As widely reported, Senators Baucus (D-MT) and Grassley (R-IA) introduced a bill last Thursday that would significantly change the taxation of publicly traded private equity firms structured as partnerships. This legislation, if passed, would cause publicly traded private equity firms to be taxed as corporations. As such, these firms generally would be subject to an entity-level corporate tax (with no preference for capital gains, including carried interest) and the owners of these firms would be subject to tax on distributions received from the firms. Here is a related NY Times article.
Rep. Charles Rangel, Chairman of the House Ways and Means Committee, praised the bill and said his committee would examine the legislation. If passed, the bill would be immediately effective for any firm that has not yet filed an IPO registration statement with the SEC. For firms that have done so, namely the Blackstone Group, the bill would not be effective until 2012.
From Travis Laster: On Thursday, Vice Chancellor Strine of the Delaware Chancery Court issued an opinion in which he enjoined The Topps Company from proceeding with a meeting of stockholders to vote on a merger with The Tornante Company (controlled by Michael Eisner). The injunction required (i) supplemental disclosure regarding Eisner’s assurances that he would retain existing management and (ii) that Topps release Upper Deck, a second bidder, from a standstill agreement so that Upper Deck could communicate with Topps stockholders and launch a topping tender offer. The Vice Chancellor concluded that Topps improperly failed to waive the standstill, used Upper Deck’s status as a competitor as a “pretext,” and that the evidence “regrettably suggests that the Topps Incumbent Directors favored Eisner, who they perceived as a friendly suitor who had pledged to retain management….”
This decision is a must-read for M&A practitioners. Here are some highlights from the 67-page opinion:
1. The court validated Topps’s decision to negotiate privately with Eisner and not to conduct an auction. VC Strine observed that (a) Topps conducted a failed auction in 2005 for its confectionary business and (b) the directors engaged in a “spirited debate” on the subject. He also noted that a recent proxy contest had put potential buyers on notice: “the pot was stirred and ravenous capitalists should have been able to smell the possibility of a deal.”
2. The court recognized the value of obtaining a binding bid from Eisner (the “proverbial bird in hand”) and found that the board left itself “reasonable room for an effective post-signing market check” through the use of a go-shop provision (“For 40 days, the Topps board could shop like Paris Hilton”).
3. VC Strine validated the customary deal protection measures used by Topps – a termination fee and matching right. He observed that while matching rights are “a useful deal protection” for buyers, they have “frequently been overcome in other real-world situations.” He considered the 4.3% post-go-shop termination fee “a bit high in percentage terms” but deemed it reasonable since it included Eisner’s expenses and “can be explained by the relatively small size of the deal.” “At 42 cents a share, the termination fee (including expenses)
is not of the magnitude that I believe was likely to have deterred a bidder with an interest in materially outbidding Eisner.”
4. VC Strine sharply criticized the Topps board for having little basis on which to terminate negotiations with Upper Deck when the go-shop expired (which was permitted if Upper Deck was deemed to be an “Excluded Party”): “Upper Deck was offering a substantially higher price…. [and] the Topps board chose to tie its hands by failing to declare Upper Deck an Excluded Party in a situation where it would have cost Topps nothing to do so.”
5. Most importantly, VC Strine came down hard on Topps’s refusal to waive a standstill agreement which prevented Upper Deck from making public statements or proceeding with a premium hostile tender offer: “That refusal not only keeps the stockholders from having the chance to accept a potentially more attractive higher priced deal, it keeps them in the dark about Upper Deck’s version of important events, and it keeps Upper Deck from obtaining antitrust clearance, because it cannot begin the process without either a signed merger agreement or a formal tender offer.”
6. The court ordered supplemental disclosures to make clear that, even though management had not negotiated retention agreements, Eisner had already made clear that he planned to retain “substantially all” of Topps’s “senior management and key employees.” The court also ordered supplemental disclosures of Upper Deck’s “he-double-hockey-sticks or high water” offer to divest itself of assets to obtain antitrust approval, which the court deemed relevant since Topps cited antitrust concerns in its decision to terminate discussions. The court also chastised Topps’s financial advisors for adjusting cost of capital assumptions and shortening management’s projections from five to three years-apparently in an attempt to support Eisner’s offer. The court ordered supplemental disclosures that reflected the original and full projections.
