m&a fairness opinions and projections in financial disclosure...
TRANSCRIPT
M&A Fairness Opinions and Projections
in Financial Disclosure Summaries Leveraging Developments on Disclosure of Management Projections, Financial Advisors’ Potential Conflicts, Fair Summary Requirements and More
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THURSDAY, FEBRUARY 21, 2013
Presenting a live 90-minute webinar with interactive Q&A
Steven M. Haas, Partner, Hunton & Williams, Richmond, Va.
Kevin Miller, Partner, Alston & Bird, New York
Blake Rohrbacher, Director, Richards Layton & Finger, Wilmington, Del.
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Steven M. Haas Partner, Hunton & Williams LLP
Kevin Miller Partner, Alston & Byrd LLP
Blake Rohrbacher Director, Richards, Layton & Finger, P.A.
M&A Fairness Opinions and
Projections in Financial
Disclosure Summaries
6
Overview: The Dynamics of Disclosure Claims
Delaware Merger Litigation Trends
The Duty of Disclosure, Materiality, and Related Litigation Issues
Disclosure of Projections
Disclosure of Financial Analyses Performed by Financial Advisors
Q&A
Discussion Outline
The Dynamics of Disclosure Claims Projections and the Financial Analyses Performed by
Financial Advisors
Copyright 2013 The views expressed herein reflect the views of the author and do not necessarily reflect the views of Alston & Bird or its clients.
The Dynamics of Disclosure Claims
The Dynamics of Disclosure Claims
• The disclosure of additional information, particularly quantitative information that could be helpful to shareholders in making an investment decision, has popular appeal and has become a fertile area for disclosure claims even though the Delaware Supreme Court has held that such information (e.g., a company’s internal financial projections and a summary of the methodologies used and the ranges of values generated by the financial analyses performed by its financial advisor) is not per se material and is consequently not required to be disclosed absent a showing it is inconsistent with or significantly differs from disclosed information (See Skeen v. Jo-Ann Stores, Inc., 750 A. 2d 1170 (Del. 2000)).
• Apparently disregarding the Delaware Supreme Court’s decision in Skeen, in a series of rulings beginning with Pure Resources, Netsmart and Maric, the Court of Chancery subsequently held that projections and a fair summary of the financial analyses underlying a financial opinion (including a summary of the valuation methodologies used and the ranges of values generated) were per se material and required to be disclosed. As a practical matter, the Court of Chancery’s rulings were unlikely to be appealed so long as the costs of abiding by the Court of Chancery’s rulings and settling class action disclosure claims based on those rulings (i.e., the plaintiffs’ attorney’s fees awarded – typically a few hundred thousand to a million dollars, even on multi billion dollar transactions) were relatively modest and the benefits (i.e., obtaining a global settlement and avoiding further delay in consummating the transaction) were substantial.
• More recent rulings of the Court of Chancery including In re Micronetics and Dent v. Ramtron, have cited Skeen and have questioned plaintiffs’ assertions, citing Netsmart, Maric and their progeny, that projections and a fair summary of the financial analyses underlying a fairness opinion are per se material and have held that in order to properly allege a disclosure violation, plaintiffs must allege facts suggesting that the undisclosed information is inconsistent with, or otherwise significantly differs from, the disclosed information.
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Delaware Merger Litigation Trends The Cornerstone Research Study
Cornerstone Research Study Results
• Study indicates that in 2010 and 2011, litigation was filed in connection with 95%/96% of announced public company acquisitions with a value over $500 million, up from 53% in 2007
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Delaware Merger Litigation Trends The Cornerstone Research Study
Prevalence
“Shareholder litigation challenging merger and acquisition (M&A) deals has increased substantially in recent years. To study this increase and characterize the recent litigation, Cornerstone Research and Professor Robert Daines of the Stanford Law School reviewed reports of M&A shareholder litigation in Securities and Exchange Commission (SEC) filings related to acquisitions of U.S. public companies valued over $100 million and announced in 2010 or 2011. [Cornerstone Research] found that almost every acquisition of that size elicited multiple lawsuits, which were filed shortly after the deal’s announcement and often settled before the deal’s closing. Only a small fraction of these lawsuits resulted in payments to shareholders; the majority settled for additional disclosures or, less frequently, changes in merger terms, such as deal protection provisions. Interestingly, while requiring additional disclosures is a common outcome, [Cornerstone Research did] not encounter a case in which shareholders rejected the deal after the additional disclosures were provided.”
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The Duty of Disclosure
Directors’ Duty of Disclosure
• “Directors of Delaware corporations are under a fiduciary duty to disclose fully and fairly all material information within the board’s control when it seeks shareholder action.” Stroud v. Grace, 606 A.2d 75, 84 (Del. 1992).
• “Directors must disclose all material facts within their control that a reasonable stockholder would consider important in deciding how to respond to the pending transaction.” Skeen v. Jo-Ann Stores, Inc., 750 A.2d 1170 (Del. 2000).
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The Definition of Material
The Definition of “Material”
• “An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote . . . [T]here must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” Shell Petroleum, Inc. v. Smith, 606 A.2d 112 (Del. 1992). See also Loudon v. Archer-Daniels-Midland Co., 700 A.2d 135, 143 (Del. 1997) and Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).
