Best Price Rule Changes

2006 Changes to Best Price Rule

Summary

SEC adopts changes to tender offer best price rule

Amends Rule 14d-10
Makes parallel changes to Rule 13e-4(f)(8)(ii)

Related rule for issuer tender offers

Clarifies that best-price rule applies only to:

Consideration paid for tendered securities
Not to consideration paid pursuant to employment compensation, severance or other employee benefit arrangements that meet certain requirements entered into
with security holders of the target company.

Should lead to increased use of two-step mergers

Adopts proposal made in Dec 2005

SEC final release summary (§ I) 11.01.06

SEC press release 10.18.06

Chairman Cox statement 10.18.06
SEC staff statement 10.18.06

Reason for Rule Changes

Response to shareholder class actions that limited use of negotiated two-step tender offers as an M&A vehicle

Shareholder class actions were being brought under the
best price rule, claiming that amounts paid (by the bidder or by the target) to target executives under employment arrangements, or to other related parties in contemporaneous transactions, actually constituted additional payments for target company shares

Plaintiffs claimed that, in effect, the target executives or related parties were getting paid more for their shares than the public shareholders - violating the best price rule
Thus, plaintiffs argued, all of the target companys public shareholders were entitled to the same aggregate per share payout

Resulted in large damage claims with large settlement value

If suit survived early dismissal

Courts split over how to apply the rule to these claims

Bright line test often led to early dismissal
Integral part test often led to actions surviving,
with later cash settlement
See Archive - Court Split below

Resulting litigation risk limited use of two-step mergers

As deals were done as one-step mergers,
rather than as tender offers, to avoid the issue entirely
Even though two-step mergers can have timing advantages
Rule changes should lead to increased use of
two-step mergers

Changes to Basic Standard

Rule 14d-10(a)(2)

Rule 14d-10(a)(2) Basic standard

Prior rule:

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.

Amended rule:

No bidder shall make a tender offer unless:
...
The 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.

Final release commentary (§ II.A) 11.01.06

Rule 13e-4(f)(8)(ii)

Rule 13e-4(f)(8)(ii) Basic standard - Issuer tender offers

Prior rule:

No issuer or affiliate 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.

Amended rule:

No issuer or affiliate shall make a tender offer unless:
...
The 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.

Final release commentary (§ II.A) 11.01.06

New Safe Harbors for Compensatory Arrangements

Rule 14d-10(d)

14d-10(d)(1)

Paragraph (a)(2) of this section shall 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:

(i) Is being paid or granted as compensation for past services performed, future services to be performed, or future services to be refrained from performing, by the security holder (and matters incidental thereto); and

(ii) Is not calculated based on the number of securities tendered or to be tendered in the tender offer by the security holder.
Final release commentary (§ II.B)

14d-10(d)(2)

The provisions of paragraph (d)(1) of this section shall be satisfied and, therefore, pursuant to this non-exclusive safe harbor, the negotiation, execution or amendment of an arrangement and any payments made or to be made or benefits granted or to be granted according to that arrangement shall not be prohibited by paragraph (a)(2) of this section, if the arrangement is approved as an employment compensation, severance or other employee benefit arrangement solely by independent directors as follows:

(i)The compensation committee or a committee of the board of directors that performs functions similar to a compensation committee of the subject company approves the arrangement, regardless of whether the subject company is a party to the arrangement, or, if the bidder is a party to the arrangement, the compensation committee or a committee of the board of directors that performs functions similar to a compensation committee of the bidder approves the arrangement; or

(ii) If the subject companys or bidders board of directors, as applicable, does not have a compensation committee or a committee of the board of directors that performs functions similar to a compensation committee or if none of the members of the subject companys or bidders compensation committee or committee that performs functions similar to a compensation committee is independent, a special committee of the board of directors formed to consider and approve the arrangement approves the arrangement; or

