M&A Litigation Goes Federal

It used to be routine for law firms to file litigation against parties to M&A transactions, alleging among other things inadequate disclosure of material facts and unfair compensation to equity holders of the acquired party.  Many of these suits were lacking in substance and, of course, many ended up in Delaware State Courts by definition.  A “settlement” between plaintiffs’ attorneys and the companies would result in the provision of some additional disclosure, typically of little value to target shareholders, and the only cash compensation would come by way of the extraction of legal fees in favor of plaintiffs’ counsel. 

Companies were relatively anxious to enter into these settlements, paying small sums of money in exchange for a judgment which protected them from future substantive litigation based on actual corporate improprieties.  In a way, merger partners were purchasing future anti-litigation insurance for short dollars.

The Delaware Supreme Court, in a widely reported 2016 decision, put a clamp on this practice by noting in fact that many of these settlements were useless to shareholders and, therefore, not worthy of compensation of lawyers.

Lawyers, being ingenious, have started to bring these claims in Federal Court.  Federal judges, spread all through the United States, do not have experience with such matters.  They do not necessarily follow the Delaware lead.  There has been an incredible proliferation in Federal litigation of this sort.  Many transactions were challenged in multiple jurisdictions.  One law firm was reported, through approximately the end of September, 2019, as having filed 163 complaints in Federal District Courts opposing mergers, alleging inadequate disclosure in all but one of these filings.

One might expect that Federal Courts will end up where Delaware ended up for the same reasons of administration of justice.  However, no one has a fix on the timeline.

Easier IPOs

Today the SEC announced an amendment, effective in about two months, of regulations that will allow all companies to “test the waters” for an IPO without risking violation of the Securities Act. The original regulation allowed emerging companies (as defined) to speak to certain qualified investors (large and sophisticated, as defined) to test the market by asking potential investors as to their level of interest in an IPO that was going to be filed or had just recently been filed. Absent this regulation, such contact in most instances violated Section 5 of the ’33 Act as a solicitation of investment without an effective Registration Statement. The purpose was to jump-start investment in emerging companies.

The expanded regulation makes this “testing the waters” approach open to all companies regardless of size or stage of development, again designed to foster greater use of the Federal securities registration system. Why now?

You no doubt have observed that many large and successful companies, indeed some unicorns, have remained privately held. And, helped by registration relaxation under the ’34 Act, these companies could grow, have many shareholders, permit some trading of their securities, all without ever having to become subject to Federal registration and disclosure and governance control under any Federal law. This resulted in a decline in IPOs. This decline was thought to be to the detriment of the regulated trading markets. The SEC has taken this new action in order to increase “the likelihood of successful public securities offerings,” according to SEC Chair Jay Clayton.

Reg BI Under RIA Atack

Last week I posted that eight States had sued the SEC over the allegedly weak content of the SEC Regulation BI that set fiduciary standards for registered investment advisers and something a bit less robust (and more confusing perhaps) for registered broker dealers.

It seems that a couple of registered investment advisers also have sued the SEC on September 10, making similar complaint that the SEC lacked authority to issue BI and its related confusing interpretive release. The suit notes that the SEC in so acting had ignored the recommendations of the SEC staff.

An observation: I don’t think BI is confusing, and I think it is made more user-friendly by the release. The real point here is not that people are confused; the real point is that many people do not like the regulatory bottom line.

The twists and turns of these suits are beyond the scope of mere blog posts, but the point generally is that lots of people are unhappy with BI, complaining that brokers are getting a skate. As of now BI stands and becomes effective for brokers the first of next year, and its implementation has not (yet) been enjoined. I bet all brokerages are gearing up for BI compliance, including extensive disclosure requirements; who can take the risk of being in SEC violation?

I am getting tired of saying, as to this subject, “stay tuned.”

I’ve Been Thinking Transit…

Why does the Mass Transit Authority, that runs public transit, have a fleet of new vehicles with ID numbers that run into the 900s? Don’t these people believe in mass transit?

Why are twenty or so of these cars parked on High Street in Boston every morning, in front of the operations center? Being used for commuting?

