September 7, 2007
MetroPCS's Takeover "motives"
Why M&A deals happen has been the subject of much study. In the case of MetroPCS Communications, Inc.'s announced offer to merge with Leap Wireless International, there appear to be a number of rationales including synergies, cost-savings and the strategic one of creating a new, flat rate national wireless carrier with licenses covering nearly all of the top 200 markets. But there may be another reason. Here is a risk factor included in MetroPCS's S-1 filed earlier this year:
On June 14, 2006, Leap Wireless International, Inc. and Cricket Communications, Inc., or collectively Leap, filed suit against us in the United States District Court for the Eastern District of Texas, Marshall Division, Civil Action No. 2-06CV-240-TJW and amended on June 16, 2006, for infringement of U.S. Patent No. 6,813,497 “Method for Providing Wireless Communication Services and Network and System for Delivering of Same,” or the ’497 Patent, issued to Leap. The complaint seeks both injunctive relief and monetary damages for our alleged infringement and alleged continued infringement of such patent.
If Leap is successful in its claim for injunctive relief, we could be enjoined from operating our business in the manner we operate currently, which could require us to redesign our current networks, to expend additional capital to change certain of our technologies and operating practices, or could prevent us from offering some or all of our services using some or all of our existing systems. In addition, if Leap is successful in its claim for monetary damage, we could be forced to pay Leap substantial damages for past infringement and/or ongoing royalties on a portion of our revenues, which could materially adversely impact our financial performance. If Leap prevails in its action, it could have a material adverse effect on our business, financial condition and results of operations. Moreover, the actions may consume valuable management time, may be very costly to defend and may distract management attention away from our business.
LaPoint v. AmeriSourceBergen Corp. and the Perils of Earn-Outs
An earn-out obligates a buyer to pay additional acquisition consideration if the target, post-acquisition meets certain performance bench-marks. By permitting the buyer to agree to a seller's higher asking price but obtaining assurance that the value promised by the seller will still exist, earn-outs can thus be a valuable tool to resolve an impasse over price between a buyer and seller. But earn-outs have their own problems:
- The seller will request the buyer to agree to properly operate the business post-acquisition so the sellers have a greater chance of receiving the full earn-out. This will likely lead to the imposition of complex drafting restrictions and obligations put upon the operation of the business -- provisions which may hamper the buyer's ability to flexibly operate the business.
- If the business goes sour, charges by the sellers will inevitably arise that it is the result of poor decisions by the buyer and they are still entitled to the money -- these charges will undoubtedly find colorable support in some of the broad language typically included in the earn-out about using "reasonable best efforts" to operate and promote the business and other optimistic statements in the agreement.
- Things change -- earn-outs can go for several years, and the restrictions and other provisions governing the business may not provide for such events.
- The need to actually determine if the earn-out is fulfilled often results in pitched battles between the buyer and seller and charges of accounting manipulation. M&A lawyers therefore have to be very careful to highlight these difficulties to their clients, and attempt to negotiate provisions in earn-outs which either willfully address or otherwise omit covering these issues. All this without over-drafting and making the earn-out terms too complex. Earn-outs are a trap for the unwary.
All of this went through my mind as I read Chancellor Chandler's opinion issued earlier this week in LaPoint v. AmeriSourceBergen Corp., No. 327-C (Del. Ch. Sept. 4, 2007). In LaPoint, AmerisourceBergen had agreed to acquire Bridge Medical Inc. for an initial payment of $27 million dollars, and further agreed to an "earn-out” to be paid to former Bridge shareholders contingent upon certain EBITA [earnings before interest, tax and amortization] targets being met over a two year period. The earn-out payment varied between $55 million and zero, depending on the EBITA of Bridge achieved in each of those years. Chandler describes the dispute as thus:
This case falls into an archetypal pattern of doomed corporate romances. Two companies Bridge Medical, Inc. and AmerisourceBergen Corporation—agree to merge, each convinced of a happy future filled with profits and growth. Although both partners harbor some initial misgivings, the merger agreement reflects these concerns, if at all, in an inaccurate and imprecise manner. After some time, the initial romance fades, the relationship consequently sours, and both parties find themselves before the Court loudly disputing what the merger agreement “really meant” back in its halcyon days.