(iii) If the subject company or bidder, as applicable, is a foreign private issuer, any or all members of the board of directors or any committee of the board of directors authorized to approve employment compensation, severance or other employee benefit arrangements under the laws or regulations of the home country approves the arrangement.
Final release commentary (§ II.C)

Instructions to paragraph (d)(2)

Instructions to paragraph (d)(2): For purposes of determining whether the members of the committee approving an arrangement in accordance with the provisions of paragraph (d)(2) of this section are independent, the following provisions shall apply:
1. If the bidder or subject company, as applicable, is a listed issuer (as defined in §240.10A-3 of this chapter) whose securities are listed either on a national securities exchange registered pursuant to section 6(a) of the Exchange Act (15 U.S.C. 78f(a)) or in an inter-dealer quotation system of a national securities association registered pursuant to section 15A(a) of the Exchange Act (15 U.S.C. 78o-3(a)) that has independence requirements for compensation committee members that have been approved by the Commission (as those requirements may be modified or supplemented), apply the bidders or subject companys definition of independence that it uses for determining that the members of the compensation committee are independent in compliance with the listing standards applicable to compensation committee members of the listed issuer.
2. If the bidder or subject company, as applicable, is not a listed issuer (as defined in §240.10A-3 of this chapter), apply the independence requirements for compensation committee members of a national securities exchange registered pursuant to section 6(a) of the Exchange Act (15 U.S.C. 78f(a)) or an inter-dealer quotation system of a national securities association registered pursuant to section 15A(a) of the Exchange Act (15 U.S.C. 78o-3(a)) that have been approved by the Commission (as those requirements may be modified or supplemented). Whatever definition the bidder or subject company, as applicable, chooses, it must apply that definition consistently to all members of the committee approving the arrangement.
3. Notwithstanding Instructions 1 and 2 to paragraph (d)(2), if the bidder or subject company, as applicable, is a closed-end investment company registered under the Investment Company Act of 1940, a director is considered to be independent if the director is not, other than in his or her capacity as a member of the board of directors or any board committee, an interested person of the investment company, as defined in section 2(a)(19) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(19)).
4. A determination by the bidders or the subject companys board of directors, as applicable, that the members of the board of directors or the committee of the board of directors, as applicable, approving an arrangement in accordance with the provisions of paragraph (d)(2) are independent in accordance with the provisions of this instruction to paragraph (d)(2) shall satisfy the independence requirements of paragraph (d)(2).

Instructions to paragraph (d)

Instructions to paragraph (d): The fact that the provisions of paragraph (d) of this section extend only to employment compensation, severance and other employee benefit arrangements and not to other arrangements, such as commercial arrangements, does not raise any inference that a payment under any such other arrangement constitutes consideration paid for securities in a tender offer.

Rule 13e-4(f)(12)

13e-4(12)(i)

Paragraph (f)(8)(ii) of this section shall 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 issuer, where the amount payable under the arrangement:

(A) Is being paid or granted as compensation for past services performed, future services to be performed, or future services to be refrained from performing, by the security holder (and matters incidental thereto); and

(B) Is not calculated based on the number of securities tendered or to be tendered in the tender offer by the security holder.
Final release commentary (§ II.B)

13e-4(12)(ii)

The provisions of paragraph (f)(12)(i) of this section shall be satisfied and, therefore, pursuant to this non-exclusive safe harbor, the negotiation, execution or amendment of an arrangement and any payments made or to be made or benefits granted or to be granted according to that arrangement shall not be prohibited by paragraph (f)(8)(ii) of this section, if the arrangement is approved as an employment compensation, severance or other employee benefit arrangement solely by independent directors as follows:

(A) The compensation committee or a committee of the board of directors that performs functions similar to a compensation committee of the issuer approves the arrangement, regardless of whether the issuer is a party to the arrangement, or, if an affiliate is a party to the arrangement, the compensation committee or a committee of the board of directors that performs functions similar to a compensation committee of the affiliate approves the arrangement; or

