One of the measures taken by federal authorities to manage the financial crisis in the fall of 2008 was a remarkable piece of administrative guidance from the IRS. Issued on September 30th of that year and less than a page long, IRS Notice 2008-83, which was styled as an interpretation of existing law, had a dramatic positive effect on the value of banks’ tax assets. The Notice effectively turned off with respect to banks an aspect of Internal Revenue Code Section 382 that generally restricts the ability of a corporation to use unrecognized tax losses from underperforming loans to offset taxable income from other sources if that corporation undergoes a significant change in equity ownership, including an acquisition.
The direct result of the guidance was that tax assets of a target bank that otherwise would have been impaired following an acquisition could be fully utilized by an acquirer, with the further implication that targets with such tax assets became more attractive to profitable acquirers who could more rapidly deduct those losses than acquirers with less taxable income to offset. This implication played out only a few days after the Notice was issued, when Wells Fargo re-entered negotiations for the acquisition of Wachovia and outbid Citibank after determining that its ability to utilize Wachovia’s tax assets would allow it to acquire Wachovia without FDIC assistance. One estimate placed the value of the Notice in respect of Wachovia’s tax assets to Wells Fargo at roughly $20 billion. Controversy over the Notice, including whether it was a proper exercise of the Treasury Department’s authority and whether it was issued specifically to favor Wells Fargo, followed quickly and the Notice was overruled when the American Recovery and Reinvestment Act was signed into law in early 2009. Thus, there was a small window of roughly 3½ months in which the Notice was in effect and part of Section 382 was disabled with respect to banks.
In a recent paper, “Taxes and Mergers: Evidence from Banks during the Financial Crisis,” we examine the impact of IRS Notice 2008-83 and, by implication, the effects of Section 382, a controversial tax rule designed to discourage tax-motivated acquisitions. The adoption and subsequent repeal of the Notice presents a unique opportunity to explore the significance of taxes in the merger decision with a natural experiment and contribute to a literature with mixed results on the importance of taxes in that context. In general, the evidence suggests the effects of taxes on the frequency of acquisitions are modest but the effects on the price and structure of corporate acquisitions are more robust. Understanding these effects is important, not least because various tax rules, including Section 382, that target tax-motivated acquisitions also impose compliance and monitoring costs as well as create other distortions in merger decisions. If taxes have little effect on merger activity then a reconsideration of these rules may be in order.
A paper called “The Value of Activism: A Hedge Fund Investor’s Perspective,” published this month by a trio of U.S. college professors, examines how much return an activist play typically produces, compared to a non-activist bet made by the same hedge fund, based on a sample of 222 hedge funds operating between 1997 and 2011. On average, the activist positions neither outperformed nor underperformed the non-activist investments, according to authors Felix Zhiyu Feng of University of Notre Dame, Chengdong Yin at Purdue University, and Caroline Zhu from the University of Oklahoma. But there were some exceptions.
Hopefully, you’ve been taking advantage of the wonderfully written stories that John has been posting in the “John Tales Blog” on this site over the past few years. Here’s the intro from one of his latest:
I was sad to see that Tom Wolfe passed away last week. If you ever want to get a feel for the Roaring 80s, his “Bonfire of the Vanities” is the obvious place to start – the glamorous life of a Wall Street “Master of the Universe” plays a prominent part in that novel’s story. This story isn’t like that. It’s about a couple of associates from a flyover state law firm who went to New York for a billion-dollar LBO closing in 1987 – and it’s really more of a cross between The Out-of-Towners and Bartleby the Scrivener.
We’d been working on the deal for several months – the company had been sold by its Fortune 50 parent company to a financial sponsor and management team in an LBO at the end of 1986. The deal was a mid-80s classic – it had been done on seller paper and highly confident letters, but had a very short fuse. In 120 days, it all turned into a pumpkin unless the parties were able to get permanent debt and equity financing in place.
There were a couple of major New York investment banks driving the deal, and they were represented by a couple of BigLaw firms. Add in the senior lenders and their lawyers, the company’s in-house staff and us, and it was a good ol’ fashioned feeding frenzy.
We were brought in to represent the management in negotiating for its equity, but because we were Ohio lawyers and this was an Ohio corporation, we also had a lot of involvement when it came to the nuts and bolts surrounding the closing of the mergers and the various financing arrangements involved in the transaction. This was the first billion dollar deal I ever worked on – and it’s still one of the biggest I’ve ever been involved with.
To say the financing arrangements were intricate is an understatement – I don’t remember all of the details, but I remember filing a resale S-1 for the deal after the closing that had so many different securities on it even the Corp Fin Staff was impressed. We called the reviewer one day to check on the status of the filing. We mentioned the name of the company, and the reviewer didn’t initially recall the filing – but then he said, “Oh, wait. . . wow, that’s the S-1 with, like, 20 different securities on it, right?” There weren’t that many, but it was nice to know we made an impression.
