Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

In re Oracle Corp. Derivative Litigation considered whether a fiduciary for an acquired entity can aid and abet breaches of duty by a fiduciary for the buyer.  Theoretically yes, almost anything is possible.  But what if the breach of duty relates only to the buyer paying the seller too much? It is an odd case, since the target fiduciaries have a duty to maximize price.

This case related to Oracle’s acquisition of NetSuite. To bring an action for aiding and abetting a breach of fiduciary duty to Oracle stockholders, the plaintiff must plead among other things that the NetSuite defendants knowingly participated in that breach by Oracle fiduciaries that remained as defendants.

Among other things, absent a fiduciary or contractual relationship, Delaware law generally does not impose a duty to speak.  Here the lead plaintiff claimed the NetSuite defendants undertook action to provide substantial aid to two Oracle defendants breach of their own duties to Oracle—the alleged substantial aid was silence on the history of key transactional negotiations.

To that end, the lead plaintiff pointed out that the NetSuite defendants owed fiduciary duties to make disclosures to NetSuite stockholders about the acquisition of NetSuite. The lead plaintiff posited that the NetSuite defendants breached those duties in aid of the secrecy necessary to further the Oracle defendants’ corrupt scheme. That is, the disclosures required of the NetSuite defendants to NetSuite’s stockholders would, if made, result in disclosure to the public, which would in turn result in disclosure to Oracle’s special committee. The lead plaintiff alleged that such disclosures would have put Oracle’s directors on alert to the allegedly lopsided transaction terms, and would have led Oracle to scuttle the deal.

For this claim to succeed, the Delaware Court of Chancery said this required:

  • Pleading that the NetSuite defendants’ fiduciary duties to NetSuite and its stockholders required that they cause NetSuite to disclose certain information, and
  • The NetSuite defendants intentionally violated such duties in furtherance of the Oracle defendants’ breach of duty to Oracle.

For emphasis the court noted the lead plaintiff’s theory was that the NetSuite defendants intentionally breached a duty of candor to NetSuite stockholders, because compliance with this duty would have also informed the public, and ultimately Oracle’s special committee, which would have imperiled the scheme to overpay NetSuite stockholders.

But under the facts alleged, the Court found that it need not determine whether the NetSuite defendants breached a duty to NetSuite’s stockholders. The reason was that even if the NetSuite defendants did breach a duty to disclose, it was not reasonably conceivable that by their silence they provided substantial assistance to the Oracle defendants’ alleged breaches of fiduciary duty, in light of the actual disclosures of record.

The court found sufficient disclosures were made so that the NetSuite defendants did not provide substantial assistance to the Oracle stockholders.  The NetSuite defendants’ actions could not have provided substantial assistance to the Oracle defendants’ breach of duty, because the alleged attempt that the NetSuite defendants made to keep certain negotiations secret from Oracle failed. It was not reasonably conceivable that the difference between what was disclosed and what the lead plaintiff alleged should have been disclosed constituted substantial assistance to the Oracle defendant’s scheme to cause Oracle to overpay for NetSuite.

We are holding a webinar titled “Preparing the Second Quarter Form 10-Q in Light of COVID‑19 and Associated Issues.”  The webinar will be held July 7, 2020 from 11.30 to 1.00 Central Daylight Time.  We anticipate CLE credit being available for AZ, CO, KS, MN, MO and TX.

Currently we plan to provide an overview on the following topics:

  • A representative from KPMG will speak about accounting matters such as going concern disclosures, asset impairment, deferred tax valuations, leases, revenue contracts, debt restructurings, cash flow hedges and collectability issues.
  • SEC guidance on COVID-19 disclosures.
  • SEC COVID-19 accommodations.
  • SEC comment letters on COVID-19.
  • COVID-19 and non-GAAP financial measures.
  • NYSE and Nasdaq COVID-19 accommodations.
  • COVID-19 related securities litigation.

You can register for the webinar here.

In 2013, Michael Dell and Silver Lake Group LLC took Dell, Inc. private through a leveraged buyout. The privately held successor of Dell, Inc. was Dell Technologies Inc. (the “Company”), which Mr. Dell and Silver Lake control.

