IN BRIEF
- Although not groundbreaking as a matter of legal precedent, In Re PLX Technology Inc. Stockholders Litigation offers lessons for all engaged in corporate governance and M&A including managers, directors, activists, advisors, and regulators.
In Re PLX Technology Inc. Stockholders Litigation[1] is not just another opinion out of the Delaware Court of Chancery: it is a parable that captures the zeitgeist of our modern activist epoch. The facts (as established by Vice Chancellor Travis Laster[2]) unfold like a morality play with a familiar and colorful cast of characters and caricatures—the opportunistic shareholder activist fixated on wringing out a quick profit, the exhausted board surrendering to the inevitable, the conflicted banker playing both sides, the complicit lawyers covering up bad process, and the powerful but perfunctory proxy advisors acting as kingmakers. As the actors play their parts, they illuminate the practical realities and complexities of corporate America in the age of activism. Although not groundbreaking as a matter of legal precedent, the case offers “teachable moments” for all engaged in corporate governance and M&A.
The Story
PLX was a small cap Delaware corporation that developed and sold high-tech gizmos (more precisely, specialized integrated circuits used in connectivity applications). After a shareholder activist fund pressured the company to sell itself in 2012, it entered into an agreement to be acquired by a competitor, IDT. That deal was shot down in 2013 by the FTC on antitrust grounds, causing PLX’s stock to plummet. At that point, another activist hedge fund, Potomac Capital Partners, led by one Eric Singer and the antagonist in our tale, bought five percent of the company’s shares at the depressed price (later increasing its stake to 10 percent). Singer’s investment thesis was simple: he read in the proxy statement for the doomed IDT deal that another bidder, Avago, had expressed interest in buying PLX during the “go-shop” market testing period, and so he figured that he could force a sale and make a quick profit.
Singer fired off a series of highly critical public letters against PLX’s management and board of directors and bullied his way into meetings with them, demanding that they sell the company forthwith. He threatened to sue them personally and launched a proxy fight. The influential proxy advisory firm Institutional Shareholder Services (ISS), whose support the court acknowledged is the deciding factor in many proxy contests, endorsed Singer and his slate even though his only plan for the company was a quick sale. Singer prevailed and was elected to the board along with his two other nominees. At Singer’s “request” and with ISS’s support, he was made chair of the special committee formed to explore “strategic alternatives” (often, as in this case, a euphemism for an effort to sell the company).
Soon after that, PLX’s financial advisor was told by a representative of Avago (whom that adviser was separately representing in buying another competitor, LSI) that Avago was in the “penalty box” while it was buying LSI, but once that deal was completed, it would be happy to buy PLX as well. In addition, the representative specified the price that Avago was willing to pay—$300 million, about $6.50 per share—which was less than LSI had offered but well above PLX’s then-trading price. The financial advisor shared that information with Singer, but neither told PLX’s management or the other members of its board.
A few months later, shortly after Avago had closed its purchase of LSI, Avago’s representative met with Singer and offered to acquire PLX for $6.25 per share. As chair of the strategic alternatives special committee, Singer managed the negotiation process and led the board in a few short days to agree to a price of $6.50, exactly what Avago had said it wanted to pay a few months earlier (which fact remained concealed from the rest of the board).
One “major problem” for that deal, the court found, was that PLX management’s existing business plan generated a discounted cash flow valuation far higher than the proposed $6.50 price.[3] The special committee and the financial adviser had management prepare a lower set of projections, which happened to place the $6.50 deal price squarely in the middle of the fairness range, and which the financial advisor then used as its “base case” for its fairness opinion. The board accepted the deal price pushed by Singer even though they had not received the explanation they had requested for the changed business plan. The judge found that there had been a coordinated effort after the fact, including finessing board minutes and coaching witnesses, to characterize the original business plan as an “aggressive” upside case (while the buyer, he noted, continued to treat that as their base case and the revised lower set of projections as the “downside case”).
Thus, the deal was announced and the tender offer launched. No higher bidders emerged (although the agreement did not impose any preclusive deal protections), and the transaction closed with each share being converted into $6.50 in cash. The board’s 14D-9 recommendation statement advocating acceptance of that price had not disclosed that Singer and the company’s investment bankers had been told by Avago six months earlier what it would be willing to pay (or that this fact had been concealed from the rest of the board). It also asserted that the new projections on which the board’s approval of the deal price was based had been prepared “in the ordinary course of business.”[4] The court found both the former omission and the latter assertion materially misleading.
