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Chapter 9
Management Incentives

Management of a company operates as an agent for the shareholders, the principals of the firm. Conflicts between principals and agents have always existed. Most investors ignore them as a cost of business until a financial crisis erupts, when abuses inevitably come to the forefront. It is only then that investors become aware of the problem.

For arbitrageurs, dealing with corporate management's conflicts of interest is part of the daily investing life. Arbitrageurs usually get involved after a transaction has been announced. It is important to understand the rationale behind a transaction to see whether a higher bid might emerge and whether management has an incentive to support such a higher bid. In management buyouts (MBOs) in particular, it is highly unlikely that a higher bidder will emerge.

In the United States, information about management's interest in a merger is supposed to be disclosed in detail. Proxy statements show the different levels of interest that management has in the transaction. The Securities and Exchange Commission (SEC) adopted special regulations under Rule 13E-3 to deal with acquisitions in which management is on both sides of the transaction. Schedule 13E-3 is filed at the same time as Schedule TO or the statements under Regulation 14A, but at least 30 days before any securities are purchased by the acquirer. Much of the material required to be disclosed in Schedule 13E-3 duplicates that of other filings in going-private transactions. As a result, many filings contain little more information that the headings followed by sentences incorporating the other material by reference. Exhibit 9.1 shows an excerpt of such a filing in the going-private transaction of rue21, Inc. There is little substantive information in the filing. The exhibit only shows the information of items 1 through 4. The remainder of the 10-page filing looks similar to the items shown here. An arbitrageur reviewing this filing learns nothing new. The only interesting element of these filings are that they are sometimes used to file board presentations from the company's advisers. Arbitrageurs can glean valuable information from such presentations.

Exhibit 9.1 Excerpt of Schedule 13-E3/A Filed by rue21, Inc

Item 1.
Summary Term Sheet.

The information set forth under the captions “Summary Term Sheet” and “Questions and Answers About the Special Meeting and the Merger” in the Proxy Statement is incorporated herein by reference.
Item 2. Subject Company Information.
1. a. Name and Address. The name of the subject company is rue21, Inc., a Delaware corporation. rue21's executive offices are located at 800 Commonwealth Drive, Warrendale, PA 15086. Its telephone number is (724) 776-9780.
2. b. Securities. The class of securities to which this Schedule 13E-3 relates is the common stock, par value $0.001 per share, of rue21, of which 23,499,510 shares were issued and outstanding as of June 19, 2013.
3. c. Trading Market and Price. The information set forth under the caption “Other Important Information Regarding rue21—Market Price of Common Stock and Dividends” in the Proxy Statement is incorporated herein by reference.
4. d. Dividends. The information set forth under the caption “Other Important Information Regarding rue21—Market Price of Common Stock and Dividends” in the Proxy Statement is incorporated herein by reference.
5. e. Prior Public Offerings. The information set forth under the caption “Other Important Information Regarding rue21—Prior Public Offerings” in the Proxy Statement is incorporated herein by reference.
6. f. Prior Stock Purchases. The information set forth under the caption “Other Important Information Regarding rue21—Certain Purchases and Sales of Shares” in the Proxy Statement is incorporated herein by reference.
Item 3. Identity and Background of Filing Person.
1. (a)–(c)
  Name and Address; Business and Background of Entities; Business and Background of Natural Persons. rue21 is the subject company. The information set forth under the captions “Parties to the Merger,” “Other Important Information Regarding rue21—Directors and Officers of the Company” and “Other Important Information Regarding the Parent Group, the Apax Investors and the SKM Funds” in the Proxy Statement is incorporated herein by reference.
  
  The SKM Funds have not been identified as filing persons in the Schedule 13e-3. The Apax Investors, Parent Group and the Company have been advised by the SKM funds that, although the SKM Funds may be deemed to be affiliates of the Company and/or Apax and the Apax Investors, (i) the SKM Funds do not believe that they are engaged in a going private transaction for purposes of Rule 13e-3 under the Exchange Act, (ii) the SKM Funds believe that they are passive sellers in the Merger and related transactions and (iii) the SKM Funds have been represented by separate counsel.
Item 4. Terms of the Transaction.
1. (a)(1) Tender Offers. Not applicable.
2. (b)(2) Mergers or Similar Transactions.
  1. The information set forth under the captions “Summary Term Sheet—Special Factors—Certain Effects of the Merger; Certain Effects on the Company if the Merger is not Completed,” “Special Factors—Certain Effects of the Merger” and “The Merger Agreement—The Merger; Merger Consideration” in the Proxy Statement is incorporated herein by reference.
  2. The information set forth under the captions “Summary Term Sheet—Special Factors—Certain Effects of the Merger; Certain Effects on the Company if the Merger is not Completed,” “Summary Term Sheet—The Merger Agreement—Treatment of rue21 Stock Options and Other Equity-Based Awards,” “Questions and Answers About the Special Meeting and the Merger” and “The Merger Agreement—The Merger; Merger Consideration” in the Proxy Statement is incorporated herein by reference.
  3. The information set forth under the captions “Special Factors—Background of the Merger,” “Special Factors—Recommendation of the Special Committee and the Board of Directors; Fairness of the Merger,” “Special Factors—Position of the Parent Group and the Apax Investors as to the Fairness of the Merger,” “Special Factors—Opinion of Financial Advisor to the Special Committee,” “Special Factors—Purpose and Reasons of the Parent Group and the Apax Investors for the Merger,” “Special Factors—Plans for the Company After the Merger,” “Special Factors—Certain Effects of the Merger,” “Special Factors—Considerations Relating to the Merger” and “Special Factors—Certain Effects on the Company if the Merger is not Completed” in the Proxy Statement is incorporated herein by reference.
  4. The information set forth under the captions “Summary Term Sheet—The Special Meeting—Vote Required,” “The Special Meeting—Vote Required” and “Questions and Answers About the Special Meeting and the Merger” in the Proxy Statement is incorporated herein by reference.
  5. The information set forth under the captions “Summary Term Sheet—Special Factors—Certain Effects of the Merger; Certain Effects on the Company if the Merger is not Completed,” “Special Factors—Certain Effects of the Merger,” “Special Factors—Interests of Executive Officers and Directors of the Company in the Merger” and “Questions and Answers About the Special Meeting and the Merger” in the Proxy Statement is incorporated herein by reference.
  6. The information set forth under the caption “Special Factors—Accounting Treatment” is incorporated herein by reference.
  7. The information set forth under the captions “Summary Term Sheet—Special Factors—Material United States Federal Income Tax Consequences of the Merger,” “Special Factors—Material United States Federal Income Tax Consequences of the Merger” and “Questions and Answers About the Special Meeting and the Merger” in the Proxy Statement is incorporated herein by reference.
3. (c) Different Terms. The information set forth under the captions “Special Factors—Certain Effects of the Merger,” “Special Factors—Interests of Executive Officers and Directors of the Company in the Merger,” “The Merger Agreement—The Merger; Merger Consideration,” “The Merger Agreement—Treatment of rue21 Stock Options and Other Equity-Based Awards” and “The Support Agreement” in the Proxy Statement is incorporated herein by reference.
4. (d) Appraisal Rights. The information set forth under the captions “Summary Term Sheet—The Special Meeting—Appraisal Rights,” “Appraisal Rights” and “Questions and Answers About the Special Meeting and the Merger” in the Proxy Statement is incorporated herein by reference.
5. (e) Provisions for Unaffiliated Security Holders. The information set forth under the captions “Special Factors—Provisions for Unaffiliated Security Holders” in the Proxy Statement is incorporated herein by reference.
6. (f) Eligibility for Listing or Trading. Not applicable.

Source: Schedule 13E-3/A filed by rue21, Inc. on June 21, 2013

rue21, Inc. was acquired by private equity firm Apax Partners. Even though there is rarely useful information in a Schedule 13E-3 filing itself, the appendices to the filing can be very useful. In the case of rue21's 13E-3, eight presentations were filed as appendices that had been given by investment bank Perella Weinberg Partners to the special committee of the board of directors.

The only benefit of Rule 13e-3 is that additional disclosures are required from buyers about their opinion on the fairness of the transaction. They are required to state whether they believe that the transaction is fair to shareholders. The information is already included in the proxy or tender offer statements and is incorporated by reference into Schedule 13E-3. Needless to say, buyers always believe that the transaction is fair. The disclosures in this section are mostly rephrased repetitions of the determination of fairness made in boilerplate language by the board of directors.

