An influential Delaware court dealt a blow to Royal Bank of Canada, ruling that the lender’s U.S. capital markets arm misled investors while acting as an adviser in a private equity buyout.
In June 2011, Warburg Pincus LLC bought Rural/Metro Corp. for $677-million (U.S.). The target, based in Scottsdale, Arizona, provides fire and ambulance services. RBC Capital Markets, a U.S. investment bank, was hired by Rural/Metro to advise a special committee formed by the company’s board of directors to help weigh strategic alternatives.
While serving as an adviser, RBC also sought to do business with Warburg Pincus, the ultimate buyer, by offering to provide debt financing to fund its purchase of Rural/Metro.
Despite the conflicts of interest resulting from working on both sides of the transaction, RBC did not disclose its attempts to woo Warburg Pincus in the takeover’s proxy circular. By failing to do so, RBC has been found liable of “aiding and abetting breaches of fiduciary duty” by Rural/Metro’s board of directors.
To illustrate why a failure to disclose matters, the Delaware court noted that proxy advisory firms such as Institutional Shareholder Services Inc. and Glass, Lewis & Co. assumed that the company completed a thorough auction process and that there were no conflicts of interest, which influenced their recommendations. Both firms advise shareholders who have to vote on takeovers.
Moreover, Rural/Metro theoretically could have fielded higher buyout prices if Warburg Pincus wasn't treated as a preferential bidder.
“RBC‘s actions resulted in stockholders voting on the merger based on a proxy statement that contained materially false disclosures and omissions about RBC‘s valuation analyses and conflicts,” the ruling stated.
“We have reviewed the opinion and are considering our options,” RBC wrote in an emailed statement. “This process is not yet over so we cannot comment further.”
Both Rural/Metro’s board of directors and Moellis & Co. LLC, who served as an adviser alongside RBC, settled out of court, but RBC let the case go to trial. The final verdict came out Friday, finding RBC at fault. Damages have not yet been declared.
Initially RBC refuted its conflict of interest. Before the trial began, RBC said Warburg Pincus made it clear it would not use the bank’s financing, so RBC had no reason to favour the firm as a bidder. However, the Delaware court found evidence against these claims. Emails proved that RBC kept pushing for a spot in the lending syndicate right until the deal was announced.
Documents also showed that RBC ultimately altered its takeover valuations of Rural/Metro. For instance, when RBC initially pitched to serve as an adviser, it presented only recently completed transactions to illustrate what value could be assigned to Rural/Metro in a takeover. The two deals in question were both inked at 9.5 times and 9.4 times the targets’ respective earnings before interest, taxes, depreciation and amortization.
Yet when RBC put together a final valuation analysis after Warburg Pincus’s bid had been submitted, it included a much older third transaction that was conducted at a much lower multiple, lowering the ‘fair value’ price for Rural/Metro.
Complicating the matter, another company, CD&R, put in a non-binding bid for Rural/Metro that matched Warburg Pincus’s. However, CD&R was tied up with another acquisition at the time and needed an extension of the bidding timeline in order to be able to participate. An extension was not granted, even though CD&R indicated to RBC that it could potentially pay more than rival buyers.
RBC’s U.S. investment bank has gained significant market share south of the border since the financial crisis. When RBC first won the right to advise Rural/Metro, managing director Tony Munoz wrote in an email that this would be the deal “that’s going to put our Healthcare services sellside effort on the map. Big name sponsors are going to look at this asset,” according to the Delaware ruling.
The decision comes on the heals of a similar high profile Delaware case, presided over by the same man, vice chancellor J. Travis Laster. In 2011, he ruled that Barclays rigged the sale process of Del Monte Foods by failing to disclose certain material facts when advising the deal’s private equity buyers.
In 2013 Rural/Metro sought bankruptcy protection because it could no longer handle its debt burden.