Thanks to Kevin Miller of Alston & Bird, below is a summary of the comments submitted to the SEC on proposed NASD Rule 2290 regarding fairness opinions (Release No. 34-53598, April 4, 2006):
– 2290(b)(3) – strongly believes that it is ill advised (and inconsistent with the approach taken in balance of the rule) to require that members have processes to evaluate whether the amount and nature of the compensation from the transaction underlying the fairness opinion benefiting any individual officers, directors or employees or class of such persons relative to the benefits to shareholders of the company is a factor in reaching a fairness determination and suggests that if the SEC and NASD nevertheless determine to adopt such a requirement, that they incorporate a safe harbor for differential benefits approved by a committee of independent directors (along the lines of the safe harbor in recently proposed amendments to Rule 14d-10) or not exceeding a de minimus value threshold;
– 2290(a)(3) – would not support an amendment to expand disclosure of material relationships to include affiliates of companies involved in the transaction underlying the fairness opinion because of (A)the
difficulty in obtaining information in the tight time frame many fairness opinions are prepared; (B) would necessitate conveying information across internal informational barriers erected in part to avoid conflicts; and (C) would unnecessarily risk inaccuracies, particularly in light of duplicative information (at least with respect to the member’s client and its affiliates) required by Item 1015 of Regulation M-A;
– 2290(a)(1), (2) and (3) – would not support an amendment to require that fee
disclosures be quantified, though would support additional disclosure if such amounts exceeded 5% of the member’s revenue, assets or market capitalization;
– would not support an amendment to require that contingent fees or other relationships be characterized as conflicts of interest;
– believes it unnecessary and inappropriate to consider expanding required disclosure to cover material relationships between parties to the transaction underlying the fairness opinion and affiliates of the member providing the opinion because of the difficulty in obtaining such information due to (A) the complex nature of large, diverse, global financial services companies of which many members are a part; (B) the existence of informational barriers addressing important legal and regulatory issues; and (C) privacy laws that may exist in certain jurisdictions – also notes that it may be counterproductive to require members to inform themselves of material relationships that could pose a conflict when they might otherwise have remained unaware of the relationship with the member’s affiliate;
– in response to query regarding a possible requirement that members disclose the type of verification they undertook with respect to information provided by their client that formed a substantial basis for the member’s fairness opinion, notes that the current practice is for members to disclose in their opinions that they do not independently verify any information and assume the accuracy and completeness of all information they are provided or rely upon – would not oppose a rule requiring disclosure of the current practice whether as a general matter or with respect to each category of information that provided a substantial basis for the opinion;
– continues to believe it impractical and inappropriate, and would not support an amendment requiring members, to verify or obtain verification for information provided by their client that formed a substantial basis for the member’s fairness opinion – members often don’t have adequate familiarity, time or expertise to verify information and much of the information on which they rely is inherently unverifiable;
– does not believe it necessary to disclose the procedures utilized in the fairness opinion; and
– a variety of technical comments seeking clarification and addressing wording issues. Otherwise generally supportive of proposed rule as currently drafted
– supports quantification of fee disclosures required by 2290(a)(1), (2) and (3), including disclosure of the amount of the fee for rendering a fairness opinion and the amount of the overall fee contingent on completion of the transaction;
– supports disclosure of “material” or “significant” relationships rather than “conflicts of interest”;
– does not support requirement that members describe the type of verification they undertook with respect to information that formed a
substantial basis of their opinion and does not support requirement that they obtain independent verification; and
– supports rule requiring procedures designed to ensure appropriate internal review of fairness opinions but does not believe additional disclosure regarding such procedures is necessary, as other rules and current proxy disclosure requirements are adequate.
