On June 13, 2013, the SEC entered into a cease and desist order and imposed an $850,000 civil money penalty against Revlon, Inc. (Revlon) in connection with a 2009 “going private” transaction (the Revlon SEC Order). This article identifies some of the significant challenges in executing a going private transaction and highlights particular aspects of the Revlon deal that can serve as a teaching lesson for planning and minimizing potential risks and delays in future going private transactions.
Background of Revlon Going Private Transaction. The controlling stockholder of Revlon, MacAndrews & Forbes Holdings Inc. (M&F), made a proposal to the independent directors of Revlon in April of 2009 to acquire, by way of merger (the Merger Proposal), all of the Class A common stock not currently owned by M&F (the Revlon Minority Stockholders). The Merger Proposal was submitted as a partial solution to address Revlon’s liquidity needs arising under an impending maturity of a $107 million senior subordinated term loan that was payable to M&F by a Revlon subsidiary. A portion of this debt (equal to the liquidation value of the preferred stock issued in the Merger Proposal) would be contributed by M&F to Revlon, as part of the transaction. This was submitted as an alternative in lieu of potentially cost-prohibitive and dilutive financing alternatives (or potentially unavailable financing alternatives) during the volatile credit market following the 2008 sub-prime mortgage crisis.
In response to the Merger Proposal, Revlon formed a special committee of the Board (the Special Committee) to evaluate the Merger Proposal. The Special Committee retained a financial advisor and separate counsel to assist in its evaluation of the Merger Proposal. Four lawsuits were filed in Delaware between April 24 and May 12 of 2009 challenging various aspects of the Merger Proposal.
On May 28, 2009, the Special Committee was informed by its financial advisor that it would be unable to render a fairness opinion on the Merger Proposal, and thereafter the Special Committee advised M&F that it could not recommend the Merger Proposal. In early June of 2009, the Special Committee disbanded, but the independent directors subsequently were advised that M&F would make a voluntary exchange offer proposal to the full Revlon Board of Directors (the Exchange Offer). Revlon’s independent directors thereafter chose to continue to utilize counsel that served to advise the Special Committee, but they elected not to retain a financial advisor for assistance with the forthcoming M&F Exchange Offer proposal, because they were advised that the securities to be offered in the Exchange Offer would be substantially similar to those issuable through Merger Proposal. As a result, they did not believe they could obtain a fairness opinion for the Exchange Offer consideration. The Board of Directors of Revlon (without the interested directors participating in the vote) ultimately approved the Exchange Offer without receiving any fairness opinion with respect to the Exchange Offer.
On September 24, 2009, the final terms of the Exchange Offer were set and the offer was launched. The Exchange Offer, having been extended several times, finally closed on October 8, 2009, with less than half of the shares tendered for exchange out of all Class A shares held by the Revlon Minority Stockholders. On October 29, 2009, Revlon announced third quarter financial results that exceeded market expectations, but these results were allegedly consistent with the financial projections disclosed in the Exchange Offer. Following these announced results, Revlon’s Class A stock price increased. These developments led to the filing of additional litigation in Delaware Chancery Court.
The Revlon SEC Order and Associated Rule 13e-3 Considerations. A subset of the Revlon Minority Stockholders consisted of participants in a Revlon 401(k) retirement plan, which was subject to obligations under the Employee Retirement Income Security Act of 1974, as amended (ERISA) and a trust agreement (the Trust Agreement) between Revlon and the Plan’s trustee (the Trustee). Provisions of ERISA and the Trust Agreement prohibited a 401(k) Plan participant’s sale of common stock to Revlon for less than “adequate consideration.”
During July of 2009, Revlon became actively involved with the Trustee to control the flow of information concerning any adequate consideration determination, to prevent such information from flowing back to Revlon and to prevent such information from flowing to 401(k) participants (and ultimately Revlon Minority Stockholders); certain amendments to the Trust Agreement were requested by Revlon and agreed to by the Trustee to effect these purposes. This also had the additional effect of preventing the independent directors of Revlon from being aware that an adequate consideration opinion would be rendered for the benefit of Revlon’s 401(k) Plan participants.
On September 28, 2009, the financial advisor to the 401(k) Plan rendered an adverse opinion that the Exchange Offer did not provide adequate consideration to 401(k) Plan participants. As a result, the Trustee informed 401(k) Plan participants, as previously directed by Revlon, that the 401(k) Plan Trustee could not honor tender instructions because it would result in a “non-exempt prohibited transaction under ERISA.” Revlon Minority Stockholders, including 401(k) Plan participants, were generally unaware that an unfavorable adequate consideration opinion had been delivered to the Trustee.
