Wednesday, June 30, 2010
Chancellor Chandler reminds us in a letter opinion in Monroe County Employee Retire. Sys. v Carlson, et al (H/T Morris James) that at the pleading stage it isn't enough for plaintiffs to simply point to a transaction where directors or insiders sit on both sides. Plaintiffs also have to plead some facts to suggest that the transaction itself is unfair before the defendants are required to shoulder the exacting entire fairness burden.
[The parties] agree about defendants’ burden at the proof stage of the proceedings. The parties sharply disagree, however, about plaintiff’s burden at the pleading stage of the proceedings; the stage in which we find ourselves situated. Plaintiff argues that to survive a motion to dismiss the complaint need only allege that a transaction between the controlling shareholder and the company exists. Defendants argue that this is insufficient, that plaintiff must make factual allegations in its complaint that, if proved, would establish that the challenged transactions are not entirely fair. Defendants have the winning argument on this point. Delaware law is clear that even where a transaction between the controlling shareholder and the company is involved—such that entire fairness review is in play—plaintiff must make factual allegations about the transaction in the complaint that demonstrate the absence of fairness. Simply put, a plaintiff who fails to do this has not stated a claim. Transactions between a controlling shareholder and the company are not per se invalid under Delaware law. Such transactions are perfectly acceptable if they are entirely fair, and so plaintiff must allege facts that demonstrate a lack of fairness.In the context of a going private transaction, it isn't enough that the plaintiffs plead that there is a controlling shareholder on both sides of the transaction. In order to survive the pleading stage, the plaintiff will also have to plead some facts that demonstrate the unfairness of the transaction. That's not the same as proving unfairness, but you have to have some facts. Remember entire fairness includes both fair dealing and fair price. Facts that demonstrate a flawed process are helpful in making the case, but if the flawed process nevertheless resulted in a fair price as a plaintiff you might find yourself out of luck.
Tuesday, June 29, 2010
Last word on this for the day. Imagine you are tasked with conducting a diligence exercise on a target. Maybe you have no idea what you're supposed to look for when the target opens up their data room. Here's a hint. If you stumble upon something like this, start taking notes.
This is another post aimed at summer associates and junior lawyers. That research memo on blue sky laws in Guam can be safely put aside - you've got your first real M&A assignment. A senior associate has asked you to help her with "due diligence" on an acquisition target. If you are like me at that stage, you quickly realize that you have precious little understanding of what's expected of you in a diligence exercise. Instruction given junior lawyers with respect to diligence exercises is typically minimal and very narrowly focused. Jeff Weiner has recently posted his Conceptual Framework for Due Diligence in M&A that's worth downloading and reading. It's a good 20,000 foot overview of the importance and the role of the diligence exercise. OK, but you're saying, will it help me build a capitalization table or figure out if the target's board book is in shape? Probably not, but it does place the exercise in context and makes it clear that it's not just a make work assignment. For a more granular "how to" on diligence Jeff recommends Crilly's Due Diligence Handbook. However, given the price tag for the handbook, you won't want to buy one for yourself.
Monday, June 28, 2010
The U.S. Supreme Court recently vacated the conspiracy conviction (premised on an improper theory of "honest services" wire fraud) of former Enron chief executive officer Jeffrey Skilling. In vacating the conviction, the Court essentially narrowed the scope of the U.S. wire fraud statute. As a result, prosecutors will likely be deterred from bringing mail and wire fraud charges against corporate executives whose alleged acts of disloyalty do not involve the receipt of bribes or kickbacks. Read this alert from Proskauer Rose to learn more about the decision and its ramifications.
