Potential national security issues that might be raised by a cross-border transaction are becoming matters of increasing concern to dealmakers. This Latham memo provides an overview of CFIUS, the interagency group charged with conducting a national security review of potential deals involving foreign buyers. Here’s the intro:
This guide provides an overview of the Committee on Foreign Investment in the United States (CFIUS or the Committee) — a US federal, interagency group with authority to review certain foreign investments in US businesses to determine whether such transactions threaten to impair US national security — and the process through which CFIUS reviews proposed transactions subject to its jurisdiction.
Topics covered include CFIUS’s composition & structure, the scope of its jurisdiction, factors to consider in deciding whether to submit a deal for review, the review process, and alternatives for mitigating national security risks identified in the review process.
If you’re a regular reader of “TheCorporateCounsel.net Blog,” you know that nothing excites me more than when someone fools the SEC’s Edgar & makes a fake filing! A little drool perhaps. Plug the term “fake” into the search box of that blog & you’ll see plenty of fake filings coverage.
The latest involves the filing of a fake Schedule TO-C, making it look like Fitbit was in play (here’s an article from back when that happened). The SEC brought a civil case; the DOJ brought a criminal one. And this dude went through all this trouble – and got into so much trouble – for a measly $3k in profit! Dummy.
According to the SEC’s complaint, Robert W. Murray purchased Fitbit call options just minutes before a fake tender offer that he orchestrated was filed on the SEC’s EDGAR system purporting that a company named ABM Capital LTD sought to acquire Fitbit’s outstanding shares at a substantial premium. Fitbit’s stock price temporarily spiked when the tender offer became publicly available on Nov. 10, 2016, and Murray sold all of his options for a profit of approximately $3,100.
The SEC alleges that Murray created an email account under the name of someone he found on the internet, and the email account was used to gain access to the EDGAR system. Murray then allegedly listed that person as the CFO of ABM Capital and used a business address associated with that person in the fake filing. The SEC also alleges that Murray attempted to conceal his identity and actual location at the time of the filing after conducting research into prior SEC cases that highlighted the IP addresses the false filers used to submit forms on EDGAR. According to the SEC’s complaint, it appeared as though the system was being accessed from a different state by using an IP address registered to a company located in Napa, California.
Earlier this month, in In re Cyan Stockholders Litigation, Delaware Chancellor Bouchard dismissed post-merger fiduciary duty and quasi-appraisal claims arising out of Ciena’s 2015 acquisition of Cyan in a primarily stock-for-stock transaction.
As this Wilson Sonsini memo notes, the Chancellor rejected the plaintiffs’ fiduciary duty claims based on fully-informed, un-coerced shareholder approval of the deal. He also declined to endorse the use of a “quasi-appraisal” claim as an end-run around applicable limits on duty of care claims:
Because the court had already rejected the plaintiffs’ disclosure claims and concluded that the plaintiffs failed to allege a non-exculpated breach of fiduciary duty, Count Two was barred by Cyan’s exculpatory charter provision adopted pursuant to Section 102(b)(7). The court held, “When the cause of action supporting plaintiffs’ request for a quasi-appraisal remedy is for breach of a fiduciary duty, plaintiffs cannot circumvent the protection afforded in Cyan’s certificate of incorporation through artful pleading.”
The memo also points out that the decision shows that post-closing disclosure claims require plaintiffs to identify material omissions, and not “laundry lists of disclosure violations that aren’t material or that are of the ‘tell me more’ variety.”
This Wachtell memo discusses the recent shareholder vote on the pending merger between US-based PrivateBancorp & Canada’s CIBC – which received support from over 80% of PrivateBancorp’s shareholders despite a negative recommendation from ISS.
The deal’s path to a vote was disrupted by the spike in US bank stocks following the election. Canadian bank stocks didn’t experience a comparable rise in price. Since the deal had a large stock component, its value took a hit. This resulted in a decision to delay the vote, prompted further discussions between the parties and extensive shareholder engagement. Negotiations resulted in two price increases that improved the merger’s value substantially before it was ultimately presented to shareholders.
