On Friday, the SEC issued this 224-page proposing release that would make significant changes to the rules governing the financial information that public companies must provide for significant acquisitions and divestitures. Here’s the SEC’s press release – and we’ll be posting memos in our “Accounting” Practice Area.
The “fact sheet” that the SEC included with its press release summarizes the changes that it proposes to make. As this excerpt indicates, they are fairly extensive:
The proposed changes would, among other things:
– update the significance tests under these rules by revising the investment test and the income test, expanding the use of pro forma financial information in measuring significance, and conforming the significance threshold and tests for a disposed business;
– require the financial statements of the acquired business to cover up to the two most recent fiscal years rather than up to the three most recent fiscal years;
– permit disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity;
– clarify when financial statements and pro forma financial information are required;
– permit the use in certain circumstances of, or reconciliation to, International Financial Reporting Standards as issued by the International Accounting Standards Board;
– no longer require separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for a complete fiscal year;
The changes would also impact financial statements required under Rule 3-14 of Regulation S-X (which deals with acquisitions of real estate operations), amend existing pro forma requirements to improve the content and relevance of required pro forma financial information, and make corresponding changes in the rules applicable to smaller reporting companies under Article 8 of Regulation S-X.
Interestingly, while Commissioner Jackson voted in favor of moving forward with the rule proposal, he also issued a statement in which he expressed concern that the proposals seem to proceed from the assumption that mergers and acquisitions are “an unalloyed good.” He expressed some skepticism about that, contending that the proposals ignore “decades of data showing that not all acquisitions make sense for investors.”
Ultimately, Jackson urged investors “to help us engage more carefully and critically with longstanding evidence that corporate insiders use mergers as a means to advance their private interests over the long-term interests of investors.”
For more detail on the rule proposals, check out this blog from Cooley’s Cydney Posner.
This Bloomberg article says that PE funds are holding on to their portfolio company investments for shorter periods than in years past – and that this could be an early warning of trouble ahead for M&A. Here’s an excerpt:
Private equity firms appear to be signaling “Last one out is a rotten egg.” If those powerhouse investment firms smell something fishy, other investors should take notice.
Holding periods — the amount of time between when a buyout firm makes an acquisition until it flips the company back into the public markets or to another buyer — have been drifting down for the past few years around the world. Last year, though, they took a dive, including in the U.S., where they had risen slightly in 2017. In 2018, it was just 4.5 years from buyout to exit in the U.S., according to research firm Preqin. That’s down from an average of 5.1 years in 2017 and the quickest turnaround time the PE market has seen since 2009.
The article acknowledges that there could be several reasons for the decline, but says that “the most likely answer is that PE professionals see economic trouble ahead and are headed for the exits.”
Most businesses seeking to capitalize on blockchain technology involve, to a greater or lesser extent, “permissioned blockchains” – i.e., those that restrict access so that only certain kinds of users can participate in the network. If you’re representing a company that’s thinking about buying or investing in a business involving a permissioned blockchain, you should check out this Davis Polk memo.
The memo lays out the differences between permissioned & permissionless blockchains and addresses a variety of legal issues associated with acquisitions & investments in permissioned blockchain businesses. Here’s an excerpt discussing potential governance issues:
One important consideration relates to governance. As a blockchain becomes more centralized, it looks less like a blockchain and more like a traditional database. Elements of centralization will certainly be useful to the acquirer, but too much centralization will give the acquirer control to manipulate or unmask on-chain data. If the acquirer comes to dominate the acquired blockchain’s technical or economic environment, that blockchain can no longer offer a shared landscape that facilitates the decentralization of trust from one central party—in other words, that blockchain will replicate the centralized dynamic of traditional databases, in which a core administrator controls the other users.