The plaintiffs sued the directors for breach of their fiduciary duties in approving the merger and for breaching their duty of disclosure when recommending the deal, and sued Potomac, the investment banker as well as the buyer Avago for aiding and abetting the directors’ breaches. The claims against Avago and some directors were dismissed, and the remaining directors and investment bank settled, leaving only Singer’s activist fund Potomac to defend the aiding and abetting claim at trial.
The Holdings
The court first held that because of the materially misleading public disclosures in the board’s recommendation statement, the directors’ decisions were not entitled to business judgment deference under the Corwin[5] line of cases. The directors’ actions instead would be subjected to the elevated level of judicial scrutiny under the Revlon[6] standard applicable when a board decides to sell the company that obligates them to seek the transaction offering the best value reasonably available to stockholders.
The court found that the company’s directors breached those fiduciary duties to stockholders by engaging in a sale process without knowing critical information in addition to breaching their duty of disclosure. The judge noted, however, that the directors other than Singer (who were no longer defendants because they had settled or been dismissed) could not be blamed in any morally culpable sense, given that they had been misled by Singer and their own financial adviser. Moreover, the judge noted that the sale process conducted by the board in this case would have fallen within in the range of reasonableness called for by Revlon absent the divergent interests of Singer and the financial adviser, which called for skepticism. In Potomac and Singer’s case, the judge noted that although shareholders are generally aligned in seeking higher value, “activist hedge funds are impatient shareholders” who “espouse short-term investment strategies and structure their affairs to benefit economically from those strategies, thereby creating a divergent interest in pursuing short-term performance at the expense of long-term wealth.”[7] The investment adviser’s conflicts derived from their contingent-fee arrangement and their “longstanding and thick relationship with Avago,”[8] both of which were disclosed, although the earlier price tip (which is what “fatally undermined the sale process”[9]) was not. The financial advisor had also settled before the trial, but both sets of divergent interests had “color[ed] the [c]ourt’s assessment of the decisions that the directors made.”[10]
Turning then to Potomac, the court held that the activist fund, acting through its co-manager Singer, had knowingly participated in—indeed caused—the directors’ breaches of duty by withholding material information from the board and by working to engineer the sale that he had wanted from the outset. The villain had been caught with his little red hands in the cookie jar. So far so good in our parable.
However, then came an unexpected plot twist: despite finding that Singer had acted improperly and caused the board to violate its fiduciary and disclosure duties, the court declined to grant any remedy for shareholders or impose any consequences on Singer or Potomac for their wrongful behavior. This is because the court found that the plaintiffs did not prove any causally related damages. The plaintiffs had argued that the company should have remained a standalone entity and, as such, it was worth more than $6.50 per share. The judge held that they failed to prove that point, and determining that on the record the merger consideration exceeded the standalone value of the company at the time it was sold, entered judgment in favor of the wrongdoers: Singer and Potomac could keep their ill-gotten gains.
The parties cross-appealed, the plaintiffs arguing that Vice-Chancellor Laster erred in not finding damages, and Potomac seeking to overturn the fiduciary breach findings. In a three-page opinion issued on May 16, 2019, the Supreme Court of Delaware affirmed the Court of Chancery’s finding that the plaintiffs failed to prove that they suffered damages and therefore did not need to address Potomac’s cross-appeal arguments. In essence, the Supreme Court determined that it had no basis to overturn the lower court’s decision that because the plaintiffs had not proven damages, Potomac could keep its gains whether ill-gotten or not.
The Moral of the Story
There are several morals that can be drawn from this sordid little tale.
One of them is hopefully not that activist stockholders can get away with unlawful and reprehensible behavior. An activist might be forgiven for concluding that, given the same situation, they can do exactly what Singer did because if they did not succeed in getting the company sold, there would be no claim, and if they did get it sold for a premium, a judge would say “no harm, no foul.”[11]
Many commentators on the corporate side of the debate over shareholder activism celebrated the PLX decision, lauding the Chancery Court’s recognition that activist shareholders often have short-term incentives that are not aligned with those of the shareholder body at large. They were also encouraged by the court’s reiteration that directors representing investors cannot cite their obligations to those investors to dilute their fiduciary duties to the company’s shareholders at large, its finding that Singer violated his duties as a director, and its willingness to hold Potomac liable for its representative’s behavior. There is indeed much to commend in this decision that should at least have activist investors considering whether their own self-interested tactics are consistent with the duties they or their board nominees have undertaken. However, the plaintiffs’ failure to convince the court that the wrongdoers did in fact cause harm to the shareholders is unfortunate.
