On January 26, 2010 the stockholders of 3Com Corporation (“3Com”) (Symbol: COMS) will meet to consider a merger of 3Com into a wholly-owned subsidiary of the Hewlett-Packard Company (“HP”) (Symbol: HPQ) for $7.90 in cash per share. In my post of January 13, 2010, I discussed the reliance by Starent Networks (Symbol: STAR) of fears of competitive harm to avoid any pre-signing market check. While a lawsuit was filed challenging the Starent merger with Cisco, it was promptly settled, and therefore the Delaware Chancery Court had no opportunity to pass upon Starent’s explanation for avoiding a pre-signing market check.
This avoidance rationale is expanding. 3Com voiced similar concerns in avoiding any pre-signing market check of its proposed merger with HP. But in this instance Chancellor Chandler of the Delaware Chancery Court did have an opportunity to address the issue. He did so, albeit obliquely, in rejecting plaintiffs’ request for expedited discovery, concluding, in passing, that 3Com’s failure to solicit other buyers before entering into the merger agreement with HP did not “support a colorable claim that fiduciary duties were breached.” (Letter Opinion of December 18, 2009, at page 12.)
A. Background of the HP Merger
This is the second time to the altar for 3Com. In September 2007 3Com agreed to merge with affiliates of financial buyer Bain Capital, a deal that would have delivered to 3Com’s stockholders $5.30 in cash per share. That deal ran into problems, including with the Committee on Foreign Investment in the United States (CFIUS) and was abandoned in April 2008. The abandonment of the merger let to a shakeup in the senior executive ranks of 3Com, including the appointment of a new CEO and COO.
The proposed marriage with HP began in a familiar fashion, with discussions at a trade show in Las Vegas in May 2009 “concerning a possible commercial relationship.” 3Com’s December 15, 2009 Proxy Statement at 18. Discussions continued over the next few months, during which 3Com reports it was also considering “other strategic initiatives” with “other large technology companies.”
The discussions over a “commercial relationship” ripened into deal talks on July 30, 2009, when HP broached the topic of acquiring 3Com in lieu of establishing a commercial relationship. The next day, July 31, 3Com conferred with its long-time banker, Goldman Sachs, to “discuss the strategic landscape of, and the potential for consolidation in, the networking industry.” Proxy Statement at 19.
HP began the dance on August 5, 2009 with a non-binding indication of interest in the range of $4.80 to $5.15 per share in cash. It requested exclusivity for a 60-day period.
3Com’s board of directors met to consider HP’s indication of interest on August 10, 2009.
I commented in my post on the Cisco/Starent merger that Starent’s description of the background of the transaction was notable for the apparent absence of counsel and Goldman, also Starent’s financial advisors, from key board meetings. Not so with 3Com. At this very first board meeting to consider HP’s interest in acquiring 3Com, 3Com’s counsel, Wilson Sonsini, attended the meeting and “advised the board regarding its fiduciary duties in connection with its consideration of HP’s August 5th indication of interest.” Proxy Statement at 19. The board also decided to engage Goldman to act as its financial advisor in evaluating the HP proposal, “including strategic alternatives to a potential acquisition by HP.”
Also at this first meeting on August 10, Messrs. Mao (CEO) and Sege (COO) discussed for the board management’s “ongoing evaluation and discussions with other companies concerning potential strategic and commercial partnerships.” Proxy Statement at 19.
Goldman joined the board at its August 10th meeting. The board naturally rejected HP’s preliminary indication of interest, “but authorized our senior management team and financial advisor to continue discussions with HP regarding a potential acquisition by HP and to provide additional information to HP to support a higher purchase price for 3Com.” Proxy Statement at 20.
3Com, like Starent, concluded that seeking alternative indications of interest at this stage was not prudent:
“After discussion among the board members, the board determined not to seek alternative indications of interest to acquire 3Com from other companies at this time due to the preliminary nature of HP’s indication of interest, the relatively wide divergence in views between the board and HP over 3Com’s valuation, and the significant risks of harm to 3Com’s business and of employee dislocation if speculation arose that 3Com was considering a transaction with potential acquirors.”
Proxy Statement at 20.
This explanation has a familiar ring, although one might ask how 3Com’s competitors and interested parties could not know that 3Com was in play given that it had spent seven months, over the period September 2007 through April 2008, trying to consummate a merger with Bain Capital?
3Com provided additional due diligence information to HP in August and September of 2009. HP bided its time. On September 23, the board held a regularly scheduled meeting. Representatives of Goldman attended and, in the context of a review of the discussions with HP, “discussed other strategic opportunities that could be under consideration by HP as potential alternatives to an acquisition of 3Com.” Proxy Statement at 20. Goldman also discussed the “potential interest of other technology companies in acquiring 3Com.” Id. at 21. Wilson Sonsini advised the board “regarding its fiduciary duties in connection with its evaluation of strategic alternatives, including a possible acquisition by HP or any other acquirer.” Id.
With HP’s eyes apparently wandering, now was the time for the 3Com board to put out feelers to other technology companies, assuming 3Com had an interest in pursuing a deal. But it did not do so, even after learning, on October 5 from published reports, that HP might be interested in acquiring one of 3Com’s competitors.
But the only suitor 3Com had an interest in was HP, and finally that desire bore fruit, for on October 19, HP upped its proposed purchase price to $6.75 per share. The board met to consider this offer the following day, and conducted the standard reviews, including of remaining independent. The board resolved to reject HP’s indication of interest, but instructed Mao to advise HP to consider increasing its proposed purchase price to between $8.00 and $8.50 per share, and to inform HP that 3Com “would consider a brief period of exclusive negotiations at a price in this range.” Proxy Statement at 22. At this meeting the board appointed a transaction committee to oversee discussions with HP “or potentially other parties” and to report regularly to the board.
HP edged closer to the altar on October 25, upping the ante to $7.80 per share (the final deal price was $7.90 per share). The board met the following day, October 26, to consider HP’s offer. The board concluded that HP’s offer was “attractive” but instructed management to make one more try.
