Sidley Perspectives | AUGUST 2016 • 1 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE ANALYSIS Shareholder Votes and Standards of Judicial Review ������������������������������������������������2 Shifting Winds in Delaware Appraisal Proceedings ���������������������������������������������������5 NEWS LEGISLATIVE DEVELOPMENTS DGCL Amendments Relating to Intermediate-Form Mergers and Appraisal Proceedings Take Effect������������������������������������������������������������������������6 Proxy Advisor Reform Bill Introduced in the House of Representatives �����������������7 JUDICIAL DEVELOPMENTS Delaware Court of Chancery Allows Termination of Merger Agreement Based on Good Faith Failure to Deliver a Required Tax Opinion �����������������������������7 New York Court of Appeals Is Unwilling to Expand the Scope of the Common Interest Exception in the M&A Context����������������������������������������������������������7 Delaware Supreme Court Upholds Damages Award to Holders of Options Canceled in Merger������������������������������������������������������������������������������������8 Delaware Court of Chancery Denies Attorneys’ Fee Request for Disclosures Issued in Merger Litigation �����������������������������������������������������������������9 Minnesota District Court Dismisses Shareholder Derivative Litigation Against Target’s Officers and Directors Following Cybersecurity Breach���������������9 SEC DEVELOPMENTS SEC Proposes Rule Amendments to Streamline its Disclosure Requirements ���������10 SEC Amends Form 10-K to Expressly Permit Summaries ����������������������������������������10 SEC Proposes to Increase Financial Thresholds in “Smaller Reporting Company” Definition�������������������������������������������������������������10 SEC Staff Issues Guidance Regarding the Application of Rule 701 in the M&A Context��������������������������������������������������������������������������������� 11 SEC Staff Provides Guidance on Schedule 13G Eligibility���������������������������������������12 SEC Approves NASDAQ Rule Requiring Disclosure of “Golden Leash” Arrangements ������������������������������������������������������������������������������12 CORPORATE GOVERNANCE DEVELOPMENTS Heads of Leading Public Companies and Institutional Investors Issue “Commonsense” Corporate Governance Principles��������������������������������������12 ANTITRUST DEVELOPMENTS FTC Sharply Increases HSR Penalties, As DOJ Imposes Record Penalty for “Investment-Only” Violation�������������������������������������������������������13 SIDLEY EVENTS������������������������������������������������������������������������������������������������������������������ 14 SIDLEY RESOURCES���������������������������������������������������������������������������������������������������������� 14 Visit sidley.com for more Sidley Perspectives on M&A and Corporate Governance. IN THIS ISSUE AUGUST 2016 Sidley Perspectives | AUGUST 2016 • 2 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE ANALYSIS SHAREHOLDER VOTES AND STANDARDS OF JUDICIAL REVIEW By Thomas A. Cole and Jack B. Jacobs1 Those of us who represent target companies in M&A deals typically brief the target’s board at the outset and refresh that briefing periodically over the course of the deal. The briefing covers (among other things) directors’ general fiduciary duties, special duties in the M&A context, standards of judicial review, burdens of proof, and finally (to keep the directors from fleeing the boardroom), director protections. The lawyers’ summary of the standards of judicial review typically discusses the three tiers thereof in increasing levels of stringency: business judgment; enhanced scrutiny (e.g., of decision making in a change of control transaction); and entire fairness (e.g., of decision making in a transaction with a controlling shareholder). The good news for corporate directors is that recent Delaware decisions clearly indicate that the courts are looking for ways to apply business judgment review in situations that previously would have implicated the more stringent standards. This article discusses where matters currently stand, how we seem to have gotten there (perhaps as part of a cautionary tale about the predictability of Delaware case law) and the limitations (and possible further implications) of the “good news.” From Enhanced Scrutiny to Business Judgment Review Until recently, it was clear that, in a change of control transaction, a target board’s decision making would at all times be under enhanced judicial scrutiny of the reasonableness of the path the board selected to achieve the best deal for the shareholders. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986); Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34 (Del. 1994). In this setting, the board would have the burden of proving the reasonableness of its actions. Now for the change: Although that Revlon/QVC form of scrutiny remains and persists up to the time of a shareholder vote, the Delaware Supreme Court determined last year that “when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies.” Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015). That is, after the vote, enhanced scrutiny does not apply and the burden of rebutting the presumption of propriety rests on the party that is challenging the board’s decision. Then, on June 30, 2016, Vice Chancellor Montgomery-Reeves of the Delaware Court of Chancery took KKR Financial one step further by concluding that “stockholder approval of a [two-step] merger under Section 251(h) by accepting a tender offer has the same cleansing effect as a vote in favor of that merger” and that “the business judgment rule irrebuttably applies to the Merger because Volcano’s disinterested, uncoerced, fully informed stockholders tendered a majority of the Company’s outstanding shares into the Tender Offer.” In re Volcano Corp. S’holder Litig., Consol. C.A. No. 10485 (Del. Ch. Jun. 30, 2016). On the one hand, this shape-shifting reversion to the business judgment review standard in the change of control context perhaps should not be surprising given the decision in MFW, which held that a transaction with a controlling shareholder would be reviewed under the business judgment standard, rather than entire fairness, if the parties to the merger agree at the outset to employ the dual procedural safeguards of a fully empowered independent committee and a majority of the minority shareholder approval requirement. Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014). On the other hand, KKR Financial and Volcano were perhaps a little surprising in light of the Delaware Supreme Court’s 2009 decision in Gantler v. Stephens discussed below. 