Monthly Archives: August 2012

Dispute Resolution for Earnouts and Purchase Price Adjustments

Daniel Wolf is a partner at Kirkland & Ellis LLP focusing on mergers and acquisitions. This post is based on a Kirkland & Ellis M&A Update by Mr. Wolf. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

We have written before of certain pitfalls that await dealmakers utilizing earnouts and purchase price adjustments. An oft-shared aspect of those two deal provisions was the subject of a recent Delaware decision by Chancellor Strine — the employment of an independent accountant to resolve post-closing disputes between the parties. The outcome, while hardly surprising, offers some timely reminders of some of the hazards presented by this popular dispute resolution mechanism.

The case arose from Viacom’s 2006 purchase of Harmonix, the maker of the Guitar Hero and Rock Band video games. A substantial portion of the consideration was in the form of a contingent earnout based on a multiple of “gross profit” for the acquired business for the two years following closing. Following a dispute relating to the 2008 earnout, the parties, per the merger agreement, submitted the disagreement to an independent accountant for review. The accountant decided in favor of the sellers awarding them $239 million, and Viacom sought court review of the decision. Chancellor Strine’s opinion largely focused on two key issues:


Derivatives Rules under the Dodd-Frank Act Affecting End-Users

The following post comes to us from John White, partner in the Corporate Department and co-chair of the Corporate Governance and Board Advisory practice at Cravath, Swaine & Moore LLP. This post is based on a Cravath memorandum; the full version, including footnotes, is available here.

Background — The Dodd-Frank Act

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) provides for new Federal regulation of the swaps market, and, when fully implemented, is expected to make fundamental changes in the way the swaps market operates. Title VII seeks to reduce systemic risk, increase transparency and improve efficiency in the swaps market by requiring centralized clearing and exchange trading of swaps as well as real-time and regulatory reporting of swap transactions. Under the Dodd-Frank Act, the Commodity Futures Trading Commission (the “CFTC”) will regulate most swaps on interest rates, commodities and currencies and the Securities and Exchange Commission (the “SEC,” together with the CFTC, the “Commissions”) will regulate swaps, including equity and credit default swaps, on single securities and narrow-based securities indices. The term “swap” is defined broadly in the Dodd-Frank Act, and includes certain foreign exchange transactions, such as non-deliverable foreign currency forwards, that may not be characterized as swaps for other purposes.


Insider Trading via the Corporation

Jesse Fried is a Professor of Law at Harvard Law School.

My paper, Insider Trading via the Corporation, recently posted on SSRN, critically examines the regulations applicable to U.S. firms trading in their own shares and puts forward a proposal for reform.

Publicly-traded U.S. firms buy and sell a staggering amount of their own shares in the open market each year. Open-market repurchases (“OMRs”) alone total hundreds of billions of dollars per year; in 2007, they reached $1 trillion. Firms are also increasingly selling shares in the open market through so-called “at-the-market” issuances (“ATMs”).

When a U.S. firm trades in its own shares, its trade-disclosure requirements are minimal. The firm must report only aggregate trading activity, and not until well into the following quarter. Thus, the firm can secretly buy and sell its own shares in the open market for several months, and never disclose the exact details of its trades to shareholders and regulators. The lack of detailed disclosure, I explain, makes it difficult to detect illegal trading on material inside information; the lack of timely disclosure makes it difficult for investors to determine when the firm is trading on valuable but sub-material information.


Aider and Abettor Liability Standards in SEC Civil Enforcement Actions

Victor Lewkow is a partner at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Lewis Liman.

On August 8, 2012, the Second Circuit issued an important decision in Securities and Exchange Commission v. Apuzzo, 2012 WL 3194303, clarifying the test the SEC must meet to establish aiding and abetting liability for a securities law violation. There previously had been uncertainty in the Second Circuit whether the SEC must prove that the aider and abettor proximately caused the harm on which the primary violation was based. In Apuzzo, the Second Circuit made clear that “proximate cause” was not an element of the aiding and abetting violation and that, to charge someone with aiding and abetting, the SEC need allege and prove only that the aider and abettor associated himself with the venture in some way, participated in the venture as in something he wished to bring about, and sought by his action to make the venture succeed. The Court of Appeals also stated that proof of a high degree of knowledge of a primary violation may lessen the SEC’s burden in proving substantial assistance.