A large part of the Chancery Court’s reasoning in holding that PLX’s shareholders were not harmed by the sale is that it was merely being true to the recent jurisprudence established in the appraisal context, as emphasized by the Delaware Supreme Court in the Dell[12] case. If the (adequately shopped) deal price is good enough to establish the value of the sold company for appraisal purposes, the argument runs, it should be good enough in the post-closing “quasi-appraisal” context as well. There is, however, a fundamental distinction between the PLX situation and the appraisal context. In a typical appraisal case, the board of directors had determined that the time was right to sell the company, and the question at issue is whether the price obtained in the sale was fair value for the challenging shareholder’s interest. In such a case, for all the reasons enunciated in the Dell and DFC[13] line of cases, it makes perfect sense to give great gravitational weight to the negotiated board- and shareholder-approved deal price. In a case like PLX, however, where an activist forced through the sale of the company, the claim that this was not the right time to sell the company, which would have been more valuable on a standalone basis, has more legitimacy. In most cases, activists who “force a sale” do so by obtaining shareholder support using some combination of financial power, stealth accumulation, bullying or bad-mouthing tactics, and open or covert collusion with their fellow travelers (or “wolf pack”). Given that they typically do not owe fiduciary duties to the other shareholders of the target company, these tactics, however disagreeable, do not amount to a fiduciary breach. (The collusion may violate federal securities laws,[14] but that is grist for a different morality play.) In this case, however, Singer added subterfuge to the usual activist arsenal and did so at a time when he was on the company’s board, thus owing duties both to the company’s other directors and to its shareholders, which he breached. Singer and Potomac’s behavior may well have cost PLX shareholders substantial value by causing the company to be sold before the time was right.
This is not just a hypothetical possibility, although the fact pattern is not one that comes up very often. One prominent example of how activist “value creation” by forcing the sale of a company can in fact be value destructive is provided by the case of Actelion Ltd., a Swiss biotech company. In 2011, Paul Singer’s Elliott Management ran a campaign to force “underperforming” Actelion to sell itself for around $10 billion (a seemingly reasonable premium to its then-market cap of around $7 billion).[15] Fortunately, Elliott was defeated (despite ISS having supported three of his candidates). This defeat allowed Actelion to keep building long-term value and sell itself in 2017 to Johnson & Johnson for over $30 billion, more than three times the value Elliott had hoped to yield.[16] Actelion’s shareholders would have forfeited over $20 billion in value if Paul Singer had used the tactics that Eric Singer used and won his bid to sell the company in 2011. PLX may well have been worth far more on a standalone basis, but the plaintiffs were not able to make that case.
Post-closing damages claims (sometimes called “quasi-appraisal” claims) are—and should be—difficult to sustain. As some recent cases have noted,[17] the Revlon test for board conduct in selling a company was designed with pre-closing injunctive relief in mind and is better suited to that equitable remedy than to post-closing damages awards. In general, plaintiffs seeking to assert that the directors did not satisfy their Revlon duties by designing a process to seek the transaction offering the best value reasonably available, or alleging flaws in the disclosure on which the stockholders’ decision is based, should bring those claims before the closing or the shareholder vote, as the case may be. However, in a case like that of PLX where the company’s management and directors were misled and unaware of the facts that “fatally undermined the sales process,” and so could not possibly have addressed them in designing the sale process or disclosed them to shareholders, there is no way the Revlon or disclosure challenges could have been brought in advance. In such a situation, a damages award against the party that tainted the process and caused the disclosure violations may well be warranted.
The lesson that activist nominees should and hopefully will derive from the PLX decision is that when they join a board, they are undertaking strict fiduciary duties to do what is best for all of the company’s shareholders, not just the investor who nominated them. They are now on judicial notice that the Delaware courts understand that activist investors often have a special interest in a short-term profit that diverges from the interests of the shareholders at large. This, of course, also—perhaps especially—holds true for activists nominating themselves. One possible consequence of this decision is that activists may seek fewer board seats for themselves to avoid the uncomfortable position of having to look out for the best interests of someone other than themselves.
