The information asymmetry between buyer and seller is a core transaction cost in corporate acquisitions. the M&A Lawyer has a good summary of the provisions of an acquisition agreement that help credibly reduce that asymmetry.
The information asymmetry between buyer and seller is a core transaction cost in corporate acquisitions. the M&A Lawyer has a good summary of the provisions of an acquisition agreement that help credibly reduce that asymmetry.
A “wolf pack” is a loose association of hedge funds (and possibly some other activists) that stop just short of forming a “group” (which would require disclosure under Section 13(d)(3) of the Williams Act once the “group” collectively held 5% or more of any class of the stock of the engaged firm). The essence of the “wolf pack” is conscious parallelism without any agreement to act in concert. The market can quickly recognize a “wolf pack” once its leader crosses the 5% threshold and files its Schedule 13D, and the market responds more enthusiastically to a “wolf pack” than to other activist investors, running up on average 14% in abnormal returns on the date of its public appearance. Also, the “wolf pack” acquires substantially more—at least 13.4% in on recent study. But this may understate, as researchers cannot know how many allies the wolf pack leader has. In the Sotheby’s proxy litigation last year, the CEO of a prominent proxy solicitor, testifying as an expert witness, estimated that hedge funds then held over 32% of Sotheby’s (a mid-cap sized firm).This is a near control block.
The key advantage of joining a “wolf pack” is that it offers near riskless profit. The hedge fund leading the pack can tip its allies of its intent to initiate an activist campaign because it is breaching no fiduciary duty in doing so (and is rather helping its own cause); thus, insider trading rules do not prohibit tipping material information in this context. If one can legally exploit material, non-public information, riskless profits are obtainable, and riskless profits will draw a crowd on Wall Street.
 For a fuller review of these tactics and the legal and market developments that made the “wolf pack” possible, as well as the concept of “group,” see John C. Coffee, Jr. and Darius Palia, “The Impact of Hedge Fund Activism: Evidence and Implications” (available at http://ssrn.com/abstract=2496518)(Oct. 2014).
 See Becht, Franks, Grant and Wagner, supra note 1, at 32. [Full cite: Marco Becht, Julian Franks, Jeremy Grant and Hammes F. Wagner, The Returns to Hedge Fund Activism: An International Study, (available at http://ssrn.com/abstract=2376271)(March 25, 2015).]
 Daniel Burch, CEO of Mackenzie Partners, so testified in the Sotheby’s litigation that hedge funds then held an estimated 32.68% of Sotheby’s. On the basis of the “threat” this constituted, the Chancery Court upheld a special “discriminatory” version of the poison pill. Third Point, LLC, the lead activist, held only 9.62% of Sotheby’s, thus showing the size of the allies that the “wolf pack” leader can assemble. See Third Point, LLC. v. Ruprecht, 2014 Del. Ch. LEXIS 64 (May 2, 2014).
It seems to me that there are several ways of responding to the wolf pack phenomenon.
First, amend Exchange Section 13(d) and the rules thereunder so that conscious parallelism requires filing a Schedule 13D. There is evidence that "wolf pack activity appears to be ostensibly uncoordinated—i.e., no formal coalition is formed—a fact that is usually attributed to an attempt by the funds to circumvent the requirement for group filing under Regulation 13D when governance activities are coalitional." Instead of requiring the SEC and/or the target to undertake the difficult task of proving that ostensibly uncoordinated activity is in fact coordinated, we should amend Section 13(d) to force wolf packs to disclose. After all, isn't sunlight the best disinfectant? In addition, as Wachtell Lipton has been urging for a long time, the 10 day window for filing Schedule 13Ds should be shortened to 2 business days.
Second, courts should be more receptive to arguments that wolf packs constitute a group that "may be liable under Section 16(b) if, in the aggregate, the group’s holdings exceed ten percent of the company’s nonexempt, registered equity securities."
