Financial Advisors in MA Transactions (PLI Trends) - 1-11-16

Copyright 2015©
Financial Advisors in M&A Transactions
Issues and Considerations
Practising Law Institute Seminar
Mergers & Acquisitions 2016: Trends and Developments
January 14-15, 2016
Barbara L. Becker
Gibson, Dunn & Crutcher LLP
New York, NY
Kevin Miller
Alston & Bird LLP
New York, NY
David M. Schwartzbaum
Greenberg Traurig, LLP
New York, NY

- 2 - Copyright 2015©
Topics
 The role of financial advisors
 Potential implications of Corwin v. KKR Financial Holdings
 Identification and disclosure of investment bank/financial advisor relationships and
actual and potential conflicts of interest
 “Documenting the Deal” - What lawyers and investment bankers can do to reduce
litigation risk
 Issues regarding financial projections in M&A transactions

The role of financial advisors
“[O]ur holding is a narrow one that should not be read expansively to suggest that any
failure on the part of a financial advisor to prevent directors from breaching their duty of
care gives rise to a claim for aiding and abetting a breach of the duty of care.191” RBC
Capital Mkts. v. Jervis, No. 140, 2015, (Del. Nov. 30, 2015)
__________
“191 In affirming the principal legal holdings of the trial court, we do not adopt the Court of Chancery’s description
of the role of a financial advisor in M & A transactions. In particular, the trial court observed that ‘[d]irectors
are not expected to have the expertise to determine a corporation’s value for themselves, or to have the time
or ability to design and carryout a sale process. Financial advisors provide these expert services. In doing so,
they function as gatekeepers.’ Rural I, 88 A.3d at 88 (citations omitted). Although this language was dictum, it
merits mention here. The trial court’s description does not adequately take into account the fact that the role
of a financial advisor is primarily contractual in nature, is typically negotiated between sophisticated parties,
and can vary based upon a myriad of factors. Rational and sophisticated parties dealing at arm’s-length
shape their own contractual arrangements and it is for the board, in managing the business and affairs of the
corporation, to determine what services, and on what terms, it will hire a financial advisor to perform in
assisting the board in carrying out its oversight function. The engagement letter typically defines the
parameters of the financial advisor’s relationship and responsibilities with its client.” (emphasis added)

The role of financial advisors (cont’d)
“I think it should be clear to everyone, as I’ve tried to explain to a group of interested
investment bankers, that the Delaware Courts are not interested in a regulatory
scheme that governs the conduct of investment bankers. You should be reminded of
the fact that the prism through which we operate is post-decision scrutiny of director
conduct, so the issue is what do the directors need to know, what have the directors
done or omitted to do, that directly impacts the discharge of their duty of loyalty and
care. So the focus is on the extent to which they make an inquiry or should make an
inquiry of investment bankers before they hire them to be able to rely upon the opinion
of the investment banker. Those cases [Del Monte and El Paso] are not an attempt by
the Delaware Courts to tell investment bankers how they should conduct their
business.” Former Chief Justice Steele at the Penn State/City Bar M&A Institute,
September 2012

The role of financial advisors (cont’d)
So how does the Delaware Supreme Court’s ruling in Rural/Metro fit in?
“The trial court, in a lengthy analysis of aiding and abetting law and tort law, held that if a ‘[i]f the
third party knows that the board is breaching its duty of care and participates in the breach by
misleading the board or creating the informational vacuum, then the third party can be liable for
aiding and abetting.’ We affirm this narrow holding.
“It is the aider and abettor that must act with scienter. The aider and abettor must act ‘knowingly,
intentionally, or with reckless indifference …[;]’ that is, with an ‘illicit state of mind.’ To establish
scienter, the plaintiff must demonstrate that the aider and abettor had ‘actual or constructive
knowledge that their conduct was legally improper.’ Accordingly, the question of whether a
defendant acted with scienter is a factual determination. The trial court found that, ‘[o]n the facts
of this case, RBC acted with the necessary degree of scienter and can be held liable for aiding
and abetting.’ The evidence supports this finding.…
“Here … the claim for aiding and abetting was premised on RBC’s ‘fraud on the Board,’ and that
RBC aided and abetted the Board’s breach of duty where, for RBC’s own motives, it ‘intentionally
duped’ the directors into breaching their duty of care.” RBC Capital Mkts. v. Jervis, No. 140, 2015,
(Del. Nov. 30, 2015)

