The Match Group litigation continues to meander its way through the Delaware courts. The latest round finds us back in Chancery, where Vice Chancellor Zurn recently issued a letter decision addressing the defendants’ motion to dismiss. In that decision, she refused to dismiss breach of fiduciary duty claims against the company’s directors, but did dismiss those claims against its alleged controlling stockholder – and it’s this latter ruling that makes the case interesting.
If you’ve been following the case, you know that Vice Chancellor Zurn originally dismissed the plaintiffs’ challenge to IAC/InterActive’s 2019 reverse spinoff of its Match.com dating business on the grounds that the transaction satisfied the MFW framework. The Delaware Supreme Court reversed that decision earlier this year, and the Chancery Court was called upon to consider alternative grounds to dismiss the plaintiffs’ claims asserted by the defendants.
The plaintiffs alleged that media mogul Barry Diller was a controlling stockholder of the company by virtue of his ownership of over 40% of the stock in its parent company. Citing the Chancery Court’s prior decision in In re EZCORP Consulting Agreement Derivative Litigation. (Del. Ch.; 1/16), the plaintiffs argued that because Diller was the controlling stockholder of the company’s parent, he was the ultimate controller of the company itself.
Vice Chancellor Zurn rejected that contention. She observed that in order to be a controller, a stockholder must either owns a majority of the voting power, which she referred to as “hard control”, or otherwise exercise control over the company’s business and affairs, which she referred to as “soft control.” This excerpt summarizes her reasoning:
Plaintiffs argue that because Old IAC had hard control of Old Match, Diller must be Old Match’s ultimate controller under EZCORP. But I do not read EZCORP to stand for the proposition that the controller of a parent company is the subsidiary’s ultimate controller, always and as a matter of law. Put differently, EZCORP does not identify a transitive property of control that redounds through every chain of controllers. Rather, EZCORP applied the first prong of the traditional controller analysis to successive holders of 100% voting power, culminating in hard control of the entity at the bottom.
Plaintiffs have not pled Diller has hard control of Old IAC’s voting power that would necessarily grant him control of Old Match’s voting power. EZCORP does not satisfy or excuse Plaintiffs’ burden of pleading Diller, in the absence of any voting power at Old Match, still exercised actual control over it.
The Vice Chancellor concluded that the plaintiffs failed to adequately plead Diller exerted actual control over the subsidiary entity, at all or through his inferred actual control of its parent. In particular, she noted that the plaintiffs’ sole allegation bearing on Diller’s actual control of the subsidiary was that he used the parent’s voting power to pack the subsidiary board with five officers and directors of the parent and three individuals with close ties to Diller.
Vice Chancellor Zurn pointed out that the plaintiffs did not allege that the use of the parent’s voting power handed Diller actual control over the sub. In that regard, she said that the appointment of five parent company affiliates to the board deepened the parent’s control over the subsidiary, not Diller’s. The Vice Chancellor concluded that, even assuming the other three directors were beholden to Diller, his ability to influence three members of a 10-member board didn’t amount to control. Accordingly, she held that Diller was not a controlling stockholder of the subsidiary and dismissed the claims against him.
Remember when the FTC wouldn’t let Exxon Mobil move forward with its acquisition of Pioneer Natural Resources unless the company agreed not to honor a commitment to put Pioneer’s founder on Exxon’s board? Well, they did it again last week – this time imposing a similar condition on Chevron’s acquisition of Hess. As this excerpt from a LegalDive.com article on the FTC’s action notes, that decision didn’t sit well with the two Republican commissioners:
In a pair of scathing dissents, the Federal Trade Commission’s two Republican-appointed commissioners accused the agency of operating a pay-for-peace racket by forcing Chevron and Hess Corp. to agree to settlement terms that would never withstand court scrutiny.
In the settlement, Chevron agreed to keep Hess CEO John Hess off its board in exchange for the agency’s sign-off on its merger proposal. The FTC in its complaint said Hess needs to stay off the board because of his vocal support for the Organization of Petroleum Exporting Countries restricting output to keep oil prices high.