Third, and perhaps most important, the Delaware courts should validate wolf pack poison pills:
... a traditional poison pill follows the federal securities laws in determining when shareholders are considered a “group” and would generally aggregate their ownership if, and only if, they entered into an agreement to act in concert with respect to their stock in the company. There is no definitive legal authority on whether a poison pill would be legally valid if it aggregated stock ownership of investors who patterned their behavior after one another, but did not have an agreement to act in concert. To avoid potential litigation, companies generally utilize the 13D definition of “group” in their shareholder rights plans although this means that their poison pill may not be an effective weapon against a wolf pack.
The Sotheby’s case may cause practitioners to rethink the desirability of adopting a wolf pack pill. Sotheby’s found that the acquisition of stock by members of a wolf pack could be a threat to the corporation based on a pattern of behavior the court described as “conscious parallelism.” The same analysis may also justify a wolf pack clause in a poison pill.
Reuters profiles serial shareholder litigant Hilary Kramer whose many lawsuits have netted shareholders zero--as in nothing, nada, zilch--but her lawyers "got a payout for every settlement. Firms representing all plaintiffs involved in class actions in which Kramer has a leading role have earned at least $14 million, Reuters calculates. That figure does not include fees in seven cases for which records are not available and four cases for which fees have yet to be awarded."
One wonders what Kramer gets out of it.
Delaware Chancellor Bouchard has issued an opinion in the Family Dollar Stores shareholder litigation, in which he concludes that the Revlon standard was triggered by a "sale of control." The opinion is devoid of analysis of why the transaction in question constitutes a sale of control but I assume Bouchard was relying on the fact that "75% of the consideration [was] to be paid in cash and 25% to be paid in [acquiror] Tree common stock."
Sigh. This opinion thus perpetuates what I believe to be a serious error--both as a matter of doctrine and sound policy--by the Delaware Chancery Court; namely, the application of Revlon simply because a certain percentage of the deal is in the form of cash.
In my article, The Geography of Revlon-Land (July 23, 2012), available at SSRN: http://ssrn.com/abstract=2115769, I argued that:
A number of Chancery decisions have drifted away from the doctrinal parameters laid down by the Supreme Court. In this article, I argue that they have done so because the Chancellors have misidentified the policy basis on which Revlon rests. Accordingly, I argue that Chancery should adopt a conflict of interest-based approach to invoking Revlon, which focuses on where control of the resulting corporate entity rests when the transaction is complete.
The focus on the form of consideration is inconsistent with binding Supreme Court precedent and bad public policy. Sadly, that focus now seems to be entrenched on the Delaware Chancery Court. I retain some hope, however, that the Delaware Supreme Court will eventually overturn these cases and restore the Revlon analysis to its correct context.
One of the reasons empirical scholarship often bugs me is that the answers you get are so dependent on how you set up the problem and crunch the numbers. One is frequently reminded of Harry S Truman's plea for a one handed economist.
Case in point:
In October 22nd 2014, ISS published a note on the financial consequences for shareholders to vote “NO” to a proposed takeover (available in an article by Steven Davidoff Solomon,“The Consequences of Saying No to a Hostile Takeover Bid”, published on October 28th, 2014, in the New York Times DealBook). ISS claims to have demonstrated that those shareholders who voted “No” to a proposed takeover of their company would have been better off financially, had they agreed to the takeover.
Unfortunately, the ISS note does not support such a blanket statement. Our take on the ISS paper highlights many debatable aspects of their analysis. We show that the paper produced by ISS to support the position of hostile bidders falls flat. It is marred by dubious analytical choices, questionable metrics and the remarkable absence of a key investment parameter, the risk/return relationship.
Allaire, Yvan and Dauphin, Francois, The Value of 'Just Say No': A Response to ISS (November 6, 2014). Available at SSRN: http://ssrn.com/abstract=2531132.
My normative priors tempt me to embrace this finding, of course.
Must reading for deal lawyers.