If this case is different, it is only in the speed with which the ardor faded. Both parties now assert that mere months after the ink on the merger agreement had dried, if not before, their erstwhile paramour had determined that the relationship was not worth the candle. Plaintiffs (former shareholders of Bridge) insist that defendant provided lukewarm support for their operations and did everything possible to avoid having to pay merger consideration contingent on the success of plaintiffs’ former firm. Defendant blames plaintiffs’ woes upon plaintiffs’ lack of long-term planning, inconsistency between plaintiffs’ strategies and actions, and an inability to cope with market changes. Plaintiffs now seek damages in response to defendant’s alleged breaches of contract.
The first charge leveled by the plaintiffs was breach of the earn-out provisions in the acquisition agreement due to ABC's promotion of other competing products, changes to Bridge's publicity policy and general failure to actively and exclusively promote Bridge products. Importantly. ABC had agreed to the following provision in the agreement:
[ABC] will act in good faith during the Earnout Period and will not undertake any actions during the Earnout Period any purpose of which is to impede the ability of the [Bridge] Stockholders to earn the Earnout Payments.
ABC had also agreed in the agreement to "actively and exclusively" promote Bridges products. Chandler ultimately found that "ABC frequently and intentionally breached its duty to provide active and exclusive support for Bridge sales efforts," but since it did not affect the business's failure to meet the earn-out targets only nominal damages of six cents were appropriate. Nonetheless, Chandler ordered ABC to pay plaintiffs $21 million arising from ABC's miscalculations of the earn-out. Here, plaintiffs had charged that ABC had intentionally miscalculated the earn-out appropriate for 2003 by giving too high a discount on a significant sale, making too big an adjustment to EBITA to account for R&D expenditures and postponing recognition of another significant sale. ABC has announced they will appeal. Given the deference provided the Chancery Court by the Delaware Supreme Court and the fact-based nature of Chandler's determination, I'm not sure it is worth their money. Again, earn-outs can be helpful in achieving a deal, but they are a trap for the unwary.
September 6, 2007
More on Yesterday's Congressional Hearings on Taxing Private Equity and Hedge Funds
Leap's Defensive Weakness?
Earlier this week, MetroPCS Communications, Inc. announced that it had proposed a strategic stock-for-stock merger with Leap Wireless International. MetroPCS is proposing to offer 2.75 shares of MetroPCS common stock for each share of Leap valuing Leap's equity at approximately $5.5 billion. For those who collect bear-hug letters, you can access the fairly plain vanilla one here. (Aside, showing my M&A geekiness, I've been collecting these for years; my pride and joy is one one of the extra signed copies of Georgia-Pacific Corp.'s bear-hug for Great Northern Nekoosa Corp., one of the seminal '80s takeover battles).
As a preliminary matter, MetroPCS phrased the offer as a merger rather than an exchange offer or just plain offer in order to avoid triggering application of Rule 14e-8 of the Williams Act which would require it to commence its exchange offer within a reasonable amount of time. This is yet another bias in the tender offer rules towards mergers which doesn't make sense -- the SEC would do better to promulgate a safe-harbor for these types of proposals so an offeror has more public flexibility in proposing a transaction structure. Although, at this point, all of the actors here, except the public, know what MetroPCS means and why they are using this language.
I was also browsing through the Leap organizational and other documents this morning to see how takeover proof it is. Leap is a Delaware company and it has not opted out of Delaware's third generation business combination statute DGCL 203. But it has no staggered board or a poison pill (though as John Coates has academically observed it still can adopt one). While Leap's directors can be removed with or without cause, there is a prohibition on shareholders acting by written consent. This, together with a prohibition on shareholder ability to call special meetings, would mean that MetroPCS would have to wait until next year's annual meeting to replace Leap's directors. And Leap could force MetroPCS to do so by adopting a poison pill. So, Leap's ultimate near-term vulnerability boils down to whether its shareholders can call a special meeting. Here is what Leap's by-laws say about the shareholder ability to call special meetings:
Section 6. Special Meetings. Special meetings of the stockholders, for any purpose, or purposes, unless otherwise prescribed by statute or by the Certificate of Incorporation, may be called by the Chairman of the Board of Directors, the Chief Executive Officer or the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any such resolution is presented to the Board of Directors for adoption). Business transacted at any special meeting of stockholders shall be limited to the purposes stated in the notice of such meeting.
