A recent SEC investigative report may prompt companies to rethink a long-standard practice of including a copy of a merger agreement as an annex to the proxy statement mailed to shareholders when a merger is pending.
The SEC’s report, issued in March 1, 2005, in connection with a settled enforcement action against Titan Corporation, warns that attaching a merger agreement to a proxy statement where the merger agreement contains representations that are inconsistent with underlying facts could create potential liability under Section 14(a) of the Securities Exchange Act and Rule 14a-9—and even Rule 10b-5.
Whenever an issuer makes a disclosure, the company is required to consider if additional disclosure is necessary to put that information “into context” so that it is not misleading, the Commission said, noting that an issuer “cannot avoid this disclosure obligation simply because the information published was contained in an agreement or other document not prepared as a disclosure document.”
Most securities lawyers have taken comfort in the ability of investors to understand that merger agreement representations are not meant to be literal “naked representations” to investors concerning the company’s present condition, but are standard contract provisions that in many instances are governed and qualified by separate disclosure schedules, said Craig M. Wasserman of Wachtell, Lipton, Rosen & Katz in New York.
But, in light of the Titan report, it might be prudent for issuers to include even greater express warnings to investors as to why the representations have been produced in the proxy statement, said Wasserman.
Affirmative Representations
The Commission’s section 21(a) report was issued in connection with an enforcement action against Titan Corporation, a military intelligence and communications solutions provider accused of violating the Foreign Corrupt Practices Act by paying more than $3.5 million to an agent in Africa—$2 million of which was allegedly funneled to the election campaign of the president of Benin. According to the SEC’s complaint, Titan made the payments to assist the company with its development of a communications project and to obtain government consent to an increase in project management fees.
In September 2003, Titan became a party to a merger agreement in which Lockheed Martin Corp. agreed to acquire Titan, pending certain contingencies. In the merger agreement, Titan affirmatively represented that it had not taken any action which would cause the company to be in violation of the Foreign Corrupt Practices Act. The merger agreement containing the FCPA representation was appended to Titan’s proxy statement, which was filed with the SEC and sent to Titan shareholders. In light of SEC and Department of Justice investigations of potential FCPA violations, the proxy statement and merger agreement were amended several times, but Titan’s FCPA representation remained unchanged. In June 2004, Lockheed terminated the merger agreement.
In the 21(a) report issued March 1, the Commission acknowledged that the shareholders of Titan “were not beneficiaries of the FCPA representation as it appeared in the merger agreement,” but that the inclusion of the FCPA representation “in a disclosure document filed with the Commission, whether by incorporation by reference or other inclusion, constitutes a disclosure to investors.” A reasonable investor could conclude that the statements made in the representation “describe the actual state of affairs and the information could be material,” the Commission said.
In the situation where a document containing such a representation is disclosed, “if additional material facts exist, such as those contradicting or qualifying the disclosure of the original representation (for example, knowledge by the senior officers of the company that the facts described in the representation are not true), omission of which makes that disclosure misleading, a company would also be required to disclose those facts,” the Commission said.
Where the company fails to make such disclosure, an issuer would violate section 14(a) of the Exchange Act and Rule 14a-9 if the failure to disclose is the result of negligence. If the failure to disclose is intentional, “the issuer would also violate section 10(b) of the Exchange Act and Rule 10b-5,” the SEC said.
In addition to settling with the SEC, Titan also settled criminal charges brought by the Justice Department. The total penalty the company agreed to pay was $28.5 million. David Danjczek, Titan’s vice president for compliance and ethics, said in a press release that he was “relieved that this chapter in the company’s history is drawing to a close.”
Reconsidering Practices
Wasserman at Wachtell Lipton called the SEC’s assertions “sweeping,” and said the Commission’s report could alter long-established disclosure practices. “Notably, the SEC report does not directly address either the topic of when a party to a merger agreement has an affirmative obligation to disclose the risk that a given representation may no longer be accurate or that related closing conditions may not be capable of being satisfied due to material pending developments or, in Titan’s case, the topic of precisely when Titan may have had a separate obligation to disclose material developments relating to its potential FCPA problems,” Wasserman said. “Instead, the report gets at both of those topics through a backdoor challenge to the publication of the merger agreement representations—in essence creating an affirmative duty to enhance such disclosures simply based on the inclusion of a boilerplate representation in the merger agreement.”
Wasserman noted that, in Titan’s case, the FCPA matters were the subject of public disclosures after the filing of the merger agreement with the SEC. The Commission seems to suggest that a violation could occur even when a merger agreement representation as modified by an issuer’s own pre-existing public statements is fully accurate, Wasserman said. This could “unfairly bootstrap a breach of a merger agreement representation into a potential SEC disclosure violation, apart from any separate violation, when nowhere in the context of a merger proxy are investors being told to rely on the merger agreement representations as direct representations made to them.”
Although disagreeing with the SEC’s reasoning, Wasserman said he would recommend that parties reconsider their practices concerning merger agreement representations. However, he said he does not believe the Titan report requires a significant change in practice in the case of merger proxies, and would not recommend publicly filing the confidential disclosure schedules that typically accompany an executed merger agreement.
“In some instances, however, it may be beneficial to simply refrain from reproducing the merger agreement representations in the merger proxy, since the representations themselves absent the associated disclosure schedule information do not provide very meaningful information to investors. Notably, there is no express legal requirement to attach the complete merger agreement as an annex to the merger proxy, though it has become common practice to do so.”
But failure to attach a merger agreement may not solve the problem. “It is worth noting that the SEC report suggests that an issue can exist even when the merger agreement is merely incorporated by reference,” Wasserman said.
Alternatively, notes Wasserman, companies should consider adding additional explanatory and disclaimer language when referencing the merger agreement representations.
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