Yesterday, as noted in this press release,
the SEC charged – and settled – Section 13(d) violations with an
investment adviser – Perry Corp. – for failing to disclose that it had
purchased substantial stock in a M&A target, King Pharma.
Perry purchased the shares in order to vote them in favor of a merger
from which Perry stood to profit. Here’s the cease-and-desist order, under which Perry agreed to pay $150,000.
The
SEC was able to bring charges because the Mylan shares were not
acquired by Perry in the “ordinary course of its business,” which is
one of the requirements of Rule 13d-1(b)(1). However, I was a little
surprised that the SEC didn’t shoot Perry down by finding that it
either (i) did not acquire the shares in the ordinary course or
(ii) was not “passive” (since “passive” is also a requirement of the
rule). Instead, the SEC focused exclusively on the “ordinary course”
requirement of the rule. So I wonder why the SEC didn’t use “not
passive” as the hook and avoided the seemingly circuitous path to “not
in the ordinary course”? I would think the SEC could have made its case
by stating that Perry was not passive – and therefore could not be
acting in the ordinary course. Let me know what you think.
By the way, the SEC’s charges unfortunately didn’t
address concerns regarding Perry’s strategy. In an effort to lock in
the merger premium it would receive on its holdings of King Pharma
shares, Perry purchased a substantial block of the acquiror’s shares
(Mylan) that it intended to vote in favor of the merger while
contemporaneously entering into hedging transactions that minimized its
economic exposure to a decline in the value of those Mylan shares.
In
essence, Perry intended to vote its Mylan shares in favor of a
transaction that was not in the economic interests of other Mylan
shareholders because it had a more substantial economic interest in the
merger being consummated as a result of its holdings in King Pharma.
Similar issues arose in connection with AXA’s acquisition of MONY.
Although this issue has received considerable attention in the US
and the UK, no clear solution has been found. Rather, the focus has
been on enhanced disclosure obligations. The SEC’s charges solely
relate to Perry’s failure to file a Schedule 13D with respect to its
acquisition of more than 5% of Mylan’s shares with the intent of
influencing the direction or management of Mylan. Hopefully,
manipulation of the voting process will be
examined as part of the SEC’s plan to rethink the proxy plumbing this
Fall. We have resources on share lending, overvoting, empty voting, etc. in our “Share Lending” Practice Area.
When the SEC puts out a big proposal, there inevitably are some sleepers because that’s the way of the world. I recently received this note from a member about the SEC’s recent proxy solicitation proposals:
There are some potent changes in the proposed proxy amendments that will generally make contests easier to conduct. One amendment codifies a recent no-action letter to Carl Icahn that allows insurgents to include nominees of other insurgents on their proxy cards.
And the amendments also overrule a 2004 case (i.e. Mony Group v. Highfields Capital Management) where a court ruled that a shareholder conducting an exempt solicitation can’t send shareholders management’s proxy card and encourage them to vote as suggested by the insurgent.
More on Berger v. Pubco: Disclosure in Notices of Appraisal Rights and Merger Proxies
From Kevin Miller of Alston & Bird: Most commentators on Berger v. Pubco are focusing on the Delaware Supreme Court’s holding granting quasi appraisal rights as the appropriate remedy for faulty disclosure in connection with a short-form merger.
“[T]he exclusive remedy for minority shareholders who challenge a short form merger is a statutory appraisal, provided that there is no fraud or illegality, and that all facts are disclosed that would enable the shareholders to decide whether to accept the merger price or seek appraisal. But where, as here, the material facts are not disclosed, the controlling stockholder forfeits the benefit of that limited review and exclusive remedy, and the minority shareholders become entitled to participate in a “quasi-appraisal” class action to recover the difference between “fair value” and the merger price without having to “opt in” to that proceeding or to escrow any merger proceeds that they received.”
While the Berger decision highlights the need to include all appropriate disclosure in a notice of appraisal rights to ensure that statutory appraisal will be the exclusive remedy for minority shareholders in a short form merger, the decision may also indicate that the level of required disclosure is not as detailed as certain Chancery Court decisions suggest.
