new jersey bankers’association 2016 annual convention ......may 13, 2016 agenda fiduciary duties...

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New Jersey Bankers’ Association2016 Annual ConventionMergers and Acquisitions

Has the Landscape Changed?

Robert C. Azarow

May 13, 2016

Agenda

Fiduciary Duties

Regulatory Challenges

Approaches to Due Diligence

Shareholder Litigation

Shareholder Activism

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Fiduciary Duties

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Fundamental Duties of Directors

Directors are charged with the overall management ofthe business and affairs of a company and cannotdelegate this fiduciary duty to management orstockholders:– Duty of Care: Directors must perform duties in good faith in a

manner they reasonably believe to be in the best interest of thecompany with such care as an ordinarily prudent person in a likeposition would use under similar circumstances

– Duty of Loyalty: Directors may not act to benefit personalinterests at the expense of stockholders; actions of directorsmust be rationally related to protection of stockholder interest;includes a duty to disclose the existence of a conflict of interest toother directors before acting on a corporate matter (“duty ofcandor”)

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Fundamental Duties of Directors (cont’d)

Benefits of Business Judgment Rule– Courts are reluctant to second-guess the decisions of a diligently

informed board

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Informed Oversight

Courts will consider the following factors in determiningthe level of diligence exercised by the board:– Director attendance at meetings

– Frequency of board meetings

– Directors’ knowledge of subject matter

– Amount of time directors spend deliberating strategicalternatives

– Requests by directors for information from management andadvisors and disclosure by management of material facts

– Discussion of information received and, where appropriate,follow-up requests if information received is insufficient orboard has a concern

– Reliance on advice from financial and legal experts

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Privileged and Confidential

Delaware Law

Three basic legal standards in the M&A context– Business Judgment Rule

– Unocal Standard for Takeover Defenses and Deal Protections

• Have directors reasonably determined a threat to legitimatecorporate interests?

• Is the defensive measure reasonably related to perceived threat?

– Enhanced Judicial Scrutiny in the Sale of a Company (“RevlonDuties”)

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Application to Specific Situations

A. No contact ─ Company is not contacted by, and does not contact any potential acquirers– Even if Board thinks the Company’s business is not doing as well

as it should or could, still no obligation to seek an acquirer; but,board must exercise duty of care when evaluating operationalalternatives for increasing stockholder value

– Board’s primary function is to evaluate business, operational andstrategic alternatives; after doing full evaluation, board can stillelect to stay the course

– If Company not following business plan, Company is notrequired to seek a potential acquirer; but, if the business plannot being followed and Company receives a firm offer with aprice, defense may be weakened

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Application to Specific Situations (cont’d)

B. Consideration of strategic alternatives; canvassing themarket; preliminary negotiations regarding a possiblestrategic business combination with another company– Business judgment rule will apply if no sale of control or decision

to seek a break-up of the Company

– Mere discussions regarding the possibility of engaging in amerger or acquisition transaction will be protected by the BJR

– Board may engage in confidential discussions with potentialacquirer without having made a decision to sell or auction theCompany, provided that maintaining the Company as anindependent entity with a long-term business plan is stillconsidered a viable option

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– If pursuing a merger agreement, standards of reasonablediligence, conscientious fairness and valid business purpose willapply

– Process must be carefully controlled

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C. Decision to auction/sell or seek a break-up of theCompany; initiation of bidding process– Any sale of control decision should be made only in the context

of a bona fide transaction that has been fully negotiated anddiligenced

– Under Delaware law, Revlon duty may be triggered, requiringthe Board to seek to obtain highest value for stockholders

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Regulatory Challenges

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Overview of Regulatory Impact

The increasing costs of regulatory compliance arebecoming prohibitive for many smaller institutions– Compliance program expenses

– Capital requirements

There is future uncertainty regarding the continuedexpansion of compliance regulation and enforcement,especially by the CFPB, and continued “raising of thebar” by all the federal regulators

Regulatory compliance has become a more significantfactor for Boards to think about as they consider theirstrategic alternatives and expansion strategies

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Crossing $10 Billion in Assets

Subject to direct supervision and examination by the CFPB

Subject to debit card interchange fee limit

Must develop and administer the standard Volcker Rulecompliance program

Subject to annual stress tests

Publicly traded U.S. BHCs with > $10 billion in totalconsolidated assets and that are publicly traded are requiredto establish a risk committee of the board of directors tooversee their risk management framework

Loss of offset for effect of increase in deposit insurancepremiums for purpose of increasing Deposit Insurance FundReserve Ratio to 1.35% of estimated insured deposits bySeptember 30, 2020

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Recent Regulatory Developments for LargerInstitutions

Approval/completion of the larger deals

One deal per year limit for mid-size banks– Continues to depress the number of larger buyers at any given

point in time

Post merger closing examinations– Post closing/pre-bank conversion operations under scrutiny

– Status and success/concerns with bank conversion process

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Regulatory Factors in an M&A Application

Financial and managerial resources and future prospectsof the combining and resulting institutions

