DealLawyers.com Blog

Awhile back, we blogged about the abandonment of the Endocare Inc./Galil merger and the potential for antitrust scrutiny of transactions even if they are not subject to Hart-Scott-Rodino pre-merger review. This recent Davis Polk memo, discussing the two opposing statements made by the FTC Chairman and Commissioners on the Endocare/Galil merger, notes that the FTC’s actions indicate that it will not make concessions from its rules for small companies.

On June 8, 2009, the FTC issued two statements expressing opposing views as to Endocare, Inc.’s announcement that its proposed merger with Galil Medical, Ltd. had been terminated “as a result of” the FTC’s ongoing investigation. The proposed merger between the medical device companies, both of which develop prostate and renal cancer therapies, was too small to be reportable under the Hart-Scott-Rodino Act.

The FTC investigation began in late 2008, more than six months prior to the company’s announcement. According to the statement of Commissioner J. Thomas Rosch,the parties had produced several boxes of hard-copy documents, but declined to produce additional documents requested on the grounds that the burden would be too great on the small companies’ “severely limited resources.” In a harsh rebuke of the FTC, Commissioner Rosch argued that the case “represents a ‘poster child’ for how protracted investigation of a transaction or practice can result in the Commission failing to determine in a timely fashion whether there is a ‘reason to believe’ that a transaction or practice will violate the antitrust laws and the public interest.” He blamed the lengthy investigation on the Commission’s own failure to apply remedies available to it to enforce the subpoena, and emphasized the public policy reasons weighing in favor of the merger, including the “very small and diminishing share of the market” for the particular type of therapy the proposed merger was intended to develop.

In a joint statement, FTC Chairman Jon Leibowitz, Commissioner Pamela Jones Harbour, and Commissioner William E. Kovacic expressed their sharp disagreement with Commissioner Rosch’s portrayal of the investigation and downplayed these policy arguments, emphasizing that a small company’s claim of limited resources will not serve as an exemption from full compliance with a second request: “No special rule or Section 7 principle . . . exempts two small companies with small scientific/engineering staffs and limited resources from meaningful antitrust review, even when the companies claim that their proposed transaction will enable them to conduct additional research and development relating to a socially significant product.” The Commissioners instead blamed the lengthy investigation on the parties’ failure to provide a complete record or to negotiate the scope of the subpoena, and noted that “even the parties’ self-selected documents were insufficient to substantiate the parties’ purported efficiencies claims.”

When I came back from a nice two-week vacation at the end of August and started to reconnect with friends in law firms, I was shocked at how a lot of people are starting to fully prepare for a busy Fall. It would seem that the reported end of the recession means that healthy companies are ready to begin an acquiring spree (this recent NY Times article says the same thing).

Take this anonymous poll to let us know how you feel about the near term for dealmaking:

Below is a note from Watson Wyatt regarding the impact of FAS #141 on M&A activity:

We can count mergers and acquisitions activity as one more casualty of the credit crisis: During the last 12 months, deals have sharply declined in volume and size. As a result, an important change in the M&A landscape has not received the attention it would have attracted just a couple of years ago.

The new Statement of Financial Accounting Standards 141R, “Business Combinations,” and 160, “Noncontrolling Interests in Consolidated Financial Statements,” might have fallen below the radar screen of many corporate dealmakers so far, but they have significantly changed the way costs for M&A deals must be managed and reported. While driven by the desire to increase transparency of accounting for deal costs, the new rules are also likely to have significant implications for HR’s management of staff reduction and other integration issues.

These standards — the first to be developed jointly by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) — were published in late 2007. The FASB standards took effect on Dec. 15, 2008, and thus apply to most current deals, and the companion IASB standards — International Financial Reporting Standard 3R and International Accounting Standard 27R — took effect more recently on July 1, 2009. The new standards change the accounting for business combinations and will likely affect integration decisions by acquirers in M&A deals. Historically, companies have been able to adjust goodwill to absorb post-deal cost surprises, which allowed for more streamlined due diligence. Under the new rules, however, the financial impact of an M&A deal must be booked at the time of the acquisition. With no recourse to a retroactive adjustment based on later analyses or data, there is less margin for error or oversight in due diligence, which is thus likely to require more time and create pressure for accurate calculations to be completed earlier in the process.