1 Thomas A. Cole is a partner in Sidley’s Chicago office who served as chair of the firm’s Executive Committee for 15 years. Jack B. Jacobs is a senior counsel at Sidley who served on the Delaware Supreme Court from 2003 to 2014 and, prior to that, on the Delaware Court of Chancery since 1985. The views expressed in this article are those of the authors and do not necessarily reflect the views of the firm. Recent Delaware decisions indicate that courts are looking for ways to apply business judgment review in situations that previously would have implicated enhanced scrutiny or entire fairness. Sidley Perspectives | AUGUST 2016 • 3 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE The Road From Gantler Gantler involved a claim that the defendant directors had breached their fiduciary duty of loyalty by rejecting an offer to acquire the company and deciding instead to reclassify the company’s shares for their personal benefit. Gantler v. Stephens, 965 A.2d 695 (Del. 2009). In language that could not be clearer, the Delaware Supreme Court, in a unanimous en banc decision authored by Justice Jacobs, stated: “Under current Delaware case law, the scope and effect of the common law doctrine of shareholder ratification is unclear, making it difficult to apply that doctrine in a coherent manner…To restore coherence and clarity to this area of our law, we hold that the scope of the shareholder ratification doctrine must be limited to its so-called ‘classic’ form; that is, to circumstances where a fully informed shareholder vote approves director action that does not legally require shareholder approval in order to become legally effective. …With one exception, the ‘cleansing’ effect of such a ratifying shareholder vote is to subject the challenged director action to business judgment review, as opposed to ‘extinguishing’ the claim altogether (i.e., obviating all judicial review of the challenged action).” In other words, under Gantler, in a merger even a fully informed vote does not cause a reversion to the business judgment rule, because a shareholder vote is “legally require[d].” The success of Gantler in restoring “coherence and clarity” was called into question in two post-Gantler Delaware Court of Chancery opinions authored by then-Chancellor (now Chief Justice) Strine. In Southern Peru, the then-Chancellor observed in a footnote that “[i]n a merger where there is no controller and the disinterested electorate controls the outcome from the get go…it has long been my understanding of the Delaware law, that the approval of an uncoerced, disinterested electorate of a merger (including a sale) would have the effect of invoking the business judgment rule standard of review.” In re Southern Peru Copper Corp. S’holder Deriv. Litig., 52 A.3d 761 (Del. Ch. 2011). Later, the then-Chancellor opined in Morton’s Restaurant—“[I]t is plain that, when disinterested approval of a sale to an arm’s-length buyer is given by a majority of stockholders…there is a long and sensible tradition of giving deference to the stockholders’ voluntary decision, invoking the business judgment rule standard of review.” In re Morton’s Rest. Gp., Inc. S’holders Litig., 74 A.3d 656 (Del. Ch. 2013). Rural Metro provides additional evidence that the standard of review issue was not as clear as the Gantler Court attempted to portray it or as clear (in the other direction) as thenChancellor Strine suggested. RBC Capital Markets, LLC v. Jervis, 129 A.3d 816 (Del. 2015). In his opinion in Rural Metro, Vice Chancellor Laster treated the question as an open issue. 2 The latest pieces of the puzzle are the decisions in KKR Financial. The trial court opinion, by Chancellor Bouchard, states that “plaintiffs do not disagree with defendants’ position that the legal effect of a fully-informed stockholder vote of a transaction with a non-controlling stockholder is that the business judgment rule applies and insulates the transaction from all attacks other than on the grounds of waste.” In re KKR Fin. Holdings LLC S’holder Litig., 101 A.3d 980 (Del. Ch. 2014). The Chancellor then addresses Gantler as follows: “I do not read Gantler to have altered the legal effect of a stockholder vote when it is statutorily required. Instead, I read it simply to clarify the meaning of the term ‘ratification’.” That is, the Chancellor held that a fully informed shareholder vote approving a transaction with a non-controller triggers business judgment review, even if (unlike as in Gantler), the shareholder vote was “legally require[d].” The Delaware Supreme Court, en banc, affirmed, adopting the Chancellor’s view that “the business judgment rule is invoked as the appropriate standard of review for a post-closing 2 “Because the Proxy Statement contained materially misleading disclosures and omissions, this case does not provide any opportunity to consider whether a fully informed stockholder vote would lower the standard of review from enhanced scrutiny to the business judgment rule,” citing Southern Peru and Morton’s Restaurant, but not Gantler. In re Rural Metro Corp. S’holders Litig., 88 A.3d 54 (Del. Ch. 2014). Sidley Perspectives | AUGUST 2016 • 4 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE damages action when a merger that is not subject to the entire fairness standard of review has been approved by a fully informed, uncoerced majority of the disinterested stockholders.” Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015). In discussing the Chancellor’s treatment of Gantler, the Supreme Court stated “No doubt Gantler can be read in more than one way, but we agree with the Chancellor’s interpretation…Had Gantler been intended to unsettle a long-standing body of case law, the decision would likely have said so.” This opinion was written by Chief Justice Strine—the author of Southern Peru and Morton’s Restaurant. Good News, But Not Without Limits It is critically important to focus on two important limitations to these most recent articulations of the effect of shareholder approval. First, the reversion to the business judgment rule applies only after the vote. Until that time (typically occurring in an action for injunctive relief), enhanced scrutiny applies and the burden of proving the reasonableness of their actions falls on the directors. Second, the vote has the desired review-changing effect only if the approval is “fully informed.” These limitations suggest that in future deal litigation plaintiffs will focus their efforts on the pre-shareholder vote period and that their greatest focus will be on disclosure. It is possible, however, that some plaintiffs will not make disclosure allegations before the vote, because those allegations can be mooted by proxy statement supplements. However, that course of action will raise potential issues of waiver. Unanswered Questions Will the Delaware