Sidley Perspectives | FEBRUARY 2016 • 1 IN THIS ISSUE SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE FEBRUARY 2016 ANALYSIS Financial Advisor Conflicts in M&A Transactions������������������������������������ 1 NEWS JUDICIAL DEVELOPMENTS Delaware Recommends New Path to Address Disclosure-Based Claims ������������� 5 Delaware Supreme Court Upholds Award of Expectation Damages for Breach of Preliminary Agreement������������������������������� 6 Regardless of Charter or Bylaw Provisions to the Contrary, Members of Declassified Boards Removable With or Without Cause if No Cumulative Voting ������������������������������ 7 Oregon Supreme Court Upholds Delaware Exclusive Forum Bylaw��������������� 8 SEC & REGULATORY DEVELOPMENTS SEC Proposes Dodd-Frank Rule for Reporting of Payments by Resource Extraction Issuers to Governments ����������� 9 Nasdaq Requests Comment on Potential Changes to Its Shareholder Approval Rules ������������������������������������������ 10 Nasdaq Files Proposed Rule Change to Give Companies Time to Regain Compliance Before Delisting for Failure to Hold an Annual Meeting���������������������� 10 CORPORATE GOVERNANCE DEVELOPMENTS Proxy Access Is Taking Hold��������������������� 11 Senate Bill Would Require Disclosure of Cyber-Expertise on Board������������������������ 12 SEC Rulemaking Related to Disclosure of Corporate Political Spending Remains in Flux ���������������������������������������������������������� 12 TAX DEVELOPMENTS Congress Passes Reforms Restricting Tax-Free REIT Spinoffs ������������������������������ 13 SIDLEY EVENTS AND SPEAKERS ��������� 14 SIDLEY RESOURCES �������������������������������� 14 ANALYSIS FINANCIAL ADVISOR CONFLICTS IN M&A TRANSACTIONS by Thomas A. Cole and Jack B. Jacobs1 The November 2015 Delaware Supreme Court decision involving Rural/ Metro Corporation (Rural Metro)2 has received considerable attention and has generated “lessons learned” lists directed at both financial advisors and the corporations and boards that they advise. (See, e.g., our Sidley Update issued on December 3, 2015.) To appreciate the deep significance of that decision, it must be considered in a broader context and as the most recent step in an evolution that began with Delaware decisions handed down in 2011. The Key Banker Conflict Cases Del Monte The first of these decisions was Del Monte, 3 decided by Vice Chancellor Laster in February 2011. In that case the Chancery Court criticized the selling company’s financial advisor for having “secretly and selfishly manipulated the sale process.” More pointedly, the Court said: “On multiple occasions, [the banker] protected its own interests by withholding information from the Board that could have led Del Monte to retain a different bank, pursue a different alternative, or deny [the banker] a buy-side role. [The banker] did not disclose the behind-the-scenes efforts of its Del Monte coverage officer to put Del Monte into play. [The banker] did not disclose its explicit goal, harbored from the outset, of providing buy-side financing to the acquirer. [The banker] did not disclose that in September 2010, without Del Monte’s authorization or approval, [the banker] steered Vestar into a club bid with KKR, the potential bidder with whom [the banker] had the strongest relationship, in violation of confidentiality agreements that prohibited Vestar and KKR from discussing a joint bid without written permission from Del Monte.” Vice Chancellor Laster went on to say that the board that had been misled had breached its fiduciary duties “[b]y failing to provide the serious oversight that would have checked [the banker’s] misconduct.” As part of the settlement relating to the Del Monte deal, the banker was ultimately liable for $23.7 million and Del Monte withheld the banker's fee of $21 million, which was used toward Del Monte's portion of the settlement. 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 senior counsel in Sidley’s Wilmington office who served on the Delaware Supreme Court from 2003 to 2014 and, prior to that, on the Delaware Chancery Court since 1985. The views expressed in this article are those of the authors and do not necessarily reflect the views of the firm. 2 RBC Capital Markets, LLC v. Jervis, No. 140, 2015, C.A. No. 6350-VCL (Del. Nov. 30, 2015). Sidley represented an amicus in the Rural Metro case. 3 In re Del Monte Foods Co. S’holders Litig., 25 A.3d 813 (Del. Ch. 2011). Sidley Perspectives | FEBRUARY 2016 • 2 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE El Paso The next case in the series involved the sale of El Paso Corporation to Kinder Morgan, Inc. under an agreement dated October 16, 2011—eight months after the Del Monte decision. 4 In the El Paso opinion issued in February 2012, then-Chancellor (now Chief Justice) Strine found that the banker had the following conflicts that the bank and its client board had failed to fully address, thereby calling into question decisions that would normally have been found to be reasonable: (1) the investment bank that represented the target owned 19% of the buyer and controlled two of the buyer’s board seats (a conflict that had been disclosed to the board); and (2) the lead individual on the banker’s team that represented the target personally owned $340,000 of stock in the buyer (a conflict that had not been disclosed to the board). The principal effort to address the known conflict—bringing in a second investment bank to advise the target—was found to be an inadequate solution because the second bank would be paid only if Kinder Morgan was the buyer. The fact that the bank created a “Chinese Wall” between its buyer and target teams received short-shrift. The Court’s reaction to the banker conflicts was also undoubtedly influenced by the fact that the CEO of the target had a conflict that had not been disclosed to the board. In the El Paso deal, the banker’s fee was $20 million, which it agreed to foreit in its entirety as part of Kinder Morgan’s settlement with stockholders. Rural Metro In Rural Metro, the target (Rural/Metro Corporation) was acquired by a private equity firm in a deal that was signed on March 28, 2011—one month after the Del Monte decision. The opinions of the Chancery Court were issued by Vice Chancellor Laster on March 7, 2014 (as to liability) and October 10, 2014 (as to damages). The Chancery Court decisions were affirmed by the Supreme Court on November 30, 2015. To simplify a case involving complicated facts, at the time that Rural Metro was being auctioned by its financial advisor, another company in the same industry, EMS, was also being auctioned—but not by the same bank. That created a conflict that (among other things) led to Rural Metro’s financial advisor being held liable for aiding and abetting a breach of the Rural Metro board’s duty of care. As summarized in the Supreme Court opinion: “The trial