“The Commission leveraged its Hart-Scott-Rodino Act authority by threatening to hold up Chevron and Hess’s $53 billion dollar merger even though the lack of a plausible Section 7 [of the Clayton Antitrust Act] theory had long been obvious,” FTC Commissioner Andrew Ferguson said in his dissent.
Commissioner Ferguson went on to accuse the FTC of taking the action in order to placate “Democratic politicians who have repeatedly and publicly urged the Commission to block this merger in order to advance their climate agenda.” Commissioner Holyoak echoed his accusations in her own dissenting statement, and also noted that claims of a potential Section 7 violation were particularly suspect given that “[t]he combined Chevron-Hess Corporation entity will control two percent of the global oil market. A reduction in its output would hardly remove a drop from the metaphorical bucket.”
This Sidley blog compares and contrasts two recent Chancery Court decisions — Shareholder Representative Services. LLC v. Alexion Pharmaceuticals, Inc. and Himawan v. Cephalon, Inc. — both involving acquisitions of development-stage biotech companies and both interpreting an earnout provision’s objective or outward-facing definition of “commercially reasonable efforts.” Interestingly, both buyers were later acquired by larger pharma companies. Both earnouts included a discretion clause, giving the acquiring company sole or complete discretion with respect to business decisions, with the CRE clause serving as a limitation on that discretion. As this excerpt describes, the two cases had different outcomes, and while factual differences mattered, so did the drafting of the CRE definition.
In Alexion, the stockholders prevailed: The court found that the company had breached the CRE clause. In Cephalon, the buyer prevailed: The court found that the company had complied with the CRE clause. …
In Alexion, the critical language was “such efforts and resources typically used by biopharmaceutical companies similar in size and scope to [Alexion] for the development and commercialization of similar products at similar development stages.” This language was followed by 11 factors to be “tak[en] into account,” related to, among other things, safety, efficacy, likelihood of approval, and commercial viability.
In Cephalon, the critical language was “such efforts and commitment of such resources by a company with substantially the same resources and expertise as [Cephalon], with due regard to the nature of efforts and costs required for the undertaking at stake.”
In Alexion, the court took issue with an “idiosyncratic corporate initiative” to launch ten new drugs by 2023 and, following the acquisition of the buyer, with the parties’ pursuit of merger synergies, finding that the change in drug development efforts to accommodate this initiative and merger synergies didn’t satisfy an outward-facing efforts clause.
In Cephalon, the evidence suggested that Cephalon/Teva took the earnout’s milestone payment into account when determining whether it was a good business decision to continue on a certain development path. Focusing on the phrase “due regard to the nature of efforts and costs required,” the court found that “the CRE clause limited Cephalon’s discretion only insofar as it required the company to ‘go forward in its own self-interest.’”
The blog compares these two cases to highlight the importance of language in a CRE definition that either permits or prohibits considerations unique to the acquiring company.
The decisions suggest that for both sellers and buyers, language that includes—or excludes—considerations unique to the acquiring company can be critical, particularly as those factors may come into existence years after the acquisition. The language in Cephalon was so permissive that the company was allowed to actively work against the seller’s interests in determining not to invest in drug development.
Michael Levin’s The Activist Investor newsletter recently flagged an academic paper by Ben Bates of Harvard Law School on advance notice bylaws, “Rewriting the Rules for Corporate Elections.” The paper analyzes advance notice bylaws from 2004 to 2023 using a dataset of 14,000+ bylaws from 3,800+ public companies. Wow! The findings prove something we already knew — that advance notice bylaws have become longer and more complex while drafting variability has increased — but the methods employed to prove this and the paper’s insights on market-wide and firm-specific events that prompted changes in advance notice bylaws over the years are worth spending time on.
