Introduction & Market Update

FTI Consulting’s Activism and M&A Solutions team welcomes our clients, friends and readers to our sixth quarterly Activism Vulnerability Report, documenting the results of our Activism Vulnerability Screener from the recent fourth quarter of 2020, as well as other notable trends and themes in the world of shareholder activism and engagement. Almost one year ago to the day, we sat down to write this report for the fourth quarter of 2019. Our team had just begun the shift to working from home offices and spare bedrooms, while still adjusting to full days of video conference calls due to the rapidly spreading COVID-19 coronavirus.

While it was not until the latter half of the fourth quarter of 2020, or even the start of 2021, that many of the pandemic’s biggest concerns began to subside, many areas of the market remained incredibly resilient throughout the year. The S&P 500 Index, the Dow Jones Industrial Average Index and the Nasdaq Composite Index rose 16.3%, 7.3% and 43.6%, respectively, in 2020. While the three leading indices all ended the year on solid ground, the incredible market voracity from the COVID-19 pandemic should not be overlooked. The S&P 500 Index reached an all-time peak of 3,386 on February 19, before it fell 33.9% in just 32 days to 2,237. As measured from March 23, 2020, however, the Index regained the previous high in less than five months on August 18 (an increase of 51.5%). For the S&P 500 Index and the Nasdaq Composite Index, the period of 2019 and 2020 represents the best two-year performance since 1998 and 1999, during the heart of the Dot-Com boom.

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Introduction

Not far behind the dramatic increase in the use of special purpose acquisition companies (SPACs) is a corresponding increase in the number of shareholder lawsuits and increased activity at the US Securities and Exchange Commission (SEC). In recent days, Reuters reported that the SEC opened an inquiry seeking information on how underwriters are managing the risks involved in SPACs, [1] and the SEC’s Division of Corporation Finance (Corp Fin) and acting chief accountant have issued two separate public statements on certain accounting, financial reporting and governance issues that should be considered in connection with SPAC-related mergers. [2] This increase in activity by SEC staff comes on the heels of nearly two dozen federal securities class action filings, several SEC investor alerts and earlier guidance from Corp Fin. [3] The surge in litigation and regulatory interest is likely to continue and expand throughout 2021 and beyond.

In Depth

A SPAC is a company with no operations that raises funds from public investors through an initial public offering (IPO). The proceeds from the IPO are placed in a trust or escrow account for future use in the acquisition of one or more companies. A SPAC will typically have a two-year period to identify and complete a business transaction. If the SPAC fails to do so during the specified period, then it must return the funds in the account to its public shareholders on a pro rata basis and then dissolve.

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Following these ten steps will prepare SPAC boards, sponsors, and advisors for the likely shareholder suits and potential regulatory investigations that are increasingly becoming part of the SPAC landscape.

If 2020 was the “year of the SPAC,” 2021 may be the year of SPAC litigation. SPACs—Special Purpose Acquisition Companies—are publicly traded companies launched as vehicles to raise capital to acquire a target company. Often called blank-check companies, SPACs are companies in which shareholders buy shares without knowing which company the SPAC will target and acquire. Investors place their faith in the sponsor: the entity or management team that forms the SPAC. The SPAC generally has around twenty-four months to seek out and acquire a target, or else must liquidate and return the capital.

Hundreds of new SPACs were launched in 2020 alone. Booming M&A or other transactional activity in any sector can invite litigation driven by plaintiffs’ attorneys, and SPACs are no exception. In just the first three months of 2021, more than 40 suits targeting SPACs have been filed. The nature of these claims evidence growing sophistication, as lawyers used to challenging traditional M&A transactions begin to tailor their claims to the unique characteristics of the SPAC lifecycle. And with SPACs going mainstream—and attracting attention from outside the usual financial circles—regulators are closely examining transaction disclosures and other aspects of SPAC deals. [1]

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Introduction [1]

In a recent statement, Acting Chief Accountant Paul Munter highlighted a number of important financial reporting considerations for SPACs. [2] Among other things, that statement highlighted challenges associated with the accounting for complex financial instruments that may be common in SPACs. Additionally, CF staff also issued a recent statement [3] highlighting key filing considerations for SPACs.