Management Compensation

In a corporation organized by Taylorist principles, the value of management is key to the success of the firm. Rank and file staff has to be just good enough to complete well-defined tasks that are assigned by management.¹ Retention of key executives is of prime importance in such organizations, and today's levels of compensation reflect management's indispensability.

Modern management compensation consists of a number of different elements:

Salary.
Short-term incentives, such as an annual bonus. These incentives are often tied to specific goals, such as financial parameters, improvements in product quality, or market share.
Long-term incentives, such as restricted stock, options, or stock appreciation rights. These incentives typically are subject to a vesting schedule.
Benefits, such as pensions, health and life insurance, financial planning assistance, personal use of corporate jets or company cars.
Indemnification. This benefit is often overlooked. It is highly contingent on extremely rare scenarios where executives are held liable personally for wrongdoing. However, the value of indemnification is very large when such a scenario occurs.

For the executives with the highest overall compensation, variable components constitute the bulk of their income. For executives with lower total compensation, salary makes the largest contribution to their income. An entire cottage industry of compensation consultants has sprung up over the years that advises the board of directors of public companies on the best level and combination of the different types of compensation. What happens if a company is acquired by another is no more than an afterthought in these discussions. However, the payout to top management can be considerable when a firm is acquired.

So-called change of control provisions in the employment agreements of management provide for large immediate payouts when an acquisition is completed. Typical payments under such provisions are listed next.

Salary and annual bonus are often paid out as a lump sum at a multiple of a single year's total.
Stock options and stock appreciation rights are cashed out at their intrinsic value. Restricted stock loses its restrictions and is also cashed out or converted into unrestricted stock of the acquirer.
Benefits usually terminate but sometimes continue to be available. Health insurance in particular is often available for an extended period of time after a merger.
Indemnification continues to be provided by buyer for executives' actions at the former target.

The large lump-sum payments for salary, bonus, and stock options are referred to as golden parachutes. They were introduced originally to overcome resistance of top managers to mergers that would enhance shareholder value but eliminate their management roles. Rather than work to make their own jobs with their comfortable salaries redundant, managers had an incentive to block mergers so that they could hold on to their highly remunerated positions. An additional incentive for top managers is the difficulty of finding comparable positions elsewhere, especially if their industry is consolidating. Although many top managers like to point out in salary negotiations that their skills are easily transferable to other firms, the reality is that it is difficult for outsiders to obtain highly compensated management positions, as these roles are often filled internally. Management stars in some top companies may find new employment easily, but run-of-the-mill executives from small- or mid-cap firms can have a harder time. Studies illustrate that CEOs of companies that are acquired experience a high likelihood of being laid off at the time of acquisition, and within several years for the few who remain employed initially.²

Exhibit 9.2 shows the disclosure of change of control payments for Omnicom. As is typical for firms that have seen a strong appreciation of their stock and are heavy users of options, the bulk of the value of a change of control comes from the immediate vesting of stock options upon the closing.

Exhibit 9.2 Change of Control Provisions of Omnicom

Potential Payments Upon Termination of Employment or Change in Control

Each named executive officer participates in our Incentive Bonus Plan; Messrs. Wren, Weisenburger and Angelastro participate in our SERCR Plan; and Mr. Hewitt has entered into an Executive Salary Continuation Plan Agreement with Omnicom. As further described below, participants in our Incentive Bonus Plan are not entitled to payment due to termination of employment or change in control, participants in the SERCR Plan are entitled to payments upon termination of employment under certain circumstances and the Executive Salary Continuation Plan Agreement provides for payment upon termination of employment under certain circumstances. Our named executive officers also hold stock options and/or stock awards, which are subject to accelerated vesting upon termination of employment under certain circumstances or upon a change in control. […] Except for these arrangements, none of the named executive officers have entered into any plans, arrangements or agreements with Omnicom providing for payments upon termination of employment or change in control of Omnicom, other than payments generally available to all salaried employees that do not discriminate in scope, terms or operation in favor of the executive officers of Omnicom.

The SERCR Plan

Omnicom adopted the SERCR Plan in 2006, and the Compensation Committee selected Messrs. Wren, Weisenburger and Angelastro to participate and enter into Award Agreements with Omnicom. The SERCR Plan is unique in its structure and objectives. It is a multi-faceted device that provides security to Omnicom through the restrictive covenants described below while delivering a valuable benefit to executives in the form of post-termination compensation. The SERCR Plan mitigates the need to provide severance benefits to participating executives as the program provides a guaranteed stream of income following termination provided the executive fully complies with his obligations.

Restrictive Covenants and Consulting Obligation

In consideration for annual benefits from Omnicom, participants in the SERCR Plan are subject to restrictions on competition, solicitation, disparagement, and other willful actions materially harming Omnicom, from the date of termination of employment through the end of the calendar year in which they receive their last annual benefits payment. In addition, prior to age 55, upon 30 days' written notice from Omnicom, the named executive officers agree to serve as advisers or consultants to Omnicom during the retention payment period, subject to certain limitations.[…]

Acceleration of Equity Awards

Messrs. Wren, Weisenburger, Angelastro, and O'Brien hold unvested stock options and performance restricted stock units pursuant to our 2007 Plan. Messrs. Angelastro and O'Brien hold restricted stock units pursuant to our 2007 Plan and restricted stock pursuant to our prior equity incentive plan, The Omnicom Group Inc. Equity Incentive Plan (the “Equity Incentive Plan”). Mr. Hewitt holds performance restricted stock units pursuant to our 2007 Plan and restricted stock pursuant to both our 2007 Plan and Equity Incentive Plan. As specified below, such named executive officers are entitled to accelerated vesting (a) on a pro rata basis upon termination of employment due to disability (b) upon death, (c) upon a change in control of Omnicom and (d) subject to certain conditions, upon retirement.

Stock Options

Unvested options granted pursuant to the 2007 Plan vest in full and are exercisable through the end of the option term if (a) the named executive officer terminates due to death or (b) a change in control of Omnicom occurs. […]

Restricted Stock, Restricted Stock Units and Performance Restricted Stock Units

Restricted stock, restricted stock units and performance restricted stock units, as applicable, granted in 2007 pursuant to the Equity Incentive Plan or thereafter under the 2007 Plan fully vest in the event of a change in control of Omnicom […]

Potential Payments Upon Termination of Employment or Change in Control

The following table provides the potential payments that each named executive officer may receive upon termination of employment or change in control of Omnicom, assuming that (a) such termination or change in control of Omnicom occurred on December 31, 2011, and (b) the price per share of Omnicom common stock equals $44.58, the closing price at 2011 fiscal year end.

Name of Executive	Death	Disability	For Cause Termination	Termination without Cause	Retirement	Voluntary Termination	Change in Control
John Wren
• SERCR Plan⁽¹⁾	$1,500,000	$1,500,000	$0	$1,500,000	$1,500,000	$1,500,000	N/A
• Incentive Bonus Plan⁽²⁾	$12,000,000	$12,000,000	$0	$12,000,000	$12,000,000	12,000,000	$12,000,000
• Equity Awards⁽³⁾	$6,972,677	$5,614,494	$0	$0	$4,236,000	$0	$6,972,677
Randall Weisenburger
• SERCR Plan⁽⁴⁾	$1,500,000	$1,500,000	$0	$1,500,000	$1,500,000	$1,500,000	N/A
• Incentive Bonus Plan⁽²⁾	$8,640,000	$8,640,000	$0	$8,640,000	$8,640,000	$8,640,000	$8,640,000
• Equity Awards⁽³⁾	$4,307,324	$3,329,680	$0	$0	$0	$0	$4,307,324
Philip Angelastro
• SERCR Plan⁽⁵⁾	$472,750	$472,750	$0	$472,750	$472,750	$472,750	N/A
• Incentive Bonus Plan⁽²⁾	$1,400,000	$1,400,000	$0	$1,400,000	$1,400,000	$1,400,000	$1,400,000
• Equity Awards⁽³⁾	$5,982,867	$4,329,564	$0	$0	$0	$0	$5,982,867
Dennis Hewitt
• Executive Salary
Continuation Agreement	$88,875	118,500	$0	$118,500	$118,500	$118,500	N/A
• Incentive Bonus Plan⁽²⁾	$625,000	$625,000	$0	$625,000	$625,000	$625,000	$625,000
• Equity Awards⁽³⁾	$851,166	$479,235	$0	$0	$0	$0	$851,166
Michael O'Brien
• Incentive Bonus Plan⁽²⁾	$850,000	$850,000	$0	$850,000	$850,000	$850,000	$850,000
• Equity Awards⁽³⁾	$1,356,303	$1,074,720	$0	$0	$0	$0	$1,356,303

(1) Except in the event of a termination for Cause, Mr. Wren or his beneficiary, as the case may be, would be entitled to receive fifteen annual payments in this amount, the first of which would be payable in 2012. Mr. Wren would not be entitled to any payments in the event of termination for Cause. The amount reported is the payment cap set forth in the SERCR Plan as in effect on December 31, 2011, such amount being subject to an annual cost-of-living adjustment. All payment obligations are conditioned upon compliance with the restrictive covenants and consulting obligation described above.