Court of Chancery decision in Volcano—extending KKR Financial—be appealed and, if so, upheld? If Volcano is upheld, will the notion of cleansing-vote-viatender-offer apply outside of the Section 251(h) context? Arguments can be made both ways. In an all cash deal, logic would seem to compel an affirmative answer. But the result might be different in a front-end cash tender offer/back-end stock merger, because the decision to tender could be characterized as a “vote” only on the cash consideration. Indeed, the vote might be viewed as coerced, with shareholders voting yes in order to avoid the back-end stock merger. On the other hand, it is also arguable that there is no principled way to distinguish between an all cash and a cash and stock deal, because in either case an informed shareholder vote should trigger business judgment review. Although it may be harder for the shareholders to be “informed” of the value of the stock component of the deal (the argument would run), that is a problem of disclosure craftsmanship, not of basic principle. Eventually the courts will have to decide this issue. Until then, we will have to wait and see. Another question is whether these cases will lead some Court of Chancery judges in the direction of Vice Chancellor Laster’s approach in the Dell appraisal case3—giving less deference to the merger price as evidence of fair value—because otherwise shareholders will have virtually no remedies available to them for a bad deal once there has been an approving vote. 3 In re: Appraisal of Dell Inc., C.A. No. 9322-VCL (Del. Ch. May 31, 2016). The business judgment rule will apply only after stockholders have approved the transactions and only if such approval was “fully informed.” Sidley Perspectives | AUGUST 2016 • 5 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE SHIFTING WINDS IN DELAWARE APPRAISAL PROCEEDINGS By Thomas A. Cole4 Appraisal proceedings in M&A deals are receiving more attention than ever before. In an apparent effort to dampen the enthusiasm for appraisal arbitrage, the Delaware statute was recently amended to allow the merged company in an appraisal proceeding to pre-pay the merger price, so as to make the currently handsome statutorily-mandated level of interest payable only on the incremental amount, if any, by which the judicially determined “fair value” exceeds the deal price. A series of cases in 2015 in the Delaware Court of Chancery placed significant, indeed presumptively exclusive, weight on the deal price agreed to after a fair and adequate sales process in determining statutory “fair value.” In the words of the Court in Merion Capital LP v. BMC Software, Inc., C.A. No. 8900-VCG (Del. Ch. Oct. 21, 2015), “[o]nce the Court has made [the determination that the price was generated by a process that likely provided market value]…the burden is on any party suggesting a deviation from that price to point to evidence in the record showing that the price must be adjusted from market value to ‘fair’ value.” Then came the headline-grabbing May 2016 decision in In re: Appraisal of Dell Inc., C.A. No. 9322-VCL (Del. Ch. May 31, 2016). There, Vice Chancellor Laster determined that “fair value” was approximately 28% over the deal price. Based on a series of conceptual arguments, he declined to rely as heavily on deal price as his colleagues had done in previous cases. He relied on a law review article for the proposition that “the deal market is unavoidably less efficient at valuing entire companies (including the value of control) than the stock market is at valuing minority shares.” He also cited the time delay between signing and closing, the latter being the statutorily-mandated measuring date for “fair value,” and expressed skepticism about the effectiveness of go-shops in MBOs and in deals of the size and complexity of the Dell deal. Most telling, although the finding of fair value was dramatically higher than the deal price, the Court observed that that did not conclusively evidence a breach either of the duty of care or of Revlon, by the Dell board or its bankers. Less attention grabbing (but directionally the same) was Chancellor Bouchard’s July 2016 decision in another Delaware appraisal proceeding where, as in Dell, the Chancellor accorded less significance to the deal price. Instead, he gave equal weight to three “imperfect techniques” for valuation: the petitioner’s expert’s DCF calculation, the average of the respondent’s expert’s DCF and comparable companies analysis, and (lastly) the deal price. Rather than relying on the conceptual arguments from Dell, the Chancellor took a more facts-and-circumstances approach, finding the deal price less dispositive, because “[t]he transaction here was negotiated and consummated during a period of significant company turmoil and regulatory uncertainty…” In addition, the deal price “is informative of fair value only when it is the product of not only a fair sale process, but also of a wellfunctioning market.” The Chancellor found the acquired company’s statutory “fair value” to be 7.5% higher than the deal price. Two questions: (1) Do the earlier cases relying heavily on the deal price reflect only a momentary legal bubble? (2) If so, is this movement away from reliance on the deal price, which came after the decision in Corwin v. KKR Fin. Holdings LLC, No. 629, 2014 (Del. Oct. 2, 2015), related to the fact that after KKR Financial an appraisal proceeding may be the only realistic pathway to recover damages after the deal is approved by a qualifying (i.e., fully informed and uncoerced) shareholder vote? 4 The views expressed in this article are those of the author and do not necessarily reflect the views of the firm. Recent decisions suggest that Delaware courts are according less significance to the deal price than they have in previous cases when determining the “fair value” of target company stock in appraisal proceedings. Sidley Perspectives | AUGUST 2016 • 6 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE NEWS5 LEGISLATIVE DEVELOPMENTS DGCL Amendments Relating to Intermediate-Form Mergers and Appraisal Proceedings Take Effect In June 2016, the Governor of Delaware signed into law amendments to the Delaware General Corporation Law (DGCL) that (i) clarify the requirements and process relating to “intermediate-form” mergers under Section 251(h) and (ii) make important changes to the Delaware appraisal statute in Section 262. The amendments to Section 251(h) are effective only with respect to merger agreements entered into on or after August 1, 2016, and the amendments to Section 262 are generally effective only with respect to transactions consummated pursuant to agreements entered into on or after August 1, 2016. The amendments to DGCL Section 251(h) clarify that: (i) Section 