Eric Talley has posted Corporate Inversions and the Unbundling of Regulatory Competition (October 15, 2014). USC CLASS Research Paper No. CLASS14-32. Available at SSRN: http://ssrn.com/abstract=2511723:
Abstract: A sizable number of US public companies have recently executed “tax inversions” – acquisitions that move a corporation’s residency abroad while maintaining its listing in domestic securities markets. When appropriately structured, inversions replace American with foreign tax treatment of extraterritorial earnings, often at far lower effective rates. Regulators and politicians have reacted with alarm to the “inversionitis” pandemic, with many championing radical tax reforms. This paper questions the prudence of such extreme reactions, both on practical and on conceptual grounds. Practically, I argue that inversions are simply not a viable strategy for many firms, and thus the ongoing wave may abate naturally (or with only modest tax reforms). Conceptually, I assess the inversion trend through the lens of regulatory competition theory, in which jurisdictions compete not only in tax policy, but also along other dimensions, such as the quality of their corporate law and governance rules. I argue that just as US companies have a strong aversion to high tax rates, they have a strong affinity for strong corporate governance rules, a traditional strength of American corporate law. This affinity has historically given the US enough market power to keep taxes high without chasing off incorporations, because US law specifically bundles tax residency and state corporate law into a conjoined regulatory package. To the extent this market power remains durable, radical tax overhauls would be unhelpful (and even counterproductive). A more blameworthy culprit for inversionitis, I argue, can be found in an unlikely source: Securities Law. Over the last fifteen years, financial regulators have progressively suffused US securities regulations with mandates relating to internal corporate governance matters – traditionally the domain of state law. Those federal mandates, in turn, have displaced and/or preempted state law as a primary source of governance regulation for US-traded issuers. And, because US securities law applies to all listed issuers (regardless of tax residence), this displacement has gradually “unbundled” domestic tax law from corporate governance, eroding the US’s market power in regulatory competition. The most effective elixir for this erosion, then, may also lie in securities regulation. I propose two alternative reform paths: either (a) domestic exchanges should charge listed foreign issuers for their consumption of federal corporate governance policies; or (b) federal law should cede corporate governance back to the states by rolling back many of the governance mandates promulgated over the last fifteen years.
There are some very handy deal diagrams that I likely will swipe borrow when I teach Mergers & Acquisitions in the spring semester. There's also a whole bunch of math, which I just sort of skip over the I do those unpronounceable names in Russian literature. But the conclusion seems sound. In any case, highly recommended (even for the math phobic).
A friend recently emailed, raising a question about the new Delaware Chancery Court decision in In re KKR Financial Holdings LLC Shareholder Litigation, --- A.3d ----, 2014 WL 5151285 (Del.Ch.2014). He writes:
I am confused by the relationship of [KKR Financial Holdings to] Kahn v. M&F Worldwide. As I understand Kahn, in a merger with a controlling shareholder you need both approval of a disinterested independent committee and a vote of a majority of the minority. In the KKR case the court concludes that KKR is not a "controlling" shareholder, but that even if the majority of the board is not disinterested (that is, a majority is somehow beholden to the acquirer) the BJR applies if there is approval by a majority of the minority. That seems to me to be inconsistent with Kahn. I don't see the difference between a company that is controlled by the acquirer and one whose board is not independent of the acquirer. What am I missing?
I'm puzzled also. I first note that the court found that a majority of the BOD was disinterested and independent, so the part that is puzzling us is dicta:
For the foregoing reasons, I conclude that plaintiffs have failed to allege facts that support a reasonable inference that eight of the twelve KFN directors, constituting eight of the ten who voted on the transaction, were not independent from KKR. Thus, plaintiffs have failed to rebut the presumption that the business judgment rule applies to the KFN board’s decision to approve the merger.
But that's not the interesting question. Instead, it is the court's statement that, "even if plaintiffs had alleged sufficient facts to reasonably support such an inference, business judgment review still would apply because the merger was approved by a majority of disinterested stockholders in a fully-informed vote."
I note that, oddly, plaintiffs did not challenge the defense position on the effect of approval by the shareholders:
Relying on Chancellor Strine’s decision last year in Morton’s ... and his earlier decision in Harbor Finance Partners v. Huizenga, defendants argue that, because the merger did not involve a controlling stockholder and was approved by a fully informed vote of KFN’s stockholders, the business judgment rule applies and insulates the merger from all attacks other than on the grounds of waste. Put differently, defendants argue that, even if a majority of the KFN’s directors were not independent, the business judgment presumption still would apply because of the effect of untainted stockholder approval of the merger.
