Last month, the SEC announced a settled enforcement action against Insight Venture Management LLC alleging that the fund advisor charged excess management fees & failed to disclose a conflict of interest relating to its fee calculations. This excerpt from the SEC’s press release describes its allegations:
According to the SEC’s order, Insight’s limited partnership agreements for certain funds it advised allowed it to charge management fees based on the funds’ invested capital in individual portfolio investments and required Insight to reduce the basis for these fees if Insight determined that one of these portfolio investments had suffered a permanent impairment. The order finds that, from August 2017 through April 2021, Insight charged excess management fees by inaccurately calculating management fees based on aggregated invested capital at the portfolio company level instead of at the individual portfolio investment security level, as required by the applicable limited partnership agreements.
Further, the SEC’s order finds that Insight failed to disclose to investors a conflict of interest in connection with its permanent impairment criteria. Because Insight did not disclose its permanent impairment criteria, investors were unaware that the criteria Insight used were narrow and subjective, making them difficult to satisfy. Therefore, the order finds that Insight’s investors were unaware that Insight’s permanent impairment criteria granted Insight significant latitude to determine whether an asset would be considered permanently impaired so as to reduce the basis used to calculate Insight’s management fees.
Without admitting or denying the SEC’s allegations, the fund advisor consented to an order finding that it had violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rules 206(4)-7 and 206(4)-8 thereunder. It also agreed to a cease-and-desist order and censure and to pay a $1.5 million penalty and $864,958 in disgorgement and prejudgment interest.
A recent Weil blog on the enforcement action offers some recommendations to PE fund advisors to avoid finding themselves in a similar situation:
In response to this enforcement action, advisers should (i) review, and carefully adhere to, (a) any implemented impairment or write-down policies, especially with respect to fee reduction practices, and (b) the relevant provisions set forth in their fund documentation, including any distinctions between “investments” and “portfolio companies” and any interplay with write-downs and, if applicable, (ii) disclose to investors (a) all relevant criteria used in the impairment analysis and (b) the fact that the adviser has a conflict of interest in applying any subjective impairment criteria, as an impairment may reduce management fees and/or impact a fund’s carried interest waterfall.
Woodruff Sawyer recently published its 2023 Guide to Representations & Warranties Insurance, which provides an overview of current market conditions, policy terms and considerations for potential purchasers of RWI. In light of commentary suggesting a tightening claims environment, I thought what the report had to say on claims was pretty interesting. Here’s an excerpt:
Halfway through 2023, we’ve found the rate of claims has been relatively consistent with previous years, while the number of claims has increased. This increase is largely attributable to the surge of M&A activity in 2021. However, we have seen interesting shifts emerging in the timing of claims noticed, types of claims filed, and areas insurers will expect heightened diligence in the future.
Timing of Claims Noticed – Historically, most claims have been noticed within the first year after binding. However, in 2022–2023, an increasing number of claims were noticed between 12 to 18 months post-close.
Types of Claims Filed – First-party, or indemnification, claims (where the insured brings a claim directly to the carrier) remain more common than third-party claims. However, third-party claims are on the rise for 2023 and will likely continue to uptick. Of the most frequently cited first-party claims, breaches of the financial and material contracts reps continue to involve the greatest potential for loss and are the claims most likely to exceed the self-insured retention (SIR), which is the portion of cost the insured must bear before the R&W policy responds.
Heightened Diligence – Data security/privacy breaches are hot on the heels of financial statements and material contracts. Carriers are increasingly concerned about the adequacy of cyber coverage, and buyers should expect this to be an area of heightened diligence. It is crucial that buyers understand the far-reaching implications of insurance diligence. In the haste of M&A deal flow, buyers can neglect to conduct adequate insurance diligence on the target company. Likewise, many purchase agreements lack clear and concise insurance representations by the sellers.
The Guide also discusses the frequency of the breaches reported in RWI claims, and notes that reps & warranties concerning financial statements, data security & privacy, employee benefits and employment top the list.
