Amendments to the tender offer best-price rules posted

By: Cydney Posner

The SEC has just posted the final amendments to the tender offer best-price rules. These amendments clarify that the provisions of the best-price rule apply only with respect to the consideration offered and paid for securities tendered in a tender offer and not to compensation arrangements with security holders of the target. The rules also include a safe harbor providing that arrangements approved by certain independent directors will not be prohibited by the rules. The amendments were designed to remove any regulatory disincentive to tender offers as a form for business combinations in light of the uncertainty created by a split among the circuits as to whether compensation should be taken into account in applying the best price rule. The amendments will become effective 30 days after publication in the Federal Register.

The best-price rule currently provides that no bidder shall "make a tender offer unless: (1) [t]he tender offer is open to all security holders of the class of securities subject to the tender offer; and (2) [t]he 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." There has been a significant amount of litigation relating to whether compensation and benefits paid to employees and directors of the target company should be viewed as part of the consideration paid "pursuant to the tender offer," and the courts have split as to the outcome, depending primarily upon whether they followed the bright-line test (which looks only at amounts paid during the time span of the tender) or the integral-part test (which looks at all integral elements of the tender, including compensation and commercial arrangements, regardless of when paid). This split among the courts created substantial uncertainty, with the result that, as concerns increased regarding potential liability for claims alleging that compensation payments violated the best-price rule, the tender offer acquisition structure fell out of favor.

Modification of Best-Price Rule

The amendments to the best-price rule do not follow either the integral-part or the bright-line test. Instead, the amendments focus on whether consideration paid to security holders for securities tendered into an offer is the highest consideration paid to any other security holder for securities tendered into the tender offer. Specifically, the amendments revise the best-price rule to state that no one may 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." The amendments also apply to the issuer self-tender best-price rule.

Exemption RequirementsGeneral. The amendments state that the best-price rule will not prohibit "the negotiation, execution or amendment of an employment compensation, severance or other employee benefit arrangement, or payments made or to be made or benefits granted or to be granted according to such an arrangement, with respect to any security holder of the subject company, where the amount payable under the arrangement:

As initially proposed, the exemption would have applied only to compensation arrangements with employees and directors of the target. The final amendments expand the universe to include compensation arrangements with all security holders of the target. As adopted, the rules will now apply to arrangements with, for example, consultants, independent contractors and employees or directors of the bidder. With respect to commercial arrangements (which have in the past been challenged under the best-price rule), no separate exemption was adopted; however, an instruction to the rule provides that the limitation of the exemption to employment arrangements should not raise an inference that an arrangement of any other nature, including a commercial arrangement, with a security holder should be treated as consideration paid for securities tendered in a tender offer. The SEC likewise did not provide a de minimis exception.

Amount payable must be paid or granted as compensation.The requirement that the arrangement relate to services is designed to ensure that amounts are paid based on "legitimate compensatory reasons." In addition, so long as the consideration paid is for services performed or to be performed or to be refrained from being performed, there is no restriction on the forms of consideration to be paid under an arrangement. In a change from the proposal, the payments need not "relate solely to" compensation; rather, the SEC makes clear that its intent was to provide an exemption only for employment compensation, severance or other employee benefit arrangements for which there is a legitimate compensatory purpose, not to circumscribe the exemption. The SEC does believe that conditioning an arrangement on a security holder's tendering securities into the tender offer would "most likely violate one or both of the requirements" of the exemption. However, merely conditioning an arrangement upon the completion or consummation of the tender offer, without imposition of any requirement to tender upon the security holder, would not preclude availability of the exemption.

Amount payable under the compensatory arrangement must not be calculated on the basis of the number of securities tendered.  The SEC also adopted certain technical changes to the proposal designed to clarify that the SEC did not intend legitimate equity-based employment compensation to fall outside the exemption from the best-price rule.

Safe harbor for arrangements approved by independent directors.  The exemption includes a non-exclusive safe harbor providing that the requirements of the exemption "shall be satisfied" if the compensation arrangements are approved by an appropriate independent board committee. More specifically, arrangements may be approved by either a compensation committee or a committee performing similar functions of the subject company’s board of directors, regardless of whether the subject company is a party to the arrangement. Alternatively, if the bidder is a party to the arrangement, the arrangement may be approved by either a compensation committee or a committee performing similar functions of the board of the bidder. With respect to issuer tender offers, arrangements may be approved by a compensation or similar committee of the issuer’s board, regardless of whether the issuer is a party to the arrangement. Alternatively, if an affiliate is a party to the arrangement, the arrangement may be approved by a compensation or similar committee of the board of the affiliate. In addition, if the approving entity does not have a compensation or similar committee or if any of the committee members is not independent, the safe harbor permits the requirement to be satisfied by a special committee of the approving entity formed to consider and approve the arrangement. All of the members of the committee used to approve an arrangement must be independent, as defined by applicable listing standards. However, it is not necessary for the entire compensation committee to approve an arrangement and, as a result, approval by a subcommittee of this committee would be effective, so long as the entire subcommittee is independent. Similarly, in the event that a compensation committee member may not be independent for purposes of a particular tender offer, recusal by that member from considering and approving the arrangement under those circumstances in accordance with state or local law or the listing standards would not preclude availability of the safe harbor: the safe harbor does not require each member of a company's standing compensation committee to participate in the consideration and approval of an arrangement.

Special accommodations have been made for foreign private issuers, which may obtain approval of the arrangement by any members of the board of directors or any committee of the board authorized to approve the arrangement under the laws or regulations of their home countries. Moreover, members of the board or committee need not be independent in accordance with the U.S. listing standards, but must be independent in accordance with the laws, regulations, codes or standards of their home countries.

While the safe harbor does require that the independent directors approve the arrangement as an employment compensation, severance or other employee benefit arrangement (i.e., determine that the arrangement is compensatory), in a change from the proposal, the safe harbor no longer requires that the approving directors determine that the compensation arrangements meet the additional requirements of the exemption. In addition, an instruction provides that a determination by the board that the board members approving an arrangement are independent in accordance with the provisions of the safe harbor will satisfy the independence requirements of the safe harbor.

The release notes that many commenters expressed the view that committee approval of specific arrangements, as compared to approval of plans or programs, should not be required. The SEC rejected that view as inconsistent with a basic premise of the safe harbor, which means that directors will need to approve individual specific arrangements in connection with the related tender offer (i.e., they must have knowledge of the specific arrangements and the tender offer at the time of approval). This position would not preclude approvals of multiple specific arrangements or stock grants generally. The approval under the safe harbor would need to be received before the consideration is paid in the tender offer. Ratification of arrangements would be permitted provided that the tender offer consideration has not been paid yet.

Although the safe harbor is premised on the exercise of fiduciary duties by directors, the SEC states that a violation of state law fiduciary duties would not have any impact on the availability of the safe harbor, as remedies are generally available for such allegations under state law.

The safe harbor also includes an instruction, similar to the instruction above, that approval by directors of an arrangement as a compensation arrangement to satisfy the safe harbor should not raise an inference that consideration pursuant to other arrangements constitutes consideration paid for securities tendered in a tender offer.

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