Potential implications of Corwin v. KKR Financial Holdings
 Potential implications of Corwin v. KKR Financial Holdings, No. 629, 2014 (Del. Oct. 2, 2015)
 “In a well-reasoned opinion, the Court of Chancery held that the business judgment rule is
invoked as the appropriate standard of review for a post-closing damages action when a
merger that is not subject to the entire fairness standard of review has been approved by a
fully informed, uncoerced majority of the disinterested stockholders.… In this decision, we find
that the Chancellor was correct in finding that the voluntary judgment of the disinterested
stockholders to approve the merger invoked the business judgment rule standard of review
and that the plaintiffs’ complaint should be dismissed. For sound policy reasons, Delaware
corporate law has long been reluctant to second-guess the judgment of a disinterested
stockholder majority that determines that a transaction with a party other than a controlling
stockholder is in their best interests.… [W]hen a transaction is not subject to the entire
fairness standard, the long-standing policy of our law has been to avoid the uncertainties and
costs of judicial second-guessing when the disinterested stockholders have had the free and
informed chance to decide on the economic merits of a transaction for themselves. There are
sound reasons for this policy. When the real parties in interest—the disinterested equity
owners—can easily protect themselves at the ballot box by simply voting no, the utility of a
litigation-intrusive standard of review promises more costs to stockholders in the form of
litigation rents and inhibitions on risk-taking than it promises in terms of benefits to them.”

Potential implications of Corwin v. KKR Financial Holdings (cont’d)
 Potential implications of Corwin v. KKR Financial Holdings, No. 629, 2014 (Del. Oct.
2, 2015) (cont’d)
 Query: Does the approval of a merger that is not subject to the entire fairness
standard of review by a fully informed, uncoerced majority of the disinterested
stockholders extinguish all breach of fiduciary duty claims absent waste, or is the
business judgment rule standard of review applicable in such circumstances under
Corwin rebuttable by reasonably conceivable allegations of gross negligence?

Identifying investment bank/financial advisor relationships and actual
and potential conflicts of interest
The Delaware Courts, SEC and FINRA are each concerned about the disclosure of material
relationships between financial advisors and transaction participants.
 The Delaware Courts
 Chief Justice Strine has noted that:
“Banks with the least number of potential conflicts (i.e., boutique banks) are not necessarily the best
advisors for a target company..." http://www.paulhastings.com/publicationdetail.aspx?publicationId=2191.
“[T]here is a difference between the typical conflicts that involve a bank or lawyer working semi-regularly on
engagements for key players, such as private equity firms, and more unusual, more material conflicts.”
(“Documenting the Deal: How Quality Control and Candor Can Improve Boardroom Decision-Making and
Reduce the Litigation Target Zone,” available at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2577356)
 And others have observed that:
“The Delaware courts are undoubtedly cognizant and respectful of the fact that the most effective advisory
services are often rendered by bankers with relationships that run broadly and deeply in the relevant
industry. In general, the courts are not seeking to dictate the choice of adviser, but rather are promoting
transparency and supervision.” http://blogs.law.harvard.edu/corpgov/2012/05/31/delaware-decisions-data-
points-not-doctrine/.

and potential conflicts of interest (cont’d)
 The Delaware Courts (cont’d)
 But VC Laster has recently questioned whether certain relationships may pose a direct,
non-waivable conflict:
“[the Court]: ‘[W]hy isn’t the answer on that that you get the inference that [the Board’s
decision to go forward with PLX’s Financial Advisor as its financial advisor] wasn’t a
decision falling within the range of reasonableness. That means to go forward with [PLX’s
Financial Advisor] having a direct concurrent relationship representing the opposite party to
the deal; that that even might be such a direct conflict that it would be non-contractable. You
at least get that inference at the pleadings stage, which is where we are.…” In re PLX
Technology S’holders Lit., CA No. 9880-VCL (Del. Ch. April 15, 2015) (Transcript of Oral
Argument).