Plaintiffs do not take issue with defendants’ position concerning the legal effect of a fully informed vote where a controlling stockholder is not involved.
But that would not excuse the court from considering the issue sua sponte, would it? In any case, the court nowhere discusses the Delaware Supreme Court decision in Kahn.
Obviously, if a majority of the board were disinterested and independent, shareholder approval would invoke the business judgment rule. But if a majority of the board were interested by virtue of a link to major (albeit non-controlling) shareholder, shouldn't that trigger Kahn? After all, you have a conflict of interest on the part of the board that arises out a relationship with a shareholder?
Case in point from ThinkProgress:
Your Whopper May Soon Come With A Side Of Tax Avoidance
American fast food chain Burger King is in talks to buy Tim Hortons, a doughnut and coffee chain based in Canada, the New York Times reported Monday.
A deal, which could be reached as soon as this week, would mean the iconically American company would be headquartered in Canada, and benefit from the country’s lower corporate tax rate, 15 percent, compared to the on-paper 35 percent rate in the U.S.
Among the comments: "I ate my last BK meal last week. Never again will I grace their doors."
The potential departure of an iconic American company because of "corporate greed" will be trotted out on the campaign trail.
And then we get to the Twitter world:
Send a message, and denounce Burger King's tax dodge scheme:... http://t.co/8zdPpQ6ZDQ— Left Action (@LeftAction) August 25, 2014
The traitorous Burger King sits on a throne of fries.— Scott Lincicome (@scottlincicome) August 25, 2014
Here's my question for anybody who's upset about tax inversions: Do you have an IRA? or a 401(k)? Did you take any deductions on your tax return last year? or any tax credits? If so, you used a perfectly legal "tax avoidance" strategy. Which is exactly what Burger King is considering.
I stand with Judge Learned Hand who famously opined that:
Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes.
Suppose you represent a potential corporate acquirer who is filing or updating a Schedule 13D disclosure document. In a close cases in which reasonable people could differ as to whether disclosure is required, involving information your client would prefer not to make public if possible, should you err on the side of disclosure or non-disclosure? I was taught to err on the side of non-disclosure. Why?
In Rondeau v. Mosinee Paper Corp., 422 U.S. 49 (1975), the issuer brought suit for the defendant's failure to file a Schedule 13D. The Seventh Circuit granted an injunction that for a period of 5 years would have prevented the defendant from voting any shares purchased between the date when a Schedule 13D should have been filed and the date on which it was in fact filed. The Supreme Court reversed, on the grounds that the plaintiff had not shown such irreparable harm that a sterilizing injunction was appropriate. The Court suggested that less severe remedies might be available under appropriate fact settings, such as enjoining the defendant from voting, acquiring additional shares or commencing a takeover bid pending compliance. Since Rondeau, however, courts finding a § 13(d) violation generally have been quite conservative in fashioning a remedy. Typically, they merely issue an order directing that the violation be cured, either by amending the filing or by filing a Schedule 13D not previously filed. Courts have been unwilling, in the belief that they are unauthorized, to grant more effective relief. See, e.g., Dan River, Inc. v. Icahn, 701 F.2d 278, 287 (4th Cir.1983) (court would not order "sterilization" of shares due to the prior insufficient disclosure); Treadway Companies, Inc. v. Care Corp., 638 F.2d 357, 380 (2d Cir.1980) (refusing an injunction where defective filing was cured and "shareholders had ample time to digest th[e] information"); Chromalloy American Corp. v. Sun Chemical Corp., 611 F.2d 240, 248–49 (8th Cir.1979) (court would not require "cooling‑off" period after submission of corrected Schedule 13D); Energy Ventures, Inc. v. Appalachian Co., 587 F.Supp. 734, 743–44 (D.Del.1984) (interim injunctive relief deemed inappropriate where corrective filing had been made); University Bank & Trust Co. v. Gladstone, 574 F.Supp. 1006, 1010 (D.Mass.1983) (injunction denied where purchaser had made curative disclosure). A rare exception authorized disgorgement in a parking case brought by the SEC. SEC v. First City Fin. Corp., Ltd., 890 F.2d 1215 (D.C.Cir.1989).