The memo discusses these efforts to address the impact of stock market volatility on the deal – and throws some shade at ISS:
Conventional wisdom would hold that a proxy adviser observing a deliberate and lengthy Board process, two price bumps, no competing offer and a market that trades at a customary discount would promptly recommend the deal.
That is exactly what occurred with two competitor firms, Glass Lewis and Egan Jones. On the contrary, ISS decided to play fundamental financial analyst and substituted its judgment for that of the Board and an efficient market, based on speculation about tax reform, the future value of U.S. regional bank stocks and the housing market in Canada. Notably, in coming up with its radical recommendation ISS did not engage with PrivateBancorp after the second price increase, and declined offers from senior executives of CIBC to speak about their company and the Canadian markets. A fundamentally flawed process leads to a flawed result.
The memo also notes that many institutions that typically follow ISS opted to reject its recommendation and vote in favor of the merger.
Cybersecurity is becoming an increasingly important part of M&A due diligence, & this Skadden memo provides guidance about key cyber-related issues to consider as part of the due diligence process. This excerpt discusses evaluating a target company’s network security:
If the target has never engaged a third-party forensic firm to conduct vulnerability assessments and penetration testing — a scenario that is becoming less common in many industries — the acquirer may want to retain a firm to undertake its own testing on the target company’s network and perhaps even conduct searches on the dark web (the part of the internet that may only be reached with anonymization tools and where many hackers sell their spoils) to see whether the target’s customer data or intellectual property is already compromised and available for sale. The acquirer should be aware,however, that the target will likely opt to conduct its own testing and provide a report rather than allow the acquirer to do so.
In an extreme scenario, the diligence investigation may uncover hackers lurking in the target company’s network, but more likely the result will be a risk calculation based on the target company’s governance and the administrative, technical and physical information security controls it uses to protect digital assets.
Other areas addressed in the memo include the target’s compliance with industry standards for cybersecurity, the use of deal terms to both verify the target’s statements about its cybersecurity and to allocate liability risks, and the role of due diligence in obtaining cyber-risk insurance on favorable terms.
Breaches of a director’s oversight responsibilities implicate the duty of loyalty, but these so-called “Caremark” claims are notoriously difficult to make. This Paul Weiss memo reviews In re Massey Energy Company(Del. Ch.; 5/17), where Chancellor Bouchard said that the plaintiffs made a viable Caremark claim against the company’s directors – but held that they lacked standing due to the company’s merger with a buyer.
The case arose out of the worst US mining disaster in 40 years, in which 29 Massey employees lost their lives. Governmental investigations established that the incident resulted directly from Massey’s willful & systematic violations of safety rules. Several company executives – including its former Chairman & CEO – were convicted of criminal wrongdoing.
Massey was acquired shortly thereafter, and the shareholder plaintiffs filed a derivative action. The memo notes that while Chancellor Bouchard believed the shareholders stated a Caremark claim, they no longer had standing to bring it:
It is well-settled Delaware law that, subject to two limited exceptions, under the so-called “continuous ownership rule,” shareholders of Delaware corporations must hold shares not only at the time of the alleged wrong, but continuously thereafter throughout the litigation in order to have standing to maintain derivative claims, and will lose standing when their status as shareholders is terminated as a result of the merger. Here, the plaintiffs lost their shares as a result of the Massey-Alpha merger, and therefore lost standing to bring their derivative claim.
A Caremark claim requires the plaintiff to show a conscious failure to act on the part of directors after being alerted to “red flags” of illegal conduct. It has been called “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” Despite its ultimate outcome, this case is worth reading as an illustration of the kind of egregious conduct that is necessary to make a viable Caremark claim.
– Tax Reform: Transaction Strategies for Uncertain Times
– Coming to Grips With Appraisal
– Purchase Price Adjustments for Tax Benefits
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This Kirkland & Ellis memo discusses Hsu Living Trust v. ODN Holding (Del. Ch.; 5/17) – the latest in a series of Delaware cases standing for the proposition that when the chips are down, the board needs to “stick it” to the holders of preferred stock. (Sorry to get bogged down in legal jargon).
