Securities Regulation and Corporate Governance

On February 14, 2017, the U.S. Securities and Exchange Commission (the “SEC”) announced the settlement of an enforcement action against CVR Energy, Inc. (“CVR” or the “Company”).  The SEC brought action against the Company for its failure to disclose adequately the material terms of its fee arrangements with two investment banks in connection with the financial advisory services each bank provided to CVR during the pendency of a hostile tender offer launched by an activist.  See CVR Energy, Inc., Exchange Act Release No. 80039 (February 14, 2017).

Notwithstanding the fact that the banks failed to help CVR avoid a takeover by the activist or produce a higher offer price, they collected approximately $36 million in success fees based on the expansive definition of the term “success” set forth in their engagement letters with the Company.  The engagement letters (negotiated with the assistance of CVR’s outside counsel), provided the banks would receive an increased fee in the event the company were sold, regardless of whether:  (i) the final sale price was deemed adequate by CVR’s board, (ii) the banks succeeded in defending against the activist’s bid, or (iii) the banks were successful in causing the activist to raise its bid for the Company.

According to the SEC’s order, CVR violated Section 14(d)(4) and Rule 14d-9 thereunder which require an issuer to summarize the material terms of the compensation arrangements with its financial advisor when disclosing a solicitation or recommendation on Schedule 14D-9 in response to a tender offer.  CVR’s Schedule 14D-9 (prepared by CVR’s outside counsel), indicated the banks’ fee arrangements were “customary.”  The SEC’s order found CVR’s disclosure of customary compensation inadequate under the circumstances noting that it failed to inform CVR shareholders of the potential conflicts of interest arising from the structure of the fee arrangements.

This enforcement action comes on the heels of recent guidance published by the SEC that addresses the appropriate level of disclosure relating to a financial advisor’s fee arrangements in Schedule 14D-9 filings.  On November 18, 2016, the Staff in the Office of Mergers & Acquisitions in the Division of Corporate Finance (the “Staff”) at the SEC released new Compliance and Disclosure Interpretations (“C&DIs”) outlining the Staff’s view of what is appropriate to disclose when summarizing compensation arrangements with financial advisors retained to assist in responding to a registered tender offer.  The C&DIs make clear that “a summary of all material terms” in a Schedule 14D-9 is required.  Even though an advisor may disclaim making a recommendation to or solicitation of shareholders, where the issuer’s board or independent committee retains a financial advisor to advise with respect to a tender offer and the analysis is discussed in the issuer’s Schedule 14D-9, a summary of material terms is required.  In such case, the act of retaining the advisor and discussing the engagement in the Schedule 14D-9 is viewed as sufficient to bring the terms of the advisor’s engagement within the scope of the line item disclosure requirement.

The C&DIs serve as a good reminder to issuers (and their counsel) that boilerplate disclosures with respect to an advisor’s compensation can be deemed inadequate by the Staff.  Specifically, issuers can expect the Staff to challenge vague or general statements in Schedule 14D-9s indicating that an advisor will receive “customary compensation.”  While acknowledging that the appropriate level of disclosure will depend on the facts and circumstances, the Staff noted the summary should be sufficiently detailed to allow an investor to make an informed decision regarding the merits of a solicitation or recommendation, as well as the objectivity of the financial advisors’ analyses or conclusions.

The SEC order in the CVR case advances this point one step further and raises the stakes for including generic or boilerplate disclosure.  Thus, going forward companies confronted with a potential takeover (as well as their counsel), should take great care when negotiating the terms of engagement letters with financial advisors.  The terms should be tailored to the circumstances, including any carve-outs (where appropriate) from the payment of success fees in hostile bids, such that the interests of a company’s financial advisor are aligned with the interests of shareholders.  Moreover, those involved in drafting and approving the disclosure in Schedule 14D-9 statements should ensure the filing contains the appropriate level of disclosure on compensation arrangements with advisors, particularly where such arrangements present a potential for conflicts of interest. 

Special thanks to Eduardo Gallardo, Jason Mehar and Jason Park who assisted with the drafting of this post.