The Supreme Court just handed down its opinion in the PCAOB case. The court ruled along familiar 5-4 lines that the way the accounting board was created in violation of the President's appointment power. From the opinion:
The Government errs in arguing that, even if some constraints on the removal of inferior executive officers might violate the Constitution, the restrictions here do not. There is no construction of the Commission’s good-cause removal power that is broad enough to avoid invalidation. Nor is the Commission’s broad power over Board functions the equivalent of a power to remove Board members. Altering the Board’s budget or powers is not a meaningful way to control an inferior officer; the Commission cannot supervise individual Board members if it must destroy the Board in order to fix it. Moreover, the Commission’s power over the Board is hardly plenary, as the Board may take significant enforcement actions largely independently of the Commission. Enacting new SEC rules through the required notice and comment procedures would be a poor means of micro-managing the Board, and without certain findings, the Act forbids any general rule requiring SEC preapproval of Board actions. Finally, the Sarbanes-Oxley Act is highly unusual in committing substantial executive authority to officers protected by two layers of good-cause removal.
I'll admit it, there's a
I'll admit it, there's alittle too much con law on this blog for me these days.
Update: The Court's ruling that the appointments process used to staff PCAOB is unconstitutional does not mean that the entire Sarbanes-Oxley Act is unconstitutional. The court considered the question severable:
We reject such a broad holding. Instead, we agree with the Government that the unconstitutional tenure provisions are severable from the remainder of the statute. “Generally speaking, when confronting a constitutional flaw in a statute, we try to limit the solution to the problem,” severing any “problematic portions while leaving the remainder intact.” […] Because “[t]he unconstitutionality of a part of an Act does not necessarily defeat or affect the validity of its remaining provisions,” […] the “normal rule” is “that partial, rather than facial, invalidation is the required course,” Putting to one side petitioners’ Appointments Clause challenges (addressed below), the existence of the Board does not violate the separation of powers, but the substantive removal restrictions imposed by §§7211(e)(6) and 7217(d)(3) do.”
The PCAOB Appointments Clause falls. The rest of it stands.
Ken Adams' excellent bog, AdamsDrafting, has another good post with helpful drafting hints. This one relates to the use of "material" as a modifier in the representations and warranties. I love this. It's the kind of stuff that makes every lawyer's heart skip - "But only represented that I wasn't in violation of a material law, not that I wasn't in material violation of any law!!"
Ken's blog is a must-read for anyone in the drafting business, which is just about all of you.
Friday, June 25, 2010
Maksimovic et al have recently posted a paper, Private and Public Merger Waves, analyzing merger waves. It's not all that surprising that they find public companies are more likely going to be involved in cyclical merger waves than private companies. They suggest that access to capital is the determining factor in the public company's participation. I tend to agree - when firms have access to cheap capital they tend to go overboard. On the other hand, they suggest that acquisitions "on the wave" are more successful. I think there's a host of anecdotal and - if you give me a minute - empirical data that suggests buying at the crest of a merger wave never works out well.
Thursday, June 24, 2010
The May edition of The Business Lawyer just arrived in my inbox. This edition is the proceedings from a recent symposium on the constitutionality of state anti-takeover laws (DGCL 203) in spired by Guhan Subramanian et al's piece, Is Delaware's Antitakeover Statute Unconstitutional? Evidence from 1988-2008. The symposium includes contributions from Eileen Nugent (A Timely Look at DGCL Section 203), A. Gilchrist Sparks (After 22 Years, Section 203 of the DGCL Continues to Give Hostile Bidders a Meaningful Opportunity for Success), Stephen P. Lamb (A Practical Response to Hypothetical Analysis of Section 203's Constitutionality), and Larry Ribstein (Preemption as Micromanagement) among others.
Definitely summer beach reading. Too bad it's not available in a Kindle version!
Tuesday, June 22, 2010
OK, so you're a summer associate or a junior litigation associate in a NY firm. Probably the highest stakes litigation around for your clients may well entail a proposed merger and a challenge to it. Your not uncommon reaction to realizing that most of your litigation work will be focused on corporate related matters may well be - "But, uh, I didn't take corporate law. ... I'm a litigator." If you're a summer associate, don't worry, that's what your 3L year is for. If you happen to have gotten out of law school with taking corporate law or M&A, there's always this: Courtney Rosen's The Litigator's Role in M&A Transactions. It's a quick review (42 pages) of everything a litigator needs to know after getting tossed into litigation over an M&A transaction. It's no substitute for taking an M&A class, but its focus on the process of litigation, including privilege and discovery issues will be useful.
