DealLawyers.com Blog

This March-April issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:

– Assessing the Locked Box Approach to Purchase Price Adjustments
– Just Enough To Be Dangerous: An Overview of M&A Tax Basics
– Shareholder Approval of Small Private Acquisitions: Has Omnicare Been Rendered a Farce?
– Boilerplate Matters: Giving Notice

If you’re not yet a subscriber, try a no-risk trial to get a non-blurred version of this issue on a complimentary basis.

Here are thoughts from legendary deal lawyer Marty Lipton that he recently penned in this memo:

I’m frequently asked to explain merger activity and to predict the level of future merger activity. In part in response to these requests and in part as the consequence of a long career of advising as to mergers, I’ve identified many of the factors that determine merger activity, but a complete catalog is beyond me and I am not able to predict even near-term levels of activity. I’ve written and lectured extensively on this and the history of merger waves since the 1880s. In preparation for work on a revision of my merger waves studies, I made an outline of the factors that I believe are the most significant that affect mergers. I thought it might be interesting to share a condensed version and that as an ancillary benefit of doing so, readers might favor me with comments and suggestions.

First, it is recognized that mergers are an integral part of market capitalism, including the types that are practiced in China, India and Russia. Mergers are an agent of the Schumpeterian creation and destruction that characterizes market capitalism.

Second, the autogenous factors, not in the order of importance, are relatively few and straight forward:

– Increasing revenue by product or geographic expansion or by increasing market power.
– Reducing costs by eliminating excess capacity and/or labor.
– Confidence of the management and the board of directors of the acquiring company that it can effectively integrate the acquired business.
– Ego and the desire for size and diversity without regard to profitability.
– Sense of responsibility to all stakeholders, i.e., employees, customers, suppliers, creditors, and communities, as well as shareholders.

Third, the exogenous factors, not in the order of importance, are:

– Availability of accounting conventions (principally those relating to depreciation and amortization) that enhance, or at least do not detract from, profitability.
– Pressure from activist hedge funds and lack of support from institutional investors to remain an independent public company seeking long-term creation of value.
– Government antitrust and competition policies.
– Availability of arbitrage to facilitate liquidity for securities that result from mergers.
– Foreign exchange fluctuations that make one currency “cheap” and the other more favorable as merger consideration.
– Regulation and deregulation and privatization and nationalization by governments.
– National policies to encourage “global champions” or to discourage foreign investment.
– The availability of experts in merger technology and in the creation of special merger currencies, such as contingent value rights and pay-in-kind debentures.
– Recognition of the legitimacy of hostile takeover bids and proxy fights and the availability of experts in the defense and waging of hostile efforts to achieve a merger.
– Labor unions, government labor policies and the political and popular power of labor generally.
– The existence of private equity funds and the amount of funds that they have available for acquisitions.
– The state of the equity and debt markets and the receptivity of the markets and banks to merger activity.
– Litigation, shareholder and class actions designed to enjoin mergers or increase the cost.
– Taxes, tax policies and potential changes therein.
– Demographic changes.
– General business and political conditions.
– Technological developments, especially breakthroughs.
– Military research, military procurement and military policies with respect to suppliers and contracting.
– Trade treaties and the creation of trade and currency blocs of nations.

Lastly, it is recognized that the interrelation of all or some of these factors creates the permutations and combinations of issues that at any given time make it impossible to predict the level of future merger activity.

Tune in tomorrow for the webcast – “The SEC Staff on M&A” – to hear Michele Anderson, Chief of the SEC’s Office of Mergers and Acquisitions, and former senior SEC Staffers Dennis Garris of Alston & Bird and Jim Moloney of Gibson Dunn discuss the latest rulemakings and interpretations from the SEC.

A few days ago, the SEC charged two financial advisors and three others in their circle of family and friends with insider trading for more than $1.8 million in illicit profits based on confidential information about a Philadelphia-based insurance holding company’s merger negotiations with a Japanese firm. The press has been all over this one given the breach of trust at an Alcoholics Anonymous meeting – see this WSJ article and this CNN Money piece…

We have posted the transcript for our recent webcast: “Transaction Insurance as a M&A Strategic Tool.”

Recently, as noted in this Sullivan & Cromwell memo (other memos are posted in the our “Antitrust” Practice Area), the DOJ and FTC extracted their first publicized penalty for a corporate executive’s failure to make a Hart-Scott-Rodino Act filing before receiving stock of his employer as part of his compensation. As a result, many members have been researching what the typical practice is for HSR filing fees that the corporate executive would have to pay to comply with the HSR filing requirement. To help in that effort, please take a few moments to participate in this anonymous “Quick Survey on HSR & Executives’ Acquisitions from Equity Compensation Plans.“

From John Grossbauer of Potter Anderson: Recently, Delaware Vice Chancellor Laster delivered this opinion in In re BankAtlantic Bancorp, Inc. Litigation. In his opinion, the Vice Chancellor grants a permanent injunction against the sale of BankAtlantic Bancorp’s sale of its federal saving bank subsidiary to BB&T because it would violate covenants in several indentures for Trust Preferred Securities that prohibit the sale of “all or substantially all” of the Bancorp assets unless the purchaser assumed the obligations under the indentures.