Convenience and needs of the community to be served

Effectiveness in combating money-laundering activities

Risk to the stability of the United States banking orfinancial system (applicants must address irrespective ofsize of institutions involved)

Competitive analysis

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Traditional Issues That May Prevent/DelayRegulatory Approval

Less-than-Satisfactory Examination Ratings or EnforcementActions

Other Financial Factors

– capital, acquisition debt, source of strength

Other Managerial Factors

– insufficient banking experience, financial responsibility

BSA/AML Compliance

Proposed Business Plan

Section 23A and Regulation W Exemption Requests

Adverse Public Comments related to Consumer Compliance

– Including fair lending and CRA performance

Competitive and Financial Stability Factors

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Recent Trends in Application Issues

Risk Management

Compliance

Governance

Fair Lending

Cybersecurity

Conversion Plans

Pre-conversion Operations

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Results of Application Review

A regulatory review of an M&A transaction applicationmay result in any of the following regulatory responses:– Application approval, subject to standard and/or nonstandard

conditions

– Application suspension pending completion of corrective actionsof identified problems before approval is granted

– Application denial or regulatory request to withdraw theapplication

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The FRB Order Approving M&T/Hudson City

“The Board expects that a banking organization willresolve all material weaknesses identified by examinersbefore applying to engage in expansionary activity. See,e.g., SR Letters 14-2 and 13-7. As noted, M&T’s issueslargely arose during processing of this application, andthe Board took the highly unusual step of permitting thecase to pend while M&T addressed its weaknesses. TheBoard does not expect to take such action in future cases.Rather, in the future, if issues arise during processing ofan application, the Board expects that a bankingorganization will withdraw its application pendingresolution of any supervisory concerns.”

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Parties to bank M&A transactions should evaluate and prepare to

address several structural and regulatory compliance issues prior to

finalizing deal terms

Several regulatory requirements are tied to:

– The size and complexity of the target institution

– Areas of operation

– Products and services offered

Changes to financial institution structure causes changes to risk

profiles and therefore may require changes to regulatory compliance

systems

Must consider the regulatory risk profile of a target institution, and

whether the target’s operations and compliance systems can

effectively integrate with the buyer’s systems

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The seller’s board needs to be aware of any existing or potentialregulatory issues facing the acquiring institution

Before approving a transaction, management should conductadequate due diligence on the buyer focusing on a number of keyregulatory areas, including:

– supervisory history of the buyer and status of any corrective actions that remain outstanding;

– record of compliance and adequacy of programs, policies and procedures, including “hotbutton” issues such as BSA/AML laws and fair lending;

– capital levels and stress test results;

– potential asset quality issues;

– Community Reinvestment Act record and history of consumer activism; and

– for larger institutions, the absence of systemic risk resulting from the proposed transaction.

Parties cannot rely on the historical rule of thumb that a strongbuyer can assuage regulatory concerns about the seller

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Enterprise Risk Management– Assess ability to establish uniform strategic objectives, risk

appetite and culture, and ERM framework post- merger

– Assess ability of target to identify and mitigate risk

– Assess ability of buyer to timely integrate sources of risk

– Strength and depth of ERM team is critical

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Stress Testing Requirement– Requirements change depending on the size and type of the

institution

– $10 billion threshold; $50 billion for BHCs

– Sufficient personnel dedicated to stress testing

– Procedure for creating, administering and reporting test

• Test must be tailored to unique aspects of the institution

• Identify and test key vulnerabilities

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Issues related to organizational structure

– Capital Adequacy Requirements

• Based on risk

• Effect M&A will have on ratios

Overdraft policies of the target institution

– Limitations and restrictions on overdrafts

– Transaction posting process

Privacy and security protections of the target institution

– Identifying and mitigating system vulnerabilities

– Implications of privacy protections of states in which institution had notpreviously operated

– Ability to monitor systems, control access and respond to breaches

Issues presented by activities of affiliates to be acquired

Prominence of insider transactions

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Issues related to residential mortgages and lending

– FCRA, Regulation E, Regulation Z

• Proper disclosure statements and procedures to trigger disclosure

– Community Reinvestment Act

• Target institution’s rating

• New “community” as a result of M&A transaction

– Fair lending requirements

• Risk of disparate impact (discriminatory effect) due to changes to composition of

institution’s customer base

• Loan terms, credit availability, application procedures, lending standards

– Qualified Mortgages and Ability to Repay assessments

• Determining what specific underwriting criteria to use

• What types of mortgages and features will be offered

– Mortgage servicing, loss mitigation and foreclosure procedures

• RESPA

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Issues related to BSA/AML– Compliance requirements tied to combined institution’s size and

complexity

– Robust transaction monitoring system

– Adequate policies, procedures and experience

• BSA Officer’s position in the organization relative to the board ofdirectors and senior leadership

– Legacy compliance issues

• Identified and unidentified by target institution’s regulator

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Key Trends – 2015*

Litigation has declined, but remains elevated– 87.7% of transactions were litigated in 2015 (as compared to

94.9% in 2014)

– The average number of lawsuits per deal was 3.6 in 2015 (ascompared to 4.4 in 2014)

A sharp decline in substantive settlements– In 2014, approximately 96% of settlements reached provided

only additional disclosure (as compared to 81% in 2014)

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*Statistics are for U.S. public company M&A activity (deals valued over $100 million).