Does everyone see the problem here? It looks like a typo -- instead of "prescribed", the drafter here probably meant "proscribed". So, instead of limiting the calling of special meetings, by changing one letter the clause expands shareholder power provided the certificate or Delaware law permits Leap shareholders to call these meetings. Here, Article VIII of the certificate does not allow it. So we are down to Delaware. DGCL 211(d) is the relevant statute, and it states:
Special meetings of the stockholders may be called by the board of directors or by such person or persons as may be authorized by the certificate of incorporate or the by-laws.
A bit circular, but it can be safe to say that Leap probably dodged a bullet here: DGCL 211(d) does not appear to specifically authorize stockholders to call a special meeting. And, in any event, Leap's board has the power to amend its by-laws although doing so in the middle of a battle for corporate control has its own legal and political ramifications. Ultimately, though, the lesson here is how one (intentional or unintentional) letter can make a very big difference -- be careful out there.
House Hearing on Taxing Private Equity and Hedge Funds
The House Ways & Means Committee is holding hearings today starting at 10:00 a.m. on the taxation of private equity and hedge fund adviser compensation. The meetings will be simulcast on the web live.
In advance of the hearing, the Joint Committee on Taxation has released Present Law and Analysis Relating to Tax Treatment of Partnership Carried Interests and Related Issues:
Despite the long title, it is a fascinating look at the state and business of private equity and hedge funds. In any event, the hearings show that the issue of fund taxation continues to have momentum.
September 5, 2007
Central States Law School Association Conference
Central States Law School Association and the Journal of Law in Society Joint Conference October 26-27, 2007
The Central States Law School Association and the Journal of Law in Society announce a joint conference at Wayne State University Law School in Detroit, Michigan on October 26-27, 2007. The conference will consist of a Friday afternoon symposium presentation of selected papers and Saturday open workshop panel presentations. With author consent, the selected symposium papers will be published in the Journal of Law in Society as its symposium issue for 2007-2008.
Authors will present selected symposium papers on Friday afternoon in up to three panel sessions with question and answer periods at the end of each panel session. A participant dinner will be held at the close of the panels on Friday. From 9 am until 4 pm on Saturday, authors will present papers on any private or public-law topic in a number of workshop panels, with question and answer periods either after each paper or at the end of each panel as the authors decide. The annual meeting of the Central States Law School Association and election of officers for 2007-2008 will conclude the conference on Saturday evening.
Does Globalization Represent a Threat or Promise for Social Justice and Democratic Institutions? With the rapid pace of globalization, countries have witnessed increasing integration of communications, economic processes, and financial markets. There is a widespread assumption that the competitive pressures unleashed by globalization are ultimately useful in spurring broader economic growth and greater integration, yet there is also growing concern that globalization plays a direct role in creating new and in some cases apparently insoluble problems for social justice and democratic institutions.
Conference participants are invited to consider this topic from three perspectives: (1) Does the growing power of corporations and their concomitant ability to set the terms of competition in a globalized economy aid or hurt social justice and democratic institutions? (2) Do increases in property right protection (including intellectual property regimes) aid or hurt social justice and democratic institutions? (3) Do financial and tax competition aid or hurt social justice and democratic institutions?
Open workshop paper proposals or abstracts may be submitted anytime up until August 25, 2007. Workshop paper proposals will continue to be accepted after the August deadline, subject to the availability of presentation slots.
Proposals must contain the following information: (1) name, address, telephone, and email; (2) title of presentation; (3) brief description of presentation idea; and (4) organization affiliation and position. Completed papers are not required, although they are welcome. Please send submissions via email to Mr. Oday Salim at the following email address: email@example.com. In the subject line, please include your name and the words "Central States."