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Materiality Claims
Materiality Claims
• In order to be actionable, a Court must conclude that:
– there is a substantial likelihood that a reasonable stockholder would consider the omitted facts important in deciding how to vote; and
–there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable stockholder as having significantly altered the total mix of information made available.
• “Omitted facts are not material simply because they might be helpful [in determining whether to pursue appraisal]. To be actionable, there must be a substantial likelihood that the undisclosed information would significantly alter the total mix of information already provided.” Skeen v. Jo-Ann Stores, Inc., 750 A.2d 1170 (Del. 2000).
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The Meaning of “Significantly Alter The Total Mix of Information”
The Meaning of “Significantly Alter The Total Mix of Information”
• Plaintiffs must allege facts suggesting that the omitted information is inconsistent with, or otherwise significantly differs from, the disclosed information.
– “The complaint alleges no facts suggesting that the undisclosed information is inconsistent with, or otherwise significantly differs from, the disclosed information. Appellants merely allege that the added information would be helpful in valuing the company.” Skeen v. Jo-Ann Stores, Inc., 750 A.2d 1170 (Del. 2000).
– See also In re Micronetics, CA No. 7276-VCP (Del. Ch. July 24, 2012) (Hearing transcript quoting that passage from Skeen) and Dent v. Ramtron, CA No. 7950-VCP (Del. Ch. Nov. 19, 2012) (Hearing Transcript) (“Here, as in the Delaware Supreme Court case Skeen v. Jo-Ann Stores, Inc., there are no facts suggesting that the undisclosed information is inconsistent with, or otherwise significantly differs from, the disclosed information.”)
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Under SEC Rules a Summary of the Financial Analyses Underlying a Fairness Opinion Is Not Always Required
SEC forms do not generally require the disclosure of all material information, only the information required to be disclosed by the applicable disclosure forms and associated rules and regulations.
• The SEC disclosure rules applicable to Rule 13e-3 going private transactions, merger proxies, merger registration statements and tender offers are not identical.
• Schedule 13E-3 requires the disclosure of the information required by Item 1015(a) of Regulation M-A – whether an opinion has been received - and Item 1015(b) of Regulation M-A – a summary of the any such fairness opinion.
• Schedule 14A (proxy statements) and Registration Statements on Form S-4 (merger prospectuses) require the disclosure of the information required by Item 1015(b) – a summary of any such fairness opinion - only if the fairness opinion is referenced in the merger proxy or prospectus.
• The SEC rules applicable to cash tender offers are materially different from those applicable to Rule 13e-3 transactions, merger proxies and prospectuses and do not require a summary of the material financial analyses underlying a fairness opinion.
• Schedule 14D-9 does not require the disclosure of the information required by Item 1015(b) – a summary of any fairness opinion – and consequently it would be inaccurate to suggest that the SEC views such information as per se material.
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Disclosure Claims
Disclosure Claims • Delaware Courts have historically not been receptive to attorneys’ fee requests absent demonstrable
benefits to shareholders, even where such fee requests have been agreed by the parties to the litigation. See e.g., In re Cox Commc’ns, Inc. S’holders Litig., 879 A.2d 604 (Del. Ch. 2005).
– In addition to rejecting or reducing requests for attorneys’ fees, Delaware Courts have, on occasion, rejected settlements or replaced plaintiffs’ counsel. See e.g., In re SS&C Techs., Inc. S'holders Litig., 911 A.2d 816 (Del. Ch. 2006) and In re Revlon, Inc. S’holder Litig., 990 A.2d 940 (Del. Ch. 2010).
• On the other hand, the Delaware Court of Chancery has, with a few recent exceptions, increasingly been willing to grant expedited discovery and injunctive relief with respect to disclosure claims. See e.g., Laborers Local 235 Benefit Funds v. Starent Networks, Corp., No. 5002-CC 2009 WL 4725866 (Del. Ch. Nov. 18, 2009) (“Under Delaware law, nearly all disclosure violations are per se irreparable harm because the harm arising from the un- or misinformed transaction is of a nature where the injury cannot be compensated adequately in damages.”).
• The Delaware Court of Chancery has, at least until recently, also generally been receptive to motions for injunctions alleging inadequate disclosure of financial projections and the details of the financial analyses underlying fairness opinions even in situations where similar claims have not survived a motion to dismiss after the closing of a transaction. See Skeen (Del. 2000) and Globis Partners, L.P. v. Plumtree Software, Inc., 1577-VCP 2007 WL 4292024 (Del. Ch., Nov. 30, 2007) (Court dismissed post closing claims that merger proxy failed to disclose projections, details of the financial advisor’s analyses and the amount of the financial advisor’s fees). [NTD: Can the injunction requirement that there be a reasonable probability of success on the merits be satisfied if the claim would likely be dismissed if brought post closing?]
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Likelihood of Appeal
Likelihood of Appeal • Disclosure based injunctions are rarely appealed as it is often much
simpler and cheaper for transaction participants to disclose management’s internal financial projections and require their financial advisors to agree to additional disclosure regarding their financial analyses if that is what is required to avoid an injunction or get an injunction lifted.