251(h) applies to a target corporation with any class or series of stock listed on a national securities exchange or held of record by more than 2,000 holders immediately prior to the execution of the merger agreement, regardless of whether all classes or series of stock are so listed or held; (ii) if the target corporation has multiple classes or series of stock, the offer may be consummated through separate offers for separate classes or series; and (iii) the offer may include a minimum tender condition. For the purpose of determining whether the offeror has sufficient shares to approve the merger, the amendments clarify that shares of stock held by direct and indirect parent entities and wholly-owned subsidiaries and “rollover stock” would be included. The amendments define “rollover stock” as any shares of stock of the target corporation that are the subject of a written agreement requiring such shares be transferred, contributed or delivered to the consummating corporation or any of its affiliates in exchange for stock or other equity interests in such consummating corporation or an affiliate thereof. The amendments to DGCL Section 262 are designed to (i) limit de minimis appraisal claims and (ii) address the issue of “appraisal arbitrage.” The first amendment requires the Delaware Court of Chancery to dismiss an appraisal proceeding if: (i) the total number of shares seeking appraisal is less than 1% of the outstanding number of shares of the class or series entitled to appraisal; (ii) the value of the consideration for that total number of shares is $1 million or less; and (iii) the merger took the form of a “short-form” merger under DGCL Sections 253 or 267. “Short-form” mergers would not be subject to the de minimis carve-out because appraisal may be the only remedy available in such a merger. Moreover, the carve-out would only apply where the shares were listed on a national securities exchange immediately before the merger or consolidation. The second amendment to the appraisal statute affords surviving corporations the option of limiting the accrual of statutory interest on appraisal awards by allowing them to pre-pay appraisal claimants in any amount determined by the company at any time before judgment is entered in the appraisal proceeding. When a company makes such a payment, interest will accrue only on the amount by which the ultimately adjudicated appraisal award exceeds the amount that was prepaid rather than on the entire amount of the appraisal award. The amount prepaid by the corporation has no weight on the court’s determination of the fair value of the shares seeking appraisal. This amendment significantly reduces a corporation’s exposure and eliminates much of the economic incentive of appraisal arbitrage, given the current statutory interest rate is 5% over the Federal Reserve rate, compounded quarterly. 5 The following Sidley attorneys contributed to the research and writing of the pieces in this section: Jonathan A. Blackburn, Beth E. Flaming, Jack B. Jacobs, John P. Kelsh, Hille R. Sheppard and Nilofer Umar. We appreciate their contributions. We also thank summer associates Ashwin Ganesan, Jeremy Mandell and Kiram Pirani for their assistance. Newly effective amendments to the DGCL are designed to eliminate de minimis appraisal claims and discourage appraisal arbitrage. Sidley Perspectives | AUGUST 2016 • 7 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Proxy Advisor Reform Bill Introduced in the House of Representatives On May 24, 2016, Representatives Sean Duffy (R-WI) and John Carney (D-DE) of the House Financial Services Committee introduced the Corporate Governance Reform and Transparency Act of 2016 (H.R. 5311) in the House of Representatives. The bill was designed to increase accountability, transparency and oversight of highly influential proxy advisors such as ISS and Glass Lewis. If adopted, the bill would require proxy advisors to (i) register with the SEC, (ii) disclose potential or actual conflicts of interest and the policies and procedures in place to manage them and (iii) publicize their methodologies for formulating proxy voting policies and voting recommendations. The bill would also require proxy advisors to give corporations a reasonable time to review and comment on the advisors’ draft proxy voting recommendations before they are provided to investors. JUDICIAL DEVELOPMENTS Delaware Court of Chancery Allows Termination of Merger Agreement Based on Good Faith Failure to Deliver a Required Tax Opinion On June 24, 2016, the Delaware Court of Chancery denied The Williams Companies, Inc.’s (Williams) request for an order requiring Energy Transfer Equity, L.P. (ETE) to close a deal to acquire Williams valued at more than $30 billion after concluding that a contractual condition to closing—that ETE’s tax counsel furnish an opinion that the contribution of Williams’ assets to ETE should be treated as a tax-free exchange—had validly failed to occur. The Williams Companies, Inc. v. Energy Transfer Equity, L.P., C.A. No. 12168—VCG (Del. Ch. Jun. 24, 2016). Shortly after the merger agreement was signed, the energy market—and the value of energy transportation assets and ETE’s publicly traded partnership units—precipitously declined. The Court concluded that the tax counsel, “as of the time of trial, could not in good faith opine that tax authorities should treat the… exchange…as tax free under Section 721(a); and [that] because Williams has failed to demonstrate that [ETE] has materially breached its contractual obligation to undertake commercially reasonable efforts to receive such an opinion…[ETE] is contractually entitled to terminate the Merger Agreement, assuming [the tax counsel’s] opinion does not change before the end of the merger period…” The Court granted judgment in favor of ETE on June 24 and ETE terminated the merger agreement on June 29. Williams has appealed the Court’s decision to the Delaware Supreme Court. For more information, see our Sidley Update available here. New York Court of Appeals Is Unwilling to Expand the Scope of the Common Interest Exception in the M&A Context In June 2016, New York’s highest court held that the common interest exception applies only to post-signing, pre-closing communications between merger parties if such communications relate to pending or anticipated litigation. Ambac Assurance Corp. v. Countrywide Home Loans, Inc., 2016 N.Y. Slip. Op. 04439 (N.Y. Jun. 9, 2016). As a general matter, if attorney-client communications are disclosed to a third party, then the privilege that attached to those communications is deemed to have been waived. Nevertheless, under the common interest doctrine, attorney-client communications disclosed to a third party that is separately represented by