Practitioners should note that unlike other recent decisions, such as Caremark-Express and Netsmart, Topps is not solely a disclosure injunction. VC Strine granted substantive relief regarding the standstill. Practitioners also should note (not surprisingly) that the plaintiff who obtained that relief was the topping bidder, not a stockholder plaintiff. VC Strine expressly noted that the arguments made by the stockholder plaintiffs would not have supported a Revlon injunction. Topps thus does not increase deal risk absent the presence of a meaningful topping bid.
Topps‘ ruling on the standstill provision is frankly a welcome precedent. The questions created by aggressive standstill agreements and subsequent waivers have been part of the Delaware counseling mix for some time. Without any meaningful decisions on the issue, however, concerns regarding potential fiduciary duty issues were often given short-shrift. Topps confirms that the use of standstill agreements and reliance on them to foreclose subsequent bids are areas that must be approached with particular care.
From FEI’s “Financial Reporting” Blog: Yesterday, FASB voted to change a prior decision in its Bus Comb project, and voted today to simplify the standard by requiring that all noncontractual contingencies not recognized at the acquisition date (those that do not meet the more likely than not recognition threshold at the acquisition date) be accounted for post acquisition in accordance with FAS 5.
However, a majority of the board (4 of the seven board members) voted to retain a Fair Value (FV) measurement requirement for initial and subsequent measurement for all contractual contingencies and those noncontractual contingencies that meet the more likely than notrecognition threshold at the acquisition date. In response to comments about lack of cost-benefit in remeasuring these contingencies at FV, the board will conduct field trials during the period between issuance of the final Bus Comb standard – with staff suggesting a pre-ballot draft may be circulated by June 30 – and the implementation date of 2009.
Separately, some board members expressed concern with requiring this new (non-FAS 5) subsequent valuation at FV for contingencies just for Bus Comb, and FASB Chairman Bob Herz said there were other matters in the Bus Comb standard he would personally give subsequent FV treatment to which the other board members did not, such as acquired IPR&D. But, all Board members agreed FAS 5 needs to be amended, and Herz asked the staff come back to the board at a subsequent meeting with a proposed agenda decision to embark on a project to amend FAS 5, and to begin preparing an ED on it. The IASB is working on an amendment to IAS 37 on contingencies and the boards will talk about convergence issues. Further information on this and other issues addressed at today’s board meeting can be found in the FASB board handout.
After several extensions, the NASD has finally filed an amendment to its fairness opinion proposal. This Amendment is No. 4 because several of the others were merely extensions of the comment period.
Although things can always change, my guess is that this Amendment will go “final as proposed” since the SEC Staff has already weighed in after seeing the comments. As noted in this firm memo, the NASD has pared back parts of the proposal in light of comments (both from the SEC Staff and the industry). We will continue to post analysis in our “Fairness Opinions” Practice Area.
Back in late March, the NY Times Dealbook had this gem: “The big investment banks are everywhere these days, underwriting public offerings, advising buyers and providing deal financing — often on behalf of the same company. This ubiquity has created some concern when a bank needs to be found to handle a “go shop” provision in a takeover agreement, which essentially creates a window during which the target tries to drum up better offers. The dilemma: Does the desire for a completely independent bank trump the desire for a bank with sufficient resources and relevant experience?
Vice Chancellor Leo E. Strine Jr., who often presides over big deal-related cases at Delaware’s Court of Chancery, offered his opinion on this hot-button issue. In a panel discussion Thursday at Tulane Law School’s Corporate Law Institute, Vice Chancellor Strine suggested that a conflict-free bank is not always the best choice.
“I question bringing in a Mickey-Mouse-size bank to respresent a go-shop,” he said on the panel. “I still err on the side of repeat players” — meaning banks that may already have an interest in a company or a deal — who “know the tricks of the game.”
A pure adviser, he suggested, can sometimes end up being a “purely ignorant adviser.” This line of discussion brought out what is likely to be one of the most memorable quotes of the event. It was spoken by panelist Robert Kindler, vice chairman of investment banking at Morgan Stanley. Referring to the universe of big banks such as his own, he said: “We are totally conflicted — get used to it.”
A couple of recent cases have highlighted situations where beneficial ownership reporting by hedge funds is called into question, in one instance with a particularly draconian result – potential imprisonment.
