Litigation, Regulatory Rows Test Advisers Doing Spin-Offs

Risks in corporate spin-offs seem to be mounting. Traditionally, the key legal issue in executing a spin-off was whether the divorce could pass IRS muster to qualify as a tax-free deal. While taxes are as vexing as ever, a batch of spin-offs launched in the last two years have been the centerpieces of much higher-profile controversies involving potentially expensive litigation and regulatory action. Two pending spin-offs underscore the extent of the clouds hanging over them – although as of early July neither parent was slowing plans to cut the ties. They suggest that potential, highly public controversies may have to be considered carefully by lawyers and bankers who structure the splits so the spun-off companies reach the market in the best possible light. Intervention in Medco case One case involves allegations of irregularities contained in lawsuits filed against Medco Health Solutions Inc., targeted for a spin-off by Merck & Co. Medco was sued in two “whistleblower” suits by two Nevada pharmacists who formerly worked for the company and a New Jersey doctor alleging that Medco manipulated or destroyed records, made false statements, and favored Merck drugs, among others. In June, the U.S. Attorney in Philadelphia, which has been investigating the industry for more than four years, said it would intervene in part of the accusations. In the second case, US Bancorp filed a Form 10 with the SEC in connection with its plan to spin off its Piper Jaffray unit and revealed that a probe of “IPO spinning” in the investment banking field is being continued by regulators. The form disclosed that Piper Jaffray itself was being investigated by Nasdaq and was cooperating. Jeff Simek, a spokesman for Medco, said the spin-off was scheduled for completion in the third quarter and that it would not be held up. The U.S. Attorney’s office said it would not seek to have the spin-off held up. The Medco and Piper Jaffray experiences follow two other controversies involving spin-offs that erupted in 2002. HealthSouth Corp. had planned to spin off its surgery center operations but scrubbed the idea after an outburst of criticism by leading investors. HealthSouth subsequently was charged with accounting fraud that led to guilty pleas by several officials and a corporate housecleaning, with the investigation continuing. Early last year, Campbell Soup Co. was accused in a suit by creditors of bankrupt Vlasic Foods that the parent was responsible for the failure. Eric Simonson, an m&a attorney at Kaye Scholer in New York, says he believes these controversies are popping up now simply because more spin-offs are being done. He points out that spin-offs have become an alternate route to restructuring because depressed pricing in the m&a market has discouraged divestitures and the weak IPO market has offered scant prospects for equity carve-outs. Simonson says he does not see much that is new or novel in the legal issues surrounding the litigation-shrouded spin-offs but adds that there may be some challenges to investment bankers setting up the structures of the companies that will go independent. Bankers face new disclosure issue As with any corporate split, he notes, the two primary legal issues are how to allocate the risk and burden of litigation and claims and whether the spun-off firm is sufficiently capitalized to pay its debts. “The legal theories are not novel,” he states. “They are the same things that are dealt with in insolvency and fraudulent conveyance. But with spin-offs, it’s not an arm’s-length situation.” A critical issue, he says, then becomes how the spun-off company will fare in the public markets if it comes with baggage attached. Disclosing all information so the market can make the right valuation decision is critical in this regard. “Rather than carving new law, this may carve new process for bankers,” he says. “How do you best comfort the market and get them excited about a stock? They may have some ideas and lawyers may have to implement them. There might be arrangements for indemnification by the parent, for example.” But he notes that indemnity obligations represent a cost to the parent, and that might not be a cost that anybody would want to incur. Copyright 2003 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com