The Perfect Private Equity Deal

The perfect deal, that’s what many private equity firms are searching for.  That’s, a buyout of a company with years of stable to growing free cash flow, moderately high and defensible profit margins and a management team right out of central casting.

The competition for those perfect deals is intense and results in private equity groups paying relatively high prices to win.  My colleague, Randy Schwimmer, author of the online newletter, “The Lead Left” reports the latest statistics in this excerpt from his recent issue:

Excerpt

For one thing, total leverage seems again to be reaching radioactive levels. Thomson Reuters LPC reports total debt to EBITDA for middle market institutional buyouts “skyrocketed” to 6.5x for the third quarter. Admittedly, that’s on a relatively small sampling, but the statistic points to a broader trend.

Higher leverage is being driven by similarly gravity-defying purchase price multiples. Of the four middle market LBOs where information is available, all were over 12x, and three were over 15x. This speaks to the fierce competition for new properties being engaged in by both private equity and strategic corporate buyers.

How long this lasts is anyone’s guess.   But, while it lasts, if your company fits the criteria, you might consider a sale.

To read “The Lead Left”, a subscription newsletter, click here.

SEC Issues Final Reg A Offering Rules

 

The SEC released its long awaited Final Rules designed to make Reg A offerings a practically useful means for private companies to raise capital.

Reg A defines the conditions under which a private company can raise capital in an offering exempt from the SEC’s registration requirements.

Shares purchased pursuant to Reg A, therefore, are freely tradable post-offering, that is, for securities regulation purposes.  Salability of the shares is still practically limited by the liquidity of the market for the shares.

One of the more attractive features of a Reg A offering is that a company can sell to either non-accredited or accredited investors.  This is a major difference from the restrictions imposed on companies using the 506 exemption from SEC registration.

Under the JOBS Act, the SEC was instructed to update the Reg A rules, now known as Reg A+ rules, which had fallen into disuse.

Reg A+ Offerings

Companies that plan to offer securities under the new Reg A+, must submit an offering statement to the SEC for qualification. 1

The Reg A+ offering statement, however, is far simpler than that required for a registered public offering.2  It will require, however, 2 years of financial statement including balance sheets, income, cash flow and equity statements if the company has been in existence that long.

One of the major changes under Reg A+ is the creation of two tiers of offerings, Tier 1 and Tier 2.

Tier 1 of Reg A+ Offerings

Tier 1 permits offering up to $20 million within a 12 month period.

Tier 1 issuers have essentially no ongoing post-offering disclosure requirements other than reporting on securities sold pursuant to the offering.3

Tier 1 offerings, however, still require state securities regulator review of the offering but under a coordinated review process designed to reduce the state “blue sky” review burden.

Tier 2 of Reg A+ Offerings

Tier 2, in contrast, permits offering up to $50 million within a 12 month period but preempts state securities regulation entirely.

Offerings under Tier 2, require the company to make post-offering filings with the SEC including annual and semi-annual financial statements as well as other material current events. 3

A Tier 2 offering also triggers the requirement that the financial statements in both the offering statement and subsequent annual filings be audited.

Each of Tier 1 and Tier 2 offerings have other limitations, including limitations on secondary selling,  which are explained in the SEC’s press release (click here) and Final Rules (click here).

Final Rules Pg. 143

Final Rules Pg. 118

Final Rules Pg. 160

Morrison Foerster, the law firm, has also posted a useful and readable recap (click here).

The NY Venture Hub also posted a readable article (click here).

Gift to Plaintiff’s Bar

businessgiftSecurities fraud litigation attorneys no doubt welcomed a recent ruling by the Second Circuit Court of Appeals (covering New York and other northeastern states).

This decision enables plaintiffs to sue a public company for securities fraud if the company fails to disclose in its SEC filings trends and uncertainties that it could reasonably expect to have a material impact on revenues.

Public companies already disclose a long litany of potential risks, trends and uncertainties.  The disclosure is so voluminous that it practically diminishes its influence.  It’s overkill.

