Yearly Archives: 2012

The JOBS Act: Implications for Private Company Acquisitions and M&A Professionals

Posted by George R. Bason, Jr., Davis Polk & Wardwell LLP, on
Wednesday, May 2, 2012
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George Bason is the global head of the mergers and acquisitions practice at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum by Mr. Bason, John D. Amorosi, William M. Kelly, Mischa Travers, and Richard D. Truesdell.

On April 5, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), which as we’ve previously noted represents a very significant loosening of restrictions around the IPO process and post-IPO reporting obligations. While most of the commentary on this legislation has thus far focused on its impact on capital markets matters, there are implications for private company mergers and acquisitions as well.

Late-stage private companies contemplating an M&A or IPO exit often undertake so-called “dual-track” processes in which they simultaneously file an IPO registration statement with the SEC and hold discussions with prospective acquirors.  The IPO side of the process effectively becomes a stalking horse for M&A discussions and tends to force the hand of prospective acquirors that might otherwise not move as quickly as the target would like.  The publicly filed registration statement both attracts attention and provides prospective acquirors with a sort of first-stage diligence that theoretically helps encourage bids.

Under the JOBS Act, emerging growth companies or “EGCs” will now have the ability to file their registration statements confidentially, so long as the confidential filings are ultimately released at least 21 days before the road show.  Whether confidential filings will become the norm remains to be seen; there are a number of reasons why an IPO candidate might want to continue to use the traditional public filing process, including the publicity, customer and employee-related benefits of having a highly visible registration statement.  For many companies, however, these benefits will be outweighed by the competitive advantages of keeping early filings confidential.  The optionality that confidential filings create may be hard to resist: A confidential filer can now pull its deal without the stigma associated with withdrawing a publicly filed registration statement.

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Equity-Holding Institutional Lenders

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, May 2, 2012
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The following post comes to us from Michael Weisbach and Bernadette Minton, both of the Department of Finance at The Ohio State University, and Jongha Lim of the Department of Finance at the University of Missouri.

In our paper, Equity-Holding Institutional Lenders: Do They Receive Better Terms?, which was recently made publicly available on SSRN, we evaluate the way in which institutional equity holders are involved in the lending process. Participation by equity-holding institutions has become a major part of the syndicated loan market. In our sample of 11,137 institutional “leveraged” loan tranches between 1997 and 2007 from the DealScan database, 2,008 (18%) have participation by a “dual holder” institution that owns at least 0.1% of the borrowing firm’s equity. Lending to firms in which one has an equity position goes against the principle of diversification, since it exposes the investor to firm-specific shocks through both its equity and debt ownership. To justify dual holding, the investor must receive compensation of some sort, either through the improvements in the value of its equity holdings, or by above market rates of return on the loan.

We estimate the abnormal return a dual holder receives by comparing spreads on dual holder tranches to those on observationally equivalent tranches that do not have a dual holder. Our estimates indicate, holding all else equal, that loan tranches with dual holder participation receive a 13 basis-point higher spread than otherwise similar tranches without an equity holder’s participation in the lending syndicate. The positive spread is statistically and economically significant for revolvers as well as term loans and for loans to borrowers of different ratings and to unrated borrowers as well.

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Limits on Extraterritorial Reach of State Law

Posted by George T. Conway III, Wachtell, Lipton, Rosen & Katz, on
Tuesday, May 1, 2012
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George Conway is partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum from Mr. Conway, Herbert M. Wachtell, Ben M. Germana, and Graham W. Meli.

Recently, in Global Reinsurance Corp.–U.S. Branch v. Equitas Ltd., the New York Court of Appeals, New York’s highest court, refused to apply the state’s antitrust statute, the Donnelly Act, to allegedly anticompetitive conduct in Great Britain that had only incidental effects in New York.  Reversing a divided decision of the intermediate appellate court, the Court of Appeals reasoned that state antitrust law could not have a broader extraterritorial reach than federal antitrust law; otherwise, statutory and judicial limitations on the federal Sherman Act “would be undone if states remained free to authorize ‘little Sherman Act’ claims that went beyond it.”

This rationale may have significant implications beyond the antitrust arena, as the Court of Appeals more broadly reaffirmed that “[t]he established presumption is, of course, against the extra-territorial operation of New York law.”  For example, the potential impact on securities claims under state common law is particularly notable.  In the wake of the United States Supreme Court’s decision in Morrison v. National Australia Bank, which held that Section 10(b) of the Securities Exchange Act applies only to domestic securities transactions (see our memo here), a number of plaintiffs have attempted to invoke state common law to recover losses on extraterritorial transactions.  One potential obstacle to such state-law suits appeared to have been removed late last year, when the Court of Appeals, in Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management, rejected a line of lower-court and federal precedents that had held common-law securities actions preempted by New York’s securities statute, the Martin Act (see our memo here).

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New PCAOB Auditing Standards

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, May 1, 2012
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The following post comes to us from Robert Buckholz, partner and co-coordinator of the Corporate and Finance Group at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication.