Quite obviously at this stage it would be a bit late to seek third-party indications of interest. Rather than rely upon concerns of competitive harm to avoid doing so, however, the board now concluded that “very few” companies with the financial resources to acquire 3Com would have an interest in doing so!
“After this discussion [whereby Goldman Sachs discussed other large technology companies that would be reasonably likely to have an interest in 3Com], the board determined that there were few companies that would likely have a strategic interest and sufficient financial resources to consider an acquisition of 3Com. The board further noted that 3Com had been engaged in ongoing discussions with certain of these companies regarding commercial relationships for some time, but none of them had expressed any interest in discussing an acquisition of 3Com at this time. Moreover, the board noted that the press had extensively reported on acquisition trends and likely targets of consolidation in the networking industry (including one of our primary competitors and 3Com itself), but that no companies had approached 3Com to discuss a potential acquisition in light of such press reports.”
Proxy Statement at 23.
Accordingly, the board resolved not to pursue any other potential acquirors and to enter into an exclusivity agreement with HP for a limited duration. HP made its final and best offer of $7.90 per share on October 26. This price, and the definitive merger agreement, were approved by the board on November 11.
B. The Plaintiffs’ Challenge of the Deal
The primary focus of plaintiffs’ complaint against 3Com is on purported disclosure violations, which is understandable since a disclosure violation automatically constitutes irreparable harm entitling plaintiffs to injunctive relief. The plaintiffs spent considerable effort in trying to establish material omissions in the proxy statement involving Goldman’s valuation and the description thereof. Plaintiffs also alleged that the process followed by 3Com in agreeing to the HP merger was flawed and constituted a breach of the board’s fiduciary duties to 3Com’s stockholders. And while plaintiffs do not allege that the reasons given by 3Com’s board to pass on conducting a market check prior to the signing of the HP merger agreement were pretense, plaintiffs allege, repeatedly, that “3Com negotiated exclusively with HP and never contacted any other potential bidder.” Consolidated Amended Complaint ¶ 46 (dated December 11, 2009). Plaintiffs make similar charges in paragraphs 47, 73, 74, and 80(a) of the Complaint. They allege in paragraph 73:
“. . . the terms of the Merger were not the result of an auction process or active market check; they were arrived at without a full and thorough investigation by the Individual Defendants [the executive officers and directors of 3Com] of strategic alternatives; . . .”
So the Chancellor, in ruling on plaintiffs’ request for expedited discovery, clearly had before him the charge that the 3Com board did nothing to conduct a pre-signing market check before agreeing to a deal with HP at $7.90 per share.
C. The Chancellor’s Decision
Chancellor Chandler ruled on plaintiffs’ request for expedited discovery by his letter opinion of December 18, 2009. The test, as stated by the Chancellor, in resolving plaintiffs’ request was whether they had alleged in their complaint “a sufficiently colorable claim [and have shown] a sufficient possibility of threatened irreparable injury, as would justify imposing on the defendants and the public the extra (and sometimes substantial) costs of an expedited preliminary injunction proceeding.” Letter Opinion at 1-2.
The Chancellor concludes that plaintiffs had not met this test. With respect to their disclosure claims, he essentially concludes that the plaintiffs were nit picking, and that 3Com had done all that Delaware law requires to explain the basis for the board’s decision to proceed with the merger with HP and had accurately summarized Goldman’s valuation analysis and its limitations. As the Chancellor observed in responding to plaintiffs’ claim that Goldman’s fairness opinion deviated from conventional practice and that such deviations should have been disclosed:
“Under Delaware law, the valuation work performed by an investment banker must be accurately described and appropriately qualified. So long as that is done, there is no need to disclose any discrepancy between the financial advisor’s methodology and the Delaware fair value standard under Section 262 (or any other standard for that matter).”
Letter Opinion at 10 (footnotes omitted).
In conclusion, observed the Chancellor, the plaintiffs’ “quibbles with Goldman’s methodologies (and inputs into those methodologies), if they are serious, can be resolved via an appraisal action.” Id. at 11.
The bulk of the Chancellor’s decision is devoted to plaintiffs’ disclosure claims (11 of 12 pages) — he gives short shrift to plaintiffs’ breach of fiduciary duty claims, and groups them together: Plaintiffs, he observes, have alleged that the 3Com directors breached their fiduciary duties by —
“(a) including a no-solicitation and matching rights provision in the Merger agreement, (b) including a $99 million termination fee, that, along with a $10 million expense reimbursement fee represents over 4% of the equity value of the Merger, and (c) failing to make an effort to solicit other buyers before entering the Merger agreement.”
The Chancellor concluded that “none” of these allegations “support a colorable claim that fiduciary duties were breached.” Letter Opinion at 12.
While the Chancellor cites authority for his conclusion as to plaintiffs’ “deal protection” allegations, he cites none for the proposition that a target need not solicit other buyers before entering into a merger agreement. Perhaps it was obvious to him.
D. Whither Pre-Signing Market Checks?
Perhaps in passing upon pre-signing market checks, Starent and 3Com took their cue from the Delaware Supreme Court’s decision in Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (2009), which I discussed in my post of March 30, 2009. The board of Lyondell did not conduct a pre-signing market check before agreeing to a deal with Basell AF at $48 per share, a number Lyondell’s banker, Deutsche Bank, concluded was “an absolute home run.” But Vice Chancellor Noble was clearly bothered by the Lyondell board’s failure to conduct any pre-signing market check, and the speed with which the board approved the deal, in denying defendants’ motion for summary judgment.
The Delaware Supreme Court reversed the Vice Chancellor and directed entry of summary judgment for the defendants. One of the key findings of the Court was that Vice Chancellor Noble had selected too early a date for the invocation of Revlon duties — the announcement of the filing of a Schedule 13D by Basell rather than the later point in time at which the board resolved to seriously consider a sale of the company. Because Lyondell involved a post-closing challenge to a merger, and Lyondell had an exculpatory provision in its certificate of incorporation, plaintiffs had to establish a lack of good faith by the directors (which is non-exculpatory) to prevail. The Court in Lyondell confirmed that to establish a lack of good faith requires establishing that the directors knew that they were not discharging their fiduciary obligations.