court…concluded that the initiation of the sale process [for Rural Metro] in December 2010 was unreasonable because [the banker] did not disclose that proceeding in parallel with the EMS process served [the banker’s] interest in gaining a role on the financing trees of bidders for EMS. [The court] found that [the banker] designed a process that favored its own interest in gaining financing work from bidders for EMS. [The banker’s] sale process design, as the trial court observed, prioritized the EMS participants so they would include [the banker] in their financing trees. [The banker] did not disclose the disadvantages of its proposed schedule.” In addition, Rural Metro’s banker was aggressively seeking to provide “stapled financing” to the bidders for Rural Metro at the same time it was advising Rural Metro’s board. The conflict created by that arrangement led to the retention by the board of a second financial advisor, which the Court described as playing only a “secondary” role and, unlike the typical arrangement for a second fairness opinion, was also being compensated on a “success fee” basis. The Court found that the involvement of the second bank did not “remedy [the banker’s] improper conduct” nor “cleanse the process.” 4 In re El Paso Corp. S’holder Litig., 41 A.3d 432 (Del. Ch. 2012). The board's retention of a second financial advisor will not necessarily cleanse a conflict involving the primary banker. Sidley Perspectives | FEBRUARY 2016 • 3 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Delaware Supreme Court in Rural Metro:“Because the conflicted advisor may, alone, possess information relating to a conflict, the board should require disclosure of, on an ongoing basis, material information that might impact the board’s process.” Echoing the Chancery Court’s criticism of the “misled” board in the Del Monte case, the Supreme Court said the following in the Rural Metro opinion: “While a board may be free to consent to certain conflicts, and has the protections of 8 Del. C. § 141(e), directors need to be active and reasonably informed when overseeing the sale process, including identifying and responding to actual or potential conflicts of interest. But, at the same time, a board is not required to perform searching and ongoing due diligence on its retained advisors in order to ensure that the advisors are not acting in contravention of the company’s interest, thereby undermining the very process for which they have been retained. A board’s consent to a conflict does not give the advisor a “free pass” to act in its own self-interest and to the detriment of its client. Because the conflicted advisor may, alone, possess information relating to a conflict, the board should require disclosure of, on an ongoing basis, material information that might impact the board’s process.” In a footnote to that passage, the Court added: “For instance, the board could, when faced with a conflicted advisor, as a contractual matter, treat the conflicted advisor at arm’s-length, and insist on protections to ensure that conflicts that might impact the board’s process are disclosed at the outset and throughout the sale process.” In Rural Metro, the primary banker’s advisory fee for the deal was approximately $5 million, although it had hoped to receive $55 million in financing fees from the combined Rural Metro and EMS deals. Ultimately, the primary banker was found liable for $76 million. Zale The last of the cases (to date) involved the sale of Zale Corporation under a contract entered into in February 2014. The Zale opinion by Vice Chancellor Parsons was issued on October 1, 2015. 5 The banker behavior challenged in Zale was that the target’s bank (and the same individual banker who led the team advising the target) had made a “pitch” to the buyer regarding a deal with the target one day before the buyer made its initial offer to purchase the target. In its pitch materials to the buyer, the bank had valued the target at between $17 and $21 per share. The buyer did not retain the bank, but made an initial offer of $19 per share in cash. The buyer later raised its offer to $19 per share in cash plus $1.50 in buyer stock and then raised its offer to $20.50 in cash. The target countered at $21 in cash. It was only after the deal was signed—indeed, during the preparation of the “background of the merger” section of the proxy statement—that the banker disclosed to the target that it had made the pitch to the buyer and its $17 to $21 valuation range. In an opinion denying a motion to dismiss the complaint against the banker, Vice Chancellor Parsons stated: “I agree with Plaintiffs that it is reasonably conceivable that [the individual banker’s] presence on both the team that presented to [buyer] and the team that advised the Board [of the target] would have undermined both his and [target’s] credibility if they attempted to negotiate…a price higher than $21…[C]onsidering the fact that the final price ended up being $21 per share, I find it reasonably conceivable that this undisclosed conflict hampered the ability…to seek a higher price for [target’s] stockholders.” The Chancery Court also found that the fact that the board met three times to consider the conflict after learning of the issue did not suffice to “cleanse the conflict.” It is important to recognize that the opinion in Zale was issued at the motion to dismiss stage in the proceeding and that the “last word” in the case has yet to come down. Nevertheless, it presents a cautionary tale. 5 In re Zale Corp. S’holders Litig., 2015 WL 5853693 (Del. Ch. Oct. 1, 2015). Sidley Perspectives | FEBRUARY 2016 • 4 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Rural Metro and other recent cases should not trigger an overreaction to plain-vanilla conflicts involving financial advisors, such as routine business relationships with potential counterparties. Actual or potential banker conflicts should be disclosed to the board as early as possible in the deal process so that the board has sufficient time to replace the bank or retain a second bank if it so chooses. The Delaware courts have always been concerned about conflicts that might operate to the detriment of stockholders. The courts have manifested this concern in several different ways. To list a few: (1) applying “enhanced scrutiny” in Revlon or Unocal situations, to counter the possibility of self-interest on the part of a board; (2) applying the “entire fairness” standard to interested transactions with controlling stockholders; and (3) strictly enforcing the statutory exclusion of breaches of the duty of loyalty from director exculpation. Moreover, as reflected in the banker cases described above and older M&A transactional cases such as Macmillan, 6 the greatest sin is the nondisclosure of a conflict that operates as a “fraud on the board,” the Supreme Court’s characterization of the