In 2016, the Company sought to acquire EMC Corporation, a data-storage firm. One of EMC’s most valuable assets was its ownership of 81.9% of the equity of VMware, Inc. The Company proposed to acquire EMC using a combination of cash and newly issued shares of Class V common stock, which would trade publicly and track the performance of a portion of the equity stake in VMware that the Company would own as a result of the deal.

The Class V shares were subject to a “Forced Conversion” right: If the Company listed its Class C shares on a national exchange, then the Company could forcibly convert the Class V shares into Class C shares pursuant to a pricing formula.

In January 2018, the Company’s board of directors (the “Board”) charged one of the existing committees of the Board with negotiating a redemption of the Class V shares. Endeavoring to qualify for the safe harbor established by Kahn v. M & F Worldwide Corp. (MFW), the Board conditioned any redemption or similar transaction on both (i) committee approval, and (ii) approval from holders of a majority of the outstanding Class V shares.

Compliance with MFW would establish that the business judgment rule governed the transaction rather than entire fairness. The Company however reserved the right to bypass the MFW process by engaging in a Forced Conversion.

Over the next three months, the Company negotiated with the committee. During this process, both Company representatives and the committee’s advisors repeatedly told the committee that if they did not agree to a negotiated redemption, then the Company would proceed unilaterally with a Forced Conversion. Both Company representatives and the committee’s advisors stressed that a Forced Conversion was the least attractive option for the Class V stockholders.

The committee agreed to a negotiated redemption of the Class V shares (the “Committee-Sponsored Redemption”).  Large holders of Class V stock objected to the Committee-Sponsored Redemption, and the Company did not believe that the Class V stockholders would approve it. Rather than negotiating further with the committee, the Company began negotiating directly with six large holders of Class V stock (the “Stockholder Volunteers”). While doing so, the Company took steps publicly to prepare for a Forced Conversion, underscoring the reality of this alternative.

After four and a half months, the Company reached agreement with the Stockholder Volunteers (the “Stockholder-Negotiated Redemption”) on improved terms when compared to the Committee Sponsored Redemption. The committee had not involved itself in the negotiations between the Company and the Stockholder Volunteers. The Company informed the committee of the terms of the Stockholder-Negotiated Redemption. The committee met for an hour and approved it.

During a special meeting of the Class V stockholders, the Stockholder-Negotiated Redemption received approval from unaffiliated holders of 61% of the outstanding Class V shares. Two weeks later, the Stockholder-Negotiated Redemption closed.

Litigation ensued (captioned In re Dell Technologies Class V Stockholders Litigation) and plaintiffs, who were former holders of Class V stock, contended that Mr. Dell, Silver Lake, and the members of the Board breached their fiduciary duties when negotiating and approving the Stockholder-Negotiated Redemption.  In a motion to dismiss, all of the defendants claimed that the Stockholder-Negotiated Redemption complied with the requirements of MFW and was therefore subject to the irrebutable version of the business judgment rule.

In their motion to dismiss, the defendants argued that they properly implemented the framework outlined in MFW.  If they did, then a version of the business judgment rule applied.  If, by contrast, the defendants failed to properly implement the MFW framework, then entire fairness becomes the applicable standard of review.  The defendants did not contend that the complaint failed to state a claim when judged under the entire fairness standard, so the motion to dismiss would be denied if entire fairness were applicable.

Under MFW, the irrebuttable business judgment rule governs only if the “controller irrevocably and publicly disables itself from using its control to dictate the outcome of the negotiations” amongst other things.  That was not the case here.

The court found the complaint supported a reasonable inference that the Company failed to properly establish the MFW conditions at the outset. Mr. Dell and Silver Lake sought to eliminate the Class V tracking stock and consolidate the Company’s ownership of VMware. The Company identified three paths to that outcome: (i) a negotiated acquisition of VMware, (ii) a negotiated redemption of the Class V stock; or (iii) a Forced Conversion. The definition of Potential Class V Transaction that framed the Special Committee’s mandate only included the first two paths and excluded a Forced Conversion.

The court held by failing to include the exercise of the Conversion Right within the definition of a Potential Class V Transaction and the universe of actions that the Company would not take without satisfying the MFW conditions, the Company failed to comply with the requirements of MFW. The Company did not empower the Special Committee and the Class V stockholders with the ability to say “No.”