BankAtlantic argued that the sale did not meet the “all or substantially all” test under New York law because it was retaining “criticized assets” as the consideration for the sale, and that the value of the retained assets rendering the sold banking subsidiary worth zero at closing. The Court rejected this argument, saying that the retained assets should be considered as part of the value of the subsidiary bank being sold, and that, qualitatively, the sale of the bank subsidiary represented the sale of Bancorp’s only operating asset and would fundamentally change the nature of Bancorp’s business. The Vice Chancellor relied extensively on the American Bar Foundation Commentaries on the Model Debenture Indenture.

Francis Pileggi also blogged about this case.

Here’s some analysis by Kevin Miller of Alston & Bird: In a recent decision – In re Micromet – Delaware Vice Chancellor Parsons denied plaintiffs’ motion to preliminarily enjoin Amgen’s acquisition of Micromet by means of a two-step transaction – an all cash tender offer to be followed by a back end merger at a $11 per share in cash.

Among other things, plaintiffs alleged that the Board breached its fiduciary duties by failing to disclose the fees paid by Micromet to Goldman Sachs over the past two years, as well as Goldman’s interest in Amgen stock and by failing to disclose certain information relating to the financial analyses performed by Goldman Sachs:

“Plaintiffs have made numerous disclosure claims in their Complaint and in the briefing. Having read and considered each of those claims, I find that Plaintiffs have not shown a likelihood of success on any of their disclosure claims.

[. . . ]

Goldman holds approximately $336 million in Amgen stock, most of which it holds on behalf of its clients. Even considering its total position, Goldman’s Amgen holdings equal approximately 0.16% of its overall investment holdings and 3.8% of its healthcare sector investments. Moreover, Goldman owns a substantially larger stake in Company B and a similar stake in another company that was contacted by Goldman as a potential acquirer during the market check.

Furthermore, the Recommendation Statement discloses that Goldman and its affiliates “may at any time make or hold long or short positions and investments, as well as actively trade or effect transactions, in the equity, debt and other securities of both Micromet and Amgen. Given this notice, any investor who desired to know the size of Goldman’s position in Micromet or Amgen as of the last reporting period could find this information in Goldman’s publicly-filed Form 13F. More importantly, Plaintiffs did not present any more detailed evidence from which the Court could reasonably infer that the size and nature of Goldman’s Amgen holdings in this case would be likely to impede its ability effectively and loyally to perform its assignment for Micromet.

As for Plaintiffs’ argument for disclosure of the fees paid to Goldman by the target, Micromet, over the past two years, I note that the Recommendation Statement does disclose Goldman’s contingent interest in the transaction, as well as the fees paid by Amgen to Goldman over the past two years. The Recommendation Statement also discloses that Goldman has performed certain services to Micromet in the past and received compensation for those services. Nevertheless, Plaintiffs claim that this partial disclosure requires supplementation to provide the actual amounts received by Goldman. They fail to provide any persuasive explanation, however, as to why the actual amount of fees paid by Micromet to Goldman would be material to shareholders or to cite any Delaware case law mandating such disclosures. This is not a situation in which Micromet, apart from Amgen, would be a potential source of future business.

[. . .]

Plaintiffs also complain that the Company should have disclosed Goldman’s “Sum of the Parts” discounted cash flow (“DCF”) analysis. The Sum of the Parts analysis was not relied on by Goldman in providing its fairness opinion. There is no dispute that Goldman did prepare such analyses at the request of the Board, buy not all analyses produced by financial advisors and given to the board are required to be disclosed under Delaware law. Instead, “[i]n Delaware only that information that is material must be disclosed.”

Here, the total value range reported under the Sum of the Parts analysis was $7.74 to $10.42 and the ex-corporate valuation range, which excluded the costs of running Micromet, was $8.92 to $11.60. Although the high-end of the ex-corporate range under this Sum of the Parts DCF analysis is slightly higher than the high-end of Goldman’s DCF analysis, the latter analysis yielded a substantially similar valuation range of $7.09 to $11.44. Therefore, I find it unlikely that disclosure of the Sum of the Parts DCF analysis materially would have altered the total mix of information available to shareholders. Accordingly, it did not need to be disclosed.

[. . . ]

Finally, Plaintiffs’ claim regarding Goldman’s use of an historical Ibbotson equity risk premium, rather than a supply-side equity risk premium, is not a disclosure claim. Instead, it is a challenge to the methodology employed by Goldman in conducting its illustrative DCF analysis. Under Delaware law, “a complaint about the accuracy or methodology of a financial advisor’s report is not a disclosure claim.” Plaintiffs claim amounts to nothing more than a “quibble with a financial advisor’s work” arguing that Goldman applied an inappropriate equity risk premium in its analysis This does not state a valid disclosure claim.”