Massachusetts Pension Reserves Investment Management Board and the Shareholder Rights Project Collaborate

Editor’s Note: Professor Lucian Bebchuk is the Director of the Shareholder Rights Project (SRP), and Scott Hirst is the SRP’s Associate Director. Any views expressed and positions taken by the SRP and its representatives should be attributed solely to the SRP and not to Harvard Law School or Harvard University.

In a joint media release, available here, the SRP and the Massachusetts Pension Reserves Investment Management Board (PRIM) recently announced their collaboration to encourage a significant number of public companies to consider moving to annual elections.

PRIM is charged with the general supervision of the Pension Reserves Investment Trust (PRIT) Fund, with pension assets exceeding $49 billion. PRIM, on behalf of the PRIT Fund, has submitted shareholder declassification proposals for 2012 and 2013 annual meetings to twenty companies with staggered boards, and the SRP is representing and advising PRIM and the PRIT Fund in connection with these proposals. The proposals urge a repeal of the companies’ classified board structures and a move to annual elections, which are widely viewed as corporate governance best practice.


Strategic Risk Management: A Primer for Directors

Matteo Tonello is managing director of corporate leadership at the Conference Board. This post is based on an issue of the Conference Board’s Director Notes series by Mark L. Frigo and Richard J. Anderson, director and professor of strategic risk management, respectively, at DePaul University. This Director Note was based on a book authored by Dr. Frigo and Mr. Anderson, available here.

As noted by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), “In the aftermath of the financial crisis, executives and their boards realize that ad hoc risk management is no longer tolerable and that current processes may be inadequate in today’s rapidly evolving business world.” [1] However, especially for nonfinancial companies that may be relatively new to these topics, enhancing risk management can be a somewhat daunting task.

This article focuses on two key aspects of the relationship between risk and strategy: (1) understanding the organization’s strategic risks and the related risk management processes, and (2) understanding how risk is considered and embedded in the organization’s strategy setting and performance measurement processes. These two areas not only deserve the attention of boards, but also fit closely with one of the primary responsibilities of the board — risk oversight.


Do Courts Count Cammer Factors?

Elaine Buckberg is Senior Vice President at NERA Economic Consulting. This post is based on a NERA publication by Dr. David Tabak, available here.

One of the key stages in many securities class actions is class certification. The most common path for plaintiffs to obtain certification includes showing that the market in which the securities at issue traded was efficient, leading to what, in 1988, the Supreme Court in Basic v. Levinson termed a “rebuttable presumption” of reliance common to all class members.

The following year, the court in Cammer v. Bloom listed five factors that would help establish that a security traded in an efficient market. Since then, dozens of courts have relied on these “Cammer factors” in evaluating market efficiency. The rulings do not state, however, how the court reached an overall opinion on market efficiency when different factors point in different directions. To help shed light on this issue, we have examined identifiable cases from 2002 through 2011 in which a court ruled on market efficiency after reviewing some or all of the Cammer factors.

Our review of the data yields a perhaps remarkable conclusion: in over 98 percent of the cases, the ultimate ruling on efficiency can be predicted by the number of factors that the court found favored efficiency less the number of factors that the court said argued against efficiency. When this figure was positive, the court found the security at issue to have traded in an efficient market in all but one instance, while when the figure was zero, the court always found the security to have traded in an inefficient market. Moreover, just limiting the analysis to a review of three Cammer factors (turnover, analysts, and market makers) yields similar results.


“Publicness” in Contemporary Securities Regulation after the JOBS Act

The following post comes to us from Donald Langevoort and Robert Thompson, Professor of Law and Professor of Business Law, respectively, at the Georgetown University Law Center.

