I am looking forward to seeing the movie Moneyball, which was released in theaters last Friday. The film is based on Michael Lewis’s eponymous book, which I read some time ago.  The book is about Billy Beane, the general manager of the Oakland Athletics, a major league baseball team that perennially had the smallest budget in the sport.

According to Lewis, the idea for the book “began, really, with an innocent question: how did one of the poorest teams in baseball, the Oakland Athletics, win so many games?” Richer teams could afford better players, and better players tended to win games. Hence, Beane was forced to ask himself, if the A’s weren’t going to exist for the sole purpose of getting beat by the league’s richer teams, how could they compete?

For years, statistics-obsessed baseball fans had shared observations about which players were best, and why. They relied on conventionally valued statistics, such as RBI’s (runs batted in) on offense, errors on defense, and ERA (earned run average) for pitchers.  It was common wisdom that such data indicated which players were good and which were bad.

One fan, Bill James, wrote an obscure annual newsletter called Baseball Abstract, dedicated to showing that baseball teams overvalued such conventional statistics as RBIs and ERA.  James noted that these statistics did not correlate to scoring runs or wins, and hence were overvalued. The consequence of overvaluing non-correlative traits, James observed, was that teams were therefore undervaluing traits that statistically correlated more closely to scoring, such as on base percentage and slugging.  Other fans and writers applied to the same analytical approach to evaluating players’ other traits.

In the 1980’s, A’s General Manager Sandy Alderson, a Harvard-trained lawyer, had started to apply these stochastic methods to player selection. Billy Beane replaced Alderson in 1998 and immediately began running the A’s using the stochastic approach favored by his former boss and mentor. Beane reasoned that the only way he could field a competitive team with a substantially smaller budget was by jettisoning age-old concepts of value and by applying good management and stochastic analysis.

Every year, the A’s won more games. Today, every MLB club plays, to some extent, what has come to be called “Billyball.

Years ago, at about the same time Beane was experimenting on the A’s with Jamesian theory, I was chatting with a friend, the CEO of a mid-sized company, about his proposed plan to grow the company through acquisition. The CEO had heard, as we all have, that cultural fit is important to successful integration. He concluded that he would only acquire a company that had a perfect cultural fit.

He had identified a valuable trait and overvalued it. By doing so, he had undervalued the role of the acquirer’s management team in managing culture. Organizational culture is important.  And in an acquisition context, cultural fit between two organizations is a predictor of integration success. However, new cultural values can be learned.

Good management teams establish and communicate organizational values that advance the company’s mission, differentiate the company from competition, and energize the workforce. But if an acquirer overvalues cultural fit, it essentially undervalues its ability to create value by establishing and leading the culture of the combined entity.  And creating value is the central object of acquisitions.

There may be many other examples of conventional but imperfect thinking in mergers and acquisitions. If Billy Beane was a deal-maker (and he was), he might say: reconsider conventional wisdom, be objective and look for undervalued traits.

By Manik Rath, Senior Vice President, General Counsel & Corporate Secretary, LMI

Corporate social responsibility is a growing movement, and now it is fostered a new form of business entity.  Over the past few years, we have seen a steady growth of the public “Benefit Corporation” or “B Corporation” movement.  The B Corp is a statutory corporate form that enables a company to enhance and encourage corporate social responsibility without running afoul of traditional notions that a company exists solely to serve the shareholder.  While traditional corporations generally look out for the benefit of their shareholders, B Corps can also take into consideration employee, community, social and environmental interests when making corporate decisions.

Recently, a friend of mine, DCS Corporation General Counsel Curtis Schehr, and I were talking with some fascination about this new form of business entity.  Curtis was working on an article on B Corps at the time (which you may read here if you are interested. He said that Maryland was the first state to adopt legislation recognizing the B Corp as a standalone business form.   Vermont, Virginia and New Jersey have passed similar laws, and, now seven additional states are considering legislation Colorado, Hawaii, New York, North Carolina, Pennsylvania, California and Michigan).

According to a B Corporation website (www.bcorporation.net), B Corps are unlike traditional businesses because they “meet comprehensive and transparent social and environmental performance standards; meet higher legal accountability standards; and build business constituency for good business.”  Currently there are 416 B Corps representing 54 industries with combined revenues of $1.94 billion.

Curtis Schehr speculates that someday “B Corporations may command higher valuations if they have established a trusting, transparent relationship with their customers, employees, suppliers and other stakeholders. Such loyalty may translate into substantial goodwill for which buyers may be prepared to pay. In addition, private equity and venture capital firms are paying increasing attention to and funding B Corporations.” I offer no opinion on that, but it will be interesting to watch the trend unfold.

(Thanks to Curtis Schehr and Tamara Jack, Ass’t General Counsel, LMI, for their thoughts on this).

Each year the National Capital Chapter of the Association for Corporate Growth (ACG) elects new members to its Board of Directors and selects a new president. These individuals are chosen to help guide the organization’s business and affairs and set its direction for the coming year.

