1 • Sidley Perspectives | AUGUST 2017 AUGUST 2017 SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Visit sidley.com for more Sidley Perspectives on M&A and Corporate Governance. ANALYSIS Corwin’s Outer Boundaries: No “Massive Eraser” ...................................................................................................2 NEWS JUDICIAL DEVELOPMENTS Delaware Supreme Court Reverses DFC Global Appraisal Decision, Finding That Merger Price Deserved Greater Weight in Determining Fair Value .................................................................................................................4 Delaware Court of Chancery Appraises Company at 57% Below Merger Price ...................................................5 Conservative Approach is Best When Disclosing Relationships in Connection with Stockholder Votes .............................................................................................................................. 6 Delaware Supreme Court Reverses Court of Chancery in Case Involving $2 Billion Working Capital Dispute .............................................................................................................................. 6 Delaware Court of Chancery Relies on Contemporaneous Documents in Reiterating High Pleading Burden for Caremark Claims .............................................................................................................................. 6 Another Challenge to Excessive Director Compensation Survives Motion to Dismiss .......................................7 DGCL Section 204 May Not Be Used to Ratify an Act That Stockholders Deliberately Failed to Approve ......8 M&A Litigation Continues to Migrate from Delaware to Federal Courts ..............................................................8 LEGISLATIVE DEVELOPMENTS 2017 Amendments to DGCL Take Effect ....................................................................................................................9 REGULATORY DEVELOPMENTS SEC Expands Confidential Review of Draft IPO Registration Statements to All Companies ............................10 Hyperlinks to Exhibit Filings Required Beginning in September 2017 .................................................................10 Begin Preparing for CEO Pay Ratio Disclosure .......................................................................................................10 Federal Reserve Proposes Supervisory Guidance Intended to Refocus Financial Institution Boards of Directors on Core Responsibilities.......................................................................................................... 11 CORPORATE GOVERNANCE DEVELOPMENTS Lone-Insider Boards: Too Much of a Good Thing? ................................................................................................. 11 Key Developments from the 2017 Proxy Season .....................................................................................................12 ISS 2018 Proxy Voting Policy Formulation Underway ..............................................................................................13 S&P Dow Jones and FTSE Russell Will Exclude Companies with Multi-Class Share Structures .......................13 TAX DEVELOPMENTS Treasury Department Identifies Eight Tax Regulations for Potential Reform or Repeal.....................................14 SIDLEY EVENTS ............................................................................................................................................................15 SIDLEY SPEAKERS .............................................................................................................................. 15 SIDLEY RESOURCES .............................................................................................................................. 15 IN THIS ISSUE SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 2 ANALYSIS CORWIN’S OUTER BOUNDARIES: NO “MASSIVE ERASER”1 By Jack B. Jacobs and Chris Barbuto2 One of today’s more widely debated issues in the M&A space concerns the precise scope, application and boundaries of the Delaware Supreme Court’s decision in Corwin v. KKR Fin. Holdings, 125 A.3d 304 (Del. 2015). Corwin held that a post-closing claim for damages arising out of a merger not governed ab initio by the entire fairness standard will be reviewed under the business judgment rule, if the merger was “approved by a fully informed, uncoerced majority of the disinterested stockholders.” A line of post-Corwin Court of Chancery decisions has confronted different aspects of that issue,3 but it has yet to come to rest and is still a work in progress. The latest, and highly significant, contribution to that doctrinal issue is Chancellor Andre Bouchard’s May 4, 2017 decision in In re Massey Energy Co. Derivative & Class Action Litig., No. 5430-CB, 2017 WL 1739201 (Del. Ch. May 4, 2017). The ‘Massey’ Decision Non-‘Corwin’ Aspects of the Ruling. Massey was one of several litigations, including civil, criminal and regulatory proceedings, growing out of an April 2010 explosion at a Massey Energy Company coal mine in West Virginia. The explosion, which killed 29 miners and was the deadliest mining disaster in the United States in 40 years, was the direct result of worn cutting equipment and the mine’s failure to maintain adequate ventilation and water spraying systems. Massey and its CEO, Donald Blankenship, had a history of flouting safety regulations and misleading regulators by manipulating compliance data in favor of maximizing coal production. Massey also had a practice of retaliating against employees who raised concerns about mine safety. This disaster led to Massey having to pay significant civil damages, criminal fines and penalties, and in the criminal conviction of CEO Blankenship. Ultimately, Massey was acquired in a merger by Alpha Natural Resources, which later filed for bankruptcy in 2015. The Delaware Court of Chancery action involved two identical counts, one styled as derivative and the other as a direct class action on behalf of former (pre-merger) stockholders of Massey. The plaintiffs sought damages against Massey’s former directors and officers, claiming that the defendants had willfully failed to make good faith efforts to assure that Massey complied with mine safety regulations. After the Chancellor denied a motion for a preliminary injunction halting the merger with Alpha, the action was stayed until after the conclusion of the criminal investigation and (thereafter) the Alpha bankruptcy. After the stay was lifted, the defendants moved to dismiss on various grounds, including failure to satisfy the “continuous ownership” requirement under which the derivative plaintiffs must hold their shares continuously throughout the litigation or lose standing to maintain the action. The defendants argued that because the plaintiffs’ shareholder interests were eliminated in the merger wherein Alpha succeeded to Massey’s fiduciary claims, the plaintiffs lacked standing to maintain the action