In our article “Publicness” in Contemporary Securities Regulation after the JOBS Act, forthcoming in the Georgetown Law Journal, we focus on the ideologically-charged question of when a private enterprise should be forced to take on public status, an extraordinarily significant change in its legal obligations and freedom to maneuver. The JOBS Act, which became law in April 2012, makes the first change in almost a half century in the criteria specified for companies that must meet public obligations under the Securities Exchange Act of 1934. Congress increased the “private space” by raising the 500 shareholder threshold to 2000 (so long as no more than 499 of those are not “accredited investors”) and permitting most new IPO companies to skip a host of regulatory obligations during their first five years as a public company.

Yet the reforms were not the product of any coherent theory about the appropriate scope of securities regulation, not just because of the political dimension but because the public-private divide has long been an entirely under-theorized aspect of securities regulation. This is illustrated by the gross inconsistency in how the two main securities statutes—the Securities Exchange Act of 1934 and the Securities Act of 1933—approach this divide Putting aside the voluntary acts of listing on an exchange or making a registered public offering, Section 12(g) of the ’34 Act has, until 2012, simply counted assets and shareholders to determine companies subject to reporting and other obligations under the Act The ’33 Act, by contrast, uses investor wealth and sophistication, i.e., investor qualification.


“Say on Pay” in the 2012 Proxy Season

David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. This post is based on an article by Mr. Katz and Laura A. McIntosh that first appeared in the New York Law Journal. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.

As the 2012 proxy season draws to a close, it is clear that executive compensation issues, particularly “say on pay,” again dominated the headlines. Though by some metrics say on pay was nearly a nonissue — after all, the median level of shareholder approval was around 90 percent, with fewer than 3 percent of U.S. companies experiencing a failed vote [1] — the vote results themselves are merely the tip of the iceberg. Say on pay was a topic of paramount concern to issuers this year and was the basis for a great deal of work both before and during the proxy season. Looking back on the past few months, two primary themes emerge: First, the importance of understanding and responding to the methodology of ISS Proxy Advisory Services (ISS), as its recommendations continue to be highly significant; and second, the importance of direct, frequent communication with shareholders and investment decision makers.

Directors who make compensation decisions that result in a negative ISS recommendation, shareholder disapproval, or other public criticism will wish to consider taking steps to minimize controversy surrounding company compensation practices. And, while, in some cases, shareholders have sued boards on the basis of a negative say on pay vote, directors can be confident that their compensation decisions, when made in good faith and in accordance with their fiduciary duties, are protected by the business judgment rule.


Private Equity/Public Target Deals: Mid-Year Update

The following post comes to us from John Pollack and David Rosewater, partners focusing mergers & acquisitions at Schulte Roth & Zabel LLP. This post is based on the Schulte Roth & Zabel PE Buyer/Public Target M&A Deal Study: 2012 Mid-Year Update, which is available here. Posts about previous versions of the study are available here, here, and here.

The large private equity buyer/public company segment of the U.S. M&A market (all cash deals over $500 million) was significantly affected in the first half of 2012 by troubles in the U.S., European and global economies. Only six trans­actions within our deal parameters were executed. Five of them had key deal terms generally consistent with our prior observations; the remaining transaction, Insight Ven­ture Partners/Quest Software, had certain key deal terms (“go-shop” period, target break-up fee and buyer reverse termination fee) that were outliers. Accordingly, for certain of our observations below, we have expressed the data including and excluding Insight Venture Partners/Quest Software (“Quest Software”). [1]

1. Fewer deals were completed in 1H 2012 and average deal size decreased. The decline in deal activity that began in Q1 2011 continued in 1H 2012. In 1H 2012, deal activity was down 33% compared to 1H 2011, and down 25% compared to 2H 2011. On an annualized basis, deal activity in the segment surveyed decreased 29% in 2012 compared to 2011. Equity values were also lower. For 1H 2012, in the deals within our survey, mean equity value fell 21% when compared to 1H 2011 and 54% when com­pared to 2H 2011. (See Chart 1 below.)


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