The Public Company Accounting Oversight Board is proposing a new auditing standard that relates to the auditor’s evaluation of a company’s relationships and transactions with related parties, and amendments to existing auditing standards that relate to significant unusual transactions and financial relationships and transactions by a company with its executive officers (including incentive compensation arrangements). The new and amended standards are intended to focus auditors’ efforts on areas that may pose an increased risk of material misstatement to a company’s financial statements.

The PCAOB’s proposals largely build upon and enhance existing requirements in these areas, primarily by providing greater specificity around the procedures that must be employed and inquiries that must be made. While the proposals would not directly impact the non-financial-statement disclosure (such as proxy disclosure) relating to related party transactions and executive compensation under SEC rules, companies should anticipate greater auditor focus and additional audit procedures on the financial statement impact of these areas if these proposals are adopted.

Subject to SEC approval, the new and amended standards would be effective for audits of financial statements for fiscal years beginning on or after December 15, 2012. The deadline for public comment is May 15, 2012.

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Separate Entity Doctrine for U.S. Branches of Foreign Banks

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, April 30, 2012
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The following post comes to us from three law firms: Cleary Gottlieb Steen & Hamilton LLP; Davis Polk & Wardwell LLP; and Sullivan & Cromwell LLP. It is based on a white paper authored jointly by the three firms on the separate entity doctrine as applied to the U.S. branches of foreign headquartered (non-U.S.) banks. The hybrid treatment of the U.S. branches of foreign headquartered banks has become a subject of focus in the wake of the financial crisis and in light of the enactment of the Dodd-Frank Act. The white paper provides a summary of the regulatory treatment of U.S. branches of foreign headquartered banks under various U.S. legal regimes, and highlights the hybrid nature of such branches. The original white paper, including footnotes, is available here.

Although a branch of a bank is not a separate juridical entity from the bank of which it is a component, U.S. law treats branches as separate from the head office and other branches of a bank when such differentiation is appropriate for various purposes. Branches are a hybrid structure, at the same time both an integral part of the banks of which they are merely offices and separate legal entities for a number of U.S. regulatory and commercial law purposes. This feature of bank branches is a central tenet of federal banking statutes, and the law governing U.S. branches of foreign banks in particular.

At times the status of a U.S. branch of a foreign bank under a particular statutory scheme is explicit. Such is the case with the U.S. law treatment of U.S. branches of foreign banks in insolvency. As discussed below, U.S. law treats those branches virtually as separate entities in insolvency.

In other circumstances, a particular statute does not explicitly address the status of U.S. branches of foreign banks, and the treatment has to be arrived at through an analysis of the purpose of the statutory scheme. For example, as discussed below, after a long series of no-action letters, the Securities and Exchange Commission (“SEC”) issued interpretive guidance providing that securities issued or guaranteed by U.S. branches of a foreign bank (but not its non-U.S. branches) could rely on the exemption from registration afforded to securities issued or guaranteed by a bank under Section 3(a)(2) of the Securities Act of 1933 (“Securities Act”). Thus, U.S. branches can rely on the Section 3(a)(2) exemption while the bank itself is required to register to distribute its securities in the United States.

This paper will review the treatment of U.S. branches of foreign banks under a variety of statutory schemes and explore the rationale for that treatment.

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FDIC Lawsuits Targeting Failed Financial Institutions

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, April 30, 2012
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The following post comes to us from Narayanan Subramanian, principal at Cornerstone Research. This post is based on a Cornerstone Research publication by Katie Galley and Joe Schertler, available here.

As widely reported in the press, seizures of banks and thrifts by regulatory authorities began to subside in 2011. Throughout the year, 92 institutions were seized compared with 157 in 2010 and 140 in 2009. In contrast, Federal Deposit Insurance Corporation professional liability lawsuits targeting failed financial institutions began to increase in 2011. These are lawsuits in which the FDIC, as receiver for failed financial institutions, brings professional liability claims against directors and officers of those institutions and against other related parties, such as accounting firms, law firms, appraisal firms, or mortgage brokers.

Overview

From July 2, 2010, through January 27, 2012, the FDIC filed 21 lawsuits related to 20 failed institutions (two of the 21 lawsuits were associated with IndyMac Bank, F.S.B). Of the 21 lawsuits, two were filed in 2010, 16 in 2011, and three in January 2012. Aggregate damages claimed in the complaints totaled $1.98 billion.

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Director Ownership, Governance, and Performance

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, April 30, 2012
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The following post comes to us from Sanjai Bhagat, Professor of Finance at the University of Colorado at Boulder, and Brian Bolton of the Department of Finance at Portland State University.

In our paper, Director Ownership, Governance, and Performance, forthcoming in the Journal of Financial and Quantitative Analysis, we study the impact of SOX on the relationship between corporate governance and company performance. A significant part of SOX and other exchange requirements increase the role of independent board members. Given that prior academic research suggests there is no positive relationship between board independence and firm performance, the above regulatory efforts are especially notable.