– Scope of 2290 – overbroad and vague – should only apply to opinions “reasonably likely to be included or summarized or referred to in disclosure documents required to be filed with the SEC;
– 2290(a)(1) – technical suggestion modifying language of rule to apply to “financial advisor to any company that is a party to the transaction” rather than “financial advisor to any transaction”;
– 2290(a)(2) – generally supportive of requirement that members be required to disclose fees or payments contingent on consummation of transaction but requests clarification that such requirement only apply to fees or payments from parties to a transaction and that the proposed rule not require members to collect information over internal informational barriers established for regulatory purposes; not supportive of any requirement that fees be quantified or that contingent fees or prior relationships be characterized as conflicts;
– 2290(a)(3) – suggests limiting required disclosure of material relationships between member and parties to the subject transaction to financial advisory services, underwritings and capital markets services, lending and financing arrangements, and merchant banking or private equity relationships involving direct equity investments in parties to the subject transaction, but not market making, asset management or research coverage; believes extending disclosure requirement to material relationships between parties to the transaction and affiliates of the member would be difficult unless limited to affiliates that are consolidated subsidiaries of the member or its parent holding company;
– 2290(a)(4) – not supportive of a requirement that members independently verify information supplied by its client that formed a substantial basis for the fairness opinion or obtain independent verification of such information;
– 2290(a)(5) – supports requirement that fairness opinions disclose whether the opinion was approved or issued by a fairness committee;
– 2290(b)(1) – generally supportive of requirement that members have procedures addressing the process by which fairness opinions are approved provided rule clarified to permit members of fairness committee to “advise” deal team with respect to appropriate negotiating strategies, etc. in the ordinary course;
– 2290(b)(2) – supports requirement that members have procedures that address the process by which fairness opinions are approved, including the process to determine whether the valuation analyses were
appropriate; and
– 2290(b)(3) – believes it inappropriate to require members to adopt policies or procedures to evaluate the amount and nature of compensation that individual officers, directors or employees will receive from the underlying transaction relative to other parties.
– Supports the required disclosures and procedures in the proposed rule but suggests rule be augmented to require procedures to (i) determine the circumstances under which an opinion should be updated and (ii) address, prior to public distribution of a fairness opinion in a proxy statement or similar document whether the opinion should be reaffirmed or withdrawn. Also suggests that if the date of an opinion in a proxy statement is not proximate to the date of the proxy statement, the member should be required to disclose the basis on which it determined not to update its opinion. [Note: not clear how the latter is to be accomplished as the member does not control the content or date of the proxy statement or whether its client desires/requests a bring-down opinion]
– References co-authored research paper entitled “Banker Fees and Acquisition Premia for Targets in Cash Tender Offers: Challenges to the Popular Wisdom on Banker Conflicts” which concludes that there is no evidence that a higher proportion of contingent fees or previous work for acquirors have an adverse impact on acquisition premia.
– Supports quantification of compensation arrangements where disclosure of such arrangements is required by proposed Rule 2290 and supports requirement that members state that a conflict may exist and describing the impact of such conflict on the fairness opinion, including a description of the compensation structure (whether or not contingent) and the amounts at stake;
– Supports a disclosure requirement covering material relationships between the parties to the transaction and affiliates of the member providing the fairness opinion;
– Does not support a potential requirement that members verify information or obtain independent verification; and
– Does not support a potential requirement that members disclose the procedures utilized in fairness opinions – current proxy disclosure is adequate.
News from GovernanceMetrics International’s “In Focus”: The European Commission has been busy trying to quash “golden share” veto takeover powers currently used by several EU member countries to protect key companies. The commission is seeking to open up markets and reduce government control of business. The EC has filed suit against Italy for maintaining golden shares at privatized companies that were formerly state-owned monopolies such as oil company Eni, power utility Enel and telephone utility Telecom Italia. Hungary is also the subject of likely suits, as it has yet to repeal the golden shares it holds over 31 companies in various industries, a repeal it promised to enact before joining the EU in 2004.
EU regulators are also eyeing Germany for its restrictions on the sale of Bankgesellschaft Berlin, the former state-owned German bank which was bailed out by the EU. Germany is restricting the use of the bank’s valuable “Sparkasse” trade name by any potential buyer, but the EC insists that the brand is a key asset of the company and must be offered as part of a sale. Bankgesellschaft Berlin is scheduled to be sold to a non-government buyer during 2007. Throughout Europe, the EC has been arguing that government protections must be limited to only specific areas, such as defense and security.
Kevin Miller of Alston & Bird notes: As many of you probably are aware, the Court of Appeals for the Second Circuit applying New York law held last year that under the “no third-party beneficiary” provision typically found in most public company merger agreements, the target company could not recover lost merger premium as damages for the acquiror’s wrongful termination/failure to close. The case was Consolidated Edison, Inc. v. Northeast Utilities, 426 F.3d 524 (2d Cir. 2005); here is a copy of the opinion.
The Second Circuit Opinion
A substantial rationale was that lost merger premium is a damage suffered by the target’s stockholders, not the target, and the target’s stockholders are not entitled to recover damages unless they are intended third party beneficiaries – something the target and buyer would be loathe to agree for fear of losing control of the transaction.
