Rep Insurance in Acquisitions

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A growing practice is for either a buyer or a seller of a company to insure the risk that there is a misstated warranty or representation in the acquisition documentation which triggers an obligation of the seller(s) to compensate the buyer for the damages arising from such misstatement.  This product offering has become more prevalent recently, as it facilitates reaching a deal rather than getting hung up on sorting out liability for unintentional misstatements.

As these policies have become more common, confusion has arisen about how efficacious they are.  This breaks into two inquiries: first, do they pay off or are the mechanics of proving a claim too arcane; second, just what is being insured against.

AIG, a major insurer in this space, has shared some experience about claims payment; seems almost 20% of all policies actually pay off with an average payment of about $4Millon; most claims arise in deals from $100M to $1B.  Most typical payments relate to misstated financials, tax obligations, legal compliance or contents of material contracts.

As to what is covered, that is really incredibly simple: these policies are widely varied and you have to read them carefully.  Law firms often say you need a lawyer to read them, and surely lawfirms can do this work and can pick up some difficult areas.  But there is no reason why any businesspeople cannot read the coverages and exclusions for themselves. For example,  all exclude active fraud and illegality, projections and matters in fact known to the insured party (typically but not always the buyer).

Areas where coverages vary, aside from amounts and premiums of course: the period of time in which a claim must be made; how large a claim must be before it is covered; whether the insurance pays first dollars of any claim or kicks in only once the seller’s indemnity obligations have been fully paid; whether particular areas are expressly excluded from insurance, such as particularized atypical representations.

As policy availability has moved down the food chain and become available for lower middle market deals, the market’s familiarity with this tool, beyond the PE fund acquirer, will no doubt increase.  These days, M&A counsel typically will at least alert clients to this deal tool on each side of a proposed transaction.

Confetti

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I again apologize for drifting away from law and business; I promise I will return to my core mission.  BUT I really wanted to share the view outside my office window right now.  The Patriots victory parade is wending its way through Boston and its nearest approach to my office has to be at least a half mile away; they go past the Commons, I am next to South Station.

Yet,outside my window, there is a constant stream of colored confetti.  Must be one heck of a parade for the wind to carry so much paper so far down the Hill and towards Southie.

And you could hardly drive to my office this morning, so many people were pouring out of South Station and assuming it was party time and that they could ignore traffic lights and cars.

That’s it; you can go back to work and so can I.

#42

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Forgive another post about baseball, particularly after my recent post noting how rarely I diverted from legal and business affairs.

Jackie Robinson was born 100 years ago today.  There is an entire section of today’s Times devoted to his life, and it is well worth reading as both baseball and social history  Although little will approach the emotional pull of Ken Burns’ treatment of Robinson in his epic baseball history, I confess that a tear (or more) came to my eyes in thumbing through the Times treatment.

I grew up in Brooklyn and my father took me to my first baseball game, at Ebbetts Field, to see Robinson play.  It is not possible to explain the role of the Dodgers in Brooklyn, nor the fervor of Dodger fans in favor of Robinson.  We did know we were making history.  It was not that history found out about us.  It was a knowing love of the man and the moment, and a proud moment for each of us.  We particularly hated those players who insulted or spiked Robinson, particularly hated those teams that were attacking #42.  Take that, St. Louis Cardinals!

Robinson is one of the few athletes to be relevant 62 years after his last game, and 47 years after his inexplicable early demise.  I still tell people what it was like in the stands, why Channel 9 invented split screen TV because viewers were more interested in seeing Robinson lead off first base than in watching the batter, how he stole home against the Yankees (yeah, the hated Yanks) in the World Series (of all places).  What I really can’t express to anyone is the sense of loss, to this day, felt about the man.

Memory is shrouded in the golden haze of childhood, sports is the early glue of a youngster defining who he is and what his tribe looks like, time promotes the mundane to the heroic, all this is true.  And it is easy to glorify someone whose social contribution is glorified by just about everyone else.  I don’t care the reason.  Every time I go to Fenway and see #42 on the facade where the retired numbers are displayed, my heart skips a beat.