Under this recent ruling, securities fraud litigation attorneys can use “20/20 hindsight” to claim that a company should have disclosed trends and uncertainties that resulted in problems for the company.

Giving the plaintiffs grounds to sue starts the litigation process which often results in a settlement before trial.  Plaintiff’s counsel typically gets a large portion of the settlement payment.  This gives the plaintiff’s bar the incentive to be aggressive in pursuing cases.

The Second Circuit’s ruling conflicts with rulings in other Circuits.  Until this conflict is resolved by the US Supreme Court, the plaintiff’s bar will likely make the most of the opportunity.

For additional background on the ruling, please click here to read an article by Benesch, the law firm, on JDSupra, the online legal resource.

SEC Rethinks Proxy Access Rules

In a surprising action mid-January, the SEC reversed a decision issued in December of last year on what’s known as proxy access rules.

Proxy access rules define who can and how to submit proposals to public companies for inclusion in the company’s proxy statement. They also describe under what circumstances companies can exclude those shareholder proposals which is the specific issue in the SEC decision reversal.

The battle over these rules has been raging for several years as illustrated by my earlier article on this subject (click here).

Corporations and their counsels had declared victory when they defeated an SEC proposal which would have created clear conditions requiring companies to include shareholder proposals in their proxies. This left companies with great discretion over whether to include shareholder proposals.

To further protect companies, many requested “no-action letters” from the SEC indicating that the SEC wouldn’t challenge the company’s decision on its treatment of the specific shareholder proxy submissions.

This was the status quo until last week (January 15) when the SEC withdrew its “no-action letter” issued to Whole Foods and announced that the SEC was re-evaluating its position on proxy access rules and related “no-action letters”.

The SEC has come under increasing criticism for its inaction on the topic since the defeat of its proposal (see article link above). With shareholder activism gaining greater mainstream acceptance, large institutional investors, including the New York City Comptroller’s Office, which oversees funds with $160 billion in assets, have lobbied the SEC to support greater shareholder influence in proxy content.

The decision to reverse the issuance of the Whole Foods “no-action letter” doesn’t indicate how the SEC will decide on the issue of proxy access rules. The SEC has announced, simply, that it is evaluating its position. Companies rightly fear, however, that it may signal that the current environment favorable to companies may change.

The New York Times “Dealbook” has a good article on this topic (click here).

Sheppard Mullin, the law firm, also issued a good article (click here).

A couple public companies have excluded shareholder provisions despite withdrawal of no-action letters by the SEC (click here) for article by Stinson Leonard Street, the law firm.

Proxy Season 2015 Prep

The beginning of the new year signals that it’s time to think about your 2015 proxy.

The last several years have witnessed interesting developments in the topics and trends of proxies and annual meetings.

While distinct but related, shareholder activism has increased, bolstered by several notable victories last year such as Yum! Brands and Bob Evans Farms.

Fortunately for us, Latham & Watkins, the law firm, provides valuable information about the topics and trends for proxy preparation to help us prepare.

Latham & Watkins is offering a free webinar on preparing for the 2015 proxy season (click here – registration required) and provides a useful write-up on proxy supplements (click here).

Please stay tuned for more developments as we move into the new proxy season.

 

 

SEC’s New “Broken Window” Policy

Applying a phrase from street cop law enforcement, a “broken window” policy, the SEC’s new enforcement zeal for what were considered minor infractions sends a signal which companies need to heed or suffer the consequences.

The SEC now has tools to enable it to identify and pursue a range of issues as described in a recent post on this site (click here).

This has resulted in enforcement actions against companies, board members and executives for:

Stock transaction and ownership reporting rule failures

Audit committee chair reporting failures, and

Corporate officer certification errors.

Failure to heed the message risks you and your firm becoming the next example.

Winston Strawn, the law firm, produced a podcast and slide deck on the SEC’s “broken windows” policy which is worth the review (click here).

Public Company SEC Topics Webinar

LathamWebinarLogo

 

 

 

Board members and corporate executives of public companies will find this webinar a valuable discussion of key issues about the new energized SEC enforcement approach.