We recently evaluated fact patterns relating to the accounting for warrants issued in connection with a SPAC’s formation and initial registered offering. While the specific terms of such warrants can vary, we understand that certain features of warrants issued in SPAC transactions may be common across many entities. We are issuing this statement to highlight the potential accounting implications of certain terms that may be common in warrants included in SPAC transactions and to discuss the financial reporting considerations that apply if a registrant and its auditors determine there is an error in any previously-filed financial statements.

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The board of directors is the nucleus of internal corporate governance. The internationally predominant board model, as known from the US or the UK, reveals a one-tier structure. In a two-tier structure, as found in continental European countries like Germany, the management and the monitoring tasks are divided between two boards. Despite a trend of functional convergence in internal corporate governance, we observe persisting divergence in regard to board models. As known from major corporate governance reforms, most advances directly or indirectly target the board of directors. It hence appears a long overdue question whether the choice of a particular board model affects the operation of governance strategies. If it does not, private parties should be free to choose the board model that they expect to best suit their interests.

The Board Model as a Basic Governance Structure

In our recent paper on The Structure of the Board of Directors: Boards and Governance Strategies in the US, the UK and Germany we argue that a board model only provides a basic structure which serves to enable the use of more specific corporate governance strategies. The paper continues and advances our earlier research on Board Models in Europe in which we discussed convergence and divergence of internal corporate governance in the UK and Germany, as well as in France and Italy. In our earlier research, we advanced a plea for more flexibility and leaving the choice of the board model to private parties. Our recent paper supports this plea.

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Over the past six months, the U.S. securities markets have seen an unprecedented surge in the use and popularity of Special Purpose Acquisition Companies (or SPACs). [1] [2] Shareholder advocates—as well as business journalists and legal and banking practitioners, and even SPAC enthusiasts themselves [3]—are sounding alarms about the surge. Concerns include risks from fees, conflicts, and sponsor compensation, from celebrity sponsorship and the potential for retail participation drawn by baseless hype, and the sheer amount of capital pouring into the SPACs, each of which is designed to hunt for a private target to take public. [4] With the unprecedented surge has come unprecedented scrutiny, and new issues with both standard and innovative SPAC structures keep surfacing.

The staff at the Securities and Exchange Commission are continuing to look carefully at filings and disclosures by SPACs and their private targets. As customary, and in keeping with the Division of Corporation Finance’s ordinary practices, staff are reviewing these filings, seeking clearer disclosure, and providing guidance to registrants and the public. They will continue to be vigilant about SPAC and private target disclosure so that the public can make informed investment and voting decisions about these transactions.

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Can fiduciaries of Delaware corporations breach their duties and face damages for a merger that provides stockholders with the equivalent of fair value in a judicial appraisal? The answer, which may surprise some, is yes. On March 1, 2021, the Delaware Court of Chancery issued an opinion, In re Columbia Pipeline Group, Inc. Merger Litigation, 2021 WL 772562 (Del. Ch. Mar. 1, 2021) (the “2021 Decision”) that expressly stated that breaches of fiduciary duty can lead to damages that exceed appraisal fair value.

Background

It has long been accepted that Delaware courts use the same valuation methodologies to determine fair value in a judicial appraisal and fair price in a fiduciary duty action. [1] There is no real debate that, “in general, the techniques used to determine the fairness of price in a non-appraisal stockholder’s suit are the same as those used in appraisal proceedings.” Gesoff v. IIC Industries, Inc., 902 A.2d 1130, 1153, n.127 (Del. Ch. 2006). However, the precise relationship between fair price in a fiduciary duty action and fair value in a related appraisal action is often unclear.

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Shareholder activism has proved to be a permanent part of the global capital markets. In 2009, activist hedge funds had approximately $39b in assets under management. Today, that number is closer to $130b.

Considering assets under management for all hedge funds that pursue activism in at least one of their strategies, the total amount of capital available for deployment globally by activists is many multiples of that number.

The narrative around shareholder activism has also evolved from its early days as an offshoot of so-called corporate raiders, whose post-acquisition cost-cutting strategies were widely panned as lining their own pockets at the expense of the average worker. Shareholder activists now promote themselves as defenders of shareholder value, holding management teams and boards accountable for the destruction of (or alleged failure to maximize) shareholder value. With this carefully crafted shareholder-focused narrative, activism has steadily gained momentum with institutional investors. High-profile campaigns in recent years make clear that large institutional holders are willing to be vocal in both their criticism of targeted companies and their support for an activist’s agenda.

