The Federal Reserve’s approval recently of Capital One’s application to acquire ING Bank, fsb, taken together with its December approval of PNC’s proposed acquisition of RBC Bank (USA), marks a path forward for bank acquisitions. Despite broad industry concerns about unrealistic capital expectations by the regulators and Dodd-Frank’s mandate that the Federal Reserve consider financial stability risk factors in M&A applications, Capital One and PNC demonstrate that with advance preparation and thoughtful structuring, it is possible for large banks to navigate the regulatory process and make strategic acquisitions. However, the regulatory process has clearly changed post-crisis, and larger banks should be prepared for a more extended and thorough vetting of their acquisitions by the regulators.

The Federal Reserve processing of the Capital One and PNC filings took approximately seven months and four-and-a-half months, respectively. The Capital One processing was extended as a result of a large number of internet-based protests organized by certain community groups, three public hearings and the Federal Reserve’s refinement of its framework for evaluating financial stability risk. Going forward, acquirors should expect renewed regulatory focus on consumer and CRA compliance matters and inquiries concerning all allegations raised by community groups and others, even those that may be regarded as non-substantive. Acquirors will need to demonstrate the sufficiency of their compliance and other risk-management systems, including in connection with their expanded operations and increased size.

…continue reading: A Path Forward for Bank Acquisitions

Prior research has documented that current U.S. corporate tax laws create incentives for some U.S. multinational corporations (MNC) to delay repatriation of foreign earnings in order to defer taxation on those earnings and hold greater amounts of cash abroad. The current financial accounting treatment for taxes on foreign earnings under ASC 740 potentially exacerbates this issue and increases the incentive to avoid the repatriation of foreign earnings by allowing firms to designate foreign earnings as permanently reinvested and to defer the recognition of the U.S. tax expense related to foreign earnings for financial reporting purposes. In our paper, Permanently Reinvested Earnings and the Profitability of Foreign Cash Acquisitions, which was recently made publicly available on SSRN, we predict and document that the combined effect of these tax and financial reporting incentives likely lead to significant agency costs. Namely, managers of U.S. MNCs with high levels of both permanently reinvested earnings and cash holdings are more likely to make value-destroying acquisitions of foreign target firms. Our findings are consistent with anecdotal evidence from the popular press. For example it has been suggested that a significant determinant of Microsoft’s decision to acquire Skype for $8.5 billion was that Skype was a foreign company with headquarters in Luxemburg, enabling Microsoft to use foreign cash “trapped” overseas to make the acquisition (Bleeker 2011).

…continue reading: Permanently Reinvested Earnings and the Profitability of Foreign Cash Acquisitions

Shareholder litigation challenging merger and acquisition (M&A) deals has increased substantially in recent years. To study this increase and characterize the recent litigation, Cornerstone Research and Professor Robert Daines of the Stanford Law School reviewed reports of M&A shareholder litigation in Securities and Exchange Commission (SEC) filings related to acquisitions of U.S. public companies valued over $100 million and announced in 2010 or 2011. [1] We found that almost every acquisition of that size elicited multiple lawsuits, which were filed shortly after the deal’s announcement and often settled before the deal’s closing. Only a small fraction of these lawsuits resulted in payments to shareholders; the majority settled for additional disclosures or, less frequently, changes in merger terms, such as deal protection provisions. Interestingly, while requiring additional disclosures is a common outcome, we have not encountered a case in which shareholders rejected the deal after the additional disclosures were provided.

In this report, we provide statistics on recent M&A shareholder lawsuits, describing their prevalence, filing timelines, venue choices, outcomes, and settlement terms.

