December 8, 2006
Today, the SEC’s amendments to the "best-price" rule became effective. As discussed in our previous client alert dated October 24, 2006, the Commission approved certain changes to the tender offer best-price rule. On November 2, 2006, the Commission posted on its website the final adopting release, SEC Release No. 34-54684.
Prior to adopting these new amendments, the best-price rule, set forth in Exchange Act Rules 14d-10(a)(2) (third party tender offers) and 13e-(f)(8)(ii) (issuer tender offers), provided that the consideration offered and paid to any security holder pursuant to a tender offer must be equal to the highest consideration paid to any other security holder during the tender offer. In other words, all holders of securities in a tender offer must be paid the same price in the tender offer.
When interpreting the best-price rule, however, courts differed on how to treat certain employment compensation, severance, and employee benefit arrangements entered into by a bidder with employees or directors of the target company in connection with the bidder’s tender offer and back-end acquisition. For example, directors and officers might enter into agreements with acquirors regarding retention, change in control, bonuses, and golden parachutes. When evaluating how such arrangements fit within the best-price rule, some courts, including the Seventh Circuit, used a bright line test, while others, including the Ninth and Second Circuits, used an integral part test to determine whether the compensatory arrangements were deemed consideration for shares tendered. If so, the bidder would violate the best-price rule and all security holders would have to receive the highest per share consideration paid to any other security holder.
As a result of the uncertain application of the best-price rule to compensatory arrangements, acquirors were less inclined to use the tender offer as a business combination strategy and often relied on the statutory merger instead. The Commission’s amendments to the best-price rule are intended to clarify the judicial confusion and put the tender offer on more equal ground with other forms of business combination transactions, such as the statutory merger.
Amendments to the Best-Price Rule
In order to resolve the uncertainty created by the courts, the Commission amended the language of the best-price rule, exempted certain compensatory arrangements from the rule, and provided a safe-harbor for arrangements approved by an appropriate committee of independent directors, typically a company’s compensation committee. Notably the Commission did not adopt any particular test, such as the bright line or integral part test, but instead relied on the amended language, the exemption, and the safe harbor to clarify that compensatory arrangements should generally not trigger application of the best-price rule.
1. Amendments Focus on Securities Tendered
The amended language of Exchange Act Rules 14d-10(a)(2) and 13e-(f)(8)(ii) now provides, "[t]he 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" (emphasis added). The inclusion of the words for " securities tendered" hopefully clarifies that the best-price rule is focused on the price paid for securities rather than compensatory arrangements entered into during the tender offer process.
2. Exemptions for Compensatory Arrangements
The amended best-price rule also provides a specific exemption from the rule for negotiations and the amendments to compensation, severance, and other employee benefit arrangements for employees, directors and officers from the inclusion in the best-price rule calculation. Where such arrangements are for past or future services (or for refraining from performing future services), and not calculated based on the number of securities tendered by the security holder in the tender offer, the best-price rule will not apply to such arrangements.
3. Safe Harbor for Compensatory Arrangements
The amended best-price rule also provides a safe harbor for arrangements approved by an appropriate committee of independent directors. The safe harbor is a very important development and should provide companies with greater certainty in the tender offer process. Some key features of the safe harbor include:
A compensation committee, or similarly functioning committee, comprised of independent directors may approve the arrangements;
The compensation committee, or similarly functioning committee, should have knowledge of the tender offer when approving the arrangements;
Companies that do not have a compensation committee can establish a committee of independent director(s) to approve the arrangements;
Foreign issuers may use the safe harbor when the arrangements are approved by any members of the board or committee of directors authorized to do so under home country laws, including the home country’s independence standards; and
The safe harbor applies to both issuer and third-party tender offers.
Additionally, though supported by many commenters, the amendments do not exempt commercial arrangements or de minimis transactions from the best-price rule.
We believe the Commission’s amendments to the best-price rule and establishment of a safe harbor will in fact put the tender offer on more equal ground with other forms of business combination transactions, such as the statutory merger. Thus, while the amendments may not go as far as some commenters may have desired, they represent a major step in the right direction toward providing greater certainty in the tender offer process. Consequently, we expect acquirors and targets to consider engaging in tender offers more often in the future.
© 2006 Gibson, Dunn & Crutcher LLP
The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.