As noted in the ConEd/NU decision, the direct damages suffered by NU were less than $30 million on a $3.6 billion dollar transaction, while the lost merger premium was over $1 billion.
Generally, the target’s expenses will represent a smaller percentage of the overall transaction value as the size of the transaction increases. Nevertheless, until recently, no large publicly company merger agreement governed by New York law appeared to contain a provision in which the target insisted on language intended to create a meaningful disincentive for buyers who, presumably suffering buyer’s remorse, might wrongfully terminate or fail to close a merger if the potential damages were limited to the relatively modest costs and expenses and not lost merger premium.
The Phelps Dodge-Inco Combination Agreement
The Combination Agreement between Phelps Dodge Corporation and Inco Limited, dated as of June 25, 2006, however, contains the following provision:
“10.4. Entire Agreement; Third Party Beneficiaries. This Agreement and the documents and instruments and other agreements among the parties hereto . . . are not intended to confer upon any other person any rights or remedies hereunder, except (i) as specifically provided in Section 7.6 and (ii) the right of [Inco’s] shareholders to receive Portugal Common Shares and cash at the Effective Time and to recover, solely through an action brought by [Inco], damages from [Phelps Dodge] in the event of a wrongful termination of this Agreement by [Phelps Dodge].”
Inco stockholders are clearly made intended third party beneficiaries with the right to recover damages (which would likely include lost merger premium) in the event Phelps Dodge wrongfully terminates the merger agreement, but only through an action brought on their behalf by Inco. Thus, the third party beneficiary rights explicitly created by contract are also explicitly limited by contract to prevent Inco stockholders from attempting to enforce those rights individually or as a class representative.
The provision nevertheless leaves a few questions unanswered:
– Since Inco only has the right to bring an action on behalf of Inco stockholders, how would Inco distribute the proceeds of such action? This is an issue the federal district court in ConEd/NU had struggled with but the Court of Appeals never addressed – do the damages belong to the stockholders of the target at the time of the breach or at the time of the judgment? Alternatively, could you vest the right to the recovered damages with the target itself (rather than merely the right to enforce the contract on the stockholders’ behalf) or specify that the right to recover damages transfers with shares of stock until the judgment date which effectively becomes the record date for the distribution of damages on a pro rata basis?
– What if the buyer doesn’t terminate the agreement but merely refuses to close, alleging the failure of a closing condition? [NU alleged this to be an effective termination but the issue was left unresolved by the Court of Appeals]
– Would courts applying Delaware law handle this situation differently?
Yesterday, the SEC adopted new executive compensation disclosure rules (as well as related-party transaction and Form 8-K rules) as expected. The SEC appeased the mass media by focusing quite a bit on option backdating in its press release. Otherwise, there was not too much in the way of change from the proposals as described at a two-hour open Commission meeting – but that’s not to say that the changes wrought by the new rules will not be dramatic! And of course, the adopting release will be key to ascertain the extent to which fine-tuning changes were made to the SEC’s proposals other than the ones identified below.
The new Compensation Discussion and Analysis remains the centerpiece of the SEC’s new rules – and it is required to be “filed.” In addition, a new Compensation Committee report is now required to be “furnished.” This new CCR is designed to keep compensation committees on their toes, as it is required to address whether the committee has reviewed and discussed the CD&A with management. While the SEC is strictly neutral as to the level and design of compensation, we expect boards that have embraced sound practices will go beyond the statements required under this new rule and will proactively state that they consider the amounts paid to be reasonable and appropriate.
In the Summary Compensation Table, only above-market or preferential earnings (rather than all earnings) on non-qualified deferred compensation is required to be included. The required defined benefit pension plan disclosure is now limited to the actuarial present value of a Named Executive Officer’s accumulated benefits.
In terms of gauging who should be identified as the NEOs, the SEC tweaked its proposal so that the metric is not the new Total Compensation column – rather, companies can back out the numbers from the two columns regarding preferential earnings on deferred compensation and increases in pension values when they identify their NEOs. This tweak addresses comments that using the Total Compensation numbers would unnecessarily skew inclusion of longer-term officers as NEOs.