The paper used absolute length (word count) and individual components (disclosures required of activists) to assess complexity. The paper identified the following categories of individual components:
Agreements, arrangements, and understandings – between an activist and related parties, such as director nominees or other investors
Affiliates – of the activist
Associates – of the activist
Acting in concert – any other parties with which the activist might collaborate
Competitors – any investment or interest in competitors of the company
Derivatives – investment in derivative securities of the company, and possibly of competitors
Family members – extend various disclosure obligations to family members of the activist and its BoD nominees, and possibly affiliates or associates
Known supporters – of the activist, such as other shareholders
Performance fees – for the activist, say based on company performance or the outcome of the activist project
Questionnaire – whether the company requires director nominees to complete one of these
SEC Reg S-K Item 404 disclosures
SEC Schedule 13D disclosures
The paper says there were two big waves of amendments to advance notice bylaws. The first coincided with the 2008 financial crisis and an increase in campaigns by hedge funds against the firms included in the data set. The second, unsurprisingly, followed the universal proxy card rules. In the last few years, most bylaw amendments both accounted for the use of UPC and added additional substantive disclosure requirements.
The paper claims that variability in advance notice bylaws is the biggest issue — in terms of cost to shareholders — and points to features of Delaware law that may promote this variation. These include the relative lack of power of shareholders in amending corporate bylaws, Delaware courts’ willingness to blue pencil bylaw provisions and the very high standard Delaware courts apply for facial invalidity. It suggests three potential reforms to promote “standardization”:
– Amend the DGCL to require a shareholder vote on all amendments of bylaw provisions that govern board elections or nomination procedures
– Delaware courts could use their equitable powers to start requiring companies to give shareholders some time to cure disclosure deficiencies, particularly for deficiencies in responding to ambiguous and contestable ANB provisions
– Courts could lower the standard for finding ANBs to be facially invalid
This recent insight from ICR focuses on the hidden costs of short attacks for companies and posits that, despite the often larger risks posed by short attacks, both reputationally and financially, companies are usually less prepared for a short attack than a proxy contest. Here are some factors they highlight on the relative risk posed to companies:
– Short activism, or short attacks, are far more frequent than proxy contests. In 2023, there were 110 different short attacks and only 27 proxy contests globally (excluding closed-end fund activism), according to ISS Compass. The lower number of proxy contests is largely a reflection of companies and activist shareholders’ ability to arrive at a settlement agreement in advance of a vote.
– While companies and activists may battle in a proxy contest, they fundamentally have the exact same goal – to improve stock performance. … Companies targeted by short attacks are often outperforming their peers and they most certainly do not share the same goal, as short sellers profit only when the stock declines in value.
– The market reaction to a traditional activist campaign announcement can be negligible or, in some cases, be very positive. … In 2023, the average one-day market reaction to a short attack was -7.1%, according to Factset Market Data.
– Traditional shareholder activism is easier to predict and therefore easier to prepare for.
Despite that unpredictability, the article says the themes of short attacks almost always fall into three buckets:
Valuation. Example: Company is overvalued based on aggressive company projections or unsupported investor hype/optimism.
Financial. Example: Unorthodox or fraudulent accounting often associated with recognition of revenue. Conflicts of interest with partners/management/board.
Product. Example: Ineffective or harmful product/service, the product/service does not work as described or is potentially dangerous to the end user.
It goes on to make the “ounce of prevention” argument, and advocates for the following proactive measures, some of which are just good IR and financial reporting practices:
– Scenario plan for potential weaknesses or attack points. Where are you vulnerable?
– Do not issue aggressive guidance that might encourage investors and analysts to overvalue your company.
– Adopt conservative accounting practices and be cautious in using non-standard accounting measures which are often “red flags” for short sellers.
– Ensure disclosure controls are effective such that public filings contain all material information, including negative sensitive issues.
– Report bad news and unexpected results or developments as promptly and thoroughly as possible.
– Prepare a “Break the Glass” Communications Plan that includes: the short attack response team; draft press releases for multiple scenarios; and draft communications for employees, customers, suppliers, etc.
– Regularly monitor short interest as a percentage of float. A spike in short interest often precedes an attack.