Any other questions can be addressed to any of our officers:
President Linda Beale, Associate Professor, Wayne State University Law School, firstname.lastname@example.org; (313)577-3941
Vice-President Cindy Buys, Assistant Professor, Southern Illinois University School of Law, email@example.com; (618)453-8743
Treasurer Carolyn Dessin, Associate Professor, University of Akron School of Law, firstname.lastname@example.org; (330)972-6358
Secretary Danshera Cords, Associate Professor, Capital University Law School, email@example.com; (614)236-6516
Movie Gallery's Death Spiral
Movie Gallery, Inc. yesterday announced that the holder of a majority of principal amount of its 11% Senior Notes, had agreed to forbear until September 30, 2007 from exercising its rights and remedies arising from MG's cross-default under its indenture for these notes. The cross-default had occurred due to MG's prior default on its first lien credit facility. MG had previously signed a forbearance agreement for its default under its financial covenants contained in its first lien credit facility. But, because of this default, MG has now cross-defaulted on its $175 million second lien facility. MG is now in default on all three of its major debt financing instruments. And to make matters worse, because of MG's non-compliance with the covenants contained in the first lien facilities, MG has disclosed that its liquidity is now threatened since "many of our significant vendors have discontinued extending us trade credit, requiring us to pay for product before it is shipped, and we have experienced additional tightening of terms with other vendors." In light of these problems the stock is now a penny one, and MG is no longer in compliance with Nasdaq Marketplace Rule 4450(a)(5), which requires a minimum bid price of $1.00 per share. MG is about to be relegated to the small-cap market in a best case scenario; bankruptcy court is also now a possibility.
This mess all started on July 2 when the nation's second-biggest video rental chain announced that it was unable to meet financial covenants due to "significantly" weaker-than-expected second-quarter results. Specifically, the company disclosed that it blew through the Interest Coverage Ratio set forth in Section 6.7(a) and Leverage Ratio requirements set forth in Section 6.7(b) and Section 6.7(c) under the First Lien Credit and Guaranty Agreement. This default set off the chain-reaction described above. And it took Movie Gallery only four months to breach these covenants, the first lien credit facility was signed on March 8. A review of the 10-Q for MG's second quarter shows a deterioration of MG's results but one that appears at quick glance to be expected. The quick timing between the execution of the first lien agreement and the event of default appears just a bit too quick, particularly since MG was a troubled business even at the time the facility was executed. This is just an educated guess, but perhaps MG lost the ball here and unwittingly agreed to covenants it could never meet. I hope not, but there is a story here -- hopefully a diligent reporter will find it so we can all learn from it. This is beside the obvious one of the perils of cross-default provisions. In the meantime, MG continues its death spiral.
MGIC/Radian Deal -- RIP
MGIC Investment Corporation and Radian Group Inc. jointly announced today that they have terminated their pending merger. Here were the very nice comments each had for the other in their joint press release:
Curt Culver, MGIC Investment's CEO, said, "I am pleased MGIC and Radian were able to reach this amicable resolution. During the course of the merger process, our MGIC team met many fine people from Radian. We wish them the best."
S.A. Ibrahim, Radian Group's CEO, said, "Our mutual decision to terminate the pending merger represents the best outcome for both companies under the circumstances. We wish MGIC and its employees well."
MGIC is clearly the much happier of the two, though, as MGIC had previously asserted that a material adverse change had occurred to Radian permitting MGIC to terminate their merger arrangement. To my knowledge, this is the first deal to be terminated on MAC grounds because of the sub-prime mortgage crisis. And a quick review of the termination and release agreement finds that it will be a clean break. MGIC will not pay any funds to Radian in connection with this termination. I have to admit, I am a bit surprised about this. Based on the publicly available facts, Radian appeared to have reasonable grounds to deny that a MAC had occurred. Nonetheless, advised by Wachtell, Radian has chosen to drop any claims and the value in them. Presumably, they know more than I do.
Ultimately, the case points to why there is so little case-law on MACS out there -- the parties typically settle these cases by terminating the deal or renegotiating the price (as appears to be the trajectory of the Lone Star/Accredited Home deal). And given the settlement and the lack of full disclosure here, it is hard to draw any conclusions from this termination for the other pending MAC cases out there. Oh -- and those nice comments above -- well expect them in all of the parties' comments on the terminated deal. Each agreed in the termination agreement to a non-disparagement clause for the next 18 months. Hopefully, this clause will not chill their speech and prevent full disclosure by Radian to its shareholders of the facts which led to this deal termination. They are having a hard enough day today as it is.