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In our paper forthcoming in the Journal of Financial Economics, we raise a question: can a firm looking for a takeover target use a target firm’s net insider buying as a signal of the potential worthiness of this acquisition? Prior studies have not examined the implication of insider trading for the outcomes of corporate mergers and acquisitions (M&As), possibly due to target insiders’ uncertain foreknowledge about acquisition outcomes and the stringent insider trading regulations prior to M&As. Our study fills this void by investigating whether target firm insider trading helps to reduce the “lemons” problem in the M&A market.

Corporate insiders’ trading activities are often used as a way to sign various potential firm-level events (e.g., dividend policy changes, seasoned equity offerings, open market share repurchases, corporate disclosures, etc.) as good or bad. However, it is not ex ante clear whether target insider trading can be used to infer the success of future M&As because the informational implications of target insider trading for acquisition outcomes are quite different from those of insider trading for the outcomes of other corporate events. In particular, prior to M&As, (1) target insiders are often uncertain about the bidder’s synergy potential, sometimes even lacking the knowledge of a potential acquisition, and (2) the Short Swing rule (i.e., SEC rule Section 16b), which requires any profits earned by insiders on round trip trades within any six-month period to be paid back to the firm, curbs target insiders’ trading prior to takeovers more severely than insider trading prior to other corporate events because takeover completion forces the sale of the target stock. (Facing any upcoming corporate events other than M&As, however, insiders can avoid the violation of the Short Swing rule simply by holding the stock over six months. If the limited target insider trading prior to M&As is unlikely to reflect target insiders’ private information, it would not be informative of M&A outcomes.) Due to these dissimilarities in the information structure and the regulatory environment of insider trading between M&As and other firm-level events, it is a discrete and important empirical issue to test whether target firm insider trading helps to reduce the adverse selection problem in the M&A setting.

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The COVID-19 pandemic has brought new attention to the period between signing and closing in M&A transactions. Transactional planners heavily negotiate the provisions that govern the behavior of the parties during this window, not only to allocate risk between the buyer and seller, but also to manage moral hazard, opportunistic behavior, and other distortions in incentives. COVID-19, however, has exposed an important connection between the material adverse effect (MAE) clause and the obligation for the seller to act “in the ordinary course of business” between signing and closing. Our new paper, Deals in the Time of Pandemic, forthcoming in the Columbia Law Review (June 2021), is the first to examine the interaction between the MAE clause and the ordinary course covenant in M&A deals.

Methodology

We constructed a new database of 1,300 M&A transactions announced between 2005 and 2020 with a transaction value of at least $1.0 billion, along with their MAE and ordinary course covenants—by far the most comprehensive, accurate, and detailed database of such deal terms that currently exists.

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During these unprecedented times, all of us have had to acclimate to new ways of working, adapting creatively to the changed environment. Economic activity, including M&A dealmaking, has inevitably been depressed by the COVID-19 crisis, especially in Q2 2020—but industries and businesses have found novel solutions to the problems they face. By Q4, M&A was again beginning to surge.

In this post, we examine the creative deal structures that are being employed with much greater frequency throughout the M&A market. Based on interviews with 150 US corporates and private equity firms, this post analyzes the ways in which M&A is moving forward in spite of the pandemic.

Q2 2020 saw a marked downturn in M&A activity relative to pre-crisis transaction levels. But, since then, dealmaking has bounced back strongly. While a full-scale recovery may not be achievable in the immediate future, there are many reasons to be positive.

The increased use of creative deal structures will be an important part of that story, helping buyers and sellers to overcome some of the risk aversion holding M&A back in the currently volatile and uncertain environment—and enabling more confident parties to pursue emerging opportunities. Indeed, we are already witnessing such an increase, reflected in the rising number of joint venture transactions and the boom in the launch of special purpose acquisition vehicles (SPACs).

