On March 7, 2014, Vice Chancellor Travis Laster of the Delaware Court of Chancery found a financial advisor liable for aiding and abetting breaches of fiduciary duties by the board of Rural/Metro Corporation in connection with the company’s 2011 sale to an affiliate of Warburg Pincus LLC. In its 91-page, post-trial opinion, the Court concluded that the financial advisor allowed its interests in pursuing buy-side financing roles in both the sales of Rural/Metro and Emergency Medical Services (“EMS”) to negatively affect the timing and structure of the company’s sales process, that the board was not aware of certain of these actual or potential conflicts of interest, and that the valuation analysis provided to the board was flawed in several respects. Both the Rural/Metro board of directors and a second financial advisor to Rural/Metro settled before trial for $6.6 million and $5.0 million, respectively.
Posts Tagged ‘Conflicts of interest’
As dealmakers put the finishing touches on public M&A transactions, the question is no longer if there will be a lawsuit, but rather when, how many and in what jurisdiction(s). And while many of the cases remain of the nuisance strike-suit variety, recently it seems every few weeks there is an important Delaware decision or other litigation development that potentially changes the face of deal litigation and introduces new risks for boards and their advisers. Now more than ever, dealmakers need to be aware of, and plan to mitigate, the resulting risks from the earliest stages of any transaction.
On March 7, the Delaware Court of Chancery published a post-trial opinion in In Re Rural Metro Corporation Stockholders Litigation (Rural Metro) finding Rural/Metro’s financial advisor RBC liable for aiding and abetting the Rural/Metro’s board of directors’ breach of its fiduciary duties in connection with the acquisition of Rural/Metro by Warburg Pincus. The decision is the latest in a series of Delaware opinions concerning conflicts of interest of banks and investment firms in advising companies in buy-out transactions.
Last week, the Delaware Court of Chancery reached the rare conclusion that an independent, disinterested board breached its fiduciary duties in connection with an arm’s-length, third-party, premium merger transaction. The decision, In re Rural Metro Corp. Stockholders Litig., C.A. No. 6350-VCL (Del. Ch. Mar. 7, 2014), which relies heavily on findings that the board’s financial advisor had undisclosed conflicts of interest, holds the advisor liable for aiding and abetting the breaches, but does not reach the question of whether the directors themselves could have been liable, as they settled before trial. The decision sends a strong message that boards should actively oversee their financial advisors in any sale process.
On January 24, 2014, the Securities and Exchange Commission (“SEC”) issued an order instituting settled administrative and cease-and-desist proceedings against KPMG LLP (“KPMG”) for violating auditor independence rules in its relationships with affiliates of three of its SEC-registered audit clients.  At the crux of the SEC’s order are its findings that:
- KPMG provided prohibited non-audit services to affiliates of its audit clients;
- KPMG hired a former employee of an affiliate of one of KPMG’s audit clients and subsequently loaned him back to the affiliate to do the same work he had done as an employee of the affiliate;
- Certain KPMG employees owned stock in KPMG’s audit clients or affiliates of its audit clients; and
- KPMG repeatedly represented in its audit reports that it was “independent.”
KPMG settled the charges for approximately $8.2 million.
The board of directors is a collective body, whose members have diverse expertise in various aspects of the company’s business. Therefore, communication between directors is critical to successful board functioning. In recent years, regulators, shareholders, and directors themselves have been paying increased attention to decision-making policies that could increase the quality of board discussions. Executive sessions that exclude the management, separation of the CEO and chairman positions, board retreats, and separate committees on specific topics have been put in place to promote more effective communication. As governance experts Carter and Lorsch (2004) emphasize, “If we could offer only one piece of advice, it would be to strive for open communication among board members.”
Rule 17g-5(c)(1) (the “Rule”) of the Securities Exchange Act of 1934 addresses nationally recognized statistical rating organization (“NRSRO”) conflict of interest concerns by prohibiting an NRSRO from issuing a credit rating where the person soliciting the rating was the source of 10% or more of the total net revenue of the NRSRO during the most recently ended fiscal year.  As noted by the Commission, this prohibition is necessary because such a person “will be in a position to exercise substantial influence on the NRSRO” and, as a result, “it will be difficult for the NRSRO to remain impartial, given the impact on the NRSRO’s income if the person withdrew its business.”  The Commission also recognized that the intent of the prohibition “is not to prohibit a business practice that is a normal part of an NRSRO’s activities,” and that the Commission may evaluate whether exemptive relief would be appropriate. 
Directors have two complementary functions in a firm: that of monitoring and offering strategic advice. Directors with current expertise in the firm’s own industry have the requisite information and therefore are clearly suited to perform these functions effectively. However, antitrust laws prohibit firms from having directors from other firms that compete in the same product market. Given these constraints, “directors from related industries” (DRIs) are well-positioned to perform these critical functions, particularly when firms face a severe information gap vis-à-vis their related upstream and downstream industries. For instance, DRIs can improve a firm’s ability to respond to demand/supply shocks or forecast trends in related upstream/downstream industries. They can also help shrink the information gap between the firm’s board and its managers regarding conditions in related industries, thereby enhancing the board’s ability to monitor managerial performance.
Public company shareholders have a vital role to play in corporate governance. To that end, they are given important rights under federal and state law. Chief among these are the right to vote for the election of directors and on other significant matters and to make their views known to the company’s management and directors. Most corporate shareholders exercise their voting rights by proxy, which makes federal regulation of the proxy process a critical focal point for investor protection purposes.
To support the exercise of their voting rights, many institutional investors and investment advisers hire proxy advisory firms to provide analysis and voting recommendations on matters appearing on the proxy.
These firms often also provide other services to their institutional clients—such as:
The recent financial crisis and subsequent events  show the dangers that can result when banks trade for their own accounts while disregarding their customers’ interests. During the financial crisis, U.S. taxpayers were forced to cover losses sustained by major financial institutions that resulted from speculative proprietary trading activities.  While several factors combined to cause the financial crisis, proprietary trading by major financial institutions was a key contributor to that crisis.  In particular, proprietary trading by deposit-taking institutions exposed a bank’s capital—and FDIC-insured deposits—to unacceptable risks and saddled taxpayers with massive losses.