• Buyers are likely to encourage settlements that merely require additional disclosure regarding projections or details of the financial analyses underlying fairness opinions. – No cost to the transaction participants as a result of a disclosure based
settlement other than relatively predictable levels of plaintiffs’ attorneys’ fees. See the appendices to In re Sauer-Danfoss S’holders Litig., No. 5162-VCL; 2011 WL 2519210 at *14-15 (Del. Ch. Apr. 29, 2011) which indicate the ranges of attorneys’ fees for disclosures of questionable quality ($75,00 to $225,000); one or two meaningful disclosures ($300,000 to $550,000; and exceptional or significant additional disclosures ($800,000 to $1,200,000).
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The Dynamics of Disclosure Claims Projections
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Are Projections Required to be Disclosed? The Delaware Supreme Court’s Approach
• Delaware Supreme Court/Skeen Approach: Projections are Not per se Material. – Skeen (Del. 2000) − the Delaware Supreme Court considered and rejected a claim that
the Board breached its fiduciary duties by failing to disclose management’s projections. • “Appellants are advocating a new disclosure standard in cases where appraisal is an
option. They suggest that stockholders should be given all the financial data they would need if they were making an independent determination of fair value. Appellants offer no authority for their position and we see no reason to depart from our traditional standard. . . . [plaintiffs] say, in essence, that the settled law governing disclosure requirements for mergers does not apply, and that far more valuation data must be disclosed where, as here, the merger decision has been made and the only decision for the minority is whether to seek appraisal. We hold that there is no different standard for appraisal decisions.” Skeen v. Jo-Ann Stores, Inc., 750 A.2d 1170, 1174 (Del. 2000).
– In re Best Lock (C Chandler 2001) − “[P]laintiffs assert that the financial projections provided to Piper were improperly omitted from the Information Statement. . . . Delaware courts have held repeatedly that a board need not disclose specific details of the analysis underlying a financial advisor's opinion. Moreover, even if such facts were required to be disclosed, this information would not have altered significantly the total mix of information available to shareholders. . . . Accordingly, the motion to dismiss with regard to these claims is granted.” In re Best Lock Corp. S’holder Litig., 845 A.2d 1057, 1071, 73 (Del. Ch. 2001).
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Skeen v. Jo-Ann Stores, 750 A.2d 1170 (Del 2000)
• In Skeen, the Delaware Supreme Court considered and rejected a claim that the Board of House of Fabrics breached its fiduciary duties by failing to disclose (i) management’s projections and (ii) a summary of the methodologies used and the ranges of values generated by the financial analyses performed by its financial advisor.
• House of Fabrics was acquired by Fabri-Centers in a two step transaction – a cash tender offer followed by a cash out merger at the same price.
• The Schedule 14D-9 filed by House of Fabrics in response to Fabri-Centers’ tender offer and the information statement disseminated to House of Fabrics’ shareholders in connection with the second step merger contained a copy of the fairness opinion rendered by DLJ which, like virtually all fairness opinions, included a brief description of the types of financial analyses (methodologies) performed by DLJ.
• Neither the Schedule 14D-9 nor the information statement disseminated to House of Fabrics’ stockholders in connection with the second step merger contained management projections or a detailed summary of the financial analyses performed by DLJ or the ranges of values generated by the financial analyses.
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Skeen v. Jo-Ann Stores, 750 A.2d 1170 (Del 2000)
• Holding – Dismissal of claims upheld - “Appellants are advocating a new disclosure standard in cases where appraisal is an option. They suggest that stockholders should be given all the financial data they would need if they were making an independent determination of fair value. Appellants offer no authority for their position and we see no reason to depart from our traditional standard.”
• The holding applies to mergers as well as appraisal rights disclosure – “[plaintiffs] say, in essence, that the settled law governing disclosure requirements for mergers does not apply, and that far more valuation data must be disclosed where, as here, the merger decision has been made and the only decision for the minority is whether to seek appraisal. We hold that there is no different standard for appraisal decisions.”
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Are Projections Required to be Disclosed? Subsequent Court of Chancery Approach
Subsequent Court of Chancery Approach: A Company’s Best Estimates of its Future Financial Performance are per se Material and are Required to be Disclosed. •Netsmart (VC Strine 2007) − “It would therefore seem to be a genuinely foolish (and arguably unprincipled and unfair) inconsistency to hold that the best estimate of the company’s future returns, as generated by management and the Special Committee’s investment bank, need not be disclosed when stockholders are being advised to cash out. . . . Indeed, projections of this sort are probably among the most highly prized disclosures by investors. Investors can come up with their own estimates of discount rates or (as already discussed) market multiples. What they cannot hope to replicate are management’s inside view of the company’s prospects.” In re Netsmart Techs., Inc. S’holders Litig. 924 A.2d 171, 203 (Del. Ch. 2007). [NTD: Skeen not cited] •Maric (VC Strine 2010) − “[I]n my view, management’s best estimate of the future cash flow of a corporation that is proposed to be sold in a cash merger is clearly material information.” Maric Capital Masterfund, Ltd. v. Plato Learning, Inc., 11 A.3d 1175, 1178 (Del. Ch. 2010). [NTD: Skeen not cited]
– But see Transatlantic (C Strine 2011). “THE COURT: “… I’m just saying the cases – I’m like Mr. Projections. The banks don’t like me. They don’t like me. But here, you’ve got a range, and you’ve got the discount rate in the range. It’s actually good. I mean, people could vote no if they really believe this and vote no on it. It’s not affected – if you saw a discount range of 17.7 to 24 percent, I mean, do we really have more than this? Or is it just you know you’ve got Strine, and he’s Mr. Projection, and so we put that in here?” MR. NOTIS: “On that point, on the Moelis, we don’t draw a distinction between coming up with a range above the deal price or below the deal price to deviate from the Court’s general preference for projections. And also – ”THE COURT: “I don’t have a general preference for anything.” In re Transatlantic Holdings, Inc. S’holders Litig, C.A. Nos. 6574 & 6776 – CS (Del. Ch. Aug. 22, 2011) (Hearing Transcript).
