• SEC Proposal Exempts Compensation Arrangements from the Tender Offer Best-Price Rule
  • January 17, 2006
  • Law Firm: Perkins Coie LLP - Seattle Office
  • The Securities and Exchange Commission recently proposed amendments to its tender offer "best-price rule," which it adopted in 1986 to prevent discriminatory tender offers by requiring that the highest price paid to any security holder in a tender offer must be paid to all other tendering security holders.

    Several court decisions interpreting the SEC's best-price rule have created uncertainty about whether compensatory and other arrangements made with a target company's officers, employees, directors and shareholders in an acquisition structured as a tender offer will be deemed tender offer consideration that is subject to this rule. As a result, many buyers and sellers disfavor tender offers as a method of structuring a friendly acquisition of a public company. This Update summarizes the key issues in the SEC's proposal.

    What Is a Tender Offer and What Are Its Advantages?

    A tender offer generally takes the form of a publicized bid to purchase shares of stock at a premium over market price that is made directly to the target company's shareholders by a bidder. The consideration offered in a tender offer may take the form of either securities or cash (tender offers involving stock or debt securities as consideration are referred to as "exchange offers").

    An acquisition of a public company that is structured as a tender offer can provide several advantages over an acquisition structured as a statutory merger. A tender offer allows a buyer to purchase a controlling interest in the target company in a relatively short period of time (a tender offer must be held open for a minimum of twenty business days), thereby reducing the chance of a competitive bid for the target company. Tendering security holders benefit because they obtain the tender offer consideration more quickly than they would in a statutory merger.

    Best-Price Rule Created Uncertainty

    What Is the Best-Price Rule? The best-price rule (Exchange Act Rule14d-10 for third-party tender offers and Exchange Act Rule13e-4 for issuer tender offers) currently provides that no bidder shall make a tender offer unless "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 best-price rule applies to all tender offers for securities that are registered under the Exchange Act.

    Claims That Compensation and Severance Arrangements Violate Best Price Rule. Litigants have claimed that new compensation arrangements and severance arrangements with executives and employees, or even commercial arrangements, negotiated at the time of a tender offer violate the best-price rule where those executives, employees or directors are also security holders of the target company. If a compensation payment is deemed to be subject to the best-price rule, then all tendering security holders would be entitled to receive the same payment. The amounts potentially payable under these cases would quickly become prohibitive if, for example, a relatively modest $300,000 severance package must be multiplied by all the target company's security holders.

    Courts Apply Conflicting Interpretations. Federal courts have responded to these claims by applying conflicting interpretations of the best-price rule. Some courts, notably the Seventh Circuit, have applied a "bright line" test -- ruling, for example, that if a compensatory arrangement is entered into prior to the commencement of a tender offer it is not a payment made "during the tender offer" and therefore not subject to the best-price rule. Other courts, including the Ninth Circuit, have ruled that a new compensatory payment, regardless of whether it is entered into prior to the commencement of the tender offer or during the tender offer, is subject to the best-price rule if it is an "integral part" of the tender offer.

    Uncertainty May Inhibit Tender Offers. Anecdotal evidence from legal practitioners and investment bankers suggests that the uncertainty created by these court decisions, and the potentially astronomical damages for a violation of the best-price rule, have led buyers and sellers to avoid structuring acquisitions of public companies as tender offers and instead to structure them as statutory mergers, since the best-price rule does not apply to statutory mergers.

    SEC Proposal Clarifies Best-Price Rule to Exclude Compensatory and Severance Arrangements

    The SEC's proposed amendments to Rules14d-10 and13e-4 clarify that compensatory and severance arrangements that meet specified requirements will not be captured under the best-price rule. However, the SEC did not adopt either the "bright line" test or the "integral part" interpretation applied by the courts.

    SEC Restates Best-Price Rule. The SEC proposal restates the best-price rule for both third-party and issuer tender offers to provide that no bidder shall make a tender offer unless "[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." This language is designed to clarify that the rule only applies to the consideration for securities tendered in the tender offer rather than pursuant to the tender offer.

    Compensation Arrangements Exempt. The proposal adds a specific exemption to the third-party best-price rule (Rule 14d-10) for the negotiation, execution or amendment of an employment compensation, severance or other employee benefit arrangement, so long as the amount payable under the arrangement

    • relates solely to past services performed or future services to be rendered (or relates to a party refraining from rendering services, e.g., non-competes) and

    • is not based on the number of shares the employee, officer or director owns or tenders.

    Safe Harbor for Arrangements Approved by Compensation Committee. The proposal also amends the third-party best-price rule to provide a safe harbor that would allow the compensation committee or similar committee of the target company's or bidder's board of directors -- depending on whether the target company or the bidder is the party to the arrangement -- to approve an employment or severance arrangement and cause it to be a "compensation, severance or other employee benefit arrangement" within the meaning of the exemption for compensation arrangements. For this safe harbor, the committee must be independent, but it is not required to be comprised solely of independent directors.

    Issuer Tender Offers and Some Arrangements Excluded. The exemption for compensation arrangements and the safe harbor would not be available for issuer tender offers subject to Rule 13e-4. In addition, the proposed amendments address only employment-related compensation, and not other compensatory arrangements, like commercial contracts.

    SEC Requests Comments on Proposal

    Although the SEC's proposed rules go a long way toward alleviating the uncertainty surrounding the best-price rule, the new proposals raise some issues.

    • Is Limiting the Compensation Arrangement Exemption and Compensation Committee Safe Harbor to Third-Party Tender Offers Appropriate? Acquirers in "going private" transactions may prefer to structure them as issuer tender offers and such transactions often involve the implementation of new compensation arrangements with key employees and severance payments to departing employees.

    • Should the Proposed Safe Harbor Be Limited to Companies With Independent Compensation or Similar Committees? Private equity funds and other privately held buyers would not be able to take advantage of the SEC's proposed safe harbor if they do not have independent directors.

    The SEC is soliciting comments on the proposed rules. Perkins Coie LLP is considering whether to submit a comment letter.

    Additional Information

    You can find the full text of the SEC's final rule at http://www.sec.gov/rules/proposed/34-52968.pdf. You can find discussion of other recent laws, regulations and rule proposals of interest to public companies on our website.