(2) As discussed above, upon a termination of employment for any reason prior to the end of a performance period or prior to the bonus payment date for such performance period, the participant is not entitled to any award. The Compensation Committee, however, has discretion to determine whether awards should be made pursuant to the Incentive Bonus Plan and the amounts of such awards. A termination of employment on December 31, 2011 would fall prior to the bonus payment date for the 2011 performance period. The amounts reported in the table assume that the Compensation Committee in its discretion authorized a payment equal to the target bonus amounts, except in the event of a for cause termination, in which case it is assumed that the Compensation Committee would not grant an award.

(3) The value of any stock options was determined by taking the aggregate fair market value, as of 2011 fiscal year end, of the common stock underlying stock options subject to accelerated vesting, and subtracting the aggregate exercise price for such stock options. The value of restricted stock, restricted stock units and performance restricted stock units was determined by taking the aggregate fair market value of the shares of restricted stock (or the shares underlying restricted stock units and performance restricted stock units) subject to accelerated vesting as of 2011 fiscal year end. The value of performance restricted stock units assumes achievement of the highest performance target and therefore the actual value could be lower than the amount disclosed. Also, the value of restricted stock has not been adjusted to reflect any par value paid by the executive for such stock on the date of grant.

(4) Except in the event of termination due to death or disability or a termination for Cause, Mr. Weisenburger would be entitled to receive fifteen annual payments in this amount, the first of which would be payable in 2013 upon Mr. Weisenburger turning fifty-five. In the event of termination due to death or disability, Mr. Weisenburger or his beneficiary, as the case may be, would be entitled to receive fifteen annual payments in this amount, the first of which would be payable in 2012. Mr. Weisenburger would not be entitled to any payments in the event of termination for Cause. The amount reported is the payment cap set forth in the SERCR Plan as in effect on December 31, 2011, such amount being subject to an annual cost- of-living adjustment. All payment obligations are conditioned upon compliance with the restrictive covenants and consulting obligation described above.

(5) Except in the event of termination due to death or disability or a termination for Cause, Mr. Angelastro would be entitled to receive fifteen annual payments in this amount, the first of which would be payable in 2019 upon Mr. Angelastro turning fifty-five. In the event of termination due to death or disability, Mr. Angelastro or his beneficiary, as the case may be, would be entitled to receive fifteen annual payments in this amount, the first of which would be payable in 2012. Mr. Angelastro would not be entitled to any payments in the event of termination for Cause. All payment obligations are conditioned upon compliance with the restrictive covenants and consulting obligation described above.

(6) This reflects 75% of Mr. Hewitt's $118,500 annual payment, payable to his designated beneficiary. Ten annual payments in this amount would be paid to such beneficiary, with the first payment being made in 2012.

(7) This reflects 30% of the highest annual rate of salary paid to Mr. Hewitt in the five years preceding December 31, 2011. Ten annual payments would be made in this amount, with the first payment being made in 2013. All payment obligations are conditioned upon compliance with the consulting obligation and agreement not to compete described above. Source: Form Def 14A by ATMI Inc. filed on April 11, 2013.

In addition to change of control payments, management can receive special rewards for effecting a merger, such as some executives of ATMI Inc. did upon the acquisition by Entegris Inc. (Exhibit 9.3).

Exhibit 9.3 Disclosure about the Transaction Bonus Agreement of ATMI Inc

Transaction Bonus Agreement

On January 13, 2014, ATMI entered into a transaction bonus agreement (referred to in this proxy statement as the Transaction Bonus Agreement) with Christian Kramer, as well as with certain other (non-executive officer) employees of the Company.

The Transaction Bonus Agreement generally provides that, upon a “change of control” (as defined in the Transaction Bonus Agreement), which includes the merger, within one (1) year following the effective date of the Transaction Bonus Agreement, subject to ATMI's shareholders receiving “transaction value” (as defined in the Transaction Bonus Agreement) of at least $900,000,000, Mr. Kramer would be entitled to a transaction bonus equal to the sum of (i) the total transaction value, multiplied by the “base bonus ratio” (as defined in the Transaction Bonus Agreement) of 0.20%, multiplied by 17.5%, and (ii) the excess amount of transaction value above $1,000,000,000, multiplied by the “additional bonus ratio” (as defined in the Transaction Bonus Agreement), which ranges from 0% to 0.20% based on the amount of transaction value, multiplied by 17.5%. The transaction bonus will be paid in a cash lump sum within five days following the change of control.

In order to be eligible for a transaction bonus, Mr. Kramer generally must remain employed through the change of control. However, if Mr. Kramer's employment is terminated without “cause” (as defined in the Transaction Bonus Agreement) following the signing of a definitive agreement in respect of a change of control, he will remain eligible for the transaction bonus if the change of control is consummated within one (1) year following the effective date of the Transaction Bonus Agreement, subject to Mr. Kramer's continued compliance with restrictive covenants in any equity award agreement or other agreement between Mr. Kramer and ATMI.

Pursuant to the Transaction Bonus Agreement, if an amount payable to Mr. Kramer constitutes a “parachute payment” within the meaning of Section 280G of the Code, such payment will be reduced to the extent necessary so that no amount payable to the executive constitutes a “parachute payment.” However, Mr. Kramer's payments will not be subject to reduction if the net after-tax payment to which he would otherwise be entitled without such reduction would be greater than the net after-tax payment to him resulting from the receipt of such payments with such reduction. All determinations under the provision will be made by a nationally recognized accounting firm designated by ATMI.

See “Proposal 3: Advisory Vote Regarding Golden Parachute Compensation” for quantification of the transaction bonus payment to which Mr. Kramer is entitled under the Transaction Bonus Agreement.

Source: Form DEFM14A filed by ATMI on March 12, 2014.

Payments to executives are subject to excise taxes unless they have been approved by shareholders. Section 280G denies a corporation a deduction for a golden parachute payment to the extent that it exceeds three times an executive's annual salary unless shareholders have approved the payment.³ A parallel regulation, section 4999, imposes a 20 percent excise tax on the recipient of the excess payment of the golden parachute.

These rules were first introduced in the 1980s after a public outcry over large payments to executives whose companies are acquired. The IRS regulations were well meant but have been diluted quite significantly. When they do apply, they have an adverse effect on shareholders. Companies are allowed to reimburse executives for the 20 percent excise tax. The result is that the cost of the golden parachute has increased for the company, and a sophisticated buyer will take the cost of the nondeductibility and reimbursement of the excise tax into account and reduce the purchase price accordingly. The net effect is a transfer of shareholder wealth to Uncle Sam. In many mergers, golden parachutes are immaterial, but for smaller companies with highly compensated executives, golden parachutes can become significant.

The rationale behind golden parachutes was to provide managers with strong financial security if they give up their jobs to support mergers that are in the interest of shareholders. The reality of change of control provisions is more differentiated than the theory suggests. Under the Dodd-Frank regulations, golden parachute payments need to be approved by shareholders. Originally Dodd-Frank was supposed to regulate banks and financial products rather than tax treatment of mergers, but experience shows that the reach of new laws quickly goes beyond the original intent. Exhibit 9.4 shows disclosures in such an advisory vote. As it is an advisory vote it is non-binding and is of no practical consequence. Nevertheless, some larger companies may find compelled to follow the outcome of a shareholder advisory vote.

