On 1 June 2010 the UK Panel on Takeovers and Mergers (Panel), issued a 'Green' Consultation Paper[1] on the Review of Certain Aspects of the Regulation of Takeover Bids in the UK (Green Paper). This Green Paper was issued following an announcement earlier in the year by the Panel that it would review certain rules of the UK Code on Takeovers and Mergers (Code) in the lights of widespread commentary and public discussion following the acquisition of Cadbury PLC by Kraft Foods Inc. in Q1 2010. On 21 October 2010[2], the Code Committee of the Panel issued a statement setting out its findings following this initial consultation period which involved reviewing nearly 100 responses from a broad range of commerce, industry and practice including academics, trade union representatives and the professional advisory community (Response Statement).

Whilst the majority of practitioners viewed the proposed policy changes discussed in the Green Paper with skeptical eyes and largely as a measure to appease the outcry following the bid for Cadbury, there was nonetheless an expectation that some changes would eventually flow through to the Code. A number of practitioners recognized that there certainly were some areas (particularly in the area of enhanced transparency and disclosure) where "easy fixes" could be made to the Code. This analysis was in large measure borne out in the Response Statement which sets out, at a high level, the areas where changes will be made to the Code. However, there are a number of "ugly" surprises in the Response Statement which many fear will have a real impact on the buoyancy of the public M&A markets in the UK and damage the hitherto positive perception of the UK as an open market free of the protectionism seen on the Continent and the other side of the Atlantic.

The Proposals That Did Not Survive

1. Acceptance Condition Threshold

The Panel considered whether the minimum level of acceptances to achieve success on takeover offer should be raised from the "50% plus one" to a higher level, say 60% or two thirds. The arguments in favour of raising the threshold were essentially based on a view that it was too easy for bidders to achieve this level and seize control of a company. Thankfully, the Code Committee clearly kicked the ball back on this issue into Vince Cable's court their view being that the current Code acceptance level which is based on the principles of UK company law [3] should remain at this level unless and until Company law changes are made to the level at which statutory control rests.

2. Disenfranchising Securities Acquired When the Target Company Is "In Play"

Similarly, the proposal to disenfranchise all voting rights acquired during an "offer period", that is, when a company is publicly "in play" (which in the view of many would be tantamount to the misappropriation of property rights) was also clearly shunted back to Government policy makers. Company law does not support the temporary freezing of the essence of rights attaching to shares in this manner particularly during transformational corporate actions. If the Code were to change it would be a case of 'the tail wagging the dog' on the fundamental company and property law rights recognized in the UK. It would also be directly against the cornerstone principle of the Code -- General Principle 1: "All shareholders should be afforded equivalent treatment".

3. Protecting Shareholders of Bidders

Moves to extend the arm of the Code to protect the interests of bidder shareholders -- whether UK or non-UK based and whether corporations, individuals listed or unlisted entities -- were also clearly vetoed. This is not and should not be the remit of the Code and could in certain circumstances result in an extra-territorial and disproportionate reach by the Code and conflict with overseas securities regulations and regulators.

4. Disclosure Level for "Major" Shareholdings, "Dawn Raid" Rules & Separate Advice for Target Shareholders

The three areas of potential reform noted above were largely regarded as falling in the category of the more "off the wall" proposals laid open for discussion in the Green Paper and were sensibly rejected. In addition, as expected, the Panel saw no need to change the already burdensome 1% disclosure level[4] to a stricter 0.5% nor was it in favour of (re)introducing the rules restricting the speed at which a party can acquire shares in a company subject to the Code . . . a rule which applies whether or not a company is "in play" and was introduced many years ago when players were more aggressive and the frequency of "dawn raids" or swoops (much like we have seen recently in Hermés by LVMH!) were all the rage. In these two areas, the Code Committee effectively said that having looked at both these issues within the past five years and amended the rules, they believe they got the balance right . . . and so indeed do practitioners. Thankfully, the wasteful and unnecessary proposal that target shareholders be entitled to receive separate independent advice[5] on the merits of an offer was rejected and the existing timetable for posting offer documents [6] has been left in place. None of this is much of a surprise at all and certainly is the right outcome.