In reversing Vice Chancellor Noble, the Delaware Supreme Court noted that the Lyondell directors were active, sophisticated, and generally aware of the value of the company and the conditions of the markets in which the company operated (970 A.2d at 241, and that they “had reason to believe that no other bidders would emerge, given the price Basell had offered and the limited universe of companies that might be interested in acquiring Lyondell’s unique assets.” Id. Moreover, Lyondell’s CEO negotiated Basell’s offer from an initial price of $40 to $48 per share, a 20% increase. And, noted the Court, “no other acquiror expressed interest during the four months between the merger announcement and the stockholder vote.” Id.
Crucial to its analysis, the Court noted that Revlon duties (to obtain the highest price reasonably available) “applies only when a company embarks on a transaction — on its own initiative or in response to an unsolicited offer — that will result in a change in control.” Id. at 242.
And the Court went out of its way to emphasize the discretion a board has in discharging its Revlon duties:
“There is only one Revlon duty — to ‘[get] the best price for the stockholders at a sale of the company.’ No court can tell directors exactly how to accomplish that goal, because they will be facing a unique combination of circumstances, many of which will be outside their control. As we noted in Barkan v. Amsted Industries, Inc., ‘there is no single blueprint that a board must follow to fulfill its duties.’ ”
970 A.2d at 242 – 243 (footnotes omitted).
In language that clearly gives comfort to those who believe a pre-signing market check is not necessary under Revlon, the Court responded in this way to Vice Chancellor Noble’s concerns about the failure of the Lyondell board to conduct an auction or market check pre-signing:
“The Lyondell directors did not conduct an auction or a market check, and they did not satisfy the trial court that they had the ‘impeccable’ market knowledge that the court believed was necessary to excuse their failure to pursue one of the first two alternatives [conduct an auction or a market check]. As a result, the Court of Chancery was unable to conclude that the directors had met their burden under Revlon. In evaluating the totality of the circumstances, even on this limited record, we would be inclined to hold otherwise. . . . Where, as here, the issue is whether the directors failed to act in good faith, the analysis is very different, and the existing record mandates the entry of judgment in favor of the directors.”
970 A.2d at 243 (emphasis added).
An evaluation of a board’s discharge of its fiduciary duties, particularly in a deal context, is heavily contextual. But the records of the Cisco/Starent and HP/3Com deals contain facts similar to those involved in the Basell/Lyondell deal: large companies experienced in doing deals, advised by competent and experienced advisors; a final merger price that exceed by a material amount the initial bids (30% in the case of Cisco/Starent and 65% in the case of HP/3Com); and, notably, the failure of any third party to jump in after the deal was announced. While deal protection measures and match rights make the prospect of busting up a deal unattractive, it can be done, as EMC’s snatching of Data Domain from NetApp demonstrated. (See my posts of June 10, 24 and 26, 2009 on the battle for Data Domain).
But this much is clear — a board disinclined to conduct an auction or pre-signing market check to validate a price that it negotiates with a suitor has both precedent and Delaware case law to justify its reluctance. And a board can take some comfort in knowing that if it truly misses the boat, a determined party (e.g., an EMC) may jump in and make the board’s error moot.
Thursday, January 21, 2010
Friday, January 15, 2010
SEC v. Bank of America Corp.: Recent Developments
This case is headed for trial on March 1, 2010 before Judge Rakoff. Two recent decisions by the Judge have sharpened the issues for trial. Whether the case actually is tried is problematic, given BofA’s obvious attempts, under new CEO Brian Moynihan, to settle all litigation arising out of BofA’s acquisition of Merrill Lynch.
A. Judge Rakoff’s Evidentiary Ruling of January 4
I have commented extensively on this case in prior posts. As I have observed, BofA’s primary defense was to be that the fact that Merrill would pay substantial 2008 year-end bonuses to its officers and employees was so well known by the market that any failure to disclose BofA’s agreement that Merrill could pay such bonuses (of up to $5.8 billion) was immaterial.
By his January 4, 2010 Opinion and Order (“Order”) Judge Rakoff dealt with the SEC’s motion to exclude from evidence all media reports concerning Merrill’s payment of year-end bonuses. The Judge granted the motion. The ground for the decision was BofA’s own October 31, 2008 proxy statement, used to solicit the consent of its stockholders for the merger. BofA was hoisted on its own petard, as it cautioned its stockholders to rely only on the information set forth in the proxy statement and information specifically incorporated by reference into the proxy statement:
“You should rely only on the information contained or incorporated by reference into this document. No one has been authorized to provide you with information that is different from that contained in, or incorporated by reference into, this document.”
Order at 1-2.
To emphasize the point, BofA repeated this admonition, in even stronger language, in bold face type, at the end of its proxy statement:
“You should rely only on the information contained or incorporated by reference in this document. Neither Bank of America nor Merrill Lynch has authorized anyone to give any information or make any representation about the merger or our companies that is different from, or in addition to, that contained in this document. Therefore, if anyone does give information of this sort, you should not rely on it.”
Order at 2.
These disclosures provided the Judge with all he needed to grant the SEC’s motion to exclude all media reports from evidence, including any reliance on such reports by both the SEC’s and BofA’s experts.
“Furthermore, even if the media reports of Merrill’s likelihood of paying bonuses could otherwise somehow be said to bear indirectly on the question of how material was the Bank’s alleged failure to disclose that it had in fact already approved the payment of such bonuses when it purported to represent that it had not given such approval, the warnings in the proxy statement totally changed the relevant mix of information for assessing materiality. Since the test of materiality is whether the undisclosed information, if disclosed, “would have been viewed by a reasonable investor as having significantly altered the ‘total mix’ of information made available,” TSC Indus., 426 U.S. at 438, one must ask what a reasonable investor would reasonably consider the total mix of information in this case. The answer is that since the Bank itself warned investors not to rely on the media, it would be unreasonable for a shareholder to consider the media pronouncements to be a part of the relevant mix of information.”
Order at 5.