Last week, the U.S. Attorney for the Southern District of New York announced that the founder and manager of two hedge funds, pleaded guilty to three counts of violating federal securities laws arising from the activities of his funds in acquiring substantial positions in the securities of two public companies. In addition to defrauding the funds’ investors about transactions that resulted in losses of $88 million, the manager was charged with failing to file on Schedule 13D to report an interest of 5% or more of one company’s stock (he and his funds controlled over 80 percent of the stock), and failing to file a Form 3 to report his beneficial interest of more than 10% in another company (while falsely reporting ownership of under 10% in a Schedule 13D).
The SEC also commenced a civil action in this case back in 2005 that is still pending. Actions such as this one should come as no surprise to those who have heard the SEC Staff publicly express the point that compliance with the beneficial ownership reporting requirements has been – and will remain – a high priority.
While the failure to file accurate beneficial ownership reports was obviously important for the markets in the common stock of the companies involved, the lack of accurate beneficial ownership information was also crucial for the manager to carry out his fraudulent scheme, as any reporting of his interests would have informed his investors that he was not acting in accordance with the funds’ investment policies. Alan Dye has blogged more about this case on his Section16.net Blog.
And Another Schedule 13D/G Action…
Recently, the Delaware Chancery Court addressed the situation of a hedge fund that reported its “investment only” intent on Schedule 13G when it was potentially considering the nomination of a short slate of directors to the company’s board. While the case of Openwave Systems Inc v. Harbinger Capital Partners principally involved the hedge fund’s failure to timely nominate its director candidates under Openwave’s advance notice bylaw provisions, the court took particular note of the fund’s status as a Schedule 13G filer in assessing whether it was really in a position to nominate its own directors within the required timeframes of the advance notice bylaw provisions, as well as in rejecting the fund’s allegation that the board of Openwave reduced the number of directors in response to Harbinger’s potential “threat.”
Join us tomorrow for a webcast – “The Art of the Cross-Border Deal” – to hear Tina Chalk of the SEC, Frank Acquila of Sullivan & Cromwell, Greg Wolski of E&Y and Peter King of Shearman & Sterling analyze the latest M&A tactics in cross-border deals.
In a early May decision – In re Topps Company Shareholders Litigation – Vice Chancellor Leo Strine of the Delaware Chancery Court held, in a case involving the $385 million takeover of the Topps Company, that Delaware’s interests in maintaining its own laws were sufficiently important for the court to retain jurisdiction over the case even though a related case had been first-filed elsewhere. The case involved a proposed buyout of The Topps Company, involved a refusal by the Court to stay a Delaware action challenging the buyout in favor of a first-filed action brought in New York.
The case continues the trend started by the Court in the recent Ryan v. Gifford opinion involving alleged options backdating, where the Court also refused to stay a second filed Delaware action in favor of a first filed action in another state where the Court finds the issues to be important and novel under Delaware law. Kevin LaCroix provides more analysis in his D&O Diary Blog.
[Editor’s Note: We’re pleased to host the following dialogue between Mark Morton of Potter Anderson and Corroon and Larry Hamermesh of Widener Law School, precipitated by Mark’s ruminations about sellers’ insistence that a go-shop provision with a matching right in a merger agreement be accompanied by a right to reimburse the expenses of a topping bidder who is subsequently matched. As always, we welcome reader comments on the discussion below.]
Mark Morton: In the typical M&A deal, there’s generally a match right. As a result, the target can’t actually terminate the merger agreement for the superior proposal until the first bidder decides whether or not to match. If the first bidder matches, he wins (unless he’s topped again). In that case, the target will not have signed a merger agreement with the interloper, so the interloper doesn’t get a termination fee. As a result, the interloper gets nothing for his superior bid–other than a large chunk of unreimbursed expenses. I would argue, therefore, that the presence of a match right creates a significant disincentive to topping bids.
I raised this issue and asked one of the private equity guys whether they are willing to jump deals, that is, to come in with a topping bid where there are matching rights. He said that they are theoretically willing to jump deals if the price is right, but they generally have not done so because they don’t want to dedicate resources to a deal where they won’t get any expenses reimbursed or any termination fees unless the target terminates the initial deal and signs with them (that is, unless the original buyer doesn’t match). In response, I asked the private equity representative if his company would jump in more often if the target had the contractual right under the terms of the initial merger agreement to pay the expenses of any party that presents a topping bid that the board determines (or is likely to be) a superior proposal. He said they absolutely would make topping bids more often.