counsel will remain privileged if (i) the third party shares a common legal interest with the client who made the communication and (ii) the communication is made in furtherance of that common legal interest. In Ambac, the New York Court of Appeals noted that the interests of counterparties to a commercial transaction are not necessarily aligned in the same way as those of codefendants In recent years there have been increasing calls for reforms to curb the power and influence of proxy advisors. Sidley Perspectives | AUGUST 2016 • 8 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE in a litigation, and that New York courts uniformly rejected efforts to expand the common interest doctrine to communications that do not concern pending or reasonably anticipated litigation. The Court stated: “Disclosure is privileged between codefendants, coplaintiffs or persons who reasonably anticipate that they will become colitigants” because otherwise, “the threat of mandatory disclosure may chill the parties’ exchange of privileged information and therefore thwart any desire to coordinate legal strategy.” However, the Court concluded that “[t]he same cannot be said of clients who share a common legal interest in a commercial transaction or other common problem but do not reasonably anticipate litigation.” As a result, the Court found that it was necessary to retain the requirement of pending or anticipated litigation in defining a common legal interest, as “[t]he difficulty of defining ‘common legal interests’ outside the context of litigation could result in the loss of evidence of a wide range of communications between parties who assert common legal interests but who really have only non-legal or exclusively business interests to protect.” M&A practitioners should be aware that although parties may include language in their confidentiality agreements and/or transaction agreements that asserts a commonality of legal interest in the information to be provided thereunder, in the absence of pending or anticipated litigation, it is unlikely that such language would preserve the attorney-client privilege under New York law as between separately represented parties. To the extent that parties to a transaction desire to retain the attorney-client privilege, the parties should consider jointly engaging one law firm to serve as special counsel for purposes of addressing any such issues. Delaware Supreme Court Upholds Damages Award to Holders of Options Canceled in Merger In June 2016, the Delaware Supreme Court affirmed a Court of Chancery decision, over Justice Valihura’s dissent, finding that the Caris Life Sciences, Inc. (Parent) board of directors, as administrator under an equity incentive plan, did not, as required by such plan, determine the fair market value of Parent common stock or adjust outstanding options to reflect the spinoff of a subsidiary (SpinCo) prior to the merger of Parent with a third party. CDX Holdings, Inc. (f/k/a Caris Life Sciences, Inc.) v. Fox, No. 526, 2015 (Del. Jun. 6, 2016). In addition, the Court held that the plain language of the equity incentive plan did not permit the holdback of a portion of the merger consideration payable to option holders. In the merger, each share of Parent common stock was converted into the right to receive $4.46 in cash, and in connection with the spinoff and merger transactions, option holders were told that the fair market value of Parent common stock for equity plan purposes was $5.07 per share—of which $4.46 was for Parent and $0.61 was for SpinCo. Because Parent and SpinCo were not publicly traded companies and the controlling stockholders received SpinCo equity and no cash, there was no transparent mechanism for determining the portion of the fair market value of Parent common stock attributable to SpinCo. Moreover, the controlling stockholders had an incentive to attribute a low value to SpinCo in order to ensure tax-free treatment of the transaction. The Parent board resolutions state “the exercise price of each [o]ption shall be proportionately adjusted to take into account the [spinoff],” but the Delaware Courts found that this fell short of a board determination of the adjustment of the exercise price or the fair market value of Parent common stock. It did not matter that the board had authorized the cancellation of options with the understanding that the outside tax advisors’ fair market valuation of SpinCo would be used. Two judges dissented in Ambac, arguing that the common interest exception should have applied in this case because the attorney-client privilege itself is not tied to the existence of actual or threatened litigation and clients often seek legal advice specifically in order to fend off litigation. Sidley Perspectives | AUGUST 2016 • 9 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE This case serves as a reminder of (i) the importance of documenting board determinations with specificity and (ii) the need to confirm during due diligence that the applicable plan and award agreements permit options to be treated similarly to common stock in a merger. Delaware Court of Chancery Denies Attorneys’ Fee Request for Disclosures Issued in Merger Litigation On July 22, 2016, the Delaware Court of Chancery denied the plaintiffs’ petition for an award of attorneys’ fees and expenses in connection with a lawsuit that had challenged the acquisition of Keurig Green Mountain, Inc. The Court earlier had granted expedited discovery in the action on the basis of a potential discrepancy between a press release and the proxy statement regarding the subject of management’s post-merger employment. Following discovery, the plaintiffs sought and obtained supplemental disclosures that confirmed, as had previously been disclosed in the proxy statement, the absence of any agreement, arrangement or understanding regarding management’s post-merger employment. In connection with the supplemental disclosures, the plaintiffs’ counsel sought a fee award of $300,000. The defendants, represented by Sidley, opposed the request on the basis that the supplemental disclosures merely confirmed information that already had been disclosed in the proxy statement. The Court agreed and denied plaintiffs’ petition on the basis that the supplemental disclosures were purely confirmatory in nature and therefore conferred no benefit on Keurig’s stockholders. Minnesota District Court Dismisses Shareholder Derivative Litigation Against Target’s Officers and Directors Following Cybersecurity Breach The shareholder derivative action related to Target Corporation’s 2013 cybersecurity breach has been closely watched, with many commentators predicting that cybersecurity-related litigation could become prevalent. In July 2016, the case, which was pending in