On November 26, the staff of the SEC’s Division of Corporation Finance published a Compliance and Disclosure Interpretation (C&DI) addressing the application of the Securities Act of 1933 to written consents by a target company’s shareholders approving a merger or other business combination transaction in which the acquiring company intends to register the transaction securities with the SEC. The staff stated that the approval of such a transaction by written consent in lieu of a meeting of the target company’s shareholders involves a private offering of the acquiror’s securities that will preclude the acquiror from later registering an offering of the securities on Form S-4. The C&DI reflects a staff view of merger “lock-up” measures it more comprehensively articulated a decade ago, but which the staff has inconsistently applied in reviewing registration statements filed for stock merger transactions that were approved by the written consent of target shareholders. If the SEC staff enforces the position expressed in the C&DI when it reviews future stock merger filings, acquiring companies will have to rely on voting lock-up agreements to commit significant shareholders of the target to support their transactions. The C&DI appears at http://www.sec.gov/divisions/corpfin/guidance/sasinterp.htm as Question 239.13.
In the C&DI, the staff evaluated the use of written consents in light of principles developed by it to assess the permissibility of lock-up agreements obligating a target’s shareholders to vote in favor of the acquiring company’s business combination transaction. The SEC staff considers voting agreements in stock transactions to involve investment decisions under the Securities Act by the shareholders entering into the agreements. In registered transactions, voting agreements often are entered into before the acquiror files its registration statement on Form S-4 and delivers the final prospectus to the target’s shareholders for use in deciding whether to approve the merger transaction at their shareholders meeting. Unless the voting agreements are structured in accordance with the SEC staff’s guidance, the staff may object to them in the Form S-4 review process as violating Securities Act registration requirements or as amounting to a private offering of the securities issuable as merger consideration that will prevent a subsequent registration of the securities.
Conditions for Lock-up Agreements
The SEC staff has long evaluated voting agreements for compliance with three conditions developed by the staff. As summarized by the SEC in 1998 in Release No. 33-7606A (sometimes referred to as the “aircraft carrier release”), and reiterated in the C&DI, the staff will permit the use of lock-up agreements if the following conditions are satisfied:
- The lock-up agreements involve only executive officers, directors, affiliates, founders and their family members, and holders of 5% or more of the voting equity securities of the company being acquired;
- The persons signing the agreements own less than 100% of the voting equity securities of the company being acquired; and
- Votes will be solicited from shareholders of the company being acquired who have not signed the agreements and who would be ineligible to purchase in a private offering.
Taken together, the second and third conditions are intended to ensure that the business combination transaction will be submitted to a vote of the target’s shareholders at a meeting held after the shareholders receive the acquiring company’s prospectus. In its 1998 release, the SEC observed that where “no vote is required or 100% of the shares are locked up, no investment decision would be made by non-affiliated shareholders and the transaction would have been completed via the lock-up agreement.” So long as the three conditions are satisfied, the SEC staff has not objected to agreements locking up holders of voting equity securities representing the voting power needed to approve the transaction for state-law purposes.
Merger Approval by Written Consent
An acquiring company may prefer to secure approval of a merger by obtaining a written consent of the target’s shareholders soon after execution of the merger agreement, rather than by obtaining voting agreements and waiting until the transaction is approved at a meeting of the target’s shareholders. Obtaining merger approval by written consent is generally practicable only in the case of a target that does not have a class of equity securities registered under Section 12 of the Exchange Act, which would include companies that do not have SEC reporting obligations and companies that file reports with the SEC but are not subject to the SEC’s proxy solicitation rules. A significant advantage of the consent approval process is that the target board’s fiduciary duty under state corporate law to consider, and possibly act upon, an alternative merger proposal may be deemed to end once shareholders have approved the acquiror’s transaction, whether at a meeting or by written consent. When approval of the merger transaction is to be voted on at a meeting of the target’s shareholders, the acquiror will have to accept the risk that another bidder could submit a competing merger proposal during the months it will take to complete the Form S-4 registration process and convene the shareholders meeting.
Under the state corporate law applicable to the target, if the company’s charter does not prohibit action by written consent, holders of a majority (or other applicable percentage) of the outstanding voting power may act by written consent to approve a merger. Because execution of a consent by the holders of the requisite voting power satisfies the statutory approval requirement for the transaction, the consent process obviates the need to obtain votes of the other shareholders. Unless the non-consenting shareholders properly exercise their statutory appraisal rights (if the rights are available), their shares in the target will be exchanged in the merger for the acquiror’s securities along with the shares of the consenting shareholders.
From a Securities Act perspective, there are important points of similarity between the execution of voting agreements by holders of the requisite percentage of the target’s outstanding voting power obligating them to approve the merger transaction and execution by those shareholders of a written consent effectuating that approval. Under each lock-up approach, the signing target shareholders make an investment decision before the acquiring company delivers a prospectus, the lock-up ensures approval of the transaction by the target company’s shareholders, and all of the target’s non-dissenting shareholders receive the merger consideration.
