Re-Emergence Of Tender Offers: SEC Adopts Amendments To Tender Offer "Best-Price" Rules

By James A. Matarese, Joseph L. Johnson III, John T. Haggerty, Lisa R. Haddad and Suzanne E. Murray

The Securities and Exchange Commission recently published new rules that will effect changes to Rule 14d-10 and Rule 13e-4 of the Securities Exchange Act of 1934, commonly known as the "best-price" rules. The best-price rules require that all shareholders be paid the same price in a tender offer. These amendments are intended to alleviate the uncertainty created by various interpretations of the best-price rules by the federal courts. This uncertainty has resulted in the decline of tender offers as a viable structure for negotiated cash acquisitions of public companies in which the parties are seeking to mitigate execution risk by minimizing the length of time between public announcement and closing of the acquisition. The new rule changes clarify that equal treatment of security holders in tender offers is predicated upon the securities tendered in the offer and that the best-price rules are not intended to prohibit compensatory arrangements with security holders of the target provided that the consideration paid pursuant to such arrangements was not paid for the purpose of acquiring securities of the target held by such security holders. In so doing, the SEC expressly acknowledged that critical personnel decisions are often required to be made concurrently with decisions regarding whether to pursue a tender offer and are made independently from the decision regarding the consideration to be paid to security holders of the target.

The SEC believes that by eliminating the uncertainty created by the conflicting federal court decisions more companies will structure acquisitions of securities as a tender offer. We agree and expect to see the re-emergence of the tender offer structure as the preferred structure for negotiated cash transactions.

These amendments are applicable to both third-party tender offers and issuer tender offers and will be effective as of December 8, 2006.

The text of the SEC release adopting the new rules is available on the SEC’s website at: http://www.sec.gov/rules/final.shtml.

The SEC adopted the best-price rules in 1986 to require equal treatment of security holders in a tender offer. The best-price rules require that all security holders must be paid the highest consideration paid to any security holder during the tender offer. Subsequent to its adoption, the best-price rules have been the subject of differing interpretations among federal courts by creative plaintiffs who have argued, successfully in many cases, that the best-price rules were violated because the bidder entered into new compensatory arrangements (or adopted existing arrangements) with management of the target or other individuals who were also shareholders of the target. These plaintiffs argue that, as a result, the management shareholders received aggregate consideration in the tender offer greater than that received by other shareholders. The courts have not applied a consistent test, however, in some cases employing a "brightline" test (i.e., the best-price rules apply only to arrangements executed and performed during the formal tender offer period) and in other cases using an "integral-part" test (i.e., the best-price rules apply to all integral elements of the tender offer whether or not entered into during the formal tender offer period, thus rejecting a strict temporal reading of the rule). As the SEC notes in its adopting release, the end result is that acquirors have been disincentivized to use the tender offer structure for fear of a potential violation of the best-price rules, particularly in view of the fact that a plaintiff might choose to bring a lawsuit in a jurisdiction that employs a test which might be more beneficial to the plaintiff’s claims.

The current best-price rules, which are set forth in Rule 14d-10(a)(2) (in the case of third-party tender offers) and Rule 13e-4(f)(8)(ii) (in the case of issuer tender offers), require that the consideration paid to any security holder pursuant to the tender offer is the highest consideration paid to any other security holder during such tender offer. The SEC amendments revise the rule to provide that the consideration paid to any security holder for securities tendered in the tender offer is the highest consideration paid to any other security holder for securities tendered in the tender offer. The new language clarifies that the rule applies only to the consideration offered and paid for securities tendered in a tender offer. These changes are based on the SEC’s belief that the bestprice rules were never intended to apply to consideration paid pursuant to compensatory, severance or other employee benefit arrangements entered into with security holders of the target so long as the consideration paid pursuant to such arrangement was not paid in an effort to acquire the securities.

The SEC also noted that by making these changes, it was not following either the "bright-line" or "integral-part" tests, and instead was maintaining consistency with the more flexible concept of a tender offer. Under that concept, a tender offer is not necessarily confined to a strict temporal test. However, the SEC also noted that the various safe harbor amendments that it has adopted with the changes to the best-price rules will, in essence, provide a measure of temporal certainty afforded by the "brightline" test.

In recognition of the intended purposes of the best-price rules, the SEC also adopted a specific exemption from the best-price rules for compensatory, severance or other employee benefit arrangements that meet certain conditions.

The exemption provides that the best-price rules do not apply to "the negotiation, execution or amendment of an employment compensation, severance or other employee benefit arrangement, or payments made or to be made or benefits granted or to be granted according to such an arrangement" in connection with a tender offer where the amount payable under the arrangement:

• Is being paid or granted as compensation for past services performed, future services to be performed, or future services to be refrained from being performed by the security holder (and matters incidental thereto); and
• Is not calculated based on the number of securities tendered or to be tendered in the tender offer by the security holder.

The amendments do not contain a specific exemption for non-compensatory arrangements such as commercial arrangements, but a new instruction to the rules provides that the lack of such an exemption shall not be deemed to mean that a noncompensatory arrangement constitutes consideration paid for securities tendered in the offer. In response to comments, the SEC noted that conditioning an arrangement on a security holder tendering securities in the offer would most likely violate one or both requirements of the exemption but that the parties could condition the arrangement on the successful completion of the tender offer.

The amendments provide a non-exclusive safe harbor for compensatory, severance or other employee benefit arrangements that are approved by an independent compensation committee (or a committee performing a similar function) of the target’s directors (regardless of whether or not the target is a party to the arrangement) or, where the acquiror is a party to the arrangement, by an independent compensation committee (or a committee performing a similar function) of the acquiror’s directors. The safe harbor also applies to compensatory, severance or other employee benefit arrangements that are approved by a special committee of the board of directors that is comprised solely of independent directors and was formed to approve the arrangement (if the company does not have a compensation committee or if the company’s compensation committee is not made up entirely of independent directors). In addition, pursuant to an instruction to the safe harbor provisions, a determination by the board of directors that the directors approving the compensatory, severance or other employee benefit arrangement are independent in accordance with the safe harbor provisions will be deemed to satisfy the independence requirements of those provisions.

If the target or acquiror, as applicable, is a listed company, the independence standards will be those for the compensation committee under the listing standards applicable to the company. If the target or acquiror, as applicable, is not a listed company, the company should use the definition of independence of a national securities exchange or association, so long as that definition is consistently applied to all members of the committee. Finally, foreign private issues have the alternative of determining the independence of the members of the board or committee approving a compensatory arrangement for purposes of the safe harbor in accordance with the laws of its home country.

Goodwin Procter LLP is one of the nation's leading law firms, with a team of 700 attorneys and offices in Boston, Los Angeles, New York, San Diego, San Francisco and Washington, D.C. The firm combines in-depth legal knowledge with practical business experience to deliver innovative solutions to complex legal problems. We provide litigation, corporate law and real estate services to clients ranging from start-up companies to Fortune 500 multinationals, with a focus on matters involving private equity, technology companies, real estate capital markets, financial services, intellectual property and products liability.