The Pre-IPO Company and D & O Risk
Voyager Pharmaceuticals is a Raleigh, N.C.-based pharmaceutical company focused on trying to develop an experimental Alzheimer’s treatment called Memryte. Voyager had plans to raise $100 million through an initial public offering. A copy of Voyager’s S-1 can be found here. According to the news article, investors had committed $65 milion when the IPO was cancelled on December 13, 2005. A copy of the withdrawl request can be found here. Voyager recently advised shareholders that because it was unable to raise needed additional cash, it was halting the late Phase II studies of Memryte.
According to the news article, Voyager filed a first lawsuit in March 2006 against Dr. Richard Bowen, Voyager’s co-founder and former Chief Science Officer. Voyager alleged that Bowen had “derailed the IPO by acting erratically and spreading false information.”
On October 11, 2006, John Stone, a Voyager shareholder, filed a separate shareholders derivative lawsuit against Voyager’s CEO and CFO. This second lawsuit alleges that the defendants misled investors by inflating the company’s value. Specifically, Stone alleges that in January 2004, Bowen transferred over 1 million Voyager shares to the CEO and the CFO. Stone further alleges that even though the transfer took place in 2004, it was backdated to November 2001. Stone alleges that by backdating the transfer to a time when the shares had lower values, the beneficiaries avoided income taxes and Voyager’s net worth was overstated.
In response to Stone’s allegations, the Board has formed a special committee to investigate. The Board has not yet responded.
Voyager appears to have its own special set of issues and to that extent its officials' current legal woes have little to suggest for other companies. But the Voyager lawsuits do represent the kinds of unfortunate disputes that can arise when deals go bad. And at another level, the sequence of event at Voyager and the lawsuits themselves provide examples of the kinds of risk exposures that officials at pre-IPO companies face. Obviously, one risk for a pre-IPO company is that the planned IPO will not go forward, which, as the Voyager example shows, could lead to claims against senior management of the company.
When a company is on a trajectory toward an IPO, there is a natural tendency to focus on the liability exposures the company will face after it goes public. But the process leading up to the IPO involves changes and circumstance that can create its own set of risks and exposures. As a company readies itself to go public, it often restructures its operations, its accounting, its debt, or other corporate features. The company also makes pre-offering disclosures, for example, in road show statements. The process also creates expectations that can create their own set of problems. All of these changes, disclosures and circumstances potentially can lead to claims, even if the offering does goes forward.
Often pre-IPO company management is reluctant to take the time to address D & O insurance issues at the appropriate time before the company is deep into the IPO process. But claims can and do arise involving companies' pre-IPO activities. The significance of the pre-IPO period in a company's life cycle underscores the importance of having a skilled and experienced insurance professional involved well before the time of the IPO.
What a "Foreign Corrupt Practice" Looks Like: Regular D & O Diary readers will recall that I view the Foreign Corrupt Practices Act as a growing source of potential liability to companies and their senior management (most recent post on the topic here). This liability exposure is escalating as U.S. businesses are increasingly drawn into the global economy and confronting the different business standards and cultural norms in other countries.
An October 26, 2006 article in the Financial Times entitled “Taking a Cut Acceptable, Says African Minister” (here, subscription required) provides a vivid picture of how these kinds of problems can arise. The article describes efforts by a South African company to enforce a judgment the company obtained against the government of Equatorial Guinea. (Equatorial Guinea, located in West Africa and about the size of Maryland, is sub-Saharan Africa's third largest oil producing country.) The company had attempted to seize two luxury homes located in Cape Town that are owned by Teodorin Ngeuma Obiang, the son and heir-apparent of Equatorial Guinea’s President, who is also Equatorial Guinea’s forest minister. In justifying the seizure of Obiang’s Cape Town homes, the company alleged that Obiang had bought the houses with Equatorial Guinea’s government’s money, because Obiang’s $4,000/month salary as forestry minister is insufficient to permit Obiang to afford the $7 million homes.
Obiang’s surprisingly candid response to the question of where he got the money to buy the luxury homes gives a stark picture of the culture of corruption that afflicts his country. Obiang declared in an affidavit that ministers and public servants in Equatorial Guinea were allowed to own companies bidding for government contracts with foreign groups, which , if successful, would permit the ministers and officials to “receive a percentage of the total contract the company gets.” This, Obiang stated in his affidavit, “means that a cabinet minister ends up with a sizeable part of the contract price in his bank account.”
So here's how it works in Equatorial Guinea; you want to do business, you set up a local company -- probably not a bad idea to set up the company with the President's son. Your local company gets the contract and of course a "sizeable part" of the deal winds up in the President's son's bank account.
It may not be surprising that this goes on; what is surprising is how straightforward Obiang was in describing the corrupt practices, and that he was willing to do so in a sworn document filed with a South African court. His affidavit certainly confirms the existence of rampant corruption in Equatorial Guinea. The matter-of-fact way Obiang conveyed the information suggests the challenge any company would face in trying to do business there. Corruption is simply expected. Equatorial Guinea is an oil-rich couintry. Foreign companies will be drawn there because of the country's natural resources and depleting oil reserves elsewhere. The expectation to do business Obiang’s way not only complicates the business transaction, but created liability exposures under the FCPA and under anti-bribery laws in OECD (Organization for Economic Cooperation and Development) countries. As I have frequently noted on this blog, these exposures can also lead D & O liabilty exposures.
Among the debts underlying the South African company’s judgment is a $700,000 obligation allegedly incurred for chartering the yacht Tatoosh, owned by Paul Allen, a Microsoft founder. Tatoosh is 300 feet long, has a crew of 30 and has auxiliary vehicles that include two helicopters, a submarine, and a separate 54-foot racing yacht. It also has its own swimming pool. A September 6, 2006 Times of London article about Obiang that describes the Christmas party for which Obiang hired the use of Tatoosh, entitled "Playboy Waits for His African Throne," may be found here.
Special thanks to a loyal reader for the link to the Financial Times article.
What a Coincidence, Terrorists Have Been Stealing the Beer from My Refrigerator: A New Jersey real estate attorney has sued his malpractice carrier for refusing to reimburse him for amounts he had to pay to make up for lost funds in his client trust account. The attorney claims that because he was “extremely busy” from 2000 through 2002, he “failed to reconcile his trust account on a regular and timely basis.” He alleges that he learned in July 2002 “that a terrorist group had over a period of time duplicated checks and forged Plaintiff’s signature to obtain the funds in question.” When he discovered the missing funds, the attorney used his own and borrowed funds to protect his clients from losses. He settled with his bank for $95,000. His suit seeks to force his insurer to pay the remaining amount. The attorney’s complaint, which may be found here, does not name the terrorist group.