I was surprised that the SEC re-proposed the so-called “Katie Couric” proposal (ie. requiring disclosure compensation for three employees who are not executive officers). As re-proposed, this rule would carve out non-executive officers with no responsibility for significant policy decisions and would only apply to large accelerated filers. This re-proposal likely will draw significant comment as before – and some clarification may be necessary because it’s worded in the negative, so it’s difficult to tell if it is intended to pick up Rule 3b-7 officers. To me, this part of the SEC’s overhaul is extremely minor in the entire scheme of things; I’m consistently amazed how some incidental issue in a rulemaking project distracts so many from the bigger – and more pressing – issues.
More extensive notes – which identify a few other changes from the proposals known so far – are posted on CompensationStandards.com under “The SEC’s New Rules.”
The new rules apply to the upcoming proxy season, compliance is required for fiscal years ending on or after December 15, 2006. For the new Form 8-K rules, compliance is required sooner – for triggering events that occur 60 days or more after the rules are published in the Federal Register. I’m still amazed the Staff got these rules out in such short order…
If you come to Washington DC to take in the conference, you still will get access to the video archive of the Conference, which will be important when you actually sit down to draft – and review – disclosures during the proxy season. The Conference is still available by videoconference if you can’t make it to Washington DC on those days.
If you haven’t yet, check out this detailed conference agenda to understand the types of challenges you should expect to face from the new rules.
The Corporate Dealmaker has just published an interesting article in the “tell all” category: Josh King’s first-person account of the epic 2004 auction that saw Cingular snatch AT&T Wireless away from Vodafone at the eleventh hour. Josh – a former Corporate Development VP at AT&T Wireless now works in business development for Clearwire – is a self-described “reformed lawyer.” Probably wishful thinking cause I am told “once a lawyer, always a lawyer” when I try to pawn myself off as a reformed lawyer…
This is is an interesting Corp Fin no-action letter. It’s novel, but only in that this issue rarely comes up. The issuer here – PMI – was apparently required, pursuant to the terms of the indenture for the debt securities at issue to make an offer to repurchase the debt (this is sometimes called a put option tender offer which is fairly common) at the same time that it was doing an exchange offer for the same class of debt securities.
The purpose of the exchange offer is to include a “net share settlement” feature in the indenture. Many issuers have been going back and amending their existing contingent convertible debt securities to include a net share settlement feature (which gives the issuer the right to settle a conversion demand in cash instead of stock) in order to gain better accounting treatment. In short, if the convertible debt security has a net share settlement feature then the issuer does not have to treat the debt on a fully converted basis for financial reporting purposes and EPS calculations.
All of this is purely for background. What is interesting here is that these two events (two tender offers) are occurring simultaneously. Sullivan & Cromwell submitted the no-action request seeking relief from the applicable tender offer provisions (Regulation 14E and Rule 13e-4) that prohibit a purchase outside a tender offer. Here the staff granted the relief requested because apparently the put option was under water, making it unlikely that any holder would tender the debt securities in the put option tender offer.
So the SEC Staff got comfortable that the only offer likely to receive tenders was the exchange offer where a holder of existing debt securities would tender and get a slightly different debt security back (one with the net share settlement feature) plus some nominal cash. Thanks to Jim Moloney for his perspective!
In this podcast, Jim Showen of Hogan & Hartson analyzes the impact of the SEC’s ’33 Act reform on M&A transactions, including:
– It’s my understanding that the SEC’s securities offering reform rules that went into effect last December specifically do not apply to M&A transactions. Yet I have heard that there may be a couple of important considerations stemming from those rules that M&A practitioners ought to keep in mind. What are those?
– Since the WKSI test involves primarily size and compliance by the issuer – and acquisitions would presumably always make the company bigger – how could an acquisition cause a company to lose its WKSI status?
– How does the securities offering reform rules work in tandem with Regulation MA during the pendency of a registered merger?
The fourth installment of our M&A Boot Camp is now available: “Selling the Venture-Backed Company.” Join Phil Torrence and David Parsigian of Miller Canfield as they teach us about “everything you need to know” to understand the basics of the issues typically present in a sale of a venture backed company with multiple class of stock and varying liquidation preferences.
If you are not a DealLawyers.com member, try a no-risk trial as we just launched our half-price “Rest of 2006” rate – believe it or not, a license for a single user is only $100 and there are similar reduced rates for offices with more than one user!
In this short decision by Delaware Vice Chancellor Strine, the court dismissed claims against a controlling stockholder that had sold its control block for a premium.