Why do conductors on my commuter rail trains fail to punch my ticket more than a third of the time?

Why did it take 30 minutes by subway one day last week, after rush hour, to travel the Green Line from Hynes Auditorium to Park Street (I think it is 3 miles, maybe less)?

When will life science and tech companies stop coming to Boston, where transportation is totally broken?

Don’t people see that broken transit encourages young high earners to live in the city, driving up rents and driving out the middle class?

Why did the city encourage this trend by allowing incredible density in the new Waterfront, spending money to increase the problems of both transit and wealth disparity?

Do you agree with me that a walk through the new Waterfront’s back streets gives one the creeps as the buildings seem to close in on you in dark menace?

Why are we seizing on bike lanes as a solution, allowing a very small number of people who bike, and only in good weather, to take up road space and thus constrict auto, commercial and bus traffic that involves delay for a vastly greater number of people? (Being “green” should not require ignoring unintended consequences. Btw, I love biking but the point here is not anti-biking, it is solving commutation issues.)

Why does Keolis do so much better a job running parts of the French transportation network than the Boston system?

Why can’t we drop a big pipe in the harbor and run a shuttle track between North and South Stations, like the NYC link between Times Square and Grand Central (they built that without even the benefit of an ocean route, right under the busiest streets in the world)?

CEOs: It’s All About Culture

CEOs of some of Boston’s leading corporations (IDG, Hancock, Boston Scientific and State Street) were unanimous in agreeing that the major issue for management, and boards of directors, is establishing and maintaining the culture of the enterprise.

At a Boston breakfast meeting last week convened by the National Association of Corporate Directors – New England Chapter, CEOs discussed their methodology for establishing a culture throughout a company with numerous employees in different locations, or indeed different countries.  The methods for communicating corporate culture were numerous, and many companies adopted many of them.  Some CEOs regularly communicate with everybody about what they themselves are doing on a given day (whether it is work-related or personal-related, as personal values matter).  But one major theme was to carefully pick the next tier of executives to be “innovators” and not “managers.”

In the context of constant technological change, the recent statement of the Business RoundTable, calling upon corporations to consider not just profit but also impact on people and communities and the world, takes on relevance.  There is an art to balancing current return to investors against societal results.  Those societal results are important to long-term of viability, and particularly important in attracting and retaining a generation of employees deeply interested in ESG factors.

One speaker, Mohamad Ali, former President of Carbonite and newly installed CEO of worldwide company IDG, made reference to those things which one might predict a CEO should be concerned with:  trade wars.  He believes that over time significant impairment of profitability will occur by their continuation.

Other major issues:  integrating women into the workforce by overcoming reticence (based on fear they lack the necessary tools), to “take a chance” and reach for more senior positions; and,  as workforces will require greater skills, companies cannot afford to tell people to “go away and when you obtain the necessary skills come back to us” (companies must themselves undertake that training).

There was discussion of European and California laws on maintaining data privacy.  The younger generation has less concern for data privacy, but privacy in the long run is absolutely necessary.  The problem is with Congress, which does not have an understanding of the issue; what is needed is a uniform law throughout the United States so as to avoid inconsistent regulations, such as the new California data privacy statute.

Private Capital vs IPOs

Fascinating hearing Thursday at the SEC, a discussion of whether easing private capital formation as a matter of regulatory law had the consequence of unfairly excluding the “retail customer” from access to great investment deals.

Trends: drop in IPOs, 2018 private capital raises were twice IPO proceeds; Jobs Act changed registration requirements under the ’34 Act allowing large widely held companies to remain private just about forever, with no public information available; retail customers cannot participate in private capital raises unless they are both “accredited” (a modest definition of wealth) and connected enough to get private deal access.

At the hearing, the sub-text was: is it wise, or unfair, to exclude the retail investor from the deals where most of the US growth capital is being invested?

