Following up on my post on the subject, I had the opportunity to speak with Colin O’Keefe of LXBN regarding the Facebook/Instagram deal. In the brief interview, I explain how things have changed since Facebook’s IPO and what, if anything, that meant for the deal’s fairness review with the California Department of Corporations.
We previously blogged about the potential liability for Facebook, Inc. directors if the company paid too much for the social media start-up company Instagram. Recall that in April, Facebook agreed to acquire Instagram for, at the time, approximately $1 billion with the consideration payable 30% in cash and 70% in Facebook common stock (now, due to the decrease in Facebook’s share price from the stipulated price of $30 per share, the deal is only worth about $650 million). A recent NY Times Deal Book article points out that if the deal fixed the total purchase price rather than the number of shares to be issued, Instagram would have gotten a much better deal due to the depressed Facebook share price. Given the declining share price of Facebook stock, is Facebook’s reduced consideration still fair to Instagram’s shareholders? This is exactly the question that will be determined by the California Department of Corporations which will be conducting a fairness review of the acquisition this Wednesday.
The purpose of this fairness hearing is to allow Facebook to take advantage of a lesser-known exemption from registration under the Securities Act of 1933 known as the “3(a)(10) exemption.” Because Facebook is issuing securities in connection with the Instagram acquisition, the 23 million shares to be issued are required to either be registered or they must be exempt from the registration requirements of the Securities Act. The 3(a)(10) exemption allows companies to issue securities in an exchange transaction without registration provided that either a court or designated state agency finds that the transaction is fair to the recipients of the new securities. This exemption was popular during the tech boom and has both advantages and disadvantages when compared with the most common exemption provided by Rule 506 of Regulation D promulgated under the Securities Act.
Most smaller companies tend to offer and sell securities on an exempt basis because of the substantial costs of conducting a registered offering. There are a laundry list of exemptions but only a few are of much practical use. Most exempt offerings are structured to take advantage
Continue Reading Is Facebook’s acquisition of Instagram fair to Instagram shareholders?
Imagine the following scenario. Your company is publicly traded. As such, senior management is keenly aware of the potential for executives and employees trading in the company’s securities on the basis of material nonpublic information in violation of Section 10(b) of the Exchange Act and the infamous Rule 10b-5 promulgated thereunder. To prevent improper trading, the company has instituted an insider trading policy which, among other things, requires certain high-level executives to pre-clear trades internally, prohibits directors and officers from trading during “blackout periods” (i.e., the period immediately prior to fiscal quarter and year ends), and requires periodic training for all employees on the scope of insider trading laws. As model corporate citizens, all of the company’s directors, officers, and employees follow the company’s policies precisely. No one would dare to take the risk of attempting to gain illicit profits by trading the company’s stock while in possession of material nonpublic information.
One day, just before the end of a quarter (and therefore during a blackout period), analysts covering your company reduce their estimates for the company’s quarterly results which in turn, causes the company’s share price to decline. The company’s officers know that the analysts’ revised estimates are accurate and that the company will report sub-par earnings results the following week but none of those officers initiated any trades to improperly take advantage of this material nonpublic information. However, as a result of the decline in share price alone, one of the company’s executive officers unknowingly violated Section 10(b) and Rule 10b-5 and both he and the company are now potentially on the hook for insider trading liability.
How can this be if none of the officers executed any trades you ask? The problem arises from the fact that company policy does not prohibit margining company securities. When the share price declined, the value of the securities in the executive’s margin account dropped sufficiently to trigger a margin call requiring the executive to deposit additional collateral to make up the shortfall or risk having the broker sell a portion of the pledged securities (this is similar to what happened to the founder and chairman of Green Mountain Coffee Roasters, Inc. earlier this year). Regardless of which route is taken, the executive is in a problematic situation.
If the executive does nothing and allows the broker to sell company stock, he’d be violating company policy by trading during the blackout
Continue Reading Margin calls: The insider trading trap
Following the recent financial crisis and government bailouts of major U.S. financial institutions, the federal government has gradually facilitated a power shift from companies and their officers and boards of directors to their shareholders. A prime example of this is the recently enacted “say-on-pay voting” requirements. Through provisions of the Dodd-Frank Act which was passed in July 2011, Congress directed the SEC to adopt rules requiring public companies to give their shareholders a vote, on an advisory basis, on the approval of executive compensation (“say-on-pay”). The implemented rules also require public companies to hold an advisory vote on the frequency (“say-on-when”) with which the say-on-pay vote would occur. Taking into account the results of the say-on-when vote, companies determined whether to hold say-on-pay votes on an annual, biennial, or triennial basis, with most electing to hold annual say-on-pay votes. Despite these shareholder votes being advisory, and as we explained in a previous blog, these votes may actually be more impactful than originally anticipated due to the effect of poor or failed say-on-pay votes on the recommendations from proxy advisory firms, such as ISS. For example, a “poor” (i.e., less than 70% shareholder approval) or “failed” say-on-pay vote result (i.e., less than 50% shareholder approval) could lower one or more of a company’s ISS “GRId” scores (or other proprietary proxy advisory firm corporate governance rating scores) which would negatively impact the recommendations published by the proxy advisory firms with respect to the election of directors and other corporate governance matters being put to a vote of the shareholders at the annual meeting. By way of example, if a public company receives less than 70% shareholder approval for executive compensation, the company must show that it took steps to address its perceived executive pay shortcomings, otherwise ISS will recommend a “withhold” vote for the directors up for re-election at the next annual meeting.