The incumbent directors of the company did not escape criticism even though the judge acknowledged that they were not morally culpable. Recognizing that they had been kept in the dark by Singer and their own financial advisers on crucial facts, he nevertheless disparaged them for deferring to Singer and allowing him to control the process, and for being “susceptible to activist pressure,”[18] noting that they “found within themselves a new willingness to support a sale at prices below the values that they had previously rejected.”[19] Alighting on an incumbent director’s testimony that the board was “engaging in the ‘art of the possible,’” the judge perceived this as being in tension with their Revlon duty to seek the best transaction reasonably available.[20]
One can readily derive lessons for corporate directors from this judicial pen-lashing: stay strong; do not give in to activist pressure or defer to activists who join the board; insist on receiving the information you need to make the decisions you are called upon to make; and be vigilant to the possibility that those advising you, whether they be outside advisers, company management, or even other directors, may have conflicting interests that taint their advice. These lessons are important, and many of these critiques may well be applicable to the PLX board; however, anyone who has been in the trenches with a board facing an activist proxy fight can also sympathize to some degree with these incumbent directors.
As much as our corporate governance system in days of yore may have facilitated passive and complacent clubby boards, our current system is stacked against the incumbents. Unless there is a sizable friendly voting bloc in the boardroom, an activist is often able to declare victory as soon as he or she emerges from the shadows. Our securities laws’ early-warning system that was intended to alert the market to impending changes in control is based on half-century-old technology and fails to pick up the range of derivatives and swap transactions used by modern activists engaging in stealth accumulations.[21] Activists are often able to accumulate stakes close to or even over 10 percent of the outstanding shares by the time they have to unveil themselves. The lead activist is often followed by a wolf pack of “me-too” investors with smaller individual stakes that can add up to a sizable supporting bloc. Sometimes these investors are tipped off by the activist about the impending campaign. After the abuses of the 1980s, people like Michael Milken and Ivan Boesky went to jail for “stock parking” violations[22] not all that different to this, but the “group” concept in our securities laws requires an actual “agreement” (even if that can be just an oral understanding).[23] Modern “alpha-wolf” activists and their wolf packs are usually careful not to lay themselves open to allegations that they had agreed to form a group, thus triggering the filing obligation (within the outdated 10-day window), and they do not have to because they can rely on conscious parallelism based on aligned incentives. Often even when there is an acknowledged “13D group” acting in concert with respect to an activist campaign, the timing of the group’s formation is fuzzy, and the SEC has not been particularly aggressive in policing groups, but has allowed the activists to decide for themselves when in the course of their dealings they have reached a sufficient degree of agreement to consider themselves a formal “group.” Adding to the power of the activist, its group members, and its wolf pack, history shows that there is a high likelihood that the proxy advisors, particularly ISS, will throw their substantial weight behind the activist, at least partially. In most companies’ cases, this assures the activist another 10 to 20 percent in support. Moreover, the proxy rules also allow shareholders considerable leeway to communicate among themselves so long as they do not actually solicit proxies.[24] The result of all this is that by the time the activist files its 13D or summons the company’s leadership for a meeting, both sides already know that the activist has a leg up of 25 or 35 percent, if not more, and the activists can often say with some credibility (although they also often exaggerate) that they have spoken with and received support from a majority of the company’s shareholders. Is it at all surprising in this system that the incumbent board will often feel irresistible pressure to accommodate the activist, even if what is being demanded is not what they themselves might feel is the best path for the company?
In recent years, it has become standard operating procedure for a company attacked by an activist to try to reach a quick settlement on suitable terms, usually involving a number of board seats for the activist’s nominees or mutually acceptable third-party candidates, depending on the parties’ relative strength. This practice of settling quickly has in fact also been criticized, including by leaders in the institutional investor community like Larry Fink, CEO of Black Rock.[25] It is a rational response to the situation facing many boards, however, not only because of the likelihood that the activist will win seats anyway (for the reasons described above), but also because the implications of a nasty proxy fight can be devastating for the company and its strategy. The core skill of economic shareholder activists (in addition to their expertise in stealth accumulations) is their ability to drive change to make something happen. Some activists (ValueAct Capital is a leading example) specialize in working behind the scenes as long as possible and taking their fight public only if they believe it necessary to achieve their goals. Others (Carl Icahn and Paul Singer are prime examples) typically come out of the gate swinging, using aggressive tactics such as poison-pen letters and a withering campaign of personal attacks (sometimes with little regard for the veracity of their assertions). Like any other bully, they know that their ability to achieve their desired outcome is proportional to their ability to inflict pain and spread fear. These tactics do not only inflict a heavy personal toll on the directors and executives targeted (something that arguably goes with the territory and may even in some cases be warranted), but they can also jeopardize the company’s ability to succeed in its chosen strategy, sometimes leaving the activist’s plan as the only viable one.
