Alerts and Updates
SEC Amends Tender Offer "Best Price Rule"
November 8, 2006
Clarifies uncertainty inadvertently injected into structuring deals as tender offers, making them less attractive means of acquisition.
On October 18, 2006, the Securities and Exchange Commission (SEC) adopted amendments to the best price rule applicable to tender offers for securities registered under the Securities Exchange Act of 1934. The rule was originally written to ensure equal treatment among shareholders by requiring the highest consideration paid to any one security holder in a class be the consideration paid to all security holders in that class. The new amendments expressly state that the best price rule applies only to the consideration offered and paid for securities tendered in a tender offer, and not to payments to employees, directors or other shareholders of a target company pursuant to employment compensation, severance or other employee benefit arrangements entered into in connection with an acquisition of the target company. The amendments are designed to eliminate any regulatory disincentive to choose a tender offer rather than a statutory merger (also known as a "long form" merger) when structuring a business combination.
The Problem with the Best Price Rule Prior to the Amendments
The best price rule requires that the consideration paid to any security holder pursuant to a tender offer be equal to the highest consideration paid to any other security holder during that tender offer. Prior to the amendments, certain courts interpreted the best price rule to apply to changes made to the target company's executive compensation and severance arrangements in contemplation of the sale of the company. This application of the best price rule arose in shareholder derivative suits claiming that where the executives in question were also shareholders, the revised compensation or severance arrangements constituted additional consideration for the executives' securities tendered in the tender offer. These derivative suits alleged that the bidder violated the best price rule when executives signed agreements or received compensation shortly before the actual commencement of the tender offer or shortly after its conclusion. This raised the potential of enormous liabilities because the bidder would have to pay the higher price to all security holders and created a substantial disincentive to the use of the tender offer structure in negotiated acquisitions.
In response to these court interpretations, the SEC in December 2005 proposed amendments to the best price rule to alleviate the uncertainty produced by various judicial interpretations of the best price rule and to eliminate the aversion to the use of tender offers.
The New Best Price Rule
The amendments to the best price rule have three components:
- Clarification of the best price rule in current Rule 14d-10(a)(2);
- The addition of a specific exemption from the best price rule for employment compensation, severance and employee benefits arrangements with any shareholder of the target company (including any director, officer or employee); and
- The inclusion of a new safe harbor provision for compensation arrangements approved by a committee of the board of directors made up of independent directors, such as the compensation committee or other special committee of independent directors.
The amendments to the best price rule clarify that the best price rule generally was not intended to apply to compensatory arrangements between security holders and the target company or bidder. At the open meeting at which the new rules were adopted, SEC Chairman Cox noted that the amendments to the best price rule uphold the principle of fair and equal treatment to all security holders, while also clarifying the scope of the rule.
Exemptions from the Best Price Rule
The amendments expressly exempt from the best price rule employment compensation, severance and other employee benefit arrangements entered into by the bidder or target company with any holder of securities of the target company, as well as payments made or to be made in connection with those arrangements, provided that such payments are being paid or granted for services performed or to be performed and are not calculated based on the number of shares tendered or to be tendered. Explaining this exemption, the SEC noted that critical personnel decisions must often be made concurrently with the decision to pursue a transaction and are generally made independent of the consideration paid for tendered securities.
Safe Harbor Provision
The amendments also contain a non-exclusive safe harbor provision excluding compensation, severance and benefit arrangements from the best price rule if these arrangements are approved by the compensation committee of the board of directors, or a committee performing similar functions, of the target company, or alternatively, if the bidder is a party to such arrangement, of the bidder. The exemption from the best price rule described above will require that a company seeking to avail itself of the exemption will need to make a determination as to whether the arrangement at issue meets certain requirements - that the payment is being paid or granted for services performed or to be performed and is not calculated based on the number of shares tendered or to be tendered. This determination likely will result in additional costs, even if only in the form of the additional time it will take to make such a determination. The safe harbor provision allows a mechanism which, while still requiring action, is expedited and not open to subjective analysis. Both the exemption and the safe harbor are optional provisions and are intended as non-exclusive methods to ensure compliance with the best price rule.
Director independence in the context of the safe harbor provision is determined based on the independence standards for compensation committee members as defined in the listing standards applicable to the company, with an accommodation for foreign private issuers. Foreign private issuers may utilize the safe harbor by having the arrangements approved by any members of the board of directors, or any committee of the board of directors, authorized to approve the arrangement under the laws or regulations of the issuer's home country. The members of the board or committee need not be independent in accordance with U.S. listing standards, but must be independent in accordance with the laws, regulations, codes or standards of the issuer's home country.
Significant Changes from the Proposed Amendments
While the final rules are generally consistent with the SEC's original proposal, there are several significant changes from the amendments to the rules as originally proposed. The most significant differences between the final rules and the amendments as proposed in December 2005 relate to the exemption from the best price rule for certain compensation arrangements and to the safe harbor provision. In particular, the exemption will apply to compensation arrangements with any security holder of the target company, as opposed to only employees and directors of the target company as originally proposed. Furthermore, the application of the exemption and the safe harbor provision were expanded to include issuer tender offers rather than only third party tender offers as originally proposed. Finally, the safe harbor provision was expanded in the final rules to (i) include compensation arrangements approved by the compensation committee of the board of directors, or any independent committee of the target company or the bidder, as applicable, in the case where there is no compensation committee or where none of the members of the compensation committee are independent, rather than only arrangements approved by the compensation committee; (ii) accommodate foreign private issuers that may have different board structures or independence requirements than domestic issuers, and (iii) provide that the directors approving the arrangements do not need to determine that the compensation arrangements meet the additional requirements of the compensation arrangement exemption in order to qualify for the safe harbor.
The amendments go into effect 30 days after the November 1, 2006, publication of the amendments in the Federal Register.
The amendments to the best price rule reduce the uncertainty in structuring deals as tender offers. Public companies that are contemplating a sale process should examine existing executive compensation arrangements early in the process and be aware of the opportunities that a tender offer may provide to close a transaction quickly.
For Further Information
If you have any questions regarding the rules, including how they may affect your company, please contact one of the attorneys of the Securities Law Practice Group or the lawyer in the firm with whom you are regularly in contact.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.
