United States: Addressing Regulatory Structure for Business Combination Market
SEC Requests Comments on Its Proposals

By David F. Kroenlein

On Nov. 5, 1998, the Securities and Exchange Commission issued the Regulation of Takeovers and Security Holders Communications release, otherwise known as the M&A Release. This Release, in conjunction with the Securities Act Reform release, issued the same day and commonly referred to, because of its size, as the Aircraft Carrier Release, aims to modernize and clarify the regulatory structure for tender offers, mergers, and other business combination transactions under the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act).

The proposals attempt to embrace the realities of the current mergers and acquisitions environment without sacrificing investor protection. The SEC's goal is to give the investor more targeted, timely and technologically friendly information, while reducing regulatory burdens upon companies effecting business combinations. The agency has requested comments by April 5, 1999 on a series of questions concerning the implications and workability of the proposed regulatory structure.

A key reform in the M&A Release eases restrictions on communications among issuers, acquirors, shareholders and the market around the time of the business combination. The SEC's belief is that providing the market with more timely information is the surest way to promote investor protection. To ensure such protection, all communications to the market will be subject to various anti-fraud and civil liability provisions in the event of defective or misstated disclosure.

The current regulatory structure in the M&A arena centers on whether the transaction involves the filing of a registration, proxy or tender offer statement. If so, the flow of information to investors prior to the filing of the applicable statement is often constrained by the concepts of "offer" and "prospectus" under the Securities Act, "solicitation" under the Exchange Act and "commencement" under the Williams Act.

The fear is that a party's communication will trigger the disclosure requirements attached to each of the four concepts. As a result of these constraints, the market often loses out on valuable information until the registration, proxy or tender offer statement is filed.

The current regulatory structure regarding communications hinges on whether the business combination is a tender offer or a merger, and whether it involves the issuance of securities.

Prior to the filing of the proxy statement in a cash or stock merger, management and security holders are reluctant to communicate with the market regarding the merger for fear that such communications will be deemed solicitations, prohibited until the proxy statement has been filed and furnished to security holders along with the proxy card. This is the case unless the solicitation is in connection with an election contest or in opposition to an earlier solicitation, or under other limited circumstances as provided in Rule 14a-12.

In a merger involving the issuance of stock, a registration statement must be filed and deemed effective before the proxy statement and proxy card can be filed and furnished to the shareholders. Communications prior to the effective date of the registration statement are chilled by fears that such communications will be deemed offers, thus violating § 5 of the Securities Act and incurring § 12(a)(2) liability for material misstatements or omissions.

In a third-party cash tender offer, a public announcement of the identity of the bidder, the identity of the target, the amount and class of securities sought and the price offered will preliminarily commence the tender offer. At this point, the bidder has five business days either to publicly announce that it will not proceed with the offer or file tender offer materials with the SEC and disseminate certain information to the shareholders.

If the bidder chooses to proceed with the offer and files the tender offer statement and disseminates information to the shareholders, the tender offer will commence on the date of filing and dissemination, not the date of the initial public announcement. This has become known as the five-day rule.

Upon commencement, the offer is required to remain open for at least 20 business days. The target must respond to the offer with a recommendation to its shareholders, and file it along with additional information on Schedule 14D-9 with the SEC, no later than 10 business days from the date the offer is disseminated. The disclosure requirements of the five-day rule often have the effect of chilling communications from prospective bidders to the market.

In a third-party tender offer involving the issuance of stock, a registration statement containing a preliminary prospectus and information required under the tender offer rules must be filed promptly after the public announcement. Commencement is triggered when security holders are provided with a final prospectus. In addition, the bidder is prohibited from triggering commencement until after the registration statement's effective date. Communications prior to the effective date of the registration statement are chilled by fears that such communications will trigger commencement and that such communications will be deemed offers, thus triggering a § 5 violation.

The regulatory framework for mergers and acquisitions has stayed virtually the same over the last 20 years. However, the M&A environment has changed dramatically during that time.

The speed at which information can now travel has allowed extensive deal-related information to reach the marketplace the moment a purchase agreement is signed. Participants have legitimate legal and economic reasons for desiring to disclose deal-related information prior to filing the registration, tender offer or proxy statement. Rule 10b-5, which prohibits any misstatement or omission of material fact made in connection with the sale or purchase of a security, often compels early disclosure in the case of business combinations. Economic reasons compelling early disclosure include informing the market about synergies and planned cost savings, so as to ensure an efficient market.

The proposed changes reflect the SEC's conclusion that investors will benefit from having more time to consider the transaction by receiving deal-related information earlier in the process. To accomplish this, the M&A Release proposes safe harbors so that acquirors, targets, shareholders and tender offerors can communicate freely with the market regarding a business combination prior to the filing of a proxy, tender offer or registration statement.

The proposals contain safe harbors providing for oral and written deal-related communications prior to the filing of a tender offer, registration or proxy statement. The safe harbors contain no content restrictions, but all communications made under them would remain subject to antifraud liability and be treated as offers subject to § 12(a)(2) liability.