…continue reading: Developments in M&A Shareholder Litigation

The aftermath of the recent acquisition of Lyondell by Basell provides a striking example of the risk that directors face if they approve a cash merger financed in substantial part through borrowing and the target then fails. The deal was characterized as an “absolute home run” by Lyondell’s financial advisor. [1] But less than thirteen months after the closing of the merger in December 2007, Lyondell filed for bankruptcy. A litigation trust established by the bankruptcy court to marshal the debtor’s assets has sued Lyondell’s former directors, seeking damages on the theory that the merger, while beneficial to Lyondell’s shareholders, unlawfully mistreated Lyondell’s creditors by causing the company to become insolvent. [2] The case is pending. To add to the directors’ problems, the excess directors’ and officers’ insurance carrier has declined coverage on several grounds, among them that, because the litigation trust stands in Lyondell’s shoes, this is an “insured v. insured” matter not covered by the D&O policy. [3]

…continue reading: Protecting Directors When Firms Fail Post-Merger

In the paper, Who Writes the News? Corporate Press Releases During Merger Negotiations, which was recently made publicly available on SSRN, we show that firms manipulate their stock prices during merger negotiations in order to affect the terms of the transaction. We argue that this strategy is made possible by the loose regulation of corporate disclosure. In particular, U.S. federal laws generally do not require firms to publicly disclose all material corporate events when they occur. Instead, firms have significant flexibility with respect to the content and timing of their press releases. We show that firms strategically exploit the flexibility afforded by the law to influence their stock prices precisely when they benefit the most from short-term manipulation.

To identify firms with incentives to manage their stock prices, we focus on stock acquisitions, a setting where a short-term change in firms’ stock prices has a long-term effect on merger outcomes. If an acquirer in a stock acquisition can temporarily raise its stock price during a short time window when the stock exchange ratio is determined (usually several weeks), it can issue fewer of its shares for each target share and reduce the true cost of the takeover. To establish causal evidence of price manipulation, we exploit the difference in the time period when the terms of the merger are determined in fixed-exchange ratio vs. floating-exchange ratio stock acquisitions. These two groups of transactions are very similar along firm and deal characteristics, but have a clear dichotomy in the timing of media management incentives.

…continue reading: Do Firms Manipulate Their Stock Prices? Causal Evidence from M&A

Financial bidders like private equity firms often compete with corporate bidders for the same target. Over the last 27 years, financial sponsors made 23 percent of all competing bids. In our paper, It Pays to Follow the Leader: Acquiring Targets Picked by Private Equity, forthcoming in the Journal of Financial and Quantitative Analysis, we examine how the presence of financial sponsor competition affects corporate buyers. Financial bidders are considered experts in the business of identifying undervalued targets. Gains from acquiring an undervalued firm pursued by private equity may accrue to any winning bidder that pays a similar premium for the target. Moreover, existing research shows that financial bidders have lower average valuations than strategic bidders. Thus, a corporate acquirer competing with a financial bidder (which is typically private) may win the auction at a lower premium than when it competes with another public corporate firm.

We find that corporate acquirers who purchase targets that are sought after by financial buyers outperform corporate acquirers who buy targets bid on by corporate firms only or those without competition. These results are robust to alternative measures of acquirer performance and different performance windows. A battery of tests shows that deal characteristics, acquirer abilities, and observable target characteristics cannot explain this difference in returns.

…continue reading: It Pays to Follow the Leader

Even with the recent slowdown in M&A activity, spin-offs have been among the transactions of choice in the past year. With everyone from economic mainstays like ConocoPhillips and Kraft to high-profile new players like TripAdvisor engaging in separation deals in the latest round of deconsolidation, it is an opportune time for dealmakers to consider the general implications of a spin-off on transformational corporate merger activity and certain structures that may allow for a combination of the two.

Corporations engage in spin-offs for a variety of business and financial reasons. A corporation’s goals can be accomplished without U.S. federal income tax to the distributing corporation and its stockholders so long as the transaction meets the requirements of Section 355 of the Internal Revenue Code.

Failure to meet these requirements either before or after the transaction can cause a spin-off to be taxable to the distributing parent company (in the form of corporate- level gain generally equal to the appreciated value of the spun-off subsidiary), to the distributing parent’s stockholders (in the form of dividend income equal to the value of the spun-off business), or both. These taxes can be prohibitively or even catastrophically expensive.