primary financial advisor’s conduct in Rural Metro. Impact on the Corporate/Banker Relationship As a result of these cases, investment banks and other financial advisors expect to be asked about conflicts at the outset of engagements. They are now prepared to generate reports about business relationships with potential counterparties and to update those reports as needed during the pendency of the advisory relationship. Boards should not overreact to disclosures that their bankers engage in financing or other business with potential counterparties. That is routine, and none of the four cases described above relates to those kinds of plain-vanilla conflicts. It is critical, however, that banker reports about business relationships be supplemented with due diligence (consistent with confidentiality obligations) about (1) relationships of individual members of their deal team with potential counterparties, (2) “pitches” that the banks may have made in the recent past pertaining to the target (i.e., the Zale-type situation) and (3) concurrent pitches that the bank may be making not directly related to, but nevertheless material to, the target (i.e., the Rural Metro-type situation). Disclosures along those lines will not necessarily be disqualifying, but should prompt consideration of whether to take steps to adequately “cabin” the conflict (a term from the El Paso opinion), such as retaining a second bank. In those circumstances, the role of the second bank and the structure of its compensation must be carefully considered for it to have the desired “cleansing” effect. Because of the exacerbating effect of the management conflict in El Paso (and, indeed, independent of that), a board should take steps to limit the potential for that conflict as well. For example, many boards expressly prohibit management from discussing personal arrangements with bidders until all key terms have been agreed to in principle. A board’s efforts to identify and evaluate banker conflicts should be clearly documented in board meeting minutes, including all relevant facts and diligence efforts that guided the board’s business judgment. The minutes should be purely factual and avoid advocacy. In Rural Metro, Vice Chancellor Laster criticized the discussion of a potential banker conflict in the minutes of a key target board meeting as being partially inaccurate and having “the feel of a document drafted in anticipation of litigation.” More than ever before, the minutes of board proceedings are being scrutinized, making contemporaneous and accurate drafting important. As Chief Justice Strine advised in an article in the Summer 2015 issue of The Business Lawyer entitled “Documenting the Deal: How Quality Control and Candor Can Improve Boardroom Decision-making and Reduce the Litigation Target Zone,” meeting minutes documenting an M&A process should be comprehensive and timely produced. This, in turn, raises the questions of (1) how much of what is captured in the board minutes should be included in the proxy statement and (2) will an expectation of such publication have a chilling effect on the robustness of the underlying disclosure to the board? 6 Mills Acquisition Co. v. Macmillan, Inc., 559 A. 2d 1261 (Del. 1989). Sidley Perspectives | FEBRUARY 2016 • 5 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Disclosure of banker conflicts to stockholders in the proxy statement may support subsequent review of the merger under the deferential business judgment standard in light of the Delaware Supreme Court’s recent decision in Corwin v. KKR Fin. Holdings LLC. As discussed in our December 2015 issue, that decision clarified the standard of review applied when a transaction not subject to entire fairness is approved by a vote of fully informed disinterested stockholders. According to Chancellor Bouchard, the Delaware Chancery Court’s historical tendency to approve disclosure settlements—often of marginal value that included broad releases and six-figure fees to plaintiff’s counsel— “caused deal litigation to explode…beyond the realm of reason” requiring a re-examination of the Court’s approach. Given the language in the footnote in the Rural Metro opinion (about possible “contractual…protections to ensure that conflicts…are disclosed at the outset and throughout the sale process”), client companies may begin seeking such provisions in banker engagement letters. Such provisions might include representations about business relationships with counterparties and covenants to update disclosures during the pendency of a deal. In an article in the Winter 2015-2016 issue of The Business Lawyer entitled “Financial Advisor Engagement Letters: Post-Rural/Metro Thoughts and Observations,” the authors elaborated at length about such possible provisions. Certain of their suggestions, which would utilize the engagement letter as the vehicle to address banker conflicts, would lead to a spirited negotiation between the banks and their prospective corporate clients. Whether this approach is desirable (or even attainable) is a question that counsel for both parties may soon be required to address. Finally, despite the favorable aspects of the opinion in Rural Metro (i.e., that the court rejected the “gatekeeper” label as applied to financial advisors and reiterated that scienter is required for aiding-and-abetting liability), these cases have prompted heightened sensitivity on the part of banks (and their counsel) when reviewing the “background of the merger” sections of proxy statements for language that gives any hint of a conflict issue that a plaintiff might seize upon as the basis for a lawsuit. Again, the engagement letter provisions relating to banker review rights deserve careful consideration. If nothing else, this heightened sensitivity could add time to proxy statement preparation. NEWS7 JUDICIAL DEVELOPMENTS Delaware Recommends New Path to Address Disclosure-Based Claims As we have reported in previous issues, the Delaware courts have been closely scrutinizing disclosure-only settlements of M&A litigation. In In re Trulia, Inc. Stockholder Litigation (Del. Ch. Jan. 22, 2016), the Delaware Chancery Court recently declined to approve another disclosure-only settlement. More significantly, in doing so, the Court suggested a new path forward for handling disclosure-based deal claims. The disclosure settlement in question arose from Zillow, Inc.’s stock-for-stock merger with Trulia, Inc. The supplemental disclosure all pertained to the financial analyses Trulia’s financial advisor provided to support its fairness opinon. After an initial settlement hearing, the parties narrowed the release included in the settlement, removing “unknown,” “foreign” and state and federal antitrust claims. In the end, Chancellor Bouchard declined to approve the settlement, noting the proxy already included a fair summary of the financial advisor’s