Exhibit 9.4 Advisory Vote on Golden Parachute Payments of ATMI Inc

Equity Awards

Immediately prior to the consummation of the merger, (i) each option to acquire shares of ATMI common stock that is then outstanding and that has an exercise price less than the $34.00 per share merger consideration, whether or not then vested or exercisable, will be cancelled and terminated, and each holder of such an option will have the right to receive an amount of cash equal to (a) the number of shares of ATMI common stock subject to each such option, multiplied by (b) the excess of $34.00 over the exercise price per share of each such option, less any applicable withholding taxes; (ii) each Company Restricted Stock Award that is then outstanding will be cancelled and terminated, and each holder of a Company Restricted Stock Award will have the right to receive an amount in cash equal to (a) the number of shares of ATMI common stock subject to such Company Restricted Stock Award, multiplied by (b) $34.00, less any applicable withholding taxes; and (iii) each Company Restricted Stock Unit Award that is then outstanding will be cancelled and terminated, and each holder of a Company Restricted Stock Unit Award will have the right to receive an amount in cash equal to (a) the number of shares of ATMI common stock subject to such Company Restricted Stock Unit Award (determined based on the actual performance achieved as if the closing date of the merger represented the end date of the performance period), multiplied by (b) $34.00, less any applicable withholding taxes.

Severance Payments and Benefits

ATMI and Messrs. Neugold, Carlson and Sharkey are parties to employment agreements, and Messrs. Kramer and Dubois participate in the ATMI, Inc. Executive Severance Pay Plan, which provide for certain severance payments and benefits in connection with a qualifying termination following the proposed merger. As a condition of an executive's receipt of the severance payments and benefits, the executive is required to execute, and not revoke, a release of claims. In addition, the employment agreements provide that the executives will be subject to certain non-competition and non-solicitation restrictions (for two (2) years in the case of Mr. Neugold, and one (1) year for Messrs. Sharkey and Carlson). In order to participate in the Executive Severance Pay Plan, Messrs. Kramer and Dubois will enter into restrictive covenants agreements with ATMI that provide that, for a period of twelve (12) months following termination of the executive's employment with ATMI, the executive will be subject to certain covenants regarding non-competition, non-solicitation of employees and non-interference with ATMI's business.

Transaction Bonus

ATMI and Mr. Kramer are parties to a transaction bonus agreement, pursuant to which he will be eligible for a lump sum cash transaction bonus payment within five (5) days following the proposed merger, with such payment calculated based on transaction value received by ATMI's shareholders in connection with the proposed merger. In order to be eligible for the transaction bonus, Mr. Kramer generally must remain employed through the proposed merger. However, if Mr. Kramer's employment is terminated in a qualifying termination prior to the closing date of the proposed merger, he will remain eligible for the transaction bonus if the merger is consummated within one (1) year following the effective date of the transaction bonus agreement, subject to Mr. Kramer's continued compliance with restrictive covenants in any equity award agreement or other agreement between Mr. Kramer and ATMI.

Estimated Payments and Benefits

The table below sets forth an estimate of the approximate values of golden parachute compensation that may become payable to our named executive officers in connection with the merger, as described herein and under the heading “Proposal 1: Adoption of the Merger Agreement—Interests of Certain Persons in the Merger.” The footnotes to the table below distinguish between the benefits available in connection with the merger without a qualifying termination (“single-trigger” benefits) and the benefits payable upon a qualifying termination in connection with the merger (“double-trigger” benefits). In accordance with SEC rules, the table assumes the closing of the merger occurs on April 30, 2014, and the employment of our named executive officers is terminated without cause immediately following the closing on April 30, 2014. If the merger were to close, and the associated terminations of employment were to occur, on a date other than April 30, 2014, certain amounts paid to the named executive officers may be higher or lower than the amounts shown in the table. The information below is based on the merger consideration of $34.00 per share.

Named Executive Officer	Cash⁽¹⁾ ($)	Equity⁽²⁾ ($)	Pension/Non-Qualified Deferred Compensation⁽³⁾ ($)	Perquisites/Benefits⁽⁴⁾ ($)	Tax Reimbursement⁽⁵⁾ ($)	Other⁽⁶⁾ ($)	Total⁽⁷⁾ ($)
Douglas A. Neugold	3,000,000	5,758,980	—	53,418	—	—	8,812,398
Timothy C. Carlson	1,171,500	2,363,571	—	47,214	—	—	3,582,285
Daniel P. Sharkey	1,029,200	1,847,095	—	34,767	—	—	2,911,062
Christian F. Kramer	808,800	1,874,244	—	38,964	—	346,013	3,068,021
Lawrence H. Dubois	733,500	1,321,738	—	38,964	—	—	2,094,202

⁽¹⁾ Cash. Represents the aggregate amount of double-trigger cash severance payments to be paid by ATMI (or the surviving corporation in the merger) following a qualifying termination of employment within 548 days (in the case of Messrs. Neugold, Carlson and Sharkey) or eighteen (18) months (in the case of Messrs. Kramer and Dubois) following a change in control in an amount equal to two and a half (2.5) times (in the case of Mr. Neugold), two (2.0) times (in the case of Messrs. Carlson and Sharkey) or one and a half (1.5) times (in the case of Messrs. Kramer and Dubois) the sum of the executive's annual salary and annual target bonus, payable over a period of thirty (30) months after termination (in the case of Mr. Neugold), twenty-four (24) months after termination (in the case of Messrs. Sharkey and Carlson) or eighteen (18) months after termination (in the case of Messrs. Kramer and Dubois).

⁽²⁾ Equity. Represents the single-trigger cash lump sum payment that will result from the cancellation of unvested options, Company Restricted Stock Awards and Company Restricted Stock Unit Awards upon the completion of the merger.
The amount for each named executive officer represents the following amounts: Mr. Neugold: $886,984 for unvested options, $1,284,758 for Company Restricted Stock Awards and $3,587,238 for Company Restricted Stock Unit Awards; Mr. Carlson: $382,272 for unvested options, $543,371 for Company Restricted Stock Awards and $1,437,928 for Company Restricted Stock Unit Awards; Mr. Sharkey: $296,057 for unvested options, $426,862 for Company Restricted Stock Awards and $1,124,176 for Company Restricted Stock Unit Awards; Mr. Kramer: $154,184 for unvested options, $751,978 for Company Restricted Stock Awards and $968,082 for Company Restricted Stock Unit Awards; and Mr. Dubois: $206,130 for unvested options, $310,182 for Company Restricted Stock Awards and $805,426 for Company Restricted Stock Unit Awards.
The payment is determined on a pre-tax basis based on the number of shares underlying awards held as of April 30, 2014, multiplied by $34.00 per share over the exercise price of the award (with respect to options) and $34.00 per share (in the case of Company Restricted Stock Awards and Company Restricted Stock Unit Awards). In the case of Company Restricted Stock Unit Awards, the number of shares underlying the award was determined based on achievement of the maximum level of performance under such awards. Amounts actually paid, which could range from $0 to the maximum amount, will be determined based on the actual performance achieved as if the closing date of the merger represented the end date of the performance period. Consistent with the requirements of Rule 14a-21(c) under the Exchange Act, the vested equity awards held by each named executive officer are not reflected in this column. For the total payments payable in respect of all stock options, Company Restricted Stock Awards and Company Restricted Stock Unit Awards, see “Proposal 1: Adoption of the Merger Agreement—Interests of Certain Persons in the Merger.”

⁽³⁾ Pension/Non-Qualified Deferred Compensation. None of the named executive officers will receive any increased pension or non-qualified deferred compensation benefits in connection with the merger.

⁽⁴⁾ Perquisites/Benefits. Represents the value of continued medical and dental coverage under COBRA at the active employee rate for the thirty (30) month period (in the case of Mr. Neugold) or twenty-four (24) month period (in the case of Messrs. Carlson and Sharkey) following termination of employment pursuant to their employment agreements. With respect to Messrs. Kramer and Dubois, represents the value of continued health coverage under COBRA at the active employee rate for eighteen (18) months following termination of employment pursuant to the Severance Plan. In addition, with respect to Messrs. Neugold, Carlson, Sharkey, Kramer and Dubois, includes the value of outplacement services at the Company's expense for six (6) months following termination of employment. These benefits are all double-trigger.
The amount for each named executive officer represents $15,000 for outplacement services and the following amounts for continued medical and dental coverage: Mr. Neugold: $38,418; Mr. Carlson: $32,214; Mr. Sharkey: $19,767; and Messrs. Kramer and Dubois: $23,964.