because the claims being asserted were derivative. Chancellor Bouchard dismissed the complaint on that ground. The derivative count, he ruled, would have stated a viable derivative Caremark claim were it not for the fact that the company (and derivatively its shareholders) had been divested of that claim in the merger. To salvage their direct claim, which was not barred by the continuous ownership requirement, the plaintiffs urged that the direct claim alleged “inseparable fraud” under 1 Reprinted with permission from the June issue of New York Law Journal. © 2017 ALM Media Properties, LLC. 2 Jack B. Jacobs is a senior counsel at Sidley who served on the Delaware Supreme Court from 2003 to 2014 and before that as Vice Chancellor of the Delaware Court of Chancery. Christopher Barbuto is a partner in Sidley’s New York office. The views expressed in this article are those of the authors and do not necessarily reflect the views of the firm. 3 See generally “Difficult in Delaware to Challenge Transactions That Have Been Approved by Disinterested and Fully-Informed Stockholders,” SIDLEY PERSP. ON M&A & CORP. GOVERNANCE (Sidley Austin, Chi.), Feb. 2017, at 7; “Delaware Again Underscores the ‘Cleansing’ Effect of Approval by Disinterested and Fully Informed Stockholders,” SIDLEY PERSP. ON M&A & CORP. GOVERNANCE (Sidley Austin, Chi.), April 2017, at 8. SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 3 Countrywide II, 4 whereby fiduciaries employ a merger to eliminate their exposure to liability for prior fiduciary misconduct that depleted the corporation’s value such that a merger became inevitable. The Chancellor rejected that argument on the basis that “inseparable fraud” required allegations of misconduct that independently would constitute a direct claim. In Massey, however, the pre-merger conduct—an alleged “business plan” to disregard safety regulations—alleged merely a form of mismanagement that implicated the directors’ duty to the corporation to manage its business with due care and loyalty. That claim, properly understood, was classically derivative. ‘Corwin’ Aspect of the Ruling. Although the opinion could have concluded at that point, Chancellor Bouchard nonetheless proceeded to address the defendants’ separate argument for dismissal, which was that even if the plaintiffs continued to have standing to prosecute their pre-merger mismanagement claims, those claims were extinguished under Corwin. The argument ran as follows: The disinterested stockholders of Massey had cast a fully informed vote to approve the merger. As a consequence, that vote “ratified” the defendant’s premerger conduct, thereby extinguishing plaintiffs’ fiduciary claims. The court’s response to this argument, although technically dictum, is important dictum that will afford the M&A bar valuable guidance. Describing the Corwin argument as “mystifying,” the Chancellor rejected it out of hand. The policy underlying Corwin is to avoid judicial second-guessing after disinterested stockholders have made an informed decision on the economic merits of a transaction. Here, the Massey stockholders voted solely on the Massey-Alpha merger, not on the board’s decision-making process or the fiduciary conduct leading up to that transaction. Indeed, the fiduciary misconduct alleged—a business plan to consciously disregard safety laws— preceded the merger by several years. As the Chancellor aptly put it, Corwin “was never intended to serve as a massive eraser, exonerating corporate fiduciaries for…actions preceding their decision to undertake a transaction.” And, moreover, the stockholders were never asked to approve a release of the defendants for pre-merger mismanagement. “In order to invoke the cleansing effect of a stockholder vote under Corwin [the Chancellor concluded]…there logically must be a far more proximate relationship…between the transaction or issue for which stockholder approval is sought and the nature of the claims to be ‘cleansed’ as a result of a fully-informed vote.” Some Brief Observations One may fairly ask whether the Chancellor’s “proximate relationship” limitation on the reach of Corwin represents a doctrinally new development. Even if that were fairly debatable, we view the court’s chosen expression only as reaffirming a long-established principle, but couched in different terms. As a matter of common sense, shareholders who vote for a transaction, but who were not asked to approve pre-transaction fiduciary conduct, should not be deemed to have approved anything other than the transaction itself. The Delaware Supreme Court so recognized in In re Santa Fe Pacific S’holder Litig., 669 A.2d 59, 68 (Del. 1995) (“Since the stockholders of Santa Fe merely voted in favor of the merger and not the [pre-merger] defensive measures, we decline to find ratification in this instance.”) and in Gantler v. Stephens, 965 A.2d 695 (Del. 2009) (“[T]he only director action or conduct that can be ratified is that which shareholders are specifically asked to approve.”). As thus viewed, the Massey court’s gloss on Corwin broke no new doctrinal ground. Only if the Massey court intended to articulate a different concept, would his “proximate relationship” expression raise doctrinal implications. Any clearer answer must await post-Massey case law development. 4 Ark. Teacher Ret. Sys. v. Countrywide Fin., 75 A.3d 888 (Del. 2013). “In order to invoke the cleansing effect of a stockholder vote under Corwin [the Chancellor concluded]…there logically must be a far more proximate relationship…between the transaction or issue for which stockholder approval is sought and the nature of the claims to be ‘cleansed’ as a result of a fully-informed vote.” SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 4 NEWS5 JUDICIAL DEVELOPMENTS Delaware Supreme Court Reverses DFC Global Appraisal Decision, Finding That Merger Price Deserved Greater Weight in Determining Fair Value In the closely watched DFC Global appraisal litigation, the Delaware Supreme Court recently reversed the Court of Chancery’s decision and remanded the case for the court to reconsider the limited weight it gave to the merger price when determining the fair value of the appraised shares. DFC Global Corp. v. Muirfield Value Partners, L.P. (Del. Aug. 1, 2017). The case involved the acquisition of DFC Global by a private equity firm in 2014. In July 2016, the Court of Chancery first determined the fair value of DFC Global’s shares to be $10.21 per share. In September 2016, on rehearing to address respondents’ objection as to the Court’s computations, the Court of Chancery revised its determination and found the fair value of DFC Global’s shares to be $10.30 per share, 8.4% higher than the merger price of $9.50 per share. The Court of Chancery afforded equal weight to what it described as three “imperfect” inputs when determining fair value: (1) the merger price, (2) a discounted cash flow (DCF) analysis and (3) a comparable companies analysis. Even though the record reflected an arm’s-length deal and a robust sale process, the Court