Canada: Don't Ask, Don't Tell?

Lessons from the SEC's recent "ring fencing" settlement with Revlon

The recent settlement in the United States between the Securities and Exchange Commission (SEC) and Revlon highlights the importance of not appearing to obstruct the flow of material information to shareholders.

The SEC settled charges that Revlon misled shareholders during a going private transaction. The SEC's order found that to avoid a potential disclosure obligation, Revlon engaged in "ring fencing" to avoid knowing that the transaction's consideration had been deemed inadequate by a third party's financial advisor.

To address the pending maturity of a term loan with a controlling shareholder MacAndrews & Forbes Holdings Inc. (M&F), M&F asked Revlon's independent board members to consider a voluntary exchange offer. As Revlon pursued the voluntary exchange offer, a minority shareholder, the trustee of Revlon's pension plan, informed Revlon that plan members could only tender their shares based on an independent financial advisor's conclusion that the consideration offered was "adequate". Prior to the adequacy determination, Revlon took steps to ensure that it would not receive this information. Among other things, Revlon:

  • proposed that the trustee simply conclude that the exchange offer provided for inadequate consideration without obtaining a financial opinion;
  • proposed that the trustee obtain a legal opinion instead of an opinion from a financial advisor; and
  • directed the trustee to inform Revlon of the tender decision without any reference to the adequacy determination.

The trustee, based on advice from its financial advisor, ultimately determined that the consideration offered was inadequate. Revlon's "ring fencing" prevented Revlon's independent board members from knowing about the advice of the trustee's financial advisor.  Meanwhile, Revlon's independent board members determined that the voluntary exchange offer was fair to Revlon and Revlon's unaffiliated stockholders but did not make a recommendation as to whether shareholders should tender their shares to the offer.  While they did note as part of their reasoning that Revlon had received an opinion from a nationally recognized valuation firm as to the adequacy of Revlon's surplus to consummate the voluntary exchange offer, it was also, more importantly, noted that the financial advisor to the independent committee of directors was not retained to advise and did not advise the committee or the full Board in connection with the voluntary exchange offer.

The SEC's investigation found that Revlon made a misrepresentation in its offering documents by stating that the board's process was full, fair, and complete in determining the fairness of the exchange offer when, in fact, the board was unable to consider the adequacy determination of the trustee's financial advisor when evaluating and approving the offer. About half of Revlon's minority shareholders tendered to the offer without the benefit of the third-party financial advisor's view on the adequacy of the transaction's consideration. As part of the settlement, Revlon agreed to pay a US$850,000 penalty without admitting or denying any wrongdoing.

The  takeaway that may be of interest to M&A participants generally is that this order makes it clear that a target company cannot turn a blind eye to, or obstruct the flow of, information that is likely to influence a shareholder's decision making. Proxy circulars for Canadian public M&A transactions involving a shareholder vote must, by regulation, disclose the transaction in sufficient detail to enable a reasonable shareholder to form a reasoned judgment concerning the matter. A directors' circular responding to a take-over bid (unsolicited or friendly) must also state the particulars of any other information known to the directors but not already disclosed in the directors' circular that would reasonably be expected to affect a shareholder's decision to accept or reject the offer.

What is further interesting here is that independent directors did not have the benefit of a fairness opinion in determining that the voluntary exchange offer was fair to unaffiliated shareholders notwithstanding that the financial advisor to the independent committee of directors had indicated that it would not be able to render an opinion that the consideration to be issued pursuant to a previous, and later abandoned, mandatory exchange offer proposal — which consisted of substantially similar financial characteristics — was fair, from a financial point of view, to Revlon's unaffiliated stockholders.

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