Sunday, July 1, 2007
One of the frustrations often expressed with the 1968 Williams Act governing tender offers is that many of its provisions and the SEC rules thereunder no longer make sense. I'm currently finishing up an article on this topic entitled The Failure of Federal Takeover Regulation (read a draft here). When it is finally published, I intend to post a longer series concerning the issues and problems with current federal takeover law. But for today, I would like to talk about the obsolescence of one particular rule: Rule 14e-5.
Rule 14e-5 was promulgated in 1969 as Rule 10b-13 to prohibit bidder purchases outside of a tender offer from the time of announcement until completion. The primary reason put forth by the SEC for barring these purchases in 1969 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.” This is no longer correct; bidders are now obligated to offer unlimited withdrawal rights throughout the offer period. 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. This is not feasible today. Poison pills and second and later generation state takeover statutes act to restrict these purchases to threshold non-controlling levels without target approval. 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. However, a bidder’s capacity to make preannouncement acquisitions has been adversely effected 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 at least forty-seven percent of initial bidders have a zero equity position upon entrance into a contest for corporate control.
A bidder’s preannouncement purchase of a stake in the target, known as a toehold, can be beneficial. The toehold purchase defrays bidder costs, incentivizes the bidder to complete the takeover, and reduces free-rider and information asymmetry problems. This can lead to higher and more frequent bids. Meanwhile, market purchases amidst a tender offer can provide similar benefits while providing market liquidity and confidence for arbitrageurs to fully act in the market.
Since the initial premise for this rule is no longer valid and recent research supports encouragement of these purchases, the SEC should accordingly consider loosening restrictions on bidder toeholds and postannouncement purchases. Bidder toeholds and off-market purchases, however, do have a potentially corrosive effect if the stake is significant. To dampen this possibility, a relaxation of these purchase rules could be combined with provisions similar to those in the U.K. Takeover Code which permit pre- and post-announcement purchases but require the bidder to pay for a set period thereafter no less than that price paid for all subsequently acquired shares. Alternatively, the SEC could wholly deregulate and leave the possibility or actuality of bidder toeholds and postannouncement purchases to be regulated by targets through a low-threshold poison pill or other takeover defenses as well as through bargaining with potential bidders.
Finally, Rule 14e-5 has never applied to bar purchases while a merger transaction is pending. Presumably, this path dependency was set in 1969 because a bidder in a merger situation requires acquiree agreement; the acquiree can therefore contractually respond to and regulate this conduct. But whatever the reason, today a bidder who runs a proxy contest without a tender offer is permitted postannouncement purchases during the contest. Unsolicited bidders will therefore initially characterize their offers as mergers in order to leave the option of such purchases. The result is preferential bias towards mergers over tender offers, discrimination which no longer seems sensical in a world where a takeover transaction will not succeed unless the original or replaced acquiree board agrees to it. Any prohibition on outside purchases should apply to both merger and tender offer structures or to neither.