SEC Overhauls Rules Governing M&A Transactions

by Eduardo N.T. Andrade and David F. Kroenlein

The Securities and Exchange Commission (the "Commission") has adopted, effective January 24, 2000, comprehensive amendments to the rules pertaining to tender offers, mergers and other extraordinary transactions. The new rules are designed to harmonize, update and simplify the three disparate and largely outdated regulatory structures that govern business combination transactions, namely the Williams Act tender offer rules, the proxy rules under the Exchange Act and the Securities Act, if the merger or tender offer consideration includes registered securities. The new rules will likely be quickly put to the test in the current flurry of business combinations.

The amendments were prompted by three current trends and realities of the market, namely, the steady increase in the number of hostile transactions in which securities are being offered, the increase in the number of transactions involving proxy or consent solicitations, and the rapid technological advances that have facilitated widespread communications among issuers and the market.

The new rules among other things: (i) permit significantly increased communications between issuers and the market in connection with business combination transactions, (ii) attempt to balance the treatment between cash and stock tender offers, (iii) simplify and integrate the disclosure requirements for takeover transactions, (iv) clarify and simplify the financial statement requirements for takeover transactions, and (v) otherwise update the tender offer rules.

The new rules reflect an effective and necessary effort by the Commission to align the M&A regulatory structure with the speed of the 21st century M&A marketplace. They represent a fair balance between protecting the investor and allowing participants in the securities markets the necessary flexibility to benefit from the rapid developments in electronic communications and in the Securities markets. Participants and security holders need to understand and be prepared to take advantage of the new rules.

The analysis below is only a summary of the principal aspects of the new rules and the rationale behind them. The full text of the release (Release No. 33-7760 and 34-42055 (October 22, 1999)) is available online (http://www.sec.gov/rules/final/33-7760.htm).

The centerpiece of the new rules is the expansion of permitted communications about a proposed business combination transaction before the filing of the mandated disclosure document (i.e., the Schedule 14A merger proxy statement, Form S-4 registration statement, or Schedule 14D-1 tender offer statement) and during the transaction. The Commission noted that restricting communications to one document was probably impeding, rather than promoting, informed investment and voting decisions.

The Commission has implemented non-exclusive exemptions under the Securities Act, proxy rules and tender offer rules that permit written and oral communications by participants and all parties to business combination transactions prior to the filing and effectiveness of the disclosure document, as well as during the waiting period and post-effective period. Written communications (which include electronic communications, videos, CD-ROMs, scripts and slide presentations), beginning with the "public announcement" of the transaction until the closing of the transaction must be filed with the Commission no later than the date of first use. The definition of "public announcement" has been revised to mean any communication by a party to the transaction, or any person authorized to act on a party’s behalf, that is reasonably designed to, or has the effect of, informing the public or security holders in general about the transaction. Such communications are subject to liability for misleading statements and earlier "fraudulent" statements cannot be cured or corrected by subsequent filings. Communications made orally do not need to be reduced to writing and filed. Internal communications, solely among parties to the business combination transaction and communications containing business information factual in nature relating solely to ordinary business matters, also need not be filed under the new rules. The new rules with respect to permissible communications apply only to business combination transactions, i.e., those to which either the proxy rules or tender offer rules apply.

The new regulatory structure, however, still requires that security holders receive the mandated disclosure document prior to being asked to make a voting or investment decision. In addition, all written communications must contain a prominent legend: (i) advising investors to read the applicable registration, proxy or tender offer statement that can be obtained without charge from the Commission’s web site and (ii) explaining which documents are available without charge from the issuer or filing person.

The Commission notes that its long standing concern that pre-filing communications could condition the market is sufficiently addressed in that the mandated disclosure document must still be delivered to security holders before they are asked to make a formal voting or investment decision (i.e., before proxy cards or transmittal letters are sent to them) and that pre-filing communications remain subject to liability provisions.

The Commission also hopes that its implementation of a more relaxed and open communications structure will serve to reduce selective disclosure. However, commenters to the proposals have suggested that the rules may, in fact, reduce only the frequency of written communications about takeover transactions and increase the frequency of oral communications (which do not have to be filed). The Commission acknowledges that selective disclosure via oral communications will likely continue and has indicated that the new rules were not designed to specifically combat oral selective disclosure. Indeed, the Commission has addressed selective disclosure through a separate release aimed at prohibiting such practices (Release Nos. 33-7787, 34-42259, December 20, 1999). The proposed rules, entitled Regulation FD, essentially require issuers disclosing material information to do so through a public forum rather than through selective disclosure.

While the new rules permitting free communications exempt the subject communications in connection with any registration statement for a business combination from Section 5(b)(1) and 5(c) of the Securities Act, if they go beyond the limited notice content of a Rule 135 notice communications relying on the exemptions would be deemed offers and thus subject to Section 12(a)(2) prospectus liability as well as Section 10(b) liability for misstatements and material omissions. The communications would also be subject to Section 11 liability if incorporated by reference into the registration statement. While basic Rule 135 notices are now considered written communications required to be filed under Rule 425, they are not deemed offers under Section 5 and therefore will continue not to have Section 12(a)(2) liability.