Last week, in Coster v. UIP Companies, (Del.; 6/23), the Delaware Supreme Court affirmed Chancellor McCormick’s earlier decision holding that the company’s board had a “compelling justification” for authorizing a dilutive share issuance to resolve a stockholder deadlock. The decision marks the lawsuit’s second trip to Delaware’s highest court. The first time around, the Supreme Court overruled an earlier Chancery Court decision and held that the Chancellor must address the argument that the board interfered with the plaintiff’s voting rights and leverage as an equal stockholder without a compelling reason to do so.
Two precedents featured prominently in the Supreme Court’s initial decision overruling the Chancery Court. The first, Schnell v. Chris-Craft Industries, stands for the proposition that actions taken by an interested board with the intent of interfering with a stockholder’s voting rights are a breach of the directors’ fiduciary duty. The second, Blasius v. Atlas Industries, holds that even good faith actions by the board that have the effect of interfering with voting rights require a “compelling justification.”
On remand, Chancellor McCormick determined that the board acted in good faith and established the compelling justification required to support its decision to issue the shares, and the Supreme Court affirmed her decision. In reaching that conclusion, the Supreme Court conducted an extensive review of Delaware case law interpreting Schnell and Blasius and concluded that the standards “have been and can be folded into Unocal review to accomplish the same ends – enhanced judicial scrutiny of board action that interferes with a corporate election or a stockholder’s voting rights in contests for control.” It then summarized what courts must do when confronted with claims that board action interferes with voting rights:
When a stockholder challenges board action that interferes with the election of directors or a stockholder vote in a contest for corporate control, the board bears the burden of proof. First, the court should review whether the board faced a threat “to an important corporate interest or to the achievement of a significant corporate benefit.” The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal. As Chancellor Allen stated long ago, the threat cannot be justified on the grounds that the board knows what is in the best interest of the stockholders.
Second, the court should review whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise. To guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control, a board that is properly motivated and has identified a legitimate threat must tailor its response to only what is necessary to counter the threat. The board’s response to the threat cannot deprive the stockholders of a vote or coerce the stockholders to vote a particular way.
Applying this standard to the Chancellor’s decision, the Supreme Court upheld her findings that the company’s board was properly motivated in responding to the existential threat posed by the stockholder deadlock. It also upheld Chancellor McCormick’s conclusion that the board’s actions in authorizing the share issuance were reasonable and proportionate to the existential threat posed by the potential stockholder deadlock and that its response was not preclusive or coercive.
Ultimately, it looks like the key takeaway from this decision is that Blasius is officially gone as an independent standard of review, and is instead subsumed into the Unocal standard – just as then-Vice Chancellor Strine advocated more than 15 years ago. For more in-depth discussion of the potential implications of this doctrinal shift, be sure to check out the commentary on this decision from Prof. Stephen Bainbridge and Prof. Ann Lipton.
Late last month, John blogged about a recent Sidley memo that reviewed all announced public transactions from January 1, 2018 through April 30, 2023 that included CVRs as part of the consideration and identified the key components of CVRs and trends in their terms. Now, we’ve also uploaded a new podcast featuring the authors of that memo, Sidley partners Sharon Flanagan and Sally Wagner Partin, that covers the following topics:
– Overview of CVRs – Prevalence of CVRs in recent M&A deals, both generally and in life sciences transactions
– Structural issues to consider and standardization of terms of CVRs
– Litigation risk, accounting considerations and other disadvantages to buyers and sellers when using CVRs
– Expectations for the use of CVRs in the near term
We’re always looking for new podcast content, so if you have something you’d like to talk about, please reach out to me at mervine@ccrcorp.com or John at john@thecorporatecounsel.net.
Programming note: In observance of Independence Day, we will not publish a blog Monday or Tuesday. We will be back on Wednesday.
Earlier this week, the FTC and DOJ announced significant proposed changes to the Hart-Scott-Rodino (HSR) Premerger Notification and Report Form. As noted in Chair Lina Khan’s statement, this is the first time the agencies have undertaken a comprehensive review of this form in its almost 45-year history. The FTC also posted this FAQ on the Federal Register Notice page, which explains why these changes are being proposed as follows:
The proposed changes stem from a top-to-bottom review of the information collected in the HSR Form by the federal antitrust enforcers at the FTC and the DOJ’s Antitrust Division (the Agencies) to update the information and improve the efficiency and efficacy of premerger review. Additionally, the proposed changes implement mandates as required by the Merger Filing Fee Modernization Act of 2022
The Agencies use information on the form to deploy their limited resources to those transactions most likely to require in-depth review through the issuance of Second Requests. Insufficient information on the HSR Form burdens both the merging parties and the Agencies to collect and confirm basic information not on the form and conduct a rudimentary competition analysis in the initial waiting period, which is typically 30 days.