Staff’s Interpretive Position
As reflected in its C&DI, however, the staff does not agree that, for Securities Act purposes, the consent approval process is substantially the same as the execution of voting agreements followed by a vote of the target’s shareholders at a meeting. The staff’s view is that a pre-filing consent approving a business combination transaction constitutes a private offering of the acquiring company’s securities that precludes the acquiror from registering the offering on Form S-4. The staff indicates in the C&DI that, where written consents by target shareholders “approving the business combination transaction” have been delivered to the acquiring company, “the staff has objected to the subsequent registration of the exchange on Form S-4 for any of the shareholders because offers and sales have already been made and completed privately, and once begun privately, the transaction must end privately.”
The C&DI does not expose the reasoning behind the critical distinction drawn by the staff between a voting lock-up agreement and a written consent approval. The distinction appears to turn on the fact that, because a consent approval satisfies the statutory vote requirement, the target is not required to solicit, and will not solicit, a vote of its non-consenting shareholders to approve the merger transaction. In the staff’s view, the target’s shareholders have made their investment decision once the consent is executed, and, because no subsequent vote will be solicited, later delivery of the acquiring company’s prospectus to the target shareholders would not serve any purpose. (The staff apparently is unwilling to accept the argument that, in merger transactions where appraisal rights are available, the prospectus would assist target shareholders in deciding whether they should exercise these rights and demand cash instead of the merger consideration.) If the acquiror obtains voting agreements, on the other hand, the uncommitted target shareholders will still have to make an investment decision by voting at the shareholders meeting. In this event, the acquiror’s prospectus will provide the target shareholders with the disclosures they need to consider in casting their votes.
The staff’s position on consent approvals is consistent with the third condition of its guidance on lock-up agreements, which requires solicitation of the vote of uncommitted target shareholders who are not eligible to purchase the merger securities on a private placement basis. The staff’s views also reflect the premise underlying the use of Form S-4 to cover merger offerings. That registration form is prescribed for use in a transaction specified in Rule 145 under the Securities Act, which includes mergers that must be approved by the “vote or consent” of a combining company’s shareholders. (It appears that, in the lock-up context, the staff interprets the term “consent” in Rule 145 as referring to a consent of shareholders solicited in compliance with Regulation 14A under the Exchange Act or, where the target does not have a class of equity securities registered under Section 12, where the consent is executed following delivery of the acquiror’s Form S-4 prospectus.) In adopting Rule 145, the SEC abandoned its former position that a stock merger transaction does not involve an “offer” or “sale” of securities if the vote of the specified percentage of shares binds the entire class of shareholders under state law (subject only to statutory appraisal rights). The SEC endorsed the position underlying Rule 145 that, by casting their votes, the shareholders exercise the individual volition that is a necessary element for an “offer” or “sale.”
Addressing Staff Objections
Notwithstanding the position it expresses in the C&DI, the staff has processed without objection over the years various Form S-4 filings for merger transactions in which the registrant had obtained a pre-filing written consent by the requisite holders of a private target and in which no other vote of the target’s shareholders was being solicited. Some of these filings may have escaped staff objection because the filings were not reviewed, while in other filings the consent issue may simply have been overlooked by the staff members assigned to the filing. Whatever the staff’s past position on the issue, the staff of the Office of Mergers and Acquisitions within the Division of Corporation Finance informally has indicated that registrants may not rely on past filings reflecting written consent arrangements inconsistent with the guidance reflected in the C&DI, and that the staff intends in the future, through the Division’s individual branches, to enforce vigorously the position expressed in the C&DI.
What happens if the staff objects to a Form S-4 filed to register an offering of shares for issuance in a merger that already has been approved by the consent of the target’s shareholders? Based on its customary practice, the staff will require the acquiring company to withdraw its Form S-4, after which the merger parties may either:
- complete the merger transaction on a private placement basis and, if consistent with the revised transaction terms, amend the merger agreement to require the acquiror to file a registration statement after the merger closing covering the resale of shares issued to the target’s shareholders; or
- amend the merger agreement to provide that (1) the transaction will be submitted to a vote of the target’s shareholders at a meeting, (2) the acquiror will refile the Form S-4 after expiration of the 30-day period in the Rule 155(b) “safe harbor” under the Securities Act that must elapse between an abandoned private offering to both non-accredited and accredited investors and a registered offering of the same securities, and (3) the final prospectus will be mailed to all target shareholders before their meeting.
The Securities Act issues may be addressed more readily than those that might arise under state corporate law. In particular, amending a merger agreement to provide for a shareholders meeting after delivery of a written consent may raise some difficult state-law questions about the status of the consent, the potential revival of the target’s “fiduciary out” rights, and the effect of the new approval process on the prior recommendation of the transaction by the boards of both the target and the acquiring company.