financial analyses, and that the supplemental disclosures were neither material nor provided any meaningful benefit to stockholders, and thus did not provide adequate consideration to support the release. In denying the proposed settlement, the Chancellor noted the dynamics that have led to the rise of disclosure settlements and the criticism of them from academics, practitioners and the judiciary (inside and outside Delaware). The Chancellor recommended that disclosurebased claims should be adjudicated in an adversarial process where defendants’ desire to obtain a release “does not hang in the balance.” He noted this could occur either: (1) in the context of a preliminary injunction motion, where plaintiffs would bear the burden of showing “a substantial likelihood that the omitted disclosure would have been viewed by the reasonable investor as material” or (2) as part of a mootness proceeding where plaintiffs’ 7 The following Sidley attorneys contributed to the research and writing of the pieces in this section: Beth E. Flaming, John P. Kelsh, Mark Metts, Hille R. Sheppard, Jim W. Ducayet, John K. Hughes, Edward R. McNicholas, Christopher Y. Lee and Clayton G. Northouse. We appreciate their contributions. Sidley Perspectives | FEBRUARY 2016 • 6 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE The Delaware Supreme Court found that expectation damages are appropriate for a Type II preliminary agreement where a plaintiff can prove the fact of damages with reasonable certainty, even if the amount of damages is an estimate. counsel seeks Court approval of attorneys’ fees after defendants have voluntarily provided stockholders with the supplemental disclosure that plaintiffs had sought, thereby mooting plaintiffs’ claims. The Chancellor warned that the Court will be increasingly vigilant as to the reasonableness of future disclosure settlements, and that they will be met with continued disfavor unless (1) the disclosures address “plainly material” misrepresentations or omissions, which he described as claims that are not a “close call,” and (2) the releases address only disclosure and fiduciary duty claims. As to the potential for plaintiffs to forum shop, the Chancellor noted forum selection bylaws are available, but he hoped sister courts will agree with Delaware’s approach. Delaware Supreme Court Upholds Award of Expectation Damages for Breach of Preliminary Agreement In SIGA Technologies, Inc. v. PharmAthene, Inc. (Del. Dec. 28, 2015), the Delaware Supreme Court upheld an award of $113 million in lump-sum expectation damages for the breach by SIGA of an obligation to negotiate a license agreement after a failed merger between two biotech companies. The obligation to negotiate was tied to a detailed licensing term sheet that set out the key economic terms of the licensing arrangement. Even though the term sheet itself contained a footer that described it as non-binding, it was attached to both a binding merger agreement and bridge loan agreement. The Delaware Supreme Court affirmed the Chancery Court’s finding that the agreement to negotiate a license agreement was a so-called Type II preliminary agreement. Specifically, the Chancery Court found that the parties had agreed to the key economic terms, even though some terms remained to be negotiated. The Court held that expectation damages are appropriate for a Type II preliminary agreement where a plaintiff can prove the fact of damages with reasonable certainty, even if the amount of such damages is an estimate. The Court also affirmed the Chancery Court’s consideration of the wrongdoer’s willfulness and failure to negotiate in good faith as factors in resolving uncertainties in the damage amount against the wrongdoer, particularly if the wrongdoer’s bad faith caused the uncertainties. The dispute arose out of SIGA’s need for funds to complete the development of an antiviral drug for the treatment of smallpox. In 2006, SIGA discussed a worldwide licensing arrangement with PharmAthene, and those discussions evolved into merger negotiations. Previously, the two parties had attempted to merge in 2003, but PharmAthene had backed out. Therefore, SIGA insisted on a back-stop licensing arrangement if the 2006 merger did not go through. Because of SIGA’s precarious financial position, PharmAthene provided SIGA with a bridge loan during the merger negotiations, which required the parties to negotiate in good faith a license agreement in accordance with the terms spelled out in a licensing term sheet if the merger was not consummated. The parties then signed a merger agreement with a similar provision. Before the merger closed, SIGA learned of several positive developments related to the drug, including the awards of various grants and government funding, and SIGA terminated the merger agreement after the drop-dead date. After termination, SIGA received positive results from a primate trial, and SIGA’s internal valuation of the drug increased dramatically. In post-termination discussions with PharmAthene, SIGA proposed an LLC agreement instead of the licensing arrangement provided for by the bridge loan agreement and merger agreement. SIGA told PharmAthene that if PharmAthene insisted on those licensing terms, the parties would have “nothing more to talk about.” PharmAthene then filed suit. In the majority opinion, Justice Seitz affirmed the Chancery Court’s award of $113 million in expectation damages to PharmAthene and held that the Chancery Court applied the correct legal standard and factual analyses. In her dissent, Justice Valihura disagreed, Sidley Perspectives | FEBRUARY 2016 • 7 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE A Delaware corporation should not count on the enforceability of charter or bylaw provisions permitting director removal only for cause unless it has a classified board or cumulative voting. concluding that expectation damages are not typically awarded for the breach of preliminary agreements because establishing these damages with sufficient certainty is too difficult. Justice Valihura also criticized the majority for relying on post-breach evidence and the “wrongdoer rule” to resolve uncertainties in the damage amount in favor of PharmAthene. The decision underscores the care parties should undertake in drafting agreements tied to term sheets, even in back-stop situations as arose in SIGA. Those agreements are enforceable and a breaching party may be on the hook for significant expectation damages, even if the amount of such damages is uncertain. Additionally, uncertainties in the amount of such damages may be resolved against the breaching party if the breach was willful and caused the uncertainty. Regardless of Charter or Bylaw Provisions to the Contrary, Members of Declassified Boards Removable With or Without Cause if No Cumulative Voting In December 2015, Vice Chancellor Laster of the Delaware Chancery Court ruled that, under the plain meaning of Section 141(k) of the Delaware General Corporation Law, a corporation’s charter or bylaws cannot provide for director removal only for cause where the corporation’s board is not classified or the corporation does not have cumulative voting. 