The court also held the complaint supported a reasonable pleading-stage inference that the Company failed to respect the MFW conditions when it bypassed the Special Committee and negotiated directly with the Stockholder Volunteers. MFW’s dual protections contemplate that the Special Committee will act as the bargaining agent for the minority stockholders, with the minority stockholders rendering an up-or-down verdict on the committee’s work. Those roles are complements, not substitutes. A set of motivated stockholder volunteers cannot take over for the committee and serve both roles.

Approval by the Class V stockholders was not a substitute for an effective special committee.  The MFW framework contemplates that the special committee will act as “an independent negotiating agent whose work is subject to stockholder approval.”  Through the involvement of the special committee, the MFW framework ensures that there are “independent, empowered negotiating agents to bargain for the best price and say no if the agents believe the deal is not advisable for any proper reason.  The committee has superior access to internal sources of information, can deploy the Board’s statutory authority and can “act as an expert bargaining agent.”   Like a board of directors, the committee “does not suffer from the collective action problem of disaggregated stockholders” and is therefore well positioned “to get the last nickel.”

The court noted that within the MFW framework, if the committee’s initial work is rejected by the stockholders, that does not mean the committee’s role is over. Nor does it mean that the committee passes the baton to a handful of stockholder volunteers to negotiate for themselves. Instead, the committee must return to the bargaining table, continue to act in its fiduciary capacity, and seek to extract the best transaction available.

In DLO Enterprises, Inc. v. Innovative Chemical Products Group, LLC, the Delaware Court of Chancery discussed privilege waiver in a dispute between a buyer and a seller involving an asset purchase agreement. The dispute centered around which party was financially responsible for defective products that were sold pre-Purchase Agreement, but that were returned post-Purchase Agreement.

Litigation was commenced and a dispute arose regarding the privilege associated with various documents responsive to discovery requests, as well as emails between the sellers and counsel on email accounts buyers acquired through the asset purchase.

Buyers sought to compel the production of two categories of responsive privileged documents:

  • Documents reflecting communications between the sellers and their former attorneys who represented them in the acquisition (the “Category One Documents”);
  • Documents reflecting communications between the sellers and their former attorneys which were currently in possession of buyer because these documents were left in buyers’ email accounts (the “Category Two Documents”).

Category One Documents

The court initially noted that cases such as Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP and  Shareholder Representative Services LLC v. RSI Holdco were not applicable because those cases arose in the context of a statutory merger.

The court held in the asset purchase context, the seller will retain pre-closing privilege regarding the agreement and negotiations unless the buyer clearly bargains for waiver or a waiver right. Here, the buyers failed to explicitly secure pre-closing privilege waiver rights relating to the negotiation of the Purchase Agreement.

Section 8.9 of the Purchase Agreement gave buyers waiver rights over the privilege relating to Assets and Assumed Liabilities transferred to buyers.  The question presented to the court was whether deal communications related to Assets and Assumed Liabilities.

Section 1.2 of the Purchase Agreement defined Excluded Assets to include the sellers’ “rights under or pursuant to this Agreement and agreements entered into pursuant to this Agreement.” Section 8.9’s privilege waiver for Assets did not reach deal communications because Sellers’ rights under or pursuant to the Purchase Agreement were carved out as an Excluded Asset under Section 1.2.

Category Two Documents

Post-Closing Communications

The Category Two Documents consisted of 48 pre-closing documents and 28 post-closing documents.  These were emails between the sellers and their attorneys on email accounts transferred to buyers as part of the acquisition, and so were in buyers’ possession. Buyers argued that by allowing the emails to fall into buyers’ hands, the sellers waived any attorney-client privilege over these documents.

The Court stated  In re Asia Global Crossing, Ltd. and In re Information Management Services, Inc. Derivative Litigation, were the appropriate tests for the 28 post-closing communications with Daniel Owen while he was Vice President of BuyerCo.   The appropriate lens was an employee’s reasonable expectation of privacy in work email.

Asia Global set forth four factors to consider as to whether there was a reasonable expectation of privacy in work related email.  The court found for post-closing Category Two Documents, three of the four Asia Global factors pointed towards production and one was neutral. But the court stated the inquiry does not end there. In Information Management, the court recognized a potential statutory override of the Asia Global analysis. If a controlling jurisdiction has a statute on the confidentiality of work emails, that statute may alter the common law results of the Asia Global analysis. The parties did not brief this portion of the analysis. To complete the analysis, the court requested the parties submit supplemental briefing on a potential statutory override.