(B) If the issuers or affiliates board of directors, as applicable, does not have a compensation committee or a committee of the board of directors that performs functions similar to a compensation committee or if none of the members of the issuers or affiliates compensation committee or committee that performs functions similar to a compensation committee is independent, a special committee of the board of directors formed to consider and approve the arrangement approves the arrangement; or

(C) If the issuer or affiliate, as applicable, is a foreign private issuer, any or all members of the board of directors or any committee of the board of directors authorized to approve employment compensation, severance or other employee benefit arrangements under the laws or regulations of the home country approves the arrangement.
Final release commentary (§ II.C)

Instructions to paragraph (f)(12)(ii)

Instructions to paragraph (f)(12)(ii): For purposes of determining whether the members of the committee approving an arrangement in accordance with the provisions of paragraph (f)(12)(ii) of this section are independent, the following provisions shall apply:
1. If the issuer or affiliate, as applicable, is a listed issuer (as defined in §240.10A-3 of this chapter) whose securities are listed either on a national securities exchange registered pursuant to section 6(a) of the Exchange Act (15 U.S.C. 78f(a)) or in an inter-dealer quotation system of a national securities association registered pursuant to section 15A(a) of the Exchange Act (15 U.S.C. 78o-3(a)) that has independence requirements for compensation committee members that have been approved by the Commission (as those requirements may be modified or supplemented), apply the issuers or affiliates definition of independence that it uses for determining that the members of the compensation committee are independent in compliance with the listing standards applicable to compensation committee members of the listed issuer.
2. If the issuer or affiliate, as applicable, is not a listed issuer (as defined in §240.10A-3 of this chapter), apply the independence requirements for compensation committee members of a national securities exchange registered pursuant to section 6(a) of the Exchange Act (15 U.S.C. 78f(a)) or an inter-dealer quotation system of a national securities association registered pursuant to section 15A(a) of the Exchange Act (15 U.S.C. 78o-3(a)) that have been approved by the Commission (as those requirements may be modified or supplemented). Whatever definition the issuer or affiliate, as applicable, chooses, it must apply that definition consistently to all members of the committee approving the arrangement.
3. Notwithstanding Instructions 1 and 2 to paragraph (f)(12)(ii), if the issuer or affiliate, as applicable, is a closed-end investment company registered under the Investment Company Act of 1940, a director is considered to be independent if the director is not, other than in his or her capacity as a member of the board of directors or any board committee, an interested person of the investment company, as defined in section 2(a)(19) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(19)).
4. If the issuer or affiliate, as applicable, is a foreign private issuer, apply either the independence standards set forth in Instructions 1 and 2 to paragraph (f)(12)(ii) or the independence requirements of the laws, regulations, codes or standards of the home country of the issuer or affiliate, as applicable, for members of the board of directors or the committee of the board of directors approving the arrangement.
5. A determination by the issuers or affiliates board of directors, as applicable, that the members of the board of directors or the committee of the board of directors, as applicable, approving an arrangement in accordance with the provisions of paragraph (f)(12)(ii) are independent in accordance with the provisions of this instruction to paragraph (f)(12)(ii) shall satisfy the independence requirements of paragraph (f)(12)(ii).

Instructions to paragraph (f)(12)

Instructions to paragraph (f)(12): The fact that the provisions of paragraph (f)(12) of this section extend only to employment compensation, severance and other employee benefit arrangements and not to other arrangements, such as commercial arrangements, does not raise any inference that a payment under any such other arrangement constitutes consideration paid for securities in a tender offer.