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The combination of record-level SPAC issuance and a flood of non-SPAC M&A has created a supply-demand imbalance in the event-driven asset class. With SPACs garnering most of the limelight, we believe investors are missing an excellent opportunity to deploy capital into “other” event-driven investments, most prominently merger arbitrage.

A Wild Year

It’s certainly been an interesting 12 months in the event-driven asset class. From soft catalyst event situations upended by the onset of COVID in Q1 2020, to the March 2020 “Arbageddon” widening in merger arbitrage spreads, to countless instances of hedge fund repositioning causing atypical volatility in typically boring share class arbitrage. It’s been a truly wild ride.
The combination of Q1 2020 performance challenges for the asset class and slow-to-recover new merger volume last spring and summer led to the perception that there was “nothing to do” in event-driven. The record issuance of SPACs in 2020 and early 2021, accompanied by some high-profile bouts of outperformance in former SPACs like Nikola, amended that narrative slightly. Recent commentary has been willing to stipulate that there was nothing to do in event-driven, apart from SPACs.

The Current Opportunity

As experienced event-driven investors, we’ve often chafed at the notion that event-driven’s attractiveness waxes and wanes as much as commentators would suggest. Indeed, our team mantra is “there’s almost always something to do,” and our historical results have supported this claim’s veracity.

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Notwithstanding a year of unprecedented economic and societal change amidst a global pandemic, non-U.S. issuers continued to be targets of securities class actions filed in the United States. Indeed, despite widespread court closures due to the coronavirus pandemic, 2020 continued to see an uptick in the number of securities class action lawsuits brought against non-U.S. issuers. It is therefore imperative that, regardless of the economic climate, non-U.S. issuers stay vigilant of filing trends and take proactive measures to mitigate their risks.

In 2020, plaintiffs filed a total of 88 securities class action lawsuits against non-U.S. issuers.

• As was the case in 2019, the Second Circuit continues to be the jurisdiction of choice for plaintiffs to bring securities claims against non-U.S. issuers. More than 50% of these 88 lawsuits (49)3 were filed in courts in the Second Circuit. A clear majority (35) of these 49 lawsuits were filed in the Southern District of New York. The next most popular circuit was the Third Circuit, with 22 lawsuits initiated in courts there. The Ninth and Tenth Circuits followed with 15 and two complaints, respectively.
• Of the 88 non-U.S. issuer lawsuits filed in 2020, 28 were filed against non-U.S. issuers with a headquarters and/ or principal place of business in China, and 12 were filed against non-U.S. issuers with a headquarters and/or principal place of business in Canada.
• As was the case in 2018 and 2019, the Rosen Law Firm P.A. continued to be the most active plaintiff law firm in this space, leading with most first-in-court filings against non-U.S. issuers in 2020 (25). However, departing from the trend of the last several years, Pomerantz LLP was appointed lead counsel in the most cases in 2020 (14); the Rosen Law Firm closely followed with 13 appointments as lead counsel.
• Remarkably, the majority of the suits (28) were filed in the 2nd quarter, at the height of the coronavirus pandemic for most areas throughout the United States, particularly in the Southern District of New York.
• While the suits cover a diverse range of industries, the majority of the suits involved the biotechnology and medical equipment industry (14), followed by the software and programming industry (9), the consumer and financial services industry (7), and the communications services industry (7).
• Of the 22 lawsuits brought against European-headquartered companies, five were filed against firms headquartered in the United Kingdom and four were filed against firms headquartered in Germany.

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The Delaware Supreme Court unanimously affirmed a trial court judgment requiring a directors and officers (D&O) excess insurer to pay a claim for losses predicated on fraudulent conduct of the director and CEO of a corporation, holding that such losses are insurable under Delaware law and coverage is not barred by Delaware public policy.

The Court also held that Delaware law applied to the insurance policy in the case, stating that a choice of law analysis for a D&O policy will most often reveal that a corporation’s state of incorporation has the most significant relationship to the insurance policy.