Pre-Closing Communications

As to the pre-closing communications in Buyers’ possession, the court noted the proper test may be one of inadvertent production, rather than solely a consideration of the employees’ expectation of privacy when working for target. The proper analysis should also consider who holds the privilege over the communications.  Sellers may hold the privilege over the sellers’ emails, such that access to the sellers’ emails would not destroy any relevant confidentiality. The court therefore requested supplemental briefing on the proper test to assess whether sellers waived privilege of the pre-closing deal communications that remain on email accounts transferred to buyers under the Purchase Agreement.

Buyers’ Review of Potentially Privileged Communications

The court stated it could not ignore buyers’ counsel’s inappropriate review of the content of the potentially privileged Category Two Documents in their possession. Upon realizing buyers possessed potentially privileged documents, counsel should have abstained from reviewing their content, and instead segregated the documents, perhaps by using metadata, pending resolution of the privilege dispute. Counsel should not have viewed these documents prior to resolving the privilege issues associated with them according to the court. Upon resolution of the pending motion, the court stated sellers may file a letter outlining the relief they deem appropriate to rectify this wrong as it relates to the Category Two Documents if they, or any subset thereof, are found to be privileged.

In a settled enforcement action, the SEC charged Argo Group International Holdings, Ltd. for failure to disclose perqs provided to its CEO and board member, Mark E. Watson III.

According to the SEC, in definitive proxy statements disclosing executive compensation paid for 2014 through 2018, which were filed in 2015 through 2019, Argo disclosed a total of approximately $1.22 million worth of perquisites and personal benefits provided to Watson, with an annual average of approximately $244,000. The disclosed perquisites and personal benefits consisted predominately of 401(k) and retirement contributions, the imputed value of insurance coverage, supplemental executive retirement plan benefits, housing and home leave allowances, medical premiums and financial planning services.

The SEC alleged these same definitive proxy statements failed to disclose over $5.3 million worth of additional perquisites and personal benefits provided to Watson, thereby understating the perquisites and personal benefits portion of Watson’s compensation by an annual average of over $1 million, or 400%. Items that Argo paid for on Watson’s behalf, but did not disclose, include, but are not limited to, expenses associated with personal use of corporate aircraft, rent and other housing costs, personal use of corporate automobiles, helicopter trips, other personal travel costs, use of a car service by family members, club and concierge service memberships, tickets and transportation to sporting, fashion or other entertainment events, personal services provided by Argo employees, and watercraft-related costs.

In February 2019, an Argo shareholder issued a press release in which it alleged, among other things, the misuse of Argo assets by Watson, including undisclosed personal usage of corporate aircraft. On April 12, 2019, during a proxy contest with this shareholder in connection with Argo’s May 2019 annual shareholders meeting, Argo filed a definitive proxy statement that failed to disclose over $1 million worth of perquisites, including over $230,000 related to Watson’s use of corporate aircraft.

Argo conducted an internal investigation, which was launched in June 2019 after receipt of a subpoena from the Commission staff. Thereafter, Watson resigned and agreed to reimburse Argo for certain perquisites and/or personal expenses, subject to an arbitration process as to any items Watson disputes.

The SEC order states that from 2014 through 2018, Argo incorrectly recorded payments for the benefit of, and reimbursements to, Watson as business expenses, and not compensation. As a result, the SEC concluded its books, records, and accounts did not, in reasonable detail, accurately and fairly reflect its disposition of assets.  As a result of the conduct described, the SEC alleged Argo violated Section 13(b)(2)(A) of the Exchange Act, which requires reporting companies to make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect their transactions and dispositions of their assets.

The SEC also charged Argo with other violations, including violations of Section 13(b)(2)(B) of the Exchange Act, which requires reporting companies to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that, among other things, transactions are recorded as necessary to maintain accountability for assets.

Argo did not admit or deny the findings in the SEC Order.  The SEC did not charge Watson.

In Borealis Power Holdings Inc. v. Hunt Strategic Utility Investment, L.L.C., the Delaware Supreme Court reversed the Court of Chancery and held the ROFR in an investor rights agreement was not applicable to an indirect equity holder.