In mid-September, the SEC announced settled charges against Deere & Co. for allegedly violating the books, records & internal controls provisions of the FCPA. Deere consented to SEC’s cease and desist order and agreed to pay disgorgement and prejudgment interest totaling approximately $5.4 million and a civil penalty of $4.5 million. The charges are relevant to readers of this blog since the violative conduct was carried out by employees and senior personnel at a newly-acquired subsidiary in the few years following its acquisition. The SEC’s press release says:
“After acquiring Wirtgen Thailand in 2017, Deere failed to timely integrate it into its existing compliance and controls environment, resulting in these bribery schemes going unchecked for several years,” said Charles E. Cain, Chief of the SEC Enforcement Division’s FCPA Unit. “This action is a reminder for corporations to promptly ensure newly acquired subsidiaries have all the necessary internal accounting control processes in place.”
The Order does not allege that any personnel at the parent company were complicit in or aware of the improper payments. … The Order notes that Deere itself had already adopted relevant policies and procedures, including policies on entertainment of government officials and policies on factory visits by non-U.S. government officials. …The fact that a penalty was assessed against Deere at all, however, underscores the continuing need for FCPA compliance after a transaction closes and while the new asset is being integrated.
This case highlights the long-term value proposition for an acquiring company to conduct risk-based FCPA and anti-corruption due diligence on potential new business acquisitions, reinforced by appropriate post-acquisition integration into the acquirer’s existing compliance and internal controls environment. With focus before and after, acquirers have a better chance to identify and address any potential legacy issues and mitigate the risk that the acquired entity’s misconduct (if any) continues undetected post-acquisition, as it appears was the case for Deere and Wirtgen Thailand.
Over on the Radical Compliance blog, Matt Kelly gives more of the details for those interested, calling this “one of the more colorful FCPA cases we’ve seen in a while.” In the end, Matt also touts pre-acquisition due diligence on the target’s potential bribery risk and compliance program together with post-acquisition integration and reminds readers, “even expenditures that might be immaterial in financial reporting can still bring material FCPA risks.”
When I read this enforcement action, I immediately thought of the fairly recently announced “Mergers & Acquisitions Safe Harbor Policy” intended to incentivize voluntary self-disclosure of wrongdoing uncovered during the M&A process. But that is a DOJ program, and this involved civil enforcement by the SEC. In his blog, Matt pointed out that the SEC order identifies the remediation steps Deer undertook, including firing responsible employees, improving internal audit and compliance programs, and cooperating with the SEC’s investigation, although the order makes no mention of voluntary self-disclosure.
In April, I blogged about the SEC’s notice & request for comment on a proposed NYSE rule change that would amend Section 102.06 of the NYSE Listed Company Manual to extend the period a SPAC can remain listed if it has signed a definitive agreement with respect to a Business Combination within three years of listing. The proposal would have allowed a SPAC to remain listed for up to 42 months and would have better aligned NYSE’s approach with Nasdaq’s. Earlier this month, the SEC posted NYSE’s notice of withdrawal of the proposed rule change.
As John shared on TheCorporateCounsel.net, the SEC’s July release instituting proceedings to determine whether to approve the proposal suggested the agency wasn’t headed in that direction. The release raised concerns under the Investment Company Act and questioned how the proposed extension would affect shareholder protection and why it’s appropriate for a SPAC to retain shareholder funds past the current maximum time period. Cooley’s Cydney Posner notes that the only comment letter was submitted by CII and echoed the SEC’s concerns in the July release.
According to a recent Cooley memo, CFIUS is increasingly relying on a “one size fits all” approach to national security agreements entered into in order to mitigate potential issues identified during its transaction review process. This approach to the negotiation process creates significant burdens for smaller companies and, when coupled with CFIUS’s hard line approach to enforcement of these agreements, may be disincentivizing parties from making voluntary filings. This excerpt explains:
From a cost-benefit perspective, obtaining CFIUS clearance for a transaction will always constitute a valuable – if often not necessary – benefit to certain parties. Anecdotally speaking, however, the cost of pursuing that benefit appears to be increasing and uncertain. From the perspective of the transacting parties, CFIUS “costs” manifest not only in the expense of undergoing a formal CFIUS review and potential investigation, but also in the operational and financial burdens of negotiating and complying with NSA terms. As CFIUS appears to be increasingly turning to NSAs to manage perceived national security risks, and relying increasingly on standard NSA templates as a basis for negotiations, the costs of submitting a voluntary CFIUS filing become correspondingly high and uncertain.