 

ACLU Agenda

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The Civil Liberties Union is a non-partisan organization defending civil rights guaranteed by the Constitution and our laws.  It’s political impact fairly can be said to be “liberal” as that phrase is understood in today’s politics.  ACLU brings numerous suits, almost always against governments; at today’s meeting at the Civil Liberties Union of Massachusetts it was noted that suits against the current Federal administration have numbered “about 200.”

Aside from litigating, ACLU has a program to establish civil rights through political action, all nonpartisan and all directed towards preservation of personal liberty. At today’s meeting, National Political Director Faiz Shakir outlined some of the actions ACLU has undertaken or is planning for 2019.  The key tool is ACLU volunteers, and the goal of ACLU is to mobilize and organize volunteers to achieve certain goals.

Those goals include: significant criminal law reform, some of which recently passed; increased voting through permitting ex-convicts to vote and easier registration of voters by various means; preserving rights of women to obtain abortions; suggesting or drafting legislation with pro-civil liberties themes; funding key state legislative initiatives through volunteers and advertising, including voting district gerrymandering; contacting potential presidential candidates now, at an early stage of their efforts, when they will be more open to forming opinions; and, encouraging legislation to limit the use of advanced technologies to surveil the general population by biometric technologies.

In the Massachusetts General Court (our legislature), many bills have been introduced this session worthy of study relating to protection from electronic surveillance, treatment for addiction, protection from forfeiture of property by the government for criminal connection unless a conviction has been obtained, rights of immigrants to attend court without ICE arrest, abortion protection, and a bill to permitting both registration and voting on election day itself.

One take-away: speakers suggested Massachusetts has a special obligation to limit  use of spying technologies on the general population, as so much of this technology is being developed by our local universities and is being deployed without statutory limits.

Hall of Fame

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The artwork on the top of the first page of this blogsite contains a courthouse and baseball players, but law generally gets the nod when I post; since I started this site years ago there are 324 lawyer posts and only 18 about baseball.  But today they announced those elected to Cooperstown and three of the players noted in the article have Boston Red Sox roots.  Not one of them made the cut, but for seemingly different reasons.

Closest to election was Curt Schilling, who won two World Series with the Sox and gained instant fame for pitching with blood oozing onto his sock.  I think the stocking is at Cooperstown though Schilling is not (yet).  He came closest with almost 70% of the vote (you need 75%) and had over 200 wins during 19 big-league years (although his win-loss ratio was not impressive).  Was it that Schilling was not good enough to be admitted, or that his politics were offensive, or that an odor lingers over his use of tens of millions of dollars of Rhode Island taxpayer money in his gaming company which fell bankrupt?

Roger Clemens, the best pitcher of his generation even before the alleged doping, received less than 60%, although that was an improvement.  Since he was superior when no one doped and then again in competition with many who doped, seems to me he was just better and should be admitted.  Certainly he was electric when on the Fenway mound, creating the kind of buzz that only superstars engender; reminded me of Robinson on the bases, of Musial at the plate, of Mantle just standing there (before his knees took him down).

Far far behind was Manny Ramirez, low 20%s.  All about the narcotics.  Manny was a great hitter although I never could buy into forgiving so many things because it was just “Manny being Manny.”  (Is it an excuse that Nero was just being Nero when Rome burned down?) To my mind, Manny should never be elected for a different reason which was he was a non-team player.  I recall being in the park one day when he was called off the bench against the Yankees when he was supposed to be rested and clearly did not want to hit.  He stood in the batters box, bat held loosely, stomach sort of slouched outward, and took three straight strikes down the middle at a critical point.  I know the idea of the athlete as hero is antiquated, it is just a job with a short time line, and some bums are making millions a year, but part of my baseball myth is that those I love have to at least appear to love the game, the team, the fans paying a buck-and-a-half for a decent seat at Fenway.  My baggage I know, but I am carrying it and will never support Manny for the HOF.  Not that anyone is asking me….