Source: Matthew D. Cain and Steven Davidoff Solomon, “Takeover Litigation in 2015 (Preliminary Figures)” (January 14, 2016).


Key Trends – 2015 (continued)*

Dismissals have increased– Dismissals (both voluntary and otherwise) increased to 46% in

2015 (as compared to 32% in 2014)

Decrease in the value of awards for “disclosureonly” settlements– Average value of $362,000 in 2015 (as compared to $390,000 in

2014)

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*Statistics are for U.S. public company M&A activity (deals valued over $100 million).

Source: Matthew D. Cain and Steven Davidoff Solomon, “Takeover Litigation in 2015 (Preliminary Figures)” (January 14, 2016).


The Future of Disclosure-Only Settlements in Delaware

In re Riverbed Technology, Inc.

– On September 18, 2015, Vice Chancellor Glasscock stated thatplaintiffs and defendants should no longer expect the ChanceryCourt to approve disclosure-only settlements

In re Aruba Networks, Inc.

– On October 9, 2015, Vice Chancellor Laster not only rejected aproposed disclosure-only settlement, but also dismissed the suit

In re Trulia, Inc. Stockholder Litigation (January 22 2016)

– disclosure settlements are likely to be met with continued disfavorunless supplemental disclosures address plainly materialmisrepresentations or omissions − immaterial modifications to deal protections will likely not convince the Court

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Shareholder Litigation – The Warning Shot

“ACQUISITION OF ASTORIA FINANCIAL CORPORATION (AF) BY NEW YORKCOMMUNITY BANCORP INC. (NYCB) MAY NOT BE IN SHAREHOLDERS’ BEST

INTERESTS

Robbins Arroyo LLP’s investigation focuses on whether the board of directors at AstoriaFinancial is undertaking a fair process to obtain maximum value and adequately compensate itsshareholders. The $19.66 merger consideration represents a premium of 18.8% based onAstoria Financial’s one-month average closing price prior to rumors of the deal surfacing in themedia on October 23, 2015, which is below the average one-month premium of nearly 22.4%for comparable transactions within the past five years.

In light of these facts, Robbins Arroyo LLP is examining Astoria Financial’s board of directors’decision to sell the company now rather than allow shareholders to continue to participate inthe company’s continued success and future growth prospects.

Astoria Financial shareholders have the option to file a class action lawsuit to ensure the boardof directors obtains the best possible price for shareholders and the disclosure of materialinformation.”

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Common Allegations

Target’s Board of Directors violated its fiduciary dutiesby conducting a flawed sales process that failed tomaximize shareholder value

Failure to conduct a sufficiently competitive sale

Existence of restrictive deal protections that discouragedadditional bids

Conflicts of interest (such as executive retention post-merger or change in control payments to executives)

Failure to disclose enough information about the saleprocess and the financial advisor’s valuation

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Potential Responses

Limited discovery (may include depositions)

Summary judgment motion

Amend merger proxy disclosures (depends on timing)

Settlement

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Shareholder Activismin the Banking Industry

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Activists in the Financial Sector

Basswood Capital Management

Lawrence Seidman

Stilwell Group

PL Capital

Trian Fund Management

Clover Partners

Greenlight

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Trends

Activism is on the rise across all public companies

Financial services industry continues to be a target

Larger banking institutions are increasingly fair game

Common traits: lagging stock price, total returns andbelow median fundamentals

Proxy fight success rates are rising

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Tactics

Activist investors may employ a variety of tactics to pursue theirobjectives. Their initial approach can range from private and moderateto public and hostile.

– accumulating a non-disclosable ownership stake of less than 5%

– filing a Schedule 13D

– privately seeking value enhancers (i.e., repurchase program, sale/leaseback ofbranches, etc.)

– formally submitting a shareholder proposal

– conducting a withhold-the-vote campaign or demanding the formation of acommittee of independent directors to review strategic alternatives for the target

– conducting a negative public relations campaign

– demanding board representation or engaging in a formal proxycontest

– enlisting proxy advisory firms to support dissident action

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Responses

Letter to activist – Just Say No (predicated onBoard-approved business plan)

SEC disclosure/PR campaign

Proxy campaign

Takeover defense review and implementation

Negotiation/settlement

White knight

Institutional support

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Advance Planning

Bylaw review of director nomination process

Stock watch -- track institutional investment

Periodic Board preparation/review of defense strategieswith counsel

Understand tendencies of your institutional shareholders

Pro-active discussions with institutional/largershareholders

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new jersey bankers’association 2016 annual convention ......may 13, 2016 agenda fiduciary duties...

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