The facts were complex.  Hunt Strategic Utility Investment, L.L.C. (“Hunt”) owned a one-percent stake in Texas Transmission Holdings Corporation (“TTHC”), a utility holding company. The remaining ninety-nine percent was split equally between two Borealis entities (Borealis Power Holdings, Inc. and BPC Health Corporation, together, “Borealis”) and Cheyne Walk Investment PTE LTD (“Cheyne Walk”). Thus, neither Borealis nor Cheyne Walk owned a majority stake in TTHC, as each owned 49.5%.

TTHC wholly owned Texas Transmission Finco LLC (“TTFinco”), which wholly owned Texas Transmission Investment LLC (“TTI”). TTI in turn owned 19.75% of  Oncor Electric Delivery Company LLC (“Oncor”). The remaining 80.25% of Oncor was held by Sempra Texas Holdings Corp. (“STH) and Sempra Texas Intermediate Holding Company, LLC (“STIH” and, together with STH, “Sempra”).

Oncor and its equityholders entered into an investor rights agreement (the “Oncor IRA”). The parties to the IRA were Oncor itself, the record owners of its units—TTI and Oncor Holdings—and STH.  Borealis, Hunt, and Cheyne Walk were not parties to the Oncor IRA. The Oncor IRA included a right of first refusal provision (“ROFR”).

The direct shareholders of TTHC and TTHC also entered into a shareholders agreement (the “TTHC SA”) that provided a process for selling shares in TTHC, including a right of first offer for non-selling shareholders (the “ROFO”).

On July 11, 2019, Hunt and Sempra (through STIH) executed a share purchase agreement (the “SPA”) with respect to Hunt’s one percent interest in TTHC. That same day, Hunt sent the SPA to Borealis and Cheyne Walk attached as an exhibit to a letter alleged to be a First Offer Notice. Borealis responded on July 22 that it would exercise its ROFO under the TTHC SA and purchase as many shares as were available, and that it considered any attempt to transfer those shares to any other third party a breach of the ROFO. In response, Sempra sent a letter to Borealis, Cheyne Walk, TTHC, TTFinco, and TTI stating that it was exercising its ROFR under the Occor IRA.

A few days later, Borealis filed a complaint in the Delaware Court of Chancery asserting a claim against Hunt for breach of the TTHC SA. Borealis also sought a temporary restraining order enjoining Hunt from transferring the Hunt shares to Sempra.

The Delaware Supreme Court analyzed the provisions of the Oncor IRA.  Section 3.1 of the Oncor IRA, entitled “Restrictions On Transfer of LLC Units,” provided that “[t]he Minority Member and its Permitted Transferees may only Transfer LLC Units as follows . . . .” before listing a number of conditions under which the Minority Member and its Permitted Transferees may transfer Oncor LLC Units. Section 3.9 of the Oncor IRA, entitled “Right of First Refusal” (the “ROFR”), provided that,

In the event that a Selling Member intends to Transfer LLC Units . . . such Selling Member shall deliver to [STH], so long as it has an indirect interest in the Company and thereafter Parent . . . written notice of its intention to Transfer LLC Units . . . and the terms and conditions of the proposed Transfer . . . . The Notice of Intention to Sell shall be accompanied by a written offer . . . to sell or otherwise Transfer to the  ROFR Party . . . for a price in cash . . . all, but not less than all, of the Offered Units, on the same terms and conditions as set forth in the Notice of Intention to Sell.

The term “Offered Units” in this section was defined as “LLC Units or IPO Units, as the cases may be.” “Minority Member” was defined in the Preamble of the Oncor IRA as “Texas Transmission Investment LLC”—TTI, for short. “Selling Member” was defined in Section 3.9 as “the Minority Member” or the Minority Member’s “Permitted Transferee.”

Finally, “Transfer”

 means any direct or indirect transfer . . . of any LLC Units (or any interest (pecuniary or otherwise) therein or rights thereto). In the event that any Member that is a corporation, partnership, limited liability company or other legal entity (other than an individual, trust or estate) ceases to be controlled by the Person controlling such Member or a Permitted Transferee thereof, such event shall be deemed to constitute a ‘Transfer’ subject to the restrictions on Transfer contained or referenced herein.

