Asset management M&A: Does your board need special transaction counsel?

May 6, 2021

By Christopher Healey and Debra Sutter, Simpson Thacher & Bartlett LLP

Potential conflicts of interest for independent directors likely are top of mind when a board is presented with a merger or acquisition transaction involving a fund's investment adviser; if such a conflict is discovered, an independent director can be recused from any deliberations related to the transaction. A less obvious, but equally important, consideration is whether counsel to the independent directors—commonly referred to as "board counsel"—has done any legal work for parties to the M&A transaction that could jeopardize his or her independence. If a potential independence issue exists, regular board counsel may be unable to advise the independent directors on matters related to the M&A deal until the transaction has closed. In such circumstances, it is advisable for independent directors to retain special transaction counsel, as activists and the plaintiffs' bar are increasingly focused on funds, their independent directors, and board deliberations in litigation related to investment adviser M&A transactions.  


Independent directors are not required to have counsel, but if they do decide to engage counsel, such counsel must be independent. The role of board counsel is to provide independent directors with impartial, unbiased, and objective legal advice—especially when conflicts of interest arise between a fund and its adviser—in order to safeguard the integrity of the decisions made by independent directors. Rule 0-1(a)(6) under the 1940 Act provides that board counsel qualifies as independent if they do not represent the fund's investment adviser, principal underwriter, administrator, or any of their control persons. If board counsel has done limited work for any of these fund affiliates, a majority of the independent directors has the power to determine that any representation since the beginning of the fund's last two completed fiscal years is or was “sufficiently limited that it is unlikely to adversely affect the professional judgment” of board counsel. In the event that board counsel begins to represent, or materially increases its representation of, any of these fund affiliates, counsel must promptly update the independent directors, so that they may once again make the aforementioned determination in light of these developments.


How can asset management M&A transactions create conflicts for regular board counsel?


In the context of asset management M&A transactions, there are several scenarios that could create a conflict for board counsel. First, when a transaction involves a change of control of a fund's adviser, board counsel's firm may represent a potential buyer of the fund's adviser (or the adviser's parent company). Second, if a transaction involves a change of adviser instead of a change of control, board counsel's firm may represent the adviser that would become adviser to the funds overseen by the board upon the completion of the transaction. Third, when a transaction will involve a fund merger, board counsel's firm may represent an acquiring fund.


Although in each scenario board counsel is not currently representing a control person of a fund's investment adviser, and thus does not fail to meet the definition of independent legal counsel under Rule 0-1(a)(6), board counsel's representation of a potential control person—or affiliate of such control person—of a fund's investment adviser potentially impairs their ability to provide objective legal advice to the independent directors in connection with the impending transaction, especially with respect to the approval of any new advisory agreements.


What are the benefits of engaging special transaction counsel?


When regular board counsel's independence is impaired, independent directors should retain special transaction counsel to advise on transaction-related issues. There are several reasons why it is important and advisable for independent directors to retain special transaction counsel in this context.


First, the board of directors, as fiduciaries, generally owe the funds they oversee a duty of loyalty and a duty of care under state law. This means that the independent directors must consider, and mitigate, any conflicts of interest that they may face in connection with their approval of transaction-related matters and must seek to be as fully informed in making such decisions, as an ordinary prudent person would under similar circumstances.


Second, special transaction counsel will help ensure that the independent directors' advisory contract approval process under Section 15(c) is fully informed and not tainted by potential conflicts, helping to avoid the appearance of the directors simply "rubber stamping" any agreements without the benefit of independent legal counsel. Even outside of the M&A context, the Section 15(c) process is demanding. It involves both drafting and delivering lengthy requests for information on behalf of the independent directors to the adviser and relevant affiliates and reviewing responses for adequacy and for any issues that require further inquiry. Special transaction counsel will ensure that such requests and reviews are completed in accordance with the 1940 Act statutory requirements and related guidance.


Third, there is a growing trend of litigation from shareholders seeking to invalidate investment advisory contracts approved as part of broader M&A transactions, and the engagement of special transaction counsel can make the board's approval process less open to attack in litigation. Specifically, the engagement of special transaction counsel can help improve the board's deliberations and support the argument that the independent directors received independent advice when analyzing the transaction and considering the related approvals. Also, the presence of special transaction counsel weakens an activist shareholder's argument that since they are not involved in selecting the buyer in the M&A transaction, independent trustees simply approve matters in connection with the transaction without meaningful consideration or dialogue. One way to dissuade potential plaintiffs from questioning the board's process in litigation would be to highlight that special transaction counsel was engaged by the independent directors in the proxy statement for any meeting at which shareholders will be asked to approve certain matters related to the M&A transaction (e.g., new advisory contracts or new directors).