of Chancery afforded just one-third weight to the merger price for two reasons. First, the Court concluded that the merger price may not be a reliable indication of fair value because DFC Global faced substantial regulatory uncertainty and risks when the deal was signed. Second, the Court reasoned that the merger price may be unreliable because the purchaser was a private equity firm that set its bid by using an LBO pricing model, which solves for achieving a certain targeted internal rate of return rather than determining the target’s going concern value. The Supreme Court rejected the first reason because the regulatory uncertainty and risks were known to the market (including potential buyers, DFC Global’s stockholders and debtholders) and were therefore factored into the merger price. The Supreme Court then rejected the “private equity carve out” as illogical and unsupported by economic principles or the record. Accordingly, the Supreme Court held that, given the robustness of the sale process, the Court of Chancery abused its discretion by affording only one-third weight to the merger price without proper explanation. The Supreme Court confirmed that the Court of Chancery may exercise considerable discretion when determining fair value, but held that it must explain “with reference to the economic facts before it and corporate finance principles, why it is according a certain weight to a certain indicator of value. In some cases, it may be that a single valuation metric is the most reliable evidence of fair value and that giving weight to another factor will do nothing but distort that best estimate. In other cases, it may be necessary to consider two or more factors.” Notwithstanding its ruling, the Supreme Court declined to establish an express presumption in favor of the merger price in appraisal proceedings because the appraisal statute explicitly requires the court to consider “all relevant factors.” Nevertheless, the Supreme Court acknowledged the “economic reality that the sale value resulting from a robust market check will often be the most reliable evidence of fair value, and that secondguessing the value arrived upon by the collective views of many sophisticated parties with a real stake in the matter is hazardous.” The Supreme Court suggested that the Court of Chancery may on remand conclude that “deal price was the most reliable indication of fair value” after considering the various factors relevant to fair value such as the robust sale 5 The following Sidley lawyers contributed to the research and writing of the pieces in this section: Jim Ducayet, Claire H. Holland, John K. Hughes, Sacha Jamal, John P. Kelsh and Beth E. Peev (formerly Flaming). We also thank summer associates Nick Behrens and Jill He for their assistance. The Supreme Court confirmed that the Court of Chancery may exercise considerable discretion when determining fair value, but held that it must explain “with reference to the economic facts before it and corporate finance principles, why it is according a certain weight to a certain indicator of value." The Supreme Court acknowledged the “economic reality that the sale value resulting from a robust market check will often be the most reliable evidence of fair value, and that second-guessing the value arrived upon by the collective views of many sophisticated parties with a real stake in the matter is hazardous.” SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 5 process, expectations of the debt markets regarding the target’s financial performance and the target’s failure to meet its revised projections. The ruling effectively directs the Court of Chancery to give the merger price significant weight when the underlying deal involved arm’s-length negotiations and a robust sale process. The ruling may lead to more cases where the fair value of the appraised shares tracks or falls below the merger price, which conceivably may discourage the practice of appraisal arbitrage. Delaware Court of Chancery Appraises Company at 57% Below Merger Price The latest Delaware Court of Chancery appraisal ruling is significant as it found appraised fair value at only 43% of the merger price. ACP Master, Ltd. v. Sprint Corp. (Jul. 21, 2017); ACP Master, Ltd. v. Clearwire Corp. (Jul. 21, 2017). The ruling was issued days before the Delaware Supreme Court ruled on the DFC Global appraisal decision discussed above and while the widely followed Dell appraisal case remains on appeal to the Delaware Supreme Court. The most recent case arose from Sprint Nextel Corporation’s $3.6 billion merger with Clearwire Corporation in 2013, which followed a competitive bidding process with Dish Networks Corporation. Sprint paid $5.00 per share for the 49.8% of Clearwire it did not already own. The merger was part of a broader deal where Softbank Corporation was contemporaneously acquiring a 70% stake in Sprint for $20 billion as part of Softbank entering the U.S. cellular market. Minority stockholders of Clearwire challenged the deal on fiduciary duty grounds and sought appraisal, alleging Sprint/Clearwire undervalued Clearwire’s spectrum so as to ease Sprint’s deal with Softbank, and that Softbank aided and abetted in these efforts. Petitioners’ valuation expert, using a DCF analysis based on one set of projections, set appraised fair value at $16.08 per share (more than 300% above the merger price). Respondents, using a DCF analysis based on another set of projections, set appraised fair value at $2.13 per share—57% below the merger price. Unlike in other recent appraisal cases, neither side asserted merger price was the most reliable evidence of fair value. The Court noted this was not surprising given a controlling stockholder was involved and, more importantly, the deal price represented an exaggerated picture of Clearwire’s value due to the considerable synergies present (ranging from $1.95–$2.60 per share or more). As a result, the Court ignored the merger price for appraisal purposes. In assessing the parties’ DCF analyses, the Court found the choice of projections used by the respective experts drove 90% of the parties’ valuation differential. The Vice Chancellor observed the projections used by petitioners’ expert were prepared by Sprint and not Clearwire management in the ordinary course of business, and did not reflect Clearwire’s “operative reality” in the event the merger did not close. In contrast, the Court noted the projections used by respondents’ expert were prepared by Clearwire’s management in the ordinary course of business and did reflect Clearwire’s operative reality on the merger date. In light of these and other findings, the Court adopted without modification respondents’ DCF methodology and its conclusion that the fair value of Clearwire on the closing date was $2.13 per share, which is what plaintiffs will be awarded (plus interest compounded quarterly) instead of the merger price. Like SWS Group, Clearwire underscores a key aspect of Delaware’s appraisal statute, which is that when a portion of the merger