the District of Minnesota, was dismissed pursuant to a stipulation that left open the question of whether the plaintiffs’ counsel would be awarded any attorneys’ fees. The plaintiffs had sued officers and directors of Target for breach of fiduciary duty and waste of corporate assets, alleging, among other things, that the defendants had known Target’s systems were vulnerable to attack, but nonetheless did not update them, that they ignored warnings, and that they had “utterly failed” to implement and oversee appropriate controls. Instead of moving to dismiss on demand futility grounds, Target’s board of directors appointed, pursuant to Minnesota law, a Special Litigation Committee consisting of a former justice of the Minnesota Supreme Court and a law professor, neither of whom had served on Target’s board or had a personal or professional relationship with Target. The Special Litigation Committee undertook an extensive investigation with the assistance of outside counsel and experts, including interviewing 68 witnesses and reviewing and analyzing thousands of documents, before concluding that it was not in Target’s best interests to pursue the shareholder derivative litigation and to seek to have it dismissed. The Special Litigation Committee then moved to dismiss the litigation, which resulted in the stipulated dismissal. Sidley Perspectives | AUGUST 2016 • 10 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE SEC DEVELOPMENTS SEC Proposes Rule Amendments to Streamline its Disclosure Requirements On July 13, 2016, the SEC proposed rule amendments to streamline its disclosure requirements as part of the ongoing “Disclosure Effectiveness Initiative” led by the SEC’s Division of Corporation Finance to review and improve the effectiveness of public company disclosure requirements. As described by the SEC, the proposed rule amendments would “update and simplify certain disclosure requirements by eliminating redundant, overlapping, outdated and superseded requirements due to changes in disclosure rules, accounting principles, and technology.” The proposals are a companion to the April 2016 concept release requesting comment on modernizing certain disclosure requirements in Regulation S-K as discussed in a previous Sidley Update available here. The SEC will accept public comments on the proposed rule amendments for sixty days after they are published in the Federal Register. The SEC identified legal proceedings as one area where current disclosure requirements overlap. In a table in the proposing release, the SEC highlighted several differences between Regulation S-K Item 103’s requirements to disclose legal proceedings and the requirement to disclose loss contingencies under U.S. GAAP. The SEC seeks comment on whether it should incorporate Item 103’s requirements into U.S. GAAP, while retaining the most expansive requirements. In certain cases, streamlining overlapping disclosure requirements may result in the relocation of disclosures within a filing. If disclosures are relocated from outside to inside the financial statements, it would mean that the information would be subject to annual audit and/or internal review and that the safe harbor under the Private Securities Litigation Reform Act of 1995 (PSLRA) would not be available for such disclosures. SEC Amends Form 10-K to Expressly Permit Summaries On June 1, 2016—to implement Section 72001 of the Fixing America’s Surface Transportation (FAST) Act—the SEC announced its approval of an interim final rule that expressly permits Form 10-K filers to provide a summary of business and financial information contained in the annual report. For each item it elects to include in the summary, a registrant must insert a cross-reference by hyperlink to the more detailed disclosure in the Form 10-K (or accompanying exhibit) to which that item relates. Thus, registrants can only summarize information that is included in the Form 10-K at the time the form is filed. Registrants need not update the summary if information required by Part III of Form 10-K is incorporated by reference from a later-filed proxy or information statement. What is perhaps most noteworthy about this new rule is its practical insignificance. Registrants were already permitted to include summaries in their Form 10-Ks. The SEC was compelled to adopt a rule of this sort by the FAST Act, but the new rule is not expected to have any meaningful impact on practice. SEC Proposes to Increase Financial Thresholds in “Smaller Reporting Company” Definition On June 27, 2016, the SEC proposed amendments to the definition of “smaller reporting company” in relevant SEC rules that would expand the number of registrants that qualify as such. Smaller reporting companies are eligible for scaled disclosure requirements, such as the ability to provide reduced financial, compensation and business disclosures. Under the current definition, registrants eligible to take advantage of these scaled disclosures requirements include those with (i) less than $75 million in public float as of the last business day of their most recently completed second fiscal quarter or (ii) no public float and annual revenues of less than $50 million during the most recently completed fiscal year for which audited statements are available. The proposed rules would raise the financial thresholds in In addition to the 318- page proposed rule, the SEC published an 193-page demonstration version highlighting the specific additions and deletions being proposed to its disclosure rules. Sidley Perspectives | AUGUST 2016 • 11 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE the “smaller reporting company” definition to accommodate registrants with (i) less than $250 million in public float or (ii) no public float and less than $100 million of annual revenues. Once a registrant exceeds either of these thresholds and no longer qualifies as a smaller reporting company, the proposed rules would provide that the registrant will remain unqualified (i) until its public float is less than $200 million at the end of its most recently completed second fiscal quarter or (ii) if it has no public float, until its annual revenues are less than $80 million during its most recently completed fiscal year. Importantly, however, the SEC did not propose any upward adjustment to the public float threshold in Exchange Act Rule 12b-2’s definition of “accelerated filer.” As a result, some registrants who would qualify as smaller reporting companies under the proposed rules (i.e., those with public floats between $75 million and $250 million) would still be subject to those requirements that currently apply to accelerated filers. These include, for example, the obligation to provide in the Form 10-K an auditor’s attestation of management’s