As is his want, Judge Rakoff could not resist putting in a final dig at BofA for its position:
In effect, the Bank is arguing that, even though it expressly warned its shareholders to disregard the media, it can now defend itself by asserting that a reasonable shareholder would have disregarded these warnings and, by consulting the media, perceived that the Bank’s alleged lies were immaterial. Even a zealous advocate might perceive that such an argument hints at hypocrisy.”
Order at 6.
B. The Judge Rejects the SEC’s Request to Amend Its Complaint
By his order of January 11, the Judge rejected the SEC’s attempt to amend its Complaint to add an additional alleged omission by the Bank, namely its purported failure to disclose Merrill’s sizeable losses incurred in the fourth quarter of 2008. Apparently the Judge was convinced this new claim was brought too late and would prejudice BofA. For our purposes it is a sideshow; its exclusion from the case doesn’t detract from the drama that is unfolding in Judge Rakoff’s court.
On January 13, the SEC filed a new complaint, also in the Southern District, against BofA repeating its allegations of proxy violations for BofA’s failure to disclose Merrill’s sizeable fourth quarter 2008 losses. While I am not familiar with the Southern District’s assignment procedures, this action could very well be deemed a “related” case to that pending before Judge Rakoff and therefore assigned to him. If so, the SEC’s filing of this second action against BofA may have strategic implications: one or both parties may request a delay in the March 1 trial date of the current action before Judge Rakoff so that both actions, clearly involving similar facts, documents, evidence, and witnesses, be tried at the same time. The SEC may also believe that the second action gives it additional leverage over BofA.
C. Prognosis
I discussed in some detail my prognosis for any trial in this case in my post of September 25, 2009 and concluded, “it’s entirely possible that even if the Bank is found liable for proxy violations as alleged by the SEC, the remedies Judge Rakoff would enter would not be as stringent as those set out in the settlement to which BofA was prepared to accept.” The settlement Judge Rakoff rejected called for payment of a civil fine by BofA of $33 million and entry of a permanent injunction against future violations of the proxy rules.
We now know, after extensive discovery, including of BofA’s lawyers (BofA waived the attorney-client privilege - see my post of October 15, 2009), that the SEC’s initial conclusions based upon the discovery it conducted prior to entering into the settlement, that the record did not establish scienter on the part of any officer of BofA or its counsel, sufficient to allow the SEC to name any such persons, have been confirmed, at least in the SEC’s mind. So the Judge’s outrage at the settlement for its failure to name any individual culprits will not be vindicated at trial. Assuming, as appears likely to this observer, that the Bank will be found liable for a proxy violation for failing to disclose its agreement with Merrill to pay year-end bonuses of up to $5.8 billion, what remedies will Judge Rakoff impose?
Given the sensitivities of the Judge to imposing upon the “victim,” here BofA’s shareholders, any damages for BofA’s proxy violations, it is entirely reasonable to conclude that the most probable remedy Judge Rakoff would impose is an injunction. As I discussed in my post of September 25, even on that remedy the Bank will mount a vigorous defense, namely on the ground that the odds of its repeating a proxy violation are nil.
The Judge is of course very bright, and probably appreciates that this case is headed in that direction so he may be more amenable to accepting the next settlement BofA and the SEC agree to. This leaves open the possibility that BofA will enter into a global settlement with the SEC and New York’s Attorney General Andrew Cuomo that includes the payment of a fine (to the extent demanded by Cuomo) and a consent to injunctive relief against future violations of the proxy rules. Given there’s a new captain of the BofA ship, CEO Moynihan, I am reasonably confident that is a settlement he would gladly accept to get the Merrill litigation behind him.
A. Judge Rakoff’s Evidentiary Ruling of January 4
I have commented extensively on this case in prior posts. As I have observed, BofA’s primary defense was to be that the fact that Merrill would pay substantial 2008 year-end bonuses to its officers and employees was so well known by the market that any failure to disclose BofA’s agreement that Merrill could pay such bonuses (of up to $5.8 billion) was immaterial.
By his January 4, 2010 Opinion and Order (“Order”) Judge Rakoff dealt with the SEC’s motion to exclude from evidence all media reports concerning Merrill’s payment of year-end bonuses. The Judge granted the motion. The ground for the decision was BofA’s own October 31, 2008 proxy statement, used to solicit the consent of its stockholders for the merger. BofA was hoisted on its own petard, as it cautioned its stockholders to rely only on the information set forth in the proxy statement and information specifically incorporated by reference into the proxy statement:
“You should rely only on the information contained or incorporated by reference into this document. No one has been authorized to provide you with information that is different from that contained in, or incorporated by reference into, this document.”
Order at 1-2.
To emphasize the point, BofA repeated this admonition, in even stronger language, in bold face type, at the end of its proxy statement:
“You should rely only on the information contained or incorporated by reference in this document. Neither Bank of America nor Merrill Lynch has authorized anyone to give any information or make any representation about the merger or our companies that is different from, or in addition to, that contained in this document. Therefore, if anyone does give information of this sort, you should not rely on it.”
Order at 2.
These disclosures provided the Judge with all he needed to grant the SEC’s motion to exclude all media reports from evidence, including any reliance on such reports by both the SEC’s and BofA’s experts.
“Furthermore, even if the media reports of Merrill’s likelihood of paying bonuses could otherwise somehow be said to bear indirectly on the question of how material was the Bank’s alleged failure to disclose that it had in fact already approved the payment of such bonuses when it purported to represent that it had not given such approval, the warnings in the proxy statement totally changed the relevant mix of information for assessing materiality. Since the test of materiality is whether the undisclosed information, if disclosed, “would have been viewed by a reasonable investor as having significantly altered the ‘total mix’ of information made available,” TSC Indus., 426 U.S. at 438, one must ask what a reasonable investor would reasonably consider the total mix of information in this case. The answer is that since the Bank itself warned investors not to rely on the media, it would be unreasonable for a shareholder to consider the media pronouncements to be a part of the relevant mix of information.”
Order at 5.
As is his want, Judge Rakoff could not resist putting in a final dig at BofA for its position:
In effect, the Bank is arguing that, even though it expressly warned its shareholders to disregard the media, it can now defend itself by asserting that a reasonable shareholder would have disregarded these warnings and, by consulting the media, perceived that the Bank’s alleged lies were immaterial. Even a zealous advocate might perceive that such an argument hints at hypocrisy.”