Here’s the intro from this blog by Cleary’s Neil Whoriskey (see John’s latest blog for more on the staggered board debate):
Beyond the cacophonous din of voices calling for companies to serve a “social purpose,” adopt a variety of governance proposals, achieve quarterly performance targets, and listen to (and indeed even “think like”) activists, there is now, most promisingly, a call from genuine long-term shareholders for public companies to articulate and pursue a long-term strategy.
This latest shareholder demand directly supports the achievement of traditional corporate purposes, and seems, more than any other shareholder demand of the last decade, the most likely to increase shareholder value. Yet in current circumstances, where all corporate defenses have been stripped in the name of “good governance,” boards and management have been given zero space in which to formulate and implement a long-term strategy. Indeed, the very fact that shareholders must demand corporations focus on long-term strategy demonstrates just how effectively the governance movement has been co-opted by market forces to serve the interests of short-term activists and traders to the detriment of long-term investors.
It is time for long-term investors to recognize that aspects of the good governance movement have in fact come at significant cost to their own investors, to be perhaps a bit more wary of partnerships with activists, and to actively create the conditions that will allow boards and management to focus on the long-term. Exhortations are not enough. The first step should be to bring back staggered boards.
– Locked box was used in 25% of all deals across Europe and was particularly popular in larger deals;
– Earn-outs remained a popular feature, especially in Benelux, German-speaking countries and Southern Europe with longer earn-out periods and more turnover-based earn-outs than previously;
– Baskets and de minimis provisions were less frequent due to nominal liability caps in deals featuring W & I insurance making them redundant;
– W & I insurance usage is at an all-time high, especially in deals exceeding EUR 25m;
– Liability caps are getting lower, especially in the bigger European jurisdictions, mainly as a result of W & I insurance;
– Limitation periods are not getting any longer, with the majority operating in the one- to two year range;
– Security for warranty claims is less frequent than it was a decade ago, with escrow accounts being very much the favoured alternative when there is security;
– MAC clauses have never been rarer in Europe;
– Arbitration regained some of its popularity with a notable trend emerging in favour of international rather than national rules where applicable.
Recently, a member posted this in our “Q&A Forum” (#402):
My client is a CEO of a public company that is being acquired by another public company in an all-stock transaction. The CEO will become a director of the acquiring company and has a desire to sell some of the CEO’s rather sizable equity holdings. The CEO would like to adopt a 10b5-1 plan to sell the shares and is wondering whether the plan can be adopted prior to closing.
I haven’t found any guidance on this issue – from off-the-shelf materials to SEC guidance – one way or another. The CEO’s broker hadn’t encountered this situation before, but the broker is with a small firm (vs. an investment bank), so the sample size is likely small. The legal argument against adopting before closing is that the SEC could view the closing in and of itself as a modification of the plan. I view the “closing as a modification” argument as quite conservative, especially if the trading triggers are straightforward (e.g., sell X shares per month, subject to a floor).
If anyone has encountered this situation before, have you found any sort of guidance on the issue? Or perhaps even have publicly-available examples (e.g., Section 16 notes, etc.)?
John responded with:
I’ve not seen anyone do something like this. The period between signing and closing a merger seems to me to be a very risky time for the CEO of the seller to adopt a 10b5-1 plan. There are simply too many moving pieces in a pending deal and it is easy to second guess whether the insider was in possession of MNPI at the time of the plan’s adoption.
This Sidley memo (pg. 4) says closer national security scrutiny of deals involving foreign buyers isn’t just a U.S. phenomenon – the EU and several European nations are taking a harder look as well. This excerpt provides an overview of recent actions:
Consistent with recent trends in the United States, the European Union (EU) and many national governments in Europe are expressing renewed interest in greater scrutiny of acquisitions by foreign investors. Government ministers in Germany recently opposed a takeover in the robotics industry by a Chinese bidder, while government ministers in the Netherlands recently opposed a takeover in the pharmaceutical industry by an American bidder.
Similarly, a number of governments in Europe have recently taken steps to reform national rules in order to increase their powers to scrutinize foreign takeovers. In total, 12 of the 28 EU Member States operate regimes for the review of foreign direct investment, or FDI. The number of prohibitions has historically been low, but new rules are widening the scope for intervention.
For example, France, whose FDI regime already covers acquisitions affecting national security or concerning the supply of energy, water, transport, telecommunications and public health, is now proposing coverage of artificial intelligence and digital technology.