We find a shift in the relationship between board independence and firm performance after 2002. Prior to 2002, we document a negative relationship between board independence and operating performance. After 2002, we find a positive relationship between independence and operating performance. We find this result is driven by firms that increase their number of independent directors. An event study provides independent evidence supportive of the above results – specifically, when a company goes from being non-compliant to being compliant with SOX’s board independence requirement, the market response is significantly positive. Why might SOX be related to this positive performance? SOX and the listing standards impose new responsibilities on firms’ directors, such as regular meetings of the independent directors, approval of director nominations by independent directors, and approval of CEO compensation by independent directors. As a consequence of these policies boards began including more independent directors, and, perhaps the independent directors became more engaged in the firm’s governance processes. For example, we find that firms with greater board independence (and stock ownership of board members) are less likely to engage in a value-destroying activity, namely, acquisitions.

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Will the SEC Facilitate Shareholder Access to the Ballot Under Rule 14a-8?

Posted by Robert J. Jackson, Jr., Columbia Law School, on
Sunday, April 29, 2012
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Robert Jackson is associate professor of law at Columbia Law School. This post was coauthored with Gabriella Wertman, member of the Columbia Law School class of 2013. Work from the Program on Corporate Governance about shareholder voting includes Private Ordering and the Proxy Access Debate by Bebchuk and Hirst; a previous post on the SEC staff’s rulings on proxy access proposals under Rule 14a-8 is available here.

In the wake of Business Roundtable v. SEC, public company shareholders and boards have, for the first time, been using Rule 14a-8 to propose, and defend against, proxy access proposals. Earlier this month, the SEC staff released a series of no-action letters  addressing management requests to exclude shareholders’ proxy access proposals from the ballot. The staff has based these early rulings on their longstanding 14a-8 precedents, which were originally crafted to address proposals outside the proxy access context. The staff’s approach leaves open the possibility that management will be able to use these rules to exclude proxy access proposals in the future, endangering the viability of Rule 14a-8 as a means of facilitating private ordering in proxy access. Before next proxy season, the SEC should make clear that it will apply Rule 14a-8 in a way that will give investors a meaningful opportunity to adopt the proxy access rules that shareholders prefer.

Although the staff’s initial rulings addressed important preliminary questions raised by the use of Rule 14a-8 for facilitating proxy access, they were much more notable for their adherence to the staff’s existing precedents for evaluating shareholder proposals outside the proxy access context. This approach has convinced corporate counsel and their clients that the SEC will allow management to use these precedents to exclude proxy access proposals from the ballot. Unless the SEC reverses course, this approach will give management a systematic advantage that will prevent shareholders from adopting their preferred approach to proxy access.

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Wal-Mart Bribery Case Raises Fundamental Governance Issues

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Saturday, April 28, 2012
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Editor’s Note: Ben W. Heineman, Jr. is a former GE senior vice president for law and public affairs and a senior fellow at Harvard University’s schools of law and government.

Wal-Mart appeared to commit virtually every governance sin in its handling of the Mexican bribery case, if the long, carefully reported New York Times story is true. The current Wal-Mart board of directors must get to the bottom of the bribery scheme in Mexico and the possible suppression by senior Wal-Mart leaders in Bentonville, Arkansas (the company’s global headquarters) of a full investigation.

In addition, the board must also review – and fix as necessary – the numerous company internal governing systems, processes and procedures that appear to have been non-existent or to have failed. And, most importantly, it must define the CEO’s core role as one which truly fuses high performance with high integrity, and does not exalt performance at the expense of integrity – and possibly discipline or remove the past CEO (still on the board) or the current CEO.

The essential allegations in the Times story are as follows:

For a substantial period before 2005, the CEO of Wal-Mart in Mexico and his chief lieutenants, including the Mexican general counsel and chief auditor, knowingly orchestrated bribes of Mexican officials to obtain building permits, zoning variances and environmental clearances, and also falsified records to hide these payments. When the lawyer in Mexico directly responsible for bribery payments had a change of heart and reported the scheme to Wal-Mart lawyers in the United States, those lawyers hired an independent firm which, after an initial look, recommended a major inquiry.

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Arbitration Provisions in Corporate Governance Documents

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, April 27, 2012
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The following post comes to us from Carl W. Schneider, special consultant to Ballard Spahr LLP and former special adviser to the SEC’s Division of Corporation Finance. This post is a summary of an article by Mr. Schneider that appeared in 26(3) INSIGHTS: The Corporate & Securities Law Advisor (Wolters Kluwer Law & Business, March 2012).

The financial press and blogs were abuzz in late January 2012 about the Securities Act of 1933 (Securities Act) registration statement filed by The Carlyle Group L.P. for its initial public offering. Its limited partnership agreement required all shareholder disputes with the partnership to be resolved by mandatory, binding and confidential arbitration. The provision included a prohibition against shareholders bringing class actions. Much of the discussion that was critical of the provision focused on the elimination of class actions and not on the pros and cons of arbitration as such.

According to published reports, the SEC advised Carlyle that it would not grant an acceleration order permitting the registration statement to become effective unless the arbitration provision was withdrawn. As a practical matter, Carlyle had no means to challenge the Commission and no practical alternative other than to withdraw its arbitration provision, which it did.

I object to the process by which the SEC killed Carlyle’s arbitration provision.

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