Federal Securities Law Source

Delaware limits appraisal rights, but at what cost?

Back in August 2016, Delaware amended Section 262 of the Delaware General Corporation Law to address the rise of the appraisal arbitrage strategy where certain sophisticated investors would find a target company that is involved in a merger or acquisition, buy stock in the target company, and then invoke appraisal rights under Section 262. The main goal of the strategy is to strong-arm management to settle for a higher sale price in order to avoid litigation costs and/or gain from receiving statutory interest that accrued on the court-appraised amount. The idea behind the 2016 amendments was to curtail this appraisal arbitrage strategy by limiting a shareholder’s appraisal rights under Section 262 in two main respects: (i) by allowing surviving corporations to prepay dissenting shareholders prior to a final court determination in order to avoid paying statutory interest on the final appraisal value,[1] and (ii) by taking away appraisal rights from de minimis shareholders who hold stock that is listed on a national security exchange.[2]

A recent study published by the Harvard Law School has analyzed the effect of the 2016 amendments on appraisal actions in Delaware since the amendments went into place one year ago. The study found that appraisal actions did, in fact, decrease by 33 percent in 2017 as compared to the same period in 2016. The analysis also found that, surprisingly, the average deal premium fell from 28.3 percent in 2016 to 22.4 percent in 2017, the lowest of any year since at least 2005. As deal premiums fell, the average total change-in-control payments to CEOs (i.e. golden parachute payments) rose from 0.9 percent of transaction equity value to 2.1 percent, which brings into question whether CEOs acquiesced in lower deal premiums for higher parachute payments at the conclusion of the transaction. All in all, the study found that the decrease in deal premiums from 2016 to 2017 resulted in target shareholders losing around $77.4 billion, which, by any standards, isn’t a nominal amount. Continue Reading

Rate increases for issuers registering securities

New rates will take effect at the beginning of the next fiscal year, Oct. 1, 2017, for public companies and other issuers to register their securities with the U.S. Securities and Exchange Commission (SEC).

The SEC announced on Aug. 24, 2017, that the fiscal year 2018 fees to register securities will be set at $124.50 per million dollars. This is up from the $115.90 per million dollars fee for fiscal year 2017. The 7.4 percent increase is significantly less than the increase from fiscal year 2016 to fiscal year 2017 ($100.70 to $115.90, or 15.1 percent). However, issuers saw the rates lowered for fiscal year 2015 to 2016. Continue Reading

Some thoughts on mimicking a corporate governance structure in Ohio LLCs

Part One

It is quite common for members of a recently formed LLC accustomed to a corporate governance structure (that is, one having directors, a board of directors and officers versus members and managers) to direct their attorney to draft their operating agreement so that the LLC will have a corporate governance structure too. The intention being to permit the members to continue to use the governance structure with which they are most familiar. (Some clients even enjoy holding board of directors meetings and the formalities of decision making.) Ordinarily, this is accomplished by a provision inserted into the operating agreement that states, more or less, that:

The members agree that the company shall be governed by a board of directors [or managers] (the board) acting collectively; and not by its members. The board shall be comprised of three (3) directors appointed by the members [or by the company’s managers if the company is manager-managed] designated on the attached Exhibit A. The foregoing is an express delegation to the board by the members of their individual right to manage the company including all powers and authority necessary for, ancillary to, or implied by such delegation to direct, manage and control the company’s business and affairs. The board may appoint one or more officers having such titles, rights and duties as are commonly given to them and as prescribed in Chapter 1701 of the Ohio Revised Code. . .

The Ohio Limited Liability Company Act (the Act), Revised Code Chapter 1705, provides in at least one provision that this type of corporate governance structure is implicitly allowed under the Act because it furthers the right of LLC members to govern their internal LLC affairs as they see fit subject however to certain non-waivable provisions of the Act. Specifically: Revised Code Section 1705.081(D), Effect of Operating Agreement, states that “it is the policy of this chapter [1705], subject to the limitations of (B) and (C) of this section, to give maximum effect to the principle of freedom on contract and to the enforceability of operating agreements. . .”

So, given that the LLC’s members have elected and contractually provided for a corporate governance structure are they then bound by implication by the other ancillary duties that fall upon corporate directors and/or officers under Chapter 1701? Continue Reading

Reminder: SEC exhibit hyperlink and format rules become effective Sept. 1, 2017

Effective for filings on and after Sept. 1, 2017, registrants will be required to include a hyperlink to each exhibit identified in the exhibit index of periodic reports, current reports and registration statements. For registration statements, the rule applies to the initial registration statement, and to each subsequent pre-effective amendment.

The SEC adopted the final rules on March 1, 2017. According to the SEC’s adopting release, the rules are intended to address the inefficient and time-consuming search required to locate exhibits that have been incorporated by reference into reports and registration statements.

