Securities Snapshot October 23, 2018

DOJ Criminal Division Establishes Updated Standards, Policies, And Procedures For The Use And Selection Of Compliance Monitors

Summary

DOJ Criminal Division establishes updated standards, policies, and procedures for the use and selection of compliance monitors; for the first time, Delaware court finds that “material adverse effect” allows buyer to back out of merger; Delaware Supreme Court clarifies the MFW business judgment rule standard for mergers; SEC launches strategic hub for innovation and financial technology.

DOJ CRIMINAL DIVISION ESTABLISHES UPDATED STANDARDS, POLICIES, AND PROCEDURES FOR THE USE AND SELECTION OF COMPLIANCE MONITORS

On October 11, 2018, Assistant Attorney General Brian Benczkowski of the Department of Justice’s Criminal Division issued a memorandum announcing and establishing standards, policies, and procedures for the use and selection of corporate compliance monitors in matters being handled by prosecutors in the units in that DOJ component. This memorandum supersedes prior guidance contained in a 2009 Criminal Division memorandum, and supplements guidance to all federal prosecutors set forth in a 2008 memorandum issued by then Acting Deputy Attorney General Morford. Consistent with that prior guidance, the Benczkowski memorandum calls for an evaluation of the potential benefits of the imposition of a monitor for both the corporation and the public, while also considering the cost of the monitor and the monitorship’s effect on the company’s operations. The memorandum sets forth that, in evaluating the “potential benefits” of a monitorship, prosecutors should consider, among other factors: (1) whether the misconduct that gave rise to the government’s investigation involved the manipulation of corporate books and records or the exploitation of inadequate compliance or control systems; (2) whether the misconduct was pervasive across the company or approved by senior management; (3) whether the company has made significant investments in, and improvements to, its corporate compliance program and internal control systems; and (4) whether remedial improvements to the compliance program and controls systems have been tested to demonstrate that they would prevent or detect similar misconduct in the future. The memorandum further states that where the company has made leadership changes or taken other remedial measures, prosecutors should consider whether such changes are adequate to safeguard against a recurrence of misconduct. In addition, the new guidance directs prosecutors to consider the unique risks and compliance challenges the company faces, including the particular regions and industry in which the company operates and the nature of its clientele, when assessing the adequacy of the company’s remediation efforts.  Moreover, the memorandum states that in weighing the costs of imposing a monitor versus the potential benefits, prosecutors should consider not only the monetary costs to the particular company, but also whether the proposed scope of the monitor’s role is appropriately tailored to avoid unnecessary burdens. Significantly, the Benczkowski memorandum stresses that “[w]here a corporation’s compliance program and controls are demonstrated to be effective and appropriately resourced at the time of resolution” with the government, “a monitor will likely not be necessary.” 

The Benczkowski memorandum, like prior guidance, details the process for monitor selection within the Criminal Division, which involves a standing committee of Criminal Division leadership, and emphasizes fairness and transparency with respect to that process. In addition, in announcing the policy set forth in the memorandum in an October 12, 2018 speech in New York, AAG Benczkowski stated that the Criminal Division will focus on its training and hiring processes to ensure that prosecutors across the division have knowledge and expertise in compliance issues. Some commentators have suggested that the memorandum’s emphasis on considerations of the burdens of monitorships to companies, and analyses of the particular compliance challenges a company faces in its industry and geographical region, foreshadow a decrease in the number of monitorships the DOJ may impose going forward. In any event, the new guidance is consistent in tone and substance with other DOJ policies announced in recent months that incentivize companies to voluntarily disclose wrongdoing, cooperate with the government and enact effective remedial measures. Along those lines, Goodwin previously analyzed the DOJ’s FCPA Corporate Enforcement Policy and its application to companies that uncover wrongdoing in the context of mergers and acquisitions here.