In Berger, the Notice of Appraisal Rights at issue only provided unaudited historical financial statements for the subject company and a five sentence description of the company. The notice of appraisal rights did not contain any disclosures regarding the company’s plans or prospects (e.g., projections), a meaningful discussion of its current operations or any financial disclosures by division or line of business. Nevertheless, the only disclosure violation found by the Chancery Court relating to the company was the failure to disclose how the controlling stockholder determined the merger consideration. Though not the focus of its decision, following a careful summary of the Chancery Court’s disclosure findings, the Delaware Supreme Court did not take issue with the Chancery Court’s disclosure holdings.
This is consistent with the Delaware Supreme Court’s prior decision in Skeen v. Jo-Ann Stores. In Skeen, a 2000 decision of the Delaware Supreme Court, the Delaware Supreme Court considered and rejected a claim that the board of the target breached its fiduciary duties by failing to disclose (i) management’s projections and (ii) a summary of the methodologies used and the ranges of values generated by the financial analyses performed by its financial advisor in a Notice of Appraisal Rights. In Skeen, the Delaware Supreme Court also confirmed that the standard of disclosure for Notices of Appraisal Rights was the same as for merger proxies.
Nevertheless, several subsequent Chancery Court decisions, including Pure Resources and Netsmart, have sought to establish more detailed disclosure requirements regarding target company projections and the financial analyses performed by financial advisors/opinion providers.
– Netsmart (3/07) – “It would therefore seem to be a genuinely foolish (and arguably unprincipled and unfair) inconsistency to hold that the best estimate of the company’s future returns, as generated by management and the Special Committee’s investment bank, need not be disclosed when stockholders are being advised to cash out. . . . Indeed, projections of this sort are probably among the most highly prized disclosures by investors. Investors can come up with their own estimates of discount rates or (as already discussed) market multiples. What they cannot hope to do is replicate management’s inside view of the company’s prospects.”
– Pure Resources (10/02) – holding that a summary of the methodologies used and the ranges of values generated by the financial analyses performed by the client’s financial advisor was required .
But see:
– CTI Molecular Imaging (E.D. Tenn) – see transcript of 2005 federal court decision denying temporary restraining order (Court stated that it was capable of interpreting the law of the State of Delaware as espoused in Skeen without the assistance of the Chancery Court’s interpretation in Pure Resources)
The Chancery and Supreme Court opinions in Berger do not specifically address whether a Notice of Appraisal Rights must include disclosure of financial projections or a detailed description of the financial analyses performed by a financial advisor or opinion provider. Given that a short form merger is effected by a 90%+ stockholder without action by the target, the target didn’t hire a financial advisor and it is not clear that the 90%+ stockholder engaged a financial advisor to advise on the price it determined to pay in the merger. Nevertheless, the Chancery Court and Supreme Court opinions in Berger may provide an indication of the views of certain members of the Chancery Court and members the Delaware Supreme Courts regarding the level of disclosure required in Notices of Appraisal Rights and merger proxies.
In Berger, the only disclosure violation relating to the company or the transaction was the failure to disclose how the 90%+ stockholder determined the merger price. The Chancery Court did not find that the failure to disclose the company’s plans or prospects was a disclosure violation, nor did the Chancery Court find that the failure to provide meaningful disclosure regarding company’s actual operations or finances by division or line of business was a disclosure violation.
In fact, it appears that the disclose of unaudited historical financial statements, together with a five sentence description of the company provided adequate disclosure regarding the company and its finances even where the company was privately held and was not required to file detailed financial and other information with the SEC. According to the Chancery Court “Plaintiff’s other arguments about alleged disclosure violations are less persuasive. Although plaintiff correctly notes that the description of the Company left much to the imagination, plaintiff has not explained why additional details about the products and services Pubco offered would have been materially relevant to the decision of whether or not to seek appraisal.”
Furthermore, if the 90%+ stockholder is not required to disclose “picayune details” about the process he used to set the price in a freeze out merger of a private company effected by the 90%+ stockholder without action by the subject company where the question is “can the minority shareholder trust that the price offered is good enough,” it is not clear why more detailed disclosure regarding projections and a financial advisor’s analyses would be required in connection with an arm’s length merger involving a public company with detailed business and financial information on file with the SEC – i.e., consistent with the Delaware Supreme Court decisions in Skeen and McMullin, should it not be sufficient for the disclosure regarding a fairness opinion upon which the board of directors is entitled to rely to disclose “in a broad sense what the process was” – i.e., the methodologies employed (e.g., selected companies, selected transactions and discounted cash flow analyses) – without necessarily disclosing the results of those analyses.