The Court found the Oncor IRA does not apply to the Hunt Sale because the ROFR in Section 3.9 was only triggered by transfers by the Minority Member and its Permitted Transferees, and Hunt was neither. Because Section 3.9 was only triggered by transfers by the Minority Member, it did not matter whether the Hunt sale constitutes a “transfer” as contemplated by the Oncor IRA, or whether the sale transfers “Oncor LLC Units.” Put another way, the fact that the ROFR was only triggered by transfers by the Minority Member was dispositive in Borealis’s favor regardless of whether the Hunt Sale could be said to effect an indirect transfer of Oncor LLC Units.

Despite the plain language of Section 3.9, Sempra argued that the intent of the parties to the Oncor IRA—TTI, Sempra, and Oncor itself—was to bind TTI’s upstairs equityholders and restrict their transfers of that upstairs equity. In support of this argument, Sempra turned to the definition of the term “Transfer” in the Oncor IRA. It argued that the first sentence of the definition, which purports to encompass “any direct or indirect transfer” of Oncor LLC Units, includes any transfers in upstairs equity, because transfers of upstairs equity indirectly transfer control of Oncor LLC Units. Sempra also argued in the alternative that, even if the Hunt sale was not a “Transfer” under the first sentence, it was a “Transfer” under the second sentence, because a transfer of Hunt’s interest to Borealis or Cheyne Walk would change the control of TTHC, and thus of TTI.

The Delaware Supreme Court held both of these contentions suffer from the same flaw; they omit to address the subject of the operative sentence in Section 3.1 of the Oncor IRA of which the verb phrase “may only Transfer” serves as the predicate. That subject, according to the Court, was not accidental or unimportant—it was the same subject for which the verb phrase “intends to Transfer” serves as the predicate in Section 3.9. As noted, that subject, which was stated conjunctively as “the Minority Member and its Permitted Transferees,” or the “Selling Member,” does not include Hunt. It was therefore unnecessary to parse the definition of “Transfer” to determine the scope of Section 3.1 and Section 3.9; this was addressed in the opening sentences on both of those sections. In sum, Hunt was not TTI, nor was it a Permitted Transferee, nor could it, as a minority shareholder of TTI’s controller, express the intent of TTI or unilaterally cause it to act. Accordingly, the Court held Hunt’s sale therefore did not trigger Sempra’s ROFR.

In 2016, Ares Management LLC, a subsidiary of a global alternative asset manager, invested several hundred million dollars in client funds in a portfolio company in the form of debt and equity. Confidentiality provisions in the loan agreement remained in effect between Ares and the portfolio company on a going forward basis. The equity investment allowed Ares to appoint two directors to the portfolio company’s board.

As one of its two representatives on the board, Ares appointed a senior member of the Ares “deal team” involved in the debt and equity investment, referred to as the Ares Representative. From time to time following Ares’ investment, the Ares Representative, along with other members of the deal team, received information from the portfolio company that posed a risk that it could be material non-public information, or MNPI. This information was sometimes then shared more widely within Ares, as contemplated by the aforementioned confidentiality provisions. The information concerned, among other things, potential changes in senior management, adjustments to the portfolio company’s hedging strategy, efforts to sell an interest in an asset, the portfolio company’s desire to sell equity and use proceeds to retire certain debt, and the portfolio company’s election, as allowed under the terms of the loan agreement, to pay interest “in kind” and not in cash.

While the Ares Representative sat on the portfolio company’s board, Ares began to purchase the portfolio company’s publicly-traded stock. The stock purchase orders had been approved by Ares’ compliance department and occurred during open “trading windows” at the portfolio company.

An Ares investment committee had approved the purchases, as well as a recommended purchase limit price and then several subsequent increases in the recommended limit price. During 2016, Ares purchased more than 1 million shares of the portfolio company’s stock on the public market.

Ares maintained certain written policies and procedures relating to the treatment of MNPI. The procedures set forth, among other things, circumstances under which securities should be subject to trading restrictions and tracked on a “restricted list.” Where Ares had an employee-representative sitting on the board-of-directors of a publicly-listed company in its investment portfolio, Ares’ written procedures required that that company’s stock be placed on Ares’ restricted list and that any trades in the stock be preapproved by Ares’ compliance staff. In such circumstances, Ares’ compliance staff were required to confirm with the subject company that any restrictive trading window applicable to directors was open, and to “check with Ares director for MNPI.”