 The Delaware Courts (cont’d)
 See also In re Atheros Commc’ns S’holders Litig., No. 6124-VCN 2011 WL 864928 (Del. Ch.
March 4, 2011) (VC Noble)
“Before shareholders can have confidence in a fairness opinion or rely upon it to an
appropriate extent, the conflicts and arguably perverse incentives that may influence the
financial advisor in the exercise of its judgment and discretion must be fully and fairly
disclosed (emphasis added).” [Discussion topic: Are stockholders entitled to rely upon the
advice of the Company’s financial advisor?]
 The Federal Courts restrict investor claims under the Federal Securities laws based on opinion.
 In re Global Crossing, Ltd. Secs. Litig., 313 F. Supp. 2d 189, 210 (S.D.N.Y. 2003) (“Materially
misleading statements of opinion and belief can be actionable under the securities laws,
where the party offering the opinion misrepresents its true belief, that is, where the opinion or
belief is not truly held.”)
 Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, No. 13–435
(US March 24, 2015) (“a sincere statement of pure opinion is not an ‘untrue statement of
material fact,’ regardless whether an investor can ultimately prove the belief wrong.” To be
actionable under Section 11 as an affirmative misstatement, plaintiffs must allege that the
speaker did not truly hold the stated opinion.)

 The Securities and Exchange Commission and FINRA
 Item 1015(b)(4) Regulation M-A promulgated under the Securities Exchange Act of 1934, as
amended, generally requires disclosure in merger proxies and certain other filings
disseminated to stockholders of companies with registered equity securities in connection with
M&A transactions of:
 “any material relationship that existed during the past two years or is mutually understood to be
contemplated and any compensation received or to be received as a result of the relationship between (i)
The outside party, its affiliates, and/or unaffiliated representative; and (ii) The subject company or its
affiliates …” (emphasis added)
 FINRA Rule 5150(a) requires FINRA members to include disclosure in publicly disclosed
fairness opinions regarding:
 “any material relationships that existed during the past two years or that are mutually understood to be
contemplated in which any compensation was received or is intended to be received as a result of the
relationship between the member and any party to the transaction that is the subject of the fairness
opinion” (emphasis added)
Note: Differences in timing and scope of SEC and FINRA disclosure rules

Disclosure of material relationships and actual and potential conflicts of interest has received
increased attention given the recent rise in aiding and abetting breach of fiduciary duty claims
based in whole or in part on alleged inadequate disclosure of material relationships and conflicts
to the board.

 When and how to disclose relationships/actual and potential conflicts of interest:
 Outset of engagement (e.g., single bidder process)
 Once limited number of likely buyers identified
 Prior to management presentations or second round of bids (e.g., if broad auction)
 How to disclose to the board:
 Verbally
 Evidentiary concerns if recollections differ
 Writing
 Creates contemporaneous written record
 Where to disclose:
 Engagement letter - See forthcoming “Financial Advisor Engagement Letters: Post-
Rural/Metro Thoughts and Observations” by E. Klinger-Wilensky and N. Emeritz at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2604250
 Memo to Board of Directors
 Board book

 Examples of what may need to be disclosed:
 Investment or ownership interests in parties (e.g., Simonetti, El Paso, Amerigroup)
 Both financial advisor and senior deal team members
 Prior, contemporaneous and future relationships with potential buyers (e.g., PLX, Dole Food,
Art Technology, Del Monte, Zenith)
 How far back and how much information (types of services and fees) – summary/aggregate v. deal-by-
deal?
 What about confidential/material non-public information re: current/future mandates?
 Attempts to market the company prior to engagement or w/o board authorization (e.g., Zale,
Rural/Metro, Del Monte) - Pitches v. ordinary course marketing based on publicly available
info?
 Ulterior motives (e.g., Rural/Metro)

“Documenting the Deal”: What lawyers and investment bankers can do
to reduce litigation risk
 In “Documenting the Deal: How Quality Control and Candor Can Improve Boardroom
Decision-Making and Reduce the Litigation Target Zone,” Chief Justice Strine
suggests ways to minimize litigation risks in the M&A process (available at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2577356):
 “[T]he focus of my remarks is on what you can do as legal and financial advisors to
conduct an M & A process in a manner that: i) promotes making better decisions; ii)
reduces conflicts of interests and addresses those that exist more effectively; iii)
more accurately records what happened so that you and your clients will be able to
recount events in approximately the same way; and iv) as a result, reduces the
target zone for your favorite plaintiffs’ lawyers.”

to reduce litigation risk (cont’d)
 Boards need to:
 Create a sufficiently detailed contemporaneous written record:
“Despite having the ability to write the play, too many advisors leave out critical parts of the
story line, depriving their clients of reliable memory aids in situations where they may be
unable to accurately recollect the reasons for decisions they made.”
 Consider implications of material relationships between prospective financial
advisors and potential counterparties and other interested parties (which may
include management):
“If conflicts were surfaced, contained, and addressed, and a strong hand was given to the
impartial members of the board, the plaintiffs’ ability to suggest that those conflicts infected the
why [certain decisions were made] is impaired. It will therefore be more difficult for the
plaintiffs to get the deal enjoined or to press a damages case.”