price represents a transfer to the sellers of value attributable to synergies, that incremental value must be subtracted in determining fair value. The ruling also reminds us that merger price does not always serve as a floor in determining fair value and that there are no guarantees in appraisal arbitrage. Our June 2017 issue of Sidley Perspectives discussed two other recent Delaware appraisal decisions, one pegging appraised fair value at the merger price (PetSmart) and another setting appraised fair value 8% below the merger price (SWS Group). SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 6 Conservative Approach Is Best When Disclosing Relationships in Connection with Stockholder Votes Parties are well-advised to take a conservative approach to disclosing facts that may be perceived as conflicts of interest following the June 2017 Delaware Supreme Court ruling in Chester Cty. Ret. Sys. v. Collins (Del. Jun. 15, 2017). In that case, the parties failed to disclose prior to the stockholder vote the fact that the chairman of the special committee was considering joining the special committee’s outside counsel as a partner. Although the Court determined that this was not a material omission, the Court stated, “prudence would seem to have counseled for bringing it to light earlier…[and] the failure to disclose it in these circumstances…raised needless questions.” This rebuke is particularly surprising in light of Vice Chancellor Laster’s earlier finding that the special committee chairman’s independence could not have been compromised by his connection to the special committee’s outside counsel and that, in light of such connection, the special committee’s outside counsel “would have worked even harder” to represent the special committee’s interests. Delaware Supreme Court Reverses Court of Chancery in Case Involving $2 Billion Working Capital Dispute The Delaware Supreme Court recently reversed the Court of Chancery’s decision in Chicago Bridge which we discussed in the February 2017 issue of Sidley Perspectives. Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co. LLC (Del. Jun. 27, 2017). The dispute involves the working capital adjustment in a deal where Westinghouse Electric Company LLC purchased a subsidiary of Chicago Bridge & Iron Company N.V. (CB&I) for $0, subject to a working capital adjustment and earnout. The unusual price is because Westinghouse and CB&I were working together to build two nuclear power plants, but due to significant cost overruns, CB&I wanted to get out of the project. While Delaware courts often focus on each word of a provision and give it meaning, this decision reminds us that courts also look at the big picture and interpret the agreement “in its entirety.” Specifically, the Supreme Court focused on the fact that the 2015 purchase agreement contained a liability bar (i.e., the transaction was a no indemnity deal whereby Westinghouse would have no recourse against CB&I if any representation was false). This made sense to the Court because CB&I was selling the target for $0. Given that CB&I was not indemnifying Westinghouse, the Court concluded that CB&I would not then have agreed to allow these very same claims to be made through the purchase agreement. The lesson of this case is that courts do not read specific provisions in isolation. Rather, they interpret provisions in light of the entire contract. Delaware Court of Chancery Relies on Contemporaneous Documents in Reiterating High Pleading Burden for Caremark Claims A recent Delaware Court of Chancery decision reiterates the significant hurdles that a stockholder must overcome to adequately plead demand futility under a Caremark-type theory that a majority of the board consciously ignored “red flags” regarding alleged violations of the law. In re Qualcomm Inc. FCPA S’holder Deriv. Litig. (Del. Ch. Jun. 16, 2017). Qualcomm entered into a “cease and desist” order with the SEC to resolve claims that it had violated the Foreign Corrupt Practices Act (FCPA) over a ten-year period. The complaint cited numerous instances in which the audit committee was advised of possible issues, including information showing that certain gifts were not being logged and instances in which the audit committee was told by its outside auditors that a company acquired by Chief Justice Strine: “By reading the True Up as unlimited in scope and as allowing Westinghouse to challenge the historical accounting practices used in the represented financials, the Court of Chancery rendered meaningless the Purchase Agreement’s Liability Bar.” SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 7 Qualcomm did not “have certain FCPA compliance processes in place.” The Court described the familiar Caremark standard and reiterated that a stockholder can state such a claim by showing that the board acted in “bad faith” (i.e., intentionally failed to act in the face of a known duty to act). Interestingly, however, the Court reviewed the underlying documents on which plaintiffs had based their claim that the board had been aware of “red flags” and noted that many of these documents contemporaneously documented “planned remedial actions.” As such, the Court held that the allegations amounted to little more than an effort to “second-guess the timing and manner of the board’s response to the red flags, which fails to state a Caremark claim.” While the result in Qualcomm is consistent with recent “follow on” Caremark cases brought after a company resolves an FCPA investigation, the decision is notable for the Court’s willingness to consider documentary evidence on a motion to dismiss showing that the board was considering remedial or other corrective steps and therefore could not have acted with a “conscious disregard” of its duties. The Court was able to consider such materials in this context because they formed the basis for the plaintiff’s “red flags” allegations and therefore were deemed to be “incorporated by reference.” The decision provides practical guidance to corporate counsel to take care that when documenting identified problems, such as potential compliance violations, to include in the same document the board or committee’s consideration of next steps, no matter how tentative, to be able to allow for the possible use of those documents on a motion to dismiss for purposes of rebutting a claim of bad faith if the board faces a subsequent lawsuit. Another Challenge to Excessive Director Compensation Survives Motion to Dismiss The Delaware Court of Chancery recently declined to dismiss fiduciary duty claims against the directors of Sorrento Therapeutics Inc. alleging that they extracted value from the company for their own benefit. Williams v. Ji (Del. Ch. Jun. 28, 2017). The directors granted themselves stock options and warrants in five subsidiaries, which they contended was permissible compensation for their service on the subsidiaries’ boards. Around the time of the grants, the board transferred valuable corporate assets to the subsidiaries. The grant were not approved by stockholders