Background

The insurance coverage at issue in RSUI Indemnity Company v. Murdock (March 3, 2021) [1] involved claims for breach of fiduciary duty and federal securities law violations under a $10 million excess D&O liability insurance policy issued by RSUI Indemnity Company to Dole Food Company, Inc. In November 2013, affiliates of David Murdock, the CEO and a director of Dole, completed a transaction to take Dole private for $13.50 per share. In 2015, the Delaware Chancery Court issued a memorandum opinion finding, among other things, that Murdock had breached his duty of loyalty and engaged in fraud in connection with the transaction, which drove down Dole’s premerger stock price, undermining it as measure of value and affecting the Dole Special Committee’s negotiating position. The Chancery Court awarded damages to unaffiliated stockholders in an amount equal to $2.74 per share (approximately $148 million in the aggregate). Dole then informed its insurers it was engaging in settlement negotiations, to which all responded by reserving their rights regarding coverage. Thereafter, Dole negotiated a settlement without further involvement of its D&O insurers, and Murdock paid the settlement amount in full.

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In In re Columbia Pipeline Group, Inc. Merger Litigation (Mar. 1, 2021), the Delaware Court of Chancery held that the CEO-Chairman and the CFO (“Skaggs” and “Smith,” respectively; together, the “Officers”) of Columbia Pipeline Group, Inc. (the “Company”) may have breached their fiduciary duties in connection with the $13 billion merger in 2016 of the Company with TransCanada Corporation (the “Merger”).

Vice Chancellor Laster found it reasonably conceivable, at the pleading stage of litigation, that the Officers had tilted the sale process to favor TransCanada, and that they were motivated by their plans to retire and their desire to receive their change-in control benefits that would be triggered on the Company’s sale. The court held that Corwin “cleansing” of the breaches was not available because the disclosure to stockholders relating to the Merger was inadequate. In addition, the court held that TransCanada may have aiding and abetting liability as it was reasonably conceivable that it knew that the Officers were violating their fiduciary duties in connection with the sale process and it “exploited the resulting opportunity.”

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On February 26, 2021, the Delaware Court of Chancery issued a landmark decision invalidating a stockholder rights plan, commonly known as a “poison pill,” that was adopted by the board of directors of The Williams Companies, Inc., an NYSE listed company (“Williams” or the “Company”), at the outset of the COVID‑19 pandemic. Steve Wolosky, the co-chair of Olshan’s Shareholder Activist Group, was a lead plaintiff in the class action lawsuit seeking to invalidate the pill. The Williams pill was one of many rights plans adopted by dozens of public companies during the pandemic, purportedly in response to specific control threats and/or precipitous drops in share price due to extreme market volatility.

The Williams pill, however, was “unprecedented” in that it was adopted purely as an “anti-activist pill” and contained a series of extreme features, including a 5% trigger and expansive “acting in concert” language that included a “daisy chain” provision. In the class action lawsuit, the certified class of plaintiffs asserted that the board of directors of the Company (the “Board”) breached its fiduciary duties when adopting the pill. In an 89-page opinion written by Vice Chancellor McCormick, the Court held that this unprecedented pill could not be justified given the Board’s motivations for its adoption and the “extreme combination of features” it possessed.

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On January 29, 2021, Vice Chancellor Laster of the Delaware Court of Chancery refused to dismiss a shareholder class action stemming from the 2019, $2.2 billion sale of Presidio, Inc., an IT solutions provider specializing in digital infrastructure and cloud and security solutions, to BC Partners Advisors L.P. (“BCP”), a private-equity firm. In Firefighters’ Pension System of the City of Kansas City v. Presidio, Inc., a shareholder of Presidio filed suit against Presidio’s CEO, its board of directors, Apollo Global Management LLC (Presidio’s controlling shareholder, owning approximately 42% of its outstanding common stock), LionTree Advisors, LLC (financial advisor to both Presidio and Apollo), and the acquiror, BCP.

The shareholder claimed that Apollo, Presidio’s CEO, and LionTree all favored—out of their own self-interests—a sale to BCP rather than a more competitive sales process. Apollo was allegedly seeking an exit from its investment in Presidio and favored a quick sale to BCP rather than a drawn-out bidding war. Presidio’s CEO allegedly favored steering the sale to BCP because BCP had promised him a lucrative post-sale pay package. As for LionTree, it allegedly was motivated by ongoing, lucrative relationships with both BCP and Apollo and tipped off BCP to another incoming bid so that BCP could stave-off a bidding war. The shareholder claimed that, as a result, Apollo, Presidio’s CEO, and the board breached their fiduciary duties and that LionTree and BCP aided and abetted the fiduciary duty breaches.

