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In Stein v. Blankfein et al the Delaware Court of Chancery considered a proposed settlement of litigation against directors of Goldman Sachs. The related complaint contained two counts for derivative relief for breach of fiduciary duties related to the payment of excessive compensation awards to non-employee directors and issuing stock-based awards that were void because of uninformed shareholder votes. The complaint also included two direct claims for breach of fiduciary duties for failure to disclose material information to stockholders when compensation plans were approved and for partial disclosures in proxy statements concerning the tax deductibility of cash-based incentive awards to named executive officers.

The Court described what the Company would give up by settling the claims. The Court noted the claims compromised were allegations that the Company’s directors are liable to the Company for excessively compensating themselves and for issuing stock-based incentive awards in reliance on stock incentive plans that were void at the time of the award. These claims are assets of the Company. The settlement, if confirmed, would release all stockholders’ and the Company’s rights to assert these and related claims going forward.

The Court than analyzed what the Company would obtain by settling the claims. According to the Plaintiff and the Director Defendants, the quid pro quo arose from the settlement of the Plaintiff’s direct claims against the Director Defendants. Those claims were composed of allegations that the Director Defendants breached fiduciary duties in failing to make required disclosures in connection with the Company’s recent stock incentive plans and proxy statements. The Director Defendants also agreed to cause the Company to do certain beneficial things, including making certain disclosures in the future and continuing certain practices, already implemented, with respect to executive compensation for at least three years. The Plaintiff alleged that the disclosures would bring future stock incentive plans into compliance with the Plaintiff’s interpretation of federal law, thus conveying a large but hypothetical monetary benefit on the Company.

However the Court declined to approve the settlement because it did not find the release of the derivative claims fair to the Company. According to the Court, in return for a release of the monetary claims against them, the Director Defendants give up nothing. Instead, the Director Defendants only agreed to cause the Company to take or refrain from certain actions that were largely mandatory given the Director Defendants’ fiduciary duties. Even if the undertaking of the Defendant Directors had merit, they were unrelated to claims for conflicted overpayment that were at the heart of the derivative claims.

Akorn, Inc., v. Fresenius Kabi AG et al will undoubtedly become known as the first case where a Delaware court found a material adverse effect, or MAC (often referred to as a material adverse effect, or MAE), to exist.  The opinion also contains a helpful description of a description of “commercially reasonable efforts” as compared to other efforts based clauses.

Efforts based clauses mitigate the rule of strict liability for contractual non-performance that otherwise governs. The Court noted that generally if a party agrees to do something, he must do it or be liable for resulting damages (or potentially be subject to an order compelling specific performance).   At times, however, a party’s ability to perform its obligations depends on others or may be hindered by events beyond the party’s control.  In those situations, drafters commonly add an efforts clause to define the level of effort that the party must deploy to attempt to achieve the outcome. The language specifies how hard the parties have to try.

Describing how many deal lawyers think, the Court cited the ABA Committee on Mergers and Acquisitions which ascribed the following meanings to commonly used standards:

  • Best efforts: the highest standard, requiring a party to do essentially everything in its power to fulfill its obligation (for example, by expending significant amounts or management time to obtain consents).
  • Reasonable best efforts: somewhat lesser standard, but still may require substantial efforts from a party.
  • Reasonable efforts: still weaker standard, not requiring any action beyond what is typical under the circumstances.
  • Commercially reasonable efforts: not requiring a party to take any action that would be commercially detrimental, including the expenditure of material unanticipated amounts or management time.
  • Good faith efforts: the lowest standard, which requires honesty in fact and the observance of reasonable commercial standards of fair dealing. Good faith efforts are implied as a matter of law.

The Court noted that commentators who have surveyed the case law find little support for the distinctions that transactional lawyers draw.  Consistent with this view, in Williams Companies v. Energy Transfer Equity, L.P., the Delaware Supreme Court interpreted a transaction agreement that used both “commercially reasonable efforts” and “reasonable best efforts.” Referring to both provisions, the high court stated that “covenants like the ones involved here impose obligations to take all reasonable steps to solve problems and consummate the transaction.” The high court did not distinguish between the two.

The Court also discussed that while serving as a member of the Court of Chancery, Chief Justice Strine similarly observed that even a “best efforts” obligation “is implicitly qualified by a reasonableness test—it cannot mean everything possible under the sun.” Another Court of Chancery decision—Hexion—also framed a buyer’s obligation to use its “reasonable best efforts” to obtain financing in terms of commercial reasonableness: “[T]o the extent that an act was both commercially reasonable and advisable to enhance the likelihood of consummation of the financing, the onus was on Hexion to take that act.”