Subsequent job reductions, previously rolled into deal accounting, might need to be recorded and accounted for as special events if details are not finalized until post-acquisition. Many M&A transactions are driven by the prospect of eliminating redundant jobs and consolidating operations. Relocating workers and reducing headcount incur short-term costs but deliver long-term savings. Historically, the anticipated severance and related costs were rolled into the deal costs. Under the new rules, if these expenses will be booked as deal costs, they must be specifically identified at the date of acquisition.

In addition to struggling with the employee relations issues triggered by the early announcement of staff reductions, companies might need to obtain agreements with works councils, labor unions or other outside parties before projecting cuts and closures. So the costs/benefits from such staff reductions will more likely need to be recorded in a later accounting period, after the company has obtained the necessary approvals. Given the intensified scrutiny from business units and shareholders on expenses incurred, relocation and restructuring plans formerly considered standard practice might need to be reconsidered.

In addition, deal expenses and fees from internal resources and external advisers — normally capitalized into goodwill — now must be expensed as a normal profit and loss (P&L) cost in the period incurred (before or after a deal is announced). For larger deals, these costs can be significant, and oversight will likely become more rigorous. An additional impact: Transaction costs might need to be publicly disclosed before the deal is completed, potentially accelerating the timing of negotiations and compromising confidentiality.

Deals that result in partial ownership or increase a company’s interest must be measured at fair value, regardless of whether the buyer attains a controlling or noncontrolling interest. The associated goodwill is measured only once — when the initial controlling interest is obtained. All subsequent adjustments to ownership or fair value will be to equity rather than to the regular P&L accounts or goodwill. The challenge for companies is that, for each additional interest acquired, the associated fair value must be assessed and accounted for. This will probably increase the number of small transactions for which fair value calculations need to be completed and could necessitate new valuation techniques for certain nontraditionally valued assets or liabilities.

In addition to calling for more thorough due diligence and triggering more rigorous oversight, the new reporting standards will likely require a response from HR at an earlier stage in the M&A process. Companies might need to communicate upcoming HR changes to employees sooner and negotiate agreements with groups representing workers. Increased scrutiny of relocation and restructuring plans could influence companies’ decision making.

News from WilmerHale:

At its Board Meeting held last Wednesday, the FDIC issued its Final Statement of Policy on Qualifications for Failed Bank Acquisitions. As expected, the FDIC reduced the Tier 1 capital leverage ratio proposed for private equity investors investing in failed banks from 15% Tier 1 to 10% Tier 1 (but only common equity) to total assets. It also removed the “source of strength” requirement in an effort to make it easier for failing institutions to attract private equity buyers. However, the Final Statement retains many of the other elements in the original proposal with the goal of adequately protecting the failed institutions and the Deposit Insurance Fund.

The Final Statement makes clear that these requirements will apply only prospectively and will not apply to investors with 5% or less of the total voting power of an acquired institution. In a further attempt by the FDIC to encourage partnerships between private equity investors and depository institution holding companies (excluding shell holding companies) where the holding company has a clear majority interest in the acquired depository institution and an established record of success in operating such depository institutions, the Final Statement makes clear that it does not apply to investors in partnerships with such depository holding companies.

The FDIC retains the right to waive one or more of the provisions of the Final Statement if such exemption “is in the best interests” of the Deposit Insurance Fund and the “goals and objectives” of the Final Statement “can be accomplished by other means.” The Final Statement will be reviewed by the FDIC within six months.

Upon return from a lengthy vacation, I was excited to learn that the Delaware Governor has nominated Travis Laster to fill VC Lamb’s vacated spot on the Chancery Court (state’s 21-member Senate must now approve the nomination, expected next month). We surely will miss Travis’ numerous contributions to this blog – but we are excited for such a distinguished lawyer to join the bench. His Delaware colleagues appear to feel the same way:

– Delaware Corporate & Commercial Litigation Blog

– Delaware Libertarian

– Delaware Online

– Race to the Bottom

– M&A Law Prof Blog

Recently, IR Magazine ran this article about tag-along activists, which features a study by Glenn Curtis of Thomson Reuters. Glenn looked at recent campaigns and the buying activity around the time they were launched. Target companies studied were Biogen, Yahoo, Motorola, Target, Wendy’s and TD Ameritrade. Curtis’ advice is to always communicate with activists – and their tag alongs. “If nothing else, it gives an IRO a feel for where the campaign is heading.”

