M & A Law Prof Blog

In re Checkfree Corp.: Delaware vs. the SEC

On Nov. 1 the Delaware Chancery Court issued an opinion in In re Checkfree Corp Securities Litigation.  The case is yet another in the recent line of Chancery Court opinions examining the required disclosure in takeover proxy statements of financial analyses underlying a fairness opinion.  The particular issue in Checkfree was whether management projections are required to be disclosed in a proxy statement if they are utilized by the financial advisor in the preparation of their fairness opinion. 

In this case, Checkfree had agreed to be acquired by Fiserv for $48 a share. In connection with their agreement, the Checkfree Board had received a fairness opinion from Goldman Sachs.  Checkfree's proxy statement to approve the transaction contained the usual summary description of the financial analyses underlying the fairness opinion.  Plaintiffs' claimed that this was deficient under Delaware law and sued to preliminary enjoin completion of the transaction.  More specifically, plaintiffs alleged that: 

the CheckFree board breached its duty to disclose by not including management's financial projections in the company's definitive proxy statement. They argue that the proxy otherwise indicates that management prepared certain financial projections, that these projections were shared with Fiserv, and that Goldman utilized these projections when analyzing the fairness of the merger price.

Here, the plaintiffs' relied heavily on the recent case of In re Netsmart Technologies, Inc. Shareholders Litigation, 924 A.2d 171 (Del. Ch.2007), for the proposition that a company is required to disclose all of the information underlying its fairness opinion in its takeover proxy statement.

The court began its analysis by rejecting this sweeping requirement.  Chancellor Chandler wrote: 

"disclosure that does not include all financial data needed to make an independent determination of fair value is not ... per se misleading or omitting a material fact. The fact that the financial advisors may have considered certain non-disclosed information does not alter this analysis."

The court then put forth the relevant standard:

The In re Pure Resources Court established the proper frame of analysis for disclosure of financial data in this situation: "[S]tockholders are entitled to a fair summary of the substantive work performed by the investment bankers upon whose advice the recommendations of their board as to how to vote on a merger or tender rely."

It then went on to distinguish Netsmart by stating:

the proxy at issue [in Netsmart] did not include a fair summary of all the valuation methods the investment bank used to reach its fairness opinion. Although the Netsmart Court did indeed require additional disclosure of certain management projections used to generate the discounted cash flow analysis conducted by the investment bank, the proxy in that case affirmatively disclosed an early version of some of management's projections. Because management must give materially complete information "[o]nce a board broaches a topic in its disclosures," the Court held that further disclosure was required.

Finally, the court held:

Here, while a clever shareholder might be able to recalculate limited portions of management's projections by toying with some of the figures included in the proxy's charts, the proxy never purports to disclose these projections and in fact explicitly warns that Goldman had to interview members of senior management to ascertain the risks that threatened the accuracy of those projections. One must reasonably infer, therefore, that the projections given to Goldman did not take those risks into account on their own. These raw, admittedly incomplete projections are not material and may, in fact, be misleading.

This is the right decision under Delaware law.  M&A lawyers in the future should now be careful about unnecessary disclosure of projections in proxy statements to avoid triggering NetSmart's requirements.  Relatively simple. 

The problem with this decision is of wider consequence.  Namely, can anyone tell me what exactly is required to be disclosed concerning fairness opinion financial analyses under Delaware law?  In Pure Resources, Netsmart and here, the Delaware courts have created an obligation of disclosure for the analyses underlying fairness opinions under Delaware law.  Yet, while a worthy goal, judge-made disclosure rules are standard-based and decided on a case-by-case basis.  This is a poor way to regulate disclosure.  It would be better done through the traditional way -- SEC rule-making under the Williams Act and proxy rules.  Yet, the SEC has largely abandoned takeover regulation.  In the last seventeen years it has only initiated two major rule-making procedures (the M&A Release and all-holders/best price amendments).  There were rumors two years ago that the SEC was looking at fairness opinion disclosure, but nothing has come of it.  Instead, we are stuck with this, uncertain disclosure rules that arguably do not ameliorate the fundamental issues underlying fairness opinions.  I'm not criticizing Delaware here -- they are doing their best to fill the gap with the tools at hand.  But, this all would be much better done by the SEC.  Is anybody out there? 

Applebees, The Transaction History and Dura Pharmaceuticals

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.