Monday, June 21, 2010
Axelson et al have a recent paper, Borrow Cheap, Buy High? The Determinants of Leverage and Pricing in Buyouts, that provides cross-sectional review of LBO structures. The paper reinforces the notion that cheap and readily available credit is the mother's milk of the LBO boom.
Thursday, June 17, 2010
As previously announced, AOL Inc. (the “Company”) has been exploring strategic alternatives for its Bebo, Inc. (“Bebo”) subsidiary including a sale or possible shutdown. The Company has completed this process and is today announcing the sale of substantially all the assets of Bebo to an affiliate of Criterion Capital Partners, LLC.
The Company currently anticipates that following this transaction it will treat the common stock of Bebo as worthless for U.S. income tax purposes. The Company’s current U.S. income tax basis in Bebo is approximately $750 million. As a result of the anticipated worthless stock deduction for the common stock of Bebo under U.S. income tax law, the Company expects to record a deferred tax asset and corresponding benefit to its U.S. income tax provision in the second quarter of 2010 in a range of $275 million to $325 million. The Company’s tax conclusion with respect to the common stock of Bebo is subject to examination by the U.S. Internal Revenue Service. Additionally, given the recent volatility in the Company’s stock price and disposition activity, the Company will be required under generally accepted accounting principles to test the goodwill of its sole reporting unit for impairment in the second quarter of 2010.
AOL/TimeWarner acquired Bebo for $852 million in March 2008. As part of the recent spin-off, AOL was holding Bebo on its books for the full value Now, it's written it down to zero. Ouch.
Although AOL hasn't disclosed the sale price, Bloomberg reports that AOL got only $10 million for Bebo.
Gillian Tett at the FT.com points to some early stage research by Hamid Mehran at the NY Fed that challenges whether it makes sense to compensate managers of banks/financial institutions with equity incentives. The problem stems from the typical capital structure of financial institutions vs other firms. Financial institutions tend to have 90-95% debt on their balance sheets while non-financial institutions have lower debt ratios - 60%. Given the high levels of leverage at financial institutions, Mehran and his co-authors argue that there is reason to believe that when bankers are compensated with equity they will chase riskier investments. All this suggests that equity-based compensation may not be a one-size-fits-all approach to inncentivizing managers. Mehran et al suggest tying compensation of banking executives to CDS spreads as a way of address the quality of their lending. Interesting. I'm looking forward to reading the paper.
Wednesday, June 16, 2010
The typical argument that one hears from managers seeking to beat back a hostile acquirer is that corporate culture is important to generating shareholder value and only by remaining independent can managers assure preservation of that culture. The experience of Zappos is a twist on that. (What's Zappos? Believe me if your students are using their laptops in class, I guarantee you at least one of them has made a shoe purchase at Zappos while you drone on about fiduciary duty this, fiduciary duty that...) In any event, Tony Hieh, CEO of Zappos, shares his story in the current issue of INC Magazine in the story Why I Sold Zappos. Under pressure from his VC backers to go public and change the corporate culture in ways that Hsieh felt would be bad for business, Hsieh sought refuge in a sale to Amazon. It's an interesting peek into the boardroom of a successful start-up and worth taking a look at.
You'll remember that state anti-takeover laws received a little bit of attention after Guhan Subramanian et al posted their paper, Is Delaware's Anti-takeover Statute Unconstitutional: Evidence from 1998-2008, asking the same question in the Spring. They suggested that it might not withstand a challenge as it currently stands. Stephen Bainbridge recently a posted his 1992 paper, Redirecting State Anti-takeover Laws at Proxy Contests, evaluating the constitutionality of state anti-takeover laws. His earlier paper concludes that these state laws should survive constitutional challenge.
Tuesday, June 15, 2010
A couple of people have (independently) asked me recently whether or not I thought the recent build-up in cash on corporate balance sheets suggested that a new merger wave is around the corner? Sadly, I think not.