As reported by Francis Pileggi in his “Delaware Corporate and Commercial Litigation” blog, the Delaware Supreme Court – in Berger v. Pubco Corp. – recently clarified Delaware law regarding the remedy for minority shareholders in a “short-form merger” under DGCL section 253 when the minority shareholders are not given material information. Here is what Francis reported:
Marcus Montejo, a Wilmington lawyer in the Prickett Jones firm, which is the firm that prevailed in the case, provides us with the following overview of the case:
“Yesterday, the Delaware Supreme Court announced for the first time the appropriate operation of a quasi-appraisal remedy when a fiduciary has failed to observe his duty of disclosure in a short-form merger. In Berger v. Pubco Corp., the court ruled that where there is a breach of the duty of disclosure in a short form merger, a quasi-appraisal remedy does not require the minority stockholders to “opt-in” or escrow a portion of the merger proceeds they received. As a result of yesterday’s ruling, minority stockholders squeezed-out in a short form merger will automatically become members of a class when the majority stockholder has failed to observe his duty of disclosure.
In ruling so, the court rejected the Gilliland “opt-in” procedure. The court reasoned that whether the minority stockholders opted-in or opted-out of a class made no difference to the corporation. Either way the corporation would know early on who was a member of the class. By contrast, an opt-in procedure was more burdensome than opting-out for the minority stockholders and risked forfeiting the opportunity to seek an appraisal recovery. Accordingly, the court found an opt-out procedure optimal.
The court also rejected the Gilliland escrow procedure. Although the court agreed with the corporation that the minority stockholders would enjoy the ‘dual benefit’ of retaining the merger proceeds and at the same time litigating to recover a higher amount, the court concluded that from a fiduciary’s standpoint, this was not an inequitable result.
Importantly, the court noted that a corporation must be held to the same strict standard of compliance and that the appraisal statute must be construed even-handedly.
To this end, the court explained that ‘minority shareholders who fail to observe the appraisal statute’s technical requirements risk forfeiting their statutory entitlement to recover the fair value of the shares. In fairness, majority stockholders that deprive the minority shareholders of material information should forfeit their statutory right to retain the merger proceeds payable to shareholders who, if fully informed, would have elected appraisal.'”
For more on this – and other short-form merger issues – see our “Short-Form Merger” Practice Area.
This July-August issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
– Threshold Issues in Cross-Border Merger-of-Equals Transactions
– The Role of the Board in Turbulent Times: How to Avoid Shareholder Activism
– Private Equity in 2009: “Back to Basics” Practice Tips: Part II
– A “Sleeper”: Delaware Court Stresses Importance of Employment/Non-Competition Agreements with Target Employees
Here is some analysis from Steven Haas of Hunton & Williams LLP:
In a very short letter opinion in Ivize of Milwaukee v. Compex Litig. Support, 2009 WL 1930178 (Del. Ch.; 6/24/09), the Delaware Court of Chancery interpreted a fee-shifting provision in an asset purchase agreement which provided that, “[i]n the event of litigation among the parties arising out of [the APA], each Prevailing Party (if any) shall be entitled to reasonable attorneys’ fees and costs associated with such litigation from its opposing party.” Under that provision, the buyer sought reimbursement after prevailing on its breach of covenant claim against the seller.
The parties seemingly agreed that “fees” meant the hourly fees charged by the buyer’s counsel, but they sparred over the meaning of “costs.” The court construed the term by referring to local Court of Chancery Rules, finding that “costs” did not include “expenses related to photocopying, transcripts, travel expenses, and computer research.” The court also explained that, although the fee-shifting provision was entitled “Litigation Expenses,” the purchase agreement prevented reference to section headings in interpreting its provisions.
I can see this issue coming up in a number of drafting scenarios, including corporate and contractual indemnification obligations. But this isn’t the first time Delaware courts have addressed the issue, so lawyers are deemed on notice. In Comrie v. Enterasys Networks, Inc., 2004 WL 936505 (Del. Ch.; 4/27/04), the court reached the same result while noting that an agreement providing for reimbursement of “all costs” might be construed differently…. Here’s a great memo on an earlier decision in this litigation.