The hearing reveals the pendulum of thinking on this issue. For some time, it was thought that retail investors were too poor or too dumb to invest in innovative companies, so the regulations excluded them and liberalized the rules allowing rich sophisticated investors or robust funds or strategics to make those investments with minimum regulation and disclosure (even barring State regulators from over-riding the Federal policy). Guess what: it worked. Retail investors were boxed out and “smart money” flowed to private deals.

This offended one’s sense of democracy–why do only the rich get in on the great deals (ignoring the statistics that indicate that very many private deals are really bad investments for those without great financial resiliance)? Not surprisingly, AOC was asking questions at this hearing.

Many speakers thus urged opening the rules to permit retail investors access into private deals. But this is of course contrary to a fundamental historical SEC mission, which was to not allow retail investors to invest in high risk without there being protections and robust disclosure. If new regulations open private capital deals to retail investors, will that in turn drive the SEC to insist on protections, full disclosure, the panoply of inhibitors to capital formation that gave birth to private capital to begin with?

Stay tuned and look for deja vu all over again….

States Sue SEC Over Broker Regulations

Just one week ago I posted a link to my current article on SEC amendments to the regulations defining the duties of investment advisers and brokers to the investing public, and noted controversy about the alleged deficiencies in the treatment of brokers asserted by critics.

Today’s press references a suit in New York Federal Court filed yesterday by eight state attorneys general seeking to void entirely the SEC standards for brokers. The grounds are technical: noncompliance with the statute that requires certain steps be taken by US agencies to amend their regulations. It is asserted that the 2010 Dodd Frank Act does not permit brokers to enjoy lesser fiduciary duties than investment advisers. Aside from New York, the other plaintiff states include California and Delaware (although not Massachusetts).

To this point, the SEC has not answered the complaint; far too soon. This suit will be a long one, and is the tip of the iceberg relative to this volatile issue.

Non-Opportunity Zones?

I am back in action, and posting, following an August “on the road.”  (Please hold your applause.) 

Summer reading and recent press indicates that the 2017 Jobs Act, which created tax advantages for investments in low income communities (“opportunities zones”) would spur job creation, new businesses and employment.  It was thought among other things that investments in these zones would foster much needed housing for the indigenous low income population.

Recent magazine press has pointed out that almost all the money that has flowed into opportunity zones, instead of fulfilling this promise, has gone into building housing, with high-end amenities, for wealthier owners or tenants.  A recent magazine article noted that the people most benefitted by opportunities zone investment were the Trumps, Kushners and LeFraks of the world. 

An interesting side note from the OPAL Wealth Management Conference held in Newport late this July:  there was a great deal of interest in opportunity zones, with promoters seeking funding from high-asset family and group family offices.

What is happening may well be an unintended consequence.  Even negative press coverage has not suggested that the 2017 Act was cleverly designed just to boost the top 1%.  However, the law of unintended consequences may be striking yet again. 

Broker/Adviser Duties Altered

The SEC this summer altered the legal obligations of brokers and investment advisers. If you invest, you should care about the groundrules that these professionals owe you. There is controversy as to whether you are now better or worse protected after the SEC actions. See https://www.duanemorris.com/articles/brokers_investment_advisors_in_your_best_interest_0819.html for my August article attempting to decipher what the SEC thought it was doing.


There are reported to be 134 funds seeking to operate in the opportunity zone space, and about 80% of these are headed by people who have never run a fund before.

There was critical analysis of these investments.  Your money is locked up for ten years.  The advantage is that after ten years there is no capital gains on your profits but meanwhile you have no liquidity.  You still have a risk of achieving successful development, and the target yield was variously described as 9%, 9% to 12%, 14%, plus “300 basis points” for the value of the ultimate tax shelter.

There was no discussion of investing in companies (which is possible), only in real estate.  The expert panel thought that vertically integrated realty developers (who could put together the package of land, build the property and manage it) would be the safest bet.

The bottom line is that this is viewed as a long-term and safe cash flow play with no liquidity; it should not be entered into just by reason of the tax deferral but rather as a way to get a recurring and safer yield.

[This is the final post in the series based on discussion at the OPAL family office conference in Newport, Rhode Island held in late July.]