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Other Decisions on Projections
• Not all Court of Chancery decisions have agreed that projections are per se material. – CheckFree (C Chandler 2007) − “Although the Netsmart Court did
indeed require additional disclosure of certain management projections . . . the proxy in that case affirmatively disclosed an early version of some of management’s projections. Because management must give materially complete information “[o]nce a board broaches a topic in its disclosures,” the Court held that further disclosure was required. . . . Because [the CheckFree] plaintiffs have failed to establish that management’s projections constitute material omitted information, they have failed to demonstrate a likelihood of success on the merits of their claim and, therefore, I deny their motion for a preliminary injunction on this ground.” In re CheckFree Corp. S’holders Litig., No. 3193-CC, 2007 WL 3262188 at *3 (Del. Ch. Nov. 1, 2007). See also Globis Partners, L.P. v. Plumtree Software, Inc., 1577-VCP 2007 WL 4292024 (Del. Ch., Nov. 30, 2007).
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More Recent Decisions on Projections
• A recent Court of Chancery decision, citing Skeen, denied a motion for a preliminary injunction for failure to disclose projections. Dent v. Ramtron, CA No. 7950-VCP (Del. Ch. Nov. 19, 2012)
• [Plaintiffs’ Counsel]: . . . Cutting right to it, Your Honor, the basis for plaintiff's motion for a preliminary injunction is that the proxy statement that's been issued by the defendants is materially false and misleading. And it's materially false and misleading because it omits information that the minority shareholders need in order to be fully informed in connection with making their decision as to how to vote at tomorrow's meeting and whether or not to exercise their appraisal rights. And the proxy omits any reference whatsoever -- any information whatsoever as to the company's projections . . .
• THE COURT: So what's the best case that you have? Give me the two best cases that you have. Because you're almost arguing for a per se all projections have to be -- if you've got management projections that are relied upon by an investment banker to make an analysis, and especially a DCF analysis, they have to be produced. That seems to be what you're saying.
• [Plaintiffs’ Counsel]: In this particular context of a cash-out merger, Your Honor, where the company's shareholders are being taken out, and one of the primary bases for the board's recommendation is a banker's fairness opinion utilizing management's best estimates, projections, this is a situation where the projections should be disclosed. And I think –
• THE COURT: Isn't that, dead on, the Skeen case? . . . the Skeen case is the Supreme Court. The later cases, I think, are the Court of Chancery, which I, of course, still respect as a member of it.
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More Recent Decisions on Projections
Dent v. Ramtron (VC Parsons 2012) (cont’d)
• RULING OF THE COURT:
“The omitted disclosure at issue in this case is Ramtron management's financial projections. "There is no per se duty to disclose financial projections furnished to and relied upon by an investment banker. To be a subject of mandated disclosure, the projections must be material in the context of the specific case." [citation omitted] . . .In this case, the evidence demonstrates that the projections are not material. Here, as in the Delaware Supreme Court case Skeen v. Jo-Ann Stores, Inc., there are no facts suggesting that the undisclosed information is inconsistent with, or otherwise significantly differs from, the disclosed information.”
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Are Free Cash Flows Required to be Disclosed?
Are Projected Free Cash Flows Required to be Disclosed? •Maric (VC Strine 2010) − “[I]n my view, management’s best estimate of the future cash flow of a corporation that is proposed to be sold in a cash merger is clearly material information.” Maria Capital Masterfund, Ltd. v. Plato Learning, Inc., 11 A.3d 1175, 1178 (Del. Ch. 2010). •But see Steamfitters (C Chandler 2010) − “But this isn’t a case where free cash flow estimates were deliberately removed or excised from a proxy disclosure. Unlike in Maric, in this case no free cash flow estimates were actually provided to Goldman Sachs. The internal analyses that were approved by management for Goldman’s use in this case didn’t have a line item for free cash flow estimates, and so unlike the Maric decision, there was no deliberate excising of free cash flow numbers. And in addition, this isn't like Netsmart, where management undertook to disclose certain projections but then disclosed projections that were actually stale and not, therefore, meaningful. The proxy here gave management’s projections that were actually used by Goldman, and those projections included net revenue, net income, EPS and EBITDA estimates for five years. . . . Now, having said all of that, and with due respect to Mr. Liebesman, who I know disagrees with me -- and I appreciate that, and respect his point of view, and can understand his point of view, frankly. And so I am quite willing, if Mr. Liebesman believes that I have erred and that there are truly reasons why in every case Delaware ought to require -- even if management hasn't produced it to the investment advisor -- that Delaware law ought to require as a per se rule that free cash flow estimates going out into the future be provided, disclosed, I would be, in the interests of clarification of Delaware law, and in the interests of perhaps leading to the creation of a bright-line rule in disclosure, which I think would be a good thing in some ways – I would be happy, Mr. Liebesman, to sign, today, an order certifying an interlocutory appeal to the Delaware Supreme Court on this question. ” Steamfitters Local Union 447 v. Walter, No. 5492-CC (Del. Ch. June 21, 2010). [NTD – No appeal was taken by plaintiffs]
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Recent Developments Regarding Disclosure of Free Cash Flows
• Gaines v. Narachi (VC Noble Oct 6, 2011) – granting plaintiffs motion for reconsideration/reargument. While not ruling on the merits of the claims, the Court found that “[a]lthough the Proxy disclosed the EBIT projections—essentially a precursor to free cash flow-used by Morgan Stanley in its DCF analysis, the Proxy did not disclose the related free cash flow estimates. This Court has stated that shareholders who are being advised to cash out are entitled to the best estimate of the company’s future cash flows. While application of this standard has not always resulted in a finding that free cash flows, specifically, must be disclosed, there is a colorable argument that, in this case, free cash flows should be disclosed to meet this standard. Indeed, in Maric this Court enjoined the proposed merger until free cash flow projections were disclosed, despite the fact that the proxy already disclosed projected revenues, EBIT, and a variation of EBITDA. Finally, it should be noted that from the record it is unclear whether AMAG management provided Morgan Stanley with free cash flow projections or if Morgan Stanley derived its free cash flow estimates from the disclosed EBIT projections.” Gaines v. Narachi, No. 6784-VCN (Del. Ch. October 6, 2011). [NTD – atypical litigation brought by a stockholder of the Acquiror for whom the proposed merger was not an end-stage transaction.]
