Fighting an Elusive Foe Fighting an Elu sive Foe in the Battle to Ste m Deal Leaks

Code names. Encrytped messages. Sanitized documents. Secure meeting locations. Sounds like elements of a war room. Yet, many m&a professionals view the effort to keep deal talks under wraps as nothing short of a battle, and use tactics like these in trying to protect against leakage of sensitive information. Anyone familiar with the deal negotiation process understands the importance of preventing leaks of confidential information. Leaks, whether deliberate or inadvertent, can affect deal negotiations and pricing, lead to premature termination of deal talks, and spark illegal trading activities. No wonder dealmakers operate in “stealth mode” as they work to cement merger and acquisition agreements. Unfortunately, no matter how many precautions parties to a deal take to prevent information leaks, in some cases word of an impending deal still manages to seep out. While dealmakers generally agree that most people who are privy to deal details guard the confidentiality of the information, they say that there will always be people looking to boast about a transaction or to reap the financial benefits of having insider information. In the fight against abuses of confidential information, human nature is a formidable foe. While financial gain may be the most common motive for abusing confidential information, other reasons for leaking deal information include the desire to run up a deal’s price, scuttle a deal, or even gain prestige. “People have a need to talk. In a competitive environment like m&a, people like to get credit for being involved in deals and for being in the know. It’s human nature to want to be at the center of what’s happening now,” says Jules Kroll, executive chairman of the board of Kroll O’Gara Co., a risk consulting company that is known for its business investigations and intelligence work. His firm was recently hired by Royal Bank of Canada to help investigate suspicious trading that had been done through its investment banking arm, RBC Dominion Securities Inc. Kroll O’ Gara discovered that a person in RBC’s m&a group had been leaking information about impending deals. Although striving to protect deal information may sometimes seem like a Sisyphean task, there are steps that parties to a deal can take to keep information leaks to a minimum. Experts who spoke with Mergers & Acquisitions suggest guidelines for using confidentiality agreements, managing the deal team, setting up “secure” facilities for deal talks, sharing information, and disposing of documents. “Believe it or not, one of the greatest controls against information leakage is setting an appropriate expectation,” says Bill Jennings, director of the Financial Services Group for Kroll O’Gara’s Midwest Region. He says that companies should distribute to all people involved in the deal process confidentiality agreements that clearly explain what inside information is and how one might come into contact with it. Jennings says it is also important that the agreement state that a breach of confidentiality is not only a violation of company policy but also is a violation of the law if a person acts on his or her own behalf and uses that information for financial gain or shares that information with others who then might act on the information. “We have found that most people will try to do the right thing if they understand what the right thing is,” Jennings says. “Unfortunately, in the lack of clear expectations, people have a tendency to rationalize behavior that is sometimes illegal.” Kroll says that deal team leaders must set a tone early in the process on how serious breaches of confidentiality are. “People who do a lot of deal work, like lawyers and bankers, understand the importance of confidentiality. But for some companies, a deal may be a once-in-a-lifetime experience, and employees might not understand the seriousness of this issue.” Art Bert, vice president and co-leader of A.T. Kearney’s Merger Integration Practice, believes in not only briefing the deal team as a whole on confidentiality and the consequences of sharing or acting on confidential information but also in talking one-on-one with each person involved in the deal process. People on the deal team need to realize that once they leave the office it is still impermissible to share certain work-related details – even with spouses, family members, or friends, he adds. Pillow talk and cocktail party chatter can circulate and, if they eventually hit the wrong ears, can lead to trouble. “One thing that the SEC has found is that an employee may talk with a relative or spouse and then that person may talk to someone he or she thinks can be trusted. “By the time you get two, three, or four degrees of separation, the information may reach someone it shouldn’t,” says Greg Benning, managing director and co-head of mergers and acquisitions at Adams, Harkness & Hill. Although leaks can happen at any point during deal negotiations, m&a pros say that they seem to happen most often when there is a significant expansion of the deal team. During initial discussions, there tends to be fewer people involved in the process, but as a deal gets closer to closing, and the “knowledge circle” widens, the risk of leaks increases. “The trick in setting up a deal team is keeping it as small as possible while making sure you have all the skills you need represented on the team,” says Benning. Working face-to-face in a small group in which all team members know each other provides the tightest security, he adds, but it also may compromise a company’s ability to do thorough due diligence. If an m&a team requires a specialized piece of advice, it often can obtain the input it needs without revealing the identities of the companies