SEC Enforcement Actions Highlight the Intelligence to Be Found in Corporate Control Contests

By: David A. Holley

Berkeley Research Group’s Global Investigations + Strategic Intelligence experts provide a unique service to boards of directors and their advisors involved in contests for corporate control. Their role is to develop information through investigation to allow clients and their advisors to make the most informed decisions consistent with their goals and legal strategy. Frequently, this information takes the form of diligence on the proffered slate of dissident directors or the proposed transaction. Our experts seek to identify and bring to light information for our clients to use to shape their shareholder engagement strategy. Our team has decades of experience conducting investigations in connection with hostile takeover defense.

Last month, the Securities and Exchange Commission (“SEC”) announced the resolution of two enforcement actions that stemmed from contests for corporate control. In both instances, the SEC found that incomplete disclosures “deprived investors of material information” needed to fairly assess and make decisions about their investments. These cases highlight the recent SEC focus on disclosures required by Exchange Act Section 14d-9, and ownership disclosures required by Exchange Act Sections 13(d) and 16(a).

In the Matter of CVR Energy, Inc., Respondent (Administrative Proceeding File No. 3-17846, February 14, 2017), the SEC’s order found that CVR Energy made inadequate disclosures in its Schedule 14d-9 filing about “success fee” arrangements it had with two investment banks retained by the company to help defeat a hostile takeover attempt. The order further found that shareholders were unaware of potential conflicts of interest that stemmed from the fee arrangements, as the investment banks could still earn success fees even if the aggressor secured control of the company.

The second case, In the Matter of Jeffrey E. Eberwein, Lone Star Value Management, LLC; Charles M. Gillman; Boston Avenue Capital, LLC; and Heartland Advisors, Inc., Respondents (Administrative Proceeding File No. 3-17847, February 14, 2017), the SEC found that a group of investors failed to disclose their ownership and collaboration in connection with five takeover campaigns involving microcap companies. In each of these takeover efforts, the groups collectively owned more than 5 percent and sometimes more than 10 percent of the companies’ outstanding common stock, yet the required ownership filings to disclose that information to the investing public were either incomplete, untimely, or nonexistent.

Similar to these recent SEC enforcement cases that were based upon incomplete or inadequate disclosures, one aspect of our work in corporate contests looks to understand whether the information provided in a dissident slate’s PREC14A or DEF14A proxy solicitation filing is accurate. As part of our efforts in these matters, BRG experts would necessarily investigate whether the proposed slate was “unaligned” as usually represented in the filing—with no prior arrangements or relationships. We would also seek to understand whether the slate was actually free of conflict—any type of conflict. For example, a candidate’s involvement with a competitor of the corporate board on which he or she seeks a seat may present a conflict, depending upon the nature and depth of the involvement.

In the context of investigating a proposed slate of dissident directors, we would undertake thorough due diligence investigations of each proposed director to identify issues in their backgrounds that may make them ill-suited to serve as a director on the company’s board. We would perform an in-depth review of public records maintained by a number of repositories in an effort to disqualify a candidate from sitting on our client’s board of directors. Obvious issues include a criminal record, regulatory problems, misstatements or inaccuracies in resumes, a history of litigation, or financial mismanagement, such as liens, judgments, or bankruptcies. While these issues are uncovered frequently during the course of our investigative efforts, problems in a candidate’s background are usually not enough to disqualify that person from a board seat.

Other types of issues we try to identify are more nuanced and require an expertise to surface and fully examine. For example, one frequent effort is to examine how a company performed during the time that the proposed board candidate sat on other companies’ boards of directors. A review of earnings, share price, and numbers of employees as compared to competitors in the same space, during the time of the candidate’s board tenure on another publicly traded company, for example, may demonstrate that as a board member the candidate did not increase the shareholder value of that company. A fact such as that may add to the conversation of the candidate’s suitability for a seat on the board of directors of the target company.

With activists seeking board seats in 212 companies last year, up from 186 in 2015,[1] it is expected that investors will be looking for opportunities in 2017 at an equal pace. Our experience in these matters can provide invaluable intelligence in a contest for corporate control long before any enforcement action.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.

[1] Svea Herbst-Bayliss, “CEO Targeted More by Activists but Give Them Fewer Board Seats,” Reuters (February 1, 2017), http://www.reuters.com/article/us-hedgefunds-activists-idUSKBN15G4KH

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