So, here’s my thought: when a target is signing up a deal with a match right, and they know they haven’t been shopped sufficiently, they should negotiate for the right to reimburse the expenses of any topping bidder. If the private equity guy is right, that should help generate more meaningful bidding interest in the market. That’s a difficult thing for the target to ignore and for the initial buyer to argue against. As a practical matter, if no one tops, then the target pays nothing and the first bidder is happy. If there’s a topping bid and the first bidder loses, then they get their termination fee, and they can’t really complain about the reimbursement of fees to the topping bidder. The first bidder will, of course, say: “But what if there’s a topping bid and we have to raise our bid to win?” Well, in that case, it’s clear that the initial bidder underbid, and they shouldn’t be heard to complain about paying the fees of the topping bid. Plus, before agreeing to such a provision, they presumably would price the cost of the provision into their bid (perhaps by cutting their price by the cost of reimbursing fees for a topping bidder). However, if they do, that lower price is even more likely to encourage topping bids–which would be, of course, beneficial for the target’s shareholders.
I think the same argument can be raised even when there’s not a top–but it’s a little less persuasive. One final twist: as I said at Ray Garrett, I think the market is moving away from match rights during the go-shop period. If that’s where the market ends up, it would affect my logic above.
Larry Hamermesh: I’m thinking about this very interesting issue you’ve raised, and my concern is about how to avoid encouraging marginal topping bids. Maybe the best way to approach the matter where there’s a match right is to prescribe a topping fee and/or expense reimbursement for a deal jumper only if the bid increment exceeds a defined dollar or percentage level. What do you think?
Mark Morton: I’m not sure I share your concern about marginal topping bids. That said, is your concern addressed if the target can only offer expense reimbursement if the topping bid exceeds the current bid by an amount equal to the expense reimbursement?
Larry Hamermesh: Or even a greater amount–if the jumper-reimbursement on top of a match right tends to discourage or reduce initial bids, I guess I’d want to see a substantial bump before being routinely sympathetic to a jumper-reimbursement right. That’s the idea, anyhow. This is from the perspective of someone who lived through the Skadden ’80s deal-jumper strategy of incremental bidding (as in Revlon and Macmillan) and found it annoyingly opportunistic.
Mark Morton: One thing is clear to me in any event: notwithstanding the suggestion in Toys R Us that a matching right is generally enough to meet directors’ fiduciary obligations, I think that in some cases they present real issues.
Private Equity M&A Nuggets
We have posted a transcript from the popular webcast: “Private Equity M&A Nuggets.”
In response to last week’s blog on Chancellor Chandler’s opinion in In re: Appraisal of Transkaryotic Therapies, Inc., an anonymous member weighed in: “By describing DTC as essentially a black box stuffed with untraceable, fungible share, I think the decision ignores the high likelihood/practical necessity that, in order to properly allocate the right to demand appraisal, DTC, its participant members, and the brokers/persons on whose behalf they act as nominees must have policies and procedures that require the persons they act for to demonstrate ownership as of the record date.
Consider if DTC did receive requests that Cede demand appraisal with respect to more shares than were eligible (on deposit with DTC and not voted in favor of the merger). DTC would check its records and could deny appraisal by participant members in excess of the number of shares such participant had on deposit as of the record date and had not voted in favor of the merger. The participant would then have to engage in the same process and could deny appraisal by persons on whose behalf it acts as nominee in excess of the number of shares such person owned through the participant as of the record date and had not voted in favor of the merger.
All that being said, as Travis correctly points out, such an excess demand for appraisal is not often likely given the number of dead shares which effectively gives aggressive stockholders a free ride to demand appraisal with respect to shares in excess of the shares they owned as of the record date.”
Does anyone know what DTC would do if the number of appraisals demanded by members exceeded the number of shares it had not voted in favor?
We have just sent our May-June issue of our new newsletter – Deal Lawyers – to the printer. Join the many others that have discovered how Deal Lawyers provides the same rewarding experience as reading The Corporate Counsel.
To illustrate this point, we have posted the May-June issue of the Deal Lawyers print newsletter for you to check out. This issue includes pieces on:
– Wake Up and Smell the E-proxy Coffee: Changes Ahead for Online Solicitations
– Lessons Learned: A Practical Look at the Caremark Trilogy
– Understanding the Real Meaning of Deal Certainty: Debunking a Few Myths and Suggesting a Few Solutions
– What’s in a Choice of Law Clause?
– Unauthorized Management Buyout Proposals: It’s Time to Reevaluate Corporate Policies
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