United States: Don't Jump The Gun On Post-Merger Compensation Arrangements

Last Updated: November 7 2019
Article by Michael S. Melbinger

We all know that plaintiffs' lawyers file lawsuits following the announcement of every public company merger or acquisition (so-called "strike suits"). Occasionally, the allegations in one of these lawsuits involve potential conflicts of interest created by compensation arrangements proposed or negotiated before the stockholder vote—and not disclosed to stockholders.

Earlier this year, a federal appellate court decided such a case, the facts and alleged facts of which may be helpful to compensation professionals navigating these treacherous waters. In Regents of the University of California v. Willis Towers Watson PLC (In Re: Willis Towers Watson PLC Proxy Litigation), the Fourth Circuit Court of Appeals, in a 2-1 split decision, vacated the district court's judgment in favor of the defendants and sent the case back to the lower court for further proceedings. 

Towers, Watson & Co. and Willis Group Holdings merged to form Willis Towers Watson (WTW) in 2015, in a transaction primarily negotiated by the CEOs of Towers and Willis.  A major investor in Willis and its CEO also were closely involved in the negotiations.  The merging companies agreed that among other points:

  • Willis shareholders would own 50.1% of WTW and Towers shareholders would own 49.9% and receive a dividend of $4.87 per share,
  • The Towers CEO would be CEO of the combined company, and 
  • The CEO of the major investor would be a director and serve on the Compensation Committee.

Towers stockholders would own a minority of WTW even though Towers was a more valuable company than Willis, which led to criticism of the proposed transaction.

After the public announcement of the proposed merger, but before filing the proxy statement for the stockholder vote on the merger, the Towers CEO met with the CEO of the major investor and apparently, discussed a proposed compensation plan with the Towers CEO under which he "stood to receive up to $165 million in compensation over three years, depending on WTW's performance. This represented a more than six-fold raise over the $25 million he stood to make as CEO of Towers." Further, apparently, this was not disclosed to the Towers directors or shareholders.

After some Towers stockholders, analysts, and investment management firms recommended a vote against the merger, the Towers CEO approached Willis and the major investor about renegotiating the merger terms. According to the plaintiffs, the Towers CEO never intended to negotiate the best deal for Towers stockholders. "Instead, he sought only the minimum concession necessary to convince Towers shareholders to approve the merger." The parties negotiated an increase in the dividend to $10.00 from $4.87 per share.

After Towers stockholders approved the merger, the WTW's board initiated share buybacks and crafted a compensation plan for Haley that was substantially similar to what Ubben had proposed before the merger.  

The plaintiffs sued, alleging that Towers' CEO, its chief negotiator, had a significant conflict of interest that arose from his secret compensation arrangement, and that conflict of interest motivated him to close the deal even if the terms were unfavorable to Towers stockholders. The court observed:

There is a substantial likelihood that a reasonable shareholder would have found this undisclosed conflict to be a material change to the total mix of information available, especially if the conflict caused [Towers CEO] not to seek the best possible merger terms for Towers shareholders.  In fact, plaintiffs allege that before the shareholder vote on the merger, a major shareholder asked the Towers board about any coordination or negotiation between [Towers CEO] and ValueAct. And a Towers board member later stated in a deposition that he would have wanted to know about compensation negotiations between [Towers CEO] and ValueAct.

The defendants and the dissenting judge characterize the plaintiffs' allegations of a secret compensation agreement as conclusory and therefore not worthy of crediting on a motion to dismiss. But the majority did not agree.

Importantly, this is not a final decision or even a decision on the merits. It is only a decision that requires the federal district court judge to reconsider whether to allow the case to go forward. As the court expressed it: 

A jury could thus reasonably conclude that disclosing the secret compensation discussions between [Towers CEO] and Ubben would have changed the total mix of information available to shareholders.

A reasonable jury could nonetheless find that Ubben's influence over [Towers CEO's] compensation was enough to convince [Towers CEO] to agree to unfavorable terms for shareholders in order to secure a lucrative compensation package for himself.  Reasonable shareholders could consider that influence a material addition to the total mix of available information.

The moral of the story is: try to avoid detailed discussions of post-merger compensation with executives, especially any executives capable of influencing the negotiations, and if such conversations occur, be certain to disclose them.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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