Special transaction counsel should be engaged as early as the conflict evaluation stage. In the event that their counsel has a conflict, the independent directors would be asked to provide a conflict waiver in order for their regular counsel to serve as counsel to the buyer (or a related party) in the potential M&A transaction. If a potential conflict is present, the independent directors' conflict waiver decision likely would occur once there is an exclusivity agreement in place between the parties to the M&A transaction. If the independent directors sign off on their counsel playing a role in the transaction, that is when special transaction counsel would be engaged to provide the independent directors with conflict-free advice going forward.


What is the typical scope of a special transaction counsel engagement?


Once retained, special transaction counsel should be the sole counsel for the independent directors on any matters that involve, or are related to, the underlying M&A transaction. It is important to note that the independent directors' role is not to approve the transaction itself but instead to focus on the anticipated impact of the transaction, if any, on the adviser's ability to continue to manage a fund.


One obvious example of such a matter is the approval of new advisory agreements, reflecting the new ownership of the adviser, and other agreements that terminate upon a change of control of the adviser. When a fund adviser (or its parent company) enters into a transaction that will result in a change of control, closing the transaction will trigger an "assignment" of the advisory agreement and other agreements for 1940 Act purposes, causing such agreements to terminate automatically in accordance with the 1940 Act and their own respective terms. Special transaction counsel should advise the independent directors through the Section 15(c) process in connection with the approval of new advisory agreements that will go effective upon the closing of the transaction.


Other examples of typical matters related to, or proposed as part of, the M&A transaction for which the special transaction counsel should be sole counsel to the independent directors include:


  • expense reimbursement or fee waiver arrangements
  • amendments to fund policies and procedures
  • fund mergers (as a growing trend in adviser M&A transactions involving two fund complexes is to merge funds with overlapping investment objectives and strategies)
  • director nominations and board consolidation measures
  • director independence questions
  • proxy solicitation approvals


There are also non-routine matters that may arise in the M&A transaction context that would require special transaction counsel to provide advice to the independent directors, including: changes to director compensation plans (including directors that will no longer serve on the board following the completion of the transaction); emeritus director policies; and any issues related to communications with interlopers or activist shareholders.


What is the role of regular board counsel if special transaction counsel is engaged?


Regular board counsel, despite being conflicted, can still be involved in certain matters to the extent board counsel's role is limited to providing factual and background information to special transaction counsel. Board counsel also can provide documents and other materials to special transaction counsel to help get them up to speed regarding a fund and its independent directors. Nevertheless, board counsel should not:


  • recommend that the board or independent directors take any action related to the transaction;
  • advise the independent directors of their rights under any agreements or policies related to the transaction;  
  • negotiate anything on behalf of the board or independent directors with other members of counsel's firm representing a buyer of the fund's adviser or affiliates of the buyer; or
  • participate in any matter on behalf of the board or independent directors that could affect the outcome of negotiations with respect to the ongoing M&A transaction.


In addition to being a source of background information for special transaction counsel, board counsel can continue to be sole counsel to the independent directors with respect to routine board/fund matters that are not related to the M&A transaction. If the independent directors are being asked to approve at a quarterly board meeting both routine matters and matters related to the transaction, it is advisable to bifurcate the meeting so that these matters are taken up separately with the appropriate counsel involved. Once the transaction closes, board counsel can resume its role as counsel to the independent directors, assuming there is no longer a conflict present. Otherwise, special transaction counsel should continue to advise the independent directors until the conflict is no longer present or board counsel is replaced with new counsel that qualifies as independent.


Continued industry consolidation is likely to increase the need for special transaction counsel.


As consolidation in the fund industry continues, we expect counsel conflict issues to arise more frequently in connection with M&A transactions, particularly given the relatively limited number of law firms that specialize in 1940 Act fund and board matters. With increasing scrutiny from the plaintiffs' bar and activist shareholders on these deals and the related board approvals, it is a good idea for independent directors to consider retaining special transaction counsel to guide them through the process and their role in the transaction.

Christopher Healey is counsel in the registered funds practice of Simpson Thacher & Bartlett LLP. He frequently counsels registered funds, business development companies, investment advisers, and fund boards on the development of innovative retail products and complex asset management M&A transactions. Debra Sutter is an associate in the registered funds practice of Simpson Thacher and advises fund, adviser, and board clients on a variety of matters, including issues related to activist shareholders.



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