The complaint alleged that (i) the controlling stockholder had received excess payments from the buyer, not for its majority interest, but as a payment for permitting the buyer to usurp the assets of the target to the detriment of the minority/remaining stockholders and (ii) the controlling stockholder had breached its duty of loyalty by permitting, aiding and abetting, the buyer’s unfettered use and enjoyment of the target’s assets without fair compensation.
While quickly dismissing the complaint for failing to state a cause of action on which relief could be granted, the decision is probably of greater interest for dicta (i) confirming the general right of a controlling stockholder to sell its majority bloc for a premium not shared with other target stockholders and (ii) suggesting additional limits on the potential liability of a controlling stockholder where the target’s certificate of incorporation contains an exculpatory provision authorized by Section 102(b)(7) of the DGCL.
Background (according to the complaint)
– Sport Supply was 53.2% owned by Emerson Radio
– Sport Supply voluntarily delisted its stock in early 2004 but continued to trade on the pink sheets.
– By late 2004, the share price had risen from the $1-$2 range to $3 per share
– By mid 2005, it was trading at $3.65 per share.
On July 5, 2005, Emerson Radio announced that it had sold its majority stake for $32 million or $6.74/share, an 86% premium to the prior day’s closing price, to Collegiate Pacific, a competitor formed by Sport Supply’s founder and former CEO.
On September 8, 2005 Collegiate announced that it had agreed to an uncollared stock-for-stock merger with Sport Supply pursuant to which the minority holders of Sport Supply would receive 0.56 of a share of Collegiate stock valued at announcement at $6.74.
Unfortunately, Collegiate’s share price began to drop as a result of increased acquisition costs and earnings dilution resulting from the conversion of outstanding notes into common equity and the merger agreement was ultimately terminated. In the interim, a large institutional shareholder sold a significant block of Sport Supply stock to Collegiate for $5.50 per share in cash.
By the time the complaint was filed, Sport Supply shares were trading at $4.85 per share.
Holding
After reviewing the complaint, the court concluded that while there is precedent suggesting that a controlling stockholder who sells to a looter may be held liable for breach of fiduciary duty, the complaint failed to plead circumstances suggesting that the controlling stockholder knew, suspected or should have suspected that the buyer was either a looter or was dishonest and had improper plans.
“Even assuming for the sake of argument that a controlling stockholder can be held liable for negligently selling control to a buyer with improper motives (as opposed to when it know it is selling to a looter or an otherwise dishonest and predatory buyer), . . . [t]he complaint is devoid of facts supporting a rational inference that the controller should have suspected that the buyer, another listed public company, had plans to extract illegal rents from the subsidiary. At most, the complaint pleads facts suggesting that the controller knew that it was selling to a strategic buyer who would attempt to capitalize on possible synergies between itself and its new non-wholly owned subsidiary. That mundane prospect provides no rational basis for a seller to conclude that the buyer intends to embark on a course of illegal usurpation of the subsidiary’s assets for its own unfair benefit.”
Dicta
Conceding that the precedent suggests that “a duty devolves upon the seller to make such inquiry as a reasonably prudent person would make, and generally exercise care so that others who will be affected by his actions should not be injured by [the] wrongful conduct,” Vice Chancellor Strine stated that he was “dubious that our common law of corporations should recognize a duty of care-based claim against a controlling stockholder for failing to (in a court’s judgment) examine the bona fides of a buyer, at least when the corporate charter contains an exculpatory provision authorized by 8 Del. C. Section 102(b)(7).
After all, the premise for contending that the controlling stockholder owes fiduciary duties in its capacity as a stockholder is that the controller exerts its will over the enterprise in the manner of the board itself. When the board itself is exempt from liability for violations of the duty of care, by what logic does the judiciary extend liability to a controller exercising its ordinarily unfettered right to sell its shares? I need not answer that question here, but do note that the unthinking acceptance that a greater class of claims ought to be open against persons who are ordinarily not subject to claims for breach of fiduciary duty at all – stockholders – than against corporate directors is inadequate to justify recognizing care-based claims against sellers of control positions.”
Vice Chancellor Strine goes on to carefully note that “drawing the line at care would do nothing to immunize a selling stockholder who sells to a known looter or predator, or otherwise proceeds with a sale conscious that the buyer’s plans for the corporation are improper. But it would impose upon the suing stockholders the duty to show that the controller acted with scienter and did not simply fail in the due diligence process.”