The upshot is that if you fail to disclose, get sued, and the court determines that you should have disclosed the information, the worst case scenario is a slap on the wrist injunction requiring corrective disclosure. BFD.
Indeed, as I tell my Mergers & Acquisitions class, it gets better. If you get sued, you file an amendment to your Schedule 13D, containing an infodump that basically says: "The target has sued us alleging that we should have disclosed the following information. Blah, blach, blach. Yada, yada, yada. We believe that we were not required to disclose that information, but are voluntarily providing it now so as to return to the real issues that matter to the shareholders of Target."
You then file a motion to dismiss the target's lawsuit on grounds that it is moot. 99 times out of 100, you'll win. (To reiterate, I only endorse this where there is a colorable legal argument that disclosure is not required.)
Interestingly, as Alison Frankel reports, that seems to be the approach William Ackman is taking in response to the Allergan lawsuit we mentioned the other day:
If Allergan’s insider trading and disclosure suit against the hostile bidders Valeant and Pershing Square is a bluff, Pershing just called it.
William Ackman’s hedge fund dumped a pile of documents that Allergan complained it had improperly withheld on the Securities and Exchange Commission on Wednesday, including Pershing’s original confidentiality agreements with the Canadian drug company Valeant, as well as the share call option and forward contracts in which the hedge fund acquired its 9.7 percent stake in Allergan.
Pershing and Valeant also filed a brief in federal court in Santa Ana, California, agreeing to expedited discovery so it can dispose quickly of Allergan’s claims. ... [A]fter accusing Allergan of suing to impede shareholders from calling for a special meeting to oust directors, Pershing and Valeant said they’re raring to defend themselves against Allergan’s accusations.
This one'll get coverage in next year's M&A class.
A few days after the Canadian pharmaceutical company Valeant announced that it had teamed up with the activist investor William Ackman to bid for Botox maker Allergan, Wachtell, Lipton, Rosen & Katz wrote ateeth-gnashing client alert about the new threat to corporate targets from the unholy alliance of a strategic bidder with an activist hedge fund. Commentators were already raising questions about whether Ackman and Valeant had engaged in insider trading, because Ackman secretly accumulated Allergan shares based on his knowledge of Valeant’s imminent takeover bid. ...
... On Friday, Wachtell – now acting as counsel to Allergan, along with Latham & Watkins – filed a complaint in federal court in Los Angeles that accuses Valeant and Ackman of executing an “improper and illicit insider-trading scheme … flouting key provisions of the federal securities laws.” The suit not only claims that Valeant and Ackman didn’t make adequate disclosures to Allergan shareholders – reviving an old takeover defense tactic from the 1980s – but also pushes the novel theory that Ackman violated a provision of the Williams Act prohibiting anyone except an acquirer from trading on material non-public knowledge that the acquirer has taken “a substantial step” toward launching a tender offer.
Frankel doubts the complaint will hold up, but go read the whole thing and make up your mind.
My take? There's more likely to be a Section 13(d) problem than an insider trading case. Item 7 of Schedule 13D requires the filer (here Ackman and Valeant) to include as exhibits "copies of all written agreements, contracts, arrangements, understanding, plans or proposals relating to: (1) The borrowing of funds to finance the acquisition as disclosed in Item 3; (2) the acquisition of issuer control, liquidation, sale of assets, merger, or change in business or corporate structure, or any other matter as disclosed in Item 4; and (3) the transfer or voting of the securities, finder's fees, joint ventures, options, puts, calls, guarantees of loans, guarantees against loss or of profit, or the giving or withholding of any proxy as disclosed in Item 6."
Frankel tells us that "Pershing and Valeant had first executed a confidentiality agreement in February, though neither that agreement nor an amended version of it was disclosed to the SEC."
If that's all Wachtell has to go on, Achman and and Valeant would at most get a slap on the wrist, espcially if they amend their Schedule 13D to disclose the missing items. Energy Ventures, Inc. v. Appalachian Co., 587 F.Supp. 734, 743–44 (D.Del.1984) (interim injunctive relief deemed inappropriate where corrective filing had been made); University Bank & Trust Co. v. Gladstone, 574 F.Supp. 1006, 1010 (D.Mass.1983) (injunction denied where purchaser had made curative disclosure).