nor disclosed to stockholders until months later. The Court rejected the directors’ argument that the business judgment rule should apply, noting that “self-interested compensation decisions made without independent protections are subject to the same entire fairness review as any other interested transaction.” Instead, because the plaintiff sufficiently pleaded facts suggesting “both an unfair process and unfair prices for the Grants,” the Court placed the burden on the directors to establish that the grants were entirely fair. This case follows two other significant decisions in recent years in which the Court of Chancery denied the defendants’ motions to dismiss claims alleging excessive director compensation. Those cases were based on the absence of “meaningful limits” on director equity compensation in the equity incentive plans at issue. Calma v. Templeton (Citrix) (Del. Ch. Apr. 30, 2015) and Seinfeld v. Slager (Del. Ch. Jun. 29, 2012). In light of the Qualcomm decision, corporate counsel should describe the consideration of remedial actions by the board (or committee) within the same document that discusses actual or potential problems or violations for purposes of rebutting a claim of bad faith. SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 8 DGCL Section 204 May Not Be Used to Ratify an Act That Stockholders Deliberately Failed to Approve Nguyen v. View, Inc. (Del. Ch. Jun. 6, 2017), a case of first impression, arose out a dispute between View, Inc. and Paul Nguyen (the founder, and at one time, holder of the majority of View’s common stock). The company was pursuing a Series B round of financing when Nguyen withdrew his required consent prior to closing the transaction. Nevertheless, the company closed on the Series B financing and, while arbitration was pending between the company and Nguyen (regarding the validity of Nguyen’s withdrawal of consent), continued to close several subsequent rounds of financing. When an arbitrator ruled that Nguyen had validly withdrawn his consent, the preferred stockholders attempted to force the company to ratify the acts required to close each round of financing. Section 204 of the DGCL—the ratification statute—states that “no defective corporate act…shall be void or voidable solely as a result of a failure of authorization if ratified as provided in this section….” The Court was therefore compelled to consider whether Section 204 may be used to ratify an act that previously failed to receive the necessary authorization during a stockholder vote. In reaching its conclusion, the Court reasoned that “Section 204 makes clear that the defective corporate acts that a corporation purports to ratify must be within the corporation’s power at the time the act was purportedly taken.” Thus, because View’s stockholders deliberately did not authorize the closing of the Series B financing transaction, this act (along with the acts of closing subsequent rounds of financing) was not within the company’s power and consequentially could not be ratified under Section 204. The importance of Nguyen is the Delaware Court of Chancery’s clarification that Section 204 may not be used to retroactively cure acts that were not “within the corporation’s power at the time [they were] purportedly taken.” The Court highlighted five categories of defective corporate acts that have traditionally been “blessed” as being candidates for cure via Section 204, which include: “(1) a board’s failure to adhere to the corporate formalities required to authorize a stock issuance; (2) technical dating discrepancies in shareholder consents; (3) improper notice to stockholders; (4) missing records issues, timing issues, authority issues, and validity of board and stock issues; [and] (5) a failure properly to seek the required approval from either a board of directors or stockholders.” M&A Litigation Continues to Migrate from Delaware to Federal Courts Cornerstone Research recently released a report entitled Securities Class Action Filings: 2017 Midyear Assessment which found that, overall, federal class action securities fraud filings hit a record pace for the first half of 2017. Plaintiffs initiated 226 securities fraud class actions in federal court, more than in any equivalent period since 1995 and 135% higher than the historical semiannual average of 96 filings between 1997 and 2016. Other key findings in the report include: ■ Both traditional and M&A-related filings were at record levels for 1H 2017. Traditional filings increased from 95 in 2H 2016 to 131 in 1H 2017. Meanwhile, M&A-related filings have risen from 28 in 1H 2016, to 57 in 2H 2016, to 95 in 1H 2017—the highest semiannual number since 2009. ■ If the litigation rate of traditional securities class actions in 2H 2017 equals that of 1H 2017, the annual rate will nearly double the historical average, while M&A-related filings in 2017 are on pace to be more than double the historical average. The Court of Chancery clarified that Section 204 of the DGCL may not be used to retroactively cure acts that were not “within the corporation’s power at the time [they were] purportedly taken.” SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 9 ■ In 1H 2017, M&A filings were concentrated in the Third Circuit (23 filings) and the Ninth Circuit (18 filings), with filings in those jurisdictions representing 43% of all M&A filings. According to the report, most of the growth in the Third Circuit was driven by 16 M&A filings in the U.S. District Court of Delaware—the most M&A filings of any district court in 1H 2017. In addition to attributing the increase in M&A-related federal claims in part to the Delaware Court of Chancery’s landmark Trulia ruling in January 2016 as discussed in the February 2016 issue of Sidley Perspectives, the press release accompanying the report indicated that “[p]art of the spike [in M&A-related claims] is clearly attributable to the migration of merger claims from state to federal court by plaintiffs looking to avoid the experienced, skeptical judiciary in Delaware. But another part of the spike seems attributable to a decline in the quality of complaints filed by attorneys who have recalibrated their business strategies to pursue a portfolio of cases with more remote payoffs because the costs of building such a portfolio remains low.” LEGISLATIVE DEVELOPMENTS 2017 Amendments to DGCL Take Effect On August 1, 2017, amendments to the Delaware General Corporation Law (DGCL) became effective to: ■ accommodate the use of blockchain technology for share transfers and corporate recordkeeping; ■ clarify that the effective date of a DGCL Section 203(b) opt-out is determined by when the related charter amendment becomes effective under Section 103 rather than when the amendment is adopted; ■ eliminate the requirement that stockholder/member consents be individually dated; ■ clarify that Delaware corporations may merge with non-Delaware entities as long as the laws of the applicable non-Delaware jurisdiction do not prohibit the transaction; and ■ clarify the