• In re SeraCare Life Sciences (VC Glasscock March 20, 2012) – In SeraCare the Court denied plaintiffs motion to expedite discovery based on disclosure and process claims including the failure to disclose free cash flows developed by the target’s financial advisor and the failure to disclose the target’s expectations regarding its ability to utilize its net operating loss carry forwards. “In the recent Nighthawk case, Vice Chancellor Laster plainly found that, unlike a situation where the board provides free cash flow projections to its financial advisor, where the advisor derived the projections on its own, those projections do not have to be disclosed. To me, this is consistent with the principle that the board need not disclose every piece of information used by its financial advisor, such that an investor could conduct its own fair value analysis using that same data.” In re SeraCare Life Sciences, CA No. 7250-VCG (Del. Ch. March 20, 2012).
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Recent Developments Regarding Materiality of Free Cash Flows
A few recent Court of Chancery rulings suggest that the level of detail required to be disclosed, including free cash flows, may be subject to a more traditional materiality review. • In re Midas, Inc. S’holders Litig. (VC Parsons April 12, 2012) (Transcript) – In Midas, the Court denied
plaintiffs’ motion to expedite proceedings based on a variety of disclosure and process claims including claims that the Board of Midas breached its fiduciary duty by failing to disclose Midas’s free cash flows and whether the discount rate used in the DCF analysis performed by its financial advisor included a small stock premium. “It appears that plaintiffs are content to rest their claim on the fact that this Court previously has required the disclosure of unlevered free cash flows in certain cases. Having reviewed the precedent on which plaintiffs rely, however, I do not find that our case law supports the proposition that unlevered free cash flows must always be disclosed as a general rule. . . . Without a further explanation as to why the company’s currently disclosed projections are insufficient or an allegation that the disclosures are misleading to shareholders in deciding whether to tender their shares in this case, I find that plaintiffs have failed to state a colorable claim that defendants breached their fiduciary duty of disclosure by not including the company’s unlevered free cash flow projections.” In re Midas, Inc. S’holders Litig., CA 7346-VCP (Del. Ch. April 12, 2012) (Transcript).
• Cox v. Guzy (C Strine June 8, 2012) (Hearing Transcript) - THE COURT: “And I happen to know that EBITDA is essentially a very close proxy to free cash flow and that the metrics are almost indistinguishably different, usually. I know that when I read this, I've got management, I know I've got EBIT because there is an EBIT line. And, you know, I actually have I believe pretty much an EBITDA line if you go down to the non-GAAP net income. . . . What I'm going to say then is -- this has been very helpful -- I'm not expediting this case. I don't see any colorable argument made by the plaintiffs that adding the free cash flow into the mix would materially change the mix of information available to stockholders.” Cox v. Guzy, CA No. 7529-CS (Del. Ch. June 8, 2012) (Hearing Transcript). • See also In re Transatlantic Holdings, Inc. S’holders Litig, C.A. Nos. 6574 & 6776 – CS (Del. Ch. Aug.
22, 2011) (Hearing Transcript).
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The Dynamics of Disclosure Claims Financial Analyses Performed by Financial Advisors
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Is a Fair Summary of a Financial Advisor’s Financial Analyses Required to be Disclosed?
The Supreme Court’s Approach
The Delaware Supreme Court /Skeen Approach – The Results of the Financial Analyses Performed by a Company’s Financial Advisor are Not per se Material.
• Skeen (Del. 2000) − the Delaware Supreme Court considered and rejected a claim that the Board of House of Fabrics breached its fiduciary duties by failing to disclose a summary of the methodologies used and the ranges of values generated by the financial analyses performed by its financial advisor.
