On March 13, 2014, the United States Securities and Exchange Commission (the "SEC"), in connection with a settlement order (the "Lions Gate Order"),1 commented on a company's disclosure requirements in the context of a takeover bid. The Lions Gate Order settles administrative proceedings by the SEC against Lions Gate Entertainment Corp. ("Lions Gate") for failing to disclose material information about a three-part set of transactions that prevented an activist investor's hostile efforts to gain control of Lions Gate. Given that the failure to disclose material information in a company's continuous disclosure documents is a breach of Canadian and United States securities laws and the test for materiality2 is similar in both jurisdictions, we believe that the Lions Gate Order may be instructive to issuers governed by Canadian securities laws.
Lions Gate is a British Columbia company with its principal offices in California and its shares listed on the New York Stock Exchange (the "NYSE").3 In the course of a more than one year battle for control, limited partnerships, owned or controlled by Carl Icahn, (the "Icahn Group") sought to take control of Lions Gate by way of takeover bids and a proxy fight. In July 2010, in between takeover bids by the Icahn Group, immediately following the end of an agreed upon standstill between Lions Gate and the Icahn Group, and in the face of the Icahn Group's declared intention to replace the Lions Gate's board of directors through a proxy vote at the forthcoming but unscheduled annual general meeting, Lions Gate completed a transaction (the "Financing Transaction") that had the effect of converting approximately US$100 million of its debt into equity, thereby deleveraging Lions Gate, but also diluting the Icahn Group holdings.
At a hearing held in October 2010, the Icahn Group sought to set aside the Financing Transaction before the British Columbia Supreme Court (the "BCSC");4 however, Lions Gate successfully argued that it had not engaged in oppressive conduct as the primary purpose of the Financing Transaction was to deleverage the company, notwithstanding that a secondary purpose was to dilute the Icahn Group holdings and thereby impede a takeover by the Icahn Group.
The Financing Transaction was effected in three stages: first, by exchanging convertible notes held by a noteholder (the "Noteholder") with new notes convertible into common shares at a more favourable price; then, the Noteholder sold the new notes to a director of Lions Gate who was friendly to management (collectively with his investment partnership, the "Friendly Director"); finally, the Friendly Director converted the new notes into approximately 9% of the common shares of Lions Gate. The result of the Financing Transaction was to effectively block the Icahn Group's bid for control. All three-parts of the Financing Transaction were executed on July 20, 2010.
On July 28, 2010, the NYSE contacted Lions Gate to inquire whether the Financing Transaction violated the NYSE Listed Company Manual.5 In response to the NYSE inquiry, Lions Gate agreed to provide additional information about the Financing Transaction but still failed to disclose key details. Subsequently, the SEC brought administrative proceedings against Lions Gate under the United StatesSecurities Exchange Act of 19346 for omitting material information from its public filings in connection with the Financing Transaction. In settlement of the charges, Lions Gate agreed to pay US$7.5 million, admitted wrongdoing, and agreed to cease and desist from future violations of U.S. federal securities laws.
Failure to Disclose Material Information
In a press release announcing the Financing Transaction, which was incorporated into a Form 8-K, Lions Gate stated that the exchange of notes with the Noteholder "is a key part of the Company's previously announced plan to reduce its total debt, as well as its nearer term maturities".7However, the Lions Gate Order notes that Lions Gate never announced a plan to reduce debt and it did not disclose the following information in the press release or the Form 8-K:
- Lions Gate expected the Financing Transaction to block the Icahn Group's takeover and management viewed that as a desirable outcome;
- the Friendly Director purchased and converted the new notes;
- Lions Gate changed its insider trading policy to allow the Friendly Director to convert the new notes; and
- Lions Gate lowered the conversion price of the new notes following discussions with the Friendly Director.8
The Lions Gate Order also notes that Lions Gate failed to comply with the Form 14D-99 disclosure in connection with the Icahn Group's tender offer by not outlining the conversion of the new notes and details related thereto and by failing to disclose key details in numerous amendments to its Form 14D-9 that would have demonstrated the extent to which Lions Gate planned and enabled the sale and exchange of the notes with the Noteholder and sale of the new notes to the Friendly Director.10 For example, Lions Gate did not disclose that it allowed the Friendly Director to review the documentation to give effect to the issuance of the new notes before providing such documentation to the Noteholder. In addition, at the same board meeting in which it approved the sale and exchange of the new notes, Lions Gate's board amended the insider trading policy to allow the Friendly Director to immediately convert the new notes to common shares. Similarly, in disclosures to the NYSE, Lions Gate took the position that the exchange of the notes with the Noteholder "was not part of a pre-arranged series of transactions to issue shares to the Friendly Director".11
In a press release issued in connection with the Lions Gate Order, the SEC noted as follows:
"Lions Gate withheld material information just as its shareholders were faced with a critical decision about the future of the company…. . Full and fair disclosure is crucial in tender offers given that shareholders rely heavily on corporate insiders to make informed decisions, especially in the midst of tender offer battles".12
In the heat of contested transactions, public disclosure can often stray to the edge of veracity – if not beyond. The Lions Gate Order shows that even four years after a contested transaction, securities regulators may hold issuers liable for misleading disclosure or the failure to disclose material information. Also, while Lions Gate was no doubt pleased with its victory before the BCSC in 2010,13 the factual finding of the BCSC that a secondary purpose for the Financing Transaction was the dilution of the Icahn Group holdings and to impede a takeover by the Icahn Group, appeared inconsistent with Lions Gate's public disclosure and may have assisted the SEC in pursuing its charges.
Issuers governed by Canadian securities legislation may be similarly subject to regulatory action in Canada and they, together with their counsel, should ensure that all public disclosure is accurate. One of the principal means of ensuring accuracy is to make certain that all public communications are reviewed by counsel and are consistent both in words and actions. In this regard, the internal and external team working on a transaction should all be made aware of the key messaging points and care should be taken in designing the communication protocols.
In contested transactions, disclosure can be problematic and will likely be subject to greater scrutiny. It is in those circumstances that there may be immediate pressure to limit disclosure; however, in order to avoid regulatory action or successful litigation, it is best to adopt a process that ensures that an issuer complies fully with its disclosure obligations.
Stefanie Di Francesco