 Boards need to (cont’d):
 Understand proposed process, available alternatives and their potential
implications:
“If and when a decision to explore a sale is made, it should be made by the board.”
“For starters, by hearing from several qualified financial advisors seeking to be retained, the
independent directors begin the necessary deepening of their knowledge base in a context
when they may need to counter management. For another, it is important that the independent
directors—in a situation when they have not made sure that the company’s regular financial
advisor owes its retention and tenure to the independent board majority and not management,
and when they must therefore hire another financial advisor—seek out the best and not go
with a singular recommendation of management.”
“[A] special or transactional committee is often empowered to make the key decisions about
how many potential buyers and what kind to solicit in the process, when it is the right time to
reduce that number down to a smaller group of final bidders, how to generate competition
among the bidders, and whether and on what terms management may talk to buyers who may
wish to keep them after a deal.”

 Take appropriate steps to document revised approach/process if bids do not match
expectations, establishing a record that:
“The objective factors that various bidders had raised in due diligence were considered and
presented. Those factors came from the finalists and others, and were consistent in theme.
Management conceded these factors were legitimate weaknesses and the financial advisors
confirmed that the concerns seemed to be genuine because they emerged from many buyers.
“The directors and their advisors then reevaluated whether to sell in light of current information
and the fact that the price was less than was earlier thought achievable. The directors also
evaluated whether to go back to bidders who had been excluded. The directors received
advice that those bidders were unlikely to maintain their previous price levels, because they
would have the same concerns as the final bidders. The financial advisor and management
also reported that the final bidders were waning in interest, and that two of them indicated they
would drop out if they could not partner with someone else.”
“If key financial assumptions, such as base case projections, need to be revised, the reasons
why should be made clear.…”

 Understand discussion materials (“Board books”) prepared by financial advisors:
“If, by way of example, management updated the cash flow estimates, that should be noted, and the
reasons for the adjustment made clear as part of the record. If an important valuation input has been
altered, that should be flagged and explained.”
“When the board met again, it received a revised financial presentation. The board asked tough
questions.…”

 Creating a sufficiently detailed contemporaneous written record:
“[T]he best documentation process builds on itself. If early in the process, board
books and minutes are produced in an accurate and complete way, the board will be
able to go over its steps again more accurately, assess whether it made any errors,
and consider what to do about them. This can involve going over the bidder pool, the
reasons for inclusion and exclusion, and whether they are still relevant. This can
involve going over the evolution in the financial assumptions that management and
the financial advisor were using, to ensure that any changes were principled and
based on objective factors untainted by self-interest.”

 Creating a sufficiently detailed contemporaneous written record (cont’d)
 Board meeting minutes
 Who should take the board meeting minutes?
 Level of detail
 Old style (e.g., “a variety of matters were discussed…”)
 Transcript (e.g., recording what each person said)
 Modern minutes (e.g., summary of specific issues and information discussed and decisions/conclusions reached)
 Who should review
 Board, legal counsel, financial advisors v. others (e.g., who weren’t at the meeting)
 Timing
 Preparation of minutes, review of minutes, approval of minutes
Note – How and why do board minutes differ from the description of the “Background of the
Merger” summarized in the Proxy?

 Directors should not be complacent:
“Instead of pressing management for answers and learning the company’s
business deeply, directors sometimes act more like well-mannered season
ticketholders to a stylized interactive theatre, in which performing managers
shepherd the audience through ritualized plays, listen to management give set
piece reports, ask a few brief questions so as not to disrupt the actors’ timing, and
complete a series of management-driven acts, often written not in the blunt, earthy
style of an Arthur Miller, but in the opaque, high-falutin style of a jejune drama
student in a Master of Fine Arts program.”
 Board books (i.e., discussion materials prepared by financial advisors)
 Ask questions if analysis not clear
 Ask questions regarding underlying assumptions
 Ask questions regarding alternative approaches

 Board books (i.e., discussion materials prepared by financial advisors) (cont’d)
 Longitudinal changes
 Chief Justice Strine advocates blacklining v. prior Board book
 Many banks identify key changes (assumptions, inputs, etc.) in Board books
 Changes to management projections
 Changes to selected companies and transactions used for comparative purposes
 Changes to discount rate calculation, including methodology and inputs
 Changes to selected multiple range
 Changes identified in footnotes and/or separate “longitudinal change” pages