 

 

The U.S. Department of the Treasury, as chair of the Committee on Foreign Investment in the United States (CFIUS), today issued temporary regulations in connection with the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), which President Trump signed into law in August.  FiRRMA is meant to protect critical American technology and intellectual property from potentially harmful foreign acquisitions.

FIRRMA authorizes CFIUS to conduct pilot programs to implement provisions in the legislation that did not become effective immediately upon enactment.  Full implementation of FIRRMA will occur no later than February 2020.

The pilot program implements authorities that expand the scope of transactions subject to CFIUS review to include certain non-controlling investments in U.S. businesses involved in critical technologies related to specific industries.  The pilot program also makes effective FIRRMA’s mandatory declarations provision for transactions that fall within the scope of the pilot program.  The pilot program will end no later than the date on which the final FIRRMA regulations are fully implemented.

In addition to the pilot program, Treasury issued temporary regulations that make limited updates to CFIUS’s existing regulations, primarily to implement provisions of FIRRMA that became immediately effective upon its enactment.  This will ensure consistency between CFIUS’s regulations and the statute.  These regulations are effective October 11, 2018.

In accordance with FIRRMA, the pilot program will commence on November 10, 2018, 30 days following publication of the regulations in the Federal Register.

For more information see Treasury’s fact sheet and text of the regulations (pilot program regulations and updates to existing regulations).

Akorn, Inc., v. Fresenius Kabi AG et al will undoubtedly become known as the first case where a Delaware court found a material adverse effect, or MAC (often referred to as a material adverse effect, or MAE), to exist. The opinion also contains a helpful description of how to read an MAE clause. MAE clauses often contain a litany of exceptions of seemingly unrelated matters, and the opinion brings some order to the analysis.

According to the Delaware Court of Chancery, in any M&A transaction, a significant deterioration in the selling company’s business between signing and closing may threaten the fundamentals of the deal. Merger agreements typically address this problem through complex and highly-negotiated ‘material adverse change’ or ‘MAC’ clauses, which provide that, if a party has suffered a MAC within the meaning of the agreement, the counterparty can costlessly cancel the deal.

The Court observed that despite the attention that contracting parties give to these provisions, MAC clauses typically do not define what is “material.” Commentators have argued that parties find it efficient to leave the term undefined because the resulting uncertainty generates productive opportunities for renegotiation.

Rather than devoting resources to defining more specific tests for materiality, The Court noted the current practice is for parties to negotiate exceptions and exclusions from exceptions that allocate categories of MAE risk. The typical MAE clause allocates general market or industry risk to the buyer, and company-specific risks to the seller. From a drafting perspective, the MAE provision accomplishes this by placing the general risk of an MAEon the seller, then using exceptions to reallocate specific categories of risk to the buyer.

Exclusions from the exceptions therefore return risks to the seller. A standard exclusion from the buyer’s acceptance of general market or industry risk returns the risk to the seller when the seller’s business is uniquely affected. To accomplish the reallocation, the relevant exceptions are qualified by a concept of disproportionate effect. For example, a buyer might revise the carve-out relating to industry conditions to exclude changes that disproportionately affect the target as compared to other companies in the industries in which such target operates.

The Court pointed out a more nuanced analysis of the types of issues addressed by MAE provisions reveals four categories of risk: systematic risks, indicator risks, agreement risks, and business risks.

  • Systematic risks are “beyond the control of all parties (even though one or both parties may be able to take steps to cushion the effects of such risks) and . . . will generally affect firms beyond the parties to the transaction.”
  • Indicator risks signal that an MAE may have occurred. For example, a drop in the seller’s stock price, a credit rating downgrade, or a failure to meet a financial projection is not itself an adverse change, but rather evidence of such a change.
  • Agreement risks include all risks arising from the public announcement of the merger agreement and the taking of actions contemplated thereunder by the parties. Agreement risks include endogenous risks related to the cost of getting from signing to closing, e.g., potential employee flight.
  • Business risks are those “arising from the ordinary operations of the party’s business (other than systematic risks), and over such risks the party itself usually has significant control. The most obvious business risks are those associated with the ordinary business operations of the party—the kinds of negative events that, in the ordinary course of operating the business, can be expected to occur from time to time, including those that, although known, are remote.

According to the Court, generally speaking, the seller retains the business risk. The buyer assumes the other risks.

The SEC has approved an amendment to Nasdaq Rule 5635(d) to modify the circumstances in which shareholder approval is required for issuances of securities in private placement transactions.