⁽⁵⁾ Tax Reimbursement. None of the named executive officers will receive a tax gross-up in connection with the merger.

⁽⁶⁾ Other. Represents the estimate of a single-trigger cash lump sum transaction bonus to be paid by ATMI (or the surviving corporation in the merger) within five (5) days following the merger.

⁽⁷⁾ Total. The following table shows, for each named executive officer, the amounts of golden parachute compensation that are single-trigger or double-trigger in nature, as the case may be. Single-trigger amounts include the amounts shown in the “Equity” and “Other” columns of the table above. Double-trigger amounts include the amounts shown in the “Cash” and “Perquisites/Benefits” columns. The total amounts do not reflect any reductions which may be made to payments which constitute “parachute payments” under the Code.

Section 951 of the Dodd-Frank Act and Rule 14a-21(c) under the Exchange Act require that we seek a non-binding advisory vote from our stockholders to approve the golden parachute compensation payable to our named executive officers in connection with the merger. Accordingly, we are asking you to approve the following resolution:

“RESOLVED, that the stockholders approve, on an advisory (non-binding) basis, the agreements or understandings with and items of compensation payable to the named executive officers of ATMI that are based on or otherwise relate to the merger, as disclosed in the section of the Proxy Statement entitled ‘Proposal 3: Advisory Vote Regarding Golden Parachute Compensation.’”

Board of Directors Recommendation

Our board of directors unanimously recommends that you vote “FOR” approval of the non-binding advisory proposal on the golden parachute compensation payable to our named executive officers in connection with the merger.

Approval of the “golden parachute compensation” proposal is not a condition to the completion of the merger. The vote with respect to the “golden parachute compensation” proposal is an advisory vote and will not be binding on us or Entegris. Further, the underlying plans and arrangements are contractual in nature and not, by their terms, subject to stockholder approval. Accordingly, regardless of the outcome of the non-binding advisory vote, if the merger agreement is adopted by the stockholders and completed, our named executive officers will receive the “golden parachute compensation” to which they may be entitled.

Source: Form DEFM14A filed by ATMI on March 12, 2014.

Accelerated vesting of restricted stock and options is the largest potential conflict of interest for managers who have to consider the sale of their firm. Mergers provide managers with two types of windfall profits:

Most mergers are done at a premium to the trading price of the stock. Options that have been issued at the money or even out of the money suddenly have a large intrinsic value that will be realized when the merger closes.
Options vest immediately. Rather than having to wait up to 10 years and going through the associated market risk for such a long period, executive options vest with the closing and can be cashed out immediately.

Therefore, change of control provisions lead to a set of incentives that make mergers potentially more attractive for managers than for shareholders. In a scenario where a firm is expected to generate long-term growth, shareholders may be best off holding on to their shares for the long run. Executives, however, may be better off selling the firm and cashing out immediately.

An example of these conflicts is the $11 billion acquisition of Sungard Data Systems by a consortium of private equity firms in 2005.⁴ Sungard's board was considering a spin-off of the firm's Availability Services business when private equity firm Silver Lake Partners made a proposal to acquire Sungard for $33 per share. The board rejected the proposal until it was subsequently increased to $36 per share. The board led lengthy negotiations with the private equity fund, until it decided to discard the idea of the spin-off in favor of the acquisition by the private equity group:

On or about March 9, 2005, management advised [Sungard's Chairman] Mr. Mann that there were severe resource constraints involved in continuing to work on completing the previously announced spin off of the Company's availability services business by the end of April, while at the same time handling all of the due diligence and other demands of the transaction with Silver Lake Partners and operating the Company's businesses. On or about March 13, 2005, after discussions among the directors, Mr. Mann informed management that, in light of the progress that had been made on the transaction with Silver Lake Partners and the strains imposed on management by continuing to work on the spin off, as well as operating the business of the Company, they should concentrate their efforts on the transaction rather than the spin off.

Def 14A filing on 5/26/2005

It is hard to see how an $11 billion company can be too small to evaluate two competing strategic alternatives, a buyout and a spin-off. It is even more troubling if the interests of management are taken into account: Chief executive officer (CEO) Cristóbal Conde received over $58 million from his sale of stock and options. At the time of the merger, only $42.6 million worth of stock had vested, so that accelerated vesting alone was worth over $15 million to him. For all 20 senior executives, the payout for their equity holdings was $226 million, and the accelerated vesting was worth $83 million in the aggregate. Had a spin-off occurred none of the vesting would have been accelerated.

The Sungard buyout has a peculiar feature, because management elected to forgo its change of control payments and instead invest in the company after the buyout. Irrespective of the absence of change of control payments, management nevertheless received $11 million in tax gross-up payments for section 4999 excise taxes, of which $3 million went to CEO Conde. The investment by management in the buyout is discussed in the next section.

Changes in executive compensation can signal to shareholders that management is preparing for an acquisition. In the case of Watchguard's acquisition by a management group with the backing of private equity firms Vector Capital and Francisco Partners, CEO Borey requested a change in his employment agreement in April 2005, shortly after receiving an indication of interest from Vector Capital in March to acquire Watchguard. The amended compensation package included change of control provisions on Borey's salary, bonus, and a lump-sum cash payment. More important, the executive stock options were repriced, because Watchguard's stock price had performed poorly recently and the options were underwater. The board adopted the changes to the employment agreement and stock options at its meeting in April 2005, unaware that discussions with a potential buyer had already occurred.

It has been argued that the change in Watchguard's compensation plans may have been a breach of management's fiduciary duties⁵, because it conferred a benefit on management that the board or shareholders would have assessed differently from management. Management knew that there was interest in an acquisition, whereas the board did not. The likelihood of an acquisition, and hence the value of the change, looks differently when one has knowledge of the discussions with the private equity firm.

Continuing Management Interest in Private Equity Buyouts

The going-private transaction of Sungard Data Systems was not only an example of how management can earn windfall compensation by selling their firms rather than pursuing other strategic initiatives, such as a spin-off. It also shows that management can have significant long-term incentives in selling to private equity funds.

In the case of Sungard, it does not appear that any strategic acquirer was a serious contender for a merger. Had there been one, it is safe to assume that management would have lost its jobs because the acquiring firm already has a management team in place. Replacement of the target management is one of the first areas in which synergies can be achieved. In contrast, private equity funds need a management team in place because they are passive investors that do not get involved in the day-to-day running of the business.

Moreover, had a strategic acquirer purchased Sungard, management would not have had the opportunity to participate in the upside of the company after the merger. Their ability to benefit from Sungard's business would have ended with the merger. In the private equity transaction, however, CEO Conde was given the opportunity to invest $22 million in the post-buyout firm. Other managers whom the private equity buyers wanted to retain were given the same privilege. Total management investment amounted to 3 percent of the post-buyout firm. Management's participation was not limited to the funds that they invested. In addition to the capital they put at risk, management would receive up to 15 percent of Sungard under an executive option plan.

It is hard to see how management could have acted with the benefit of shareholders in mind when they were presented such a win-win opportunity. They received an immediate riskless payout from the change of control provisions and, in addition, continued to participate in the future upside of the firm. Had Sungard not gone private, management would have had only a participation in the upside of a public Sungard without a risk-free payout.

The Sungard buyout is a variation of a management buyout. In a classic MBO, the managers ultimately take control of the firm. Private equity funds are only the providers of temporary capital that is paid back over time until management has taken full control. Management buyouts of this type occur today mainly in the middle market. In the overall buyout market, it is more common to see management as co-investors along with private equity. The problems involving buyouts by private equity are discussed in Chapter 8.

There are many theoretical justifications for MBOs, most of which are valid arguments.

The increased debt burden of a company that has been taken private instills discipline on managers to run the firm efficiently.
The regulatory burden on private companies is less than that of public companies. Especially since the advent of Sarbanes-Oxley, the cost of being public has increased. By going private, companies can be run independently of the constraints, burdens, and cost of being public.
Public companies are judged by their quarterly numbers, and management may have too much of a short-term focus on the next quarter. When a company has been taken private, it is easier for managers to take a long-term view rather than manage to next quarter.
It is easier to improve efficiency in privately held companies than public ones.