Order at 6.
B. The Judge Rejects the SEC’s Request to Amend Its Complaint
By his order of January 11, the Judge rejected the SEC’s attempt to amend its Complaint to add an additional alleged omission by the Bank, namely its purported failure to disclose Merrill’s sizeable losses incurred in the fourth quarter of 2008. Apparently the Judge was convinced this new claim was brought too late and would prejudice BofA. For our purposes it is a sideshow; its exclusion from the case doesn’t detract from the drama that is unfolding in Judge Rakoff’s court.
On January 13, the SEC filed a new complaint, also in the Southern District, against BofA repeating its allegations of proxy violations for BofA’s failure to disclose Merrill’s sizeable fourth quarter 2008 losses. While I am not familiar with the Southern District’s assignment procedures, this action could very well be deemed a “related” case to that pending before Judge Rakoff and therefore assigned to him. If so, the SEC’s filing of this second action against BofA may have strategic implications: one or both parties may request a delay in the March 1 trial date of the current action before Judge Rakoff so that both actions, clearly involving similar facts, documents, evidence, and witnesses, be tried at the same time. The SEC may also believe that the second action gives it additional leverage over BofA.
C. Prognosis
I discussed in some detail my prognosis for any trial in this case in my post of September 25, 2009 and concluded, “it’s entirely possible that even if the Bank is found liable for proxy violations as alleged by the SEC, the remedies Judge Rakoff would enter would not be as stringent as those set out in the settlement to which BofA was prepared to accept.” The settlement Judge Rakoff rejected called for payment of a civil fine by BofA of $33 million and entry of a permanent injunction against future violations of the proxy rules.
We now know, after extensive discovery, including of BofA’s lawyers (BofA waived the attorney-client privilege - see my post of October 15, 2009), that the SEC’s initial conclusions based upon the discovery it conducted prior to entering into the settlement, that the record did not establish scienter on the part of any officer of BofA or its counsel, sufficient to allow the SEC to name any such persons, have been confirmed, at least in the SEC’s mind. So the Judge’s outrage at the settlement for its failure to name any individual culprits will not be vindicated at trial. Assuming, as appears likely to this observer, that the Bank will be found liable for a proxy violation for failing to disclose its agreement with Merrill to pay year-end bonuses of up to $5.8 billion, what remedies will Judge Rakoff impose?
Given the sensitivities of the Judge to imposing upon the “victim,” here BofA’s shareholders, any damages for BofA’s proxy violations, it is entirely reasonable to conclude that the most probable remedy Judge Rakoff would impose is an injunction. As I discussed in my post of September 25, even on that remedy the Bank will mount a vigorous defense, namely on the ground that the odds of its repeating a proxy violation are nil.
The Judge is of course very bright, and probably appreciates that this case is headed in that direction so he may be more amenable to accepting the next settlement BofA and the SEC agree to. This leaves open the possibility that BofA will enter into a global settlement with the SEC and New York’s Attorney General Andrew Cuomo that includes the payment of a fine (to the extent demanded by Cuomo) and a consent to injunctive relief against future violations of the proxy rules. Given there’s a new captain of the BofA ship, CEO Moynihan, I am reasonably confident that is a settlement he would gladly accept to get the Merrill litigation behind him.
Wednesday, January 13, 2010
Cisco/Starent Merger: Relying Upon Fears of Competitive Harm to Avoid a Pre-Signing Market Check
Cisco and Starent networks announced their all-cash $2.9 billion merger on October 12, 2009. The deal proceeded apace, with a plaintiffs’ class-action lawsuit dutifully filed in early November, settled within one month, Starent’s stockholders approving the merger on December 11, antitrust clearance obtained on December 16, with the merger closing on December 18. Very efficient. Now on to the next one.
A review of the background of the merger, however, as disclosed in Starent’s definitive proxy statement of November 9, 2009 circulated to its stockholders in connection with the special meeting called to approve the merger, squarely raises the question of the appropriateness of relying upon a fear of competitive harm to avoid any pre-signing market check. Unfortunately for those of us interested in M&A doctrine, as enunciated by the Delaware courts, prompt settlement of the legal challenge to the deal will leave resolution of that question to another day.
A. Background of Cisco’s Acquisition of Starent
This deal had its germination in a June 2009 meeting between Starent’s CEO, Ashraf Dahod, and representatives of Cisco to discuss a potential global reseller arrangement between the parties. Simultaneously, Starent commenced discussions with another firm in its industry concerning a possible strategic alliance with respect to the development and sale of certain products. Starent called upon Goldman Sachs, which underwrote Starent’s IPO in 2007, to impress upon Cisco the need to move quickly on negotiations over a reseller arrangement “in light of other strategic alternatives being considered by Starent.” For reasons not explained, Starent’s formal engagement of Goldman, as its financial advisor in this deal, was not formalized until September 23, 2009.
Cisco got down to business in meetings between the parties on August 9 and 10, expressing an interest to Dahod of exploring a possible business combination with Starent. The Starent board met on August 10 and, according to Starent’s proxy statement, made the ritualistic determination “that for the time being Starent should continue to pursue its business plan as an independent company.” No Revlon trigger here. At this very first board meeting to consider a possible deal, the strategy of avoiding a market check of Starent’s value or any auction of Starent was adopted:
“Our board of directors also discussed the potential harm to our business that might result if current or potential customers or competitors were to become aware that we were considering a possible business combination, and our board of directors concluded that there was a need to maintain the confidentiality of any acquisition discussions in order to avoid the potential for such harm, particularly in view of the uncertainty that Starent and Cisco would ever reach an agreement with respect to a business combination.”
Proxy Statement at 17.
The proxy statement does not state, in its description of this first board meeting on a possible deal, that either Goldman or Starent’s counsel participated in the meeting, which is odd since one would think each might have had a view on the board’s conclusion.