The revised rule provides shareholder approval is required prior to a 20% Issuance at a price that is less than the Minimum Price.  A “20% Issuance”, for purposes of Rule5635(d), is defined as a transaction, other than a public offering as defined in IM-5635-3, involving the sale, issuance, or potential issuance by the issuer of common stock (or securities convertible into or exercisable for common stock), which, alone or together with sales by officers, directors, or substantial shareholders of the issuer, equals 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance.

The definition combines the existing provisions of Nasdaq Rule 5635(d)(1) and (d)(2) into one provision. According to NASDAQ, this revision does not make any substantive change to the threshold for quantity or voting power of shares being sold that would give rise to the need for shareholder approval, although the applicable pricing test has changed.

“Minimum Price,” is defined as the price that is the lower of (1) the closing price (as reflected on Nasdaq.com) immediately preceding the signing of the binding agreement or (2) the average closing price of the common stock (as reflected on Nasdaq.com) for the five trading days immediately preceding the signing of the binding agreement.

The revised rule no longer includes a requirement that the price exceed the book value of the common stock.

In perhaps the fastest moving SEC enforcement action of all time, the SEC charged Elon Musk with securities fraud on September 27, 2018 after settlement agreements reportedly fell apart.  Selecting the nuclear option, one of the remedies the SEC sought was to bar the iconic Mr. Musk as serving as an officer or director of a public company. By September 29, 2018, the action against Mr. Musk and a separate action against Tesla were settled.

According to the SEC, the settlement terms were as follows:

  • Musk will step down as Tesla’s Chairman and be replaced by an independent Chairman. Musk will be ineligible to be re-elected Chairman for three years;
  • Tesla will appoint a total of two new independent directors to its board;
  • Tesla will establish a new committee of independent directors and put in place additional controls and procedures to oversee MR. Musk’s communications;
  • Musk and Tesla will each pay a separate $20 million penalty. The $40 million in penalties will be distributed to harmed investors under a court-approved process.

On November 5, 2013, Tesla filed a Form 8-K disclosing that Mr. Musk’s Twitter account would be used to disseminate material information about the company. In the complaint against Tesla, the SEC alleged Mr. Musk did not routinely consult with anyone at Tesla before publishing Tesla-related information via his Twitter account. Likewise, no one at Tesla reviewed Mr. Musk’s tweets prior to publication.

The SEC charged Tesla with violating Rule 13a-15 of the Exchange Act because:

  • Tesla failed to maintain controls and procedures designed to ensure that information required to be disclosed in the reports that it files or submits pursuant to the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the Commission’s rules and forms.
  • Tesla also failed to maintain controls and procedures designed to ensure that information required to be disclosed in the reports that it files or submits pursuant to the Exchange Act is accumulated and communicated to its management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Devoid from the complaint against Tesla is any allegation whatsoever that Tesla improperly failed to file a required SEC report or filed an incorrect SEC report. The fact that there were no disclosure controls and procedures is enough.

So the message to public companies is clear: If you have executives out there communicating material information on social media, you need to have disclosure controls and procedures in place to review the information before and after publication. Or at least one or the other.

It would seem the White House would benefit from a similar rule.

On September 28, 2018, S&P Dow Jones Indices and MSCI, Inc. will introduce a new grouping to their Global Industry Classification Standard (GICS) system. This new classification, coded 5020, will be called “Media & Entertainment.” Certain other changes, including renaming the top-level GICS 50 industry, eliminating GICS 2540 (“Media”), and creating six- and eight-digit classifications within GICS 5020, will also be made.

Certain ISS policies, procedures, and products rely on GICS classifications, including executive compensation peer group formation, equity compensation plan evaluation, and Environmental & Social QualityScore. ISS has issued FAQs designed to answer the most frequently asked questions regarding how the adjustment to GICS structure will impact ISS analyses, and when those changes will be effective.

The FAQs address the following questions:

  • How will the new GICS code affect the evaluation of equity compensation plans under ISS’ U.S. Equity Plan Scorecard?
  • How will the new GICS code affect the evaluation of equity plans under ISS’ burn rate policy for France?
  • How will the new GICS code affect the evaluation of executive compensation?
  • How will the new GICS code affect the evaluation of director compensation?
  • How will the new GICS code affect Environmental & Social QualityScore?
  • How will the new GICS code affect ISS policies, such as the director performance evaluation policy, that examine a company’s TSR performance relative to its industry?
  • When will Question 130 in Governance QualityScore, which examines each covered company’s burn rate relative to its industry, be updated to reflect the new GICS structure?