Certain commenters questioned whether the imposition of potential Section 12(a)(2) liability would have a chilling effect on communications. In light of the extensiveness and frequency of pre-filing communications regarding proposed business combinations, many of which probably constituted offers subject to Section 12(a)(2) liability under the prior regulatory scheme, the Commission has indicated its belief that the new rules do not alter the liability standard in this regard and, therefore, would not have a chilling effect on communications.

The Commission also has revised and expanded Rule 14a-12, which governs solicitation before furnishing a proxy statement, so that it dovetails with the revisions to the Securities Act and Williams Act. Exempt communications will be subject to the antifraud provisions of Rule 14a-9.

One significant component of the new rules is that confidential treatment of merger proxy materials is now permitted only if the parties to the transaction do not take advantage of the new rules permitting free communications but rather limit their communications to what is permitted under Rule 135. The Commission's rationale is that if parties to the transaction are disclosing extensive deal-related information to the market prior to the filing of a proxy statement, there is no reason why they should receive confidential treatment while the Commission and issuer resolve comments. The Commission also noted that limitation of confidential treatment of proxy statements aligns itself with the treatment of stock tender offers, where confidential treatment has never been available.

The Commission has revised Rule 14d-2 and 14d-9, to require the filing of all written communications pertaining to a tender offer beginning with the public announcement of the tender offer under Schedule TO or 14D-9, as appropriate. In line with the revisions to the Securities Act and Proxy Rules, communications made under 14d-2 and 14d-9 must be filed upon first use and contain a legend advising security holders to read the full tender offer statement or recommendation statement when available. Exempt communications will be subject to the antifraud provisions of Section 14(e).

New Rule 14a-12 also allows free communications in all proxy solicitations, not just solicitations pertaining to mergers. As with merger transactions, Rule 14a-12 does not permit issuers to solicit securities holders' votes before a proxy statement is delivered. Some commenters to the original proposals had urged the Commission to permit issuers to informally solicit votes without sending the holder a proxy card. The Commission, while rejecting so-called "testing the waters" solicitations for now, has stated that it may reconsider this concept in a future rulemaking release.

The Commission also refrained from implementing a federally mandated proxy disclosure period (e.g., 20 days so as to coincide with the Tender Offer period) as had been floated in the original proposals. The Commission stated it was satisfied that regulation of proxy periods should remain with the states.

A key concern for the Commission when implementing the new rules was the inequitable regulatory treatment of cash and stock tender offers, especially as to timing and commencement. Prior to January 24^th, tender offers involving securities could not commence until the registration statement pertaining to the securities was declared effective by the Commission, whereas solicitations of cash tenders could commence upon the filing of the tender offer materials and the publishing of the tombstone advertisement. As a result of this disparity, tender offers involving stock were at a clear timing disadvantage.

The Commission has taken significant steps in the new rules towards rectifying the disparity and clarifying the regulatory structure through (i) permitting early commencement of exchange offers, and (ii) eliminating the five business day rule and revising the definition of "commencement."

Under the new structure, third party bidders and issuers may commence issuer and third-party exchange offers upon the filing of the registration statement and tender offer statement, although bidders cannot deliver letters of transmittal or proxy cards until the related registration statement is effective. The Commission has resisted instituting automatic effectiveness for exchange offer registration statements but has indicated its commitment to expedite review so that they may effectively compete with cash tender offers. The Commission noted that from the standpoint of bidders, automatic effectiveness would essentially level the playing field between competing cash and exchange tender offers; however, automatic effectiveness would strain investor protection too much due to the often complex disclosure and accounting issues involved in the business combination context which would go unchecked when the offer is instituted.

The Commission considered, but refrained from, extending early commencement to going-private transactions due to the numerous comments customarily generated by the Commission staff in relation to these transactions.

Prior to January 24th, cash tender offers commenced upon the public announcement of certain limited information unless a tender offer statement was filed within five business days of the announcement and delivered to security holders (whereupon commencement occurred upon that date), or the bidder made a subsequent public announcement withdrawing the offer within the five business day period.

The Commission has eliminated the five business day rule. Commencement now occurs when the bidder first publishes, sends or gives security holders the means to tender securities in the offer, at which time the bidder is required to deliver the tender offer Schedule 14-D1 and the mandated 20 business day open period for tender offers begins to run.

In order to address and prevent potentially manipulative false offers, the Commission has implemented new antifraud Rule 14e-8, which prohibits bidders from announcing an offer without the intent to commence the offer within a reasonable time and complete the offer, with the intent to manipulate the price of the bidder or the target’s securities, or without a reasonable belief that the person has the means to purchase the securities sought. Although commenters to the original proposal were wary that the rule would create new grounds for frivolous litigation, the Commission notes that the plaintiff has the burden of proving that the bidder either did not have the intent to commence and complete the offer or did not reasonably believe it had the ability to purchase the securities. The Commission suggested that, although not required, a commitment letter or other evidence of financing ability (e.g., funds on hand or an existing credit facility) would in most cases be adequate to satisfy the rule's requirement that the bidder have a reasonable belief that it can purchase the securities sought.

