On 6 May this year, the Securities and Exchange Commission (SEC) proposed significant changes to its cross-border M&A rules, aiming to expand and enhance their usefulness. The rules, first adopted in 1999, provide relief from the US tender offer and registration requirements that would otherwise apply to takeovers of non-US public companies with US shareholders, whether or not such companies have a US listing. They encourage bidders to include US shareholders in bids for non-US companies, while providing US shareholders with the protections of the US federal securities laws where necessary.
The amendments now being proposed reflect experience gained by the SEC since adoption of the rules and acknowledge the increased globalisation of the world’s capital markets. They follow recent and welcomed rule-making initiatives by the SEC that affect non-US companies, in particular the amendments to the de-registration rules for leaving the US regulatory system and the accommodation of financial statements prepared in accordance with international financial reporting standards, without reconciliation to the US’s Generally Accepted Accounting Principles (GAAP).
The current cross-border rules provide relief from US regulation if one of two exemptions is available. If US beneficial ownership of the non-US target is 10% or less, the US tender offer rules and registration requirements are generally not applicable (tier I exemption). If US beneficial ownership is more than 10%, but not more than 40%, specific exemptive relief, which is designed to address recurring areas of conflict with non-US regulatory regimes (tier II exemption), is available.
The most significant amendments for UK takeover bids concern the calculation of US beneficial ownership for the purposes of determining the availability of the exemptions. The existing requirement that the ownership calculation be made as of a single set date (the 30th day before commencement of a takeover offer or business combination transaction) has proved unworkable in some jurisdictions. In addition, conducting the required ‘look-through’ analysis to identify US beneficial owners is burdensome and often too time-consuming to be completed within the 30-day timeframe. The SEC is proposing to make the test more flexible by permitting bidders to calculate US ownership as of any day within the 60-day period preceding the announcement of a transaction. The proposed changes in this area are aimed at alleviating the timing and informational restrictions that have impeded the application of the current cross-border exemptions.
Publicly-traded UK companies have the right under section 793 of the Companies Act 2006 to obtain details about the beneficial ownership of their shares, but similar rights do not exist in other countries. Even where such an investigation is possible, it is very difficult to obtain completely accurate information within a reasonable time, often due to a chain of nominee holders that have to be contacted, served with the appropriate notices and given a reasonable time to respond. Although the proposed new timeframe tries to address this issue, there may still be insufficient time to complete these inquiries within the timetable of many major public takeover transactions.
More importantly, the proposed changes do not alleviate the concern that conducting a look-through analysis might prematurely tip off the markets regarding a transaction. This problem may even be exacerbated by changing the trigger point of the calculation to the date of the public announcement in jurisdictions where no historical share data is available. In the UK, the changes would provide target companies with more flexibility in sending out their notices to shareholders. Due to confidentiality concerns, this is likely to be after the announcement, asking for the information as of a date in the past. For the purposes of US law this includes an announcement about the possibility of a transaction, as long as the parties to the transaction are specified.
The SEC has asked for comments on whether it should adopt a different test based on an alternative measure of US interest for negotiated transactions. We believe that a test using US trading volume as an additional criterion in determining eligibility for the exemptions should be adopted. A trading volume test — based on 12-month average daily trading volume in the US, not exceeding a specified percentage of worldwide trading volume over the same period — would alleviate many of the practical concerns associated with the look-through analysis. Such a test, based on a clearly-defined process with appropriate benchmarks, would provide transaction participants with greater certainty about the applicability of the rules, prior to the announcement of a transaction. If the determination of eligibility for the exemptions remains too burdensome, bidders will continue to look to exclude US shareholders from bids or structure transactions in a way to avoid the applicability of US laws, through schemes of arrangement, for example. While a takeover bid that does not qualify for the cross-border exemptions must comply with US tender offer rules and registration requirements, a UK scheme of arrangement is generally exempt from those requirements and therefore often the preferred transaction structure in friendly transactions, especially where stock consideration is involved.
A trading volume test is already used under current SEC rules in the context of unsolicited transactions, which, by their nature, must be structured as takeover offers. Under the current rules, a hostile bidder may avail itself of the Tier I or Tier II exemption so long as the 12-month average daily trading volume of the target securities in the US does not exceed the relevant percentage of worldwide trading volume over the same period (10% in the case of Tier I, 40% in that of Tier II). Currently the test must be based on the 12-month period ending 30 days prior to the commencement of the hostile offer.
In its amendments and in line with the approach taken for negotiated transactions, the SEC is proposing to relax the timing requirements of the test for unsolicited transactions so the average trading volume may be measured during a 12-month period ending no later than the 60th day prior to announcement. This change is equally welcome. The availability of the test is qualified by information about US ownership the bidder knows or has reason to know. The SEC has now clarified that a bidder has ‘reason to know’ only information that is publicly available prior to the announcement of the transaction. Conflicting information received after such date would not prevent reliance on the trading volume test.
A significant number of other proposed changes relate to the Tier II exemption (US ownership level of 40% or less). These amendments would (i) allow bidders to structure tender offers as one offer in the US and multiple offers outside the US (eliminating the current restriction on the number of non-US offers); (ii) permit bidders to include certain foreign shareholders in US offers and US shareholders in non-US offers; (iii) create more flexibility in structuring a subsequent offering period (extending the length, allowing more time for payment, allowing the payment of interest and allowing separate offset and proration pools; and (iv) permitting purchases by bidders and financial advisers outside of the offer.
The SEC has also provided interpretative guidance on a number of topics. On exclusionary offers, it has reiterated that a bidder seeking to avoid the application of US rules must take special precautions, including the use of proper legends, to assure that its offer is not made in the US. The Commission has also emphasised that, in future, staff will more closely monitor such exclusionary offers. It is also inviting views on whether any amendments to the US equal treatment provisions are necessary or advisable to allow certain foreign target security holders to be excluded from an offer subject to US law. A change in this area would be welcome as compliance with the laws of all applicable, often non-critical, non-US jurisdictions may be unduly burdensome.
We strongly support the SEC’s continued efforts to improve the regulatory system applicable to non-US companies through its proposed changes to the cross-border rules. However, while the proposed changes are welcome, further improvements to the exemption eligibility requirements, in particular the adoption of a trading volume test for negotiated transactions, are necessary to make the rules even more workable in practice.
George Karafotias is a partner and Babett Carrier an associate at Shearman & Sterling in London.
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