– “The Information Statement included a copy of the fairness opinion given by House of Fabrics’ investment banker, Donaldson, Lufkin & Jenrette (DLJ); the company's audited and unaudited financial statements through January 31, 1998; and House of Fabrics’ quarterly market prices and dividends through the year ended January 31, 1998. The complaint alleges that, in addition to this financial information, House of Fabrics’ directors should have disclosed: (1) a summary of “the methodologies used and ranges of values generated by DLJ” in reaching its fairness opinion; (2) management's projections of House of Fabrics’ anticipated performance from 1998-2003; (3) more current financial statements; and (4) the prices that House of Fabrics discussed for the possible sale of some or all of the company during the year prior to the merger. . . . We agree that a stockholder deciding whether to seek appraisal should be given financial information about the company that will be material to that decision. In this case, however, the basic financial data were disclosed and appellants failed to allege any facts indicating that the omitted information was material.”
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Is a Fair Summary of a Financial Advisor’s Financial Analyses Required to be Disclosed
The Court of Chancery Approach
Subsequent Court of Chancery Approach - The Financial Analyses are per se Material and, Consequently, a Fair Summary of the Financial Analyses is Required to be Disclosed.
• Pure Resources cited McMullin v Beran, as an arguably conflicting decision of the Delaware Supreme Court six months after Skeen.
– “[T]he Delaware courts have been reluctant to require informative, succinct disclosure of investment banker analyses in circumstances in which the bankers’ views about value have been cited as justifying the recommendation of the board. But this reluctance has been accompanied by more than occasional acknowledgement of the utility of such information, an acknowledgement that is understandable given the substantial encouragement Delaware case law has given to the deployment of investment bankers by boards of directors addressing mergers and tender offers. These conflicting impulses were manifested recently in two Supreme Court opinions. In one, Skeen v. Jo-Ann Stores, Inc., [750 A.2d 1170] the Court was inclined towards the view that a summary of the bankers’ analyses and conclusions was not material to a stockholders’ decision whether to seek appraisal. In the other, McMullin v. Beran, [765 A.2d 910 (Del. 2000)] the Court implied that information about the analytical work of the board’s banker could well be material in analogous circumstances. In my view, it is time that this ambivalence be resolved in favor of a firm statement that stockholders are entitled to a fair summary of the substantive work performed by the investment bankers upon whose advice the recommendations of their board as to how to vote on a merger or tender rely.” In re Pure Resources Inc., S’holders Litig., 808 A.2d 421, 449 (Del. Ch. 2002).
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Is a Fair Summary of a Financial Advisor’s Financial Analyses Required to be Disclosed
The Court of Chancery Approach
Subsequent Court of Chancery Approach (cont’d) - The Financial Analyses are per se Material and, Consequently, a Fair Summary of the Financial Analyses is Required to be Disclosed.
• Globis v. Safenet (VC Strine Dec. 20, 2007) (Hearing Transcript) where the Court awarded plaintiffs’ attorneys’ fees of $1.2 million, having effectively threatened to enjoin a third party tender offer unless the target company publicly filed with the SEC on Form 8-K copies of the confidential discussion materials provided to the target’s board of directors by the target’s financial advisors apparently under the mistaken impression that the absence of a “fair summary” of the financial advisor’s financial analyses in the target’s Schedule 14D-9 filed with the SEC did not pass muster under applicable SEC rules (“I'm surprised -- I'm not even sure we get out of the SEC under the current environment, having been down there this autumn with a couple defense-side lawyers to talk about the whole disclosure issue.”) and without citing prior Delaware legal precedent for requiring a “fair summary” of a financial advisor’s financial analyses in a Schedule 14D-9 filed in an arms’-length transaction. Globis v. Safenet CA No. 2772 VCS (Del. Ch. Dec. 20, 2007) (Hearing Transcript).
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Other Recent Court of Chancery Decisions on the Disclosure of Financial Analyses
See also the following Court of Chancery decisions approvingly citing Pure Resources:
• Netsmart (3/07 - Strine) − “the plaintiffs have failed to persuade me that the Proxy [containing SEC style long form of summary of “the methodologies used and ranges of values generated by the financial analyses performed by Netsmart’s financial advisor] does not fairly describe William Blair’s work.” NetSmart, 924 A.2d at 204
• CheckFree (11/07 - Chandler) − The In re Pure Resources Court established the proper frame of analysis of disclosure of financial data in this situation: “Stockholders are entitled to a fair summary of the substantive work performed by the investment bankers upon whose advice the recommendations of their board as to how to vote on a merger or tender rely.” CheckFree, 2007 WL 3262188 at *2.
• Plumtree (11/07 - Parsons) − “Stockholders are entitled to a fair summary of the substantive work performed by the investment bankers upon whose advice the recommendations of their board as to how to vote on a merger or tender rely.” [Citing CheckFree (quoting Pure Resources) and Netsmart]. Plumtree, 2007 WL 4292024 at *11, citing CheckFree 2007 WL 3262188 (quoting Pure Res. 808 A.2d at 449) (see also NetSmart, 924 A.2d at 204).
• Simonetti (6/08 – Noble) − “[S]tockholders are entitled to a fair summary of the substantive work performed by the investment bankers.” [Citing Pure Resources]. Simonetti, 2008 WL 5048692 at *9 citing Pure Res. 808 A.2d at 449.