assessment of internal controls over financial reporting. SEC Staff Issues Guidance Regarding the Application of Rule 701 in the M&A Context In June 2016, the SEC issued seven new Compliance and Disclosure Interpretations (C&DIs) relevant to acquisitions of privately held companies that have issued securities under certain compensatory benefit plans and contracts in reliance on the Rule 701 exemption from registration. Some of the new C&DIs clarify that: ■ no exemption from registration is required in connection with the acquirer’s assumption of options to acquire target securities (or other derivative securities of the target) offered and sold by the target under Rule 701 so long as the plan under which such options (or other derivative securities) were issued permits such assumption without the consent of the holders thereof; ■ if the target complied with Rule 701 at the time of the grant of options or other derivative securities, the exercise of the options (or conversion of other derivative securities) assumed by the acquirer is exempt from registration provided that the acquirer satisfies the information requirements of Rule 701(e), where applicable; ■ when determining the amount of securities that the acquirer may sell under Rule 701(d) and whether the disclosure requirements of Rule 701(e) apply, the acquirer must include in its calculations securities previously sold by the target pursuant to Rule 701 within the relevant timeframe; and ■ when determining whether the sales price or amount of securities sold has exceeded 15% of the issuer’s total assets or 15% of the outstanding amount of the class of securities being offered and sold, the acquirer may use a pro forma or a post-merger balance sheet reflecting the total assets and/or outstanding securities of the combined entity. In light of the new C&DIs, acquirers that are subject to Exchange Act Section 13 or 15(d) reporting requirements may determine not to register assumed options or other derivative securities, but as a practical matter, it may be less risky and less expensive to do so. Acquirers that are not subject to Exchange Act Section 13 or 15(d) reporting requirements should consider the availability of the Rule 701 exemption post-closing given the extent of the target’s use of such exemption. The proposed increases to the financial thresholds would enable more companies to qualify as “smaller reporting companies” and thereby become eligible to take advantage of scaled disclosure requirements. Sidley Perspectives | AUGUST 2016 • 12 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE SEC Staff Provides Guidance on Schedule 13G Eligibility An investor is eligible to report its beneficial ownership of securities on a short-form Schedule 13G only if it acquired or is holding the securities without the purpose or effect of changing or influencing control of the issuer. The “investment-only” exemption from premerger notifications under the Hart-Scott-Rodino (HSR) Act is only available if an investor acquired securities of the issuer “solely for the purpose of investment” without any intention to influence the issuer’s business decisions. In July 2016, the SEC issued a new Compliance and Disclosure Interpretation (C&DI) clarifying that an investor’s inability to rely on the “investment-only” exemption will not, by itself, preclude it from reporting on Schedule 13G. The determination of eligibility to use Schedule 13G is made based upon all relevant facts and circumstances, including the subject matter of an investor’s discussions with the issuer’s management and the context in which such discussions occurred. The new C&DI explains that engagement on executive compensation and social topics and promotion of good corporate governance practices generally will not disqualify an otherwise eligible investor from using Schedule 13G. On the other hand, Schedule 13G would not be available to an investor that engages with an issuer’s management regarding a contested election of directors or the sale of the company or a significant amount of its assets. SEC Approves NASDAQ Rule Requiring Disclosure of “Golden Leash” Arrangements On July 1, 2016, the SEC approved a NASDAQ rule proposal requiring NASDAQ-listed companies to publicly disclose “golden leash” arrangements, whereby directors or director nominees receive compensation for their candidacy or service from third parties. Specifically, under the new rule, listed companies will be required to disclose “the material terms of all agreements and arrangements between any director or nominee, and any person or entity other than the company…relating to compensation or other payment in connection with that person’s candidacy or service as a director.” Companies will not be required to disclose agreements and arrangements that (i) relate to reimbursement of expenses; (ii) existed prior to a nominee’s candidacy, if the relationship with the entity making the payment has already been disclosed; or (iii) have already been disclosed in the current year. The rule became effective on August 1, 2016. Disclosure for most companies will be required in the next proxy statement and annually in the proxy statement thereafter. In lieu of including the information in their proxy statement, companies may elect to disclose the relevant information through their website. If a company discovers an arrangement that should have been disclosed but was not, the company will have to include this information in a Form 8-K. NASDAQ companies should include a question in their D&O questionnaire regarding this new requirement. Companies will not be deemed deficient if they have undertaken reasonable efforts to identify all covered compensation agreements. CORPORATE GOVERNANCE DEVELOPMENTS Heads of Leading Public Companies and Institutional Investors Issue “Commonsense” Corporate Governance Principles In July 2016, a group of 13 executives from the company’s largest public companies and institutional investors issued a set of Commonsense Corporate Governance Principles designed to “provide a basic framework for sound, long-term oriented governance” at public companies. The group, which includes Warren Buffett and Jamie Dimon, teamed up in an effort to restore investor trust in public companies as their numbers have declined in In light of the new rule, NASDAQ-listed companies should update their D&O questionnaires to request information from directors and director nominees about any third-party compensation arrangements. Sidley Perspectives | AUGUST 2016 • 13 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE recent years. In general, the principles are high-level and reflect widely-accepted corporate governance best practices (e.g., majority voting in director elections, robust director evaluations), but