Tune in tomorrow for this DealLawyers.com webcast – “Alternative Fee Arrangements for Deals: Little Less Talk and Lot More Action?” – to hear Wilson Chu of Haynes and Boone; Scott Depta of Dell and Lance Jones of Trilogy talk about how the ways that deal fees are being restructured, a trend hastened by a down economy.
Podcast Series for M&A Practitioners
We recently came across a new resource for M&A practitioners – a series of podcasts by Booz & Company, the management consulting firm that split off last year from Booz Allen.
To date, Booz & Co has posted 24 podcasts on various M&A and restructurings topics – many of them related to books authored by staffers there – including: M&A in China, bank merger integration and mistakes to avoid in financial sector M&A. The latest podcast, called “Velocity and Impatience,” includes a discussion on whether the pace of business has become too fast, the reason deals are closing more quickly today and its implications for merger integration.
Below are some thoughts from William Newman of Sullivan & Worcester on the regulatory regimen in the US for inbound M&A deals – often a significant factor in determining whether a deal will be completed or not – that he recently posted on his firm’s blog:
A lawsuit that could have determined whether a filing made with CFIUS can be considered customary has ended. In May 2009, husband and wife Joseph and Judy Ehrenreich sued 3Com Corporation for damages they allegedly suffered from the loss in value of their 3Com shares. The case was brought under the provision of the federal securities laws that enables purchasers of stock to recover losses arising out of incorrect or incomplete statements made by the issuer of the shares. 3Com is a Massachusetts-based enterprise networking solutions provider.
The Ehrenreichs claimed that the cause of their loss was 3Com’s failure to specify that CFIUS review of its proposed merger with affiliates of Bain Capital was a significant risk. 3Com had published a press release announcing the proposed merger on September 28, 2007. The press release stated that the merger was subject to “customary regulatory approvals.” CFIUS review was not mentioned. The plaintiffs purchased 13,000 shares of 3Com stock after the announcement of the proposed merger.
The basis of the plaintiff’s case was that the proposed merger did truly raise serious national security concerns and that, as a result, CFIUS review was not customary. The plaintiffs interpreted “customary” to mean perfunctory or ministerial. The aspect of the merger that triggered CFIUS review was that, as part of the transaction, affiliates of China’s largest network equipment company, Huawei Technologies, were to acquire an interest in 3Com. Press reports associated Huawei with China’s military and possible links to Chinese cyber warfare efforts against the U.S. and the U.S. military.
Although 3Com disclosed on October 4, 2007 that it intended to make a CFIUS filing, the plaintiffs contended that 3Com’s announcement omitted the reasons for seeking the review and downplayed the risk that CFIUS could block the transaction. Five months later, 3Com withdrew its CFIUS filing. One month later, the parties terminated their merger. The announced reason was that CFIUS intended to prohibit the deal. The price of 3Com stock plummeted from its level at the time of the original announcement.
The complaint claims that the peculiar structure of FINSA – its voluntary and not mandatory filing requirement — gives parties an incentive not to mention the possibility of CFIUS review. It suggests that parties might try to “fly under the radar screen” and not provoke public reaction to a deal.
We will not know from this case whether 3Com’s initial failure to specify CFIUS review and the basis on which CFIUS could review the transaction was an incorrect or incomplete statement. The plaintiffs voluntarily withdrew on June 30, dismissing their case with prejudice. A settlement may have occurred. Even if abandoned at this stage, the case stands as a warning to parties contemplating a CFIUS filing. When communicating to the markets, it’s best to say more about the likelihood of a CFIUS review rather than less. Parties now are on notice that CFIUS review may be more than perfunctory. It’s safer to make that clear if the review leads to an unexpected end to the deal.
Here’s some analysis from Cliff Neimeth of Greenberg Traurig:
As widely anticipated, in an open session of the SEC’s Commissioners last week, they approved (in a 3-2 split-vote) the elimination of NYSE Rule 452. This will end the long-standing practice of broker-dealer discretionary authority to vote “uninstructed client shares” in uncontested director elections.
Under Rule 452, uncontested director elections historically were classified as a “routine matter” enabling brokers to vote as they deemed appropriate in respect of shares for which they did not receive specific client voting instructions prior to the 10th day next preceding the stockholder meeting. Statistically, such shares overwhelmingly were voted “for” director candidates nominated by the issuer.