Black Market Capital
Last Friday, the Wall Street Journal ran an interesting article on the large number of individual investor comments the SEC is receiving for its pending rule proposal to raise the wealth requirements for investment in hedge funds and private equity. Apparently, the bulk of these comments criticize the SEC for depriving these investors of the opportunity to invest in hedge funds and private equity. These investors rather want unrestricted access to these investments. The article was fortuitously timed as I have just finished up my summer writing project -- Black Market Capital -- which touches upon this subject and argues for just such investor access (download the article on the SSRN here). I'll be presenting parts of this article to the securities reg. section meeting at AALS in January. Here is the abstract:
Hedge funds and private equity offer unique investing opportunities, including the possibility for diversified and excess returns. Yet, current federal securities regulation prohibits the public offer and purchase in the United States of these investments. Public investors, foreclosed from purchasing hedge funds and private equity, instead seek to replicate their benefits. This demand drives public investors to substitute less-suitable, publicly available investments which attempt to mimic the characteristics of hedge funds or private equity. This effect, which this Article terms black market capital, is an economic spur for a number of recent capital markets phenomena, including fund adviser IPOs, special purpose acquisition companies, business development companies, structured trust acquisition companies, and specialized exchange traded funds all of which largely attempt to replicate private equity or hedge fund returns and have been marketed to public investors on this basis. Black market capital has not only altered the structure of the U.S. capital market but has shifted capital flows to foreign markets and engendered the creation of U.S. private markets such as Goldman Sachs' GSTrUE. This Article identifies and examines the ramifications of black market capital. It finds this effect to be an irrational by-product of current hedge fund and private equity regulation, one that is likely harmful to U.S. capital markets. A solution is to restore equilibrium in U.S. markets and enhance their global competitiveness by amending the Investment Company Act and Investment Advisers Act to permit public offerings of hedge funds and private equity funds. Though further study is warranted, the economic benefits of such a regime prospectively outweigh objections previously raised by regulators and others. Current market volatility and distress does not affect this conclusion. Black market capital is also an example of the unintended effects of regulating under the precautionary principle and difficulty of regulating in an era of market proliferation.
September 3, 2007
Fall M&A Preview
Here it is folks, the Fall M&A Preview. This is my take on the big (and not so big) M&A and other market legal issues and expected events for the Fall of 2007. It is going to be a fascinating time to be watching the markets.
The Big Picture
Expect strategic transactions to be driving M&A activity in the Fall as the private equity firms focus on clearing out some of the big deals on their plates. Regardless, also expect market innovation and adjustment to occur as these private equity firms attempt to close these deals and reallocate the liabilities and costs among the parties (ala Home Depot) as they, their targets and financing banks desperately avoid one of these big deals breaking. NB. This is a much harder task in the public company context than in the Home Depot paradigm.
There are now four potential material adverse change (MAC) cases by my count (Lone Star/Accredited; SML/PE Consortium; Genesco/Finish Line; Radian/MGIC). If markets further deteriorate, expect more of these cases as acquirers attempt to escape or renegotiate deals and use the MAC as a bargaining tool. The big MAC case right now is the Lone Star/Accredited one which is in litigation and has scheduled hearings before VC Lamb in Delaware Chancery on Sept. 26. An opinion would resolve significant questions over what constitutes disproportionality under a MAC clause and have much wider market ramifications for other, pending deals. So, as a law professor I am rooting against settlement and for an opinion, though, given that Lone Star is a financial buyer (unlike Tyson) resolution through litigation seems unlikely.
Private Equity (And SPACs and BDCs)
It is going to be a busy Fall for private equity as they attempt to close their pending deals. Here, I expect the private equity shops who can to use reverse termination fees as a bargaining tool to renegotiate deals. These fees provide them a clean way to walk away from a deal without further liability provided they pay a termination fee of approximately 3-4% of deal value (see my post on these here which was quoted in the N.Y. Times: thanks Andrew R. Sorkin!). This maneuver was used in the Home Depot deal where it was reported by the WSJ that the lending banks offered to pay the reverse termination fee if the private equity firms walked. Showing perhaps that this story was planted by the private equity firms themselves, the story also reported that the private equity firms balked at this stance due to the reputational effect of such a maneuver. Aren't they swell? Nonetheless, private equity firms are not charities, if the market does further deteriorate expect the private equity firms to strongly reassess this position, and in any event to use this provision to non-publicly attempt to renegotiate troubled deals.