Discussions continued apace between Starent and Cisco in early and mid-August. The board met again on August 19. Clearly anticipating an offer from Cisco, the board “considered the possibility of engaging in discussions with other potentially interested parties.” The board confirmed its decision not to engage in discussions with any other potentially interested party:
“Our directors discussed the likely interest of other potentially interested parties in a business combination, as well as the possible ramifications to Starent if competitors or customers were to become aware of any such discussions. Our directors determined that given the preliminary nature of the discussions with Cisco and the potential competitive harms and risk to the alternative strategic alliance under discussion with Company Y, it was not in the best interests of Starent and its stockholders to initiate such discussions at this time, but that the directors would continue to evaluate the advisability of such actions as the discussions with Cisco evolved.”
Proxy Statement at 18.
Again, no mention of Goldman’s or counsel’s participation in this discussion, and no specification of the “potential competitive harms.”
Six days later, the board met again to review the now obviously intense discussions going on between Starent and Cisco. The board again records its decision not to pursue discussions with any other party about a deal:
“There was also discussion at this meeting as to specific other parties that might be interested in a business combination or strategic transaction with Starent and the business issues that would arise if we were to approach other possibly interested parties as to a business combination or other strategic transaction, including specifically the significant potential business risks to Starent that might arise if competitors or customers were to learn that Starent was exploring a sale of its business. The directors concluded that, given the potential for harm to Starent’s business and the jeopardy to its strategic alliance discussions, other potentially interested parties should not be approached at that time and that the issue would be reconsidered if and when Starent were to receive a business combination proposal from Cisco at a value that our board of directors viewed as sufficient to warrant further exploration.”
Proxy Statement at 18.
Again, no mention of Goldman or counsel, and no detail on the “business risks” feared.
Cisco showed its preliminary hand on September 4, 2009, offering in a telephone conversation a price of $27 per share, subject to further due diligence. (The final deal price was at $35 per share.)
On September 8, 2009, Starent entered into an indemnification letter with Goldman. This too is a bit odd given that the formal engagement letter was not entered into until some 15 days later, on September 23. Why not enter into both agreements at the same time (typically the bankers’ indemnification is set out in or in an exhibit to the engagement letter)?
The Starent board rejected Cisco’s preliminary proposal on September 8. In response, Cisco did the obvious, and invited Starent’s management to Cisco’s offices “to explain why Starent’s business and prospects merited a higher price.” After this dog-and-pony show, Cisco upped the ante on September 21, raising its price to $33 per share.
The Starent board met on September 21, and concluded that $33 was “insufficient.” But obviously the end game was near, so what did the directors decide about conducting a market check? No surprise —
“The directors also discussed other parties that might be potentially interested in a business combination. Our board of directors requested that management and Goldman Sachs prepare an assessment of other potentially interested parties. The directors also discussed possible different sales processes that might be pursued if our board of directors were ultimately to determine to pursue a sale of Starent.”
Proxy Statement at 19.
But why request of management and Goldman Sachs “an assessment” of other potentially interested parties if the board had concluded, on August 25, that engaging other parties in deal discussions would pose “significant potential business risks to Starent”? And what about Company Y?
“Our board of directors also discussed the possibility of contacting Company Y with respect to its interest in a possible business combination transaction. Our board of directors concluded that, at that time, such a contact could reasonably result in termination of discussions with Company Y as to a potential strategic alliance and, given that the potential alliance with Company Y represented a potentially significant business opportunity and continued to be a reasonably likely outcome, such outcome should not be jeopardized, particularly since it was uncertain whether Starent and Cisco would ever reach agreement on terms for a business combination.”
Id.
It is at this meeting, September 21, 2009, that the board resolves “to engage Goldman to act as Starent’s financial advisor …”! The horse had just about left the barn and now Goldman is retained?
Three days later the board met again and, apparently for the first time, reviewed with Goldman parties that might be interested in a business combination with Starent. The board then made this significant conclusion:
“Our board of directors also reviewed the possibility that a financial buyer might be interested in a potential acquisition of Starent and determine that such interest would be unlikely at a price equal to or greater than the price under discussion with Cisco [$33 per share].”
Proxy Statement at 20.
Did Goldman support this view?
With financial buyers off the table, the board next turned to strategic buyers, and reaffirmed its early (and often) conclusion that the competitive harm in talking to such potential buyers outweighed any potential benefit:
“The directors reviewed again the potential harm that could be inflicted on Starent if the possibility of a business combination were made public or otherwise became known to customers or competitors. After this review, the directors and management concluded that, in light of the potential competitive and business risks to Starent from approaching any other potentially interested party, and the relatively low likelihood that other parties [this reference appears to be to both strategic and financial buyers] would be interested or able to pursue a business combination with Starent at a value exceeding that offered by Cisco, it was not in the best interests of Starent or its stockholders to contact other potentially interested parties about a possible business combination.”
Proxy Statement at 20.
On September 25, Cisco increased its acquisition price to $35 per share, subject to satisfactory completion of due diligence. On September 29, the hammer dropped with John Chambers (Cisco’s CEO) informing Dahod that $35 was it: Cisco would not go any higher.
Starent apparently had one last possibility to test the Cisco proposal, by broaching a possible business combination with Company Y. But, again, the board declined to do so out of fear that doing so would jeopardize the negotiations with Company Y over a strategic alliance. (The board subsequently resolved to negotiate a commercial OEM reseller agreement with Cisco to mitigate the loss of the strategic alliance with Company Y that would occur upon the announcement of any Cisco/Starent merger.)
B. Legal Considerations
I reviewed the Delaware Supreme Court’s decision in Lyondell Chemical Company v. Ryan, 970 A. 2d 235 (2009) in my post of March 30, 2009. In Lyondell, the Delaware Supreme Court reversed Vice Chancellor Noble’s refusal to grant the Lyondell board summary judgment against plaintiffs on the board’s approval of the merger of Lyondell and a subsidiary of Basell AF. In Lyondell, the Court made clear that where a board is disinterested, and the target has included in its certificate of incorporation (as all public Delaware companies now do) a limitation on the monetary damages available against its directors (as permitted by Section 102(b)(7) of the Delaware GCL), then director liability is available only for conduct that is not in good faith, which requires a showing that the directors “knew” that they were not discharging their fiduciary obligations.