The study notes these lead activists and possible tag alongs:

– Barington Capital – Benchmark, Clinton, DB Zwirn, Ramius
– Carl Icahn -TIAA-Cref, Highfields Capital, JANA Partners, SAC, Sandell
– The Children’s Investment Fund – 3G, Atticus
– JANA Partners – SAC, Third Point
– Pershing Square – Greenlight Capital, Third Point
– Pirate Capital – Steel Partners
– Sandell – JANA Partners
– Third Point – David Knott, Jason Aryeh, JPMorgan Ventures
– Trian – Pershing Square

Thanks to Jim McRitchie and his CorpGov.net for pointing this article and study out!

Over the past few months, we’ve posted a total of five blogs telling stories about deal cubes and deal closings (here’s the latest one). Below is another story from a member about IPO closings (heartening to hear since there’s been a dearth of these deals over the past year):

Who says IPO closings can’t be eventful. On my first IPO (circa 1983 or 84), we were at the closing at Wertheim’s office in the Pan Am Building. The CFO takes a $400 million check from the underwriters (wire transfers were too unreliable back then). He leaves with his commercial banker to deposit the check and the lawyers stay behind to stack up documents.

The CFO returns 10 minutes later, ashen-faced, having lost the check! It was eventually returned a couple hours later – someone had found it on the floor in Grand Central Terminal. In the meantime, we dealt with such questions as to whether we had to call a board meeting to authorize the CFO to give an indemnity for the lost check or whether that was covered by the boilerplate “and such other actions” authority in the board resolutions; and whether a firm partner would give a legal opinion to that effect. Ah, them’s the days.

The recent abandonment of the Endocare Inc./Galil Ltd.merger highlights the potential for antitrust scrutiny of transactions even if they are not subject to Hart-Scott-Rodino pre-merger review. As descrived in this Cahill Gordon memo, Endocare announced in June that it was terminating its proposed merger with Galil – midway through the FTC investigation. Although the transaction was not reportable under HSR, the companies appear to have received subpoenas from the FTC seeking information not unlike that typically sought by a “second request.”

Although it doesn’t happen often, nonreportable transactions can be investigated by the antitrust enforcement agencies if the agencies become aware of the transaction and perceive a potential antitrust concern. This case also highlights the importance of early identification of any antitrust issues, the allocation of antitrust risk among the parties and the negotiation of the terms of the parties’ conduct in response to any investigation or other challenge prior to closing a merger.

Not long after the abandonment of the Endocare/Galil merger, Endocare announced that it had enetered into a merger agreement with HealthTronics. Galil sued Healthronics in the Delaware Chancery Court for tortuous inference of its merger agreement. That litigation was recently settled out of court.

Recently, the FTC fined a CEO $1.4 million for failing to make a filing under the Hart-Scott-Rodino Act after he purchased company stock when he exercised options. Sounds crazy, right?

Apparently, it’s not so crazy – it has long been the position of the FTC that the HSR Act is applicable to any acquisition of voting stock, including an acquisition by an individual, that exceeds the HSR’s jurisdictional thresholds. Below is a summary and analysis of the case by Davis Polk:

The Federal Trade Commission recently fined John C. Malone, CEO and Chairman of Discovery Holding Company, $1.4 million to settle allegations that he violated the Hart-Scott-Rodino Antitrust Improvements Act in connection with acquisitions of Discovery shares in 2005 and 2008. The FTC alleged that Malone failed to file the notice required by the HSR Act in 2005 after making a reportable acquisition of Discovery shares, made a corrective filing in June of 2008, but subsequently acquired, via an exercise of two options, additional Discovery shares before the expiration of the required waiting period which followed the submission of the June 2008 corrective filing. As described below, this case holds several important lessons, including:

• Even if a person has lawfully made prior acquisitions of shares of an issuer, the person may have to make an HSR filing before completing additional incremental acquisitions of shares.
• The FTC’s informal interpretations of the HSR rules may change over time, and practitioners need to keep informed of these changes.
• Depending upon the circumstances, the FTC may object to the use of an escrow account to permit a transaction to close prior to expiration of the HSR waiting period (with shares delivered into escrow). It is strongly advised to consult with the FTC’s Premerger Office before using an escrow arrangement as a means of closing a transaction prior to the expiration of the waiting period.