8 Thus, the Court declared invalid and unenforceable the provisions of VAALCO Energy, Inc.’s charter and bylaws that stated that its directors were removable only for cause. The Court stated that the invalidity and unenforceability of such provisions did not affect the validity or enforceability of the other provisions contained in VAALCO’s charter and bylaws, which is good news for the nearly 200 public companies with charter or bylaw provisions similar to VAALCO’s. The Delaware Supreme Court has not passed on the Chancery Court ruling. (The parties settled shortly after the ruling.) However, Delaware corporations with charter or bylaw provisions similar to VAALCO’s should not count on the enforceability of such provisions. As a practical matter, such provisions will be relevant only in the unusual case of a consent solicitation (as in VAALCO) or where a stockholder seeks to call a special meeting to remove directors—both of which are less likely to occur with companies that do not have a classified board. Some commentators have suggested that if companies do not amend their organizational documents to eliminate provisions similar to VAALCO’s, there is some risk that stockholders could bring suit or serve stockholder demands claiming breach of fiduciary duty, and, where amendments are subsequently made, plaintiffs’ firms could seek payment for effecting such removal. Accordingly, companies with provisions similar to VAALCO’s should consider amending their organizational documents to eliminate such provisions. However, where such an amendment would require stockholder approval, a company might consider as an alternative adopting, and publicly disclosing, an amendment to its corporate governance guidelines undertaking not to enforce such provisions. For boards that are considering declassification, the VAALCO decision has two key takeaways: (1) after the board is declassified, directors will be removable with or without cause (assuming the company does not have cumulative voting) and (2) declassifying over time in a manner that results in one class remaining before full declassification is effective should preserve removal only “for cause” through the effective date of full declassification. 8 Transcript ruling dated December 21, 2015 from the In re VAALCO Energy, Inc. S’holder Litigation. Sidley Perspectives | FEBRUARY 2016 • 8 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE TriQuint marks the first appellate ruling outside of Delaware that considered the validity and enforceability of a Delaware exclusive forum bylaw. In upholding TriQuint’s Delaware exclusive forum bylaw and finding that TriQuint’s directors did not breach their fiduciary duties in adopting it, the Oregon Supreme Court noted that TriQuint’s “bylaw does not prevent its shareholders from challenging the merger. It only provides where they may do so.” Oregon Supreme Court Upholds Delaware Exclusive Forum Bylaw In Roberts v. TriQuint Semiconductor, Inc. (Ore. Dec. 10, 2015), the Oregon Supreme Court overturned a lower Oregon court decision and held that a Delaware corporation’s exclusive forum bylaw was enforceable under Oregon law. The decision is significant because it is the only appellate court ruling outside of Delaware to address the issue. Furthermore, the decision continues a trend of upholding these provisions outside of Delaware. TriQuint is a Delaware corporation headquartered in Oregon. In February 2014, TriQuint’s board of directors amended the company’s bylaws to designate the Delaware Chancery Court as the exclusive forum for resolving internal corporate disputes, including stockholder derivative suits. Two days after the board adopted the exclusive forum bylaw, TriQuint announced plans to merge with RF Micro Devices, Inc. Each corporation’s board of directors unanimously approved the merger. Two stockholder derivative suits were filed in Oregon, and three similar suits were filed in Delaware. TriQuint moved to dismiss the Oregon actions, based on its exclusive forum bylaw. The Oregon plaintiffs argued that the TriQuint board breached its fiduciary duties in adopting this bylaw. Specifically, they argued that the bylaw was invalid because it was being used for improper purposes inconsistent with the directors’ fiduciary duties. (Such an exception to validity was discussed by the Delaware Chancery Court in Boilermakers Local 154 Retirement Fund v. Chevron Corp. (Del. Ch. 2013).) Alternatively, the Oregon plaintiffs argued that—as applied in this case—the bylaw was unenforceable and unfair, primarily because giving effect to the bylaw would deprive TriQuint’s stockholders of their statutory right to amend the bylaws. The Oregon trial court denied TriQuint’s motion to dismiss. The court held that, even though Delaware law authorized TriQuint’s board to adopt unilaterally an exclusive forum bylaw, by doing so in close proximity to the time it approved the merger, the board effectively deprived TriQuint’s stockholders of their statutory right under Delaware law to modify or repeal bylaws adopted by the board. The Oregon Supreme Court reversed, ruling that the question of whether the TriQuint board had breached its fiduciary duty was a question of Delaware law, not Oregon law. The Supreme Court relied on the Delaware Chancery Court’s decision in City of Providence v. First Citizens BancShares, Inc. (Del. Ch. 2014), which also involved an exclusive forum bylaw that was adopted contemporaneously with approval of a merger. The Oregon Supreme Court held that the TriQuint board had not breached its fiduciary duty by adopting the bylaw because the “bylaw does not prevent its shareholders from challenging the merger. It only provides where they may do so.” With respect to the plaintiff’s second argument—the unenforceability or unfairness of applying the bylaw to this plaintiff—the Oregon Supreme Court held that, in this case, the question of which state’s law applies to a forum-selection clause is a question of Oregon law, not Delaware law. But the Court found that Oregon law was not dissimilar to Delaware law on the point. The Court noted that, when purchasing stock in a Delaware corporation, stockholders buy into a legal framework that permits the unilateral adoption of an exclusive forum bylaw by the board. The Court held that—in the “absence of compelling policies to the contrary”—the Court would not interfere with that framework. The Court found no such compelling policies in this case, since the Delaware courts were “well-equipped to resolve intra-corporate disputes” and there was no evidence that proceeding in the