involved in the deal, says Ron Barusch, a partner at Skadden, Arps, Slate, Meagher & Flom and office leader for the firm’s Reston, Va., office. If a client needs legal advice on a certain aspect of a deal, often a team of lawyers who do not know the deal or the companies involved in it but merely know the legal issue that’s being discussed can give that advice, he adds. Gleaning information that way helps to limit the number of people “in the know.” The Daimler/Chrysler deal is a good example of a transaction in which the slow expansion of the deal team helped keep leaks to a minimum. Sources say that people were brought into the deal team one at a time and were “read the riot act.” Reportedly, there were no deal leaks until a day before the scheduled deal announcement date, which is remarkable for a deal of that size. Leaks can occur in any type of deal, but the chances of information seeping out during a hostile takeover attempt are probably greater than in a friendly deal, says Richard Wool of Sitrick And Co., a financial, transactional, and crisis communications firm. Hostile deals often take longer than friendly transactions to unfold and many times white knights step into the picture, he adds. “The more parties that are involved and the more due diligence that gets done, the wider the circle of people who know about the deal becomes.” Using a secure facility for holding deal meetings helps to preserve secrecy, says Bert. Ideally, the location should be off site from the companies involved in the transaction, he adds. “The more people who are on site, the more suspicion you will arouse,” he notes. Using the offices of the bankers, lawyers, or consultants is a good option, but even within a third-party facility, the deal team should meet in a private place, such as a conference room without windows, with a lock on the door, and with limited access, he remarks. Technology can be both a boon and a bane to dealmaking, m&a experts say. E-mail, cell phones, and fax machines help people relay information quickly and efficiently. Yet, when it comes to sharing sensitive information with fellow deal team members, none of those methods provides a truly secure means of communication. That is why dealmakers recommend using code names for each deal and advise people to not even mention the industries, locations, or individuals involved in the transaction around people who are not working on the deal since names can easily be tied to the companies. While using codes names helps to keep a lid on deal information, Kroll warns that people should choose the names carefully. “They are often so transparent that they virtually spell out who the company is,” he says. Fax machines, another technological advance that many people rely on, are a secure method of transmitting documents only if they have encrypted fax lines. Bert says that even if the person you are sending a document to has the fax machine in his or her office, alert the person that you are sending a fax to and make sure that he or she is standing by the machine to receive it. Dial the number manually and double-check it before you send, he adds. Speed dials can be dangerous because there is always the possibility that the sender will push the wrong button and that the fax will not be sent to the intended person, Bert notes. Also, be careful when leaving voice messages and sending e-mail, because many people have their voice mail and e-mail screened by their assistants, Benning warns. Sending encrypted messages by e-mail, however, is preferable to sending a document by courier, through the mail, or by fax, he notes. “The fewer people who touch something the better, but if you send an e-mail and it doesn’t have the proper security, it is like saying something in a crowded room,” he says. “Information leaks have always been difficult to stem, but technology makes the problem much worse,” says Skadden’s Barusch. As recently as three or four years ago, lawyers hated to send documents by e-mail, he says. Now e-mail has become “essential to our way of life,” although lawyers generally still do not put highly sensitive information in e-mail messages, he asserts. Chat rooms, a way of exchanging information instantaneously, are the bane of existence of many companies, the experts say. They are extremely difficult to monitor and by the time the culprit who has posted messages is tracked down, the damage to the company has already been done. Many dealmakers agree that companies should establish corporate policies about employee participation in chat rooms. Jennings, whose firm has been involved in numerous insider trading and other corporate investigations, recommends that companies engage in an ongoing chat room monitoring program to keep abreast of the information that is posted about them. Dealmakers are often on the road, toting laptops and documents that contain confidential information in taxis, airplanes, and between various work locations. Whenever people transport documents to different work places they open themselves up to risk, A.T. Kearney’s Bert says. “I’ve heard more stories about people forgetting a file in a taxi or on a plane. Even though the person who finds a document may have good intentions of trying to locate the document’s owner, that person is exposed to confidential information in the process of trying to return it,” he says. If people are trying to catch up on some work in a taxi or in an airport lounge, they must be especially careful about retrieving all of their belongings when they’re done working, he adds. Beware of broadcasting your deal in public Bert also says that people should refrain from looking at documents and discussing business in public places. “I find out a lot about what our competitors are doing just by sitting in a hotel lounge. I get more competitive