Interposed with this federal scheme are state laws that regulate the actual decision of a company’s board of directors to agree to a takeover transaction. State law primarily regulates this decision through the imposition of fiduciary duties on directors to a company’s shareholders, standards that are heightened in change of control or conflicted circumstances. For companies organized under the laws of Delaware, these are the Revlon duties and the requirements of Unocal and Blasius discussed in earlier chapters. Delaware law also goes further, for example, by regulating the disclosure process for takeovers. Each state also has an appraisal option available in certain confined circumstances that permits a shareholder to dissent from an acquisition transaction and seek a judicial valuation of his or her shares.
In both the state and federal circumstances, the law could use some pruning and reworking. The federal law in particular was first promulgated in the 1960s and was built upon piecemeal by SEC rule making throughout the 1980s. However, since that time, there has been substantial change in the world and mechanics of takeovers. There has been no corresponding update to the federal takeover code. Instead, it regulates to the state of the takeover market circa 1983. This was a time when the poison pill did not exist, proxy contests were only one means to acquire a company resisting a takeover bid, Delaware was not the primary regulator of takeovers, and financial innovation had yet to become the force it is today. The federal law does not take these developments into account; it is due for modernization.
Federal Takeover Law
The principal problem with federal takeover law is the inappropriate distinction it makes between tender offers and mergers. To understand this distinction, though, it is first necessary to understand the choice a buyer makes when deciding between a tender offer and a merger.
A buyer attempting to take over a public target faces a decision: How will it structure this acquisition? Historically, there have been three choices:
1. A tender offer followed by a back-end or squeeze-out merger
2. A merger
3. An asset purchase
Each option has its benefits and detractions, but an asset purchase of a public company is quite difficult. In this scenario, the buyer actually chooses the assets and liabilities of the target it purchases.This has an innate advantage if you are, say, Bank of America purchasing the banking assets of Washington Mutual. If so, you can simply purchase the assets and leave behind selected liabilities. Nonetheless, asset purchases of entire public companies are rare because they can create adverse tax consequences for the buyer and seller’s shareholders. Moving assets out of the publicly traded shell can also be quite difficult for logistical reasons as well as provisions in contracts that prevent their assignment. Because of these and other transfer problems, the typical acquisition structure is either a merger or a tender offer.
The advantage of a tender offer over a merger is that, as currently regulated under the Williams Act, it can be completed in a quicker time frame than a merger. A tender offer must be held open a minimum of 20 business days, meaning that it can be completed in about a month rather than the two to three months a merger takes on account of federal and stock exchange notice, mailing, and review requirements for the required proxy statement.1 However, with speed comes more federal regulation. A tender offer is subject to the Williams Act restrictions, including the all-holders best price rule and Rule 14e-5.2 The former rule requires that the tender offer be open to all stockholders and the highest price paid in the tender offer be paid to all holders. The latter rule prohibits share purchases outside the offer from the time of its announcement until completion.
Moreover, the short-form squeeze-out threshold in the 50 states is 90 percent of a target’s outstanding shares. At this threshold, a vote of the target’s shareholders is not required to squeeze out the remaining shareholders. The 90 percent owner can simply file a merger certificate accomplishing this without a vote.3 If the bidder’s tender offer fails to achieve acceptances from shareholders holding 90 percent of the target’s outstanding shares, then the bidder must also do a so-called long-form merger, which requires that a proxy be prepared and the same two-to three-month wait after the tender offer period.
Buyers thus prefer mergers in two circumstances. First, a buyer may predict that it will have trouble reaching the 90 percent threshold. In such a circumstance, the longer period for a merger is justified because it assures that the buyer will obtain all of the publicly held shares in a quicker time frame. Conversely, if a buyer thinks that another bid is likely, a tender offer may be preferable even in such a circumstance, as a tender offer assures faster control but not complete ownership.
To ameliorate this issue, in the past few years buyers have been demanding and obtaining top-up provisions in agreed tender offers. A top-up provision provides that so long as a majority of shareholders tender in the offer, the target will issue the remaining shares necessary to put a buyer over the 90 percent threshold.The minimum number of shares triggering the top-up varies, but the target share issuance must be below 20 percent of the target’s outstanding shares because of stock exchange rules. Of course, the penalty for violating this rule is delisting from the stock exchange, something that was going to happen anyway. This means that the only effective limit on shares issued under a top-up are the fiduciary duties of a target and the number of remaining authorized shares of the target. In 2008, 100 percent of negotiated tender offers included a top-up arrangement, up from 55.6 percent in 2006 and 35 percent in 2004.4
The second circumstance for a bidder to prefer a merger over a tender offer is when the parties know beforehand that the bid will take a longer time period to complete, meaning there is no benefit to the speed provided by a tender offer. Examples are where regulatory approvals are required, a process that can take several months to years, or in the private equity context, where there is a go-shop or financing required, in both instances requiring several months to complete. In both cases, control cannot be achieved until these clearances are obtained and these time periods pass, so a tender offer does not provide any real timing benefit.