Delaware courts would be “seriously inconvenient.” Sidley Perspectives | FEBRUARY 2016 • 9 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE As extended by the SEC in late January 2016, the deadline for initial public comments on the proposed disclosure rules applicable to resource extraction issuers is February 16, 2016. The deadline for reply comments (responding only to issues raised in the initial comment period) is March 8, 2016. SEC & REGULATORY DEVELOPMENTS SEC Proposes Dodd-Frank Rule for Reporting of Payments by Resource Extraction Issuers to Governments On December 11, 2015, the SEC proposed Rule 13q-1 under the Securities Exchange Act of 1934, together with amendments to Form SD (the Proposed Rule). If adopted, the Proposed Rule would have far-reaching consequences for companies engaged in mining businesses and upstream and midstream oil & gas businesses in the United States and worldwide. It covers far more than just payments made to governments overseas in order to obtain oil & gas or mining concessions. The Proposed Rule is intended to implement Section 1504 of the Dodd-Frank Act, which requires that resource extraction issuers disclose payments to federal and foreign governments. The SEC initially adopted Rule 13q-1 in August 2012, but it was subsequently vacated by the U.S. District Court for the District of Columbia. The SEC is now proposing a modified form of Rule 13q-1 and—just as importantly—has elaborated on its rationale for its formulation of the rule in order to address the federal court’s concerns about the process that the SEC used in proposing its initial version of the rule. The Proposed Rule requires each “resource extraction issuer” to file a Form SD with the SEC no later than 150 days after the end of that issuer’s fiscal year. A “resource extraction issuer” is an issuer that (1) is required to file an annual report with the SEC on Form 10-K, 20-F or 40-F and (2) engages in the “commercial development” of oil, natural gas or minerals. The Proposed Rule does not exempt smaller reporting companies, emerging growth companies or foreign private issuers. The SEC defines “commercial development” to mean exploration, extraction, processing and export, or the acquisition of a license for any such activity. The Proposed Rule makes clear that midstream activities such as gas processing are included in the definition. However, transportation and downstream activities (such as refining and smelting) are excluded, as are ancillary services. Under the Proposed Rule, a resource extraction issuer would be required to disclose annually on Form SD any “not de minimis” payment made by such issuer (or by a subsidiary or entity under control of such issuer) to the U.S. federal government or a foreign government for the purpose of the commercial development of oil, natural gas or minerals. The term “foreign government” includes companies that are majority-owned by a foreign government, as is the case with national oil companies. The term “payments” is broadly defined. It includes taxes, royalties, license fees and other fees, production entitlements, bonuses, and payments for infrastructure improvements. Ordinary dividends based on share ownership are not included, but dividends in lieu of royalties or license fees would be included. “Not de minimis” means any payment (whether a single payment or a series of related payments) that equals or exceeds $100,000 during the most recent fiscal year. Significantly, the disclosure is required on a project-by-project basis, and “project” is defined granularly so that each separate contract or license with a governmental body represents a separate project. However, operational activities governed by multiple legal agreements may be considered a single project if those agreements are both operationally and geographically interconnected. Furthermore, company level taxes (such as income taxes or franchise taxes) must be disclosed, but they can be reported on an aggregate basis and do not need to be allocated to individual projects. The Proposed Rule does not include any express exemptions, including an exemption under circumstances where a foreign government prohibits the disclosure of the information. However, under its existing authority under the Exchange Act, the SEC will consider Sidley Perspectives | FEBRUARY 2016 • 10 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE requests for exemptive relief on a case-by-case basis taking into account an issuer’s particular facts and circumstances (e.g., potential competitive harm from public disclosure). Resource extraction issuers would be required to comply with the rules for fiscal years ending no earlier than one year after the effective date of the adopted rules. Therefore, each resource extraction issuer will likely need to begin complying with the adopted rules with respect to its fiscal year ending in 2017. However, because of the detailed nature of the information required to be reported—including a determination of how to identify each “project” within the meaning of the Proposed Rule—we recommend that each affected issuer begin developing systems to capture and report the required information. Nasdaq Requests Comment on Potential Changes to Its Shareholder Approval Rules Similar to the New York Stock Exchange, Nasdaq requires listed companies to obtain shareholder approval prior to certain types of transactions. These transactions include a change in control, issuances of greater than 20% of an issuer’s common stock and the adoption or material amendment of equity compensation plans. These rules have for the most part been in place since 1990. In November 2015, Nasdaq requested public comment on whether and how these rules should be modified. In its request for comment, which is available here, Nasdaq noted that since the adoption of the rules there have been additional investor protection mechanisms (i.e., stronger corporate governance practices) put in place and an increased threat of shareholder litigation. As a result, Nasdaq suggested that the rules may no longer serve their original shareholder protection purpose. Nasdaq’s request for comment is focused on the transaction-based aspects of its shareholder approval rules rather than on the aspects of the rules related to equity compensation. NASDAQ Files Proposed Rule Change to Give Companies Time to Regain Compliance Before Delisting for Failure to Hold an Annual Meeting Nasdaq rules require that Nasdaq-listed companies hold an annual meeting of shareholders within one year after the end of each fiscal year. Current Nasdaq rules further provide that a company that fails to comply with this requirement is subject to immediate suspension and delisting, subject to the company’s right to request review by a Nasdaq Hearings Panel. This is the only Nasdaq rules violation that automatically triggers the initiation of a delisting