Monthly Archives: January 2015

The Threat to the Economy and Society from Activism and Short-Termism Updated

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Sabastian V. Niles, and Sara J. Lewis. Earlier posts by Mr. Lipton on hedge fund activism are available here, here and here. Recent work from the Program on Corporate Governance about hedge fund activism includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here) and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here). For five posts by Mr. Lipton criticizing the Bebchuk-Brav-Jiang paper, and for three posts by the authors replying to Mr. Lipton’s criticism, see here.

Again in 2014, as in the two previous years, there has been an increase in the number and intensity of attacks by activist hedge funds. Indeed, 2014 could well be called the “year of the wolf pack.”

With the increase in activist hedge fund attacks, particularly those aimed at achieving an immediate increase in the market value of the target by dismembering or overleveraging, there is a growing recognition of the adverse effect of these attacks on shareholders, employees, communities and the economy. Noted below are the most significant 2014 developments holding out a promise of turning the tide against activism and its proponents, including those in academia. Already in 2015 there have been several significant developments that are worth adding, which are included in bold at the end.

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Forum-Selection Bylaws Refracted Through an Agency Lens

The following post comes to us from Deborah A. DeMott, David F. Cavers Professor of Law at Duke University School of Law. 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.

Director-adopted bylaws that affect shareholders’ litigation rights have attracted both praise and controversy. Recent bylaws specify an exclusive judicial forum for litigation of corporate-governance claims, require that shareholder claims be arbitrated, and (most controversially) impose a one-way regime of fee shifting on shareholder litigants. To one degree or another, courts have legitimated each development, while commentators differ in their assessments. My paper, Forum-Selection Bylaws Refracted Through an Agency Lens, brings into clear focus issues so far blurred in the debate surrounding these types of bylaws.

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ISS 2015 Independent Chair Policy FAQs

Carol Bowie is Head of Americas Research at Institutional Shareholder Services Inc. (ISS). This post relates to ISS independent chair voting policy guidelines for 2015.

1. How does the new approach differ from the previous approach?

Under the previous approach, ISS generally recommended for independent chair shareholder proposals unless the company satisfied all the criteria listed in the policy. Under the new approach, any single factor that may have previously resulted in a “For” or “Against” recommendation may be mitigated by other positive or negative aspects, respectively. Thus, a holistic review of all of the factors related to company’s board leadership structure, governance practices, and performance will be conducted under the new approach.

For example, under ISS’ previous approach, if the lead director of the company did not meet each one of the duties listed under the policy, ISS would have recommended For, regardless of the company’s board independence, performance, or otherwise good governance practices.

Under the new approach, in the example listed above, the company’s performance and other governance factors could mitigate concerns about the less-than-robust lead director role. Conversely, a robust lead director role may not mitigate concerns raised by other factors.

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Gender Diversity at Silicon Valley Public Companies 2014

The following post comes to us from David A. Bell and Shulamite Shen White, partner and senior associate in the corporate and securities group at Fenwick & West LLP. This post is based on portions of a Fenwick publication titled Gender Diversity in Silicon Valley: A Comparison of Large Public Companies and Silicon Valley Companies (2014 Proxy Season); the complete survey is available here.

Fenwick & West has released its annual study about gender diversity on boards and executive management teams of companies in the technology and life science companies included in the Silicon Valley 150 Index and very large public companies included in the Standard & Poor’s 100 Index. [1] The Fenwick Gender Diversity Survey uses almost twenty years of data to provide a better picture of how women are participating at the most senior levels of public companies in Silicon Valley.

This year’s survey also introduces the Fenwick Gender Diversity Score™, a metric for assessing gender diversity overall within each of the indices. This composite score is based on data at the board and executive management level in the SV 150, top 15 companies of the SV 150 by revenue, and the S&P 100 over the nineteen years surveyed and in a set of categories selected as representative of the overall gender diversity picture.

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New Decision Holds Some Post-Closing Purchase Price Adjustment Provisions Unenforceable

The following post comes to us from Lisa R. Stark and Jessica C. Pearlman, partners in the Corporate/Mergers & Acquisitions practice at K&L Gates LLP, and is based on a K&L Gates publication by Ms. Stark and Ms. Pearlman. 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.

In private company acquisitions, it is common for the buyer to require that a portion of the merger consideration be set aside in escrow as an accessible source of funds to cover the buyer’s post-closing indemnification claims relating to breaches of the target company’s representations and warranties and other specified contingencies. However, the buyer might demand additional protection if its losses under such claims exceed the escrow amount by insisting upon collection of the full loss from the target company’s stockholders. If the losses are significant and the indemnification obligations are uncapped or have a sufficiently high cap, this could require the target company’s stockholders to return their full pro rata share of the merger consideration to the buyer.

Although the Delaware courts have previously upheld post-closing purchase price adjustments, a recent decision found common provisions unenforceable in certain circumstances. Cigna Health and Life Insurance Co. v. Audax Health Solutions, Inc., C.A. No. 9405 (Del. Ch. Nov. 26, 2014) (V.C. Noble). In this case, the merger agreement and related Letter of Transmittal (the “LoT”) required the target company’s stockholders (1) to indemnify the buyer, up to their pro rata share of the merger consideration, for the target company’s breaches of its representations and warranties, and (2) to release the buyer and its affiliates from any and all claims relating to the merger. The Court found these common provisions unenforceable under the facts in Cigna; accordingly, this decision has significant implications for other private company acquisitions by merger.