the group chose not to take a firm position on certain more controversial governance topics (e.g., proxy access, term limits or a mandatory retirement age). The group acknowledges that the principles are not one-size-fits-all and would have to be tailored based on a company’s size, business and leadership structure. Public company boards would be well-advised to review the principles and consider whether they should make any updates to their corporate governance guidelines in light of them. ANTITRUST DEVELOPMENTS FTC Sharply Increases HSR Penalties, As DOJ Imposes Record Penalty for “Investment-Only” Violation The maximum civil penalty for violations of HSR premerger notification obligations increased significantly on August 1, 2016 from $16,000 per day to $40,000 per day. Because HSR violations often span many days, the penalty amounts can add up rapidly. A record civil penalty of $11 million was announced July 12 between the U.S. Department of Justice and several funds managed by ValueAct Capital, settling litigation that had been filed in April 2016. ValueAct had purchased shares of Baker Hughes and Halliburton, but had not submitted HSR filings; instead, it relied on Section 802.9 of the HSR rules, which exempts acquisitions of 10% or less of an issuer’s outstanding voting securities where the acquisition is “solely for the purpose of investment.” In the April complaint, the government alleged that ValueAct’s activities, including meetings with senior management of both companies to encourage decisions relating to the companies’ proposed merger, went beyond “investment-only” purposes and deprived ValueAct of the availability of the 802.9 exemption. The government originally sought a penalty of $19 million, based in part on six prior HSR violations by ValueAct funds; the last three of the prior violations had resulted in a $1.1 million penalty in 2007. The government has brought two actions alleging “investment-only” violations in the past year. In addition to ValueAct, an earlier case against Third Point funds for acquisitions of Yahoo! shares was settled without monetary penalty because the alleged violations were found to have been inadvertent, were short-lived, and were each fund’s first HSR Act violation. Other signs also point to a narrowing of the government’s view of the breadth of the investment-only exemption—the FTC’s Premerger Notification Office has recently added notices to past informal 802.9 staff opinions stating that these precedents do not reflect current enforcement positions. Numerous issues as to the scope of the 802.9 exemption remain unresolved under current law. The fact that the ValueAct case settled, rather than going to judicial decision and possible appeal, means that the courts will not be providing guidance in an area that cries out for clearer tests. Among other key questions, the investment community continues to face uncertainty about (i) the range of activities in which the investor is permitted to participate vis-à-vis the issuer before losing the exemption and (ii) the role and evaluation of the investor’s intent when applying the exemption, particularly where the investor’s plans shift or are contingent. For more information, see our Sidley Update available here. Sidley Perspectives | AUGUST 2016 • 14 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE sidley.com Sidley Austin provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Attorney Advertising - Sidley Austin LLP, One South Dearborn, Chicago, IL 60603. 312 853 7000. Sidley and Sidley Austin refer to Sidley Austin LLP and affiliated partnerships as explained at sidley.com/disclaimer. AMERICA • ASIA PACIFIC • EUROPE SIDLEY EVENTS Bay Area General Counsel Roundtable September 22 | Menlo Park, CA Sidley will host its annual Bay Area General Counsel Roundtable in Menlo Park, CA on September 22. The event is limited to General Counsel, Chief Legal Officers and their direct reports. Anyone interested in attending should contact Elpidio Benitag at email@example.com or (415) 772-7409. Sidley Corporate College September 27-29 | Chicago, IL and New York, NY Sidley will host its annual Corporate College in Chicago and New York from September 27-29. Sidley’s Corporate College is a program intended to expose participants to a broad spectrum of topics likely to be encountered by a transactional lawyer. Sidley clients interested in attending should contact Puja Batura at firstname.lastname@example.org or (312) 456-5789. SIDLEY RESOURCES An article entitled Hot Topics for Boards from the 2016 Proxy Season by Holly Gregory, a partner in our New York office, was published in the July/August edition of Practical Law’s The Governance Counselor. An article entitled New York and Delaware Agree: Directing Should Be Left to Directors by Andrew Stern and Benjamin Burry, attorneys in our New York office, was published in the New York Law Journal on July 18. The article discusses the New York Court of Appeals’ recent decision in In Re Kenneth Cole Productions, in which it expressly adopted the standard from Delaware's highest court in its 2014 Kahn v. M & F Worldwide Corp. decision, governing transactions in which a controlling shareholder proposes to take a public company private. Sidley represented the independent directors of Kenneth Cole Productions in the case. Sidley published a Corporate Governance Report on June 27 entitled Proxy Access Momentum in 2016. The report describes recent developments relating to proxy access, including voting results on shareholder proxy access proposals in 2016. It also includes an Appendix which highlights, on a company-by-company basis, the various detailed terms of proxy access provisions adopted by 118 companies in 2015 and 123 companies in the first half of 2016. Sidley published a Tax Update on June 10 entitled New IRS Restrictions on REIT Spinoffs Coupled with Tax-Free Mergers and Extension of “Sting Tax” Period Back to 10 Years. The update discusses new temporary regulations intended to prevent what the IRS regards as circumventions of the recently enacted statutory rules limiting REIT spinoffs. Sidley also published a Tax Update on July 19 entitled Treasury and IRS Issue Significant New Guidance on Tax-Free Spinoffs. The update discusses proposed regulations which would, among other things, restrict companies (including REITs) from effecting tax-free pro rata spinoffs involving significant nonbusiness assets. They would also require each of the spinning corporation and spun off corporation to hold assets of a qualifying trade or business with a fair market value of at least 5% of its total assets. 40% of companies in the S&P 500 have now adopted proxy access and we expect proxy access to become a majority practice at S&P 500 companies within the next year.