process. The only other circumstance subjecting a company to immediate suspension and delisting is when the Nasdaq staff determines that a “Company’s continued listing raises a public interest concern.” On December 22, 2015, Nasdaq filed proposed rule amendments with the SEC that would provide the Nasdaq staff with limited discretion to grant a listed company that failed to timely hold its annual meeting of shareholders an extension of time to comply with the requirement. Under the proposed rules, in considering whether to grant such an extension, the staff would consider the “likelihood that the Company would be able to hold an annual meeting within the exception period, the Company’s past compliance history, the reasons for the failure to timely hold an annual meeting, corporate events that may occur within the exception period, the Company’s general financial status, and the Company’s disclosures to the market.” Sidley Perspectives | FEBRUARY 2016 • 11 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Nearly 25% of companies in the S&P 500 have now adopted proxy access. We expect that proxy access will become a majority practice among S&P 500 companies in the next two to three years. CORPORATE GOVERNANCE DEVELOPMENTS Proxy Access Is Taking Hold As discussed in our Sidley Update entitled “Proxy Access in 2015—The Year in Review,” the full year data now confirms that 2015 was the tipping point for proxy access, following the private ordering pattern of majority voting in uncontested director elections. The 2015 proxy season saw a significant increase in the number of shareholder proxy access proposals (91 voted on compared to 18 in 2014) and shareholder support for such proposals (55 passed with an average percentage of votes cast in favor of 55%, compared to 5 passed with average support of 34% in 2014), as well as an increased frequency of negotiation and adoption of proxy access via board action. The back half of the year saw an accelerating trend towards boards unilaterally adopting proxy access, in many cases without first receiving a shareholder proposal. Proxy access will continue to be a hot topic in 2016, particularly in light of the New York City Comptroller’s announcement in January 2016 that the New York City Pension Funds submitted proxy access proposals at 72 companies for the 2016 proxy season. One hundred and eighteen companies adopted proxy access in 2015, including 56 adoptions in the last two months of the year. More than 20 additional companies adopted proxy access in January 2016. The Appendix to our Sidley Update highlights the various terms of the proxy access provisions adopted in 2015 on a company-by-company basis and overall prevalence. The following terms are becoming increasingly standard in proxy access bylaws: 3% minimum ownership for at least three years for up to 20% of the board (at least two directors) with a group size limit of 20. In December 2015, ISS issued FAQs to its 2016 proxy voting guidelines that outline when it may issue negative vote recommendations against directors of companies that do not implement a majority-supported shareholder proxy access proposal substantially in accordance with its terms. In evaluating the board’s response, ISS will examine (1) whether the major points of the shareholder proposal are being implemented and (2) additional provisions that were not included in the shareholder proposal in order to assess whether such provisions unnecessarily restrict the use of a proxy access right. To forestall negative vote recommendations against directors at their 2016 annual meetings, a few companies recently have amended their proxy access bylaws to eliminate some restrictions that ISS identified in the FAQs as “potentially problematic” (including an ownership threshold above 3%, aggregation limit below 20 shareholders or a cap on proxy access nominees set at less than 20% of the board). In October 2015, the SEC Staff issued a legal bulletin announcing that it will permit a company to exclude a shareholder proposal under Exchange Act Rule 14a-8(i)(9) as “directly conflicting” with a management proposal only if a reasonable shareholder could not logically vote in favor of both proposals. The new guidance made it unlikely that a company could exclude a shareholder proxy access proposal under Rule 14a-8(i)(9) by putting forth a management proxy access proposal with different terms. Most companies that have submitted no-action requests to the SEC in recent months are seeking exclusion of proxy access proposals from their 2016 annual meeting ballots on the basis of “substantial implementation” under Rule 14a-8(i)(10). It is yet to be seen whether the SEC will provide no-action relief if the provisions of the proxy access bylaw adopted by the company vary considerably from the terms of the shareholder proposal or if the shareholder proposal seeks to exclude or modify a particular term in an existing proxy access bylaw. Sidley Perspectives | FEBRUARY 2016 • 12 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE In a press statement, Senators Reed and Collins cited a review by the New York Stock Exchange and a security firm that found that two-thirds of surveyed companies believe their boards are ill-prepared for a cyber attack. Senate Bill Would Require Disclosure of Cyber-Expertise on Board The new Cybersecurity Disclosure Act of 2015 would require public companies to disclose whether any members of their boards are cybersecurity experts. Introduced in December 2015 by Senators Jack Reed (D-RI) and Susan Collins (R-ME), the Act targets the perceptions that many boards of directors lack the experience to understand risks to information assets with the same level of rigor that is brought to understanding financial and operational issues. “Cybersecurity is one of the most significant and enduring challenges businesses face and should be accounted for as part of the corporate risk management process,” stated Senator Reed. “This legislation will highlight how focused firms are in terms of data security and safeguarding private information and should encourage more companies to improve their cybergovernance.” The legislation would require public companies to disclose in their SEC filings “whether any member of the governing body, such as the board of directors or general partner, of the reporting company has expertise or experience in cybersecurity.” If the board lacks this experience, companies would have to disclose “what other cybersecurity steps” were taken by the board in nominating members to the board. What constitutes cybersecurity expertise or experience would be defined by the SEC in conjunction with the National Institute of Standards and Technology (NIST). SEC Chair Mary Jo White has stated that “[t]he SEC’s formal jurisdiction over cybersecurity is directly focused on the integrity of our market systems, customer