Over the past several decades, transactions (subject to HSR filing requirements) have become increasingly complex, with the rise of new investment vehicles and changes in corporate acquisition strategies, along with increasing concerns that antitrust review has not sufficiently addressed concerns about transactions between firms that compete in non-horizontal ways, the impact of corporate consolidation on American workers, and growth in the technology and digital platform economies. When the Agencies experienced a surge in HSR filings that more than doubled filings from 2020 to 2021, it became impossible to ignore the changes to the transaction landscape and how much more complicated it has become for agency staff to conduct an initial review of a transaction’s competitive impact. The volume of filings at that time also highlighted the significant limitations of the current HSR Form in understanding a transaction’s competitive impact.
This Covington alert summarizes the notable proposed changes, which include expanded document production requirements, narrative responses, identification of officers, directors, or board observers, information relating to prior acquisitions and a diagram of the deal structure, among other things. What does this mean for HSR filers? As John previewed last year, if adopted, these changes could substantially increase the time and cost of HSR filings, even for reportable transactions that don’t raise competition concerns. The alert quantifies that impact as follows:
In particular, the FTC estimates that, if the proposed changes take effect, the average HSR filing would require 144 hours to prepare—nearly 4x the 37 hours that the FTC estimates it takes under the current system. The FTC also estimates that for parties with more complex transactions/filings—which it says constitute 45% of all filings—the proposed changes would result in an HSR filing taking 259 hours to prepare, which is 7x the current average. Assuming that the FTC’s estimates are correct, parties to HSR-reportable transactions will require significantly more time to prepare their filings than the typical 10 business days that many merger agreements contemplate.
In the meantime, as noted in the FTC’s press release, the next step is the publication of the Notice in the Federal Register, which will start the clock on the 60-day comment period.
Leading up to the 2023 proxy season, there was much debate about how universal proxy would change the game. With a more level playing field and possibly lower costs, would companies see a spike in activism? In this M&A update, Kirkland analyzed all of the activist campaigns at US-listed companies from September 1, 2022 through June 16, 2023 and compared the data to prior periods. As detailed further below in the key takeaways from the article, UPC did not result in a significant spike in activism in the 2023 season — its impact was more nuanced:
– Activity levels: Activism levels remained high, but fewer campaigns resulted in proxy fights while more settled
– Target size: Activism campaigns targeted companies of all sizes, but the vast majority of proxy fights occurred at smaller companies
– Number of nominees: Activists did not nominate more candidates per slate
– Proxy fight costs: While universal proxy theoretically lowered the cost of entry for an activist, proxy fight costs did not come down and there was no surge in bare-bones campaigns
– Proxy advisor recommendations: While ISS and Glass Lewis continue to require that activists make a case for change, they are placing greater emphasis on individual director qualifications
– Litigation: In a highly litigious proxy season, companies challenged the validity of activist nominations at unprecedented levels
– Success level: Universal proxy may be increasing the odds of at least some activist success, but it has not opened the floodgates
When I hear top 40, I can’t help but think of tuning in Sunday mornings to my local radio station that played Casey Kasem’s American Top 40. This is a very different top 40. Rather than the joy that only came with finally hearing your new favorite song after waiting and waiting by the radio — my kids will never understand — hearing some of these names can cause fear and apprehension (although see this interesting commentary from Bloomberg).
The latest quarterly ownership analysis from Morrow Sodali (available for download) outlines global trends in activist investor portfolios and lists the top 40 activists, split into two tiers based on propensity for active engagement. It also details the largest new positions by activists, analyzes sector exposures and breaks down activist ownership and penetration by region.
From an industry perspective, the report’s summary indicates — not surprisingly — that regional banks saw the largest sub-sector increase in activist positioning with 28 new positions, although it also had many liquidations. Technology also remained an activist focal point in the quarter, with Application Software and Semiconductor sub-sectors having significant new positions.