The new rules have clarified and harmonized the disclosure requirements between the three separate regulatory structures for tender offers and mergers through unifying the disclosure requirements under subpart 1000 of Regulation S-K, entitled Regulation M-A. Most notably, old Schedules 13E-4 and 14D-1 (used for issuer tender offers and third-party tender offers, respectively) are now combined into new Schedule TO. In a going-private transaction, Schedule 13E-3 can be combined with the applicable tender offer schedule under Schedule TO as well. The new disclosure requirements serve not only to reduce the cost of compliance for participants through the reduction of duplicative filings but also will facilitate the completion of transactions through the reduction in required disclosure.

The new rules require a plain English summary term sheet for all cash tender offers and cash mergers, as well as going-private transactions. This requirement dovetails with the previous requirement to provide a plain English summary for transactions involving the registration of securities (Rule 421(d)).

The new rules have also harmonized and simplified the required financial statement disclosure between mergers and tender offers in Schedule 14A and Schedule 14D-1, respectively. The Commission found that in many instances the required financial statement disclosure, especially for bidders/acquirors in cash tender offers and cash mergers, was unnecessarily burdensome. The new rules only require bidder/acquiror financial statement disclosure for cash tender offers or cash mergers when the financials are "material" to the security holders' evaluation of the transaction. Item 10 to Schedule TO specifies that a bidder's financials are not "material" when (i) only cash consideration is offered; (ii) the offer is not subject to any financing condition; and either: (a) the bidder is a public reporting company that files reports electronically on EDGAR or (b) the offer is for all outstanding securities of the subject class. In addition, the new rules have eliminated the requirement to deliver target financial statements in cash mergers where the transaction does not require the vote of the acquirors' security holders.

The Commission also addressed situations during stock mergers and stock tender offers where the target is not a reporting company. The old rules dictated that the acquiror provide three years of financials for the non-reporting target in such situations, the new rules have relaxed this requirement to one year of financials. In addition, where the acquiror's security holders are not voting on the transaction and the non-reporting target is not significant to the acquiror (below the 20% level), no target financial statements are required.

The new rules also revise various portions of the tender offer rules, with the intention of harmonizing the rule with current practices occurring in the market.

Possibly the most important revision to the tender offer rules is the adoption of Rule 14d-11 permitting subsequent offering periods for third party tender offers (cash and exchange). The rule permits a follow-up offering period of at least three but not more than twenty days during which no withdrawal rights apply. In order to qualify for Rule 14d-11, the following conditions must be met: (i) the offer must be for all outstanding securities of the class; (ii) all conditions to the offer must be deemed satisfied or waived by the bidder on or before the close of the initial offering period; (iii) the bidder must accept and promptly pay for all securities tendered during the initial offering period on the closing of the initial offering period; (iv) the bidder must announce the approximate number and percentage of outstanding securities that were deposited by the close of the initial offering period no later than 9:00am Eastern time on the next business day after the scheduled expiration date of the initial offering period; and (v) the bidder must immediately accept and promptly pay for all shares as they are tendered in the subsequent offering period. While not adopted as a specific requirement in the Rule, the Commission indicated in no uncertain terms its belief that the addition of a subsequent offering period not contemplated in the initial offering materials would constitute a material change to the terms of the offer that must be disseminated in advance of the expiration of the initial offering period.

Rule 14d-11 will benefit both issuers and security holders in that issuers get another chance to meet the statutory state law minimum necessary to engage in a short-form, back-end merger, while security holders who did not tender initially are given an additional opportunity to tender and avoid the delay and illiquidity that results from waiting until the bidder starts and completes the back-end merger. However, concerns exist that the requirement for advance notice of the subsequent offering period may create a "hold-out" problem, with security holders waiting until the subsequent offering period to tender shares. In response to such concerns, the Commission has indicated that after it gains practical experience, it may opt to shorten or eliminate the requirement for advance notice.

The new rules mark a significant and commendable change in the regulatory scheme governing takeover transactions. As a result, investors will receive information earlier, which should result in better investment decisions. The attempt at leveling cash and exchange tender offers should result in more efficient market, which also will benefit investors. This should encourage exchange offers, as securities will increasingly gain credibility as a currency for takeovers in the "stock rich" new economy. Finally, the new regulatory structure undoubtedly allows participants significantly increased flexibility in structuring and timing M&A transactions, which should keep M&A deals pouring through the floodgates.

Eduardo N.T. Andrade is an associate of the Corporate/ Financial Institutions Department of Whitman Breed Abbott & Morgan LLP, and David F. Kroenlein is a partner and chairman of the firm's Corporate/Financial Institutions Department. John H. Denne, a partner with the firm, also assisted in the preparation of this article.

To discuss these issues, please call Eduardo at 212-351-3241, or e-mail him at eandrade@wbam.com. To speak with David, call him at 212-351-3026, or e-mail him at dkroenlein@wbam.com.

This article is reprinted with permission from the January 31, 2000 edition of the New York Law Journal, © 2000 NLP IP Company.