data protection, and disclosure of information.” The Cybersecurity Disclosure Act of 2015 underscores the need for public companies to ensure that a cybersecurity governance structure is in place and that boards are appropriately informed and educated about their companies’ cyber risks. The legislation would further strengthen cybersecurity disclosure requirements and build upon existing SEC guidance, including the Division of Corporation Finance’s cybersecurity disclosure guidance issued on October 13, 2011, which already recommends disclosure of material information regarding cybersecurity risks and incidents. SEC Rulemaking Related to Disclosure of Corporate Political Spending Remains in Flux As discussed in our December 2015 issue, the SEC faces mounting pressure to adopt rules requiring public companies to disclose their expenditures on political activities. Calls for the SEC to draft political spending disclosure rules have come from variety of sources, including from members of Congress and in over 1.2 million comment letters from the public in response to a 2011 rulemaking petition on the subject. It is likely that the presidential election campaign in 2016 will increase the pressure for more transparency in corporate political expenditures. Despite this increased focus on the issue, Congress took action in December 2015 that will restrict the SEC’s ability to adopt corporate political spending disclosure rules this year. The omnibus spending bill adopted by Congress for 2016 contains a provision prohibiting the SEC from using funds to “finalize, issue, or implement any rule, regulation, or order regarding the disclosure of political contributions” in 2016. However, this development may not mean that the rulemaking item will fall off the SEC’s 2016 agenda entirely. The provision does not expressly limit the SEC’s ability to propose such a rule in 2016, and several Democratic senators and members of Congress have urged the SEC to continue working on the rule proposals so that they will be ready for adoption once the spending bill expires. Sidley Perspectives | FEBRUARY 2016 • 13 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE TAX DEVELOPMENTS Congress Passes Reforms Restricting Tax-Free REIT Spinoffs In December 2015, Congress passed the Protecting Americans from Tax Hikes Act of 2015, which contains important reform measures for real estate investment trusts (REITs). The Act significantly restricts REIT spinoff transactions, a popular transaction in recent years for U.S. companies with significant real estate assets. Under Section 355 of the Internal Revenue Code, a corporation may distribute to its stockholders the shares of a corporate subsidiary in a manner that is tax-free for both the distributing corporation and its stockholders if certain requirements are met. In recent years, mostly under pressure from activist investors, tax-free spinoffs by corporations with significant real estate assets have been combined with an immediate REIT election in respect of either the distributing corporation or the spun out subsidiary. Typically, the subsidiary (the property company) leases its property back to the distributing corporation (the operating company) under a master lease. These structures are commonly known as “REIT spinoffs” or “opco/propco” REIT spinoffs. On the ground that REIT spinoffs permanently remove the appreciation in the real estate assets from the reach of the corporate level tax, REIT spinoffs have been described as the latest “Wall Street tax shelter” or “domestic inversion transactions.” In addition, the Internal Revenue Service recently issued Notice 2015-59, announcing that it would study REIT spinoffs. To prevent the further proliferation of REIT spinoffs, the Act provides that Section 355 does not apply if either the distributing corporation or the spun off subsidiary is a REIT, and neither the distributing corporation nor the spun off subsidiary can make a REIT election within the 10-year period following the spinoff. REITs that spin off other REITs or “taxable REIT subsidiaries” (or TRSs) held for more than three years are exempt from the “no REIT spinoff” rule. This “no REIT spinoff” rule became effective for spinoffs occurring after December 7, 2015, except that REIT spinoffs for which an IRS private letter ruling request was pending on that date are grandfathered. In light of the Act, we expect to see fewer REIT spinoffs in the near term. It is worth noting that the Act did not adopt additional anti-“opco/propco” proposals that have targeted the lease contracts between the operating company and the property company. (In particular, rules have been proposed regarding limitations on fixed percentage rents if a REIT (the propco) has rental income from only very few corporate tenants (the opco).) Accordingly, it is likely that the market will consider alternative structures to achieve similar results. For more information on the Act and its implications, see our Sidley Update available here. 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AMERICA • ASIA PACIFIC • EUROPE SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE SIDLEY EVENTS AND SPEAKERS The Business Judgment Rule and the Board of Directors April 12, 2016 | New York, NY Jim Ducayet, a partner in our Chicago office, will participate on a panel entitled The Business Judgment Rule and the Board of Directors at The Association of Corporate Counsel’s Mid-Year Meeting in New York City on April 12. The presenters will (1) review recent case law on the business judgment rule, (2) discuss ways to advise boards regarding the business judgment rule and its application and (3) provide practical tips relating to drafting board minutes and record retention from a litigator’s perspective. Click here for more information. General Counsel Roundtable June 7, 2016 | Chicago, IL Sidley will host its 9th annual General Counsel Roundtable in Chicago on June 7. This event is limited to general counsel and chief legal officers. Anyone interested in attending should contact Shannon Reith at firstname.lastname@example.org or (312) 456-5883. SIDLEY RESOURCES Sidley recently published an Antitrust Update entitled FTC Announces HSR Premerger Notification and Clayton Act §8 Thresholds. The Update discusses the FTC’s approval of new thresholds (1) for premerger notification under the Hart-Scott-Rodino (HSR) Act, applicable to transactions that close on or after February 25, 2016, and (2) for interlocking directorates under Section 8 of the Clayton Act, effective January 26, 2016. The key HSR “size-oftransaction” threshold will increase from $76.3 million to $78.2 million. An article entitled Rural Metro: Lessons Learned by Sidley attorneys John K. Hughes (Washington, D.C.), Jack B. Jacobs (Wilmington, DE) and Daniel A. McLaughlin (New York, NY) was published in the January-February 2016 edition of Deal Lawyers.