Some of these arguments are disproved easily. If high levels of debt are supposed to make managers work harder and focus more on efficiency, then Microsoft or Berkshire Hathaway must be among the most inefficient firms and must be run by real slackers. Although it is true that the regulatory burden on private companies is lower than for public firms, reporting subject to Sarbanes-Oxley does not necessarily end when a company becomes private. Many firms issue bonds that are traded without restrictions, and therefore they continue to make periodic filings subject to Sarbanes-Oxley. In addition, one of the exit strategies of MBOs is to take firms public again after a few years. When the firm makes its initial public offering (IPO), it needs three years of audited financial statements and, at that point, will have to go through the entire Sarbanes-Oxley process. With many firms going public again after three to five years, the cost savings are minimal to nonexistent.

Even the argument that private companies can make better long-term decisions bears little validity. Public markets are inefficient, but not to the point that they cannot take a long-term view at all. Most biotech firms would not be in business if market were that shortsighted. If management complains about the market's lack of understanding of its strategic vision, then the fault most likely lies in an inadequate communication of the strategy.

Finally, the argument that improvements in efficiency are easier done in private companies than public ones does not carry much weight. Some of the largest companies have been the object of sometimes dramatic turnarounds. Entire sectors, such as the airlines or electric power, are regularly undergoing restructuring while remaining publicly traded. The question is why public shareholders should not reap benefits of improvements in efficiency.

The fundamental problem with management buyouts lies in the unique position that the management team holds relative to outside shareholders. Not only do the managers as buyers have an information advantage, they are also dealing on both sides of the transaction: As sellers, they provide the special committee of independent directors and its financial advisers with information about the firm's value, and as buyers, they have an interest in acquiring the firm for the lowest price possible. Even though a special committee is established to manage the sales process, management still controls the information that is available to the committee. Assuming that management will act with a complete emotional detachment in its role as seller disregards human nature. There are many instances, some of which are discussed in this book, where the true activities of managers were hidden from the special committee. The special committee process is at best a Band Aid for a seriously conflicted situation.

Long-Term Planning in Management Buyouts

Management should take the long view. When it comes to preparing for management buyouts, taking the long view can be toxic for shareholders. Unscrupulous managers have many ways to prime a company for an acquisition at a low price. Management controls the company and its operations and can manipulate

Choice of accounting principles. By expensing rather than capitalizing costs or selecting last in, first out inventory management over first in, first out, earnings can be managed. Accounting is a particularly attractive area for manipulation because prudence dictates a conservative approach to accounting. When a company is prepared for a management buyout, some extra prudence can help to decrease the price that management will have to pay.
Cost structure. Managers can avoid making improvements in efficiency and build up an earnings reserve. Earnings will be lower while the firm is public and can be boosted as soon it goes private by making minor changes to costs.
Management discussion and analysis. Overly pessimistic descriptions of the business climate and outlook can depress a stock.
Projections. Withholdings projections or lowballing assumptions to underestimate growth will depress a stock price.
Boost investment. Some categories of investment, such as certain software development costs, are expensed rather than capitalized. It is impossible for outside shareholders to determine the exact nature of a company's expenses. For all they know, profitability is low and the firm is a dud. The benefit of the investment will be reaped by managers after a low-priced buyout.

In an extreme scenario, unscrupulous managers can make long-term plans to take a company private by depressing the stock price through a number of devices. As buyers, managers want to pay as low a price as possible for the company. If they plan an MBO well in advance, they will no longer work in the interests of shareholders but undermine shareholders in their own interest. Unfortunately, it will be almost impossible for shareholders to detect such behavior. Even courts are of little help, because they give management sufficient leeway under the business judgment rule to cover all but the most blatantly abusive actions.

Consider an oil firm that is to be taken private through an MBO. One way to reduce its value is to slow its drilling program. An oil company must drill new wells constantly to maintain its output because yields on existing wells decline after some time. Less output equates to lower profits. There can be many legitimate reasons why drilling slows: difficult geological environment at the drilling location, wear and tear on the equipment, and labor shortages, to name but a few. It will be impossible for shareholders or courts to determine whether a slowing of the drilling program is genuinely due to such factors or whether these are just excuses to drive down the firm's valuation. Once the MBO is complete, managers can then ramp up the drilling program by investing in new equipment or hiring more employees. If sufficient time passes between the slowdown of the drilling program and the MBO and no clear linkage can be established through documentary evidence, a court will give management the benefit of the doubt under the business judgment rule.

Assume that the slowdown was due genuinely to outdated equipment. Even if this fact were disclosed, management could acquire the firm through an MBO and subsequently replace the equipment. Managers doing such an MBO would use their inside knowledge of the firm and the assets of shareholders for their own benefit.

Short of banning MBOs, there is little that can be done to overcome these problems. Disclosures can provide some relief. At this time, management is required only to release its projections performed as management. Projections performed by management as the buyer are not disclosed. Shareholders would get a better understanding of the rationale for MBOs if all projections and business plans were required to be disclosed. Current disclosures are completely inadequate. Consider, for example, the disclosures of the discussion of the board of Netsmart, shown in Exhibit 9.5. The disclosures are mostly boilerplate language and simply rephrase a few simple key points:

An MBO is better than remaining a public company. No real rationale is given other than the “belief” of the board.
The price is fair.
The procedure is fair.

The filing from which the excerpt in Exhibit 9.5 is taken did not even disclose management's internal projections. They became public later, only after shareholders had filed litigation. During the litigation, it became known that Netsmart's management had restricted its search for a buyer exclusively to private equity funds. Management did not want the firm to be acquired by a strategic buyer, which probably would have brought in its own management team. From management's perspective, the acquisition by a private equity fund offered not only job security but the ability to participate in any appreciation of the firm's value, since it is common for private equity funds to offer managers significant equity stakes in the firm. It transpired during the litigation that management had actually used the term “second bite at the apple” in a presentation that described the advantages of a buyout. That term was omitted from the final version of the presentation.

Exhibit 9.5 Reasons for the Merger Given by Netsmart's Board

In the course of reaching its determination, the Special Committee considered the following substantive factors and potential benefits of the merger, each of which the Special Committee believed supported its decision:

Its belief that the merger was more favorable to unaffiliated stockholders than the alternative of remaining a stand-alone, independent company, because of the uncertain returns to such stockholders if the Company remained independent in light of the Company's business, operations, financial condition, strategy and prospects; as well as the risks involved in achieving those returns, the nature of the industry in which the Company competes, and general industry, market and regulatory conditions, both on an historical and on a prospective basis;
Its belief that the merger was more favorable to unaffiliated stockholders than the potential value that might result from other strategic alternatives available to the Company, including, among others, remaining an independent company and pursuing the current strategic plan, pursuing a significant acquisition, seeking strategic partnership arrangements or pursuing a sale to or merger with a company in the same markets, given the potential rewards, risks and uncertainties associated with those alternatives;
The fact that, prior to entering into the Merger Agreement, the Company had been engaged in a competitive bid process which included the solicitation of indications of interest from seven potential financial buyers, the delivery of corporate and financial information to three potential acquirers that signed a confidentiality agreement with Netsmart, the receipt and response to inquiries from three potential acquirers, and the receipt and evaluation of indications of interest from one potential acquirer, which subsequently determined not to proceed with a transaction at its initial bid price. See “—Background of the Merger.”
Its belief that no other alternative reasonably available to the Company and its stockholders would provide greater value to stockholders within a timeframe comparable to that in which the merger would be completed in light of the fact that the offer from the Sponsors was the highest firm offer received after a competitive bid process;
The fact that the merger consideration of $16.50 per share is all cash, so that the transaction allows the Company's unaffiliated stockholders to realize in the near term a fair value, in cash, for their investment and provides such stockholders certainty of value for their shares;
Netsmart's historical and current financial performance and results of operations, its prospects and long-term strategy, its competitive position in its industry, the outlook for the behavioral healthcare market and general stock market conditions;
The historical market prices of Netsmart common stock, including the market price of the Netsmart common stock relative to those of other industry participants and general market indices, and recent trading activity, including the fact that the $16.50 per share merger consideration represented a 6.7% premium over Netsmart's closing stock price on November 16, 2006 (the last business day prior to the approval of the transaction), and a 24.1% premium over Netsmart's average share price for the 20 trading day period ended November 16, 2006;
Its belief that Netsmart's stock price was not likely to trade at or above the $16.50 price offered in the merger in the near future. The board based this belief on a number of factors, including: the directors' knowledge and understanding of the Company and its industry; management's projections and the Company's business plan; and the various valuation methodologies and analyses prepared by William Blair and described under “Special Factors—Opinion of Netsmart's Financial Advisor” below;
The financial analysis reviewed by William Blair at the meetings of the Special Committee on November 16 and 17, 2006 and at the meeting of the board of directors on November 17, 2006, and the opinion of William Blair, described in detail under “Special Factors—Opinion of Netsmart's Financial Advisor” that, as of November 17, 2006 (as confirmed in its written opinion dated November 18, 2006), and based on and subject to the various factors, assumptions and limitations set forth in its opinion, the $16.50 per share merger consideration to be received by holders of shares of Netsmart common stock (other than the Management Investors, the Sponsors and their respective affiliates) was fair, from a financial point of view, to the holders of such shares;
The efforts made by the Special Committee and its advisers to negotiate a Merger Agreement favorable to the Company and its unaffiliated stockholders and the financial and other terms and conditions of the Merger Agreement; and
The fact that, subject to compliance with the terms and conditions of the Merger Agreement, the Company is permitted to terminate the Merger Agreement, prior to the adoption of the Merger Agreement by our stockholders, in order to approve an alternative transaction proposed by a third party that is a “superior proposal” as defined in the Merger Agreement, upon the payment to the Buyer of a termination fee of 3.0% of the total equity value of the transaction and its belief that such termination fee was reasonable in the context of break-up fees that were payable in other transactions and would not impede another party from making a competing proposal. The Special Committee believed that these provisions were important in ensuring that the transaction would be fair and the best available to Netsmart's unaffiliated security holders and providing the Special Committee with adequate flexibility to explore potential transactions with other parties.

