies of the fund complex, etc., without trying to focus in on a specific offering that you’re doing – that’s what we’ve been doing all along and it sometimes works, sometimes doesn’t. So, the surefire way to do it is to decide you’re going to do a 506(c), and particularly, if you’re selling to institutions, I think the verification shouldn’t be a big problem.
In case you’re wondering – no, I didn’t sit down & transcribe this podcast for you. But somebody at Ropes & Gray did, and the transcript accompanies the podcast. I hope other law firm podcasters are paying attention, because that’s a smart move.
A few weeks ago, I blogged about Canon & Toshiba’s unsuccessful efforts to structure an acquisition around HSR’s pre-merger notification requirements. U.S. regulators imposed a total of $5 million in monetary penalties on the parties, among other sanctions. Now European regulators have weighed in – and this Wilson Sonsini memo reports that they’ve imposed a much larger monetary sanction on one of the parties. Here’s the intro:
As the time taken to secure merger control clearances for global transactions lengthens, the parties and their advisers may be tempted to explore alternative deal structures that might allow a transaction to close sooner than otherwise expected. In a stark reminder to industry that it will not tolerate schemes that have, in its view, been devised to circumvent or undermine the efficacy of merger review, the European Commission (EC) announced on June 27, 2019 that it was fining the Japanese conglomerate, Canon, EUR 28 million (almost $32 million) for closing its acquisition of Toshiba Medical Systems (TMSC) in 2016 before notification to the EC and other competent agencies.
Like its American counterparts, the EC didn’t think the deal’s two-step structure passed muster. Instead, it viewed as a “warehousing scheme” that was part of a single transaction. Accordingly, it concluded that the transaction was subject to a notification requirement prior to the first stage of the deal, & that Canon had violated its standstill obligation by completing the first step prior to notification.
It’s been 50 years since Apollo 11, and now it looks like the prospect of space tourism is finally on the horizon. Personally, I don’t think I’m built for it. I’ve found that the harnesses on some roller coasters at Cedar Point aren’t designed for – ahem – athletic builds like mine, and I can’t imagine that I’d have better luck with whatever harness Richard Branson intends to use to strap people into their seats on his spaceship.
While I may not be in the market for a ride on a rocket, other people are excited enough about Branson’s prospects to permit his company, Virgin Galactic, to plan to go public in a deal that values the business at $1.5 billion. This Pitchbook article discusses the transaction, which will be accomplished in a very unorthodox way for such a high-profile deal – a reverse merger with a SPAC. Here’s an excerpt:
Virgin Galactic and tycoon Richard Branson are planning to take their promise of space tourism to the public markets—with a little help from Social Capital and founder Chamath Palihapitiya. A special-purpose acquisition company called Social Capital Hedosophia has agreed to purchase a stake of up to 49% in Virgin Galactic at an enterprise value of $1.5 billion, with Palihapitiya contributing $100 million and taking over as chairman of the newly combined entity. Social Capital Hedosophia will put about $800 million into the deal, according to The Wall Street Journal, a bet on Virgin Galactic’s ability to safely send earthlings into the stratosphere—and, of course, bring them back.
Reverse mergers with public shells have long been the go-to route to public status for microcaps peddling cancer cures & cold fusion. More recently, they’ve been used as a quick way to investors’ wallets by participants in the so-called “China Hustle.” While legitimate companies have successfully gone public through reverse mergers, the deal structure had been abused enough that the SEC saw fit to issue an investor bulletin on it back in 2011.
But in recent years, VCs & private equity players have entered the game and have sponsored their own SPACs. Reverse merger deals like the one Virgin Galactic & Social Capital are working on suggest that the credibility that these financial sponsors add may make this route to the public markets more attractive to real companies than it has been in the past.
Here’s an interesting new study by several prominent scholars – including SEC Commissioner Robert Jackson – that asks the question: does Revlon matter? In order to come up with an answer, the authors analyzed data from over 1,900 transactions that took place over a 15-year period. Their conclusion was that in Delaware, Revlon matters a lot – but in other jurisdictions that have adopted the standard, it doesn’t seem to move the needle. Here’s an excerpt from the abstract:
After subjecting this sample to empirical analysis, our results show that Revlon does indeed matter for companies incorporated in Delaware. We find that for Delaware Revlon deals are more intensely negotiated, involve more bidders, and result in higher transaction premiums than non-Revlon deals. However, these results do not hold for target companies incorporated in other jurisdictions that have adopted the Revlon doctrine.
Our results shed light on the implications of the current state of uncertainty surrounding Revlon and provide some direction for courts going forward. We theorize that Revlon is a monitoring standard, the effectiveness of which depends upon the judiciary’s credible commitment to intervene in biased transactions. The precise contours of the doctrine are unimportant provided the judiciary retains a substantive avenue for intervention.
In other words, the Delaware courts have demonstrated a willingness to intervene in cases of management bias that doesn’t seem to be present among courts in states where the doctrine’s been imported.
The authors note that recent Delaware decisions in C&J Energy and Corwin have been criticized for “overly restricting” Revlon, but their study suggests that those concerns are overblown so long as the transactions are monitored by Delaware judges who prioritize the substantive concerns about managerial bias that gave rise to the doctrine in the first place. They emphasize that this means not allowing the procedural emphasis of decisions like Corwin to overwhelm these substantive concerns:
Corwin, as we have already noted, focuses courts on the procedural prerequisites of a fair and fully informed vote of the disclosures under Corwin should therefore look to information that is probative of management bias, not matters that would be irrelevant to an application of enhanced scrutiny. If the plaintiffs succeed in uncovering previously undisclosed evidence of management bias, the shareholder vote should not count as “fully informed” and the cleansing effect of Corwin should not apply.
Speaking of other states, here’s a blog from Keith Bishop discussing the rather curious fact that California courts have been almost completely silent about the Revlon doctrine.