In the Revlon SEC Order, the SEC concluded that Revlon engaged in a series of materially misleading disclosures in violation of Rule 13e-3. Despite disclosure in the Exchange Offer that the Revlon Board had approved the Exchange Offer and related transactions based upon the “totality of information presented to and considered by its members” and that such approval was the product of a “full, fair and complete” process, the SEC found that the process, in fact, was not full, fair and complete. The SEC particularly found that the Board’s process “was compromised because Revlon concealed from both minority shareholders and from its independent board members that it had engaged in a course of conduct to ‘ring-fence’ the adequate consideration determination.” The SEC further found that “Revlon’s ‘ring-fencing’ deprived the Board (and in turn Revlon Minority Stockholders) of the opportunity to receive revised, qualified or supplemental disclosures including any that might have informed them of the third party financial advisor’s determination that the transaction consideration to be received by the 401(k) members . . . was inadequate.”
Significance of the Revlon SEC Order. The Revlon Order underscores the significance of transparency and fairness being extended to all unaffiliated stockholders in a Rule 13e-3 transaction, including the 401(k) Plan participants whose shares represented only 0.6 percent of the Revlon Minority Stockholder holdings. Importantly, the SEC took exception to the fact that Revlon actively prevented the flow of information regarding fairness and found that the information should have been provided for the benefit of these participants, as well as all Revlon Minority Stockholders. This result ensued despite the fact that Revlon’s Exchange Offer disclosures noted in detail the Special Committee’s inability to obtain a fairness opinion for the Merger Proposal and the substantially similar financial terms of the preferred stock offered in both the Merger Proposal and the Exchange Offer transactions.
Going Private Transactions are Subject to Heightened Review by the SEC and Involve Significant Risk, Including Personal Risk. Going private transactions are vulnerable to multiple challenges, including state law fiduciary duty claims and wide ranging securities law claims, including claims for private damages as well as SEC civil money penalties. In the Revlon transaction, the SEC Staff conducted a full review of the going private transaction filings. Despite the significant substantive changes in disclosure brought about through the SEC comment process, the SEC subsequently pursued an enforcement action and prevailed against Revlon for civil money penalties.
Although the SEC sanction was limited in scope to Revlon, it is worth noting that the SEC required each of Revlon, M&F and M&F’s controlling stockholder, Ronald Perelman, to acknowledge (i) personal responsibility for the adequacy and accuracy of disclosure in each filing; (ii) that Staff comments do not foreclose the SEC from taking action including enforcement action with regard to the filing; and (iii) that each may not assert staff comments as a defense in any proceeding initiated by the SEC or any other person under securities laws. Thus, in planning a going private transaction, an issuer and each affiliate engaged in the transaction (each, a Filing Person) must make these acknowledgements, which expose each Filing Person (including certain affiliates who may be natural persons) to potential damages and sanctions.
The SEC also requires Filing Persons to demonstrate in excruciating detail the basis for their beliefs regarding the fairness of the transaction. These inquiries typically focus on the process followed in pursuing and negotiating the transaction, the procedural fairness associated with such process, and the substantive fairness of the overall transaction, including financial fairness. As a result of this, each Filing Person (including certain natural persons) in a going private transaction should be prepared to diligently satisfy cumbersome process and fairness requirements as part of the pre-filing period deliberative process, and later stand behind extensive and detailed disclosures that demonstrate and articulate the basis of the procedural and substantive fairness of the transaction, including financial fairness.
Damages and Penalties in Going Private Transactions Can Be Significant. It is worth noting that civil money penalties and settlements that have been announced to date by Revlon for its Exchange Offer going private transaction is approximately $30 million. After factoring in professional fees, it would not be surprising that the total post-closing costs, penalties and settlements approach 50 percent of the implied total transaction value of all securities offered in the Exchange Offer transaction. From this experience, it is obvious that costs, damages and penalties can be a significant component of overall transaction consideration, and these risks must be factored in as part of overall transaction planning at the outset.
Given the risks of post-transaction damages and costs, it is essential that future going private transactions be structured and executed by Filing Persons with the foregoing considerations in mind in order to advance a transaction with full transparency, a demonstrably fair procedural process and deal consideration that is substantively fair and demonstrably supportable as fair from a financial point-of-view.