There is no reason to conclude from Starent’s description of this deal that the Starent board was conflicted and not disinterested, notwithstanding that eight key employees (including Dahod and five other executive officers) of Starent secured employment agreements with Cisco. Accordingly, a post-closing challenge to this deal would be out of the question. But the teaching of Lyondell does not apply to a request for injunctive relief. In any such request, Revlon principles should apply in full force. The challenge for plaintiffs, therefore, would be to establish that the board of directors of Starent was grossly negligent in not discharging its fiduciary duties under Revlon to obtain the highest price reasonably attainable for Starent’s stockholders.
In their complaint challenging the deal, the closest the Starent plaintiffs came to challenging the Starent board’s reliance upon competitive harm to avoid any market check is a somewhat pro forma allegation that the board failed “to adequately consider potential acquirers, ….” Complaint ¶ 94 (November 3, 2009). The board’s resorting to the tent of competitive harm to avoid any pre-signing market check is not developed in the complaint and, because the case has been settled, the issue will not be joined before the Delaware Chancery Court.
If the issue were joined, then clearly the board’s conclusions would be tested, i.e., what were the nature of the competitive harms feared, and how would specific customers and competitors of Starent react to any rumors that Starent was in play? Surely blanket statements of competitive harm cannot excuse a board from exercising its Revlon duties, as a resort to such fear could virtually eliminate the need for any pre-signing market check.
It would also be of interest to explore in further detail the roles of Goldman and counsel in the board’s deliberations on the competitive harm that would ensue were Starent to talk to other parties about a deal. From a review of Starent’s description of the background of the deal, it appears that Goldman and counsel played little role in these deliberations.
While it might be too much to say that the Starent board got away with one ($35 per share was some three times Starent’s IPO price of two years earlier), the public record of this transaction shows that Cisco had the field to itself. And Cisco is a savvy dealmaker.
A review of the background of the merger, however, as disclosed in Starent’s definitive proxy statement of November 9, 2009 circulated to its stockholders in connection with the special meeting called to approve the merger, squarely raises the question of the appropriateness of relying upon a fear of competitive harm to avoid any pre-signing market check. Unfortunately for those of us interested in M&A doctrine, as enunciated by the Delaware courts, prompt settlement of the legal challenge to the deal will leave resolution of that question to another day.
A. Background of Cisco’s Acquisition of Starent
This deal had its germination in a June 2009 meeting between Starent’s CEO, Ashraf Dahod, and representatives of Cisco to discuss a potential global reseller arrangement between the parties. Simultaneously, Starent commenced discussions with another firm in its industry concerning a possible strategic alliance with respect to the development and sale of certain products. Starent called upon Goldman Sachs, which underwrote Starent’s IPO in 2007, to impress upon Cisco the need to move quickly on negotiations over a reseller arrangement “in light of other strategic alternatives being considered by Starent.” For reasons not explained, Starent’s formal engagement of Goldman, as its financial advisor in this deal, was not formalized until September 23, 2009.
Cisco got down to business in meetings between the parties on August 9 and 10, expressing an interest to Dahod of exploring a possible business combination with Starent. The Starent board met on August 10 and, according to Starent’s proxy statement, made the ritualistic determination “that for the time being Starent should continue to pursue its business plan as an independent company.” No Revlon trigger here. At this very first board meeting to consider a possible deal, the strategy of avoiding a market check of Starent’s value or any auction of Starent was adopted:
“Our board of directors also discussed the potential harm to our business that might result if current or potential customers or competitors were to become aware that we were considering a possible business combination, and our board of directors concluded that there was a need to maintain the confidentiality of any acquisition discussions in order to avoid the potential for such harm, particularly in view of the uncertainty that Starent and Cisco would ever reach an agreement with respect to a business combination.”
Proxy Statement at 17.
The proxy statement does not state, in its description of this first board meeting on a possible deal, that either Goldman or Starent’s counsel participated in the meeting, which is odd since one would think each might have had a view on the board’s conclusion.
Discussions continued apace between Starent and Cisco in early and mid-August. The board met again on August 19. Clearly anticipating an offer from Cisco, the board “considered the possibility of engaging in discussions with other potentially interested parties.” The board confirmed its decision not to engage in discussions with any other potentially interested party:
“Our directors discussed the likely interest of other potentially interested parties in a business combination, as well as the possible ramifications to Starent if competitors or customers were to become aware of any such discussions. Our directors determined that given the preliminary nature of the discussions with Cisco and the potential competitive harms and risk to the alternative strategic alliance under discussion with Company Y, it was not in the best interests of Starent and its stockholders to initiate such discussions at this time, but that the directors would continue to evaluate the advisability of such actions as the discussions with Cisco evolved.”
Proxy Statement at 18.
Again, no mention of Goldman’s or counsel’s participation in this discussion, and no specification of the “potential competitive harms.”
Six days later, the board met again to review the now obviously intense discussions going on between Starent and Cisco. The board again records its decision not to pursue discussions with any other party about a deal:
“There was also discussion at this meeting as to specific other parties that might be interested in a business combination or strategic transaction with Starent and the business issues that would arise if we were to approach other possibly interested parties as to a business combination or other strategic transaction, including specifically the significant potential business risks to Starent that might arise if competitors or customers were to learn that Starent was exploring a sale of its business. The directors concluded that, given the potential for harm to Starent’s business and the jeopardy to its strategic alliance discussions, other potentially interested parties should not be approached at that time and that the issue would be reconsidered if and when Starent were to receive a business combination proposal from Cisco at a value that our board of directors viewed as sufficient to warrant further exploration.”
Proxy Statement at 18.
Again, no mention of Goldman or counsel, and no detail on the “business risks” feared.
Cisco showed its preliminary hand on September 4, 2009, offering in a telephone conversation a price of $27 per share, subject to further due diligence. (The final deal price was at $35 per share.)
On September 8, 2009, Starent entered into an indemnification letter with Goldman. This too is a bit odd given that the formal engagement letter was not entered into until some 15 days later, on September 23. Why not enter into both agreements at the same time (typically the bankers’ indemnification is set out in or in an exhibit to the engagement letter)?
