A defence of disclosure-based settlements in US M&A litigation

February 2013 | PROFESSIONAL INSIGHT | LITIGATION & DISPUTE RESOLUTION

Financier Worldwide Magazine

For the past several years, mergers and acquisitions (M&A) litigation in the US has increased dramatically, both in terms of the number of suits filed and as a percentage of overall securities litigation. While there is debate about the causes of the increase, its implications are clear: M&A litigation has become a significant risk management concern for publicly traded companies. M&A litigation, once viewed as a fairly low risk proposition by directors and officers liability insurance carriers, is now increasingly regarded as a risk similar to traditional securities fraud litigation. Unsurprisingly, M&A litigation has also come under fire from some in the business community who argue that M&A lawsuits serve primarily to enrich plaintiffs’ attorneys, while providing few real benefits to the shareholders on whose behalf they are filed. Particularly, critics single out disclosure-based M&A settlements as examples of waste. While this position is understandable, given the difficulty M&A litigation can create for corporations, it fails to take into account both the direct and systemic benefits that such disclosures provide to shareholders.

Under the corporate law of the vast majority of US states, directors owe a fiduciary duty of candour to shareholders. Accordingly, when a corporation’s board approves the sale of the corporation, it must provide all of the material facts underlying the transaction to the shareholders.

However, corporations are inherently – and understandably – averse to disclosure. In business, information is money. The most successful firms are those that excel in aggregating and synthesising information about their markets, while protecting their information from competitors. Laying bare the internal workings of the corporate decision-making process, and the data on which it is based, cuts deeply against the ingrained corporate tendency toward secrecy. As a result, the target company in a merger often releases a proxy that fails to give shareholders a complete and accurate picture of the proposed transaction. This creates a serious problem for shareholders, who are thus unable to make an informed decision on whether to support the deal.

Disclosure-based settlements provide a vital remedy to this problem by filling in the gaps in corporate disclosures in several areas.

Supplemental disclosures often include information about the board’s decision-making process in evaluating the initial offer, appointing an independent transaction committee to oversee the sale of the company, seeking alternate bids, and negotiating the terms of the final deal with the successful suitor. Without full material disclosures in this area, shareholders cannot know whether the board made all reasonable efforts to secure maximum shareholder value. Such process-based disclosures are particularly important in the many states that recognise so-called ‘Revlon duties’, i.e., affirmative fiduciary obligations to secure the best possible price in a change-of-control transaction. (See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986)).

Supplemental disclosures may also include information on potential conflicts of interest affecting the board of the target company. Such potential conflicts include deferred stock benefits or other compensation triggered by a change of control, ‘golden parachute’ severance packages for directors who also serve as corporate officers, the promise of a board membership or employment with the surviving company, and any other benefit board members will receive from the merger that is not available to general shareholders. Another important type of conflict disclosure involves information about relationships among the target company and acquiring company, their board members, their financial advisers, and any other major party with a vested interest in seeing the transaction consummated. Full material disclosure in these areas is crucial because, without it, shareholders cannot fairly evaluate whether the board’s decision to approve the transaction was disinterested. Full material disclosure of potential conflicts involving the company’s financial adviser is also essential because such conflicts have the potential to taint the advisor’s fairness opinion.

Finally, supplemental disclosures often include increased information underlying the financial advisers’ fairness opinions themselves. In formulating its opinion, the financial adviser appraises the value of the target company, compares the financial terms of the proposed transaction to those of similar deals, and, where applicable, evaluates potential synergies arising from the transaction. Without full material disclosure of the projections and assumptions underlying the financial adviser’s fairness opinion, the shareholders cannot know whether the proposed merger consideration provides adequate value. Disclosures in this area can be harder to obtain than in others. The financial advisers are third-party firms – often large investment banks – with their own interests in safeguarding their processes and techniques from prying eyes. Therefore, obtaining supplemental financial disclosures often means fighting a two-front battle, against both the target company and the financial adviser.

Not only do supplemental disclosures provide necessary information to the shareholders of the target company in a particular deal, they have systemic benefits to shareholders of public companies across the board, and may even benefit corporations themselves.

As M&A litigation exerts constant pressure in favour of increased disclosures, rational target corporations can be expected to provide increasingly comprehensive initial disclosures to shareholders. This approach is a rational course because it may reduce settlement costs by decreasing the magnitude of disclosures attributable to litigation challenging the merger (thus reducing attorneys’ fee awards) or may avoid such litigation completely. This trend toward better initial disclosures is a public good enjoyed by shareholders generally.

Disclosure-based settlements may also benefit corporations by providing valuable information as to what their proxies should contain. In order to form the basis for a settlement, disclosures must be material, meaning that “there is a substantial likelihood that a reasonable shareholder would consider [them] important in deciding how to vote.” (Arnold v. Soc’y for Sav. Bancorp, Inc., 650 A.2d 1270, 1277 (Del. 1994)). Courts must evaluate the materiality of disclosures even in cases ending in a voluntary settlement. Thus, as M&A litigation proliferates, corporations have the benefit of an ever-expanding body of case law defining the materiality of disclosures. This provides directors with valuable guidance for ‘getting it right the first time’ by including all material disclosures in the initial proxy.

Robert O. Wilson is an associate at Finkelstein Thompson LLP. He can be contacted on +1 (202) 337 8000 or by email: rwilson@finkelsteinthompson.com.

Robert O. Wilson

Finkelstein Thompson LLP