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Medley Capital: Two Independent Directors Resign

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NEWS

On March 20 2019 after the close Medley Capital (MCC) reported two of its “independent” directors had resigned.

The two individuals are John Mack and Mark Lerdal.

Both resigned as of March 18, 2019.

MCC indicated that the “decision to resign from the Board was not due to any dispute or disagreement with the Company, or on any matter relating to the Company’s operations, policies or practices”.

Furthermore:

On March 18, 2019, the Company notified the New York Stock Exchange (the “NYSE”) that, following the resignations of Mr. Mack and Mr. Lerdal, the Company had only two independent directors and audit committee members. On March 19, 2019, the Company received a notice from the NYSE that, due to the resignations of Mr. Mack and Mr. Lerdal from the Board, the Company no longer satisfies (1) the requirement that listed companies have a majority of independent directors as set forth in Section 303A.01 of the NYSE Listing Company Manual and (2) the requirement that the audit committee of a listed company to have a minimum of three members as set forth in Section 303A.07 of the NYSE Listing Company Manual. On March 20, 2019, the Company filed with the NYSE a written affirmation to notify the NYSE of the deficiencies described above.

The Company’s Nominating and Corporate Governance Committee is searching to identify qualified candidates to replace Mr. Mack and Mr. Lerdal as directors of the Board, members of the Audit Committee of the Board, and members of other committees of the Board. The Company intends to fill the vacancies created by the resignations of Mr. Mack and Mr. Lerdal in conformity with Sections 303A.01 and 303A.07 of the NYSE Listing Company Manual and regain compliance as soon as practicable.


ANALYSIS

Who’s Who

Here are the biographies of the two directors who resigned, copied from an earlier filing:

Mr. Mack has over 40 years of international banking and financial business management experience. From November 2002 through September 2005, Mr. Mack served as Senior Managing Executive Officer and Chief Financial Officer of Shinsei Bank, Limited of Tokyo, Japan. Prior to joining Shinsei Bank and for more than twenty-five years, Mr. Mack served in senior management positions at Bank of America and its predecessor companies, including twelve years as Corporate Treasurer of NationsBank Corporation and NCNB Corporation. From November 2011 through December 2013, Mr. Mack was a member of the board of directors of Residential Capital LLC, and from January 2010 through March 2015, Mr. Mack was Vice-Chairman and a director of Islandsbanki hf located in Reykjavik, Iceland. Mr. Mack is currently a member of the board of directors of Incapital Holdings LLC, Searchlight Minerals Corp., Tiptree Financial Inc. and GlobalMin Ventures Inc. Mr. Mack holds an MBA from the University of Virginia Darden School of Business and received his bachelor’s degree in Economics from Davidson College. Mr. Mack has served in senior management positions at large financial institutions and has extensive experience in finance, accounting and regulatory issues. In addition, his tenure in the financial services industry and service as a director of both public and private companies provide industry-specific knowledge and expertise to the board of directors.
Mr. Lerdal has served as the Executive Chairman of Leaf Clean Energy, a closed-end listed fund in the renewable energy sector, since March of 2014. He also serves on the boards of TerraForm Global, Inc. and Trading Emissions plc. Additionally, he serves as an operating partner at two private infrastructure funds. He has been active in the energy and finance industries for over 30 years. He earned a AB in Economics from Stanford University and a JD from Northwestern University.
Compensation
For the record Mr Mack owned 1,000 shares of MCC stock and Mr Lerdal owned none.
Mr Mack was paid $275,000 in the twelve months to September 30, 2018 and Mr Lerdal $252,500.
Role Play
Under the proposed merger between MCC, Sierra Income and Medley Management (MDLY), Mr Mack was to become a director of the combined company.
Reasons For The Resignations
None given, but the Delaware Chancery Court judge who recently opined on Front Four Capital’s lawsuit against the merger was hyper-critical of the role played by “independent” directors of MCC whose fiduciary duty is to the shareholders of the BDC.
The BDC Reporter covered the subject in an earlier article on March 14, 2019. That article contains a link to the judge’s opinion.
Nothing Good To Say
The judge’s review of the case alternates between showing the directors as dupes of the Medley Management insiders or willing tools or indifferent stewards or even just plain unaware.
Here are some extracts from the judge’s brief. First, the judge points out that the interests of MCC’s shareholders are not aligned with their shareholders but do sync with the MDLY insiders:

As to the outside directors, the value of their director fees dwarfs the value of their Medley Capital common stock. Ainsberg, Hirtler-Garvey, and Mack have each been paid over $1 million for serving on the Board and its committees.  For the company’s fiscal year ending September 30, 2018, Ainsberg earned $299,000, as a Medley Capital director, representing roughly half of his 2018 income. Lerdal has been paid $288,702 for his two years as Medley Capital director. By contrast, at the deal price, the value of all of the outside directors’ combined common stock is under $40,000. In the Proposed Transactions, two of Medley Capital’s four outside directors will serve on the Board of the combined company; all four outside directors interviewed for the position after the Merger Agreement was signed. (Pages 13-14)

Moreover, the judge revealed that the “independent” directors were kept in the dark about key elements of the merger.

On January 26, 2018, the Medley Capital Board convened a meeting to receive updates on Medley Management’s sales process.Brook Taube reported on the process as well as the status of negotiations with Party X. His report to the Board was high-level. It omitted information that he had presented to Medley Management’s board of directors that same day. The Board was not informed, for example, that the arm’s-length parties were only willing to pay premia of 8.4% (one third-party) – 30.0-55.4% (Party X). They were not told that Party X had dropped its price due to concerns about the performance of Medley Management. They were not made aware of the standstill provisions restricting transactions at Medley Capital. Before this litigation, none of the Board members ever asked for or were made aware of this information. (Page 18).

Furthermore, in April 2018 Origami Capital Partners reached out to MCC about a potential transaction. Both Mack and Lerdal, members of a Special Committee set up to review possible alternative deals, were not made aware of “Origami’s overtures”. Page 20.

Oblivious

Also, the judge revealed that as early as 2018 Medley Management was “under enormous pressure” from a financial standpoint, but the directors of MCC were unaware of that fact, and the possible catalyst that might be providing for the proposed merger:

Brook Taube proposed implementing drastic steps, including closing Sierra Total Return Fund to boost cash flow, ending the Sierra distribution to gain $4 million in EBITDA, and imposing other cost saving initiatives to squeeze another $2 million out of the business. On May 9, 2018, Brook even requested that two of his senior management members agree to defer cash payments owed to them and take Medley Management stock instead.His colleagues declined. Before this litigation, the Special Committee was unaware of the pressures Medley Management faced during this time period.In a candid moment during trial, Ainsberg [an independent director] admitted that he wished he had known.

Dereliction Of Duty ?

The Delaware judge was also critical of the performance of the MCC Special Committee that Mr Mack and Lerdal were members of. We have re-printed below a large block of the judge’s opinion which deals with this subject, and which is remarkably explicit. The highlights are ours.

“What the Special Committee Did Not Do.

Out of the gate, the Special Committee failed to assert control over the timing of process. At the June 2018 Medley Capital Board meeting, Medley Management presented an aggressive timeline, which contemplated that the parties would execute definitive transaction agreements and announce a transaction by July 31, 2018.This made sense for Medley Management, which had shopped itself for more than a year prior to that point. By contrast, Medley Capital had not undertaken any strategic process before the June meeting. Between its January 26, 2018 formation and the June 19, 2018 Board meeting, the Special Committee did not hold any meetings, retain a financial advisor, or engage in any substantive discussions with the Taube brothers or other members of Medley Management about a strategic transaction. Unlike Medley Management, the Special Committee was starting from scratch. Unlike Medley Management, the Special Committee had no reason to rush deliberations. Yet, the committee capitulated to the timeline Medley Management proposed.