Importantly, even the perception that these outcomes could occur would drive some participants elsewhere, because an acquirer that retains some latent right to unilaterally control or censor the blockchain is still an extremely centralized presence. To mitigate these risks, an acquirer could enter into agreements with other participants that contractually limit its own ability to make certain kinds of governance decisions, such as unmasking on-chain data.
An acquirer could also offer participants equity in a limited joint venture formed for the purposes of governing the blockchain, or transfer governance rights to an independent nonprofit, to signal that the acquirer views decentralization as an important factor in the overall health and value of the blockchain. Finally, the acquirer could give participants the right to influence dispute resolution processes, such as the right to choose an arbitrator.
Other topics addressed include intellectual property issues, risks associated with the potential use of blockchains to avoid sanctions & for other illegal transactions, and cybersecurity issues. The memo also addresses how some of the risks associated with an acquisition of a permissioned blockchain business might be mitigated by an investment instead of an outright purchase of the business.
I’ve previously blogged about how private equity funds are finding that activists -who have historically been a source of deal flow for PE funds – are increasingly competing with them for deals. This Skadden memo on 2019 activism trends highlights how the lines between activism & private equity continue to blur:
A key trend to watch in 2019 is the blurring of the lines between traditional shareholder activism — where investors, typically hedge funds, take an ownership position in a public company and seek to effect material change by utilizing various tactics including proxy contests, stockholder proposals, and public and private agitation — and private equity transactions, where investment firms aim to acquire or take a significant position in private companies (or public companies that they seek to take private) with the goal of exiting in the future at a higher price.
Over the past few years, activist investor Elliott Management has engaged in a more traditional private equity strategy, including its acquisition of Gigamon in 2017; its purchase, with Veritas, of Athenahealth in November 2018; and most recently, its take-private acquisition, part-nering with Siris Capital, of Travelport. Early in 2019, activist investor Starboard Value stepped into the quasi-private equity space with its $200 million strategic investment in Papa John’s.
The memo says that in some respects, private equity is a “natural next step” for activists. One reason is that by demonstrating the capability to acquire the company an activist increases its credibility when it approaches a company. After all, the knowledge that a company is dealing with somebody that is willing to acquire or make a significant investment in it is unlikely to be lost on the board & management.
According to Dechert’s latest report on antitrust merger investigations, the number of significant U.S. investigations declined almost 40% during the 12 months ending in Q1 2019 compared to the prior rolling 12 months. That’s the good news for dealmakers. The bad news is that notwithstanding regulators’ stated desire to speed up the pace of these investigations, their average duration increased by nearly a month, due in part to the 35-day U.S. government shutdown.
Dechert’s report also includes data on a number of other antitrust M&A issues, including the number & duration of EU antitrust investigations. This excerpt addresses what parties can expect when it comes to a potential investigation’s timeline:
Current statistics suggest that parties to the hypothetical average “significant” investigation subject to review only in the United States would have to plan on approximately 11 months for the agencies to investigate a transaction, and another five to seven months if they want to preserve their right to litigate an adverse agency decision.
Deal timetables for EU cases where the investigation is likely to proceed to Phase II need to allow for an average lapse of almost 13 months from announcement to clearance. If the investigation is likely to be resolved in Phase I with remedies, the deal timetable should allow for approximately 8 months from announcement to a decision.
One aspect of the report that caught my eye related to contractual termination rights & antitrust reverse breakup fees. Extended contractual “drop dead” dates to address antitrust issues & provisions calling for payment of reverse breakup fees are common when a seller anticipates that a deal may involve significant antitrust risk. Here are some of the key takeaways on this topic:
– Analysis of publicly available transaction agreements for deals involved in significant U.S. merger investigations suggests that companies are agreeing to longer termination periods but smaller break fees.
– The average time from deal announcement to the final termination date in transaction agreements for significant U.S. merger investigations that concluded in 2018 was 16.9 months, up from an average of 14.6 months from 2015-2017.