Previously, there were two additional reasons buyers favored mergers over tender offers. First, the application of the all-holders best price rule to tender offers and not mergers created bias toward use of the merger structure. The reason is that courts, starting in the 1990s, began to broadly interpret the meaning of a tender offer to arguably encompass change of control and other payments to executives in connection with the transaction. If a court found that the payment was indeed in connection with the tender offer, then it would apply the all-holders best price rule and order the buyer to pay this differential compensation to all target stockholders. This is a risk that many buyers did not want to take, and so there was a strong bias against tender offers and toward mergers, where this rule did not apply. This bias has largely disappeared, however, since the SEC in 2006 promulgated rules to eliminate this issue and create an easier-to-follow bright-line rule for when the all-holders best price rule applies to change of control and other executive payments.5
Second, if stock as opposed to cash is the consideration offered, a merger was historically preferable because the buyer could not commence the offer until the registration statement for this stock consideration became effective, a process that could take months for the SEC review process. In 1999, the SEC attempted to eliminate this timing distinction by permitting preeffective commencement of exchange offers.6 Nonetheless, despite expectations of its widespread use, the exchange offer has yet to be so utilized. In fact, in 2008 there were only four takeover offers made via an exchange offer.7 This was probably due to the historical issue of the all-holders best price rule. It also probably had something to do with the fact that exchange offers, because they involve the preparation of a registration statement in a condensed amount of time, require a tremendous amount of resources and work for takeover attorneys.
In light of these SEC rule changes, though, the tender offer has exp
erienced a resurgence. In 2008, 24 percent of agreed transactions were tender offers, compared with a range of 7 to 10 percent between 2004 and 2006.8 This trend is likely to continue as private equity transactions, which typically were mergers due to financing requirements and margin rules, remain scarce due to the credit climate. Moreover, tender offers are likely to see increased use in troubled times where speed is essential.The rise in hostile transactions will also spur their use. Typically, a hostile bid is accompanied by a tender or exchange offer.
This allows the bidder to table a bid, albeit a highly conditional one, and show its seriousness. A bidder cannot launch a hostile merger, as the target board must agree to a merger, requiring that it be replaced in a proxy contest, whereas a bidder does not require target board approval to launch a tender offer.
Tender Offer and Merger Parity
Against this backdrop, the SEC still maintains a historical bias in favor of mergers over tender offers. This is because the federal takeover code has traditionally had its locus in the Williams Act regulation of tender offers, with mergers regulated via the proxy rules. The SEC traditionally justified this distinction because mergers were viewed as requiring less federal supervision. They were negotiated contracts between commercially sophisticated parties. Thus, the problematical, coercive aspects of tender offers were presumed absent. The initial federal regulatory focus upon tender offers was therefore defensible since in the 1960s the target could not negotiate the terms of a tender offer.
However, the existence of the poison pill and other takeover defenses has rendered this federal regulatory bias moot. A proxy contest is now the only viable way for a bidder to acquire a recalcitrant target. For example, both Microsoft and InBev staged their hostiles to advantage themselves with an accompanying proxy contest if necessary. Recent successful examples of joint proxy contests and tender offers include BASF’s successful $5 billion bid for Englehard, the pigment and catalyst maker, and Oracle’s successful $10.3 billion bid for PeopleSoft.9
The tender offer alone can no longer achieve corporate control in such situations. Yet Delaware law largely regulates proxy contests. Delaware companies can adopt staggered boards, thereby arguably deterring hostile bids. Moreover, Delaware notice and director removal statutes further regulate hostile contests.
The shift in focus in unsolicited takeovers to proxy contests implicates the entirety of the federal takeover code, including the proxy and tender offer procedural and substantive rules. Federal takeover law has traditionally distinguished in the scope and manner of its regulation of tender offers and mergers. However, the old, simplified reason for this distinction, the ability of a bidder to implement an unsolicited offer without target consent, is no longer valid. The death of the true hostile, functional requirement of target consent and other takeover developments has made many of these historical biases largely anomalous. More bluntly, there no longer appears to be any reason to continue the federal takeover code’s general, disparate treatment of the two structures.
The most glaring example of this unwarranted discrimination is the undue timing advantage tender offers have over mergers. Again, the justifications for this distinction appear no longer relevant in a world where targets must ultimately consent to the takeover, as the target can negotiate its preferred takeover structure. There are other cases where discrimination seems no longer sustainable in light of a target’s effective ability to control the takeover structure. The federal disclosure requirements in mergers and tender offers are distinct, with different and increased or lesser disclosure required for each.10 The propriety of this differentiation on the whole no longer seems appropriate; harmonization should be considered. Moreover, the all-holders best price rule is applicable only to tender offers.11 There is no longer a reason for this. If the rule is maintained, application of the rule to merger transactions (or elimination in the case of tender offers) may be appropriate to stem the bias that the rule, as currently interpreted, provides toward merger transactions. It was this distinction that permitted JPMorgan to openly purchase Bear Stearns shares in the market at a price higher than the one it ultimately paid to Bear Stearns’s shareholders.