Background

The HSR Act requires parties to mergers and acquisitions that exceed certain jurisdictional thresholds to make filings with the FTC and the Department of Justice (“DOJ”) and to observe a waiting period before closing. In this case, Malone previously held shares of Discovery, but it was the additional acquisitions, when aggregated with current holdings, that gave rise to the filing requirement.

The Commission’s press release, which includes a link to the complaint, can be found here. From the release: “The HSR Act and its filing requirements are well-known to companies and individuals making acquisitions. The significant civil penalties imposed here should reinforce the need to fully comply with the Act, including observing the waiting period,” said Marian Bruno, Deputy Director of the FTC’s Bureau of Competition.

Factual Allegations

As stated in the FTC’s complaint, Malone, in May of 2005, properly filed under the HSR Act for an acquisition of shares of Liberty Media Corporation (“Liberty”), and observed the waiting period prior to that acquisition. Two months later, Discovery was spun off from Liberty, and voting securities of Discovery were distributed pro rata to Liberty shareholders. The receipt of Discovery shares by Malone, as a result of the spin-off, was exempt from HSR Act reporting.

In August 2005, however, Malone purchased additional shares of Discovery on the open market. According to the FTC, a new filing should have been made in connection with this acquisition because (i) Discovery was, at that time, its own “ultimate parent entity,” and (ii) the sum of the value of Discovery shares already held by Malone and the value of the new shares acquired exceeded the initial HSR Act filing threshold (then $53.1 million). No such filing was made. As the FTC alleged, no exemption from filing was available based upon the fact that Malone previously filed for acquiring a minority stake in Discovery’s parent prior to its spin-off. Malone completed that August 2005 Discovery stock acquisition, and continued to make additional acquisitions of Discovery stock through April 2008, without ever filing for an acquisition of such stock.

In June 2008, Malone made a corrective filing for these prior acquisitions of Discovery stock. After making this, but before the waiting period which followed that corrective filing expired, Malone acquired, via two stock options, additional stock of Discovery.

Of particular interest within the FTC’s complaint for the alleged failure to make a timely HSR notification are:

• Malone made a prior corrective filing for an “inadvertent” HSR Act filing violation, though that corrective filing was made in May of 1991.
• In a letter explaining the reason for the failure to file in August 2005, Malone referenced a 2001 informal interpretation of the Premerger Office of the FTC which appeared to support the view that no filing was required. However, this informal opinion was disavowed in February 2005 by another informal opinion. Malone stated in the letter that neither he nor counsel on his behalf discovered the subsequent opinion. (The subsequent opinion was available only at the FTC’s website.)
• Malone attempted to place the shares obtained via the two option exercises in escrow pending expiration of the waiting period following the June 2008 corrective filing. (The options were scheduled to expire before the termination of the HSR waiting period.) In the FTC’s view, however, the escrow arrangement was insufficient to insulate Malone from obtaining beneficial ownership of the shares immediately upon exercise of the options. The complaint further stated that neither Malone nor counsel contacted the Premerger Office to clear the mechanics of the option exercise and escrow arrangement prior to the expiration of the relevant waiting period.

The $1.4 million fine was approximately 1/8th of the maximum amount for his violation of the HSR Act. Specifically, Malone was deemed to be in violation of the HSR Act from August 9, 2005, the day of the first post spin-off open market purchase of Discovery stock, to July 14, 2008, the day on which the waiting period applicable to his June 2008 corrective filing expired. His maximum fine would have been approximately $11.7 million ($11,000 per day).

For more on HSR/antitrust, see our “Antitrust” Practice Area.