SEC staff recently issued this Compliance and Disclosure Interpretation:

Question 105.09

Question: On August 17, 2018, the SEC adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification. The amendments will become effective 30 days after publication in the Federal Register. Among the amendments is the requirement to presentthe changes in shareholders’ equity in the interim financial statements (either in a separate statement or footnote) in quarterly reports on Form 10-Q. Refer to Rules 8-03(a)(5) and 10-01(a)(7) of Regulation S-X. When are filers expected to comply with this new requirement?

Answer: The amendments are effective for all filings made 30 days after publication in the Federal Register. In light of the anticipated timing of effectiveness of the amendments and expected proximity of effectiveness to the filing date for most filers’ quarterly reports, the staff would not object if the filer’s first presentation of the changes in shareholders’ equity is included in its Form 10-Q for the quarter that begins after the effective date of the amendments. For example, assuming an effective date of October 25, a December 31 fiscal year-end filer could omit this disclosure from its September 30, 2018 Form 10-Q. Likewise, a June 30 fiscal year-end filer could omit this disclosure from its September 30, 2018 and December 31, 2018 Forms 10-Q; however, the staff would object if it did not provide the disclosures in its March 31, 2019 Form 10-Q. (Sept. 25, 2018)

The FTC recently spoke about the time it takes review a consent package after FTC staff and the parties formally submit a settlement package to the Director of the Bureau of Competition.

According to the FTC it typically takes four weeks to review a consent package after staff and the parties formally submit the settlement package to the Director of the Bureau of Competition. The Director of the Bureau of Competition then will take two weeks to review the consent package. Once the Director agrees that the proposed settlement addresses the competitive risk raised by the merger, the Director will make a recommendation to the Commission that the Commission accept the proposed consent order for public comment. The Bureau of Economics will separately make its own recommendation. The Commission will typically take two weeks to review the Bureau Directors’ recommendations before voting on whether to accept the consent. The Commission’s time to review and to vote is solely in the Commission’s discretion and the Commissioners’ review may exceed two weeks when necessary.

The FTC notes the foregoing timelines for Bureau’s and Commission review may be shortened or lengthened—in the discretion of the Bureau Directors in the first period, or the Commission in the second period— and suggests counsel should not make commitments that the review period will be shorter.

The FTC also notes if parties believe that expedited review of a consent package is appropriate in their particular matter, they must submit a letter requesting expedited review and explaining why expedited review is requested. According to the FTC, before seeking expedited review, parties should have notified Bureau of Competition staff as early as possible during the investigation of the issues cited in the letter justifying expedited review. The FTC believes expedited review is unlikely to be granted when the parties had the power to address these issues themselves, or it was reasonably foreseeable that there would be timing issues (e.g., the parties negotiated a drop-dead date that allowed only four months to close, or agreed to a ticking fee on financing that failed to anticipate antitrust review). According to the FTC routine business exigencies related to deal closing are unlikely to constitute sufficient grounds for expedited review. Finally, the FTC states frequent outreach to the Bureau of Competition Front Office or to Commissioners’ offices is unlikely to expedite a decision further once a letter is received.

 

As noted on our Benefits Notes blog, on August 21, 2018, the IRS issued its initial guidance on the amendments to Section 162(m) made by the Tax Cuts and Jobs Act, in the form of Notice 2018-68. The guidance is fairly limited and does not completely address some of the questions it takes on. Notably, the guidance on what compensation will not be subject to the amended Section 162(m) under the grandfather rule may be very restrictive with respect to performance-based compensation that is subject to negative discretion, depending on the extent to which that discretion may be exercised under applicable law.

As a reminder, Section 162(m) limits the deduction for compensation paid to certain employees of companies with publicly traded equity or debt (“covered employees”) to $1 million per year. Among other things, the amendments to Section 162(m) eliminated the exception from that limitation for performance-based compensation and redefined covered employees so that once an employee becomes a covered employee, he or she remains one, even after termination of employment.  Similar to Section 162(m) as originally enacted, the amendments provide for grandfathering of compensation paid pursuant to a “written binding contract” in effect on November 2, 2017 that is not modified in any material respect.  The key areas addressed by the guidance are how covered employees are identified and what compensation will be eligible for grandfathering.

We recommend issuers review their Section 162(m) disclosures in proxy statements as a result of the foregoing.

We have also updated our blog on Preliminary Planning for the 2019 Proxy Season to reflect the foregoing.