Friday, June 19, 2009
This digression will be familiar to California lawyers, but maybe a little foreign for others. When doing a deal for stock, it is key that the stock be registered with the SEC so that recipients can freely trade it. This entails the time and expense of filing an S-4 with the SEC and going through rounds of comments before the registration statement becomes effective and the stock can then be traded. That means months of additional delay. But, if the goal is to use stock that can be freely traded the day after the transaction closes, registration isn’t the only option.
Pursuant to Section 3(a)(10) there is a valid exemption from the registration requirement for any securities that have been issued in exchange for other securities where the terms and conditions of such exchange have been approved after a fairness hearing by a court of governmental authority. At such a hearing (which must be open to shareholders), the reviewer must find that the terms and conditions of the exchange are fair (both procedurally and substantively) to those to whom securities will be issued; and must be advised before the hearing that the issuer will rely on the Section 3(a)(10) exemption based on the reviewer’s approval of the transaction. The SEC’s most recent staff interpretation of the rules relating to 3(a)(10) fairness hearings can be found here.
The California Department of Corporations is authorized under California law to conduct fairness hearings (CCC: 25142). Such hearings are conducted by officers of the Department in both San Francisco and Los Angeles. The Department of Corporations reports doing some 423 fairness hearings over the past ten years, with the bulk occurring during the dot com bubble when stock ruled as consideration.
ALthough the reliance on fairness hearings has declined recently, the fairness hearing is not entirely a product of the bubble. It was used by Aruba Networks in their acquisition of Airwave last year. The application as well as the hearing transcript are available through the CALEASI database here. The merger agreement is unfortunately not included in the materials made available online.
The hearing took place less than two months after the deal was signed – so about a month faster than an S-4 process. The expense was also likely considerably less – no late nights at the printer and no lengthy comment letters before the hearing. However, there was a hearing and it was more than just a check the box exercise. If you take a look at the transcript of the hearing, you’ll see that the hearing officer spends a lot of time on procedure, but then delves into the substance of the transaction. Here’s a sample of his questioning of the buyer and counsel:
Q: Let’s discuss the economic terms of the merger. What was the purchase price that the parties agreed on?
A: Gross level of 37 million.
Q: Okay, how was that determined?
A: So we went through an economic analysis. We looked at if we were to bring this in-house, where would the revenues come from. So we looked at what revenues could Airwave contribute. We looked at selling the Airwave product with the Aruba product. What that would generate. We looked at selling their technology into our install base; and then the reverse, selling their technology into our install base….
Q: And how is the purchase price going to be paid?
A: It’s a mixture of cash and stock.
Q: Okay, What’s the appropriate mix?
A: So we ended up at 45% cash and 55% stock.
Q: And was the agreement amended to reflect that ratio?
A: Yes, it was. We started at 35% cash and incremented that to 45 as one of the amendments.
Q: Why was that change made?
A: So, there has been a decrease in our share price. Partly just by macroeconomics, partly we’re in a high tech basket. We had downward pressure on it.
and so on...
Although in the current deal environment, there aren’t many transactions getting done for stock at some point when things turn around the fairness hearing may make a come-back. In any event, it’s worth keeping the fairness hearing in one’s tool-kit of potential solutions.
UPDATE: Steven Davidoff at The Deal Professor notes that pursuant to a 1999 staff interpretation that a foreign scheme of arrangement can qualify for the 3(a)(10) exemption.