On May 1, 2024, the Delaware Supreme Court issued its decision in City of Sarasota Firefighters’ Pension Fund v. Inovalon Holdings, Inc., reversing the Delaware Court of Chancery’s dismissal of the case under the MFW framework and remanding the case, holding that in order for stockholders to be fully informed — as required for the MFW framework to be effective — all potential material conflicts with a special committee’s financial advisors must be disclosed to stockholders and that a stockholder vote of a majority of the minority does not cure the failure to disclose. This follows the Delaware Supreme Court’s April 4, 2024, decision in In re Match Group Derivative Litigation, where the court clarified that in any controlling stockholder transaction a corporation must satisfy both MFW elements, which are approval of: (i) a special committee that is entirely independent, disinterested, empowered and meets its duty of care in negotiating a fair price, pursuant to a fair process; and (ii) a majority of fully informed and uncoerced minority stockholders.
In Inovalon, the court’s analysis focused on the second MFW element. The issues on appeal were whether: (i) equity incentives for managers of the post-transaction entity were adequately disclosed in the proxy materials; (ii) the special committee’s advisors’ concurrent and prior representations of the acquiror and its equity consortium members were adequately disclosed; and (iii) the special committee’s financial advisor’s role in outreach to potential bidders was overstated in the proxy materials, thus creating the false impression among stockholders that it served as a check on the otherwise conflicted company’s financial advisor. The court reversed the Chancery Court’s decision based on the second issue, holding that the special committee’s financial advisor’s concurrent and prior representations of the acquiror and member of its equity consortium were conflicts and thus material information, the absence of disclosure of which rendered the minority stockholders’ votes uninformed.
Facts
Throughout 2021, Inovalon Holdings, Inc. negotiated a sale to private equity firm Nordic Capital. Upon finalizing the deal, Nordic informed Inovalon that it would require members of management to rollover a portion of their equity. Since management would be rolling over equity, the deal needed to satisfy both MFW mechanisms. A special committee was formed and the special committee continued to consult with Inovalon’s financial advisor that the board as a whole was working with originally to find a merger partner, and a secondary financial advisor that the special committee retained shortly thereafter. Each financial advisor provided relationship disclosures to the special committee regarding prior and concurrent relationships and engagements with the acquiror, but not specifying current relationships and engagements with the acquiror and other members of its equity consortium and only partially disclosing prior relationships and engagements with members of the acquiror’s equity consortium.
The deal closed with Inovalon stockholders voting overwhelmingly to approve the deal. After the closing, stockholders brought the action against Inovalon, Inovalon’s founder and other directors. The Court of Chancery found that the requirements of MFW had been satisfied and dismissed the claims.
The Court’s Analysis
The Delaware Supreme Court held that the Inovalon proxy statement failed to adequately disclose conflicts of both financial advisors. In so holding the court highlighted the similarities between the action and an earlier action, in which the Delaware Supreme Court in March 2024 also reversed for disclosure-related reasons. In the earlier, March 2024 action,the court reasoned that although the financial advisors did not have any then-current engagements with the acquiror (nor did the advisors provide conflicts disclosure letters at the time they were engaged), one financial advisor had received up to $90 million in fees from the acquiror in the two years prior to being retained and owned a nearly half-billion-dollar interest in acquiror-related entities. The conflicted advisor had also earned up to $15 million in fees from the target company during the same time period. The court held that such financial interest in affiliates of a counter party would be material from the perspective of a reasonable investor. The court also held that proxy material’s use of the word “may” in addressing whether the financial advisor had holdings in any of the counter party’s affiliates was misleading.
In Inovalon, the Delaware Supreme Court held that the proxy statement did not adequately disclose the special committee’s financial advisor’s concurrent conflicts with counter parties to the transaction and the company’s financial advisor’s concurrent and past conflicts with counter parties to the transaction. In so holding, the Supreme Court stated, “[i]n this case, it was similarly misleading for the Proxy to state that [the special committee’s financial advisor] ‘may’ provide advisory services to Nordic and [a member of its equity consortium] when, in fact, it was providing such services, and thus there was an actual concurrent conflict. [The special committee’s financial advisor’s] concurrent representation, in unrelated transactions, of Nordic, the bidder of the Company, and the equity consortium member, a co-investor, were material facts.” Left unsaid is how in-depth the conflict check for members of the equity consortium must go. Delaware courts will judge the disclosure of undisclosed conflicts from the perspective of a reasonable investor, which is a fact-specific inquiry.
The court further stated, “[w]e conclude that the Proxy’s statement that [the company’s financial advisor] will receive ‘customary compensation’ in connection with [its] concurrent representations is not sufficient. First, absent disclosure of the amount of the fees, the stockholders could not compare [the company’s financial advisor’s] concurrent fees from counter parties with the fees collected from the Company in this Transaction — approximately $42 million [which] prevented stockholders from contextualizing and evaluating [the company’s financial advisor’s] concurrent conflicts of interest.”
The court also stated “[i]nstead of explicitly disclosing [the company’s financial advisor’s] fees ranging from $348 to $383 million received from members of the equity consortium” during the two years preceding the date of the company’s financial advisor’s opinion, the proxy stated that, during that same time period, “[the company’s financial advisor] and its affiliates have had and continue to have commercial or investment banking relationships with certain affiliates of [the acquiror], including [the acquiror’s] parent company . . . as well as certain affiliates . . . for which [the company’s financial advisor] and such affiliates have received, or will receive, customary compensation. In addition, [the company’s financial advisor’s] commercial banking affiliate is an agent bank and a lender under outstanding credit facilities of certain [other] affiliates . . . for which it receives customary compensation or other financial benefits. Although the Proxy stated that [the company’s financial advisor] has ‘had and continue[d] to have commercial or investment banking relationships’ with [the acquiror] and members of the Equity Consortium, for which it and its affiliates will receive ‘customary compensation[,]’ this disclosure created a misleading impression as to the ‘rough scale’ of the omitted fees. The undisclosed fees were roughly twenty-five times the disclosed fees and ten times the fees earned in the Transaction. By disclosing the amount of fees earned in the prior two years from Nordic — namely $15.2 million — stockholders could be misled into thinking that the undisclosed fees earned in the concurrent representations were of a similar magnitude.”
The court stated that while “there is no hard and fast rule that requires financial advisors to always disclose the specific amount of their fees from a counter party in a transaction,” the court will review the materiality of such information from the perspective of a reasonable stockholder. The court found that in this case that materiality standard was met.
Finally, the court addressed disclosure about the special committee’s financial advisor’s role in the bidder outreach process, which the plaintiffs claimed had been overstated in the proxy. The court held that it would not decide the issue as it had reversed the case on the conflicts issue, but that the overstating of the special committee’s financial advisor’s role in the proxy materials likely was misleading given the conflict of the company’s financial advisor.
Key Takeaway
The Delaware Supreme Court has again made clear that the MFW framework will apply in various controlling stockholder transactions and focused on the need for complete disclosures to address potential material conflicts of interest. The court also clarified what satisfies proper disclosure of material information to minority stockholders where financial advisors face potential conflicts. Proxy disclosures must provide accurate information as to the status of a financial advisor’s relationship with a counter party to a transaction as well as provide a way for stockholders to gauge the magnitude of the financial advisor’s past and concurrent relationships with counter parties, which may take the form of the total value of financial advisory work performed for counter parties.