annual reporting requirements of Delaware and non-Delaware entities. The amendments to DGCL Section 228 dispensed with the formality that consents (written or electronic) bear the date of signature of each stockholder or member signing the consent. As amended, the 60-day period for the delivery of consents begins on the first day a consent is delivered to the corporation, rather than from the date of the earliest dated consent. The amendments relating to dating consents are effective only for actions taken by consent with a record date, for purposes of determining the stockholders or members entitled to consent, on or after August 1, 2017. The amendments to the provisions dealing with mergers and consolidations are primarily technical and clarifying in nature and do not effect any substantive changes. For example, Sections 254, 263 and 264 are being amended to expressly permit merger and consolidations of Delaware corporations with entities formed or organized under the laws of a non-Delaware jurisdiction unless the laws of the non-Delaware jurisdiction “prohibit” such transactions. Previously there was some inconsistency because certain DGCL sections required that the laws of the non-Delaware jurisdiction “permit” such transactions while other sections required only that the other jurisdiction’s laws “not forbid” such transactions. SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 10 REGULATORY DEVELOPMENTS SEC Expands Confidential Review of Draft IPO Registration Statements to All Companies In June, the SEC announced that its Division of Corporation Finance would permit all companies to submit draft IPO registration statements for review on a confidential basis. The new policy took effect on July 10, 2017. In the past, confidential review was limited to foreign private issuers and “emerging growth companies” as defined under the JOBS Act (EGCs). The SEC published guidance in the form of 18 FAQs to answers preliminary questions about the expanded process for voluntarily submitting draft IPO registration statements. This development illustrates the SEC’s ongoing initiative to boost capital formation. Hyperlinks to Exhibit Filings Required Beginning in September 2017 The SEC published final rules in March 2017 requiring certain registrants to provide a hyperlink to each exhibit listed in the exhibit index to their SEC filings. The rules apply to registrants that file registration statements and periodic and current reports that are subject to the exhibit requirements of Item 601 of Regulation S-K or that file on Forms F-10 or 20-F. Registrants will be required to provide an active hyperlink from the exhibit index in the SEC form to the exhibit itself, whether included with the form or incorporated by reference from another SEC filing. The rules will take effect on September 1, 2017 for large accelerated filers and accelerated filers. Accordingly, for large public companies with calendar fiscal years, the first periodic report that will be required to include hyperlinked exhibits will be the Form 10-Q for the third quarter of 2017. These companies will also have to include hyperlinks to exhibits in the current reports on Form 8-K they file after the September 1, 2017 effective date. Nonaccelerated filers and smaller reporting companies that submit SEC filings in the ASCII format will have until September 1, 2018 to comply with the new requirements. The SEC updated its EDGAR Filer Manual in July 2017 to include detailed instructions for hyperlinking to exhibits in Sections 126.96.36.199 and 188.8.131.52. Companies should prepare for compliance by reviewing the updated manual and discussing the new requirements with their financial printers. Begin Preparing for CEO Pay Ratio Disclosure The SEC adopted the final version of the so-called “pay ratio disclosure rule” in 2015. For many public companies, this disclosure will be required for the first time in the proxy statement filed in connection with the 2018 annual meeting of stockholders. While there has been some speculation that the implementation of the requirement would be further delayed, it appears increasingly likely that it will go into effect as planned. Companies should begin preparing for this disclosure requirement now not only because of the technical difficulties that preparing the required compensation disclosure may present, but also because companies will be facing reactions from their own employee base as a result of this information becoming public. Thus, devising strategies for calculating the pay ratio and communicating it to employees—both steps that will require time and careful planning— may be equally essential to successfully navigating this new disclosure requirement. SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 11 Federal Reserve Proposes Supervisory Guidance Intended to Refocus Financial Institution Boards of Directors on Core Responsibilities On August 3, 2017, the Board of Governors of the Federal Reserve System requested public comment on a corporate governance proposal that outlines supervisory expectations for boards of directors of financial institutions supervised by the Federal Reserve. The guidance was informed by the Federal Reserve’s multi-year review of board practices at large banks which revealed that (1) boards devoted a significant amount of time to non-core tasks, (2) boards faced significant information flow challenges and (3) the supervisory expectations of senior management versus the board were indistinct. The proposal aims to refocus boards on their core responsibilities which, when discharged effectively, should promote the safety and soundness of the financial institutions. The proposal consists of three parts: ■ Attributes of effective boards. The proposal identifies five key attributes of effective boards that would be used by Federal Reserve supervisors when assessing a financial institution’s board including: (1) setting clear, aligned and consistent direction regarding strategy and risk tolerance, (2) actively managing information flow and board discussions, (3) holding senior management accountable, (4) supporting the independence and stature of the independent risk management and internal audit functions and (5) maintaining a capable board composition and governance structure. ■ Existing supervisory expectations. The proposal would eliminate redundant and outdated supervisory expectations for boards and revise certain existing expectations to more closely track the Federal Reserve’s supervisory framework. ■ Communication of supervisory findings. The proposal would clarify that Federal Reserve supervisors should typically direct matters to senior management for corrective action and that matters should only be directed to the board if (1) the matter involves corporate governance responsibilities or (2) senior management failed to take appropriate remedial action. The Federal Reserve Board concurrently requested public comment on a proposal to update its Large Financial Institution (LFI) rating system to reflect regulatory and