– While termination periods have increased, antitrust-related reverse break fees have been trending downward since 2015. Significant U.S. investigations concluding in 2018 had an average reverse break fee of 3.2%, down from an average of 4.4% from 2015-2017.
Family businesses are unique in many ways – and the process by which they find a buyer is often one of them. This DLA Piper memo has some tips for private equity sponsors on how to successfully navigate the challenges associated with buying a family business. Here’s an excerpt that says not to show up at the business looking like a bunch of private equity “deal jocks”:
One business owner told us, “They came here straight from the airport in suits and black cars. My employees thought the FBI was coming to take me in.” That business owner was able to laugh about the behavior of the private equity sponsors who were courting him, but those discussions failed to launch.
Every business has a culture or ethos that drives behavior, including dress, mannerisms and manifestations of respect. After spending time with a team at the management presentation, it is important that the sponsor’s deal team try to follow the company’s leadership in terms of style and dress.
Moreover, it is easy to forget that, as exciting as the deal may be for everyone, the business owner will still want to keep these discussions confidential from most people. Dressing and behaving in an inappropriate, high-profile way may alarm the company’s long-term employees, family members, and, of course, material customers and suppliers, who may be unaware that a founder or family-business owner is preparing to leave the business. Avoid the need to do damage control (and to force the owner to do damage control) and help the business owner stay focused on your offer by being thoughtful in how you present yourself.
Other tips include things like the need to identify the real decision maker – titles sometimes don’t matter much in a family business – and the need to be willing to invest more time in the deal process than you might in other settings.
CFIUS recently announced that it had imposed a $1 million civil monetary penalty against an undisclosed entity for repeatedly breaching a 2016 mitigation agreement. CFIUS has had the ability to impose fines for non-disclosure & other compliance issues, but it hasn’t exercised this authority in the past. This Winston & Strawn memo says that CFIUS’s decision to impose a fine now is kind of a big deal:
On April 12, 2019, CFIUS released a brief statement on its website that in 2018 it imposed a fine of $1 million on an unnamed company for failure to comply with a mitigation agreement. Specifically, the penalty was imposed for “repeated breaches of a 2016 CFIUS mitigation agreement, including failure to establish requisite security policies and failure to provide adequate reports to CFIUS.” This appears to be the first time CFIUS has used its penalty powers and a signal that it may do so more frequently.
Part of this interest in penalties may be due to the recent creation within CFIUS of a team wholly dedicated to monitoring compliance with mitigation agreements.
Companies need to keep CFIUS’s new willingness to exercise its authority to impose monetary penalties in mind, because as the memo points out, those fines can pack quite a wallop. The Foreign Investment Risk Review Modernization Act enacted last year granted CFIUS the authority to mandate certain filings & impose fines on those that fail to comply – and regulations under the Pilot Program provide that penalties for failure to comply with mandatory filing requirements can be as much as the value of the transaction.
This King & Spalding memo addresses the role that “self help” remedies played in the successful defense of the DOJ’s challenge to the AT&T/Time Warner merger. This excerpt provides an overview of the actions taken by the parties to the deal & the Court’s reaction to them:
Among the many issues raised by the litigation is the potential significance of company-initiated “remedies,” as opposed to government-mandated divestitures or behavioral commitments, in countering government merger challenges. One of the DOJ’s key allegations in the litigation was that the combined AT&T/Time Warner would be more likely to raise prices for Turner Broadcasting content to rival video distributors (such as Comcast or Dish) because in the event of a Turner Broadcasting blackout on rival platforms, some disgruntled customers would switch to AT&T’s DirecTV services.
A week after the DOJ filed its complaint to block the merger, Turner Broadcasting sent letters to 1,000 distributors pledging that it would offer arbitration in any renewal disputes and that distributors would have the right to continue to carrying Turner networks pending the outcome of the arbitration, meaning no blackouts during the arbitration process. This arbitration provision would be in place for seven years.