The opinion is worth a close reading as it contains lots of additional guidance on a number of current issues relating to process and other disclosure claims.

Last week, Kevin Miller blogged about the hearing transcript in the In re El Paso S’holder Litig. case that wound up being decided the next day. This WSJ commentary by Ronald Barush analyzes Chancellor Strine’s opinion:

Wednesday, Chancellor Leo Strine, who heads the Delaware Court of Chancery, all but threw up on parts of the negotiation process of Kinder Morgan’s acquisition of El Paso. But in the end he decided that if shareholders, who are being told of the troubling facts, can live with it and vote for it, he can hold his nose and let the deal move forward. It doesn’t mean that down the road the defendants, if they don’t settle, won’t be looking at big damages. We will come back to that.

But you have to hand it to El Paso. It gave Chancellor Strine a lot of grist for the mill of his criticism. For example, the CEO got caught considering a management buyout of El Paso’s E&P assets (which Kinder Morgan was always planning to sell) without telling his board, the opinion says. Frankly, it is not clear that he went very far with that interest, but this is a bit like getting caught with too big a lead off of first base. He was just asking to be picked off. Any CEO should know there is going to be litigation and that conflicting interests will be searched for. And it costs nothing to move closer to base and tell your board everything.

And then there is Goldman Sachs. Goldman, one of El Paso’s financial advisers, had different issues. Goldman thought it had fully disclosed its conflict (its PE arm owns a big stake in Kinder Morgan). But in another unforced error, according the Chancellor Strine, even though an attempt was made to wall off the part of Goldman with that interest, no one bothered to tell El Paso that the Goldman lead banker on the El Paso account personally owned $340,000 of Kinder Morgan stock. And in addition, Strine characterized the efforts to address Goldman’s disclosed conflicts as “inadequate.”

But what is more significant than the salacious details–since, after all, if the shareholders vote for the deal Strine will let it close–is the unstated messages of Strine’s opinion. It is filled with implicit warnings to both investment bankers and directors.

First, this decision caps a series of recent decisions where courts have been critical of investment bankers’ conduct and conflicts. The world of investment banking is filled with conflicts. Bankers trade securities, they have proprietary interests (like Goldman’s 19.9% interest in Kinder Morgan) and they seek M&A advisory roles–all at once. There is no code of conduct for investment bankers–they can have conflicts. They should disclose them to their clients, but if clients can live with them, up until recently it would appear to be up to the board of directors’ business judgment as to what to do about them.

But Thursday’s decision, as well as other recent decisions, was highly critical of the conduct of investment banks. Under the business-judgment rule, in which courts defer to disinterested directors, one would expect these matters to be the realm of the business judgment of the directors and not subject to second guessing by a court. However, Chancellor Strine concluded that the plaintiffs have “a reasonable likelihood of success in proving that the Merger was tainted by disloyalty.”

Chancellor Strine does not say it, but the courts are coming very close to the conclusion that investment-banker conflicts are deserving of some form of enhanced scrutiny by a court to determine if a process has been “tainted” by those conflicts–even if they are fully disclosed. That is a big warning to both investment banks and directors that more vigilance is required. As a result, bankers may be forced to pass on more assignments where they have conflicts, even if their client does not object.

There is another subtle warning to directors as well. The court did not criticize the directors for not ferreting out the El Paso chief executive’s desire to buy the E&P products which, according to the Court, gave him a conflicting interest. Indeed the court said it thought it unlikely the directors (other than the CEO) would be held liable for any damages in this case.

Rather, the court was critical of the negotiating strategy of the CEO–largely with the concurrence of the board- which the court characterized as “velvet gloved.” In future cases, directors cannot count on judges being so sympathetic to sale processes that go awry if independent directors are not actively exercising real time oversight. To entrust a CEO with full authority to negotiate a sale of a company without close independent director supervision could lead to something more disastrous. And after the El Paso experience, not to question the CEO carefully about conflicts could damage how a judge looks at a board’s conduct.

This case isn’t over. The court found that the plaintiffs have a reasonable likelihood of prevailing on the merits of the case and the lawsuit has now turned into a damages action. Chancellor Strine hints that he sees exposure in the half billion dollar range (and there will be no jury and he is the judge).

It is likely that in the end Kinder Morgan will end up paying most of any damages since, once the deal is completed, Kinder Morgan will own El Paso and have indemnity obligations to pretty much all of the defendants: the directors, the CEO and Goldman. With a record like this, look for Kinder Morgan to find a way to settle the case and write some checks without the agony of a full-blown trial.

We have posted the transcript for the recent webcast: “The Dynamics of Disclosure Claims.”