Then, throughout the negotiations, Brook Taube pressured the Special Committee to stick to the aggressive timeline. He denies this, but contemporaneous documents prove otherwise. In a July 11, 2018, email to the Medley Management Board, Brook emphasized that “[t]ime is not in our favor given performance, inquiries, letters, etc.” He specifically flagged the possibility of “unwanted interloping” and emphasized that it was “real and should be taken seriously by the board.” He went on to underscore the fact that the transaction represented a “100% premium and a great deal” for Medley Management.  On July 27, 2018, Brook instructed Medley Management and Goldman to advise Medley Capital that they “have a fiduciary obligation to close.” That same day, he emailed Broadhaven: “Make this happen!!!!!!”

On July 31, 2018, Brook Taube emailed Jeff Tonkel while Tonkel was on a “Sierra call with Tony.” He instructed Tonkel: “Thursday board meetings are the time to push these guys hard in person.” On August 1, 2018, Brook reported to the Medley Management Board that “[w]e and Goldman continue to believe the risk is substantial if we announce earnings without simultaneously announcing this deal.” On August 5, 2018, Lerdal texted Brook Taube: “Are we on track? Anything you need from me?” Taube responded: “Let’s talk soon / Pushing Hard :-)”

The Special Committee did not analyze the value of Medley Management, or understand what Medley Management would obtain in the Proposed Transactions, although in effect Medley Capital and Medley Management were competing for consideration. The Medley Management transaction and Medley Capital/Sierra Merger were cross-conditioned, and the new, combined company would own Medley Management post-closing. The Special Committee did not consider alternative transactions, although disgruntled stockholders were publicly advocating for a sale process as of April 2018. In letter to the Board dated April 17, 2018, one Medley Capital stockholder wrote: “We believe the Board of Directors should immediately undertake a serious effort to sell the business (the underlying investment portfolio and the management agreement). We believe there is an attractive market for [Medley Capital’s] investment portfolio well above where [Medley Capital’s] current stock trades.”Although the Special Committee was broadly empowered, they laser focused on only one option. Sandler corroborated—they viewed their role as evaluating the three-way combination only. The Special Committee did not conduct a pre-signing market check. When asked why, Hirtler-Garvey [an independent director] said she was happy with the transaction at hand. She wanted a deal with Medley Management. Ainsberg [another independent director] testified his belief that the 2017 Medley Management sales processes “effectively” checked the market for Medley Capital. He believed that Party X’s offer had the potential to result in a deal with Medley Capital.

Mack went further, testifying that he understood the Party X transaction to be geared toward a deal with Medley Capital, not with Medley Management. This, of course, was wrong.Brook Taube testified, and contemporaneous evidence reflects, that the 2017 sales processes and negotiations with Party X aimed to develop strategic transactions and generate potential bidders for Medley Management, not Medley Capital. Medley Capital was not “effectively” shopped. Although the 2017 Medley Management process informed the Special Committee’s decision not to conduct a pre-signing market check, the committee members did nothing to inform themselves of basic aspects of Medley Management’s prior two sales processes. As discussed above, one member did not know that the process aimed to generate a deal for Medley Management, not Medley Capital.

No one asked about the terms of the potential Party X transaction or any other proposal received by Medley Management as part of those processes. Critically, none of the committee members knew that approximately thirty confidentiality agreements contractually foreclosed potential third-parties from proposing a transaction with Medley Capital. Of the thirty agreements, only two standstill periods expired before the Proposed Transactions were announced on August 9, 2018. The other twenty-eight agreements restricted potential counterparties during the entire period that the Special Committee was negotiating the deal. When asked about the standstill agreements during his deposition, Mack stated his belief that “[t]his is a management issue, not a director [issue].” He thought that more signed standstill agreements would be beneficial for Medley Capital.  He admitted, “I was not familiar with the specifics,” and disclaimed any interest in being informed: “I may not want to know how sausage is made.”