FOR THE FIRST TIME, DELAWARE COURT FINDS THAT “MATERIAL ADVERSE EFFECT” ALLOWS BUYER TO BACK OUT OF MERGER 

On October 1, 2018, the Delaware Court of Chancery, in Akorn, Inc. v. Fresenius Kabi AG, ruled that pharmaceutical company Fresenius Kabi AG was not required to perform  under its agreement to acquire generic drug manufacturer Akorn, Inc. due to unforeseeable “material adverse effects” to Akorn’s business since the signing of the agreement. In 2017, Akorn and Fresenius signed a $4.75 billion merger agreement, which was subject to various closing conditions. One such condition that allowed Fresenius, the purchaser, to back out of the agreement was a finding that Akorn’s business had suffered a “material adverse effect.”  Relying on this language, and noting that Akorn’s financial performance had declined considerably during the post-signing period, Fresenius refused to close.  Akorn, in turn, filed suit seeking to compel Fresenius to close the merger. The court sided with Fresenius, and held that Fresenius was free to walk away from the deal due to the fact that Akorn’s business had suffered a “material adverse effect.” In particular, the court found that “Akorn’s business performance fell off a cliff, delivering results that fell materially below Akorn’s prior-year performance on a year-over-year basis.” More specifically, quarterly revenue declined significantly year-over-year (between 27% and 34%), as did operating income (between 84% and 292%), and the company faced remediation costs equal to about 20% of its value. The court explained that Akorn’s business problems were “[c]ompany-specific problems, rather than industry-wide conditions,” (Akorn had blamed its issues on unexpected competition and the loss of an important contract) and were “durationally-significant.” Because of these unforeseen adverse effects, the court held that Fresenius was not required to close the deal under the specific terms of the merger agreement.  This case shows that Delaware courts are willing to respect the contract language in merger agreements, and sets forth what kinds of conditions might qualify as “material adverse effects.

DELAWARE SUPREME COURT CLARIFIES THE MFW BUSINESS JUDGMENT RULE STANDARD FOR MERGERS

On October 9, 2018, a Delaware Supreme Court en banc panel, in Arthur Flood et al. v. Synutra International Inc. et al., affirmed the chancery court’s dismissal of a shareholder suit concerning the potential buyout of baby formula company Synutra International Inc. Synutra minority shareholders filed suit in 2017, alleging that the merger deal did not follow the framework established in the Kahn v. M&F Worldwide Corp. case (“MFW”), which allows controlling-party takeovers to be evaluated under the lenient business judgment rule standard if the proposed deal is approved by (1) an independent special committee and (2) a majority of minority shareholders before merger negotiations commence. Here, the plaintiffs contended that an “entire fairness” standard, rather than the “business judgment rule” standard, should apply because the controlling stockholder, in his first expression of interest, had failed to condition the buyout proposal on the satisfaction of the MFW conditions. The plaintiffs argued that the MFW conditions needed to be in place “from inception,” i.e., from the controlling stockholder’s first buyout offer, in order for the business judgment standard to apply. The court rejected the plaintiffs’ argument, ruling that the plaintiffs’ proposed interpretation of when the beginning of buyout negotiations started was too stringent. The court explained that in order for the business judgment rule to apply, the controlling stockholder must have accepted that “no transaction goes forward without special committee and disinterested stockholder approval early in the process and before there has been any economic horse trading.” Thus the court found that, despite the fact that the controlling stockholder, in his initial expression of interest, had failed to condition his buyout proposal on the satisfaction of the MFW conditions, the business judgment standard still applied because the controlling stockholder ultimately met both requirements before any actual negotiations took place. This decision thus supplements and clarifies the MFW-line of cases: plaintiffs cannot focus solely on the “from inception” language found in MFW in arguing for the inapplicability of the business judgment standard, and instead must plead that the MFW conditions were not in place before any substantive economic negotiations commenced, regardless of whether the controlling stockholder failed to condition the buyout proposal on the MFW conditions in his first expression of interest.

SEC LAUNCHES STRATEGIC HUB FOR INNOVATION AND FINANCIAL TECHNOLOGY

On October 18, 2018, the Securities and Exchange Commission announced the launch of the agency’s Strategic Hub for Innovation and Financial Technology, which will be known as “FinHub.” The group will serve as a resource for public engagement on Fintech-related issues, including the use of distributed ledger technology, digital marketplace financing, and artificial intelligence/machine learning. FinHub will be led by Valerie A. Szczepanik, Senior Advisor for Digital Assets and Innovation and Associate Director in the SEC’s Division of Corporation Finance, and staffed by representatives from the SEC’s divisions and offices who have expertise and involvement in these emerging technologies. In conjunction with this announcement, the SEC also established an online form for companies to request meetings and other assistance from FinHub. This initiative emphasizes the SEC’s priority of actively engaging with Fintech companies seeking to navigate the federal securities laws as applied to these emerging technologies.