During the trial and the appeal, the merging parties repeatedly referenced the arbitration offer in response to the DOJ’s allegations of competitive harm from increased bargaining leverage, and both the trial court and D.C. Circuit emphasized the importance of the arbitration/no-blackout proposal in their decisions. Indeed, the D.C. Circuit said that the arbitration offer made the DOJ’s challenges to the district court’s treatment of the DOJ’s economic theories “largely irrelevant.”
While the DOJ has pushed back against self-help remedies & continues to prefer structural remedies (e.g., divestment) to conduct-based remedies, the memo says that appropriately tailored conduct commitments may be helpful in dealing with a merger enforcement action – particularly in the case of vertical mergers. That’s because, as the DOJ admitted in the AT&T/Time Warner case, vertical transactions “present greater theoretical and evidentiary hurdles for the government as compared to horizontal merger enforcement.”
Well, so much for two of my biggest stories – first, Rent-A-Center had the temerity to settle its reverse breakup fee claim on Monday without consulting me, and then, yesterday, the SCOTUS dismissed the Emulex case.
Rent-A-Center’s claim for a $126.5 million reverse termination fee arising out of its decision to terminate its merger agreement with affiliates of Vintage Capital had the potential to make some interesting law on a topic that Delaware courts haven’t spent much time on. Instead, the company opted to accept a $92.5 million settlement from Vintage to resolve the matter.
Meanwhile, back at the Supreme Court, the Emulex case – in which the existence of an implied private right of action under Section 14(e) of the Exchange Act was potentially at issue – was dismissed after oral arguments had already been heard. Why? SCOTUSblog reports that the reason was procedural:
Although the Supreme Court in earlier years routinely found private rights of action to be “implied” in the text of the federal securities laws, the court this century has viewed that practice as intruding on the authority of Congress to define the causes of action that federal courts can consider.
The problem, though, is that Emulex did not raise that argument in the lower courts. Several of the justices (most notably Justice Sonia Sotomayor) suggested that a decision considering the broad question – whether there should be a private right of action at all – would reward the defendants for not presenting that question to the lower courts. Today’s dismissal allows the court to postpone consideration of the broader question until it has been presented squarely.
So, the bottom line is that I’m left with nothing to write about. Sometimes, it’s hard out there for an M&A blogger. I’ll see you tomorrow – I’m going back to bed.
In order to for a spin-off to qualify under Section 355 of the Tax Code, the parent and the subsidiary must be engaged in an “active trade or business” immediately prior to the transaction & have been engaged in such business for at least five years. The IRS’s position has long been that in order to satisfy that requirement, a company must ordinarily generate income.
The IRS’s position has made it very difficult for most developmental stage companies to qualify to participate in a spin-off. Last fall, I blogged about the IRS’s apparent willingness to ease the income requirement while it studied the issue further. This Ropes & Gray memo says that the IRS has recently taken tangible steps in that direction, by suspending 2 problematic revenue rulings. This excerpt provides the details:
Specifically, the IRS, in Revenue Ruling 2019-09, has suspended the two prior rulings, each issued in 1957, during the pendency of the IRS study, because the rulings “could be interpreted as requiring income generation for a business to qualify” as an active trade or business. The suspension is a concrete step by the IRS with immediate impact, upon which taxpayers and their advisors may rely in evaluating whether the spinoff of an historic R&D-based business will qualify for tax-free treatment, or in seeking a private letter ruling from the IRS.
For now at least, the suspension resolves the tension between the suspended rulings and the regulations that adopt a somewhat more liberal approach. While the suspension is not necessarily permanent, the move provides further evidence that the IRS is prepared to take a more modern approach to the qualification of businesses without revenue as “active trades or businesses.
While it was sometimes possible to work around the 1957 revenue rulings, the memo notes that prior to their suspension, the rulings could have been interpreted as significant obstacles to tax-free spinoffs by life sciences, technology, or other businesses that are research-intensive and are not yet collecting income.