This is not the corporate governance system one would design if one were writing on a blank slate. The PLX parable therefore also offers teachable moments for those who are empowered with the ability to influence our corporate governance system: the SEC, Congress, state legislatures, and judges. They should be aware of the flaws in our system so that they can try to address them.
At the most basic and practical level, companies and boards of directors can learn from PLX that they must remain extremely vigilant against activist investors, especially at moments of vulnerability. Any event that can cause a temporary drop in stock price creates an opportunity for short-term speculators—like Potomac in this case—to buy in and try to orchestrate a quick profit. Losing an announced transaction as PLX did is an obvious situation for such a risk, but unexpected management changes, natural or man-made disasters, legal pronouncements, announcement of some acquisitions, even missing a quarter by a few pennies, could do it too. Vigilance means having contingency plans, knowing what could happen and how you would respond, knowing who your friends and enemies are likely to be, and having a trusted team on deck to deal with any crisis that may arise.
[1] In re PLX Tech. Inc. Stockholders Litig., CA No. 9880-VCL, 2018 WL 5018535 (Del. Ch. Oct. 15, 2018).
[2] The 70-plus pages of factual findings summarized briefly in this article are, as in any case, based on the record before the judge and his determinations of which witnesses were more credible.
[3] In re PLX Tech. Inc. Stockholders Litig., CA No. 9880-VCL, 2018 WL 5018535 at *2 (Del. Ch. Oct. 15, 2018).
[5] See Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015). See also Singh v. Attenborough, 506 A.2d 151 (Del. 2016); In re OM Group, Inc. Stockholders Litig., 2016 Del. Ch. LEXIS 155 (Ch. Oct 12, 2016); In re Volcano Corp. Stockholders Litig., 143 A.3d 727 (Del. Ch. 2016).
[6] Revlon, Inc. v. Macandrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).
[7] In re PLX Tech. Inc. Stockholders Litig., CA No. 9880-VCL, 2018 WL 5018535 at *41 (Del. Ch. Oct. 15, 2018).
[11] Indeed, at last one article touted this case as a victory for Potomac and activist hedge funds. See Activist Insight, Potomac Capital Scores a Win in Pushing PLX Technology to Sell Itself , ValueWalk, Oct. 19, 2018.
[12] Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017).
[13] DFC Glob. Corp. v. Muirfield Value P’rs., 172 A.3d 346 (Del. 2017).
[14] See, e.g., 17 C.F.R. § 240.13d-102.
[15] See, e.g., Chris V. Nicholson, Investor Urges Shake-Up at Actelion, N.Y. Times, Feb. 4, 2011.
[16] See, e.g., Chad Bray, Johnson & Johnson Bolsters Drug Roster With $30 Billion Actelion Deal, N.Y. Times, Jan. 26, 2017.
[17] See, e.g., Corwin, 125 A.3d at 312 (Del. 2015).
[21] See, e.g., Wachtell, Lipton, Rosen & Katz, Petition for Rulemaking Under Section 13 of the Securities Exchange Act of 1934 (Mar. 7, 2011).
[22] See, e.g., Steve Coll & David A. Vise, Alleged ‘Parking’ Scheme by Milken, Broker Probed, N.Y. Times, Feb. 25, 1989; David A. Vise & Steve Coll, SEC Charges Boesky Trader With ‘Parking’ Securities, Washington Post, Apr. 8, 1987.
[23] 17 C.F.R. § 240.13d-5(b).
[24] See, e.g., 17 C.F.R. § 240.14a-1(l)(2)(iv).
[25] Matt Turner, Here is the Letter the World’s Largest Investor, BlackRock CEO Larry Fink, Just Sent to CEOs Everywhere, Business Insider, Feb. 2, 2016.