E*TRADE Board Sued for Keeping Morgan Stanley Merger on Track

The actual value of merger deal dropped as Stanley stock lost 25%, which provides a negative premium for E*TRADE stockholders.

E*TRADE’s directors were hit with a lawsuit in a New York court for keeping its proposed all-stock $13 billion merger with Morgan Stanley on track without determining if the recent financial results of both entities undermined the deal logic.

Plaintiff Chris Ramsubhag, a stockholder of the discount broker, says the E*TRADE management provided “materially incomplete and misleading” presentation for both the SEC and stockholders to pass the takeover deal. The allegations centered around financial projections issued by E*TRADE management which, according the complaint, omits critical expectations for both firms, including revenue, dividends, tangible book value and earnings per share.

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In addition to alleging a general dereliction of duty, it accuses the E*TRADE directors of misleading public investors by continuing to rely on financial projections from February, when the merger agreement was signed, that possibly no longer accurate.

Specifically, E*TRADE operators have revised down their projections for the company’s earnings based on financial results through December 31, 2019. However, the proposed proxy to recommend the merger did not include an upward adjustment to these weak projections which the plaintiff says it makes sense following strong results the company achieved in the Q1 2020. Furthermore, the positive revision was justified even before that as E*TRADE exceeded earnings expectations in both Q3 2019 and Q4 2019.

“Unlike poker where a player must conceal his unexposed cards, the object of a proxy statement is to put all one’s cards on the table face-up. In this case only some of the cards were exposed—the others were concealed. If a proxy statement discloses financial projections and valuation information, such projections must be complete and accurate,” the complaint states.

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A demand for revised information

The proposed shareholder class action also alleges that the company’s directors for no obvious reason hired two separate financial advisors to oversee a deal with “minimal bidders and a truncated sales process.” This has led to incur an additional $20 million in fees while the practice becomes justified only in cases of a possible conflict of interest brough by an existing financial advisor.

“Here, J.P. Morgan was E*TRADE’s “long-standing financial advisor.” Information that bears on whether an investment bank faces conflicts of interest is material to shareholders when deciding how to vote on a merger as it is imperative for the shareholders to be able to understand what factors might influence the financial advisor’s analytical efforts,” the argument further reads.

Finally, Ms. Ramsubhag accuses the company’s directors of breaching their duties when they didn’t disclose that E*TRADE has outperformed in the months leading up to the proposed merger. Moreover, since the announcement of the deal, Morgan Stanley stock fell by over 28% from $56.31 on February 19, to $40.28 on May 18.

In practice, this has caused the actual value of merger deal to be drastically reduced and even provides a negative premium for stockholders. It also makes the whole situation differs from the initial offer when Morgan Stanley proposed a cheaply valued stock that trades around 10 times projected 2020 earnings per share, while paying 15 times projected earnings for E*Trade. According to the deal terms, Morgan Stanley will issue 1.0432 of its shares for each E*Trade share.

The American lender announced in February plans to move further from its core origins with an agreement to buy the discount brokerage firm E-Trade for about $13 billion, joining the battle for middle America’s wealth management market.

The addition of E-Trade would allow Morgan Stanley to tap into a new source of revenue through an additional 5.2 million customer accounts and $360 billion in assets. The takeover would also give Morgan Stanley a significant share of the market for online trading and puts it on firmer footing with competitors like Bank of America and Wells Fargo.

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