• SEC Adopts Final Amendments to the Tender Offer Best-Price Rules
  • November 1, 2006 | Authors: David M. Grinberg; Gordon M. Bava
  • Law Firm: Manatt, Phelps & Phillips, LLP - Los Angeles Office
  • On October 18, 2006, the Securities and Exchange Commission (SEC) adopted final amendments to its "tender offer best-price rules." The amendments are intended to resolve confusion that arose from a split in federal circuit courts over the application of the best-price rules to payments for employment compensation, severance, or other benefits to employees or directors or other shareholders of a target company. In addition, experts believe that the amendments will reduce disincentives to the structuring of mergers as tender offers.

    The purpose of the tender offer best-price rules is to ensure that all shareholders are treated equally in a tender offer. Therefore, the rules require that the consideration paid to any security holder in a tender offer is the highest consideration paid to any other security holder in the offer. The final amendments to the best-price rules clarify that the rules apply only with respect to the consideration offered and paid for securities tendered in a tender offer. The amendments exclude compensation arrangements, as long as they meet certain requirements and provide a safe harbor for compensation arrangements that are approved by independent directors as such, and not as extra payment for securities tendered.

    Over the last several years, federal circuit courts have differed in their interpretation of the best-price rules. Some courts have held that if a shareholder receives compensation for services, that amount has to be added to the price paid to other shareholders in the tender offer. Other courts disagreed with this approach and concluded that while the rule does require that consideration paid for shares tendered in a tender offer must be the highest paid to any other security holder, it was not intended to capture amounts paid for services as part of an employment arrangement.

    The final amendments contain several modifications from the proposed rules issued by the SEC last December. These modifications reflect input that the SEC received from various comment letters and include the following:

    • As adopted, the exemption for compensation arrangements applies to employees, directors and other shareholders of the target company, not just employees and directors.

    • The exemption and safe harbor were proposed as additions only to the rules applicable to a tender offers by a third party, but were adopted as additions to both those rules and the rules applicable to a tender offers by a company for its own stock.

    • With regard to the safe harbor, the final rules permit the formation of a special committee of the board of directors as independent directors to approve the compensation arrangement in question.

    However, the SEC did reject some recommendations contained in the comment letters and declined to expand the exemption and safe harbor of the best-price rules to cover commercial agreements and to craft a de minimis exception to the best-price rules with respect to employment arrangements.

    In his remarks explaining the purpose behind the amendments, SEC Commissioner Christopher Cox stated that the “changes to the rule recognize that compensation arrangements are often a critical aspect of a business combination, because the retention or severance of key employees can be a very important consideration in deciding whether to proceed with a transaction. . . . I'm convinced that these changes to the best-price rule will provide greater clarity and greater certainty to our regulation.” Commissioner Cox also stated that the amended rules are good for investors because companies are "more likely to have the kind of business transaction that offers shareholders the best price."

    These amendments should facilitate the structuring of two step acquisitions—tender offers followed by cash-out mergers. Legitimate compensation arrangements for services rendered will be eligible for payment without concern for violations of the best-price rules. For example, a transaction fee paid to a large shareholder, such as a private equity fund, for originating, structuring and negotiating an acquisition would appear to be permitted, especially if approved by a special committee of independent directors. On the other hand, additional acquisition consideration disguised as a commercial arrangement would be prohibited. For example, additional consideration paid to a large shareholder by means of a special “price increase” paid to a supplier of the target owned by the large shareholder would appear to be proscribed.

    Since under Delaware law the duties and standards for Board action in tender offers are less stringent than for merger transactions, it is possible that these amendments will lead to more use of tender offers, even in negotiated acquisitions.