supervisory changes since the system was introduced in 2012. The Federal Reserve Board will accept comments on the proposals for 60 days after their publication in the Federal Register. CORPORATE GOVERNANCE DEVELOPMENTS Lone-Insider Boards: Too Much of a Good Thing? A widely-reported study published in the Strategic Management Journal6 indicates that public companies would benefit from having more than one insider serve on their boards. Based on S&P 1500 company data from 2003 to 2014, the study concluded that companies with lone-insider boards (i.e., boards with no inside directors other than the CEO) awarded their CEOs “excess pay” (i.e., pay above what factors such as firm size, CEO age, CEO tenure, CEO equity ownership, industry, stock returns and performance would predict), with such CEOs receiving approximately 82% more pay than CEOs at peers with more than one insider on the board. The study found that, as compared to their non-lone-insider peers, companies with lone-insider boards (1) have a $2.99 million larger pay gap between the CEO and other top management team (TMT) members, (2) are 1.27 times more likely to experience financial misconduct (defined as instances of financial restatements that are not 6 Home Alone: The Effects of Lone-Insider Boards on CEO Pay, Financial Misconduct, and Firm Performance (2017) by M. Zorn, C. Shropshire, J. Martin, J. Combs and D. Ketchen. SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 12 due to clerical errors or minor accounting issues) and (3) experience poorer performance (e.g., a 10% lower return on assets). The study also found that analyst coverage and a high percentage of institutional share ownership mitigated the negative effects of having a lone-insider board with respect to CEO pay and firm performance but not with respect to CEO-TMT pay gaps or financial misconduct. Institutional investors are taking note of this study, and it may be that, in the coming years, institutional investors will begin to call for more members of management to serve on public company boards. Although the study did not indicate the ideal number of inside directors, it did determine that boards with two insiders do not provide CEOs with excess compensation, are negatively associated with CEO-TMT pay gaps and are less likely to experience financial misconduct. Key Developments from the 2017 Proxy Season The 2017 proxy season brought a measure of predictability in a year that has otherwise been filled with regulatory uncertainty. Here were some of the key developments: ■ Proxy access continues to be adopted by many large-cap companies. As of July 2017, more than 60% of S&P 500 companies have adopted proxy access bylaws or charter provisions. ■ Many companies that adopted proxy access in prior years received so-called “fix-it” proposals (i.e., proposals asking stockholders to vote in favor of expanding the proxy access right). The SEC has generally permitted companies to exclude these proposals from their proxy statements. ■ Social and environmental proposals once again constituted the largest category of proposals submitted during proxy season. –Board diversity and gender pay equity have become a central focus with State Street and BlackRock taking the lead. State Street voted against or withheld votes from nominating and governance committee chairs at 400 of its portfolio companies with no female directors. BlackRock supported nearly all board diversity proposals during the 2017 proxy season and voted against nominating and governance committee members at certain companies for failure to address gender diversity issues. –Support for climate change proposals has also dramatically increased over the past five years, and institutional investors such as BlackRock, State Street, Fidelity and Vanguard are making it clear that they may be willing to support environmental proposals. Three proposals calling for a report on the impact of climate change policies passed this year, including at Occidental Petroleum, PPL Corporation and Exxon Mobil. ■ Say-on-pay proposals were approved at a rate of 93% (up from 91% in 2016). Stockholders expressed a preference for annual say-on-pay votes at more than 95% of S&P 500 companies. ■ The prevalence of virtual meetings increased as 5% of S&P 500 companies held virtualonly annual meetings in 2017 (compared to 3% in 2016). However, institutional investors began making their opposition to these meetings known. The New York City Comptroller urged several S&P 500 companies that previously held virtual-only meetings to return to holding in-person meetings, and ISS has suggested that it may make adverse recommendations against directors if virtual-only meetings are being used to prevent stockholder discussions or proposals. Institutional investors may start advocating for more management directors in light of the new research. SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 13 ISS 2018 Proxy Voting Policy Formulation Underway Institutional Shareholder Services (ISS) is seeking feedback on policy questions as part of its process for updating its proxy voting policies for the 2018 proxy season. This year, ISS is undertaking its annual policy survey in two parts: (1) a brief Governance Principles Survey to gauge market sentiment on select topics and (2) a more in-depth Policy Application Survey covering five broad topics broken out by region. The Governance Principles Survey focuses on five high-profile governance and compensation issues, signaling that ISS may adopt new policies or refine its position on these topics: ■ One-share, one-vote principle. ISS asks whether it is ever appropriate for a company to have a multi-class capital structure with unequal voting rights and, if so, whether there should be a sunset provision on these rights. ■ Board gender diversity. ISS seeks input on the level of concern when there are no female directors on a public company’s board and what actions should be taken in response. ■ Share issuance and buyback proposals. ISS asks how it should evaluate share issuance and buyback proposals at companies that are listed, but not incorporated, in the U.S., which may subject them to conflicting stockholder approval requirements for share issuances or buybacks. ■ Virtual meetings. ISS asks whether virtual-only and/or hybrid annual shareholder meetings are acceptable, noting that over 200 U.S. companies have held such meetings so far in 2017. ■ Pay ratio disclosure. ISS seeks input as to how companies and their stockholders plan to use pay ratio data. Four questions in the Policy Application Survey are relevant to U.S. companies: ■ Outcomes-based compensation measures. ISS asks whether and, if so, how realized or realizable pay should be used as part of ISS’ quantitative pay-for-performance evaluation. ■ Non-employee director pay. ISS asks what factors it should consider when determining if non-employee director pay is excessive and when a negative vote recommendation may be warranted. ■ Gender pay equity. ISS asks whether and when companies should be required