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McMullin v. Beran, 765 A.2d 910 (Del. 2000)
• McMullin principally dealt with allegations that a Board had breached its duties to make an informed judgment as to whether a sale to a third party negotiated and recommended by its controlling stockholder maximized value for all shareholders
• It was alleged that the controlling shareholder’s preference for cash to finance an acquisition caused it not to pursue potentially higher valued transactions for stock
• At the very tail end of the McMullin decision, the Delaware Supreme Court refused to dismiss a plethora of disclosure claims that included an alleged failure to disclose “the valuation methodologies used by [the fairness opinion provider]” but went on to state:
“In Skeen, it was argued that the minority shareholder should have been given all of the financial data they would need if they were making an independent determination of fair value. We declined to establish “a new disclosure standard where appraisal is an option.” We adhere to our holding in Skeen.”
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Are Skeen and McMullin Inconsistent?
• In Skeen, the Delaware Supreme Court considered and rejected a claim that the Board of House of Fabrics breached its fiduciary duties by failing to disclose a summary of the methodologies used and the ranges of values generated by the financial analyses performed by its financial advisor.
• In McMullin, the Delaware Supreme Court reversed the dismissal of a claim regarding the alleged failure to disclose “the valuation methodologies used by [the fairness opinion provider].”
“In the specific context of this case, an answer to the complaint, discovery and a trial may all be necessary to develop a complete factual record before deciding whether, as a matter of law, the Chemical Directors breached their duty to disclose all material facts to the minority shareholders.” McMullin, 765 A.2d at 925-26.
• Arguably, there is no inconsistency between the Skeen and McMullin – McMullin did not hold that the disclosure of the methodologies used was per se material, only that further proceedings were required to determine materiality. In addition, requiring disclosure of the methodologies used (McMullin) and requiring a summary of those methodologies and ranges of values generated by those analyses (Skeen) are different things.
• McMullin can also be distinguished on the basis that McMullin involved a controlling stockholder and Skeen did not.
“In a similar context, the Court of Chancery has held the fact that the majority shareholder controls the outcome of the vote on the merger “makes a more compelling case for the application of the recognized disclosure standards.”
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The CTI Court Held that McMullin Did Not Change the Materiality Analysis Required by Skeen
• CTI Molecular Imaging (E.D. Tenn April 26, 2005) (cont.) The Court: “[P]laintiff implicitly argues in its briefs and in oral argument that the Delaware Supreme Court backtracked from the Skeen decision in its decision issued six months later, McMullin, by allowing a plaintiff to proceed to trial on a disclosure claim related to an investment banker’s report. The Court has carefully evaluated both decisions and has carefully considered plaintiff’s argument, but the Court finds that the McMullin decision did not change the Skeen materiality analysis. First of all, the Court in McMullin expressly stated, “We adhere to our holding in Skeen that minority shareholders need not be given all of the financial data they would need if they were making an independent investment determination of fair value. . . [T]he Court in McMullin noted that the facts it faced involving a transaction which was led by a controlling shareholder made it a more compelling case for the application of the recognized disclosure standards. This, not a change in the materiality standard, explains why the McMullin court allowed the plaintiff to proceed with its claim . . . while the Skeen court did not. Using the standards set out in Skeen, the Court therefore finds that the plaintiff here has not shown any indication the investment banker’s report would be inconsistent with or otherwise significantly different from the volumes of information defendants have disclosed regarding the transaction.”
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What Level of Detail is Required for a Fair Summary of a Financial Advisor’s Financial Analyses?
• In re Best Lock – “Delaware courts have held repeatedly that a board need not disclose specific details of the analysis regarding a financial advisor’s opinion. Thus, defendants need not have disclosed the basis for applying a control premium of 15%.” In re Best Lock S’holder Litig., No. 16281-CC 485 A.2d 1057 (Del. Ch. 2001).
• Globis v. Plumtree – “Plaintiff notes the discount rate used in the Present Value of Future Share Price Analysis was not disclosed, arguing it was “especially important because Jefferies had failed to perform a discounted cash flow analysis of the transaction. . . . The Merger Proxy states that Jefferies’ summary of the Present Value of Future Share Price included as part of its calculation a “discount” based on the Capital Asset Pricing Model using the median capital-structure adjusted beta for the public company comparables”. . . Globis has not alleged sufficient facts to support a reasonable inference that the omission of the discount rate was material enough to alter the total mix of information presented to the shareholders. Globis makes no argument for why the omission of the exact rate, when its derivation was disclosed, alters the total mix of information. The omission of a discount rate in this context does not constitute, per se, a disclosure violation.” Plumtree, 2007 WL 4292024 at #12-13, internal annotations omitted).
• But see Steinhardt v. Howard-Anderson (aka Occam) (VC Laster Jan. 24, 2011) – “The second issue that wasn’t discussed this morning, but I think it’s another pretty clean partial disclosure, is the accretion/dilution analysis. It’s an analysis that was in the final book. It’s summarized incompletely and partially in the proxy. You need to give the range. You gave the ranges for all the others, but for some reason, on accretion/dilution, you just said accretive or not accretive. So that’s an incomplete summary. Stockholders are entitled to a fair summary.” Steinhardt v. Howard-Anderson, C.A. No. 5878-VCL (Del. Ch. Jan. 24, 2011).
