If you're writing a novel of mergers and acquisitions, you'd be hard pressed to find a better title than "The Board Meets at Midnight." That's a section header in this Securities and Exchange Commission order settling disclosure claims against Lions Gate Entertainment, and really the fun, or more accurately the not-at-all-fun, was just getting started. Lions Gate, a movie studio that was fending off a hostile tender offer from Carl Icahn, had a busy morning on July 20, 2010. The full timeline runs something like:
- 12:01 a.m.: Lions Gate's special committee meets, almost at midnight, to approve a convertible note exchange with Kornitzer Capital Management, exchanging around $100 million of out-of-the-money convertibles for new, at-the-money convertibles.
- "immediately afterwards": the full board meets to approve the exchange.
- 1:07 a.m.: Kornitzer's lawyers send wire transfer instructions to Mark Rachesky, a hedge fund manager, Lions Gate director, former Carl Icahn protégé, and current Icahn enemy, who planned to buy the new convertibles from Kornitzer at about a 5 percent premium to their face value. "The Wire Instructions Were Sent at 1:07 A.M." would be a less dramatic but more representative M&A novel title.
- 1:47 a.m.: Lions Gate asks Kornitzer if it would be willing to exchange its old convertibles for new ones, 40 minutes after Kornitzer sent wire instructions for selling them, and an hour and a half after the board approved the exchange.
- 1:48 a.m.: Kornitzer says it's "amenable" to the exchange. Which seems sort of overdetermined? Obviously this was negotiated long before the 1:47 a.m. proposal.
- 4:00 a.m.: Kornitzer and Lions Gate sign the exchange agreement.
- 6:30 a.m.: Icahn announces a new tender offer for Lions Gate stock at $6.50 per share
- by 9:30 a.m.: Rachesky buys the new notes from Kornitzer.
- by afternoon: Rachesky converts the notes into Lions Gate stock at a price of $6.20 per share. Rachesky gets about 9 percent of the shares now outstanding, increasing his ownership from 19.99 to 28.9 percent and reducing Icahn's ownership from 37.87 to 33.5 percent.
One imagines the directors were tucked into bed by 12:10,1 and that the long night was mostly for the lawyers.
The point of these transactions was to dilute Icahn and get more shares into friendly hands. Kornitzer's out-of-the-money convertibles were not doing anyone any good, and were soon coming due at par. By exchanging them for at-the-money convertibles, and then having them convert, Lions Gate would be issuing a lot more shares (and, sure, reducing debt). By moving them from Kornitzer's hands to Rachesky, and having Rachesky convert into stock, Lions Gate would be putting that much more shares into friendly hands. Kornitzer was happy: It sold its notes at a 5 percent premium. Rachesky was happy: He effectively bought shares at about $6.57, and they were trading above that price within two days.2 And Lions Gate's board was happy: It had effectively sold 16.1 million shares to a friendly holder at $6.20, slightly above the last close, and used those shares to pay down debt.
Also of course it blew up Carl Icahn's hostile tender offer: That offer was conditional on Lions Gate repealing its poison pill, which in turn was dependent on Icahn winning a proxy fight, which did not happen:
At a shareholder’s meeting on December 14, 2010, shareholders elected management’s slate of directors and rejected the slate endorsed by the Shareholder. The margin of defeat for one of the five directors proposed by the Shareholder (who, if elected, would have occupied one of the Company’s twelve board seats) was approximately 16 million shares — the same number of shares the Friendly Director obtained as a result of the July 20 Transactions.
That is cutting it close, I must say, but still, well done.
Was there anything suspicious about this? Quite a bit actually! Carl Icahn was suspicious, pointing out problems with the exchange3 and eventually suing for fiduciary violations. The New York Stock Exchange was suspicious, since you're really not supposed to enter into agreements to issue shares to related parties without getting stockholder approval.4 And the SEC became suspicious enough to go after Lions Gate for being a bit light on its disclosure, eventually settling this case for $7.5 million and an admission of wrongdoing. (Icahn settled long ago, selling his stock to Lions Gate and Rachesky in August 2011 and dismissing his lawsuit.)