These rules apply to the following types of filings:

  • Form 8-K
  • Form 10-Q
  • Form 10-K
  • Form 10
  • Form 10-D
  • Registration statements:
    • Forms S-1, S-3, S-4, S-8, S-11, F-1, F-3, F-4, SF-1, SF-3, SF-3, F-10 and 20-F

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The impact of efforts clauses in transactional documents

Most transactional documents include effort clauses as covenants to require a party to perform a certain act or acts to achieve a stated goal. These terms generally include the following:

  • Best efforts
  • Reasonable efforts
  • Commercially reasonable efforts

There are no universally accepted definitions or standards for interpreting these terms. As a result, their use can create ambiguity and uncertainty when a dispute arises, making it difficult to predict an outcome.

When a court evaluates whether a party has exerted the necessary effort standard, the court generally first examines the business contract for a definition of the efforts term. If the business contract contains such a definition, the court will apply that standard. If the business contract is silent, the court has discretion to interpret an efforts clause or term by considering the business contract’s facts and circumstances.

In the absence of a definition, a court will impose standards of:

  • Good faith, which requires honesty and fairness from the acting party
  • Reasonableness, which requires diligence from the acting party and is often a more demanding standard than good faith

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Retaining key employees in an acquisition

Imagine identifying an acquisition target that looks great on paper: strong earnings, efficient operations and good workplace environment. But after acquiring the target, a key employee leaves, taking with him or her key customers and suppliers. From day one, the newly acquired business is treading water due to the lack of business continuity after the acquisition.

Even though an acquisition might look good in theory, the reality of its execution poses multiple threats that could disrupt the business after the transaction, including employees who view the change in ownership as a threat or a risk, customers who feel the change in ownership might be a good time to shop around and suppliers wanting to perhaps renegotiate contracts. In order to alleviate some of these risks, potential buyers need to address these considerations head-on during the due diligence and negotiation process.

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Learning from Yahoo!’s missteps: Meeting SEC disclosure obligations after a cyber-attack

In July 2016, Verizon announced it would buy Yahoo! for an unprecedented $4.83 billion. Several months later, Yahoo! disclosed two massive data breaches that affected 1.5 billion people, threatening to scuttle the agreement. Although Verizon recently finalized the acquisition, the hack forced Yahoo! to accept a $350 million reduction in purchase price.

Within the last few years, publically held companies—including Sony, Target, and most recently, Chipotle Mexican Grill—have been infiltrated by hackers bent on stealing trade secrets and personal information. The efficacy of cloud computing has spawned a digital arms race between companies who attempt to safeguard customer information and private and state actors, who wish to obtain it. Given that large-scale data breaches are becoming the norm, companies need to be aware of reporting and disclosure obligations they may face in the event of a breach. While most companies recognize their obligations under state data breach laws and HIPAA, few publically traded companies consider what, if anything, they should disclose to the U.S. Securities and Exchange Commission (SEC) in the event of a breach. In failing to do so, they risk SEC sanctions and potential liability from class action lawsuits, either of which could result in significant losses.

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Non-competition agreements: Ensuring enforceability

A non-competition agreement raises state-law public policy concerns. As a result, states often restrict the scope of non-competition agreements before they will enforce them. The protectable interests that states will recognize, the rules of construction that states will apply and the required elements of a non-competition agreement will vary from state to state. You may adhere to general guidelines in drafting non-competition agreements, but you should always consult local law.

Most jurisdictions disfavor non-competition agreements as a matter of public policy because they view such agreements as a restraint of trade. Broader language places a heavier burden on the employer to justify the restrictions whereas narrowly tailoring the language of a non-competition agreement reduces the risk that a court will construe the agreement to unnecessarily restrain trade.

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The importance of reading the documents

One of the most important things lawyers and clients should do in every merger & acquisition transaction is to read the documents, and be clear on the central facts of their transaction. This seems so profoundly simple and obvious that it seems that it would not need to be repeated. But a recent U.S. Tax Court case highlights the implications of not doing so.

In Makric Enterprises, Inc. v. Commissioner, TC Memo 2016-44 (Dkt. No. 1017-13, issued 03/9/2016), the taxpayers of Makric Enterprises, Inc. (Makric) sued the IRS to set aside a determination that the they collectively owed the IRS $2,839,780 and an accuracy-related penalty of $567,956 stemming from a relatively simple sale of the common stock of a parent company of its wholly owned subsidiary to a third-party purchaser.

Makric was the parent company, its subsidiary entity was Alpha Circuits, Inc. (Alpha), and the third party purchaser was TS3 Technology, Inc. (TS3).

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Data breaches and due diligence

Chances are that you or someone you know has been the victim of a data breach. The high number of cyberattacks and data breaches, now reported almost daily, calls attention to the importance of addressing these areas in the due diligence process in M&A deals.

Whether a target company has had issues with cybersecurity breaches in the past is a question that should be on the top of all acquirer’s minds, especially if that target has an online presence. If the target is a consumer facing business who regularly collects personal information, acquirers should focus its due diligence requests on the security practices of the target. Has the target implemented credit card tokenization? Have they updated their point-of-sale systems? How long do they retain customer information? If a target does not have a consumer base, the due diligence may instead focus on other areas, including how the target protects its trade secrets or confidential information. Continue Reading