One other thing to look for is how the many, pending initial public offerings of SPACs (special purpose acquisition companies) and BDCs (business development companies) fare. These are private equity derivative investments that have been all the rage of late (e.g., SPACs constituted twenty-eight percent or thirty seven of the 133 initial public offerings through July 20, 2007). I look at these offerings as the "canary in the mine-shaft" so to speak; they will be a good indicator through the Fall of the current state of private equity and the prospects for the takeover market generally. And BDCs will take a particular hit though no matter what given the implosion of KKR Financial, LLC, KKR's BDC. Nonetheless, I expect fund adviser ipos to continue to pop-up and for KKR's ipo to go through in the Fall. Their historical record right now is unlikely to get any better, and so it is a good time for them to sell even if they won't get Fortress's or Blackstone's pricing.
The M&A action in Europe these days is incredible; it is a much more vibrant and innovative takeover market than the U.S.-one as the actors struggle and adjust with the 25 differing takeover regimes. Here, the Takeover Directive has now been fully implemented; in its final form everyone knew it was weak medicine for harmonization. But the required implementing legislation has led to a reexamination by many countries of their takeover codes which has pushed the countries even farther apart. France has used this process as an excuse to adopt legislation permitting targets to issue stock warrants in the face of a hostile offer – a modified form of poison pill. Meanwhile, Britain has stayed in the opposite camp. It has maintained its prohibitions on takeover and transaction defenses in all circumstances (which the English call frustrating action). The result is grist for a worthy academic study on federalism and regulatory competition as the effects of these differing laws on their domestic/cross-border M&A markets take effect (one that I hope to pursue). Ultimately, despite any inhibiting effects of these laws the European takeover market is now as robust as the U.S.-one; expect it to stay that way through the Fall, as shareholders and institutional investors become increasingly active in the takeover process (e.g., ABN Amro/Barcalays/RBS; Arcelor/Mittal).
M&A Specific Issues
The Return of the Tender Offer? In the first five months of 2007, 15.5 percent of negotiated transactions were accomplished through tender offers (see my prior post outlining the reasons for this here). While that is a low figure, it is more than three times higher than in the same period last year. As strategic transactions return to the fore, expect more acquirers in negotiated transactions to continue to use this acquisition structure.
The Top-Up. Expect top-ups to become standard in tender offers, to the extent they are not already.
The Rise of the Exchange Offer? I'm rooting for it. In the M&A Release, the SEC attempted to put cash and stock offers on parity by providing for early commencement of equity exchange offers in Rules 162 and 430 of the Securities Act. Now, with reform of the all-holders/best price rule, the main problem with tender offers has disappeared. So, with the return of the cash tender offer, I would expect to see the exchange offer begin to emerge. Exchange offers permit stock-for-stock acquisitions to be consummated on a tender offer time table instead of the 2-3 months for a merger. M&A lawyers would do well to inform their acquiring clients of this despite the significant extra lawyer time it involves.
Whither the Go-Shop? These provisions have been criticized here and elsewhere for their illusory nature, providing cover to private equity firms and management who attempt to take over a company. Go-shops have also been subject to increasing judicial scrutiny in Delaware in the NetSmart and Topps cases. Hopefully, this scrutiny and criticism will bring innovation among M&A practitioners to revise the terms of these provisions to provide them with more significance. But otherwise, they will continue to persist in some form in private equity deals.
Shareholder/Board Action. Expect shareholder activism to diminish to the extent we remain in a down market and shareholders take what they can get. Still, the Topps transaction is likely to be defeated. Also, to the extent shareholders do protest takeovers, expect boards to avail themselves of Strine's recent decision in Mercier to attempt to further influence the shareholder approval process in takeovers (more on this here).