We've had a number of "merger waves" in our history - late 1890s, the 1920s, the 1960s, the 1980s, and the more recent credit bubble wave. In all these waves of merger activity, businesses were riding stock market booms, credit was cheap, and boats were rising for everyone. A rising economy can cover a lot of sins so why in those circumstances shouldn't a manager seek to expand through an acquisition. But what's happening now is fundamentally different.
Firms are hoarding cash because they're still scared. It wasn't all that long ago that managers woke up to the realization that the lines of credit they used to fund payroll might not always be there. That's a scary thought. Even scarier, Europe has been teetering on the edge of economic collapse for months with no end in sight. Add to that an environmental catastrophe in the Gulf of Mexico that appears to have no end. In response, firms have been rightly putting away cash (BW 2009 on this question) Times are definitely uncertain.
Now, that doesn't mean that all that cash isn't burning a hole in someone's pocket and that we're not going to see opportunistic add-ons or consolidations. Of course, that's going to happen. There are always going to be those - like Andrew Carnegie - consolidate when targets are in distress. Though with acceptance of takeover defenses, the hostile tender offer and the market for corporate control are not quite what they used to be.
So while there will continue to be acquisition activity, what's not going to happen is that the "party" is not going to get started again anytime soon. Acquisition activity of that type tends to ride on the coat-tails of other good economic news. With a paucity of good news out there right now, there's no reason to think that acquisition activity will lead us out.
Sunday, June 13, 2010
So it looks like the Rams ownership situation is moving along. When last we checked, Stan Kroenke was trying to manage the cross-ownership restrictions that would prevent him from completing a purchase of the NFL's St. Louis Rams. At the time, the scuttle-butt was that he might transfer one of his conflicted interests to his wife. Multiple sources (here, here, and here) are now reporting that he will sell his interest in the NBA's Denver Nuggets to his 30 year old son, Josh in order to begin the process of removing the cross-ownership conflicts that prevent him from acquiring the Rams.
According to the Denver Post, NBA Commissioner David Stern has positive things to say about the move:
NBA commissioner David Stern said his league has not received anything official regarding Kroenke transferring ownership of the Nuggets to Kroenke's son. Stern said a transfer of ownership would have to be approved the NBA's board of governors.
"I know (Josh), I know the family — very smart business and basketball family," Stern said. "I know he's deeply involved in the basketball side of the (Nuggets') operations. I know he also worked (an internship) at the NBA and worked in a number of departments, seeing what the business of basketball is about."
A native of
"He's very business savvy," said Nuggets star Carmelo Anthony. "As an owner, it'll take some time for him to learn everything. But eventually, I think he'll become a great owner."
The fate of the NHL's Avalanche has yet to be announced, but I suppose it wouldn't be too wild a guess to assume that Josh Kroenke will get the Avalanche as well.
Thursday, June 10, 2010
For the fourth year in a row, Weil, Gotshal & Manges has produced a survey of sponsor-backed going private transactions that analyzes and summarizes the material transaction terms of going private transactions involving a private equity sponsor in the United States, Europe and Asia-Pacific.
Weil surveyed 28 sponsor-backed going private transactions announced from January 1, 2009 through December 31, 2009 with a transaction value of at least $100 million (excluding target companies that were real estate investment trusts). Fourteen of the surveyed transactions involved a target company in the United States, nine involved a target company in Europe and five involved a target company in Asia-Pacific.
The survey can be found here.
There's a healthy interest in contingent value rights (CVRs) as acquisition currency. Chatterjee and Yan have a good paper on the use of CVRs in acquisitions, Innovative Securities under Asymmetric Information. In general, CVRs are essentially a credible signalling device intended to back up statements by a buyer using its stock as an acquisition currency that its stock is not overpriced and that if it turns out to be over valued the buyer will, in effect, make the seller whole through the CVRs. It's like the opposite of an earnout - where the seller is deferring payment and making it contingent upon the buyer receiving information about the true valuation of the seller.