Going one-step further, however, the United Kingdom announced on June 20, 2012 that it will be implementing a binding say-on-pay vote requirement for public companies. According to the Department for Business Innovation and Skills, the U.K. government will “introduce a new binding vote on companies’ pay policies in order to empower shareholders and
Continue Reading Binding say-on-pay: Is it coming to a public company near you?
Social media is all the rage and seems to be rearing its head in just about every aspect of daily life. Turn on any television news program, whether CNN, ESPN, or any other, and you’ll be sure to be brought up to date with who has “tweeted” what to whom or what someone’s latest facebook status update means to the future of the world as we know it. However, there is more to social media than providing additional outlets to those persons and businesses already in the limelight. The fact of the matter is that these new social media tools allow just about anyone to widely disseminate information across the world at little to no cost. Naturally, organizations have realized the power of social media for promoting their cause and for fundraising purposes, particularly charitable organizations and political campaigns, many of which have raised significant amounts through a crowd-sourced approach.
Entrepreneurs have also recognized this potential and have sought to utilize social media for their own capital raising purposes. Unfortunately, many of the entrepreneurs may not realize that raising capital in this manner has securities laws implications which, if not sufficiently addressed at the outset, could be extremely detrimental to their business. Accordingly, these social media-based capital offerings are required to be registered with the SEC or offered pursuant to an exemption from registration. Until recently, there did not exist a specific exemption for crowdfunded offerings. However, the recently enacted Jumpstart Our Business Start-ups Act, or “JOBS Act”, created a crowdfunding exemption as the result of a successful campaign by small business advocates who saw crowdfunding as a useful tool to help small businesses in need of capital while at the same time minimizing investor protection concerns by imposing a small per capita investment limit. Many blogs and business-oriented publications have been creating a buzz about the new crowdfunding exemption and have been touting it as a boon for small businesses in need of capital. But as the title, of this post implies, we feel that this excitement is generally misplaced.
Continue Reading The new crowdfunding exemption: much ado about nothing
It is a basic tenant of corporate law that directors of a corporation are not liable for business decisions as long as the directors acted with a reasonable level of care in making these decisions. This is referred to as “the business judgment rule.” Because directors are not guarantors of corporate success, the business judgment rule specifies that a court will not review the business 
decisions of directors who performed their duties (1) in good faith; (2) with the care that an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner the directors reasonably believe to be in the best interests of the corporation. As part of their duty of care, directors have a duty not to waste corporate assets by overpaying for property (e.g., 100% of the stock of a target company in an acquisition) or employment services. The business judgment rule is very difficult to overcome and courts will not disregard it absent, among other things, a showing of fraud or misappropriation of corporate funds.
One of the landmark cases in this area of law was Smith v. Van Gorkam, which was decided by the Delaware Supreme Court in 1985. In that case, the board of directors of TransUnion approved a merger with Marmon Group without consulting outside experts as to the fairness of the price to be paid to TransUnion shareholders, rather, the board relied on the recommendations company’s CEO and CFO, neither of whom made any substantive attempt to determine the actual value of TransUnion. Additionally, the board did not inquire as to the process used by the CEO and CFO in determining the merger consideration. As a result, the Delaware Supreme Court found that the directors of TransUnion were grossly negligent in carrying out their fiduciary duties to the company. Because of this, the board was found not to have satisfied their duty of care and were therefore not entitled to the presumptions and protections of the business judgment rule. Ultimately, the TransUnion board agreed to pay $23.5 million in damages resulting from their fiduciary duty breaches.
The facts of Facebook’s recently announced acquisition of Instagram (as reported by the Wall Street Journal) are strikingly similar to the Van Gorkam case. Allegedly, Facebook’s CEO Mark Zuckerberg and Instagram’s CEO Kevin Systrom worked out the details of the acquisition privately over the course of 3 days at Mr. Zuckerberg’s home. Once the details were finalized for the $1 billion acquisition, the deal was presented, without notice, to the Facebook board of directors who approved the deal, likely without outside expert advice as to the fairness of the transaction. According to several reports, the board vote was largely symbolic because Zuckerberg has control of 57% of the voting power of the company. Facebook directors were likely put in a precarious
Continue Reading Could directors be personally liable if Facebook paid too much for Instagram?
Recent comments from SEC commissioner Luis Aguilar indicate that the SEC may consider new rules that would require public companies to disclose political expenditures. In his recent speech from February 24, 2012, Commissioner Aguilar informally called on the SEC to adopt political spending disclosure rules in light of the landmark U.S. Supreme Court Case, Citizens United v. Federal Election Commission, which struck down federal restrictions on corporate political spending as unconstitutional. Although public companies are still restricted from directly contributing corporate funds to political candidates, they are permitted to contribute funds for campaign advertisements that support or oppose political candidates. Additionally, companies may contribute to independent organizations that engage in political advertising or lobbying.
