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SHANDLER v. DLJ MERCHANT BANKING, INC. – Delaware Court offers insight into What an Independent Director Should Not Do/Be Posted by esopwebmaster (2010/8/23)

SHANDLER v. DLJ MERCHANT BANKING, INC. – Delaware Court offers insight into What an Independent Director Should Not Do/Be

July 26, 2010, Court of Chancery of Delaware

In this recently released decision, although not rendered in the context of an ESOP company, the Delaware Court of Chancery offered some insight into conduct by a supposedly independent director that it found lacking. The case involves a situation where an investment bank, having acquired a controlling interest in a public Delaware corporation, decided that the best financial move was to spin-off a division by selling it to an affiliate. It should be noted that this court ruling arose in the context of a motion to dismiss prior to trial, in which the court assumed that the facts pleaded by the plaintiffs were true – something that may or may not be sustained after a full trial. As alleged in the pleadings filed by the plaintiff, directors appointed by the investment bank in essence negotiated and structured the preliminary terms of a transaction, engaged an independent law firm and financial advisor, whereupon the board then appointed an independent director who, within the span of 5 days, reviewed the transaction, retained the “independent” law firm and “independent” trustee selected by the board, and then blessed the transaction with the support of a fairness opinion rendered by the financial advisor. While many of the plaintiff’s claims in this case were dismissed, and the remaining claims may ultimately be dismissed, the courts observations about the speed and alleged lack of independent diligence by the alleged independent director and others offer an example of “what not to do” for the independent director, trustee, or other fiduciary involved in an ESOP transaction. The court observed that “As to defendant Ashton, the circumstances of his behavior and interests are sufficiently unusual as to raise an inference that his willingness to jump in as a new board member and
to ratify an interested transaction within five [italicized in court ruling] days of being seated was influenced by his relationships with DLJ. That oddly rapid action may turn out to be evidence merely of an incisive and decisive mind, quick to grasp all material facts and come to a wise decision. But, it may also be evidence of a mindset well captured by Chancellor Allen in his 1990 article in The Business Lawyer about the need for special negotiating committees to act with genuine vigor and independence if they are to fulfill their intended purpose. In that regard, I note that the complaint alleges that Ashton allowed himself to be named by a resolution that simply indicated he had no material relationship with DLJ, while failing to state that he had previously served as the CEO of a private equity portfolio company that a DLJ-related company
controlled.”

The lesson for those involved as fiduciaries in an ESOP transaction is that even though a transaction may be explored, structured, and preliminarily negotiated by the interested parties, when a independent trustee, director, and other financial and legal advisors are brought in, they should not confine their activities to a cursory review and approval, but must take (and be allowed to take) the time and effort necessary to undertake a diligent and independent investigation of the transaction and its terms. These activities can seldom be completed within 5 days (or even a few weeks), thus the parties to such a transaction must either expect an appropriately longer period, or bring these parties into the discussions and negotiations at an earlier stage.

[2010/8/23] Sherburne Tele Systems, Inc. seeks Prohibited Transaction Exemption for Sgare redemption
Application Nos. and Proposed Exemptions; D-11569, Sherburne Tele Systems, Inc.; and D-11597, John D. Simmons Individual Retirement Account; et al. [8/6/2010]
[note-the IRA related application and proposed exemption are omitted from this reprint]

Federal Register: August 6, 2010 (Volume 75, Number 151)]
[Notices]
[Page 47639-47644]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr06au10-129]
...
[2010/8/10] S Corporation Cannot Deduct Accrued Expenses for Related Parties
from: Employee Plans News - August 2, 2010

If an Employee Stock Ownership Plan (ESOP) owns an S corporation’s stock, that S corporation may not deduct any accrued expenses for any ESOP participant, including retirement plan contributions based on accrued compensation.

Under Code §267(a)(2), a taxpayer, including an S corporation, may only deduct an expense in the same tax year that the payment is reported as income by a related party. Under Code §267(e)(1)(B)(ii), a...
[2010/8/2] FR-10 (Fiduciary Responsibility) (ERISA Section 404(a), 405(a)(3), 405(b)(1)(A), 409(a))
FR-10 Q: An employee benefit plan is considering the construction of a building to house the administration of the plan. One trustee has proposed that the building beconstructed on a cost plus basis by a particular contractor without competitive bidding. When the trustee was questioned by another trustee as to the basis of choice of the contractor, the impact of the building on the plan's administrative costs, whether a cost plus contract would yield a better price to the plan than a fixed price...
[2010/8/2] FR-9 (Fiduciary Responsibility) (ERISA Section 412(a), 406(a))
FR-9 Q: May an employee benefit plan purchase a bond covering plan officials?

A: Yes. The bonding requirement, which applies, with certain exceptions, to every plan official under section 412(a) of the Act, is for the protection of the plan and does not benefit any plan official or relieve any plan official of any obligation to the plan. The purchase of such bond by a plan will not, therefore, be considered to be in contravention of sections 406(a) or (b) of the Act.