For many issuers who, in the past few years, have adopted “majority voting” bylaw standards for uncontested director elections (or, at a minimum, have adopted so-called “plurality plus” director resignation requirements), the elimination of Rule 452 adds significant fuel to “withhold authority” campaigns initiated by activist hedge funds and other dissident stockholders to advance agendas not necessarily in the best interests of all stockholders.
Moreover, in view of (i) new Sections 112 and 113 of the DGCL – effective August 1, 2009 – which enable the adoption of binding bylaw provisions permitting direct insurgent access to the issuer’s proxy materials and, in certain circumstances, reimbursement of expenses incurred by dissidents in opposition election contests; (ii) proposed SEC Rule 14a-11 which, if adopted substantially as proposed in time for the 2010 proxy season, will mandate the inclusion in issuer proxy materials of insugent (short-slate) nominees, provided that certain minimum ownership and other procedural requisites are satisfied; (iii) recent Delaware decisions strictly construing the validity and use of certain organic takeover defenses; and (iv) the SEC’s recently adopted “e-proxy” rules and exempt solicitation “stockholder forum” rules, dissident boardroom access is being made increasingly more available to activists and far less less costly.
In turn, unsuspecting (or unprepared) issuers are becoming increasingly vulnerable.
What to Do Now
As you’ve no doubt read on all of these subjects, it is very important to review with your clients their existing advance notice bylaws and other organic and structural takeover defenses (including rights plans, etc.). This is further compounded by the current macroeconomic environment which has been an impetus for operating and financial performance shortfalls across myriad industries, and the sharp decline in straight buyside and sellside deal activity, in each case further giving rise to alternative “liquidity event” agendas and other management displacement and corporate change-in-control campaigns.
Of course, shark repellents that only can be implemented by means of charter amendment (under applicable state law) would require both director approval and stockholder adoption – which may be impractical or untimely in many circumstances.
The need to assess client “targetability” tends to be more pronounced in the case of small cap issuers who tend to be disproportionately more vulnerable to unsolicited assault for a variety of economic, structural, and other reasons.
The SEC also announced yesterday that, in addition to pending Rule 14a-11, it intends to undertake a comprehensive review of all current proxy regulations with a view to “overhaul” them as may be necessary.
Kevin Miller of Alston & Bird notes: In this order on Friday, Delaware Chancellor Chandler granted plaintiff’s motion for expedited proceedings to seek injunctive relief to address a board’s alleged failure to fulfill its Revlon duties.
Highlighting the significance that the procedural posture of a case can have, the Court noted that the Delaware Supreme Court’s recent decision in Lyondell Chemical v. Ryan may preclude an award of monetary damages for a breach of the duty of care where the target company’s charter contains a 102(b)(7) exculpatory provision. But exculpation for monetary damages does not preclude injunctive relief -“[t]hus, in cases such as this one, the shareholders’ only realistic remedy for certain breaches of fiduciary duty in connection with a sale of control transaction may be injunctive relief.”
Background/Allegations (for purposes of motion, the court treats plaintiff’s well plead allegations as true):
– In March 2009, Data Domain began discussions with NetApp regarding a potential business combination
– On May 11, the Data Domain board was informed that EMC was interested in meeting with Data Domain and a meeting was subsequently scheduled for May 27.
– On May 20, Data Domain and NetApp entered into a merger agreement pursuant to which Data Domain would become a wholly owned subsidiary of NetApp and Data Domain’s shareholders would receive $25 in a combination of cash and Net App stock. The merger agreement allegedly contains a number of deal protection provisions including a no-shop clause, a matching right and a termination fee and certain officers and directors of Data Domain entered into an agreement to vote approximately 20% of Data Domains shares in favor of the merger with NetApp.
– On June 1, EMC launched an all cash tender offer for Data Domain at $30 per share.
– On June 3, NetApp increase the cash component of its offer by $5, raising the overall value of its offer to $30 per share. Data Domain agreed to NetApps revised offer and left all the deal protection measures in place.
Plaintiffs alleged that Data Domain’s directors violated their fiduciary duties in the context of a sale of control of the company under Revlon v. MacAndrews & Forbes – i.e., that Data Domain’s directors breached their fiduciary duties by failing to take steps to obtain the best price reasonably available, by granting/permitting preclusive deal protection provisions and by failing to inform themselves.
[Note: where the consideration is cash and stock, Delaware case law is unclear as to whether and when Revlon duties apply. Here it appears a majority of the consideration is cash.]