The SEC’s legal action against Target’s CEO and CTO reveals the consequences of misleading buyers in M&A deals. Learn about the case and its implications for ethical M&A negotiations.
M&A Insights
Choosing the ethical path in M&A negotiations is not only morally right but also strategically beneficial: “The road to greatness is not easy, but it’s the one worth taking.” — Lucius Amnaeus Seneca
January 19, 2021
Introduction:
In acquisition deals, the price paid is often based on what the acquired company is projected to earn in the future. It’s crucial for the leadership of the target company to honestly present significant facts supporting these forecasts to the buyer. Failure to do so can lead to serious consequences for the target’s leadership if these representations turn out to be false.
The Background:
The target in this case was a privately held Israeli company specializing in selling cell phone and satellite interception products. The buyer was a Florida-based publicly traded special-purpose acquisition company. The acquisition took place in 2015 through a merger, which transformed the target into a publicly traded entity.
Before the deal closed, the target’s executives asserted that there was a backlog of orders and potential revenues amounting to $148 million. They also predicted the company’s revenue for fiscal year 2016 to be $108 million. Additionally, the executives claimed ownership of a groundbreaking product.
The Lawsuit:
After the acquisition was completed, it was revealed that the target’s 2016 revenue was only $16.5 million, and the company reported a net loss of $8.1 million for that year.
It turned out that the target didn’t actually own the groundbreaking product. Instead, it had an arrangement with the actual owner, entitling the target to 50% of the product’s revenues. The claimed backlog, as stated in the SEC complaint, “was not backed by actual, signed purchase orders.” Moreover, a significant portion of the backlog came from the target’s main customer—a Latin American police agency—based on verbal agreements with managers who were terminated due to the escape of an infamous international drug trafficker.
The SEC’s Actions:
The SEC aims to reclaim the gains made by the executives from the deal, along with interest and penalties. Furthermore, they seek to permanently prevent the target’s CEO from holding positions as an officer or director in any public company.
Although the target’s officers attempted to have the SEC’s case dismissed, their motion was rejected by a federal district court in Manhattan, and the legal proceedings are ongoing.
This case is referred to as Securities and Exchange Commission v. Hurgin, No. 19-cv-5705 (MKV), United States District Court, S.D. New York, (September 4, 2020)
Commentary:
This case raises important considerations for both buyers and sellers involved in similar deals. Could the buyer have uncovered during due diligence that the groundbreaking product was not owned outright by the target and that revenues had to be shared through a reseller agreement? Could the buyer have verified the claimed backlog and pending deals with actual signed contracts?
If the SEC’s allegations hold true, one has to question whether the potential gains for the CEO and CTO were worth the consequences of providing false information about the target company—especially considering the possibility of forfeiting their profits and, for the CEO, being permanently barred from holding positions in public companies as an officer or director.
By John McCauley: I help people manage M&A legal risks.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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