In a consolidation, two or more corporations combine to form a new corporation. In our earlier example, suppose Ajax and Acme decided to consolidate rather than merge. In that case, neither Ajax nor Acme would survive the consolidation. Instead, a new corporation (call it NewCo) would be formed and succeed to all the assets, rights, duties, liabilities and so on of both Ajax and Acme. The differences between the merger and the consolidation thus are purely form and semantics. They are effected in the same manner and have the same substantive results. as a result, in colloquial speech (even among sophisticated lawyers) the terms are often used interchangeably.
So here's my questions: When would you expect a client to prefer a consolidation to a merger, if ever? When would you advise a client to choose a consolidation over a merger, if ever?
Interesting new paper by Albert Choi:
Abstract: This paper examines how post-closing contingent payment (PCP) mechanisms (such as earnouts and purchase price adjustments) can facilitate mergers and acquisitions transactions. By relying on verifiable information that is obtained after closing, PCPs can mitigate the problems of asymmetric information over valuation and, in contrast to the conventional understanding, this benefit applies to both earnouts and purchase price adjustments. When both the acquirer and the target are aware that there is a positive (but uncertain) surplus from the transaction, PCPs function more as an imperfect verification, rather than a signaling, mechanism and a pooling equilibrium is possible, in which all parties adopt a PCP. When the parties are uncertain as to whether a positive surplus exists, on the other hand, PCPs function as a separating device, in which the seller with a positive surplus successfully signals its valuation with a PCP. The paper also addresses the problems of post-closing incentives to maximize (or minimize) the PCP payments. When such a moral hazard is a concern, the paper shows that (1) the PCPs will be structured so as to minimize the deadweight loss and a separating equilibrium is more likely to result; and (2) when the deadweight loss is sufficiently large, the parties will forego using a PCP mechanism altogether.
Facilitating Mergers and Acquisitions with Earnouts and Purchase Price Adjustments (June 30, 2014). Virginia Law and Economics Research Paper No. 2014-10. Available at SSRN:http://ssrn.com/abstract=2460777
I wish I found this statistic shocking:
Only 2 percent of lawsuits filed in response to M&A deals that settled in 2013 produced monetary returns for shareholders.
Meanwhile, I guess we're all supposed to be dancing in the streets because Delaware courts are not quite as liberal as they used to be in approving legal fees for plaintiffs lawyers:
The report also finds that plaintiff attorney fees awarded in disclosure-only settlements of M&A cases continued to drop in 2013. In addition, over the last four years, the Delaware Court of Chancery approved 80 percent of the fee amounts requested in such cases, compared with 90 percent in other courts.'
BFD. If plaintiff lawyers get fees in 80% of cases and plaintiffs get a monetary recovery in only 2%, well you do that math. The point is that the Delaware courts are still basically rubber stamping a system that amounts to a massive wealth transfer from investors to lawyers.
Some will ask: If derivative litigation cannot be justified on compensatory grounds, can it still be justified as a useful deterrent against managerial shirking and self-dealing? In short, no. There is no compelling evidence that derivative litigation deters a substantial amount of managerial shirking and self-dealing. Certainly there is no evidence that litigation does a better job of deterring such misconduct than do markets. There is evidence that derivative suits do not have significant effects on the stock price of the subject corporations, however, which suggests that investors do not believe derivative suits deter misconduct. There is also substantial evidence that adoption of a charter amendment limiting director liability has no significant effect on the price of the adopting corporation’s stock, which suggests that investors do not believe that duty of care liability has beneficial deterrent effects.
 See, e.g., Michael Bradley & Cindy A. Schipani, The Relevance of the Duty of Care Standard in Corporate Governance, 75 Iowa L. Rev. 1 (1989); Roberta Romano, Corporate Governance in the Aftermath of the Insurance Crisis, 39 Emory L.J. 1155 (1990).
 See Daniel R. Fischel & Michael Bradley, The Role of Liability Rules and the Derivative Suit in Corporate Law: A Theoretical and Empirical Analysis, 71 Cornell L. Rev. 261 (1986).