What Changes Will We See?

As we expected . . . Enhanced Disclosure & Transparency

5. The "Soft Target" . . . Advisers

It was clear from the start of the consultation process that the easy sacrificial lamb would be advisers . . . and their fees. Even the Association for Financial Markets (the key body representing the interests of investment banks/ financial advisers) recognised the need for enhanced disclosure of advisers' fees. Aggregate and individual disclosure of advisers' fees (lawyers, PR consultants and accountants have not been excluded from the list) will be required, including disclosure of minimum and maximum levels where performance or outcome related. The Code Committee has however recognized that the disclosure of certain aspects of fee arrangements may be commercially sensitive (in particular where outcome related or driven as they may reveal offer tactics/ defences) and will not require information at this level to be made public and it has resisted the plea from some quarters to ban success fee arrangements.

6. The Easy Fix . . . Financial Information About Bidders

Again, the easy wins on the enhanced disclosure and transparency side relate to requiring more financial information about a bidder and its bid financing (and post bid refinancing) (whether or not they have tabled a stock or cash bid). The Code Committee has stepped outside the current boundaries of the Code (which is focused on the needs and interests of target shareholders only) to take into account the interests of a wider group of parties potentially impacted by a takeover (e.g. employees and others who will continue to have an ongoing interest in the target). More information will need to be included about the bidder's finances, bid financing and its financial condition, going forward.

7. The Inevitable . . .

On the "no surprises" list was the focus of the Code Committee on what was the genesis of the debate and proposals in the first place -- the perceived need for fuller disclosure of the plans and intentions of the bidder in relation to employees, future business of the target, redeployment of assets, locations of the places of business and strategic plans generally for the target. Even though the majority of the respondents to the Green Paper were of the view that the "rules are good but the practice is bad", the Code Committee is of the view that there still is room for some change to the rules. There will be a new requirement for bidders to make negative statements if they do not have plans in relation to employees, locations, places of business in addition to disclosing specific plans for the same. In addition, the Panel has put bidders (and their advisers) on alert that they would expect these statements made to hold true for at least 12 months following the time they were made -- an approach which extends the previously "unwritten 6 month status quo rule" which bidders and their advisers had taken.

8. (Largely) Window Dressing . . . Appeasing the Employees

One of the proposed changes is to facilitate employee representatives from providing their views on a bid. In a rather paternalistic, "molly-coddling" move, the proposals include the requirement on boards of target companies to remind employee representatives of their right to have their views on the offer included in the response circular or offer document. The Code Committee has also gone on to clarify and assure boards that notwithstanding the rules regarding secrecy in the period before the company is publicly "in play", there is no prohibition on boards speaking to employee representatives about possible bids before they are announced. These proposals are largely window dressing and do nothing to move us on from the position in which we already find ourselves. The only "substantive" element behind the employee representatives package is the requirement that the target company funds any advice required and sought by the employee representatives in pulling together their views as "may reasonably be required for the verification of information contained in the employee representative's opinion". As to what will be treated as "reasonable" . . . we have to wait and see the detailed rules.

The (Ugly) Surprises . . . . "

What did come as a surprise however was the deference given by the Code Committee to the view that it had become too "easy" for hostile offerors in the UK M&A space. The Code Committee has taken the view that the balance needs to be redressed in favour of target companies, and in a series of paternalistic moves the Committee has proposed (against the views of an overwhelming majority of respondents to the Green Paper) the following changes to the Code.