The Special Committee also considered a number of factors relating to the procedural safeguards involved in the negotiation of the merger, including, among others, those discussed below, each of which it believed supported its decision and provided assurance of the fairness of the merger to the unaffiliated stockholders of Netsmart:

The fact that, other than for customary fees payable to members of the Special Committee (that were not contingent on the Special Committee's recommendation of a transaction or the consummation of a transaction), the acceleration of options to acquire an aggregate 15,000 shares of Netsmart common stock and the receipt of payment for stock options that will be cancelled in accordance with the terms of the Merger Agreement, the directors (other than Messrs. Conway and Koop in their capacity as continuing employees) will not receive any consideration in connection with the merger that is different from that received by any other unaffiliated stockholder of the Company;
The fact that the consideration and negotiation of the transaction was conducted entirely under the oversight of the members of the Special Committee consisting of all members of Netsmart's board of directors other than those directors who are members of management or former members of management, and no limitations were placed on the authority of the Special Committee. Accordingly, the Special Committee was free to explore a transaction with any other bidder it determined was more favorable or likely to be more favorable than Buyer. The purpose for establishing the Special Committee and granting it the authority to review, evaluate and negotiate the terms of the transaction on behalf of the Company was to ensure that the Company's unaffiliated security holders were adequately represented by disinterested persons. None of the members of the Special Committee have any financial interest in the merger that is different from the Company's unaffiliated security holders generally (other than the exchange of options to acquire shares of Netsmart common stock in accordance with the terms of the Merger Agreement);
The fact that the Special Committee had ultimate authority to decide whether or not to proceed with a transaction or any alternative thereto, subject to our board of directors' approval of the Merger Agreement following its approval by the Special Committee;
The fact that the financial and other terms and conditions of the Merger Agreement were the product of arm's-length negotiations between the Special Committee and its advisers, on the one hand, and Insight and its advisers, on the other hand;
The fact that Netsmart is permitted under certain circumstances to respond to inquiries regarding acquisition proposals and, upon payment of a termination fee, to terminate the Merger Agreement in order to complete a transaction with respect to a “superior proposal” as such term is defined in the Merger Agreement;
The fact that the Special Committee retained and received advice from its own independent legal counsel in negotiating and recommending the terms of the Merger Agreement;
The fact that the Opinion of William Blair addresses the fairness, from a financial point of view, of the merger consideration to be received by unaffiliated stockholders;
The fact that the transaction will be subject to the approval of Netsmart stockholders and that members of Netsmart's senior management and of the board of directors do not own a significant enough interest in the voting shares of Netsmart to substantially influence the outcome of the stockholder vote. As of Thursday, February 22, 2007, the record date for the special meeting, these persons collectively owned an aggregate of 492,736 shares, representing approximately 7.5% of Netsmart's outstanding common stock, excluding 549,878 shares issuable currently or issuable within 60 days upon exercise of outstanding options which if exercised would result in ownership of 14.6% of Netsmart's outstanding common stock. These shares consist of 106,348 shares owned by James L. Conway, 104,815 shares owned by Anthony F. Grisanti and an aggregate 281,573 shares owned by the other members and former members of the board of directors. See “Special Factors—Interests of Officers and Directors in the Merger” beginning on page 46; and “Common Stock Ownership of Management, Executive Officers and Certain Beneficial Owners” beginning on page 70;
The likelihood of the Sponsors obtaining the required debt financing for the transaction, given the solidity of the commitment letter from WFF; and
The fact that under Delaware law, the stockholders of the Company have the right to demand appraisal of their shares. See “Appraisal Rights” beginning on page 55.
The Special Committee was aware of and also considered the following adverse factors associated with the merger, among others:
That the public stockholders of Netsmart will have no ongoing equity participation in the surviving corporation following the merger and will cease to participate in Netsmart's future earnings or growth, or to benefit from any increases in the value of Netsmart stock;
That if the merger is not completed, Netsmart will be required to pay its fees associated with the transaction as well as, under certain circumstances, reimburse Buyer for its out-of-pocket expenses associated with the transaction;
The limitations on Netsmart's ability to solicit or engage in discussions or negotiations with a third party regarding specified transactions involving Netsmart and the requirement that Netsmart pay Buyer a $3,479,527 termination fee (less any amount of reimbursement of the Buyer and Merger Sub's expenses previously paid by Netsmart up to a maximum of $1,159,842) (which amounts assume no exercise of options or warrants since the date of the Merger Agreement) in order for the board of directors to accept a superior proposal;
That if the merger is not completed, Netsmart may be adversely affected due to potential disruptions in its operations, including the diversion of management and employee attention, potential employee attrition and the potential effect on the Company's business and its business relationships;
The fact that Netsmart is entering into a merger agreement with a newly formed corporation (Merger Sub) with essentially no assets and, accordingly, that any remedy in connection with a breach of the Merger Agreement by Merger Sub could be limited, although the Sponsors have agreed to fund Merger Sub in the event that it is obligated to pay the Company's expenses upon certain terminations of the Merger Agreement and the Sponsors have provided equity commitment letters;
The fact that the funding of the financing contemplated by the debt commitment letter issued to Buyer, or alternative financing on terms that are not materially less favorable to Buyer than those contained in the Debt Commitment Letter from WFF, is a condition to Buyer and Merger Sub's obligation to complete the merger; and
That Netsmart's business operations will be restricted prior to the completion of the merger.

Source: Form DEFM14A filed by Netsmart on March 2, 2007, p. 23.

In a landmark decision, Judge Leo Strine of the Delaware chancery court ruled that Netsmart should not have restricted its search for buyers to financial buyers only but should have considered strategic buyers as well. In particular in light of Netsmart's status as a small-cap company, it is unlikely that all potential acquirers would have known that it was for sale. For larger companies, there are fewer potential strategic acquirers, and a search can be somewhat more restrictive.

To test the market for strategic buyers in a reliable fashion, one would expect a material effort at salesmanship to occur. To conclude that sales efforts are always unnecessary or meaningless would be almost un-American, given the sales-oriented nature of our culture.

Judge Leo Strine, In re Netsmart Technologies, Inc. Shareholders Litigation, No. 2563-VCS (March 14, 2007)

Milking a Company through Related Party Transactions

The legal term related party transactions (or affiliated transactions) describes deals between a company and its managers, board members, or other persons who have influence in the firm and also stand on the other side of the transaction. These affiliates are in a privileged position because they have the power to influence decision making, potentially in their favor. Related party transactions always blur the line between personal assets and those of the firm. The question is only to what extent that separation breaks down. Some of the most infamous related party transactions were partnerships in which Enron's chief financial officer Andrew Fastow bought assets from his employer and subsequently sold them back to Enron for a risk-free profit.