Notwithstanding that Ares placed the portfolio company’s stock on its restricted list, according to the SEC Ares did not sufficiently take into account the special circumstances presented by the Ares Representative’s dual role as both a member of the portfolio company’s board and an Ares employee who continued to participate in Ares’ trading decisions concerning the company. Although Ares’ compliance staff confirmed with the portfolio company that the relevant trading windows were open, Ares’ policies and procedures did not provide specific requirements for compliance staff concerning the identification of relevant parties with whom to inquire regarding possession of potential MNPI and the manner and degree to which the staff should explore MNPI issues with these parties. Moreover, according to the SEC, Ares’ compliance staff failed, in numerous instances, to document sufficiently that they had inquired with the Ares Representative and the members of the deal team as to whether any of them had received potential MNPI from the portfolio company, or to apply a consistent practice to the inquiries made, resulting in ambiguity whether, or if, inquiries were made in certain instances.

According to the SEC, and taking into consideration that Ares predictably received potential MNPI by virtue of having confidentiality provisions in place with portfolio company issuers and appointing employees to the boards of directors of such issuers, including the portfolio company, Ares did not sufficiently implement and enforce its written policies and procedures for preventing the misuse of MNPI, in violation of the Investment Advisers Act, the Exchange Act, and the rules and regulations under each Act.

Ares did not admit or deny the findings in the SEC order.

Treasury has proposed rules that would modify provisions in the regulations of the Committee on Foreign Investment in the United States, or CFIUS, that implement the Foreign Investment Risk Review Modernization Act of 2018, or FIRRMA. The proposed rule would modify the mandatory declaration provision for certain foreign investment transactions involving a U.S. business that produces, designs, tests, manufactures, fabricates, or develops one or more critical technologies. It also makes clarifying amendments to the definition for the term “substantial interest.”

CFIUS previously established mandatory declarations for certain non-controlling investments in, and certain transactions that could result in control by a foreign person of, U.S. businesses that produce, design, test, manufacture, fabricate, or develop one or more critical technologies in connection with any of 27 industries identified by reference to the North American Industry Classification System, or NAICS.

The proposed rule revises the declaration requirement for certain critical technology transactions so that it is based on whether certain U.S. government authorizations would be required to export, re-export, transfer (in country), or retransfer the critical technology or technologies produced, designed, tested, manufactured, fabricated, or developed by the U.S. business to certain transaction parties and foreign persons in the ownership chain.

The proposed rule introduces the term and a definition of “U.S. regulatory authorization” to specify the types of regulatory licenses or authorizations that are required under the four main U.S. export control regimes, which if applicable in the context of a particular transaction described under the proposed rule, would trigger a mandatory declaration.

The proposed rule does not modify the definition of “critical technologies,” which is defined by FIRRMA. The proposed rule instead prescribes the types of transactions subject to mandatory declarations based on whether certain types of regulatory licenses or authorizations would be required for export and related activities involving the specific critical technology of the U.S. business.

The proposed rule also makes clarifying amendments to paragraphs (b) and (c) of the definition of substantial interest at § 800.244 of the Part 800 Rule, which establishes how to determine the percentage interest held indirectly by one entity in another for purposes of that term. In particular, the proposed rule clarifies that paragraph (b) applies only where a general partner, managing member, or equivalent primarily directs, controls, or coordinates the activities of the entity. It also removes the word “voting” before “interest” wherever it appears in paragraph (c) so that the calculation rule clearly applies to the calculation of “voting interests” as described in paragraph (a) and “interests” as described in paragraph (b) of that section.

The SEC has adopted amendments to the financial disclosure requirements in Regulation S-X for acquisitions and dispositions of businesses. When a registrant acquires a significant business, other than a real estate operation, Rule 3-05 of Regulation S-X generally requires a registrant to provide separate audited annual and unaudited interim pre-acquisition financial statements of that business.  The number of years of financial information that must be provided depends on the relative significance of the acquisition to the registrant.  Significance is measured using one of the highly technical tests specified under the rules.