A second issue with the federal takeover code is its prohibition on purchases outside the tender offer. Since 1969, former Rule 10b-13 (now redesignated Rule 14e-5) has prohibited bidder purchases outside a tender offer from the time of announcement until completion.12 The primary reason put forth by the SEC for barring these purchases was that they operate “to the disadvantage of the security holders who have already deposited their securities and who are unable to withdraw them in order to obtain the advantage of possible resulting higher market prices.”13 This is no longer correct; bidders are now obligated to offer unlimited withdrawal rights throughout the offer period.14 Moreover, Rule 10b-13 was issued at a time when targets had no ability to defend against these bidder purchases. They were yet another coercive and abusive tactic whereby the bidder could obtain control through purchases without the tender offer, thereby exerting pressure on stockholders to tender before the bidder terminated or completed its offer on the basis of these purchases.15 Of course, now there is the poison pill. In the wake of these developments, the original reasons underlying the promulgation of Rule 10b-13 no longer exist.
Moreover, Rule 14e-5, by its terms, acts to confine bidder purchases to periods prior to offer announcement.16 However, a bidder’s capacity to make preannouncement acquisitions has been adversely affected by a number of subsequent changes in the takeover code, such as the Hart-Scott-Rodino waiting and review period requirements. These have combined to chill a bidder’s ability to make preannouncement acquisitions or forthrightly precluded such purchases. Consequently, one study has recently reported that “over the past three decades only two percent of more than twelve thousand bidders initiating a control contests for publicly traded U.S. target firms chose to purchase a toehold shortly (within six months) prior to making the offer.”17
Recent research and study has found that a bidder’s preannouncement purchase of a stake in the target, known as a toehold, can be beneficial. The toehold purchase defrays bidder costs and incentivizes the bidder to complete the takeover, by providing the bidder compensation if its offer is subsequently trumped by a third party.18 This can lead to higher and more frequent bids. It also can serve as a substitute for a termination fee. Meanwhile, market purchases amid a tender offer can provide similar benefits while providing market liquidity and confidence for arbitrageurs to fully act in the market. And these purchases can be regulated by targets through the poison pill or other takeover defenses, as well as through bargaining with potential bidders. Since the initial premise for this rule is no longer valid and recent research supports encouragement of these purchases, the SEC and other governmental agencies should accordingly consider loosening restrictions on bidder toeholds and postannouncement purchases.
Finally, Rule 14e-5 has never applied to bar purchases while a merger transaction is pending. Presumably, this made sense in 1968 because a bidder in a merger situation requires target agreement; the target can therefore contractually respond to and regulate this conduct. Accordingly, a bidder who runs a proxy contest without a tender offer is permitted postannouncement purchases during the contest. In most cases, the target will have the buyer contractually agree to abstain from such purchases upon agreement to a merger. But this is a negotiated point among the parties. For example, again in the JPMorgan-Bear Stearns transaction, the parties deliberately did not include such a provision to allow for JPMorgan to make market purchases. Unsolicited bidders also initially characterize their offers as mergers in order to leave the option of such purchases.The result is preferential bias toward mergers over tender offers, discrimination that no longer makes sense in a world where a takeover transaction will not succeed unless the original or replaced target board agrees to it. Any prohibition on outside purchases should apply to both merger and tender offer structures or to neither.
Due Diligenc
e and Disclosure
There is another significant issue with federal takeover law: the way it treats due diligence and disclosure in the takeover process.
In recent years, the SEC has administered disclosure obligations haphazardly to the detriment of shareholders. Continuing its undue distinction between mergers and tender offers, SEC disclosure requirement makes inappropriate distinctions between these two structures. Moreover, in the private equity context, the SEC has failed to force disclosure of debt and equity commitment letters for buyer financing. Although some confidentiality on pricing terms may be appropriate, the complete nondisclosure of these letters has left shareholders without information about the ability of buyers to draw on financing and complete acquisitions. This has resulted in situations like the Clear Channel litigation, where shareholders were unaware of the ability of the banks to assert a legal claim that they could walk under the letters until litigation erupted.
Meanwhile, the SEC has increasingly allowed bidders to refrain from fully disclosing the conditions to the completion of their acquisition or other seemingly material information. Instead, the SEC has allowed the parties to put this information in disclosure schedules to the acquisition agreement, a part of the transaction documentation that is typically kept confidential. The problem with this was readily apparent in the 3Com transaction. There, the CFIUS condition discussed in Chapter 5 appeared to have been put in the disclosure schedule so shareholders did not even know of its existence. Finally, the SEC has seldom acted to enforce its own disclosure requirements in the takeover context. The result has been an increasing trend for buyers to underdisclose and to avoid disclosure of key acquisition terms.
Gods at War: Shotgun Takeovers, Government by Deal, and the Private Equity Implosion Page 32