Latham & Watkin’s webinar covers many issues and examples including:

  • SEC’s greater use of technology to permit investigation and enforcement of infractions previously unobserved;
  • Increasing use of whistleblower incentives to discover and prosecute infractions;
  • Greater coordination between SEC Divisions including Corporation Finance and Enforcement.

It’s better to be forewarned than to remain unaware and vulnerable.

Click on this link to go to the sign-up page for Latham & Watkin’s “Securities and Exchange Commission: Critical Issues Facing Public Companies” (Duration: 60 minutes)

SEC Charges Two Audit Committee Chairs

In another shot across the bow, the SEC has charged two companies’ Audit Committee Chairs for failing to act on obvious red flags of fraudulent accounting and financial reporting.  Both of the companies were primarily operating in China but the Audit Committee Chairs are US citizens.

While some might be inclined to discount this warning signal because of the China connection, Daniel Goelzer, a partner with law firm Baker & McKenzie and former SEC general counsel and former member of the Public Company Accounting Oversight Board suggests otherwise.

Click here to read the article from Baker & McKenzie from which this excerpt is drawn:

“During the past year, the SEC chair and staff have announced a new focus on gatekeepers, such as attorneys, accountants, and directors, and these cases seem to illustrate how the Commission intends to apply its gatekeepers program to audit committee members,”

Coming on the heels of the SEC charging company executives for false certification (click here), this seems to signal the SEC’s serious intent to enforce its rules rather than look the other way.

Below are links to a Compliance Week article and two SEC documents describing the circumstances and charges of the two cases mentioned.

Compliance Week article: http://www.complianceweek.com/blogs/accounting-auditing-update/sec-charges-two-audit-committee-chairs-for-blind-eye#.VAODSWx0wdU

Agfeed’s SEC Complaint: http://www.sec.gov/litigation/complaints/2014/comp-pr2014-47.pdf

L&L Energy Cease and Desist Order: http://www.sec.gov/litigation/admin/2014/34-71824.pdf

Expanding the Compensation Battle

Compensation paid to management has been a source of contention between companies and shareholders for some time.   This year is no exception as described in recent articles in “The Street” and “Forbes”.

The new front in the compensation battle, however, involves payment to non-executive directors or what directors pay themselves.  A recent lawsuit challenging Facebook’s Board compensation policies is a notable example (click for “Reuters” article).

This battle has been building as described by Michael Melbinger, an attorney with Winston & Strawn on “Lexology” (Click here).  Recent successes by shareholders in shareholder derivative litigation will likely prompt more challenges.

Michael Melbinger notes:

DGCL § 141(h) expressly provides that “Unless otherwise restricted by the certificate of incorporation or bylaws, the board of directors shall have the authority to fix the compensation of directors.” However, that does not prevent shareholders from challenging the amount or form of compensation paid.

Companies are likely to find that when activists challenge management’s compensation, challenging board compensation is likely a next step.

SEC Charges Company Exec’s with False Certification

In a rare case, the SEC has charged the CEO and CFO of Quality Services Group, a computer equipment company, with falsely certifying its financial statements.

The charge stems from an SEC review of the company procedures which revealed that company management misrepresented the state of its internal controls over financial reporting to its auditors, and not from a misstatement of financial results.

Excerpt from SEC Press Release

The Sarbanes-Oxley Act of 2002 requires a management’s report on internal controls over financial reporting to be included in a company’s annual report. The CEO and CFO must sign certifications confirming they’ve disclosed all significant deficiencies to the outside auditors, reviewed the annual report, and attest to its accuracy.

“Corporate executives have an obligation to take the Sarbanes-Oxley disclosure and certification requirements very seriously. Sherman and Cummings flouted these regulatory requirements and misled investors and external auditors in the process,” said Scott W. Friestad, associate director in the SEC’s Enforcement Division.

FierceCFO, the online newsletter noted

Indeed, many companies and executives are likely taking a careful look at internal controls, given the charges the Securities and Exchange Commission levied recently against Quality Services Group, a computer equipment company in Florida.

Click here to read the SEC press release.

Click here to read the FierceCFO article.