February 9, 2009

Some Guidance on Corp Fin’s Updated 13e-3 Interps

Here is a good summary from Cleary Gottlieb: A few weeks ago, the SEC released updated interpretations regarding the application of Rule 13e-3 to going private transactions. Among other things, Rule 13e-3 imposes heightened disclosure obligations on certain acquisition transactions in which an affiliate of the target company is the acquiror.
The updated interpretations are noteworthy in a number of respects, including the following:

Application of Rule 13e-3 to Acquisitions by Financial Sponsors with Management Participation – Financial sponsor acquirors often invite target management to continue after completion of the acquisition and provide for equity-based compensation for such management. Sponsors are aware of the possibility that such participation by target management could cause the transaction to be subject to Rule 13e-3 and frequently take steps to avoid this possibility.

Based on prior SEC staff guidance, these steps include (1) not having any substantive negotiations or discussions regarding the terms of such participation until after the acquisition agreement has been signed and (2) limiting the amount of equity to be issued to the management group. The updated interpretations make it clear that the SEC staff is not likely to accept the argument related to the absence of negotiations and discussions prior to signing of the acquisition agreement, noting that Rule 13e-3 may apply where “there exists a general understanding that a target’s senior management will receive equity in a surviving entity”.

The SEC, however, framed its position in the context of a hypothetical scenario in which the target’s senior management would receive 20% of the surviving entity’s equity following the transaction and did not distinguish between rollover equity invested by management, up-front grants of new equity for no consideration and equity options subject to substantial vesting conditions.

Thus, it may remain possible to argue that Rule 13e-3 does not apply to particular transactions involving lower levels of management equity participation or where a significant portion of management equity is contingent. Nevertheless, for planning purposes, financial sponsors should assume that the SEC staff may take the position that Rule 13e-3 applies to a broader spectrum of acquisitions in which management participates than has been the case in recent years.

Application of Rule 13e-3 to Acquisitions by Non-affiliated Strategic Buyers – The updated interpretations include a note that Rule 13e-3 may apply even in transactions in which the acquiror is not affiliated with the target if “continuity of [target] management” will exist following the transaction. The staff notes that factors to be considered include (1) whether target management’s compensation will increase after the acquisition, (2) whether target management will receive equity in the acquiror and (3) whether any member of target management will become a member of the board of directors of the acquiror.

The application of Rule 13e-3 to acquisitions by strategic acquirors where some combination of the foregoing factors are present would be a surprising expansion of the scope of the Rule. For example, in many acquisitions of US public companies by a non-US strategic acquiror, the acquiror expects (and needs) the target’s senior executives to continue to manage the company and often provides improved compensation and other terms to the executives to induce them to do so. Most practitioners would not expect Rule 13e-3 to apply to such transactions.

Disclosure of Financial Advisor Reports and Advice – The updated interpretations confirm the staff’s broad interpretation of the requirement in Rule 13e-3 transactions of detailed disclosure of all “reports, opinions [and] appraisals” materially related to the transaction. In particular, the interpretations confirm the staff’s view that “detailed” disclosure is required of oral presentations that the acquiror’s financial advisor may make to the acquiror even if such presentations are not related to the consideration to be offered to target shareholders.