The Special Committee did not probe meaningfully into the value of Medley Management. Medley Management’s financial projections forecasted “hockey stick” growth in the outer years of the forecast based on revenue from new projects and clients.Sandler ran a sensitivity analysis, but lacked much of the information that was concerned with whether the NII benefit from the deal was just projected growth, or whether there was underlying value and earnings to support the figures.Also, the Special Committee did not know about two expressions of interest from third parties in a transaction with Medley Capital. The first was from Origami, discussed above. The Special Committee did not learn of Origami’s 2018 outreach until Origami publicly disclosed it in February 2019.171 The second was from Lantern, which executed a confidentiality agreement on May 23, 2018, as part of the Medley Management sales process. On July 3, 2018, Tom Schmidt of Lantern reached out to Goldman about its interest in acquiring Medley Management and potentially recapitalizing Medley Capital. Schmidt followed up on July 10.He followed up again on July 20, this time expressing frustration. On July 30, Lantern submitted an indication of interest.Among other things, Lantern explained that it was “interested in exploring alternatives for providing a significant cash infusion of new capital into Medley Capital to the extent it is prudent. Lantern’s recapitalization idea did not reach the Special Committee before execution of the Merger Agreement.” Pages 32-40.

In a footnote Mr Mack is quoted as being confused at which financial adviser (in this case Goldman Sachs) was working for which of the three Medley companies:

“Mack also testified that he did not know or think about who Goldman Sachs was working for. Id. at 99:20–25. “They were – they were trying to shop to see whether there was a deal out there, but I’m not sure that I ever thought about who they were working for.”


VIEWS

Take Your Pick

There are a host of reasons the two “independent” directors of MCC could choose from to resign from the Board at this point, nine days before the shareholder vote.

The damage to their reputation – and potentially to their pocketbook – is too high to endure and there is little doubt that further litigation is on the way.

The Delaware judge has already left the door open for FrontFour to seek relief from the court system and other injured parties must be considering their options.

That Other Shoe

It’s also possible that the other two “independent” directors will resign as well, which will compound the problem the BDC has in meeting basic SEC and market regulations.

Terra Incognita

As we are now in uncharted territory where the BDC Reporter is concerned, we don’t know if the vote may have to be postponed again until the issue of having sufficient “independent ” directors is resolved.

Just Say “Uncle”

We also wonder if these defections may cause the Medley insiders – surely likely to lose the vote on March 29 after this final ignominy – to use the opportunity to call off the merger once and for all.

In our Medley Fantasy Merger game, we regard that as a high probability.

However, what happens after that – or if the vote does go ahead and get rejected – remains highly speculative.

No Home Court Advantage

Our position – until now – has been that the incumbents have a huge advantage in these sorts of contests.

However, Medley has just lost two important pieces in this game of chess and with them much of their edge.

If the other directors also head for the exits a whole new slate of “independent” directors will have to be assembled and under the greatest scrutiny – something rare in the world of BDC public companies where most shareholders, investors and analysts can barely be forced to read the Proxies and turn up at the ballot box in normal times.

What The Markets Believe

Obviously, for all three Medley companies these are not normal times and anything can happen.

At the close on Wednesday, MCC was trading at $3.19, up slightly on the day, presumably as investors with their ears to the ground bet on a deal not getting done.

By contrast, MDLY dropped 5% to $2.98.

The stock’s all-time low was $2.88.

One of MDLY’s Baby Bonds  with the ticker MDLQ- which is becoming one of the ways speculators are using to take advantage of this uncertain situation – dropped (9%) on the day to $12.40, or 50% off par.

The other Baby Bond – MDLX – is at $11.80 already.

Thursday and the days that follow could well see much price movement in all 4 public securities as this drama plays out.

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