The Delaware Court of Chancery recently made a series of rulings that underscore the importance of oversight by directors in performing their fiduciary duty of care, particularly as it pertains to financial advisors and their potential conflicts. The decisions highlight the importance of directors being proactive in overseeing their financial advisors, including by requiring that they identify and address conflicts, as well as avoid creating potential informational deficits that exist or that may arise. The decisions likewise reinforce a concept raised in the recent Rural/Metro decision, namely, that financial advisors must ensure that directors are fully apprised of and able to scrutinize the financial advisor’s potential conflicts, or they risk potential liability for aiding and abetting directors’ breaches of fiduciary duty. Moreover, these decisions indicate that financial advisors should try to ensure that directors are performing their oversight function, or such financial advisors risk potential aiding and abetting liability. As we discussed in our recent article on the In re Dole Food Company, Inc. Stockholder Litigation decision, the Court of Chancery lauded both the special committee and its financial advisor for their attempts to overcome an informational deficit and support the special committee in performing its fiduciary duties. It is important to note that each of the three decisions discussed below regarded motions to dismiss, where the court must draw all reasonable inferences in the plaintiff’s favor and accept all well-pleaded factual allegations as true. As a result, the “fact’s” discussed herein should be viewed as allegations accepted as facts for purposes of determining whether to grant a motion to dismiss, rather than facts found by the court after a full trial.
In re PLX Technology, Inc. Stockholders Litigation
In August 2014, Avago Technologies Limited (Avago) acquired PLX Technology, Inc. (PLX) in a $6.50 per share cash merger. A stockholders’ suit followed wherein it was claimed, among other things, that the PLX directors breached their fiduciary duties in the way they conducted the sale process and that PLX’s financial advisor aided and abetted the directors’ breach of their fiduciary duties. According to the plaintiffs, PLX’s sale committee failed to ask its financial advisor to update its potential conflicts since an unsuccessful 2012 sale transaction. In addition, the plaintiffs alleged that one day prior to rendering its fairness opinion, PLX’s financial advisor disclosed to PLX that it (i) had received over $56 million in fees from Avago in the prior three years (versus only $1 million from PLX); (ii) had positions totaling approximately $250 million in Avago’s credit facility and loans; and (iii) was working for Avago at the same time on an unrelated acquisition. On September 3, 2015, Vice Chancellor Laster issued a telephonic ruling in which he declined to dismiss the stockholders’ claims against the PLX directors and their financial advisor. The court noted that, among other things, the directors may have failed to uphold their obligation to oversee their financial advisor, including their obligation to properly inquire about the financial advisor’s potential conflicts. As a result, the directors may have not adequately identified, understood and addressed their financial advisor’s potential conflicts of interest with Avago. The court further found that the financial advisor’s disclosure of its current and former representations of Avago precluded dismissal of the claim that it aided and abetted potential breaches of fiduciary duty by PLX’s directors, because the financial advisor had reason to know that the PLX directors may have been breaching their fiduciary duties by not having information about the financial advisor’s relationships with Avago in time to deliberate and act on that information.
In re Zale Corporation Stockholders Litigation
In an October 1, 2015 decision, Vice Chancellor Parsons permitted a claim that the financial advisor to Zale Corporation (Zale) aided and abetted the breach of fiduciary duties by Zale’s directors for failing to adequately and timely disclose its potential conflicts. The transaction in question was the 2014 acquisition of Zale by Signet Jewelers Limited (Signet) for $21 per share. In October 2013, Signet approached certain directors of Zale about a potential merger between the two companies. The day after Signet’s approach, representatives of Zale’s financial advisor (which had recently served as lead underwriter to Zale, and therefore may have been in possession of confidential information of Zale, but at that point had not been engaged by Zale to assist on the potential merger (although such representatives did not have access to such confidential information and had no knowledge of the approach to Signet)) met with Signet’s CEO and CFO regarding a possible acquisition of Zale at a value of $17–$21 per share. In November 2013, Signet made a formal proposal to Zale, and the latter retained the financial advisor to assist it in evaluating the potential transaction. The lead banker to Zale also participated in the Signet meeting. Although the financial advisor had disclosed to Zale its prior work for Signet, it did not disclose to Zale its meeting with Signet until after the deal was announced. Zale’s board ratified the financial advisor’s conduct and said it did not affect the price negotiations. Nevertheless, Vice Chancellor Parsons found the disclosure untimely and that the plaintiffs sufficiently alleged that the financial advisor “knowingly participated” in the board’s alleged breach of its duty of care. As a result, in his initial ruling he did not grant the financial advisor’s motion to dismiss.
