Davis Polk & Wardwell Newsflash

SEC Votes to Adopt Sweeping Amendments and Guidance to Cross-Border Rules

September 5, 2008

At an open meeting last week, the SEC voted to adopt significant revisions to its rules relating to cross-border business combinations that are designed to facilitate these transactions and to encourage the inclusion of U.S. investors in the transactions. The adopting release containing the text of the rules is not yet available and it, therefore, is uncertain whether the changes adopted will simplify meaningfully U.S. compliance in cross-border business combinations.

The new rules have three basic components.  They include modifications to the eligibility tests for determining a company’s ability to rely on the exemptions.  The amendments facilitate cross-border transactions by codifying many of the exemptions that the SEC had previously granted only on a case-by-case basis and thus eliminate the need for foreign companies to consult with the SEC on these issues as part of their transaction-planning process.  Finally, the new rules include the adoption of interpretive guidance with respect to a number of issues, including the circumstances under which a company may exclude U.S. investors from a cross-border offer and the use of “vendor placements.”

According to an oral presentation made at last week’s meeting, the revised rules:

  • Modify the time as of which U.S. ownership must be calculated for purposes of determining eligibility for the exemptions.  Currently, where no more than 10% of the target’s securities are held by U.S. investors, the transaction will qualify for broad relief under the “Tier I” exemptions to the cross-border rules.  Where U.S. investors hold more than 10% but less than 40% of the target’s securities, the transaction will qualify for more limited relief under the “Tier II” exemptions.  In negotiated transactions, an acquiror calculates the U.S. ownership percentage of a target by excluding securities held by persons who hold more than 10% of the target’s securities or by the acquiror itself and by looking through record ownership to beneficial ownership in specified jurisdictions.  Calculations must be made on the 30th day before commencement of the offer or on the record date of a rights offering.  In response to numerous comments regarding the difficulties associated with calculating U.S. ownership as of one specific date and with linking the calculation to the commencement date of the offer rather than to the date when the offer first is announced, the new rule revises the reference date for calculating U.S. beneficial ownership to permit calculation within a range that is no more than 120-days before and no less than 30-days after, public announcement of the transaction;
  • Eliminate the requirement to exclude holders that hold more than 10% of a target company’s securities when calculating U.S. ownership.  The securities held by the bidder will continue to be excluded.  This change should substantially increase the availability of the Tier I exemption since many non-U.S. companies have one or more large (greater than 10%) shareholders and, in the past, the exclusion of these shareholders from the calculation has artificially inflated the level of U.S. ownership;
  • Adopt, in connection with negotiated transactions, an alternate eligibility test for issuers and acquirors based on a comparison of the average daily trading volume (“ADTV”) of the subject securities in the U.S. as compared to the ADTV worldwide.  Despite numerous comments from us and others advocating the adoption of an ADTV test in place of the existing beneficial ownership test, the SEC declined to make this change.  However, the new rules will permit companies to use an ADTV test if they are “unable to conduct the modified look-through analysis.”  Whether the addition of this alternative test offers meaningful flexibility or a solution to any of the difficulties encountered in connection with the beneficial ownership test will depend on the meaning of “unable to conduct the modified look-through analysis” in the final text of the new rules and on the interpretation of that text by the SEC staff.  When questioned, the Staff explained that the ADTV test could not be used simply because it would be too expensive or burdensome to conduct the modified look-through analysis, but could be used, for example, with regard to Japanese subject companies since information regarding beneficial ownership in Japan is available only a few times a year.  The SEC announced that, in the case of both negotiated and non-negotiated transactions, when applying the ADTV test, the new rules will require an acquiror to take into account U.S. ownership figures reported in filings with the SEC, the home country regulator or in the jurisdiction of the target’s primary trading market as well as any other information about U.S. beneficial ownership that the acquiror or issuer “knows or has reason to know” from other sources;
  • Expand the scope of the Tier I exemption so that it will apply to “going private” transactions under Rule 13e-3 regardless of the form of the structure or form of transaction.  Until now the Tier I exemption has only been available for “going private” transactions conducted under Rule 802 or Rules 13e-4(h)(8) or 14d-1(c), all of which relate to companies with shares listed in the U.S.  In the future, the exemption will also be available for “going private” transactions involving companies whose shares are not listed in the U.S.;
  • Extend the availability of Tier II exemptions to unregistered tender offers, such as tender offers for securities that are not registered under Section 12 of the Exchange Act;
  • Allow multiple foreign offers to be conducted contemporaneously with a U.S. offer and relax rules regarding who may be included in each such offer;
  • Permit the suspension of withdrawal rights after the expiration of a tender offer while tendered securities are being counted and before they have been accepted for payment;
  • Modify the rules applicable to the subsequent offering period in a tender offer to make the rules more compatible with those of other jurisdictions.  Among other changes, the new rules will permit acquirors to “bundle” securities during a subsequent offering period and purchase them as a group rather than on a “pay as you go” basis and to pay interest on securities tendered during a subsequent offering period;
  • Permit the early termination of an initial offering period in a Tier II cross-border tender offer upon the satisfaction of all offer conditions;
  • Codify the exemptive relief previously provided, to permit purchases made outside of a tender offer conducted under the Tier II exemptions; and
  • Eliminate the current 20-business-day limit on the length of subsequent offering periods.

The new rules will put certain foreign institutions on equal footing with U.S. companies when making ownership disclosures by giving them the ability to file on the shorter and less onerous 13G form.  Corresponding changes will also be made to the beneficial ownership requirements for purposes of Section 16.  A foreign institution would be required to certify that it is subject to a regulatory scheme substantially comparable to U.S. rules and the subject securities are acquired and held in the ordinary course of business and without the purpose or effect of influencing control of the issuer.

In addition to amending its rules, the SEC voted to provide updated guidance with respect to certain topics and issues of interest in connection with cross-border transactions.  The SEC announced that the guidance would include clarifications with respect to matters covered in the proposing releases but did not offer further details.  The topics that will be addressed are:

  • the ability of bidders to reduce or waive a minimum acceptance condition in a tender offer without providing withdrawal rights;
  • the ability of bidders in tender offers for U.S. companies to exclude foreign target security holders in tender offers subject to U.S. equal treatment principles;
  • the ability of bidders in cross-border tender offers to exclude U.S. target security holders without violating U.S. tender offer rules; and
  • the ability of bidders in cross-border exchange offers to provide cash to U.S. security holders while offering shares to foreign target holders through the use of a procedure known as a vendor placement.

This summary is based on an oral presentation made at last week’s meeting and remains subject to the text of the adopting release, which should be posted to the SEC’s website shortly. We will be monitoring commentary and analyzing the adopting release with a view to providing more detailed guidance.  In the meantime, if you would like to discuss any of these issues or have questions regarding this newsflash, please call your regular Davis Polk contact.

Davis Polk & Wardwell