First Rule of Mergers: To Fight Is to Lose

Sean Griffith in The Wall Street Journal, March 26, 2014

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Corporate mergers are often fraught with uncertainty over whether the deal will succeed, culture clashes between the two companies and the fate of executives.

But two things are virtual locks: The companies will get sued by shareholders unhappy with some aspect of the deal, and eventually they will settle with the offended parties without significant changes to the transaction.

Shareholders challenged 94% of U.S. public-company deals last year, up from 44% in 2007, according to Cornerstone Research, a litigation consulting firm. The average deal now faces five lawsuits, often filed in different state and federal courts.

Lawsuits are among the weapons at shareholders' disposal to hold boards accountable. But the recent proliferation of legal actions has diluted their power, people on both sides of these cases say.

"It's a classic case of crying wolf," said Sean Griffith of Fordham University School of Law. "If the goal of the legal system is to add value for shareholders, it's failing."

When Cisco Systems Inc. agreed last July to buy software company Sourcefire Inc., the first shareholder lawsuit came within three days, alleging the price was too low. Three more followed in state and federal court.

The cases settled six weeks later, with Sourcefire agreeing to tell shareholders more about the deal, including how its bankers deemed Cisco's $2.7 billion offer fair. It also agreed to pay $400,000 to the plaintiffs' lawyers. Shareholders got no additional money. The deal closed in October.

The vast majority of these cases settle as Sourcefire's did, with no bump in the deal price. Instead, companies agree to disclose more details and pay shareholders' attorneys' fees, which averaged $500,000 last year, according to Cornerstone. In return, they can close their merger without the threat of a long court battle.

"It's Kabuki theater," said Robert Daines, a former Goldman Sachs Group Inc. banker and now a professor at Stanford Law School. "Everybody knows the moves."

Critics say the system benefits plaintiffs' lawyers, who collect hundreds of thousands of dollars in fees, and defendant companies, who get peace of mind for what amounts to a rounding error in deals that often are valued in the billions.

It is almost always cheaper and less risky for companies to settle, especially when facing lawsuits in multiple courts. One unfavorable ruling can derail a deal for months.

The one group that usually doesn't benefit, at least financially, is shareholders. Out of more than 380 challenged deals since 2011, only four—about 1%—yielded more money for shareholders in court, according to Cornerstone. Some critics warn the increase in litigation actually may hurt shareholders by burying real cases of misconduct in a flood of filings. "Some good suits get missed," Leo E. Strine, Jr. , chief justice of the Delaware Supreme Court, wrote in a paper last year.

In some lawsuits, judges have found troublesome behavior. El Paso Corp. paid investors $110 million after a judge found that conflicts of interest among the company's management and bankers likely tainted its 2012 buyout. Similar claims in the 2011 sale of Del Monte Foods yielded nearly $90 million for shareholders. Neither company admitted wrongdoing.

Just this month, a judge found that RBC Capital Markets LLC manipulated the 2011 sale of ambulance operator Rural/Metro Corp. in an effort to win more fees for itself, a decision that could hand shareholders millions of dollars. RBC has said it acted properly and is weighing its options.

Plaintiffs' lawyers note that in other countries, government regulators review deals for fairness. In the U.S., "nobody is looking out for shareholders except lawyers," said Mark Lebovitch of Bernstein Litowitz Berger & Grossmann LLP, which represents investors.

Still, even some defenders of the system say it can and should work better.

"The plaintiffs' bar has swung too far, and that's a problem," said Stuart Grant, who represented shareholders of El Paso and Del Monte. "It hurts shareholders who have good cases."

The flood of filings may be creating odd incentives. Some critics of companies allege they are deliberately withholding deal details to have fodder for quick settlements.

The issue cropped up in the recent sale of Mako Surgical Corp. to Stryker Corp. Mako's financial projections were missing from the preliminary packet of information sent to shareholders. Courts generally have said shareholders are entitled to these numbers.

Plaintiffs' lawyers accused Mako of deliberately holding back the projections to be able to disclose them later to settle the case. "For them to play 'hide-the-ball' with the shareholders like this is really gamesmanship," lawyer Donald Enright said at a November hearing. The deal closed in December, after Mako made additional disclosures and agreed to negotiate a "reasonable" fee for Mr. Enright's firm and others.

Similar claims have been made in other cases. Some have found sympathetic judges frustrated by what they see as tactical holdbacks.

"You create this situation where the bankers have an incentive to not put in this stuff," J. Travis Laster, a judge in Delaware's business court, said in a 2011 hearing.

Some judges have been pushing back against suits they deem frivolous. The average fee awarded to plaintiffs' lawyers has fallen by nearly half since 2008, according to Cornerstone.

In other cases, judges have rejected disclosure-only settlements. Judge Strine in February refused to approve such a settlement over the sale of Medicis Pharmaceutical Corp. The plaintiffs' lawyers were seeking $400,000, which Medicis had agreed to pay. But Judge Strine said the plaintiffs' lawyers hadn't uncovered any problems with the transaction. "I think at some point in time, you have to candidly say, 'We struck out,'" he said in court.