Other jurisdictions have opted instead to expand the scope of review by their competition authorities Germany and Austria, for example, recently introduced new thresholds into their merger control regimes which are designed to extend their jurisdiction to review acquisitions of data-rich targets in the technology and life sciences sectors.
These trends are expected to result in an increase in the overall number of deals reviewed, and are also expected to result in technology & data-related deals being subjected to both competition and national security review.
Common law “quasi-appraisal” claims have become more common in Delaware M&A litigation, and this Blank Rome memo says that the increasing prevalence of these claims could alter the risk profile of deals. This excerpt summarizes how quasi-appraisal actions change the potential liability landscape:
While the amount involved can be high, appraisal actions are typically limited to a small percentage of stockholders. Only stockholders who timely perfected their appraisal rights are permitted to obtain an award of “fair value” instead of the merger price (and of course, “fair value” could be less than the merger price—a risk many stockholders are unwilling to take). If “fair value” is determined by the court to be higher than the merger price, the buyer is responsible to make those additional payments to the dissenting stockholders. As such, the statutory threshold for the perfection of appraisal rights can provide a buyer with a level of risk predictability in a transaction.
But, what about when, for whatever reason, stockholders do not timely perfect appraisal rights under Section 262? Can such stockholders use the concept of quasi-appraisal as a substitute for appraisal? In such a quasi-appraisal claim, a stockholder can bring a claim (likely dressed up as a breach of fiduciary duty claim, i.e., not enough information provided to allow one to make a decision on the exercise of appraisal rights) without the need to exercise appraisal rights under the statute.
Because quasi-appraisal is rooted in fiduciary duty actions, directors/former directors are typically the target of such actions and may be on the hook for any difference in the merger price and the determined “fair value.” Quasi-appraisal actions are often pursued as class actions on behalf of most of the stockholders, meaning directors may face crushing personal liability if the court were to find liability and award quasi-appraisal damages.
The memo points out that continued growth in quasi-appraisal claims may result in a much less predictable environment than the one typically experienced when dealing with traditional appraisal claims. Instead of a limited number of dissenters, buyers may find themselves facing post-closing class actions alleging breaches of fiduciary duty by the sellers board. In many instances, the buyer will have indemnity responsibility for these claims.
We’ve previously blogged about the bipartisan push for CFIUS reform legislation & the Trump Administration’s initiatives to impose greater restrictions on Chinese investments in U.S. companies. This O’Melveny memo says that both of those efforts continue to move forward.
Earlier this week, the White House announced the President’s decision to implement “investment restrictions and enhanced export controls for Chinese persons and entities related to the acquisition of industrially significant technology” – with specific actions to be announced by the end of June. At almost the same time, CFIUS reform legislation – The Foreign Investment Risk Review Modernization Act, or FIRRMA – was unanimously approved by the Senate Banking Committee & the House Financial Services Committee.
The memo says that both FIRRMA & the new restrictions on Chinese investment are expected to be in place by August. This excerpt says that their combined effect will represent a substantial change in US policy toward foreign investment:
Individually or in combination, the White House action and FIRRMA will mark a pronounced — and probably permanent — departure from the 225-year-old US policy of welcoming foreign investment except in narrow circumstances. By highlighting “industrially significant,” “emerging,” and “foundational” technologies as specially under CFIUS protection, the government will assume broad new regulatory authority that will set the stage over the long term for future investment controls based more explicitly on economic policy and public interest concerns.
More immediately, implementation of the new authorities will significantly impact the financing and exit strategies of early stage US companies, as well as M&A and development partnership transactions involving mature companies, that possess technologies fitting the new designations.
The memo goes on to review the key components of the White House statement & the versions of FIRRMA that emerged from the House & Senate committees.
The UK’s decision to exit the EU put a damper on inbound M&A activity – with the dollar value of inbound deals declining from its 2015 peak of $341 billion to only $91 billion last year. However, this P.J. Solomon report says that the inbound M&A market in the UK appears to be stabilizing. This excerpt highlights this year’s activity:
– 2018 year-to-date UK inbound M&A has increased $170B compared to last year. Even excluding the 3 largest announced transactions YTD (Shire’s $81B bid for Takeda, Comcast’s $41B bid for Sky and Disney/Fox’s competing $37B bid forSky), UK inbound transaction volumes are still up $29.7B or 32.2% relative to last year.
– Foreign investment into the UK is being driven by greater comfort around Brexit and continued strength of global currencies relative to the British Pound (even despite the Pound’s recent run up)
– Overall, inbound M&A dollar volume has increased to 70% of all UK cross-border transactions, up from 57% in 2016. U.S. and Japanese companies have been the top bidders for UK targets in 2018, at $91B and $82B, respectively.
The report also covers other trends in global cross-border M&A, and provides a variety of data on YTD 2018 U.S. outbound & inbound activity.