The first time I went through Cooperstown was in 1952 or 1953.  I was a kid and a nut Dodger fan.  It took only a half hour.  There were so few players then with plaques on the wall.  And I knew virtually all of them although I was a kid and many played in the 1880s and 1890s.  Baseball was still mythic then, and I could dream.  Today the Hall is still a bit stodgy and boring, and although I have lived through the careers of many many of the additions, it is to me a good deal less interesting.  Maybe it is just the years, not being a kid.  Maybe it was all explained away in the Ken Burns documentary, so dripping in nostalgia hat you had to laugh at yourself.  Maybe it’s the paychecks which seem — unseemly.  Although a good friend reminds me it is entertainment and filling seats and take a look at what singers and actors earn.

In all events, if you visit Cooperstown bring your sneakers.  It’s a long walk down those plaque-filled corridors these days.

Trending Proxy Issues

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What will be the major issues for public companies in the 2019 proxy season?  An expert panel convened by the National Association of Corporate Directors – New England on January 15 suggested these:  is your Board composition appropriately diverse, and what does diversity mean; is your audit committee competent to fulfill its obligations as they have evolved over time; has the annual shareholder selection of your auditing firm become too automatic and should this function be highlighted in the proxy statement; is the company overpaying its Board?

The panel, included a representative from the institutional advisory firm ISS.  ISS now will consider whether your board is sufficiently diverse, bearing in mind that statistics indicate that diverse boards perform better for shareholders.  ISS threatens adverse advice starting in 2020 if there is no diversity, but diversity is not defined.  Glass-Lewis (another advisory firm) may offer negative comment during 2019, depending upon the facts.  Diversity in the past has been focused primarily on gender diversity; a robust discussion of diversity in a proxy statement might well address other kinds of diversity, and also the question of the number of diverse members.  For example, is placing only one woman on the board effective?  The panel noted that SEC disclosure requirements concerning diversity are “lame” and that most of the diversity pressure comes from the investment community.

Have auditing committees become the “dumping ground” for all sorts of complex issues?  Members of the audit committee with financial expertise may not be the right people to deal with all sorts of risks, notwithstanding the New York Stock Exchange manual assigning risk evaluation to that committee (a requirement the panel says is typically ignored).  Why for example does cyber risk or reputational risk or political risk end up with the audit committee?  A suggestion was made that the proxy statement might provide more granular disclosure, indicating which committees are evaluating which types of risks, and how?

The panel then held an inconclusive discussion concerning auditor selection, suggesting that proxy disclosure might benefit from discussing the decisional process.  It was noted that large companies run both higher costs and certain risks in replacing established auditing firms, given complexity and the lack of familiarity with operations for a new firm.  Additionally, many large companies utilize a variety of accounting firms, one being the auditor but others being retained for tax or other advice, making replacement difficult (auditing firms cannot provide most other services to a client beyond the audit).  For example, if no change in auditors has been made, perhaps the proxy statement ought to explain why.  In candor, this issue to my mind is not ripe for proxy statement inclusion, given that the average public company proxy statement now is about 100 pages already.

The year 2018 saw an increase in negative shareholder votes on “say on pay.”  While the absolute number of “no” votes was still low (an increase from 2017 to 2018 from 34 to 53), the panel suggested that shareholder rejection rates might increase, particularly if the stock market continues to lose ground, causing investor satisfaction to decline.

Lastly, it was suggested that this is the year to completely readdress proxy Risk Factors, rather than simply repeating them.  With market developments in terms of valuation, tariffs, political risk, cyber risk, LIBOR, regional and global tensions, a complete redrafting of Risk Factors may be in order.

Announcing My First Book

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I don’t blog about myself, as readers of this post well know.  However I am breaking my own rule to announce that my first book, a collection of five decades of poetry, has been published.  It is entitled “Messing Around With Words” and is available if you search either Amazon Books or Barnes and Noble under my name.  If you order and read, let me know what you think.

And be forewarned that later this year you will see a volume of short stories, although those were written more recently than some of  the verse.