The CVR is an elegant way to bridge a valuation gap when the buyer is using stock. Anyway, it turns out not to be so much of a big a deal. Why? Well, of the 1,744 transactions in the SDC database since 2007 where stock is the acquisition currency only 6 (0.3%) have included an offer of a CVR. Given the volatility in the marketplace during the past few years, I'd have thought that sellers taking stock would have asked for more assurances.
Wednesday, June 9, 2010
In the wake of the collapse Prudential - AIA transaction FT columnist John Kay reminds us to beware the cult of the heroic CEO and the mega-merger:
Many Prudential shareholders are relieved at the collapse of the company’s attempt to buy the Asian operations of American insurer AIG. The business history of the past two decades is studded with failed mega-mergers. Time Warner gave away half the world’s most successful media business for a web portal that proved to be worth almost nothing. Royal Bank of Scotland bid for ABN Amro at the peak of the credit boom and had to be rescued by the state.
Alongside these catastrophes are many smaller disasters. The story of Jean-Marie Messier, the French water company boss who used his shareholders’ and customers’ money to become a US media tycoon, borders on farce. The destruction of great companies of seemingly unchallengeable stability, such as GEC and Swissair, through inept acquisition strategies can only be rendered as tragedy.
Most of these deals are the product of a style of thought popular in business schools and consultancies. The Great Leader concerns himself with corporate strategy, and remains aloof from ordinary operational matters. He manages a collection of activities as a fund manager manages a collection of stocks. The scope of his vision is the key to success; price is secondary. “This is a strategic acquisition” is a euphemism for “we are paying more than this business is worth”.
Now comes word that Prudential’s Chairman will be meeting with major shareholders over the next week to discuss the future of Prudential’s management team. According to Reuters investors are, it seems, upset.
This investor also said management should forgo bonuses in the light of the money spent on the failed bid. "They spent a lot of shareholders' money on a deal that didn't happen. I think they should be hit as well."
Earlier today, Sky News reported that some of Prudential's largest investors, including Legal & General Investment Management and Fidelity, are demanding a shake-up of the company's leadership.
Richard Buxton, head of UK equities at Schroders, said: "Someone has to be accountable for 450 million pounds ($650 million) of losses as a result of the bungled deal.
"Otherwise it's carte blanche to every investment banker in town to encourage CEOs to do deals -- there's no downside. (It will be case of) 'Don't worry, if (the deal) doesn't happen, you'll still be safe in your job'."
So much of corporate governance has to do with norms and not legal rules. From a legal point of view, Thiam is safely ensconced in his position. His and the board’s decision to pursue AIA are protected by the British version of the business judgment presumption. But the business judgment presumption doesn't mean that boards can act in an unrestrained manner. True, the law and a court won't penalize a board for pursuing an ill-conceived, though rational, transaction. Here, it's the marketplace that will make its voice heard - and voice is what managers who pursue these kinds of transactions should expect.
Given the large share holdings of institutional investors who may not have the option of selling (exit) their positions in a company like Prudential because of Prudential's position in an index or the nature of a particular fund, voicing their objections is the only avenue left for investors. Voice, as Hirschman reminds us, is a "non-market force" characterized by politics rather than economics.
In a first approximation, the role of voice would increase as the opportunities for exit decline, up to the point where, with exit wholly unavailable, voice must carry the entire burden of alerting management to its failings.
It's in this context that we can think about a new kind of shareholder activism. I'm thinking about an institutional activism of the kind that's hard to really get kick started. In a world where index funds compete on costs, there's not a whole lot of incentive any investment manager to expend the resources required to influence management - or have their voice heard. But yet, if investors are increasingly locked into index funds, finding a way to generate voice for shareholders will be critical to the long-term success of what some call fiduciary capitalism. If not, then we may be required to accept heroic CEOs and their occasional expensive decisions.
I'm going to be thinking more about this and would be interested in hearing from people with ideas. I suspect the Carl Icahn's of the world - activists with high-powered incentives - will play an increasingly important role - if they don't already - going forward.