fiduciary duty issues in m&a transactions - Jackson Walker LLP

with the notable exception of the claim against the Company’s directors alleging Caremarkviolations.In 1998, HBOC’s audit committee met with HBOC’s outside auditor to discuss HBOC’s1997 audit and was informed that the 1997 audit was “high risk” and explained its concerns.Although a subsequent SEC investigation established that HBOC was misapplying the generallyaccepted accounting principles for financial reporting in the U.S. (“GAAP”), the auditors did notinform the audit committee of this fact, and reported that there were no significant problems orexceptions and that the auditors enjoyed the full cooperation of HBOC management.During the summer of 1998, HBOC held discussions with McKesson regarding apotential merger. McKesson engaged independent accountants and investment bankers to assistit in evaluating the proposed merger. In a meeting with these advisors, McKesson’s board ofdirectors discussed the proposed merger and the due diligence issues that had surfaced, and firstlearned of HBOC’s questionable accounting practices, although there was no indication that theMcKesson board actually knew of any of HBOC’s material accounting violations.In October 1998, after a brief suspension of merger negotiations, the parties resumeddiscussions and agreed upon a modified deal structure, but they did not resolve the issues relatedto HBOC’s accounting practices. On October 16, 1998, with awareness of some of HBOC’saccounting irregularities, McKesson’s board approved the merger and agreed to acquire HBOCfor $14 billion in McKesson stock. Following the effective time of the merger, theHBOC/McKesson Survivor’s audit committee met with its advisors to discuss the transactionand certain accounting adjustments to HBOC’s financial statements, which the audit committeeknew were insufficient to remedy the accounting improprieties that its auditors had previouslyidentified. The HBOC/McKesson Survivor took some remedial action in April 1999, when itannounced that it would restate its prior earnings downward and, a few months later, terminatedthe senior management responsible for the accounting improprieties.Thereafter, the plaintiffs brought a duty of oversight claim against the directors of theHBOC/McKesson Survivor alleging, inter alia, that the Company directors had failed to (1)correct HBOC’s false financial statements, (2) monitor the accounting practices of the Company,(3) implement sufficient internal controls to guard against wrongful accounting practices thatwere uncovered following the merger, and (4) disclose HBOC’s false financial statements. TheCourt noted that under Caremark “a derivative plaintiff must allege facts constituting ‘asustained or systematic failure of the board to exercise oversight – such as an utter failure toattempt to assure a reasonable information reporting system exists.’” To survive a motion todismiss, the plaintiff was required to show that the HBOC/McKesson Survivor board shouldhave known that the alleged accounting problems had occurred or were occurring and made nogood faith effort to rectify the accounting improprieties. Noting that the plaintiff was entitled tothe benefit of all reasonable inferences drawn from the applicable facts, the Court found that theplaintiffs had alleged sufficient facts to infer that the boards of each of McKesson and HBOC –members of which comprised the board of the HBOC/McKesson Survivor – knew, or shouldhave known, of HBOC’s accounting irregularities, noting that (i) HBOC’s audit committeebecame aware of the accounting problems when it learned that its 1997 audit was “high risk” andthat the McKesson board learned of some of the problems during the July 1998 board meeting atwhich due diligence issues were discussed, and (ii) the HBOC/McKesson Survivor’s audit5446095v.118