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Delaware Supreme Court Holds That Revlon Does Not Require Active Market Check

The following post comes to us from Jason M. Halper, partner in the Securities Litigation & Regulatory Enforcement Practice Group at Orrick, Herrington & Sutcliffe LLP, and is based on an Orrick publication by Mr. Halper, Peter J. Rooney, Christin Joy Hill, and Christine M. Smith. 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.

On December 19, 2014, the Supreme Court of Delaware reversed the Delaware Court of Chancery’s November decision (discussed on the Forum here) to preliminarily enjoin for 30 days a vote by C&J Energy Services stockholders on a merger with Nabors Red Lion Limited, to allow time for C&J’s board of directors to explore alternative transactions. The Supreme Court decision clarifies that in a sale-of-control situation, Revlon and its progeny require an effective, but not necessarily active, market check, and there is no “specific route that a board must follow” in fulfilling fiduciary duties.

The decision also reaffirms the type of record that must be made to support a mandatory preliminary injunction, a type of injunction that requires parties to take affirmative actions as opposed to merely maintaining the status quo. The Court found that the Chancery Court “blue penciled” the merger agreement, and in the process stripped Nabors of its contractual rights, by effectively inserting a go-shop provision into the contract where the parties never agreed to one. Moreover, the Chancery Court improperly did so without finding that Nabors aided and abetted a fiduciary duty breach and based its holding only on disputed facts that were not adjudicated following a trial. While the decision does not break new ground, it is significant in better defining directors’ duties when selling control and articulating the limits of a court’s ability to issue mandatory preliminary injunctions.

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Director Tenure: A Solution in Search of a Problem

The following post comes to us from Scott C. Herlihy, partner in the Corporate Department at Latham & Watkins LLP, and is based on an article by Mr. Herlihy, Steven B. Stokdyk, and Joel H. Trotter that originally appeared in NACD’s Directorship magazine.

Director tenure continues to gain attention in corporate governance as term limits become a cause célèbre. Proponents argue directors should no longer qualify as independent after 10 years of service, even though no law, rule or regulation prescribes a maximum term for directors.

We believe director term limits would be misguided and counterproductive. Institutional Shareholder Services (ISS) has increased its focus on the issue. ISS’ governance rating system, QuickScore, views tenure of more than nine years as an “excessive” length that potentially compromises director independence. ISS’ more moderate proxy voting guidelines, while opposing proposals for director term limits and mandatory retirement ages, indicates that ISS will “scrutinize” boards whose average tenure exceeds 15 years.

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REIT and Real Estate M&A in 2015

Adam Emmerich is a partner in the corporate department at Wachtell, Lipton, Rosen & Katz focusing primarily on mergers and acquisitions and securities law matters. This post is based on a Wachtell Lipton firm memorandum by Mr. Emmerich and Robin Panovka.

Following a year in which REITs returned more than 30% and were involved in a wide variety of strategic transactions, we are keeping an eye on the following trends:

1. Based on the current pipeline, we expect REIT and real estate M&A and consolidation activity to continue at a steady pace, accelerating in a few sectors and with traditional public-to-public mergers likely to pick up. The potential for privatizations is increasing but we are not yet seeing meaningful action.

2. Unlocking the value of corporate real estate through OpCo-PropCo structures, REIT spins and conversions is set to continue as long as REIT multiples remain robust relative to corporates, but we are not expecting an avalanche—these transactions are complex and time consuming and need to be carefully measured against alternatives.

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The Threat to the Economy and Society from Activism and Short-Termism

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton. Earlier posts by Mr. Lipton on hedge fund activism are available here and here. Recent work from the Program on Corporate Governance about hedge fund activism includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here) and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here). For five posts by Mr. Lipton criticizing the Bebchuk-Brav-Jiang paper, and for three posts by the authors replying to Mr. Lipton’s criticism, see here.

In a comprehensive report on prosperity and the sharing of prosperity in the industrial democracies, an all-star commission has examined and made recommendations for public and private initiatives to improve GDP growth and fair distribution of prosperity. Among the matters studied are corporate governance and short-termism and activism. The following specially selected quotes (omitting compensation and other matters that the report finds promote short-termism) from the report support the limitations on activism that many of us believe are essential to the American economy and society:

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Tying Incentives of Executives to Long-Term Value Creation

Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on an article by Mr. Bachelder, with assistance from Andy Tsang, which first appeared in the New York Law Journal. Research from the Program on Corporate Governance on long-term incentive pay includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

There is an important difference between the price paid for a business enterprise and the intrinsic value of that enterprise. As Benjamin Graham said, “Price is what you pay; value is what you get.” Warren Buffett has made himself and many others wealthy by understanding this difference and making investments accordingly.

Part I of this post looks briefly at the intrinsic value versus the market price (sometimes the latter is referred to as market value or market cap) of a publicly traded corporation. Part II looks at current design of long-term incentives awarded to the management of such corporations. These awards tend to be tied to short-term increase in the market price of the corporation’s stock. Part III suggests a way in which long-term incentive awards might be tied more to generators of long-term value of the corporations awarding them.

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