The day after the initial Zale decision was announced, the Delaware Supreme Court issued its decision in Corwin v. KKR Financial Holdings LLC, in which it held that the vote of an informed majority of unaffiliated stockholders will cause the relevant standard of judicial review to go from enhanced scrutiny to the more deferential business judgment. In response, upon a motion to reargue, the Court of Chancery reconsidered its decision in Zale. Vice Chancellor Parsons found that the stockholders knew of the alleged conflict and approved the deal, meaning the question of whether the directors breached their fiduciary duty of care would be reviewed under the business judgment rule. He further concluded that the directors’ conduct did not rise to the level of gross negligence and it was not “reasonably conceivable that the [directors] breached their duty of care.” Without the predicate breach of fiduciary duty by the directors, the aiding and abetting claim against the financial advisor was dismissed.
In re TIBCO Software Inc. Stockholders Litigation
In December 2014, Vista Equity Partners V, L.P. (Vista) acquired TIBCO Software Inc. (TIBCO) for $24 per share, or an aggregate equity value $4.144 billion. When the merger agreement was signed in September of that year, however, both parties thought the aggregate equity value implied by the transaction was $4.244 billion – approximately $100 million or $0.57 per share more than what was reflected in the merger agreement. The discrepancy arose from a mistake in the capitalization spreadsheet for TIBCO that double-counted approximately 4 million shares. Vista used the spreadsheet during its bidding process and the financial advisor used the spreadsheet in preparing its fairness analysis. The error was discovered by the financial advisor after the merger agreement was signed but prior to the closing of the transaction. The financial advisor informed both TIBCO’s board and Vista of the discrepancy, but despite becoming aware that Vista relied on the inaccurate capitalization table when making its offer, the court found that the financial advisor may not have informed TIBCO’s board of Vista’s reliance. The financial advisor subsequently reaffirmed its fairness opinion and the board affirmed its recommendation to TIBCO’s stockholders (96% of stockholders voted to approve the sale). The plaintiffs alleged that the financial advisor’s failure to disclose Vista’s reliance was motivated by its desire to protect its $47.4 million fee, almost 99% of which was contingent on the transaction closing. In his October 20, 2015 decision, Chancellor Bouchard found that TIBCO’s directors may have breached their duty of care in failing to adequately inform themselves after discovery of the error about “certain basic matters one rationally would expect a board to explore to properly assess its options.” This potential breach permitted the aiding and abetting claim against the financial advisor to survive the motion to dismiss. The court found that it was reasonably conceivable from the facts alleged that the financial advisor was “motivated to and intentionally created an informational vacuum” at a critical time, and that in so failing to inform the board, it was reasonably conceivable that the financial advisor knowingly participated in a breach of the board’s duty of care. Notably, however, the court dismissed all other claims, including the claim that the financial advisor owed a duty to TIBCO’s stockholders.
Takeaways
PLX , Zale and TIBCO each reinforce the principle that boards have an obligation to oversee their financial advisors and affirmatively investigate financial advisors’ potential conflicts. In all three cases, the respective boards’ alleged breach of fiduciary duties arose from an informational deficit when making decisions to approve the transactions – an informational deficit allegedly created by the failure of the financial advisors to disclose vital information as well as the boards’ failure to investigate. In each case, the court concluded that it would not dismiss an aiding and abetting claim against a financial advisor if it was reasonably conceivable that the board breached its fiduciary duties as a result of the informational vacuum created by the financial advisor’s non-disclosure.