Executives who run businesses in the same industry as the public companies that they manage often have business dealings between their private firms and the publicly traded company. In theory, such transactions are supposed to be conducted at arm's length on terms that are no worse than those an unrelated third party would offer. The more exotic the assets involved, the more difficult it becomes to determine such a fair market value. Transactions with affiliates are a convenient method to milk companies and strip assets from public shareholders.

Whenever a loss-making company with significant related party transactions is acquired by management, shareholders can bet that the company has been milked. The only reason managers would want to acquire such a company is because it is a valuable component of the executive's overall business interests. The losses in the public entity may in fact subsidize gains that the executive makes in the privately held firms. Unfortunately, such suspicions are difficult to prove because the business judgment rule gives management enough room to maintain a seemingly fair process. As we have seen before, as long as the process is robust enough to have sufficient elements of fairness, courts will not interfere even when smoking guns abound.

Related party transactions with a company's affiliates are disclosed in a company's proxy statement. Exhibit 9.6 shows the disclosures of Central Freight's related party transactions.

Exhibit 9.6 Related Party Transactions of Central Freight

We currently lease 22 active terminals and seven dormant terminals from Southwest Premier Properties, L.L.C. Southwest Premier is owned by some of our directors, executive officers and existing stockholders, including 77% by Jerry Moyes, and 10% by Robert Fasso. In 1998, we sold thirty-four of these properties to Southwest Premier, along with additional terminals that have since been sold, for an aggregate of $27.8 million in a sale-and-leaseback transaction that was accounted for as a financing transaction. We also currently have operating leases for two active terminals owned by Mr. Moyes. We incurred aggregate expense to Southwest Premier of approximately $6.8 million in 2004. We incurred aggregate lease expense to Mr. Moyes of approximately $1.2 million in 2004.

Swift Transportation Co., Inc. and Central Refrigerated Service, Inc. provide us with a variety of transportation services. Mr. Moyes is the Chairman and Chief Executive Officer of Swift and the owner and Chairman of the Board of Central Refrigerated. Together, these companies provided us with approximately 25.7% of all third-party linehaul transportation services in 2004. Under these arrangements, Swift provided us with approximately $12.0 million in services in 2004. At year end, we owed Swift approximately $0.9 million. Central Refrigerated provided us with approximately $2.0 million in services in 2004. At year end, we owed Central Refrigerated approximately $0.1 million. We believe that the amounts paid are equivalent to rates that could have been obtained in an arm's length transaction with an unrelated third party.

We currently lease terminal space from Swift in Memphis, Tennessee at a lease rate of $15,836 per month and in Fontana, California at a lease rate of $60,500 per month. We also sublease portions of our terminal facilities to Swift at seven different locations. Swift leases property from us in Tyler, Texas, for $3,750 per month, in Houston, Texas, for $15,181 per month, in Little Rock, Arkansas, for $800 per month, in San Antonio, Texas for $7,835 per month, and in Amarillo, Texas for $160 per month. All leases with Swift are, either by their terms or due to expiration of the contract, on a month-to-month basis.

Under these subleases and other subleases we formerly had with Swift, our rental income from Swift was approximately $0.4 million in 2004. We believe that the amounts paid are equivalent to lease terms and rates that could have been obtained in an arms' length transaction with an unrelated third party.

We lease independent contractor drivers and their tractors through Interstate Equipment Leasing, Inc., a company owned by Jerry Moyes. The independent contractors provide linehaul services for us at a rate per mile that we believe is equivalent to rates that could have been obtained in an arm's length transaction with an unrelated third party. We incurred expenses with Interstate of approximately $0.5 million in 2004. At year end, we had no liability to Interstate.

Source: Central Freight DEF 14A filing of April 22, 2005, pp. 17–18.

In many instances, a creeping takeover of a firm by its management team starts with related party transactions such as these. Central Freight was indeed acquired by Jerry Moyes in 2006. The Central Freight story started when Moyes took the firm public through an IPO in 2003. Just before the IPO, the board agreed to a repricing of the leases. Annual lease payments by Central Freight to Moyes increased from $4.4 million to $7.2 million “to reflect fair market value.” As a result of this repricing, Moyes earned almost as much from the leases as he paid to outside shareholders when he bought out the 60 percent held by the public in 2006. While public, Central Freight never had a chance to become profitable, partly because of the lease payments to Moyes.

At first sight, it would not make sense for Moyes to acquire a loss-making trucking firm. In the context of this overall business strategy, however, the acquisition of the firm made sense: Had Central Freight remained public, it would eventually have run out of money and gone bankrupt. Moyes's terminals would probably have been idle. As a stand-alone company, Central Freight was not a viable business, but in connection with ownership of the terminals, the overall complex was likely to generate profits.

Outside shareholders did not fare well while Central Freight was public. Shares in the 2003 IPO were sold at $15 per share, and when the firm went private in 2006, shareholders received only $2.25 per share.

A slightly less egregious attempt to appropriate valuable assets in connection with a merger occurred when the CME Group attempted to acquire GFI Group in late 2014. As part of the merger, the company was to be broken up with a consortion of key executives acquiring the clearing and brokerage business, whereas CME Group was going to acquire GFI's European energy trading platform as well as a currency trading technology business (Exhibit 9.7).

Exhibit 9.7 Related Party Acquisition of GFI Group

Transaction Structure

The transaction will be effected through a merger of GFI Group and CME Group and a concurrent acquisition of the wholesale brokerage business by an entity controlled by the private consortium of GFI Group management. GFI Group stockholders will receive shares of CME Group Class A common stock for each share of GFI Group common stock held based on an exchange ratio the numerator of which is the offer price of USD 4.55 per share of GFI Group common stock and the denominator of which will be the 10-day average closing price of CME Group common stock prior to the closing date of the transaction. Based on the closing price of shares of GFI Group common stock on July 29, 2014, the last day of trading prior to the announcement of the transaction, the exchange offer represents a premium of 46% to GFI Group's share price, for a total value of approximately USD 580m. In addition, CME Group will assume USD 240m in outstanding debt, for a total value of approximately USD 820m. Concurrently, CME will sell GFI's wholesale brokerage business to a private consortium led by current management for USD 165m in cash and the assumption, at closing, of approximately USD 63m of unvested deferred compensation and other liabilities. CME expects to retire the debt in 2015. In aggregate, the total consideration is approximately USD 655m for the Trayport and FENICS businesses before certain tax benefits that will be achieved based on the structure of the transactions.

Analysts were questioning the valuation implicit in the transaction, as it allowed management to retain the part of the business that generates consistent cash flows, whereas the CME was acquiring technology assets that were producing little cash flow but had significant potential earnings power. When two assets with such divergent characteristics are held in a single corporate structure the resulting valuation of the umbrella tends to be lower than the sum of the value of the parts. In a transaction where management can recover one of these assets for their future benefit it can be questioned whether the merger consideration was reflecting the full value of each of the two assets.

This concern was not completely misplaced. Shortly after the merger with CME Group was announced, GFI's competitor BGC Partners launched an all-cash bid for GFI that valued the firm more than 15 percent higher than the CME Group merger.

In the press release announcing BGC's bid the firm addresses the valuation concerns explicitly:

BGC believes the pending transaction with CME deprives GFI shareholders of the appropriate value of their investment, because GFI management and its Board approved a transaction that allows GFI management to purchase the brokerage business from CME at a discount. BGC remains willing to engage directly with the Board of GFI Group to negotiate a transaction. However, GFI Group's prior refusal to engage in such discussions requires BGC to take its superior, all-cash offer directly to shareholders.

BCG Partners Press release, September 9, 2014

Ultimately, the winner of the bidding war over GFI Group was BGC, which announced an agreement to acquire the company for $6.10 per share on February 27, 2015, compared with an initial bid by the management group of $4.55 per share on July 30, 2014.

Notes

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Table of Contents for Chapter 9: Management Incentives

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Management Compensation

Continuing Management Interest in Private Equity Buyouts

Long-Term Planning in Management Buyouts

Milking a Company through Related Party Transactions

Notes

Table of Contents for
Chapter 9: Management Incentives