Issues regarding financial projections in M&A Transactions
 How and why are projections prepared and by whom?
 Transaction specific v. management compensation targets v. for purposes of negotiating
covenants in loan agreements
 What is the role of the board and company counsel in supervising the preparation and
approval of projections in an M&A process?
 Fox v. CDX Holdings, CA No. 8031-VCL (Del. Ch. July 28, 2015)
“During a sales process, a company may provide optimistic or bullish projections to bidders, even
‘extremely optimistic valuation scenarios for potential buyers in order to induce favorable bids.’16 There is
an important line, however, between responsibly aggressive projections and outright falsehoods: ‘Pushing
an optimistic scenario on a potential buyer is to be expected; shoveling pure blarney at that stage is
another.’ Pennaco Energy, 787 A.2d at 713. ‘An optimistic prediction regarding a company’s future
prospects’ may rise to the level of a ‘falsehood’ if accompanied by ‘evidence that it was not made in good
faith (i.e., not genuinely believed to be true) or that there was no reasonable foundation for the
prediction.’”
___________
16 In re Pennaco Energy, Inc., 787 A.2d 691, 713 (Del. Ch. 2001) (Strine, V.C.) (citations and internal quotation marks
omitted); see also In re Topps Co. S’holders Litig., 926 A.2d 58, 76 (Del. Ch. 2007) (Strine, V.C.) (“[O]ne of the tasks of a
diligent sell-side advisor is to present a responsibly aggressive set of future assumptions to buyers, in order to extract
high bids.”).

Issues regarding financial projections in M&A Transactions (cont’d)
 Dealing with changes to management projections
 What if prior projections are deemed unrealistic (independently or as a result of
buyer feedback)?
 Early v. late in sale process
 “The objective factors that various bidders had raised in due diligence were considered and
presented. Those factors came from the finalists and others, and were consistent in theme.
Management conceded these factors were legitimate weaknesses and the financial
advisors confirmed that the concerns seemed to be genuine because they emerged from
many buyers.” CJ Strine, “Documenting the Deal: How Quality Control and Candor Can
Improve Boardroom Decision-Making and Reduce the Litigation Target Zone,” available at:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2577356

 Dealing with changes to management projections (cont’d)
 What if projections are updated during a sale process to reflect actual results or
changes in prospects?
 “If key financial assumptions, such as base case projections need to be revised, the
reasons why should be made clear.…” CJ Strine, “Documenting the Deal: How Quality
Control and Candor Can Improve Boardroom Decision-Making and Reduce the Litigation
Target Zone,” available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2577356
 What should a buyer be told and when?
 What if a board/special committee or a financial advisor has reservations regarding:
 Management’s projections?
 Counterparty’s projections?

 Avoiding disputes regarding the projections financial advisors were authorized to rely
on.
 Criteria for determining when to press for buyer projections?
 Under what circumstances can you consider relying on publicly available analyst
estimates in lieu of internal management projections?
 How should multiple projections cases be considered by the board/special committee
and financial advisors?
 What if management cannot or will not identify a single set of projections
representing its best estimates as to the future financial performance of the
company?
 Is there a difference between “Cases” and “Sensitivities”?

 Federal v. Delaware disclosure regimes (cont’d)
 Delaware law
 Maric Capital Masterfund. v. Plato Learning., 11 A.3d 1175, 1178 (Del. Ch. 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.”
 Dent v. Ramtron, CA No. 7950-VCP (Del. Ch. Nov. 19, 2012) 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.”
 Nguyen v. Barrett, CA No. 11511-VCG (VC Glasscock Oct. 8, 2015) “Our case law provides
that, where the bankers derive unlevered, after-tax free cash flows rather than relying on
management projections, the inputs on which they rely are not per se subject to disclosure.
As this Court has previously noted, ‘a disclosure that does not include all financial data
needed to make an independent determination of fair value is not per se misleading or
omitting a material fact.’”

 Federal v. Delaware disclosure regimes
 Example of SEC Staff Comment - May 21, 2015 - Re: Horizon Bancorp
Registration Statement on Form S-4 Filed May 5, 2015, File No. 333-203868
“We note that senior management of both Horizon and Peoples Bancorp provided
financial projections to their respective financial advisors. Please disclose two years
of any material projections or other material non-public information, including
revenue, income, and income per share provided by Horizon to either Peoples
Bancorp or its financial advisor. Similarly, please revise this section to disclose any
projections or other material non-public information provided by Peoples Bancorp to
Horizon or its financial advisors.”

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