to disclose information regarding gender pay equity. ■ Poison pills. ISS asks whether it should consider negative vote recommendations against directors when a short-term (one year or less) poison pill is adopted without a stockholder vote. Companies should consider communicating their views by participating in the policy survey which can be accessed here. The Governance Principles Survey will close on August 31, 2017, and the results of that survey are likely to be published in late September 2017. The Policy Application Survey will close on October 6, 2017. ISS will then open a comment period for feedback on proposed changes to its policies before releasing final policy updates for 2018. S&P Dow Jones and FTSE Russell Will Exclude Companies with Multi-Class Share Structures In July 2017, S&P Dow Jones announced that companies with multi-class share structures are no longer eligible for inclusion in the S&P 1500 or its component indices (the S&P 500, S&P MidCap 400 and S&P SmallCap 600) effective as of August 1, 2017. Companies currently included in the S&P 1500 with multi-class share structures (e.g., Alphabet, Facebook) were grandfathered in and not affected by the policy change. S&P Dow Jones explained that the SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 14 policy change was informed by responses received from various market participants following a consultation period that began in April 2017. FTSE Russell also announced changes to its index eligibility policies in July 2017 after a consultation process. Its new policy will require at least 5% of a company’s voting rights to be held by unrestricted shareholders for the company to be eligible for inclusion in the Russell 3000 index and small-cap Russell indices. The policy change will take effect in September 2017 for new index constituents. Companies currently included in the indices will have until September 2022 to comply with the new 5% minimum voting rights threshold. FTSE Russell plans to review the threshold annually. Companies considering going public should take these policy changes into account when determining the appropriate capital structure. TAX DEVELOPMENTS Treasury Department Identifies Eight Tax Regulations for Potential Reform or Repeal The Treasury Department has identified eight tax regulations that impose an undue financial burden on taxpayers, add undue complexity to federal tax laws, or exceed the IRS’s authority. The regulations were identified in response to an April 21, 2017 executive order by President Trump instructing the Treasury Department to identify all significant tax regulations issued by the Obama Administration after December 31, 2015 that meet those criteria. The executive order further instructs the Treasury Department to submit a final report by September 18, 2017 recommending specific actions to mitigate the burdens of identified regulations, and the Treasury Department indicated it will propose reforms potentially ranging from streamlining problematic provisions to full repeal. The eight identified regulations are as follows: ■ Final and temporary regulations under section 385 of the Internal Revenue Code (the Code) that classify certain related-party debt as equity. These regulations were issued as part of a larger package of regulations aimed at curbing inversion transactions but have been widely criticized as too broad. ■ Final regulations under section 367 of the Code that eliminate the ability to transfer foreign goodwill and going concern value to foreign corporations without tax. ■ Final regulations under section 987 of the Code providing rules for translating branch income into the branch owner’s functional currency and for computing certain foreign currency gain or loss related to a branch. ■ Temporary regulations under section 337(d) of the Code addressing spin-off transactions where property is transferred by a C corporation to a real estate investment trust (REIT), and more generally transfers of property to a regulated investment company or REIT. ■ Temporary regulations under section 752 of the Code providing partnership debt allocation rules in disguised sales, and in “bottom-dollar payment obligation” arrangements. ■ Proposed regulations under section 2704 of the Code disregarding for estate and gift tax valuation purposes certain restrictions on the ability to dispose of or liquidate familycontrolled entities. ■ Final regulations under section 7602 of the Code addressing the ability of outside attorneys under contract with the IRS to participate in taking testimony under oath. ■ Proposed regulations under section 103 of the Code defining a “political subdivision” eligible to issue certain tax-exempt bonds. SidleyPerspectives ON M&A AND CORPORATE GOVERNANCE Sidley Perspectives | AUGUST 2017 • 15 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.com SIDLEY EVENTS Corporate College September 12–13 | Chicago, IL and New York, NY Sidley will host its annual Corporate College in Chicago and New York on September 12–13. 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. In-house lawyers of all levels are invited to attend this program. Anyone interested in attending should contact [email protected] Bay Area General Counsel Roundtable September 28 | Menlo Park, CA Sidley will host its 8th Annual Bay Area General Counsel Roundtable in Menlo Park on September 28. The program will include an afternoon of engaging panel discussions, networking and a keynote address from former Secretary of State John Kerry. The event is limited to General Counsel and Chief Legal Officers. Anyone interested in attending should contact [email protected] Dallas General Counsel Roundtable October 24 | Dallas, TX Sidley will host the Dallas General Counsel Roundtable on October 24 which will include an afternoon of engaging panel discussions, networking and a keynote address from former Secretary of State John Kerry. The event is limited to General Counsel and Chief Legal Officers. Anyone interested in attending should contact [email protected] SIDLEY SPEAKERS Tom Cole, senior counsel in our Chicago office, will participate in a panel entitled The Role of the GC in Board Related Matters at the Northwestern Pritzker School of Law Corporate Counsel Institute in Chicago on September 28. Click here for more information. SIDLEY RESOURCES An article entitled Corporate Social Responsibility, Corporate Sustainability, and the Role of the Board by Holly Gregory, a partner in our New York office, was published in the July/ August 2017 edition of Practical Law’s The Governance Counselor. Sidley attorneys Holly Gregory, Rebecca Grapsas and Claire Holland authored the United States chapter of Getting the Deal Through—Corporate Governance 2017, an annual summary of key corporate governance practices in 24 jurisdictions worldwide. Topics addressed in the chapter include: sources of governance rules and practice, shareholder rights, duties and liability, anti-takeover devices, board structures, directors’ legal duties, and disclosure and reporting requirements.