Final Release 34-54684 11.01.06 Hyperlinked

§
-	How to use this Index Underlined links go to indicated point in Release
-	Top of Release
I	Background Introduction History - Reasons for todays amendments Overview of proposed amendments
II	Amendments to the best-price rule
II.A	Amendments to the basic standard Basic standard Discussion Comments on proposal
II.B	Exemption for compensatory arrangements Discussion Comments on proposal Parties to the arrangement Types of arrangements covered "paid or granted as compensation for" "not calculated based on the number of securities tendered"
II.C	Approval by independent directors - Safe harbor SEC_CODE_REF_0090001192884 Discussion Comments re safe harbor Committee approval required Approving party Approving body Determining independence Procedural aspects Challenges to the safe harbor Application to issuer best-price rule
	Miscellaneous sections of Release (III - VII) Paperwork Reduction Act Cost-Benefit Analysis Background Benefits Costs Small business issuers Efficiency, Competition, Capital Formation Regulatory Flexibility Act Statutory Basis
VIII	Amendments Text of rule amendments Key provisions: Amend 13e-4 (#4) Amend 14d-10 (#5)

Proposal Release 34-52968 12.16.05 Hyperlinked

§
-	How to use this Index Underlined links go to indicated point in Release
-	Top of Release
I	Executive Summary Reasons for proposed amendments History of the best-price rule Split in court interpretations of the rule Integral part test Bright-line test Impact of split Proposed approach to address split
II	Proposed Amendments To Rules 13e-4(f)(8)(ii) and 14d-10(a)(2) To Rule 14d-10(c) Requirements of the exemption Compensation committee safe harbor
III	Request for Comment
	Miscellaneous sections of Release (III - IX) Paperwork Reduction Act Cost-Benefit Analysis Benefits Costs Small business issuers Efficiency, Competition, Capital Formation Regulatory Flexibility Analysis Small Business Regulatory Enforcement Fairness Act Statutory Basis
X	Proposed Amendments Text of proposed rule amendments Key provisions: Amend 13e-4(f)(8)(ii) Amend 14d-10

Comment Letters to SEC

Comment letters on proposal

Commentary on Rule Changes

Re: 2006 final rule changes

Wachtell Lipton 11.02.06
Latham & Watkins 10.18.06

Re: 2005 proposed changes

Weil Gotshal 12.15.05
Willkie Farr 12.20.05
Wachtell Lipton 12.21.05
Skadden Dec 2005
Latham & Watkins 1.18.06
Fried Frank 1.20.06

Archive: Rule Changes Address Court Split

Prior to 2006 rule changes, courts had split
on how to apply the best price rule

Bright line test often led to early dismissal
Integral part test often led to actions surviving,
with later cash settlement

Resulting litigation risk limited use of two-step mergers

As deals were done as one-step mergers,
rather than as tender offers, to avoid the issue entirely
Even though two-step mergers can have timing advantages

Bright Line Test

A transaction that preceded commencement of the
tender offer could never be subject to the best price rule

Gave bidders predictability
Courts applying this test often dismissed cases
before discovery began

Sample opinions

Katt v Titan Acquisitions, et al Civ Action 99-0655
(MD Tenn 1.10.03) (Slip Op) (Echols, J.)
Compare earlier decision (MD Tenn 2000)
Gerber v Computer Associates (2d Cir 2002)
In re Digital Island (D Del 2002)
Walker v Shield Acquisition (ND Ga 2001)
Lerro v Quaker Oats (7th Cir 1996)

Integral Part Test

A transaction integral or closely related to the tender offer could be subject to the best price rule

aka Functional Test
This test was ambiguous and its application was more difficult to predict
Motions to dismiss were often denied and required defendants to bear the expense of discovery

Sample opinions

Epstein v MCA (9th Cir 1995)
126 F3d 1235 (CA 9 Cal 1997)

Luxottica is an example of litigation risk

Action brought in Eastern District New York illustrates potentially draconian application of best price rule
Luxottica acquired Sunglass Hut by tender offer in 2001

Italian eyeglass company paid $11.50 per share,
a substantial premium
Plaintiffs argued that $15 million non-compete agreement struck before the tender offer with Sunglass Hut CEO
(a 4% shareholder) implicated the best price rule
Claims were also brought alleging payment was a bribe;
CEO and board settled this claim for $3.75 million
Early ruling in case applied the integral part test
Which plaintiffs argued would require every shareholder to get the same per share payment as the CEO;
Making defendant liable for as much as $280 million