Potential Fraud Liability for Merger Agreement Representations and Warranties
A recent Ninth Circuit decision in Glazer Capital Management, LP v. Magistri, 2008 WL 5003306 (9th Cir. (Cal.) Nov. 26, 2008), found that investors may be able to rely on the representations and warranties contained in a merger agreement filed as an exhibit to a company’s public filings as factual statements to investors to support a securities fraud claim. By so doing, the Ninth Circuit has called into question the customary practice by public companies of excluding merger agreement disclosure schedules from public filings.
In light of Glazer, and considering a 2005 SEC report in connection with the settlement of an enforcement action against the Titan Company, public companies should strongly consider including disclosure in the SEC report to which an acquisition agreement is filed as an exhibit disclosing material exceptions to representations or warranties that appear in the disclosure schedules.
Glazer Capital Management
Glazer involved an appeal of a lower court’s dismissal of Glazer Capital Management’s class action securities fraud claims against InVision Technologies, Inc., based on alleged public misstatements made by InVision. InVision was a publicly traded company providing explosive detection systems. On March 15, 2004, InVision announced that it had signed a merger agreement pursuant to which it would be acquired by GE in an all-cash transaction for $50 per share. That same day, InVision filed its annual report on Form 10-K with the SEC and attached a copy of the merger agreement as an exhibit to the Form 10-K.
On July 30, 2004, InVision issued a press release stating that an internal investigation had revealed possible violations of the Foreign Corrupt Practices Act of 1997 (FCPA) in connection with certain foreign sales transactions. Following this announcement, the price of InVision stock dropped by more than $6 per share. On December 6, 2004, InVision announced that it had entered into a nonprosecution agreement with the DOJ and had agreed to pay a fine of $800,000. That same day, InVision and GE consummated the merger.
A few days after InVision’s July 30 announcement, Glazer filed a class action complaint in the Northern District of California that alleged that InVision, along with its CEO and CFO, violated section 10(b) of the Securities Exchange Act and Rule 10b-5 there under by making three alleged statements to investors that were false or misleading. The three statements appeared in the representations and warranties section of the merger agreement between InVision and GE, and included InVision’s representations that (1) it was in compliance in all material respects with all laws, (2) it was in compliance with the books and records provision of the Exchange Act, and (3) neither it nor, to its knowledge, any of its directors, officers, agents, employees, or other persons acting on its behalf had violated the antibribery provisions of the Exchange Act.
The merger agreement explicitly stated that the representations and warranties were qualified by a separate disclosure schedule delivered by InVision to GE simultaneously with the execution of the merger agreement. The disclosure schedule was not filed with the SEC nor otherwise publicly disclosed.
InVision argued that the mere context of the alleged misstatements—representations directed to GE in a private agreement between InVision and GE—rendered them legally incapable of supporting a securities fraud claim by public investors. InVision also pointed to a passage in the merger agreement that provided that the agreement was “not intended to . . . confer upon any [p]erson other than the parties hereto any rights or remedies hereunder.” In addition, InVision referred to language in the merger agreement that expressly qualified the representations and warranties by information contained in the disclosure schedule. InVision argued that, because the disclosure schedule was never released to the public, no reasonable investor would have relied on the representations and warranties contained in the merger agreement as statements of fact.
The Ninth Circuit court ultimately affirmed the dismissal of Glazer’s claims because it ruled that Glazer did not plead facts raising a strong inference that the CEO knew that the representation was false. Nevertheless, the court rejected InVision’s argument that the mere context of the statements in the representations and warranties section of the merger agreement was enough to render the statements incapable of supporting a securities fraud claim as a matter of law. It found that the fact that the merger agreement was a private document and included reference to a nonpublic disclosure schedule would not, as a matter of law, prevent a reasonable investor from relying on the representations and warranties as statements of fact when the merger agreement is filed with the SEC as an exhibit to a company’s public filings.
Public companies can take heart in the court’s ultimate affirmation of the dismissal of Glazer’s securities fraud claims based on Glazer’s failure to plead scienter on the part of InVision’s CEO. However, the court’s conclusion that factual statements contained in the representations and warranties section of a merger agreement may support a securities fraud claim becomes more important in light of the SEC’s section 21(a) report in connection with the settlement of an enforcement action against the Titan Corporation, issued on March 1, 2005.
The Titan Report was issued in conjunction with the SEC’s settlement of an enforcement action against the Titan Corporation, a defense contractor, for alleged violations of the FCPA. The SEC’s stated purpose in issuing the Titan Report was to make clear its view that representations and warranties included in agreements filed or summarized in documents filed with the SEC are statements subject to antifraud liability. The SEC cautioned in the report that the failure to adequately qualify disclosure regarding material provisions of agreements described in public filings or filed as exhibits to or incorporated by reference into public filings may be actionable under sections 10(b) and 14(a) of the Exchange Act and Rules 10b-5 and 14a-9 thereunder.
Best Practices for Disclosure
Public companies should reconsider their approach to public disclosure of material agreements in SEC filings, particularly with respect to whether information contained in disclosure schedules and disclosure letters is omitted from SEC filings. In the wake of Glazer and the Titan Report, companies should strongly consider the following two actions as part of the public filing of acquisition agreements.
First, companies should include a general disclaimer—both in the disclosure document (the proxy statement, Form 10-Q, Form 10-K, or Form 8-K) and in the agreement itself. The general disclaimer should explain when applicable that (1) the representations and warranties contained in the agreement were made for the purposes of allocating contractual risk between the parties and not as a means of establishing facts; (2) the agreement may have different standards of materiality than standards of materiality under applicable securities laws; (3) the representations are qualified by a confidential disclosure schedule that contains some nonpublic information that is not material under applicable securities laws; (4) facts may have changed since the date of the agreement; and (5) only parties to the agreement and specified third-party beneficiaries have a right to enforce the agreement. Note, however, that the SEC has advised that general disclaimers will not protect against a failure to disclose specific facts known to the issuer.
Second, companies should include disclosure of material information, including material exceptions to representations or warranties, contained in the disclosure schedules in their SEC reports to which an acquisition agreement is filed as an exhibit or in which an agreement is described. A company, at a minimum, should ensure that material information contained in the disclosure schedules is disclosed to investors in some way, such as by including separate disclosure in a Form 8-K of material facts appearing in the disclosure schedules that previously have not been disclosed.
Hutchings is a partner in the Seattle office of DLA Piper LLP. His email is firstname.lastname@example.org.
“Keeping Current: Securities: Potential Fraud Liability for Merger Agreement Representations and Warranties,” by Michael Hutchings, 2009, Business Law Today, 18:4. Copyright 2009 © by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
© Copyright 2009, American Bar Association.