If you’re a director of a public company with a controlling shareholder, and that shareholder wants to buy out the rest of the shares, you have a problem. On the one hand, you have fiduciary responsibilities to your non-controlling shareholders to get them the best possible deal. On the other hand: you have a controlling shareholder! He’s controlling! He has inside knowledge that no outside bidder or shareholder can match. He can do stuff like fire you, or make it impossible for you to sell to a higher bidder, or generally make life unpleasant if you reject his bid. He’s got a distinct advantage in negotiating against you, his employee.
Courts and lawyers try to minimize this problem through arid procedural stuff – lots of disclosure and independent directors and majority-of-the-minority votes and “entire fairness” review – but it’s actually just a real problem. You can read about the pending Dole buyout, where founder/CEO/40% shareholder David Murdock wants to buy back his company at an inglorious 18% premium and is carefully following1 all those arid procedural rules, and ask yourself: who cares? Are shareholders really in the same negotiating position as they would be if they were selling an un-controlled company to an outside bidder? Mehhhhh.
But that’s boring and instead you should read today’s astonishing SEC order stemming from the approach to this problem taken by the board of Revlon, a company that at this point is probably more famous for making merger law than cosmetics.2 In 2009, Revlon’s 61% shareholder, Ron Perelman vehicle MacAndrews & Forbes, wanted to buy out the rest of Revlon in a moderately convoluted way.3 So M&F and Revlon negotiated a merger, but that ran aground when Revlon’s M&A banker, Barclays Capital, told Revlon that its fairness committee had said no dice:
Also on May 28, 2009, the Special Committee held a telephonic meeting during which Barclays Capital summarized the views of its fairness committee with respect to the original MacAndrews & Forbes April 13 proposal and the May 26 alternative, based on the status of discussions at that time. Barclays Capital indicated that its internal fairness committee had determined that, if asked, Barclays Capital would not be able to render an opinion that the consideration to be offered to holders of Revlon’s Class A Common Stock (other than MacAndrews & Forbes and its affiliates) in the Merger was fair, from a financial point of view to such holders of Revlon Class A Common Stock.
Savor that! We talked yesterday about how hard it is for junior bankers to nix a fee-paying deal just because it’s a bad idea for the client. It’s not really all that much easier for senior bankers, or even fairness committees: doing business always feels better than turning it down.4 You don’t see banks refusing to provide fairness opinions, for deals their clients want to do, all that often.
You especially don’t see it much in documents sent to shareholders asking them to approve those deals! Because that’s what I was quoting from – Revlon’s September 2009 exchange offer document proposing essentially the same deal that its bankers had refused to bless. The logic here is simple enough: you can’t do a merger without a fairness opinion,5 but you can do the same deal as a tender offer. It’s not necessarily a great idea, when you’re a board of director saying things like “After careful consideration, on September 23, 2009 our Board of Directors … has determined that the Exchange Offer is fair to Revlon and Revlon’s unaffiliated stockholders,” to not have a bank’s fairness opinion backing you up, but you can do it. It’s an even worse idea if you specifically asked a banker to give you a fairness opinion and they specifically said no, but, again, you can do it. I wouldn’t! But here I am with my blog.
Where the SEC comes in is that Revlon’s board apparently decided that it could live with one bank’s conclusion that the deal was unfair, but it drew the line there for some reason.6 Unfortunately, as part of the tender offer, Revlon’s 401(k) plan was required to get a third-party financial adviser to give it an “adequate consideration determination” – basically another fairness opinion – and was not allowed to tender if the financial adviser determined that the consideration was unfair. It seems to have been a foregone conclusion that no bank would conclude that the deal was fair, and Revlon seems to have thought that, if its 401(k) trustee got an inadequate-consideration opinion and told Revlon about it, Revlon would have to tell its other shareholders too, and then they might not tender. Remember: they were already telling their shareholders that Barclays had found the deal unfair. They just couldn’t handle telling the shareholders that another bank had also found the deal unfair.
So they engaged in a series of shenanigans that they hilariously described as “ring-fencing,” “which were acts undertaken by Revlon to avoid receiving an opinion from a third-party financial adviser who ultimately found that the terms of Revlon’s proposed ‘going-private’ transaction did not provide for adequate consideration … to participants in Revlon’s 401(k) plan.” “Ring-fencing” is a word with semi-technical meaning in, like, credit structuring, but here it’s just a stupid phrase for “covering our ears and singing la la la la when anyone talks about the 401(k) plan.”