Delaware courts have long held that when the interests of the holders of common & preferred stock diverge, the board’s fiduciary duties run to the common, while the preferred has to look to whatever contractual rights it may have. But the ODN Holding case shows that when the going gets tough, even the most well-crafted contractual protections may not accomplish what the preferred holders intended. That’s because if there’s an opportunity for an “efficient breach”, a board’s fiduciary obligations to the common may require it breach the company’s contractual obligations to the preferred.
Here’s an excerpt that walks through the Court’s reasoning:
Vice Chancellor Laster refused to dismiss claims against the board of ODN that they breached their fiduciary duties to common stockholders by selling off pieces of ODN in anticipation of funding at least a portion of a mandatory redemption of the sponsor’s preferred stock that vested after five years, because the asset sales shrunk the company significantly and impaired its ability to generate long-term value to the remaining stockholders.
The court readily acknowledged the validity of the contractual obligation to the preferred holders to redeem their stock once the mandatory redemption right vested. However, VC Laster held that the board had a fiduciary duty to decide whether it was in the best interests of the common stock to commit an “efficient breach” of the company’s obligation to the preferred and not take actions to fund the redemption because doing so diminished the long term upside potential of the business (i.e., whether the portfolio company would be better off being subject to a damages claim from the holders of the preferred as compared to taking the company actions necessary to satisfy its obligations to the preferred).
The memo suggests a number of alternatives to avoid putting the board in the middle when it comes to protecting the rights of preferred stockholders. These include preferred terms that raise the economic consequences of a breach, strong “drag along” rights that allow preferred stockholders to compel a sale, & the use of alternative entities, such as LLCs, that don’t have a corporation’s fiduciary baggage.
This blog from Steve Quinlivan reviews the Delaware Chancery Court’s recent decision in Davis v. EMSI Holding – where the Court held that selling stockholders facing indemnity claims from the buyer were entitled to expense advancement as former D&Os of the target. As this excerpt notes, the Court reached that conclusion despite the existence of a broad release of claims by the selling stockholders in the stock purchase agreement:
The relevant provision of the stock purchase agreement included a broad release of the plaintiffs’ claims against the acquired entity. However, there was a carve out to the release which provided that the release did not apply to any right to indemnification the plaintiffs had as an officer or director under the relevant governing documents. The Court found the defendant’s argument that the carve out only applied to pre-existing third party claims and not to first party claims under the stock purchase agreement was illogical as the release applied to both first party and third party claims.
The Court also rejected claims that the stockholders weren’t sued in their capacity as officers. While the claims may have been couched as breaches of reps & warranties, they were premised on alleged misuse of their positions as D&Os of the company to engage in a financial fraud.
This WilmerHale memo reviews market practice when it comes to takeover defenses at IPO companies, and compares their defenses to those in place at S&P 500 and Russell 3000 companies.
There are many similarities between IPOs & established companies – most companies have an advance notice bylaw, authorize a class of blank check preferred & prohibit shareholder action by written consent. However, there are a number of defenses that are much more prevalent among IPO companies. These include:
– Classified boards (77% of IPOs vs. 11% of S&P 500 and 43% of Russell 3000),
– Supermajority voting requirements (76% of IPOs vs. 21-41% of S&P 500 and 18-57% of Russell 3000 – varies depending on type of action)
– Limitation of stockholders’ right to call special meetings (94% of IPOs vs. 37% of S&P 500 and 51% of Russell 3000)
– Exclusive forum bylaws (59% of IPOs v. 36% of S&P 500 and 38% of Russell 3000)
One other thing that’s clear from the memo is that almost nobody has a “poison pill” in place these days – only 1% of IPOs, 3% of the S&P 500 and 5% of the Russell 3000 have adopted pills. Of course, that doesn’t count the many companies that have pills “on the shelf” & ready to be rolled out at a moment’s notice if needed.