intelligence that way than I do out of any publication,” he asserts. Joele Frank, Managing Partner of Joele Frank, Wilkinson Brimmer Katcher, a takeover communications firm based in New York, says that members of her company are no longer permitted to work on airplanes. She notes that she has been able to view many merger documents just by looking over someone’s shoulder. Another good control against deal leaks is maintaining a system of accountability about who the information has been given to, Jennings says. Later, if the information is used improperly, it makes an investigation easier because “you know who to ask first.” Bert says that he firmly believes in numbering the copies of sensitive documents and making sure that each individual page within a document is numbered. That way, if there is a breach of confidentiality when a page gets out, it can be traced back to whose copy it was from, he notes. People tend to be more careful about handling documents when they have numbered copies, he states. “While you may feel paranoid about taking all of these precautions, there really are people out there to get you. There are people who are actively looking for information that is none of their business,” says Benning. George Kelts, managing partner in charge of Deloitte & Touche’s Merger and Acquisition Services Practice in Northern California, says that lawyers, bankers, accountants, and other professionals involved in a deal generally understand the importance of confidentiality and have well-established procedures in place to prevent leaks from happening. However, at the companies themselves, he thinks it may be harder to keep deal information secure, because many times the companies have never been involved in a deal before and may not have clear guidelines and procedures for keeping information under wraps, he says. “Someone involved in the deal may have an assistant taking materials to a conference room or photocopying, faxing, or mailing documents, so people either learn or figure out what’s going on. When you are part of the senior management of a company, you can’t really say, We might be doing something and if you hear about it, don’t tell anybody.’ That’s too unsettling for the employees,” he says. When it comes to disposing of documents, m&a experts say that shredding is imperative. “People say that they shred everything, but often the documents go off on a big cart to a shredding area where someone eventually gets around to shredding it. That’s not secure,” says Bert. There should be a shredder in the secure work location, and the task of shredding should never be delegated to an assistant. “All of these precautions are things that people take for granted, but I can give you a war story about a confidentiality breach for each one of them,” Bert remarks. Despite all the precautions that they take to prevent leaks, dealmakers concede that sometimes information still seeps out. Whether a leak is inadvertent or deliberate, it still has the potential to jeopardize a deal. In recent months, Telenor, the Norwegian telecommunications company, saw its discussions with SBC Communications Inc. come to a sudden halt when word of a deal leaked out. The companies had been negotiating a possible acquisition by Telenor of SBC’s stake in TDC, a Danish telecommunications company. Unusual trading activity and Internet message-board talk that preceded the announcement of Cisco Systems Inc.’s takeover of ArrowPoint Communications Inc. suggest that news of that deal might have leaked. And Purina Mills Inc., under pressure to explain a sharp rise in its stock price, had to disclose that it was considering an acquisition offer. There are many consequences to deal leaks, but the one that makes the headlines most is insider trading. Although m&a pros say that we are unlikely to see today the type of insider trading activity that achieved widespread notoriety in the 1980s, they assert that there will always be people looking to gain an informational edge – and the ability to use that edge to profit, or avoid loss, in the stock market. Today, insider trading is less characterized by Boeskyesque stings and more often involves financial analysts or lower-level workers at investment banks who pass on tips to friends and family members. Because it believes that insider trading cheats honest investors and undermines public confidence in the stock markets, the Securities and Exchange Commission (SEC) has treated the detection and prosecution of insider trading violations as one of its enforcement priorities. In an effort to bust inside tipsters, the Commission instituted a little-known bounty program in 1989 to reward informants who provide tips that lead to insider trading convictions. Informants get 10% of the civil penalties paid for insider trading violations. Stiffer sentences for white-collar criminals Additionally, the U.S. Sentencing Commission recently proposed doubling prison sentences for insider trading and other white-collar crimes. The new punishments will take effect November 1, unless Congress rejects them. The Commission is proposing that people convicted of insider trading activities exceeding $1 million face up to 5 1/4 years in prison. The current maximum is about three years. Unfortunately, no matter how many safeguards people take to prevent information leaks, dealmakers say it is like fighting an uphill battle to squelch them entirely. There will never be a sure-fire way to prevent people from boasting or trying to make a buck. Even the threat of being turned in for a reward or facing a stiffer prison sentence is probably not enough of an incentive for people to keep their lips sealed. But by adopting a “war room” mentality and taking some precautionary measures, parties to a deal can cut their risk of leaks significantly.