In his “Private Equity Law Review” Blog, Geoffrey Parnas continues to post interesting analysis, including this recent one below on private equity club deals:

Leveraged buyouts of companies by private equity consortia – also known as private equity club deals – often capture the headlines and the imagination of the business press. Buyouts that demand substantial equity investments, such as the $900 million injected into the failed Florida lender BankUnited Financial by a private equity group that included WL Ross & Co., the Carlyle Group, and Blackstone, often require several private equity firms to club together to come up with enough capital. Besides the large equity investment required, what distinguishes club deals from garden-variety leveraged buyouts is the need for multiple firms to agree on how the transaction will be managed. In this post, we’ll take a look at some of the chief terms of interim investor agreements among members of a private equity consortium.

Interim investor agreements for private equity consortia are by their nature temporary: the agreement terminates either upon the successful closing of the transaction or the deal’s termination in accordance with the share or asset purchase agreement. If the transaction proceeds as planned, an interim agreement details the steps that need to be taken to complete the deal and lays down the groundwork for how the business will be operated after closing. On the other hand, an interim agreement specifies how the consortium’s members will allocate responsibility for transaction costs and other liabilities, such as reverse break-up fees, should the deal founder. The agreement is signed on the same day the private equity funds sign their respective equity commitment letters, the banks issue their debt financing commitment letters, and the consortium’s shell acquisition vehicle, or “Newco,” enters into the purchase agreement with the target company.

A few of the principal matters typically covered in an interim investor agreement include:

Pre-Closing Agreements and Covenants

The members of the private equity consortium agree to cooperate with one another to resolve any outstanding issues with the target company, negotiate definitive loan agreements with the consortium’s lenders, execute employment agreements with the future management of Newco, and nail down any other final terms and conditions. In addition to approving the purchase agreement and other transaction documents, the private equity firms memorialize their consent to the proposed transaction structure, usually by reference to the pre- and post-closing organizational charts of Newco and its subsidiaries prepared by the consortium’s accountants. If the target is a public company, the members promise to comply with all applicable securities laws and to file all necessary documents with governmental authorities, such as filings under the Securities Exchange Act’s Regulation 13D disclosing beneficial ownership interests.

Finally, the private equity firms confirm how Newco will be managed during the period between the signing of the purchase agreement and closing. The interim investor agreement identifies the number of representatives from each of the consortium’s members appointed to Newco’s interim board of directors, usually in proportion to their respective equity investments. Each of the private equity funds indemnifies (on a pro rata basis) and holds harmless Newco’s interim board of directors from any claims or other liabilities arising from any error or omission by a director. Directors appointed to Newco’s interim board are likely to become named defendants in any future lawsuit regarding the transaction, whether the plaintiff is a consortium member, one or more of the financing banks, or the target company or its shareholders.

Definitive Investors’ Agreement

The private equity sponsors agree to negotiate a definitive shareholders’ agreement promptly after the transaction closes and may identify any special tax or ERISA matters (in the case of a public company) that need to be addressed in the definitive agreement. Most important, this section of the interim agreement incorporates by reference the private equity consortium’s investor term sheet, which summarizes the principal terms of the future definitive shareholders’ agreement.

Advisers’ Fees and Transaction Costs

The interim investment agreement also handles the allocation of transaction fees among the private equity firms’ advisory arms and how transaction costs (including liabilities from potential lawsuits) will be handled both in the event the deal closes and in the event the deal is terminated. Upon completion of the deal, the advisory arms of the private equity firms that sourced the deal receive a transaction fee that usually reflects their proportionate ownership interests in Newco.

The agreement also specifies how the consortium’s financial, accounting, legal, and other advisers will be paid. If the deal closes successfully, the interim agreement provides that Newco picks up the private equity consortium’s advisers’ fees and expenses. The way advisers are paid in the event of a failed deal turns on whether or not the consortium is entitled to a break-up fee from the target. If there is no break-up fee in the purchase agreement, the private equity firms will share costs on a pro rata basis. If there is a break-up fee under the purchase agreement, then the amounts received will be applied first to pay the advisers’ fees and expenses and other transaction costs, with the remainder being distributed among the private equity firms. If the deal is terminated because one of the private equity funds fails to finance its equity commitment, the defaulting private equity firm will indemnify the non-defaulting firms and be liable for all transaction fees, expenses, and other liabilities.

A private equity consortium’s interim agreement typically also requires confidentiality and specifies whether disputes will be resolved through arbitration or judicial process. In our next post, we’ll explain how interim investor agreements address the consortium members’ equity syndication procedures.