Changes Afoot, And Welcome, For Best-Price Rule

The Securities and Exchange Commission wants comments on proposed revisions to its so-called “best-price” rule, which observers say should bring more clarity to how the rule will apply to employment arrangements hatched during tender-offer merger deals.

Pryor

The proposed revisions “are the most significant change to the tender-offer rules to come down the pike since Reg M-A in 1999,” says Gregory Pryor, a partner in the mergers and acquisitions practice group of White & Case. The best-price rule, Exchange Act Rule 14d-10(a)(2), which requires that equal consideration be paid to all tendering security holders, “has had a tremendous chill on the willingness of acquirers to proceed by way of tender offer,” he says.

Comments on the proposed rules are due by Feb. 21. Among the issues the SEC seeks comment on are:

Application—

Whether the SEC should revise the proposed language of the best-price rule so that the rule would apply to arrangements entered into by employees and directors with the bidder or subject company, regardless of whether they tender their securities in the offer;

Wording—

The effect of the removal of the word “during” from the best-price rule on the bright-line case law precedent;

Consequences—The outcome and possible consequences if officers or directors recommend that securities holders tender into the transaction but, to avoid the best-price rule, the same officers or directors opted to withhold tendering their own securities.

Indeed, experts say cash tender offers fell out of favor in recent years largely due to worries that employment, severance or other compensatory arrangements for target company executives might be deemed to violate the “best-price” rule, requiring buyers to “top up” the target stockholders by giving them all the same additional consideration.

“This risk prevented them from utilizing the benefits of a tender-offer structure, which generally allows faster time to closing,” says David Healy, co-chair of the mergers and acquisitions group at Fenwick & West.

Tender offers can be can be closed in as few as 20 business days and mandate the protection afforded by the best-price rule, while stockholder-approved cash mergers require more time and don’t offer the best-price rules’ protection, Healy notes.

de Wied

“People are reluctant, even when the facts are favorable, to do a tender offer the way the rules are now,” says Warren de Wied, a partner in the corporate department at Fried, Frank, Harris, Shriver & Jacobson. That’s because plaintiffs have used the rule to challenge employment, severance, bonuses and other arrangements with target employees and directors, while federal courts have been split on the application and interpretation of the rule.

While some courts took the view that no issue arose so long as the compensatory arrangements weren’t consummated during the time tender offer was ongoing, others studied the context of the arrangements, and took the view that even if the arrangements were outside the tender offer, they could still be integral to it and therefore violate the rule.

For example, de Wied notes, if a $100,000 noncompete payment to a target executive who owned 1,000 shares of target stock is ruled to be a part of the offer—and thus a violation of the best price rule—the buyer would have to increase the offer by $100 a share for all stockholders, “which would be economic suicide for a buyer.”

Pryor agrees; differing judicial interpretations “made everybody extremely nervous about proceeding in an acquisition by way of tender offer, because the consequences of being wrong are dire.”

A Better Best-Price Rule

SUMMARY

The excerpt below is from the Executive Summary And Background section of the SEC's proposed amendments to the tender offer best-price rule:

The tender offer best-price rule was adopted ... to assure fair and equal treatment of all security holders of the class of securities that are the subject of a tender offer by requiring that the consideration paid to any security holder is the highest paid to any other security holder in the tender offer. We are proposing amendments to the best-price rule for three reasons. First, we want to make it clear that compensatory arrangements between subject company employees or directors and the bidder or subject company are not captured by the application of the best-price rule. Second, we would like to alleviate the uncertainty that the various interpretations of the

best-price rule by courts have produced. Finally, we want to remove any unwarranted incentive to structure transactions as statutory mergers, to which the best-price rule does not apply, instead of tender offers, to which it does apply.

Briefly, we [the SEC] propose to:

amend the language of Rules 13e-4(f)(8)(ii) and 14d-10(a)(2) to clarify that the best-price rule applies only with respect to the consideration offered and paid for securities tendered in a tender offer;

add a new provision to Rule 14d-10(c) to provide an exemption from the third-party best-price rule for the negotiation, execution or amendment of payments made or to be made or benefits granted or to be granted according to employment compensation, severance or other employee benefit arrangements that are entered into by the bidder or the subject company with current or future employees or directors of the subject company; and

for purposes of the exemption, add a new provision to Rule 14d-10(c) to include a safe harbor provision that provides that the compensation committee of the board of directors (or a committee performing similar functions) comprised solely of independent directors of the bidder or subject company, depending on which entity is party to the arrangement, may approve the employment compensation, severance or employee benefit arrangement and thereby deem it to be such an arrangement for purposes of the exemption.

Source

Proposed Rule: Amendments To The Tender Offer Best-Price Rule (Published By The SEC Dec. 16, 2005)

To address those concerns and encourage greater use of cash tender offers, in December the SEC proposed revising the best-price rule, adding an exemption for certain compensatory arrangements and a safe-harbor provision for compensatory arrangements with target employees or directors that are approved by an independent compensation committee (see box above, right for the proposal and related resources).

The SEC says the amendments would: make it clear that compensatory arrangements between subject company employees or directors and the bidder or subject company aren’t captured by the application of the best-price rule; would alleviate the uncertainty that the various court interpretations of the rule have produced; and would remove any unwarranted incentive to structure transactions as statutory mergers, to which the best-price rule doesn’t apply, instead of tender offers, to which it does.

Healy

“Companies will now be able to consider tender offers as a more viable option in doing cash deals, and stock deals that don't require a buyer stockholder vote, so they can compare tenders versus cash mergers, without as much concern that use of a tender will result in litigation over the best-price rule,” says Fenwick & West's David Healy.

“The proposed rule language is more narrow, so it should rein in plaintiffs’ ability to make claims [of rule violations] and also give judges a stronger ability to dismiss claims that are made,” Pryor says, adding, “The safe harbor goes a long way toward eliminating the doomsday effect of a violation of 14d-10.”

De Wied says a general element of the amendments, which is “intended to make it clear that the basic question under the best-price rule is whether one shareholder is getting paid more for tendering securities in the tender offer than other holders,” needs to be clarified.

“It’s not entirely certain what the SEC intended,” he says. “Read literally, it would imply that any payment to a shareholder who does not tender in the offer is exempt from the best price rule. But the SEC was explicit in its commentary to the proposals that it was not proposing a bright line, temporal test.”

Another issue, he adds, is that, while the proposals “generally should work well” for corporate buyers, private equity buyers—who do the most cash acquisitions of public companies—“probably won’t be comfortable” with the amendments as currently proposed since those buyers typically offer management equity rollovers. Such rollovers don’t appear to fall within the proposed exemptions to the best-price rule.

And even if these proposed rule changes are adopted, Healy says, “tender offers will still not be the best choice for every cash deal.” The desirability of a tender offer structure, he says, should be evaluated based on the following:

The regulatory approvals required. If a prolonged antitrust review is anticipated, a one-step cash merger may yield an earlier stockholder approval, eliminating "topping" risk sooner than in a tender offer.;

The corporate law of the target's jurisdiction. For California corporations, the minimum condition for most cash tender offers is 90 percent rather than 50 percent, making the one-step cash merger usually preferable from a speed-to-closing perspective;

Whether it’s necessary for the buyer to obtain stockholder approval. The need for such approval can obviate much of the speed advantage of the tender offer, notes Healy.