The Global Competition for Listings. The comment period for the SEC's concept release on IFRS accounting for U.S. issuers expires November 13, 2007. While this is not a great idea (there are different considerations for U.S. issuers than foreign ones which make it more appropriate to compare apples with apples), the SEC is starting to "get" the fact that there is a global listings and offerings market and to actually compete in it. I believe that this is the most exciting regulatory development this year. Put this on top of the SEC's push for IFRS for non-U.S. issuers by 2009 and the effectiveness of the foreign issuer deregistration rules this Spring, and I am positively giddy. Also, expect an article by a news reporter this Fall headlined -- foreign issuers flee the United States -- reporting the high number of non-U.S. issuers who have now deregistered in recent months. It will likely quote an academic who says this points to Sarbanes-Oxley and the anti-competitive position today of the United States. Don't believe it. The deregistration/delisting wave is a product of the the pent-up demand for delistings and a restoration of market equilibrium in light of the new SEC rules permitting such deregistration. The more important indicator here is the number of new cross-listings -- and all signs through today point to this number as being a good one. [NB. if any law professor out there is interested in putting together a comment on the concept release please contact me -- I'm working on one right now and would welcome a co-signer or two]
Hedge Funds. The SEC will consider this Fall raising the Regulation D Rule 506 investing requirements for investment in hedge funds and private equity to $2.5 million for individual investors. Showing what it thinks of the benefits of economic cost/benefit analysis, the SEC did not cite a single financial or academic study to support raising this standard. Instead, the SEC continues to rely on the proposition that hedge funds are too "risky" for public investment, and issues of systematic risk to place these investments off limits to public investors. Here, I am reminded of the Massachusetts Securities Division which refused to permit residents of that state to invest in the initial public offering of Apple Computer because it was “too risky”. The SEC would do better to undertake real cost/benefit analysis of public investment in these funds, a study which would have to recognize their benefits for diversification and excess returns (i.e., alpha). For those who want more on these issues see Troy Paredes recent, terrific article on this.
Fairness Opinions. After four amendments and eight extensions, the time period for SEC action on Rule 2290, the FINRA rule on fairness opinions, will expire on October 31 (see the rule filings here). At this point, everyone would be better off if FINRA acknowledged reality and withdrew the rule. Instead, the SEC should sit down and take a hard look at fairness opinion practice. These opinions are subjective and not prepared using best practices or to any definitive standards; problems which are exacerbated by the conflicted nature of the investment bank in rendering these opinions. Moreover, SEC rules need to be updated in this area (e.g., fairness opinion disclosure is required in proxies but not for Schedule TOs). For more on this, see my article Fairness Opinions published in the American Law Review.
My New Years' Wish List. Since I get three wishes as blog editor here they are:
- Merger/Tender Offer Parity. The poison pill has sterilized the use of the tender offer as a takeover device. Consequently, there is no significant difference between the tender offer and merger structure any more. The SEC should undertake a comprehensive review to end the disclosure, timing and other regulatory differences between tender offers and mergers to put them on parity. (e.g., a company who is not current in its financial reporting can be the subject of a tender offer but, because of an SEC staff proxy rule interpretation, may not be able to issue a merger proxy, a particular problem in options back-dating cases. There is no reason for this. For more on these inappropriate differences, see here).
- Updating the Cross-Border Rules. The Cross-Border Rules were a significant step by the SEC to attempt to accommodate cross-border acquisitions. Yet, because of a number of technical problems with the rules (detailed here), they have not been fully utilized and instead issuers have increasingly relied on the exclusionary offer to avoid wholesale application of the U.S. securities laws. The SEC should take the easy steps to fix these problems and again encourage these transactions to include U.S.-based holders. It would also help if the SEC looked at the scheme of arrangement exemption under Section 3(a)(10); most U.K. acquirers now use it as the preferred method to largely avoid the U.S. securities laws in acquisitions, and I am not so sure that it functions the way the SEC thinks intended it should when it first permitted this exemption (I'll post more on this later this week).
- Abolish Rule 14e-5 as it applies to tender offers. My pet-peeve. 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. Not true anymore either -- the poison pill and other regulatory bars limit or inhibit bidder purchases outside an offer. And Rule 14e-5 applies to tender offers but not mergers (the parity issue again). But the Market Reg. division of the SEC has assiduously protected this rule despite its obsolescence. The SEC would do better to deregulate and leave the possibility or actuality of bidder toeholds and post-announcement purchases to be regulated by targets through a low-threshold poison pill or other takeover defenses as well as through bargaining with potential bidders (For more on this see here).