ACG National Capital’s Board of Directors is an all volunteer board representing the various local industry sectors and all facets of ACG’s membership. During their four- year term, these individuals will work to establish guidelines and policies for the chapter. Directors participate on a team of committed industry leaders to establish the goals, strategies and objectives to enable the Chapter to fulfill its mission of driving middle-market corporate growth. They provide financial oversight and develop action plans and programs to support and grow membership, and increase the overall value of the organization.

The newest Board of Directors includes some of the most distinguished business leaders in the region. This robust group brings a strong voice to capital market growth and M&A strategy further extending the value that the Chapter offers to its members.

Greg Van Beuren was appointed as the new ACG Capital Chapter president, assuming the role from past president Jason Rigoli. Most recently, Greg was a managing director in the Defense & Government Services Group of BB&T Capital Markets | Windsor Group, where he advised on numerous middle-market M&A transactions ranging in value from $10 Million to more than $700 Million and resulting in more than $3.0 Billion in value for his clients.

This year’s new class also includes:

Joe Cormier, Sotera Defense Solutions, Inc

Joe Cormier is the executive vice president and chief financial officer for Sotera Defense Solutions, Inc. He joined the company in January 2010 and oversaw the company’s financial operations. As executive vice president and CFO, he is responsible for directing the fiscal functions of the company.

Dr. Sue Evans, Evans Incorporated

Dr. Sue Evans is the founder, president and CEO of Evans Incorporated, where she has led organizational assessment, business reengineering, change management and IT strategy projects for private, government and not-for-profit organizations.

She has conducted organization assessments and reengineering efforts, gathered system requirements and developed human modeling systems for the Air Force, Army, Office of the Secretary of Defense and the Nuclear Regulatory Commission.

Catherine Jones, UGL Equis Services

Catherine Jones is a senior vice president at UGL Services’ Washington D.C. office, where her focus and expertise is on the planning and execution of complex projects for major corporations, professional firms and government entities. Catherine holds several industry and civic leadership positions in the greater Washington area. She is a board member of The Boys and Girls Clubs of Greater Washington D.C., a graduate of the Leadership Washington organization, and the 2008 Finance Chair for the Kennedy Center Choral Arts Gala and annually since 2009.

Beth Monroe, JustinBradley

Beth Monroe is the president of JustinBradley. She has 18 years experience forming and managing staffing and related service firms, including operations, sales, mergers and an IPO.

Randy Phillips, CSC

Randy Phillips is a corporate vice president and chief development officer (CDO) at CSC. He is the corporate officer responsible for strategic planning as well as identifying, negotiating, and closing all acquisitions, divestures, and related transactions that drive CSC’s growth strategies.

Manik Rath, LMI

Manik Rath is senior vice president, general counsel and corporate secretary at LMI, where he is responsible for the legal and corporate development affairs of the company. He has authored numerous articles, and frequently is invited to speak about corporate growth issues.  He has been quoted in the Washington Post, Investor’s Business Daily, CBS Marketwatch, National Law Journal and StreetInsider.com, amongst others.

We want to congratulate the newest members of the ACG National Capital Board of Directors and our next ACG National Capital President. The addition of such talented, experienced and knowledgeable individuals to the association’s leadership guarantees the continued success of the National Capital Chapter.

By Manik Rath, Senior Vice President, General Counsel & Corporate Secretary, LMI

On May 3, the Department of Justice filed suit against Deutsche Bank and its subsidiary, Mortgage IT Inc., in the Southern District of New York for fraud in connection with mortgages generated and sold subject to FHA insurance.   

This may presage a new set of False Claims Act prosecutions to recover government funds mismanaged in the recent economic crisis.   This case is notable because of the government’s attempt to use the False Claims Act to turn due diligence failures into fraud. 

The complaint brings claims under three sections of the False Claims Act: 31 U.S.C. §§ 3729(a)(1)(A), 3729(a)(1)(B), and 3729(a)(1)(G). In these claims, the government asserts that the defendants knowingly, or with deliberate ignorance or reckless disregard (1) presented or caused to be presented false claims to an officer or employee of the government, (2) made, used, or caused to be made or used, false records or statements material to false or fraudulent claims for payment, and (3) made, used, or caused to be made, false records or statements in order to avoid, decrease, or conceal an obligation to pay money to the government. The complaint also alleges claims for breach of fiduciary duty, negligence, gross negligence, and indemnification. 

            According to the complaint,

“MortgageIT repeatedly made false certifications to HUD to obtain approval of mortgages that MortgageIT underwriters wrongfully endorsed for FHA insurance. These mortgages were not eligible for FHA insurance under HUD rules. Notwithstanding the mortgages’ ineligibility, underwriters at MortgageIT endorsed the mortgages by falsely certifying that they had conducted the due diligence required by HUD rules when, in fact, they had not. By endorsing ineligible mortgages and falsely certifying compliance with HUD rules, MortgageIT wrongfully obtained approval of these ineligible mortgages for FHA insurance, thereby putting millions of FHA dollars at risk.” 