‘Nuf said.

Trends in Life Settlements

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The current issue of a leading life settlements industry newsletter predicts that 2019 should be a good year to invest in life settlements because it is a growing recognized investment class; but also and frighteningly, because aging boomers will need to sell their policies for cash in order to pay for their own health care!

Life settlement investment works like this: you buy a life insurance policy on the life of Mr. Smith for a sum of money you calculate as follows: you pay say $10X dollars for a policy that on death pays say 20X; and the cost of premiums is $X a year; you calculate how long Mr Smith will live based on health, age, actuarial tables, etc.; you “bet” that Mr Smith will die sooner rather than later so that you collect your $20X life insurance death benefit before your cost to purchase + premiums you paid + your cost of money is less than the $20X proceeds– much less.

Obviously you can get lucky with Mr Smith (next week he is hit and killed by a driver-less car, for example), but there is risk; he may have great genes or a propensity for diseases which modern medicine can treat, and he lives to be 110.  So the safe approach, aside from getting good actuarial tables, is to buy a variety of policies so that statistically the portfolio will protect you from buying a policy on a small number of unlucky — that is long-lived — people.  This business concept gave birth to both a recognized industry and an investment class.

Back to the boomers selling their policies in order to pay health care costs.  This is facially unsettling, yes?  What about the benefits of Social Security, Medicare, Medicaid, the support structure we are supposed to have in order to protect our aging population?  In a related development, a US House bill, which in fact died at the end of the last Congressional session, sought to permit seniors selling their policies to avoid paying taxes on the proceeds provided the proceeds were used for healthcare, including long-term care.  It is expected that the bill will be re-introduced next session.

I guess the lesson here is that if you have sizable life insurance which you no longer believe you need to maintain, you should get a quote to sell the policy and compare it to any cash surrender value you might receive from the insurance company; particularly for term policies, with no surrender value and possibly lower premium costs, you may well find yourself with a hidden profit center by selling your policy, even after you adjust for any tax burden.

 

 

SEC Pay Ratio Revisited

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Years ago (six? more?) Congress legislated that the SEC should design a mandatory disclosure comparing CEO comp to the median compensation of all entity employees.  It took the SEC years to institute that disclosure requirement, during which time its bald impact was softened to permit companies with odd situations to, for example, make estimates or report sampling in some instances.  But even as enacted, the rule seemed to many (and to me) silly.  Using disclosure to control what was perceived to be runaway executive compensation seemed likely to be ineffectual as proposed, not to mention possibly just unwise; perhaps a CEO should even be rewarded for creating a vast difference between his or her comp and that of the other employees, having found inexpensive labor sources, perhaps even overseas.

So now we have an SEC requirement to effect a relatively complex computation comparing CEO comp to the median cost of labor in an entity, and no one is paying attention, right?

Well, not quite right; but, there is a twist.

Today, there is as much interest in income disparity across all of society is there is concerning CEOs within one company.  Investors, worried about the long-term societal implications of growing income discrepancies across our whole society, now are suggesting that the statistic be used as a window into the company’s approach to its entire workforce.  That kind of interest, perfectly logical, once was viewed as wholly operational and thus shareholders were to hold their tongues; the ratio was a way for shareholders to get a voice in this key operational metric.

Meanwhile, the prestigious Corporate Counsel blog, which I swear I recall at one time derided gathering the ratio statistic, now wants comp committees to pay attention because the effect of detailed disclosure of CEO pay has, to date, simply driven boards to continue to pay CEOs in the top quartile, in a rush to the top.  What board wants to tell shareholders, in effect, “we have chosen to lead your company a person who is average”?

People who slam-dunk or hit 40 home runs out-earn most CEOs.  The market-place speaks to us.  It may be that the solution to leveling comp in our overall society lies with the taxing authorities, as unsettling as that prospect always has been.  Or adoption of an enlightened social policy that recognizes the risk of social upheaval as outweighing what has become our sense of the free labor market.  Neither of those discussions is much informed by the SEC ratio disclosures.