The PLX and Zale rulings reiterate some of the lessons learned in Rural/Metro, that a financial advisor may be liable for aiding and abetting a board’s breach of its fiduciary duty if it fails to timely disclose all of its potential conflicts to a board. In each case, the court found the financial advisor failed to timely disclose the full extent of its potential conflicts, leading the respective boards to approve the transactions without, allegedly, having material information necessary to make an informed decision. At the same time, PLX and Zale also indicate that it may not be enough for a board to simply inquire into whether the financial advisor has potential conflicts, but also to investigate whether the relationships disclosed by the financial advisor are an actual conflict of interest. In Zale, the court suggested that the board would have been served by “asking probing questions” regarding the financial advisor’s past relationships and/or by requiring representations and covenants from the financial advisor in the engagement letter. The dependency on the actions of the board to avoid potential aiding and abetting liability reinforce the importance of a financial advisor disclosing to the board all potential material conflicts.
TIBCO , while not dealing with the issue of financial advisor conflicts, highlights the symbiotic nature of the board-financial advisor relationship and the importance of disclosure and investigation thereof. The financial advisor’s potential aiding and abetting liability did not stem directly from the error in calculating share amounts but from its alleged failure to disclose to the board that Vista had relied on the incorrect calculations in making its offer to purchase and the board’s alleged failure to appropriately investigate the circumstances surrounding that error. The board’s alleged breach of its duty of care derived not solely from the financial advisor’s non-disclosure but from the board’s alleged failure to investigate whether the financial advisor “had discussed the [calculation] error or its implications with Vista, or … whether [the financial advisor] believed Vista should or would pay the full $4.244 billion [price].” The alleged failure of the financial advisor to disclose, compounded by the alleged failure of the board to investigate, led the board to reaffirm its support for the transaction without having all of the facts necessary to make an “informed” decision – a breach of its fiduciary duty of care. The financial advisor, the court concluded, should have recognized that its disclosure failure and the board’s investigatory failure would result in a breach of the board’s fiduciary duties, and, as such, it was reasonably conceivable that the financial advisor knowingly participated in the board’s potential breach.
In light of PLX and Zale (and Rural/Metro), we believe that financial advisors will likely need to implement policies and procedures that will permit them to keep track of past representations and/or pitches that may constitute actual or potential conflicts of interests (or the mere appearance of a conflict) in connection with possible engagements. An unsettled question, however, is what precisely constitutes a pitch (versus ordinary course of business marketing presentations)? The court did not provide an answer, but we believe it will likely look to the following criteria, among others: (i) whether one target was identified or whether many targets were identified; (ii) whether confidential information was exchanged; (iii) whether there was any overlap between those that made the pitch and the deal team; (iv) whether the pitch included a preliminary valuation; and (v) how far back in time the pitch occurred. Financial advisors should also reevaluate their preferred method of disclosing potential conflicts (i.e., in a disclosure letter, in a pitch book, or as an addendum or a representation and/or covenant in the engagement letter), and how often and at what intervals in a transaction process to update the potential conflicts check.
The recent decisions are milestones in the evolution in financial advisor conflict disclosure rules in the Delaware courts, which we believe harken back to In re Del Monte Foods Company Shareholders Litigation in 2011. In that decision, Vice Chancellor Laster enjoined a stockholder vote in part because the court found that the financial advisor to Del Monte, without the board’s knowledge, manipulated the sale process to engineer the transaction so as to permit it to obtain buy-side financing fees, and such conflict tainted the sale process. The following February, Vice Chancellor Strine issued the In re El Paso Corporation Shareholder Litigation decision, in which the court found that a financial advisor’s disclosed interest was inadequately cabined to fully cleanse its conflict (despite not imposing injunctive relief for the plaintiffs). Two years later, in Rural/Metro, Vice Chancellor Laster found the financial advisor’s undisclosed attempts to solicit a mandate from a key competitor in the target’s industry at least partially led to aiding and abetting liability for the financial advisor. Most recently, the PLX and Zale decisions further explore financial advisor conflicts, likely spurring financial advisors to more fully consider and possibly disclose (i) fees to adverse parties going back further than two years; (ii) current engagements and recent pitches; (iii) the equity and debt positions held by the financial advisor and its deal teams; (iv) whether such relationships apply to investment banking activities only or whether they extend to other relationships outside of investment banking; and (v) social, economic and family relationships. We believe the Delaware courts will continue to explore financial advisor conflicts and related liability, however, and we suggest financial advisors evaluate how they investigate, consider and disclose conflicts in light of these recent decisions.