Deloitte just released its 2023 M&A Trends Survey, now in its ninth year. The survey polled 1,400 executives at US companies and PE firms between October 25 and November 11, 2022 regarding their expectations for M&A activity in the next 12 months and experiences with recent transactions. Here are a few of the key takeaways from the report:
– Given the uncertain times, dealmakers are seeking more certainty and risk mitigation. As such, the survey data uncovered two strategies private equity and corporate leaders are now pursuing with cross-border deals. First, acquirers are increasingly pursuing targets in areas geographically closer to home; and second, dealmakers are prioritizing developed nations more for stability.
– With financing costs higher and other risks ascendant, many companies and funds are behaving more judiciously: smaller M&A deals, more emphasis on restructuring (including spinoffs), and revisiting previous acquisitions and divestitures in search of greater returns. As such, there is a great deal of dry powder—undeployed capital—in the market. There may be attractive opportunities for some corporations and funds to get off the sidelines and invest the cash, as other targets rise in availability and value. Nearly 80% of our respondents expect this trend to continue across 2023.
– Technology is playing an ever-greater role in improving deal process efficiency and effectiveness, and there may be still more it can contribute. We found significant digital initiatives happening in the target identification and deal execution phases of the M&A lifecycle. Where else can digital add to dealmaking?
In a speech delivered earlier this week, DOJ Antitrust chief Jonathan Kanter announced that the DOJ will consider a wider range of potential competitive harms in its analysis of bank mergers than those set forth in its 1995 bank merger guidelines. Kanter indicated that the move is prompted by significant changes in the competitive environment for banking and in the needs of consumers for financial services. This excerpt provides an overview of the DOJ’s new approach:
The division is modernizing its approach to investigating and reporting on the full range of competitive factors involved in a bank merger to ensure that we are taking into account today’s market realities and the many dimensions of competition in the modern banking sector.
In preparing the competitive factors reports that we are required by law to submit to the banking agencies, the DOJ will assess the relevant competition in retail banking, small business banking, and large- and mid-size business banking in any given transaction. These analyses will include consideration of concentration levels across a wide range of appropriate metrics and not just local deposits and branch overlaps. Indeed, the division and the federal banking agencies are working together to augment the data sources we use when calculating market concentration to ensure we are relying on the best data possible and using state-of-the art tools to assess all relevant dimension of competition.
However, our competitive factors reports will not be limited to measuring concentration of bank deposits and branch overlaps. Rather, a competitive factors report should evaluate the many ways in which competition manifests itself in a particular banking market—including through fees, interest rates, branch locations, product variety, network effects, interoperability, and customer service. Our competitive factors reports will increasingly address these dimensions of competition that may not be observable simply by measuring market concentration based on deposits alone.
Simpson Thacher’s memo on the policy change notes that the DOJ’s updated approach represents a “significant shift” away from its approach under the 1995 guidelines, which assesses the competitive impact of a proposed deal at the local level and relies heavily on branch network overlaps and deposit shares.
The memo also points out that Kanter announced that the DOJ will be less willing to accept branch divestitures as a solution to competitive concerns and will no longer provide negotiated divestiture agreements to banking agencies – opting instead for non-binding advisory opinions. The memo says that this change in approach will increase the DOJ’s leverage:
DOJ’s revised approach of no longer providing negotiated divestiture agreements in advance of banking agency approval may also have significant timing implications. Unlike in other industries where to prevent a merger from closing DOJ must obtain a court ordered injunction, in the bank merger context the banking statutes provide that DOJ simply filing a complaint will stay the effectiveness of the bank regulatory approval indefinitely. This gives DOJ additional timing leverage and DOJ may have no incentive to move quickly in the litigation process.
The May-June issue of the Deal Lawyers newsletter was just posted and sent to the printer. This month’s issue includes the following articles:
– Anatomy of a CVR: A Primer on the Key Components and Trends of CVRs in Life Sciences Public M&A Deals
– Chancery Ruling Highlights Important Role of Special Litigation Committees in Maintaining Board Control Over Derivative Litigation
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without in order to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.