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Introduction

2020 marked an incredible surge in the prevalence of Special Purpose Acquisition Company (“SPAC”) initial public offerings and business combinations (“deSPAC transactions”). In 2020, there were 248 SPAC IPOs (raising total gross proceeds of over $83 billion) and 66 deSPAC transactions, as compared with 2019’s 59 SPAC IPOs (raising approximately $13.6 billion in gross proceeds) and 28 deSPAC transactions. [1] And the pace continues to skyrocket in 2021 with 160 SPAC IPOs in the first two months of the year and 13 completed deSPAC transactions. [2] This spectacular rise, and the related profits, has unsurprisingly garnered attention from both the United States Securities and Exchange Commission (“SEC”) and plaintiffs’ law firms. Most recently, the SEC’s Division of Corporation Finance released guidance [3] (the “SEC’s SPAC Guidance”) concerning disclosure obligations for SPAC IPOs and deSPAC transactions, highlighting many process and disclosure-related issues that plaintiffs’ lawyers typically raise and have focused on in recent SPAC lawsuits. As we anticipate that plaintiffs’ firms will continue to hone in on SPAC-related litigation in 2021 (likely using the SEC’s SPAC Guidance as its new and more tailored playbook), SPAC sponsors, their boards of directors, and the directors and officers of acquisition targets should all be focused on key steps to limit litigation risks and minimize costs associated with these risks.

Disclosure-Based Claims and the SEC’s SPAC Guidance

Given that SPAC transactions have not historically been the subject of significant litigation, particularly as compared to traditional IPOs and public-to-public M&A transactions, plaintiffs’ firms played catch-up in this area during 2020, largely recycling their traditional M&A playbook. Accordingly, following the filing of the initial Form S-4 in connection with the deSPAC transaction, plaintiffs’ firms have alleged disclosure-based claims under Section 14(a) of the Exchange Act, claiming that the proxy statements issued are deficient due to the failure to disclose financial projections for the SPAC entity, immaterial details relating to negotiations or pursuit of other potential acquisition targets, reasoning for not hiring a financial advisor, or financial analyses that the SPAC board considered. See Wheby v. Greenland Acquisition Corp., C.A. No. 1:19-cv-01758 (D. Del. Sept. 19, 2019) (basing Section 14(a) action on alleged failure to make disclosures related to line items and reconciliations underlying financial statements, the target’s financial projections, terms of a non-disclosure agreements and letters of intent with potential targets, the basis for not hiring a financial advisor, and communications regarding future employment of the SPAC sponsors). More recently, however, plaintiffs’ firms are couching such pre-closing disclosure-based claims as breach of fiduciary duty claims, often filing in New York state courts, and are honing in on the unique aspects of SPACs and deSPAC transactions.

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Board members are reconsidering their oversight priorities after a tumultuous 2020 and slow economic recovery. For many, this means navigating some level of financial difficulty that will take a combination of outside capital, resourcefulness and innovation to overcome. For others, it means focusing on emerging or elevated risks and opportunities impacting corporate strategy execution.

Concurrently, shareholders, regulators and other stakeholders have expanding expectations for board action in the wake of the pandemic. Boards of directors are being prompted to address financial and social pressures, a reimagined workplace, evolving regulatory demands and increased scrutiny on environmental, social and governance (ESG) activities. The 2021 BDO Winter Board Pulse Survey reveals how public company boards are moving forward despite continued uncertainty.

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Introduction

As we begin to see the light at the end of the tunnel of a pandemic that upended all of our lives and disrupted almost every business, activist investors are getting in gear, and the pieces are expected to be in place for continued growth in merger and acquisition activity through 2021. Political unrest, accelerating social change, and renewed emphasis on corporate purpose beyond shareholder primacy will continue to shape the future and inject uncertainty. Our world is literally changing before our eyes, and we have to ask ourselves, how will this affect shareholder activism in 2021 and beyond, and what will the impact be on M&A activity? And how have the events of 2020 changed what board directors need to do to be prepared for M&A generally and to deal with activists that might emerge?

The 2020 slowdown set the stage

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