All pre-filing written communications made (which includes communications through electronic media, videos and CD-ROMs) after the public announcement involving the issuance of securities must be filed with the SEC upon first use as pre-filing prospectus supplements. However, factual business information that does not relate to the business combination, made after the public announcement, is exempt from the prohibition on offers and would not need to be filed. The proposals retain the provision from the current regulatory structure that security holders must receive the mandated disclosure document setting forth complete and balanced information before being required to make an investment decision.

In crafting the new M&A regulatory structure, the SEC strived to align the regulatory schemes for offerings, mergers and tender offers. However, while the scope and depth of the Aircraft Carrier Release safe harbors for capital raising transactions depend upon whether the issuer is large and seasoned, the M&A Release does not hinge its safe harbors on the size and status of the participants. The agency reasons that the timing of decisions by the investor in the M&A context are often more complex and important than in pure capital raising, pointing out that inaction by the investor in a business combination can result in a change in security ownership.

At present, Rule 14a-12 permits solicitations prior to the filing and furnishing of a proxy statement only in contested situations, such as an election contest, an opposition to an earlier solicitation or a prior invitation to tender. The proposed rules provide for an expansion of the Rule 14a-12 safe harbor.

As such, it would apply to solicitations in all situations as long as: 1) the identity of the participants in the solicitation and their interests are disclosed, 2) written solicitations are filed with the SEC upon the date the solicitation material is first published, sent or given to security holders, 3) a proxy statement is furnished to security holders at the earliest practicable date and 4) no proxy card is delivered to security holders without being preceded by the proxy statement.

All solicitations would continue to be subject to the antifraud provisions in Rule 14a-9. However, as a holdover from the Private Securities Litigation Reform Act of 1995, pre-filing forward looking communications would continue to be shielded from liability when made in connection with mergers under § 21E of the Exchange Act.

The proposals would allow bidders to freely communicate with shareholders without triggering commencement. Specifically, the rules would abolish the five-day rule for third-party cash tender offers and eliminate the requirement to file a registration statement immediately after the public announcement in a third-party stock tender offer.

Instead of the five-day rule, commencement of third party tender offers would be triggered upon providing the security holders the means to tender into the offer, i.e., the transmittal letter. Upon commencement, bidders would be required to file and disseminate the tender offer materials.

Written pre-commencement communications made after the public announcement and relating to the tender offer would be required to be filed upon first use. Proposed Rule 14d-2 also would require bidders to deliver to the subject company and any other bidder for the same class of securities, as soon as practicable, the first communication that identifies the bidder and the target company, the amount and class of securities sought, and the price or range of prices offered.

In a third-party stock tender offer, the proposals would eliminate the requirement to file a registration statement immediately after the public announcement, in order to put stock tender offers on a similar time frame as cash tender offers. The bidder could choose to commence a stock tender offer upon filing the registration statement instead of having to wait until its effective date.

To prevent reckless bidders from making disingenuous tender offer announcements, the SEC proposed Rule 14e-8, which would make it unlawful to announce a tender offer: 1) without the intent to commence and complete the offer, 2) with the intent to manipulate the price of either the bidder's or target's securities or 3) without the reasonable belief that the bidder has the ability to purchase the securities sought.

The proposed rules also would permit the target to make pre-commencement communications without triggering disclosure requirements. At present, a target must file a Schedule 14D-9 and furnish security holders specified information upon making a recommendation concerning the offer, even if the bidder has not yet commenced the offer. The proposed rule would require a target to file pre-commencement communications upon first use.

The M&A Release, along with the Aircraft Carrier Release, represent the most bold and sweeping package of securities regulation reform since the Securities Act and the Exchange Act were written, and as such many questions and concerns arise. Indeed, the SEC has requested comment on virtually all aspects of the M&A Release.

Of particular importance, the agency has suggested for comment two alternate communications safe harbors for business combinations. The first proposes a 48-hour free communication period after the public announcement, after which the acquiror or tender offeror must remain quiet until the registration, proxy or tender offer statement is filed.

The second alternative proposes an unlimited free communication period after the public announcement requiring the acquiror or tender offeror to cease communications for a 30-day period prior to filing the registration, proxy or tender offer statement. The authors do not believe that it is practical to shut down the flow of information pending filing once the tap is open.

The proposed system would be enhanced by instituting expedited review or even automatic effectiveness, at least for large, seasoned issuers, of the tender offer and proxy material -- a possibility the SEC has suggested. The authors also support a federally mandated 20-business-day solicitation period before the shareholder meeting date for mergers. Such a period would give beneficial holders time to receive and digest the pre-filing free writing and the mandated proxy materials.

The SEC has established April 5, 1999 as the conclusion of the comment period for both the Aircraft Carrier and M&A Release. These releases will continue to generate comment and debate as the regulatory framework adapts to the evolution occurring in the capital formation process.

David F. Kroenlein is a securities partner and Chairman of the Corporate/Financial Institution Department at Whitman Breed Abbott & Morgan LLP. Eduardo N. T. Andrade, an associate with the firm, and John H. Denne, a partner, assisted in the preparation of this article. Please call David with your questions at 212-351-3026 or e-mail him at dkroenlein@WBAM.com.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.