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Recent Decisions Regarding the Level of Detail
Compare:
• Turberg v. Arcsight, CA No. 5821 VCL (VC Laster 2011) Hearing Transcript Sept. 20, 2011 – In contrast to Openlane, in Arcsight, the Delaware Court of Chancery approved a settlement, including an award of $500,000 in plaintiff’s attorneys’ fees, where the supplemental disclosure obtained by plaintiffs largely consisted of additional disclosure regarding certain observed trading and transaction multiples that were in the discussion materials provided to the board by the company’s financial advisor but were omitted from the first draft of the merger proxy filed with the SEC. It appears that the primary differences were the supplemental disclosure of the implied multiples for each of the selected companies and transactions rather than just the selected ranges of multiples applied by the financial advisor based on that analysis as well as the supplemental disclosure of 2010 Revenue and earnings multiples and 2010 and 2011E EBITDA multiples rather than just 2011E Revenue and earnings multiples; and
• In re Openlane, Inc. S’holders Litig., CA No. 6849-VCN ( VC Noble Sept. 30, 2011) – In Openlane the Delaware Court of Chancery refused to an enjoin a transaction where it was alleged that the merger proxy did not contain a fair summary of the work performed by Openlane’s financial advisors because it lacked sufficient detail, including the identity and financial metrics of the underlying transactions. “This level of detail is simply not necessary for the directors to fulfill their duty to provide a “fair summary.” The Supplemental Proxy explains the methodology Montgomery employed and the resulting multiples. Providing details of all of the underlying transactions analyzed would likely inundate the reader and dilute the impact of the disclosure; further, these details are more akin to what is needed to make “an independent determination of fair value” than they are to a “fair summary.”’ (emphasis added); and
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Recent Decisions Regarding the Level of Detail
• See also In re Micronetics, CA No. 7276-VCP (Del. Ch. July 24, 2012) (Hearing transcript)
“For the sake of completeness, I address briefly the third category of alleged disclosure violations, which relate to the financial analysis performed by Cypress and disclosed in the proxy in connection with the basis for its favorable fairness opinion.
In Skeen v. Jo-Ann Stores, Inc., the Delaware Supreme Court specifically addressed the level of detail required of an investment bank's fairness opinion. The plaintiffs sought, among other things, "a summary of the methodologies used and ranges of values generated by the investment bank in reaching its fairness opinion," arguing that this added financial data is material because it would help stockholders evaluate whether they should pursue an appraisal.
The Supreme Court determined, however, that such information simply was not material where, as also appears to be the case here - and this is a block quote -- "The complaint alleges no facts suggesting that the undisclosed information is inconsistent with, or otherwise significantly differs from, the disclosed information. We agree that a stockholder ... should be given financial information about the company that will be material to its decision. In this case, however, the basic financial data were disclosed and appellants failed to allege any facts indicating that the omitted information was material.“
Against this controlling precedent from the Supreme Court, plaintiffs cite a transcript from one of Vice Chancellor Laster's recent cases involving the award of attorneys' fees in the context of a settlement, in which he suggested that companies should disclose the same level of financial analysis that the investment bank provides to the board of directors. While that statement may reflect best practices and have supported the decision reached by Vice Chancellor Laster in that particular case -- and the case was Turberg v. ArcSight, September 20, 2011 - it does not relieve plaintiffs of their burden under Skeen and similarly controlling precedents to indicate in the complaint why the omitted information is material. . . . To the extent plaintiffs argued at yesterday's hearing that the missing information is the range of market multiples that the company's investment adviser, Cypress, selected for the company -- that is, for Micronetics -- in connection with its comparable companies analysis, for example, 8 that argument is without merit.”
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Recent Decisions Regarding the Level of Detail
See also:
• In re Ness Technologies (VC Noble Aug 3, 2011) – “the Plaintiffs seek additional details regarding the financial advisors’ analyses such as the reasons why different companies were selected for each advisor’s comparable company analysis or information regarding how the advisors arrived at the multiples they used for those comparable companies. Again, the Preliminary Proxy provides shareholders with fair summaries of the financial advisors’ work, and the Plaintiffs have not shown that additional detail would be material to shareholders.” In re Ness Tech. Inc., S’holders Litig, CA No. 6569-VCN (Del. Ch. Aug 3, 2011).
• In re Sauer-Danfoss S’holders Litig. (VC Laster Apr. 29, 2011) - "The original Schedule 14D-9 disclosed the multiples the banker selected for the discounted cash flow analysis, and both the original Schedule 14D-9 and the original Schedule 13E-3 disclosed the multiples implied by the companies deemed comparable for purposes of the comparable companies transaction. The summary of the discounted cash flow analysis did not mislead stockholders into thinking that the discounted cash flow analysis’s exit multiple range was derived from the comparable companies. It was obvious from the disclosures that the bankers exercised their subjective judgment. The additional information (i.e., that “Lazard used an EBITDA exit multiple range of 6.0x to 7.5x based on the long-term EBITDA trading multiple averages for the Company”) was immaterial.“ In re Sauer-Danfoss S’holders Litig., No. 5162-VCL 2011 WL 2519210 (Del. Ch. Apr. 29, 2011).
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Conclusion Kevin Miller
(212) 210-9520
Steven M. Haas
(804) 788-7217
Blake Rohrbacher
(302) 651-7847
The views and opinions expressed in these slides and the accompanying discussion are of the applicable individual presenters only and not necessarily those of the other presenters or any of their firms, partners or clients. Nothing in the discussion or the slides constitutes legal advice or shall be deemed to create any attorney-client relationship. These slides may constitute marketing materials in certain jurisdictions.