In addition, Article 11 of Regulation S-X requires registrants to file unaudited pro forma financial information relating to the acquisition or disposition.  Pro forma financial information typically includes a pro forma balance sheet and pro forma income statements based on the historical financial statements of the registrant and the acquired or disposed business, including adjustments to show how the acquisition or disposition might have affected those financial statements.

Under the final amendments, the complex significance tests have been modified to:

  • revise the investment test to compare the registrant’s investments in and advances to the acquired or disposed business to the registrant’s aggregate worldwide market value if available;
  • revise the income test by adding a revenue component;
  • expand the use of pro forma financial information in measuring significance; and
  • conform, to the extent applicable, the significance threshold and tests for disposed businesses to those used for acquired businesses (including increasing the threshold for determining the significance of a business disposition from 10 percent to 20 percent).

The final amendments also:

  • require the financial statements of the acquired business to cover no more than the two most recent fiscal years;
  • permit disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity; and
  • no longer require separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for nine months or a complete fiscal year, depending on significance.

The revised rules amend the pro forma financial information requirements to improve the content and relevance of such information. More specifically, the revised pro forma adjustment criteria provide for:

  • “Transaction Accounting Adjustments” reflecting only the application of required accounting to the transaction;
  • “Autonomous Entity Adjustments” reflecting the operations and financial position of the registrant as an autonomous entity if the registrant was previously part of another entity; and
  • Optional “Management’s Adjustments” depicting synergies and dis-synergies of the acquisitions and dispositions for which pro forma effect is being given if, in management’s opinion, such adjustments would enhance an understanding of the pro forma effects of the transaction and certain conditions related to the basis and the form of presentation are met.

The amendments will be effective Jan. 1, 2021.  However, voluntary compliance with the final amendments is permitted in advance of the effective date.

Fortis Advisors LLC, v. Allergan W.C. Holding Inc. addressed defendant Allergan’s request for an order requiring the former stockholders of Oculeve, Inc. to participate in discovery as real parties in interest and to be subject to trial subpoenas as parties.  In the alternative, Allergan sought to compel the stockholders’ agent, plaintiff Fortis Advisors LLC,  referred to as Fortis or Shareholder Representative, to procure and produce documents and testimony from the stockholders.

Ultimately, Fortis, as Shareholder Representative, asserted Allergan materially breached the Merger Agreement by failing to make an Enhanced Product Labeling Milestone payment, and by failing to use commercially reasonable and good faith efforts to achieve the Enhanced Product Labeling Milestone before March 31, 2018.

Allergan served its initial document requests, which defined “Sellers” as each of the sellers named in Schedule I to the Merger Agreement, together with certain related parties.  The definition included over fifty individual selling stockholders. Fortis objected to the requests on the basis that they were directed to the ‘Sellers’ who were not parties to the litigation.

The Merger Agreement appointed Fortis as the stockholders’ “sole, exclusive, true and lawful agent, representative and attorney-in-fact of all Sellers . . . with respect to any and all matters relating to, arising out of, or in connection with, this Agreement.” In particular, Allergan agreed that Fortis would “act for the Sellers with regard to all matters pertaining to the . . . Contingent Payments,” including the Enhanced Product Labeling Milestone. The Merger Agreement did not empower Fortis to compel stockholder participation in litigation; rather, it appointed Fortis to litigate in the stockholders’ stead.

According to the court, the contractual appointment of a shareholder representative to bring certain actions makes that representative the real party in interest in those actions. This structure is helpful to both buyers and sellers, as it “enables each side to resolve post-closing disputes efficiently.” Buyers also benefit from the fact that the structure makes a judgment against the representative binding on all the stockholders, eliminating the risk of inconsistent judgments. The opinion states the court has been reluctant to disregard the clear contractual authority of a stockholders’ representative at the behest of a party.

The court held the Merger Agreement specified Fortis was to act for the sellers with regard to all matters pertaining to the Contingent Payments. Allergan consented to the shareholder representative structure as formulated in the Merger Agreement, which did not include the discovery rights it sought to enforce, and which limited itself to the enumerated rights. The fact that the Merger Agreement did not give Fortis control over the stockholders and their discovery was not Fortis’s “fault” or “problem”—it was a result that Allergan bargained for.