How was the disclosure? Mehhhh it was not great. Lions Gate smugly announced the transaction on the afternoon of July 20 in a press release not mentioning Rachesky or Icahn, and instead saying, "The transaction is a key part of the Company’s previously announced plan to reduce its total debt, as well as its nearer term maturities." And it really did reduce total debt! Only one little problem:
Lions Gate had never announced a plan to reduce total debt prior to issuing the press release on July 20, 2010. Contrary to the statement in the July 20 press release, Lions Gate’s prior public filings stated ... the Company was likely to take on more debt ...
The bar is pretty low, but really, if you're going to use a self-serving M&A tactic to prevent a hostile takeover, and claim that it was "a key part of the Company’s previously announced plan to reduce its total debt," the one requirement is that you actually have a previously announced plan to reduce your total debt.5 You can't just be like "oh, you know, that plan, the one we announced on Thursday? Remember? No? Hmm. You must not have been listening." There is a public record of this stuff.
The SEC lists a bunch of other disclosure failures, all of them basically related to the fact that "Lions Gate failed to reveal that the move was part of a defensive strategy to solidify incumbent management’s control" and that "Lions Gate also represented that the transactions were not 'prearranged' with the management-friendly director, and failed to disclose the extent to which it planned and enabled the transactions with the expectation that the director would get the shares."6
Lions Gate also asked that Mr. Icahn disclose information about a "side deal" he allegedly made with Internet entrepreneur Mark Cuban to induce him to accept Mr. Icahn's tender offer and sell his stake in the film studio. Lions Gate identified Joe Francis, creator of the "Girls Gone Wild" video series, as its source of information.
Because I guess if you have back-room tender offer machinations they might as well involve Carl Icahn and Mark Cuban, and if you want to know about them, Joe Francis is the obvious source of information?7
Maybe some other celebrities here are Wachtell, Lipton, Rosen & Katz, Lions Gate's lawyers,8 who tend to be good at mergers and acquisitions, and have a specialty in dealing with hostile takeovers. You'd have to give them some points for creativity in arranging this transaction to keep Icahn out of power, and by the thinnest of margins. But you'd have to dock a lot of points for the disclosure.9 Roughly $7.5 million dollars worth of points. You're not supposed to lie about what you're doing in your disclosure! Especially in the middle of a hostile takeover battle with Carl Icahn! He tends to notice these things! And sue!
Still you can sort of see where they were coming from. Two basic rules of thumb in hostile takeover battles are:
- everything management does is probably done in part as "a defensive strategy to solidify incumbent management’s control," and
- you don't really need to say that.
Because, for one thing, Carl Icahn will say it for you. (He did!) And because, for another thing, it's part of the background of cynical assumptions about all takeover battles: Management just wants to keep itself in power, while the hostile bidder just wants to make a quick buck by buying the company at below its fair value. Everyone knows these things. And if the cynical interpretation of a specific maneuver is hard to figure out, well, the adversarial process will solve the problem. Maybe not every shareholder could figure out what happened in this exchange, but Carl Icahn could, and he made a lot of noise about it.
Of course the SEC doesn't really regulate on the assumption that everyone reads disclosure as cynically as possible; its simpler goal is to have that disclosure be accurate. And while the adversarial process always ends in each side accusing the other of fraud and dishonesty, sometimes those accusations are actually true.
1 The SEC order doesn't specifically say that the meetings were telephonic. Maybe they all met in a law firm conference room? But that seems like a drag. Incidentally this all happens at absurd hours of the night (1) because Icahn and Lions Gate had a standstill that expired at midnight on July 19/20, so this was the earliest it could happen, and (2) because everything in M&A happens at absurd hours of the night, especially everything involving lawyers.
2 Effective conversion math: Rachesky bought $99,718,000 principal amount of notes at a premium, for a total of $105,650,993. These converted at a conversion price of $6.20, for a total of 16.1 million shares ($99.7 million divided by $6.20). Given the price Rachesky paid, his effective cost was $6.57 per share ($105.7 million divided by 16.1 million shares). The stock closed at $6.03 on Monday, July 19, but closed at $6.53 on the 20th after Icahn announced his new tender offer, and at $6.81 by the 22nd.