We previously blogged about a petition which was submitted by a group of ten law professors in response to the Supreme Court’s opinion in Citizens United asking the SEC to consider adopting rules that would require public companies to make disclosures about their political contributions. The petition was prompted by, among other things, the Court’s assertion that procedures of corporate democracy would be a means by which shareholders could monitor the use of corporate assets for political purposes and also effect corporate change where such political purposes were inconsistent with shareholder interests. As the petitioners pointed out, the Court’s reasoning is partially based on the assumption that shareholders have access to information concerning a company’s political spending. While certain companies voluntarily make political spending disclosures in their public filings with the SEC, there are currently no rules or regulations that require a company to make such disclosures.
Continue Reading Are more disclosure requirements for public companies in the works?
When someone refers to a company as being “publicly traded” we normally understand that to mean that it has sold shares to the public through an initial public offering (or “IPO”) and is listed on a national securities exchange (like the NYSE or Nasdaq) and makes periodic filings with the SEC. However, some smaller companies that are not listed on a national exchange and that have never filed any documents with the SEC are coming to find out that they may in fact be “publicly traded” and may not even realize it. Moreover, being classified as “publicly traded,” under certain circumstances, can impose requirements on the company to provide notice for certain corporate events and pay associated fees.
Rule 10b-17 and FINRA Rule 6490
Section 10(b) of the 1934 Securities and Exchange Act (the “Exchange Act”) is one of the anti-fraud provisions of the Exchange Act and imposes liability on persons engaged in the use of “manipulative or deceptive devices or contrivances” in connection with the purchase or sale of a security. Pursuant to its rule making authority, the SEC has enacted a number of rules (the most well-known of which is Rule 10b-5) which regulate these manipulative and deceptive devices and contrivances in order to protect investors.
Less well-known among these rules is Rule 10b-17 which relates to untimely announcements of record dates. Specifically, Rule 10b-17 states that failure by an issuer of a class of securities publicly traded to give 10-days’ prior notice to FINRA of the establishment of record dates relating to dividends, distributions, stock splits, or rights or other subscription offerings, constitutes a “manipulative or deceptive device or contrivance” for Section 10(b) purposes.
FINRA Rule 6490 (effective as of September 27, 2010) codified the Rule 10b-17 notification requirements and requires issuers subject to the rule to pay the applicable fees in connection with their submission of the required notice. Most notably, notifications which are late can trigger a late fee of up to $5,000.
Our company is privately-held so why should we care?
At first glance, the rules above seem to only apply to companies who have securities which are publicly traded. In fact, the rule
Continue Reading Your company may be ‘publicly traded’ without your knowledge – and there may be a price to pay
Section 1502 of the Dodd-Frank Act mandates the SEC to adopt rules requiring reporting companies to disclose whether certain minerals used in production chains originate from the Democratic Republic of the Congo or its neighboring countries. Minerals sourced from these areas of central Africa often fund militia and other military groups’ operations which have exacerbated
Section 951 of the Dodd-Frank Act states that the results of a shareholder say-on-pay advisory vote will not trigger or imply a breach of fiduciary duty. Because Congress went out of its way to be explicitly clear on this point, most legal commentators felt that shareholder derivative suits based on failed say-on-pay votes, without more, would likely never be successful. To further support this position, a number of derivative lawsuits were in fact filed on this very basis in 2011 but none have been successful to date. However, a recent decision by the Federal District Court for the Southern District of Ohio may have breathed new life back into the debate.
In NECA-IBEW Pension Fund v. Cox, the plaintiff shareholders (suing derivatively on behalf of Cincinnati Bell) alleged the company’s board of directors breached its duty by approving and recommending approval of an executive compensation package to the shareholders in its annual proxy statement. The compensation package included significant bonuses and pay increases for executives despite a $61 million decrease in the company’s net income and a drop in earnings per share from $0.39 to $0.07. The plaintiffs alleged that the board-approved executive compensation, which was subsequently rejected by 66% of the shareholders in the say-on-pay vote at the annual meeting, was contrary to the company’s written compensation policy which stated “a significant portion of the total compensation for each of our executives is directly related to the Company’s earnings and revenues and other performance factors” and that at-risk compensation should be “tied to the achievement of specific short-term and long-term performance objectives, principally the Company’s earnings, cash flow, and the performance of the Company’s common shares, thereby linking executive compensation with the returns realized by shareholders.”
The director defendants filed a motion to dismiss the complaint for failure to state a claim for which relief could be granted arguing, among other things, that executive compensation determinations are board decisions protected by the business judgment rule. The business judgment rule generally protects directors that make informed business decisions absent a deliberate
Continue Reading Has New Life Been Given to Derivative Suits Based on Failed Say-On-Pay Votes?