On June 13, 2013, the Securities and Exchange Commission (SEC) announced that it had reached a settlement with Revlon, Inc. (Revlon) regarding allegations that Revlon deceived minority shareholders in connection with a 2009 “going private” transaction.1 Under Section 13(e) of the Securities Exchange Act of 1934 and Rule 13e-3 thereunder issuers are prohibited from taking fraudulent or deceitful actions in connection with a “going private” transaction. The SEC’s rules for “going private” transactions require disclosure, among other things, of any report, opinion, or appraisal from an outside party that is materially related to the transaction.2 The SEC alleged that Revlon engaged in a variety of deceptive acts in order to avoid disclosure of a third-party financial advisor’s determination that the “going private” transaction would not provide adequate consideration for minority shareholders. Revlon did not admit or deny the SEC’s findings set forth in the cease-and-desist order, but agreed to cease and desist from committing any future violations and to pay an $850,000 penalty. Section 13(e) of the Securities Exchange Act of 1934 and Rule 13e-3 thereunder have rarely been the subject of SEC enforcement action. This settlement may signal that, just as the Staff of the Enforcement Division of the SEC is more generally expanding its enforcement reach into the area of private equity firms — which are often involved in going private transactions — its enforcement priorities may also be expanding into areas that have been historically addressed by private litigants in civil actions brought under state corporate fiduciary law.
The Revlon Settlement
In 2009, Revlon was highly leveraged with significant long-term debt obligations, including $107 million on a senior subordinated note to its controlling shareholder MacAndrews & Forbes Holdings Inc. (M&F), which owned stock representing 75% of the combined voting power of all of Revlon’s outstanding equity securities. Failure to repay the M&F note upon its pending maturity would result in defaults under certain of Revlon’s long-term debt instruments. To address this situation, Revlon and M&F explored a “going private” merger transaction in which each Revlon common stock shareholder would be required to surrender their common stock shares in exchange for newly issued preferred shares. The surrendered common stock would be provided to M&F in partial repayment of its subordinated debt. A special committee of Revlon’s independent board members was formed to evaluate the merger proposal. The merger proposal was abandoned after the financial advisor retained by the special committee advised that, if asked, it would not find the merger proposal was financially fair to Revlon and its minority shareholders.
M&F then asked Revlon’s independent board members to consider a voluntary exchange offer, similar in structure to the mandatory merger proposal, under which Revlon’s minority shareholders could tender their Revlon common stock in exchange for newly-issued preferred stock that would provide an annual dividend but no equity appreciation. The tendered common stock would in turn be provided to M&F to pay down its note. The independent board members were tasked with determining the fairness of the exchange offer.
Certain of Revlon’s minority shareholders held their common stock shares through Revlon’s 401(k) plan, which was administered by a trustee (the Trustee) whose responsibilities were governed by a trust agreement with Revlon. Under the Employee Retirement Income Security Act (ERISA), the Trustee could allow 401(k) participants to tender their shares in the exchange offer only if the transaction provided “adequate consideration,” generally defined in ERISA as fair market value, for their shares. The Trustee retained a third-party valuation firm to determine if the proposed exchange represented adequate consideration and informed Revlon’s management that the advisor’s opinion would be dispositive. The Trustee did so after rejecting proposals by Revlon that would not have involved the opinion of a third-party financial advisor, and would not have required disclosure to shareholders.
According to the SEC’s findings, Revlon took several steps to avoid receiving the opinion of the Trustee’s valuation advisor, and also took steps to avoid disclosing the opinion to the shareholders considering the exchange, notwithstanding the provisions of Rule 13e-3. According to the SEC, first, Revlon persuaded the Trustee to amend the trust agreement in a manner that prevented the Trustee from sharing the opinion with Revlon, its employees, or participants in the 401(k) plan. Second, Revlon purportedly ensured that it was not a party to the valuation advisor engagement letter, although it reimbursed the Trustee for the entire cost of the engagement. Third, the Trustee was allegedly directed not to communicate any information to Revlon regarding the adequate consideration determination but only whether 401(k) participants’ instructions to tender would be honored. According to the SEC’s findings, a Revlon employee described these actions as “ring fencing” the information.
The valuation advisor retained by the Trustee ultimately determined that the exchange offer did not provide adequate consideration to shareholders who held their shares through Revlon’s 401(k) plan. The 401(k) participants who wished to tender their shares in the exchange offer were unable to participate. As a result of the purported “ring-fencing” actions, however, neither Revlon’s minority shareholders nor its independent board members were made aware of the opinion by the Trustee’s valuation advisor regarding adequate consideration under ERISA nor the steps taken to keep the information from them. The independent directors determined that the transaction was fair to Revlon and its shareholders, whether tendering or not, and disclosed to Revlon’s shareholders this determination and the factors which the independent directors considered in making their decision.
As described in the SEC’s findings, Revlon’s actions resulted in several materially misleading disclosures to its shareholders. First, Revlon represented in its offering documents that the board’s process was full, fair, and complete in determining the fairness of the exchange offer. However, the SEC found that the “ring-fencing” resulted in the independent directors not having the benefit of the valuation opinion before the exchange offer was approved. Second, the purported “ring-fencing” deprived the board and minority shareholders of the opportunity to receive revised, qualified, or supplemental disclosures, including the adequate consideration determination. Third, the SEC alleged that Revlon materially misled minority shareholders when it stated that shareholders, including the 401(k) participants, could decide whether to voluntarily exchange their shares. According to the SEC, in reality, the independent board members and all minority shareholders were not aware that the 401(k) participants would not be able to tender their shares if it was determined that the consideration offered for their shares was inadequate.
Accordingly, the SEC found that Revlon violated Section 13(e) of the Securities Exchange Act of 1934 and Rule 13e-3(b)(1), which prohibit issuers and their affiliates in “going private” transactions from directly or indirectly engaging in any act, practice, or course of business that operates or would operate as a fraud or deceit. As stated above, the SEC ordered that Revlon cease and desist from committing any future violations of Section 13(e) and to pay an $850,000 penalty.
Both state law and federal securities laws create disclosure obligations that apply to “going private” transactions. The Delaware courts have held that directors and officers of the target company (and the controlling stockholder where involved) have duties to ensure that stockholders are provided all facts that are material to their decision to approve or reject the proposed transaction. Most “going private” transactions are challenged in state court (and oftentimes, Delaware Chancery Court), generally based on claims of breach of fiduciary duty, the focus of which is often failure to meet shareholder disclosure obligations and improper incentives of management and the Board. While “going private” transactions regularly receive regulatory scrutiny, the Revlon settlement may signal an increase in federal enforcement efforts by the SEC in the area of “going private” transactions and related disclosures. Moreover, while Revlon paid a relatively small penalty, the SEC took into account the “substantial monetary payments” that Revlon had already agreed to pay in civil class action lawsuits related to the conduct related to the exchange offer. Other companies should not presume that the SEC will decline to impose more significant penalties in future cases, nor should they presume that the only exposure from a going private transaction comes from the private sector.