3 A sampling:
The Lions Gate press release did not disclose that the exchange of the notes was conducted with Kornitzer Capital Management, Inc., which immediately sold the new notes to an investment fund controlled by Mark Rachesky, a director and significant shareholder of Lions Gate. Rachesky’s fund immediately converted the new notes into an additional 16,236,305 Lions Gate common shares. The Lions Gate press release also did not disclose that as a consequence Mark Rachesky acquired these shares at a bargain price, resulting in an increase in his ownership of Lions Gate common shares from 19.9% to 28.9% of the outstanding shares. All other Lions Gate shareholders were significantly diluted as a result of this transaction. Mark Rachesky is a supporter of Lions Gate’s board of directors and senior management. If allowed to stand, this scheme will insulate the directors and management from having to face a fair election at the upcoming annual meeting of Lions Gate’s shareholders.
Mr. Carl C. Icahn stated: “These transactions, in which the board of directors of Lions Gate provided stock that was acquired by Mark Rachesky at the bargain price of $6.20 per share, after recently advising all Lions Gate shareholders not to accept my previous tender offer of $7.00 per share because the price was allegedly ‘inadequate’, have the effect of insulating the existing directors and management from a proxy fight, as well as enriching one director at the expense of all shareholders. I find this scheme especially reprehensible in light of the fact that the board recently advised shareholders that the shares were worth $8.85 per share. ..."
I've omitted a lot of bolding and underlining and whatnot.
4 From the SEC complaint:
On July 28, 2010, the NYSE contacted Lions Gate to inquire whether the July 20 Transactions may have violated Section 312.03(b) of the NYSE Listed Company Manual (“Section 312.03(b)”). Section 312.03(b) requires a company to obtain shareholder approval prior to the issuance of common stock and securities convertible into common stock to a director or to any company in which the director may have a substantial interest when the number of shares to be issued exceeds one percent of the shares of stock outstanding before the issuance. If the July 20 Transactions were a “related transaction” within the meaning of Section 312.03(b), Lions Gate would have been required to submit the July 20 Transactions to all its shareholders for approval prior to executing it -- which it had not done. Lions Gate took the position that the transactions did not require a shareholder vote, which is required by a NYSE rule applicable to large transactions between NYSE-listed companies and related parties, including board members.
On or about September 7, 2010, Lions Gate provided NYSE a draft public disclosure concerning the nature of the July 20 Transactions. This disclosure included the representation that the Exchange of Notes -- the first component of the July 20 Transactions -- was not part of a “pre-arranged series of transactions to issue shares to [the Friendly Director],” but did not disclose other details about the exchange that would have demonstrated the extent to which Lions Gate enabled the exchange and sale of the notes.
5 To be fair, "Lions Gate had consummated and publicly disclosed four debt-reduction transactions between December 2008 and December 2009," which is almost like announcing a plan to reduce debt.
6 It's really pretty bad; here is an amended Schedule 14D-9 filed in September:
The Exchange was on arms-length terms and was not conditioned on the Notes Sale by Kornitzer Capital Management, Inc. to MHR Institutional Partners III LP or the Conversion by MHR Institutional Partners III LP. Each of the parties to the Exchange, the Notes Sale and the Conversion made an independent decision with respect to engaging in the transaction or transactions to which it was a party. The Exchange was not part of a pre-arranged series of transactions to issue shares to MHR Institutional Partners III LP or any other entity affiliated with Dr. Rachesky.
Very little of that seems to have been true, though I suppose some of it was true-ish. (The exchange was not "conditioned on" the sale in the sense that there was no condition in the contract, and they weren't a "pre-arranged series of transactions" in the sense that no formal agreements were made until that night. But, you know. The transactions were pre-negotiated in the week before the deals were signed.)
7 Really, why not? Here is Lions Gate's complaint against Icahn, citing Joe Francis; I cannot in good conscience recommend reading it.
8 And my former employers! Of whom I am quite fond, and whom I hate to criticize.
9 More points might be deducted (1) if Icahn won his fiduciary duties lawsuit (he dropped it, and I'm not sure how strong the fiduciary claim was) or (2) if the New York Stock Exchange found that this deal violated its listing rules (see footnote 4), which ... I don't know, doesn't it kind of look like it did?
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