These approaches were pretty silly:
Revlon proposed to the trustee alternatives to obtaining an adequate consideration opinion from a third-party financial adviser. For example, Revlon proposed that the trustee simply conclude that the exchange offer provided for inadequate consideration without obtaining an opinion, or obtain a legal opinion instead of an opinion from a third-party financial adviser.
So: the board, which was telling shareholders in the exchange offer document that it had concluded the deal was fair to them, was also telling its 401(k) trustee “oh, you can probably just conclude that this deal is unfair without asking anyone, it’s so obviously unfair.”
In an effort to avoid any potential disclosure obligations, Revlon subsequently engaged in several acts designed to keep Revlon out of the flow of information concerning the adequate consideration determination. … First, Revlon proposed and entered into an amendment to the existing trust agreement between it and the trustee. In particular, the trust agreement was amended to mandate that “any reports, documents or other work product (and the contents thereof) prepared by or for the [t]rustee or any such outside advisors shall be the proprietary information of the [t]rustee and shall not be disclosed to [Revlon], its affiliates, any employee of [Revlon] or its affiliates, or any participant in the [401(k) plan] under any circumstances, except as required by a court of competent jurisdiction.” … Second, Revlon directed the trustee to exclusively obtain the adequate consideration determination without any Revlon involvement and without Revlon being a party to the engagement letter with the third-party financial adviser.
Revlon also rewrote the letter the trustee sent to 401(k) participants to omit any mention of a financial advisor or, for that matter, fairness of consideration.7
Of course, the exchange offer document mentions none of this, and instead contains the usual blather about how ““The Board of Directors approved the Exchange Offer and related transactions based upon the totality of the information presented to and considered by its members” and how the independent directors “were granted full authority to evaluate and negotiate the Exchange Offer and related transactions.” The SEC, it probably won’t surprise you too much to learn, considers all of this very fraudy, and so sued Revlon today and entered into a simultaneous settlement for $850,000.
Which … isn’t that much? The fraud here – the failure to disclose these antics – is bad and should be punished and all that. But it’s not that big a deal. The bigger deal is that Revlon’s board, at the behest of its controlling shareholder, approved and advocated (and completed!) a transaction that pretty much everyone agreed was unfair to its public shareholders. There’s not much the SEC can do about that. There wasn’t much the board could do about it either.
SEC Charges Revlon with Misleading Shareholders in Going Private Transaction [SEC and Order (pdf)]
1. Let us pause to acknowledge the Breakingviews headline “Dole buyout harvests fresh Delaware fruit.” Appetizing!
2. The 1986 Revlon case is probably the most famous American M&A law case, finding basically that boards who are selling their company for cash are obligated to get the highest available price.
3. The impetus here was that M&F was also a creditor of Revlon, and no one was happy about that. The idea is that M&F would cancel Revlon’s debt to it, in exchange for more Revlon shares, which Revlon would buy by issuing a weird preferred stock that would eventually be bought out so that shareholders would get cash. For our purposes it’s just: M&F wanted to buy the rest of Revlon, and had some threats (the maturing loan) to help it along.
4. Not for analysts, of course, but you know what I mean. Also, to be fair, it is easier to say no in controlling-shareholder buyouts like this one, just because everyone knows with 100% certainty that they’ll get sued, which focuses the mind on the downside.
5. Another famous merger case says that, basically.
6. Part of the reason is that Barclays DK’ed the merger in May, and the exchange offer was completed in September, and was structurally a little different though substantively basically the same. So Revlon could plausibly say “oh well the Barclays unfairness opinion doesn’t still count now” or whatever.
The Employee Retirement Income Security Act of 1974, as amended (‘ERISA’), and the trust agreement between Revlon and [the trustee] prohibit the sale of Common Shares to Revlon for less than ‘adequate consideration.’ An independent financial advisor has been engaged to determine whether the consideration the Plan will receive under the Offer constitutes ‘adequate consideration’ within the meaning of ERISA. If the financial advisor determines that the Plan would not receive adequate consideration in return for the Common Shares tendered through the Exchange Offer, notwithstanding your direction to tender Common Shares in the Exchange Offer, the Common Shares attributable to your account will not be tendered.
As required by applicable law, [the trustee], as the Plan trustee, will disregard your instructions to tender Class A Common Stock if it determines that following them would result in a non-exempt prohibited transaction under the provisions of the Employee Retirement Income Security Act of 1974, as amended (including the rules, regulations and interpretations thereunder).
Do you know what sorts of things “result in a non-exempt prohibited transaction under the provisions of the Employee Retirement Income Security Act of 1974, as amended”? Would you interpret that sentence to mean “we won’t tender if a financial advisor tells us the price is too low”?