…continue reading: Spin-offs and Reverse Morris Trusts

For buyers of public companies, an obscure but increasingly evident judicial remedy known as “quasi-appraisal” is fast becoming a source of concern. Quasi-appraisal – as its name suggests – is not quite what parties expect from M&A litigation and has the capacity to upset the familiar process accompanying the sale of a public company.

There are three primary types of M&A litigation: Pre-closing disclosure litigation, post-closing loyalty litigation and appraisal. Not every litigation fits neatly into one of these categories, but most do. Pre-closing disclosure litigation often culminates in the plaintiffs, the target company and the buyer agreeing to additional disclosures (and occasionally revisions in the transaction terms) in exchange for a class-wide release and a court-approved award of plaintiffs’ fees. In the absence of a pre-closing disclosure settlement, the second type of litigation may arise which is post-closing, class-action litigation alleging breaches of fiduciary duties (other than disclosure). Most often, such post-closing actions relate to transactions subject to entire fairness review, as, for example, when a controlling stockholder is involved. And finally, in cash-out mergers, stockholders can pursue a post-closing appraisal claim, a remedy that requires each individual stockholder wishing to pursue appraisal to dissent from the merger vote, refrain from accepting the merger consideration, and bear litigation costs. In an appraisal, dissenting stockholders also bear the risk that the court will appraise the stockholder’s shares at a lower value than the merger consideration.

…continue reading: Quasi-Appraisal: The Unexplored Frontier of Stockholder Litigation?

This time last year appeared to hold the promise of increased deal activity, as a series of significant strategic deals were announced in the waning days of 2010 and fundamentals appeared to be aligned. That promise began to manifest itself in the opening months of the year, with several significant deals. As the year wore on, though, deal activity was dampened by several troubling environmental realities: an alarming sovereign debt and bank crisis in Europe, persistent U.S. monetary policy promising sustained low interest rates and a flat yield curve, a weak U.S. housing market and a tricky legal and regulatory landscape.

There were, though, some very bright spots. Leading the way were transformative deals by Comerica, Capital One and PNC. We also witnessed increasingly ambitious efforts by several stronger community banks to intelligently strengthen their franchises through successive smaller acquisitions in strategically important markets. Bank M&A in 2012 will likely remain episodic, as current ongoing business and regulatory conditions and weak equity market valuations will surely take more time to work through. Still, we should see a continued trend of stronger banks making selective, targeted acquisitions focused more on securing their long-term competitive positioning and maintaining balance sheet strength (and less on a short-term boost to quarterly earnings) as well as increasing pressure on smaller banks from several fronts to accept current valuations.

…continue reading: The Outlook for Bank M&A in 2012

A September 2011 Delaware Court of Chancery decision refused to dismiss claims alleging that a board of directors breached its fiduciary duty of loyalty in authorizing a sale of a corporation to a third party. The stockholder plaintiff alleged that the sale was motivated by the corporation’s former chairman and chief executive officer, who owned 37% of the corporation’s common stock and needed liquidity. The decision is significant for refusing to dismiss allegations of disloyal conduct against outside directors who were disinterested in the transaction and otherwise unaffiliated with the former CEO.

Background

New Jersey Carpenters Pension Fund v. infoGROUP, Inc. involved the 2010 sale of infoGROUP, Inc., to a private equity fund. The stockholder-plaintiff alleged that the sale was motivated by the corporation’s former chairman and chief executive officer, who owned 37% of the company and “desperately needed liquidity” to fund a new venture and to satisfy $12 million in settlement obligations stemming from a Securities and Exchange Commission action and a derivative suit brought against him. The plaintiff claimed that the board of directors breached its fiduciary duties by capitulating to the former CEO’s pressure and approving a transaction that was not in the best interests of all shareholders.

…continue reading: Loyalty Claims Against Outside Directors