Wednesday, September 12, 2007
By now most of you have probably read that Applebee's last week disclosed in its preliminary proxy filing that its board split 9-5 in favor of being acquired by IHOP. The dissenters included the current and former CEOs of IHOP. The history is worth a full read as it reveals Applebee's consideration and rejection of a stand-alone plan involving a recapitalization and special dividend and that IHOP reduced its offering price from $27.50 to $25.50 as a result of its due diligence on Applebee's.
What I think is the more troubling here is a Applebee's failure to disclose this split vote until about a month and a half after it agreed to the transaction. I think that you could make a good claim that Applebee's failure to do so was a material omission in violation of the federal anti-fraud rules. If I am a shareholder purchasing shares post-transaction announcement, I would think I would find this significant in the total mix of information. After-all, this fact would have significance to many shareholders in making their vote.
You could quibble with this point, but I think that in a post-Dura Pharmaceuticals v Broudo, 544 U.S. 336 (2005) world Applebee's has almost no liability exposure if indeed the fact is material. Dura held that a plaintiff could not establish loss causation under Rule 10b-5 by proving that the price on the date of the purchase was inflated because of the misrepresentation. Rather, a plaintiff must show an actual loss such as a share price fall related to the misstatement. In the case of Applebee's, to establish loss causation in a post-Dura world a plaintiff would have to show that there was a share price movement triggered by Applebee's disclosure of this fact in its proxy statement filing. The problem, though, is two-fold. First, the Applebee's share price is anchored by the IHOP offered price. This isn't likely a foreclosing problem under Dura, though, as the trading of Applebee's stock would still likely be affected to some extent due to a reassessment of the chances of the deal collapsing. Rather, the actual problem is that the institutional shareholders and proxy advising agencies will not make their recommendations and take positions until closer to the vote, and certainly will not on the day the proxy statement is filed -- they need time to read and analyze it. A more significant change in the Applebee's share price will not come until that assessment is completed and disclosed and shareholders have more information on their respective positions. Under Dura loss causation for failure to disclose this information at the time of the transaction announcement would therefore be almost impossible to establish. Yet, these institutional shareholders and proxy services will likely base their decision on this split vote. Of course, if the shareholders then vote to disapprove the merger, the share price will move even more then, but again, loss causation will be even closer to impossible to prove for this ommission.
I admit there are a number of assumptions underlying my statements above, and that I make one double materiality assumption (i.e., the information is material to the instit shareholders and proxy services and their voting decisions are material to other shareholders). Nonetheless, my main point here is that post-Dura the incentives to disclose material information early in takeover transactions appear to be shifted to permit more leeway towards non-disclosure. This likely exacerbates the traditional problems with disclosure in the history of the transaction section of takeover documents. This section is often the most carefully drafted portion of the takeover document; it is written to gloss over or spin problems which arose during the transaction negotiation, and often management will put strong pressure on the lawyers to make judgments about materiality which exclude seemingly important facts. The SEC review process often picks up on some of these problems and corrects them, but this review is limited at best. The interesting development is that, in this void, the Delaware courts have rapidly become the guardians for good disclosure. In NetSmart, Lear and other recent Delaware cases the Chancery Court has been quick to enjoin transactions under Delaware law for failure to disclose material information about the history of the transaction. This is attributable to the active role in takeovers by Delaware, compared to the quiescent one of the SEC (in contrast to other areas of securities law, the SEC has since the 1990s abstained from active regulating in the takeover arena). It is also due to the discovery power in litigation that plaintiffs have in the Delaware courts -- they can find these non-disclosed facts. It is clearly symbolic that the Delaware courts are increasingly enforcing the disclosure obligations of participants in takeovers -- something which historically has been the SEC's sole regulatory turf. For more on this see my forthcoming Article, The SEC and the Failure of Takeover Regulation.