9. Protectionism at Its Worst? Tightening up the 'Put Up and Shut Up' Regime . . . The Panel says "Good Bye to Hostile Bids"

The Code Committee has severely tightened up the PUSU regime[7] by requiring all possible or virtual bidders to be "outed" -- going forward all possible offer announcements must disclose the identity of the possible bidder, even if this information had not leaked into the marketplace. In a real surprise move, the Code Committee has also imposed a standard four week PUSU period which can only be extended upon joint application by bidder and target. The impact of these changes will be clearly to disincentivise bidders who are either not familiar with the public M&A arena and have a fear of being revealed prematurely (e.g. when they may still be only at the initial stages of launching what is a real (and not "virtual") bid, e.g. putting a consortium in place, actively raising financing). Of greater impact is that these proposals will inevitably quash the potential for unsolicited or hostile complex (e.g. stock deals dependent on regulatory or shareholder approvals/ consortium bids/ highly leveraged) bids to be tabled -- four weeks is simply not enough time to issue a Rule 2.5 statement and have all the funds ready to launch these type of bids. The new rules clearly push bidders into a friendly dialogue with target companies and are a clear move against hostile bids.

10. Paternalism at Its Extreme? Boards of Target Companies are Banned from Offering Bidders Deal Protection Measures & Inducement Fees

In a shock move, the Code Committee has proposed an absolute ban on all deal protection measures being offered by target companies to bidders (e.g. exclusivity periods, "no shop" undertakings, "matching" or "topping" rights) and on inducement or break fees. The sub-text behind this proposal is the clear lack of trust or confidence in target company boards to "defend" themselves from the pressure placed on bidders to secure deal protections and break fee arrangements. The Panel has intervened and in a hugely paternalistic move has taken away that decision from the boards of target companies. We here in the UK were already "labouring" under a very restrictive regime in relation to inducement fees -- the Code contains strict limits on the size of inducement fees (1% of the offer value) -- in real contrast for example to the practice in the US where break fees of between 3% - 5% are common. Whilst some commentators have taken the view that "since it was such a small fee anyway this ban will have no real effect", this in fact is a flawed and incomplete view of the market place. Albeit modest, the 1% inducement fee has in many cases been a real boost to bidders, in particular, from the private equity community, considering whether to table a bid. The fear is that the combination of these measures will result in a fewer offers being tabled to target shareholders in the wake of the enhanced deal risk.

Drivers for Change . . . Myth and Reality

Much of the debate which led to the Green Paper was the fear that the UK's open door policy had led to an influx of foreign bidders stealing our national domestic assets. Data from The Office of National Statistics in the UK clearly shows that investors from outside the UK own over 41% of UK shares listed on the London Stock Exchange . . . and this was also the case with Cadbury plc . . . even before the so-called short term arbitrageurs and locusts started to move into the register once it was "in play"! The world has changed . . . shareholder registers have changed. To regard a company such as Cadbury as a UK company ignores this reality. Who are we protecting?

Other commentary around the time of the Kraft Foods bid for Cadbury was the painful lament and chest beating that we in the UK had shot ourselves in the foot -- we were the cause of our own misfortune by creating a set of takeover rules which allowed for an uneven playing field -- the UK is open to hostile and foreign bidders but this ease is lacking in all other major developed economies and competitors. The reality -- statistics [8] show that in the past decade UK companies on successfully bid more for foreign companies, than foreign companies bidding for UK companies -- we are "winners" on a net basis!

Lastly, the Code Committee's Response Statement starts with an observation that "it has become too easy for 'hostile' offeror (i.e. offerors whose offers are not from the outset recommended by the board of the offeree company) to succeed". Whilst this may be a fair statement to make in comparative terms to say hostile bidders in the US, it leaves unanswered the following questions: (1) How many bids which start as hostile bids close on a hostile basis? Panel statistics show that only a small minority of hostile bids close on a hostile basis and the majority close on a recommended basis with a significantly higher premium on the offer price than originally tabled . . . is this a bad thing for target shareholders?! (2) Are hostile bids a "bad thing"? The premise of the Code Committee's observation appears to be that hostile bids are fundamentally a bad thing -- for whom? Target shareholders? Bidder shareholders? There is in fact no clear answer on this important debate. A variety of studies[9] have shown that hostile takeovers are actually efficient and ultimately result in greater returns and value to target shareholders and companies. We need to be careful that we do not end up with a regime that protects defensive boards with self-serving interests.

. . . So what next . . . The Code Committee is expected to publish one more public consultation paper in due course setting out the proposed amendments in full. More anon.