This trend – combined with FIRRMA’s strict liability standard and CFIUS’s pivot to a more aggressive enforcement posture – can create significant disincentives for transaction parties to submit voluntary CFIUS filings, ample uncertainty to justify foregoing filings in the first place, and a decision to assume the risk of a post-closing CFIUS inquiry.
The memo says that the emerging NSA negotiation and enforcement dynamics and the evolving cost-benefit assessments regarding voluntary filings may be contributing factors to the 23% decline in CFIUS filings during 2023.
SRS Acquiom recently published its 2024 M&A Claims Study, which analyzes more than 850 private target acquisitions with escrows that were fully released during the period from Q3 2022 to Q2 2024. The data set includes 518 individual indemnification claims and nearly 200 earnouts. Here are some of the key takeaways from the study:
Indemnification Claims Relatively Flat – Claim Sizes Trend Up: Indemnification claims activity on a per-deal basis appears to have slightly trended down, with 28% of deals facing a least one post-closing indemnification claim. Conversely, the study also found that deals with Reps & Warranties Insurance (RWI) saw a slightly higher prevalence of indemnification claims. Claim sizes trended up, with a notable increase in claims in the $150,000 to $500,000 size range (Slide 12). Additionally, claims are taking about 25% longer to resolve with about 1 in 27 resulting in formal arbitration or litigation (Slide 18).
Tax Claims Dominate – Undisclosed Liabilities Rise Dramatically: The study found that of the subset of claims examined, tax claims continue to dominate, and undisclosed liability claims more than doubled since the 2022 SRS Acquiom report. Decreased buyer due diligence, among other factors, in the competitive 2021 M&A market may be contributing to this trend.
Earnouts Not Guaranteed, But Some See Success: The study found that the majority of deals with an earnout saw at least partial payment, but only about half of the maximum earnout amount is paid on those deals. The study also found that at least 28% of deals in this dataset were ones in which the sellers contested the earnout. Renegotiations have a big impact, with SRS Acquiom marking over $132 million in additional earnout payments as a result, which is 17% of the earnout dollars paid.
The HSR Act’s notification requirements are usually thought to apply to M&A, but the statute has much broader application than that. In fact, any transaction that results in someone acquiring securities having a value that exceeds the reporting threshold needs to be scrutinized for a possible HSR filing. Many people who have purchased stock in public companies have discovered that to their chagrin. A recent Wilson Sonsini memo says you can add the CEO of GameStop to the list. This excerpt explains:
On September 18, 2024, the FTC announced that Ryan Cohen, chief executive officer and chairman of GameStop, has agreed to a pay civil penalty of nearly $1 million to settle charges that his acquisition of Wells Fargo & Company (Wells Fargo) voting securities violated the HSR Act.
In March 2018, Cohen acquired more than 560,000 Wells Fargo voting securities through an open market purchase. According to the complaint, this acquisition exceeded HSR filing thresholds in effect at the time and therefore triggered Cohen’s obligation to submit an HSR notification to the FTC and the U.S. Department of Justice (DOJ) and observe a waiting period before consummating the acquisition. The complaint states that Cohen failed to do so and was in continuous violation of the HSR Act until he submitted a corrective filing almost three years later on January 14, 2021.
The memo notes that what makes this enforcement action interesting is that it was Cohen’s first violation of the HSR reporting requirements. The FTC typically hasn’t imposed fines in situations involving first-time violations by individuals. Another thing about this proceeding that’s worth noting – particularly when dealing with activists – is that Cohen’s efforts to obtain a board seat at Wells Fargo disqualified him from relying on the “investment only” exemption from the HSR filing requirements.