In addition, according to the complaint, MortgageIT and Deutsche Bank never implemented the quality control procedures required of direct endorsement lenders.  On various occasions when HUD discovered evidence that MortgageIT was violating the quality control requirement, MortgageIT falsely stated the failures had been corrected. 

The government’s complaint reinforces the need for a robust compliance program, including following up on any statements of corrective action or other identified issues, taking seriously certifications of compliance with rules and regulations, and being thorough in due diligence of potential acquisition targets, including their compliance with government rules and regulations.

By Manik K. Rath and Tamara Jack, LMI

In the 20^th century, projecting U.S. power meant having a large military presence in Europe and East Asia, and the ability to strike distant enemy nation-states. Today, projecting power means knowing when and where an asymmetric and sometimes furtive enemy will strike, before anything happens. Today’s enemies may be nation states, failed states, terrorist groups, or individuals, hence intelligence gathering has become increasingly important in projecting power.

Given the volume and complexity of the intelligence that can be gathered, the intelligence agencies have come to rely on intelligence contractors to provide innovative solutions, resources and skill sets to deal with such unique problems. Thus, despite the overall decrease in mergers and acquisitions in the last year, the volume and valuation of deals involving companies that contract with the intelligence agencies has remained relatively strong.

It has occurred to us that very little has been written in the mergers and acquisitions literature on the unique considerations to executing such transactions. M&A deals involving intelligence contractors are more complicated due to special issues associated with doing classified work. Below we discuss top things to understand when undertaking the acquisition of such a company.

The Intelligence Community. Led by the Director of National Intelligence (DNI), the U.S. Intelligence Community (IC) is a body of 16 different federal government agencies and organizations with a defined mission of dealing with national security issues.

The Security Classification. The U.S. security classification system safeguards critical military, foreign policy and intelligence data and information. For the purposes of understanding the basic structure of this complex regime, the following information is relevant: 

• The Department of Defense (DoD) manages the largest industrial security program;
• Several other intelligence agency’s manage their own security programs;
• The DoD classification system has three levels:
  • Confidential
  • Secret
  • Top Secret
• Additionally, there are nine other protection categories

In order for individuals or companies to gain access to classified data, the U.S. government must first authorize such individuals and companies through the security clearance process. For individuals, this process is called Personnel Security Clearance (PCL); and for companies this process is called Facility Security Clearance (FCL).

Security Clearances. Companies interested in acquiring intelligence contractors, must be familiar with the National Industrial Security Program (NISP) and the National Industrial Security Program Operating Manual (NISPOM) and NISPOM supplements. NISP is monitored by the Defense Security Service (DSS). DSS is charged with ensuring NISP compliance by the DOD and other federal agencies contractors. Further, contractors with access to agency top secret programs with “special compartmentalized information” status (SCI), must be familiar with additional regulations, independently administered by such agencies. These may include the CIA’s Director of Central Intelligence Directives (DCI-Ds).

For personnel security clearances, generally, the company must demonstrate to the government’s satisfaction that there is a need for such employees to have access to classified information. The company can demonstrate this need if the employee will be working on a classified contract, or if the employee in question is a Key Management Personnel (KMP). Generally, KPMs are individuals with control over the company, such as owners, partners, officers, and directors.

For facility security clearances, a government agency or another cleared contractor must sponsor a company by showing a definite, classified procurement need. This sponsorship is accomplished by a sponsorship letter which the government agency or the sponsoring contractor submits to the applicable security office.

Classified Assets and Clearances. During the due diligence phase of the deal, the buyer should be looking at the classified contracts it is acquiring, target’s employees with security clearances, as well as understanding any special contractual requirements associated with the target’s involvement in the classified space.

The buyer must start with the “Contract Security Classification Specification” on Form DD 254, issued by the government for each classified contract. The DD 254 sets security classification and applicable safeguarding requirements. Also, the DD 254 will provide much needed information on whether the buyer is equipped with the personnel and any facility safeguards required to continue the classified work post-closing.

M&A activities affect the company facility security clearance. Accordingly, the parties to the deal must comply with the NISPOM requirements associated with such M&A activities. These include: submitting a “notification of change” letter to the Cognizant Security Agency (CSA), obtaining CSA approval for any new cleared facilities or for the transfer of sponsorship of the existing facility security clearance, and examining any requirements related to physical security of the building, hiring of new personnel, the need for any special telecommunications connections for transmitting Secret and Top Secret data, and the need to create special rooms for storing and handling classified information, called Sensitive Compartmented Information Facilities (also known as SCIFs, or Special Access Program Facilities).

The above steps should be underway during the due-diligence and integration planning phase, and completed or nearly completed during the post-closing integration phase.

We have provided an overview of a few special considerations associated with M&As involving intelligence agency contractors. Such companies operate within a very complicated space of the U.S. industrial security regime. Special understanding of this regime and the associated requirements will help the parties to advantageously complete the deal and ensure successful post-closing integration.