A Fine Line Between Good News And Deal Hype

Acquirers touting the earnings power and synergistic benefits of their transactions should make sure they can deliver. The 1990s is certainly the decade of the “strategic” merger. Not a day goes by without a new announcement about the latest megadeal, usually involving the bidder’s high-flying stock as currency. It has become almost standard operating procedure for bidders to announce, in relatively great detail, anticipated synergy or efficiency gains and other economic forecasts for the impending marriage. Many of these forecasts are now in the press releases accompanying the signing of deals and are announced well before the formal proxy, registration statement, or tender offer disclosure documents are filed with the Securities and Exchange Commission and distributed to the bidder’s and target’s shareholders. It is fair to say that most of these forecasts are well done, based on reasonable assumptions and data that can be independently tested by the marketplace. But many amount to little more than boxcar numbers backed up by slogans about huge economies of scale, “rationalizations” of surplus employees or assets, new cross-marketing plans, or other fuzzy opportunities, which seem designed primarily to justify a bidder’s assurances that a deal will be accretive to earnings pretty quickly. The reason for these deal forecasts is simple. Bidders, investors, and analysts like them. The forecasts are often what sells – or doesn’t sell – the transaction in the marketplace, particularly when stock is being offered and the bidder is promoting its value on the come. Experience suggests that the numbers indeed influence a shareholder’s decision of whether to vote for the deal or tender shares. And presented properly, these forecasts promote broad and immediate efficiencies in the capital markets as well as level the playing field between the few analysts who may have an inside track with the companies and the rest of the investor community. The old practice for acquirers was to rarely ever mention these types of numbers, at least through “official” channels. Companies feared shareholder litigation if the projected gains never materialized, and in stock deals the SEC strictly enforced a doctrine to prevent “gun-jumping.” In the m&a context, the doctrine essentially straightjacketed companies from discussing the merits of a deal that was not yet in registration with the SEC. But all of this has changed. Because of mounting pressures on dealmakers to release immediate forecasts and other kinds of forward-looking information that began with the big bank mergers of the early 90s, the SEC, in an admirable move, informally relaxed its gun-jumping position to permit dissemination of analyses and forecasts during a brief period after the announcement of the deal. What’s more, the Private Securities Litigation Reform Act of 1995, passed by Congress over President Clinton’s veto, has made it more difficult for shareholders to pursue litigation concerning a company’s forecasts. This also has given companies more confidence in issuing forward-looking statements. The interesting part of all of this is that it is still too early to tell whether several of these strategic deals will work out the way the detailed forecasts even remotely indicate. The continuing bull market certainly has leavened, or even completely buried, the adverse impact of some acquisition failures to date. However, this won’t last forever, and one wonders what will happen down the road when the stock market turns down. Recent studies have questioned the efficacy of these strategic acquisitions, particularly stock deals, from an economic standpoint. It may be that these studies underrate the value of strategic mergers because they tend toward overreliance on cherry-picked and small-bore statistical indicators. Nevertheless, their conclusions will only add fuel to the fire of shareholder discontent in the aftermath of an acquirer’s underperforming stock. What kind of exposure do bidders face? Despite the 1995 Securities Reform Act, a target’s shareholders could advance a securities law claim along the lines that the bidder actually knew that the forecasts were too aggressive, and did not provide enough warning about the risks. Or a bidder’s shareholders could claim that the board of directors violated its fiduciary duty by overpaying for the target and not properly doing its homework about the real consequences of the acquisition. Exhibit A to the litigation would be the roadmap in the form of the published forecasts that didn’t pan out. Moreover, the SEC’s informal liberalization of its gun-jumping rule should not be interpreted as indifference to the content of these forecasts. On the contrary, the SEC’s subsequent review can result in changes to the substance or format of the forecasts, creating exposure for companies whose shareholders traded on the information contained in the press releases disclosing the initial forecasts. In preparing projections and forecasted data on a proposed transaction, an acquirer can take several practical steps to protect itself if the deal’s benefits don’t materialize after the transaction is completed. Gather and disclose backup detail. Specify clearly all material assumptions and the bases, methodologies, and rationales supporting the assumptions. This analysis goes beyond the key drivers, such as sales, profits, costs, restructuring charges, taxes, capital expenditures, interest rates, and the like. For example, identify which assumptions are merely hypothetical as opposed to management’s best prediction of future results. Which assumptions reflect anticipated conditions that depart from current conditions or are not otherwise reasonably apparent? Which assumptions depart from those generally adopted by industry analysts or consultants? Build in hedges. “20/20 hindsight” can always disprove the accuracy of forward-looking statements. But were the predictions misleadingly wrong when made? The 1995 Securities Reform Act, SEC Securities Act Rule 175, Exchange Act Rule 3b-6, and the “bespeaks caution” doctrine adopted by many courts can provide securities law liability protection where appropriate disclosure and warnings are made. These include: *Discussing the key vulnerabilities in the assumptions, with sensitivity analyses where appropriate; *Noting any deviation from or noncompliance with published guidelines regarding forecasts or projections (e.g., the American Institute of Certified Public Accountants, the SEC); *Clarifying that there is no intention to update the predictive information, even if conditions change; *Setting forth applicable limitations concerning the context in which such forecasts were prepared (e.g., with a view to public disclosure; in connection with analysts presentations) or the sources from which the information was derived; and *Identifying, if possible, the projections and related information as “forward-looking statements” within the meaning of the 1995 Securities Reform Act and accompanying them with “meaningful cautionary statements” setting forth important factors that could cause actual results to differ from those in the projections. “Pure heart, empty head” only goes so far. True, the 1995 Securities Reform Act provides liability protection if the plaintiff fails to prove that the information was disclosed by the entity with actual knowledge that it was false or misleading. There are limitations, though. The act doesn’t cover projections in all situations (e.g., financial statements, tender offers, going-private deals, IPOs, and roll-ups), and if the information is egregiously wrong, a court may very well dismiss any warnings and infer that a bidder had actual knowledge of the misleading character of the information. Moreover, the SEC staff usually will insist on an affirmative statement that the projections were prepared in good faith and on a reasonable basis, and request elimination of any disclaimers of responsibility by the entity actually preparing the information. The Reform Act covers federal securities law claims against public companies, and arguably not other allegations like “duty of candor” claims under state law, and as previously noted, misleading or inaccurate projections could be used against a bidder to allege a breach of the fiduciary duty of care under state law if the errors reveal carelessness. Accuracy, therefore, counts. In addition, the disclosed information needs to be consistent in all material respects with the information previously provided to the bidder’s board of directors in analyzing and approving the deal. Avoid selective disclosure problems. Experienced acquirers often file the forward-looking information, whether or not contained in press releases announcing deals, with the SEC promptly so that the information is immediately available to all parties. In stock-for-stock transactions the SEC usually will insist that the information conveyed in pre-filing communications be reflected in the offering documents subsequently filed with the agency. Moreover, if acquirers intend to “sell” the benefits of a stock-for-stock merger before the deal closes and they fear gun-jumping, the buyers often will forego the confidentiality provisions normally afforded to preliminary proxy statements during the SEC review period. Instead, they initially will file a publicly available preliminary prospectus containing the forward-looking information in order to facilitate the selling effort. The lesson for bidders is certainly not to stop doing deals or marketing their benefits. Forecasts are useful disclosure when they are done right. Bidders just need to take a step back from the immediate deal hype and remember that the quick pitch to sell a deal can bear a long and potentially unhappy legacy. So, tell it like it is. In biblical terms, “Be not deceived; God is not mocked; for whatsoever a man soweth, that shall he also reap.” (Galatians 6:7).