The Starent board rejected Cisco’s preliminary proposal on September 8. In response, Cisco did the obvious, and invited Starent’s management to Cisco’s offices “to explain why Starent’s business and prospects merited a higher price.” After this dog-and-pony show, Cisco upped the ante on September 21, raising its price to $33 per share.
The Starent board met on September 21, and concluded that $33 was “insufficient.” But obviously the end game was near, so what did the directors decide about conducting a market check? No surprise —
“The directors also discussed other parties that might be potentially interested in a business combination. Our board of directors requested that management and Goldman Sachs prepare an assessment of other potentially interested parties. The directors also discussed possible different sales processes that might be pursued if our board of directors were ultimately to determine to pursue a sale of Starent.”
Proxy Statement at 19.
But why request of management and Goldman Sachs “an assessment” of other potentially interested parties if the board had concluded, on August 25, that engaging other parties in deal discussions would pose “significant potential business risks to Starent”? And what about Company Y?
“Our board of directors also discussed the possibility of contacting Company Y with respect to its interest in a possible business combination transaction. Our board of directors concluded that, at that time, such a contact could reasonably result in termination of discussions with Company Y as to a potential strategic alliance and, given that the potential alliance with Company Y represented a potentially significant business opportunity and continued to be a reasonably likely outcome, such outcome should not be jeopardized, particularly since it was uncertain whether Starent and Cisco would ever reach agreement on terms for a business combination.”
Id.
It is at this meeting, September 21, 2009, that the board resolves “to engage Goldman to act as Starent’s financial advisor …”! The horse had just about left the barn and now Goldman is retained?
Three days later the board met again and, apparently for the first time, reviewed with Goldman parties that might be interested in a business combination with Starent. The board then made this significant conclusion:
“Our board of directors also reviewed the possibility that a financial buyer might be interested in a potential acquisition of Starent and determine that such interest would be unlikely at a price equal to or greater than the price under discussion with Cisco [$33 per share].”
Proxy Statement at 20.
Did Goldman support this view?
With financial buyers off the table, the board next turned to strategic buyers, and reaffirmed its early (and often) conclusion that the competitive harm in talking to such potential buyers outweighed any potential benefit:
“The directors reviewed again the potential harm that could be inflicted on Starent if the possibility of a business combination were made public or otherwise became known to customers or competitors. After this review, the directors and management concluded that, in light of the potential competitive and business risks to Starent from approaching any other potentially interested party, and the relatively low likelihood that other parties [this reference appears to be to both strategic and financial buyers] would be interested or able to pursue a business combination with Starent at a value exceeding that offered by Cisco, it was not in the best interests of Starent or its stockholders to contact other potentially interested parties about a possible business combination.”
Proxy Statement at 20.
On September 25, Cisco increased its acquisition price to $35 per share, subject to satisfactory completion of due diligence. On September 29, the hammer dropped with John Chambers (Cisco’s CEO) informing Dahod that $35 was it: Cisco would not go any higher.
Starent apparently had one last possibility to test the Cisco proposal, by broaching a possible business combination with Company Y. But, again, the board declined to do so out of fear that doing so would jeopardize the negotiations with Company Y over a strategic alliance. (The board subsequently resolved to negotiate a commercial OEM reseller agreement with Cisco to mitigate the loss of the strategic alliance with Company Y that would occur upon the announcement of any Cisco/Starent merger.)
B. Legal Considerations
I reviewed the Delaware Supreme Court’s decision in Lyondell Chemical Company v. Ryan, 970 A. 2d 235 (2009) in my post of March 30, 2009. In Lyondell, the Delaware Supreme Court reversed Vice Chancellor Noble’s refusal to grant the Lyondell board summary judgment against plaintiffs on the board’s approval of the merger of Lyondell and a subsidiary of Basell AF. In Lyondell, the Court made clear that where a board is disinterested, and the target has included in its certificate of incorporation (as all public Delaware companies now do) a limitation on the monetary damages available against its directors (as permitted by Section 102(b)(7) of the Delaware GCL), then director liability is available only for conduct that is not in good faith, which requires a showing that the directors “knew” that they were not discharging their fiduciary obligations.
There is no reason to conclude from Starent’s description of this deal that the Starent board was conflicted and not disinterested, notwithstanding that eight key employees (including Dahod and five other executive officers) of Starent secured employment agreements with Cisco. Accordingly, a post-closing challenge to this deal would be out of the question. But the teaching of Lyondell does not apply to a request for injunctive relief. In any such request, Revlon principles should apply in full force. The challenge for plaintiffs, therefore, would be to establish that the board of directors of Starent was grossly negligent in not discharging its fiduciary duties under Revlon to obtain the highest price reasonably attainable for Starent’s stockholders.
In their complaint challenging the deal, the closest the Starent plaintiffs came to challenging the Starent board’s reliance upon competitive harm to avoid any market check is a somewhat pro forma allegation that the board failed “to adequately consider potential acquirers, ….” Complaint ¶ 94 (November 3, 2009). The board’s resorting to the tent of competitive harm to avoid any pre-signing market check is not developed in the complaint and, because the case has been settled, the issue will not be joined before the Delaware Chancery Court.
If the issue were joined, then clearly the board’s conclusions would be tested, i.e., what were the nature of the competitive harms feared, and how would specific customers and competitors of Starent react to any rumors that Starent was in play? Surely blanket statements of competitive harm cannot excuse a board from exercising its Revlon duties, as a resort to such fear could virtually eliminate the need for any pre-signing market check.
It would also be of interest to explore in further detail the roles of Goldman and counsel in the board’s deliberations on the competitive harm that would ensue were Starent to talk to other parties about a deal. From a review of Starent’s description of the background of the deal, it appears that Goldman and counsel played little role in these deliberations.
While it might be too much to say that the Starent board got away with one ($35 per share was some three times Starent’s IPO price of two years earlier), the public record of this transaction shows that Cisco had the field to itself. And Cisco is a savvy dealmaker.
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