Merger Process

Although arbitrageurs take their positions mostly after a merger has been announced, it is helpful to understand the legal requirements that companies have to follow in the adoption of the merger. A poorly conducted process is open to attack in the market or the courts. In this case, there are three possible outcomes:

1. The deal is delayed or collapses. An outright collapse rarely happens, but delays can occur and depress the annualized return (see Chapter 5).
2. The buyout price increases. This is the dream scenario in every deal.
3. Another buyer gets involved. This can also lead to a higher price, but as in all contested transactions (Chapter 5), an arbitrageur may suffer a loss if a short squeeze develops on the short side of the arbitrage.

Maximizing shareholder value has become the holy grail of modern management. Unfortunately, all too often, managers cite shareholder value to justify many strategies that are more likely to destroy rather than create it. “Shareholder value” has become a somewhat empty phrase used to justify any corporate activity, from the expansion of new productive capacity to country club memberships for senior executives. Not surprisingly, mergers and acquisitions are also done in the name of shareholder value. As with country club memberships and corporate jets paid for by the firm in the name of realizing more business opportunities, it is often difficult for outsiders to discern the real motive behind a merger: Will it benefit ultimately shareholders or mainly the company's executives?

In theory, the decision to sell a company lies with shareholders, who vote in a shareholder meeting. In practice, most shareholders vote with the board, so that the de facto power to sell a company rests with its board. Proxy advisory firms also issue voting recommendations in favor of the board's recommendation except in rare cases where opposition from shareholders against a merger has reached a certain threshold. The board, in turn, itself relies to a large extent on representations made to it by management executives. Conflicts of interest exist whenever a company is up for sale. Economists refer to this as a principal/agent problem. The shareholders as principals hire an agent (manager) to act on their behalf but cannot be sure that the agent actually will act in their interest. Management and board members may be more interested in keeping their jobs than in maximizing shareholder value. Stock options may help to eliminate this conflict by aligning the interests of managers and shareholders: If managers are paid in stock, then they should act as if they were shareholders. In reality, options and share ownership can introduce new conflicts of interests. For example, options usually vest fully and are cashed out when a company is sold. A manager with sizable unvested option holdings may be more interested in selling the company at a lower price if the options vest immediately than risk waiting for several more years until the options vest. Given such complexities in modern corporations, it can be very difficult, if not impossible, for outside shareholders to understand the true motivations of management.

Two approaches to handling the principal/agent conflict in mergers are implemented throughout the world. The first relies on shareholders making the decision on whether to sell. This approach is taken in tender offers globally and mergers in the United States. The other approach relies on court supervision of the merger process. This underlies schemes of arrangement that derive from the United Kingdom legal tradition.

Corporation Codes

Many aspects of mergers and the arbitrage process are governed by the corporation codes of the jurisdiction under which the target company is incorporated. In the United States and Canada, companies incorporate under the laws of a state or province, respectively. The most prominent is the Delaware General Corporations Law. In all other countries, corporation codes are established under national laws, even in countries that otherwise have devolved powers to subnational provinces such as Switzerland or Belgium. Obvious special cases are, in the case of the United Kingdom, Crown Dependencies and Overseas Territories, as well as, in the case of China, Hong Kong, which have their own distinct laws. U.K. Company Law serves as the point of reference for these jurisdictions.

The good news is that corporation codes are fairly static and play no more role than to provide a general framework from which court decisions are derived. Corporations are governed by the law of the country or state under which they are formed, and hence their merger or dissolution is first and foremost controlled by the statues of their state of incorporation. However, state codes tend to remain relatively general in order to provide maximum flexibility to their corporate citizens. Most U.S. states model their codes after Delaware General Corporate Law; even the country of Liberia follows Delaware's example. While this might appear to be a far-fetched example, arbitrageurs had to deal with Liberian corporate law in 2004, when Stelmar Shipping, a Liberian container shipping firm founded by British/Greek entrepreneur Stelios Haji-Ioannou, was acquired by Overseas Shipholding Group. Some other shipping companies traded on Western exchanges are incorporated in Liberia, so other mergers involving Liberian companies are likely to happen in the future.

Corporation codes define the decision making and management of a firm. So it is surprising that for takeovers they play a secondary role: In the United States, SEC rules are as much a driver of a takeover process as state corporation codes. In countries that have implemented a takeover code, it is obviously these rules that are the driving force in a takeover. Company law or state corporation codes determine only the mechanics of effecting a merger. The specifics of how to get there—information rights, timing, takeover defenses—depend less on corporation laws and more on the second set of rules and regulations.

Some intricacies of different codes involve not only anti-takeover provisions but also the availability of dissenters' rights for appraisals. This topic is addressed in more detail in Chapter 13. State statutes also define many anti-takeover provisions, discussed later in this chapter.

Takeover Code and Its Derivatives

The United Kingdom's City Code on Takeovers and Mergers, or “Takeover Code” for short, is the basis for mergers and tender offers in the United Kingdom and also numerous other countries that have adopted laws that imitate it, sometimes down to minute details. Countries that follow the tradition of common law and, in particular, follow the U.K. corporation code closely, such as India, Ireland, Australia, Hong Kong, or Singapore, have adopted takeover codes that follow the U.K. precedent very closely, or have incorporated many features of the Takeover Code directly into corporate law or takeover legislation. In the following I will focus on the U.K. Takeover Code but occasionally show examples from such other countries when the similarities make them perfect substitutes.

The origins of the Takeover Code go back to the 1960s when the Panel on Takeovers and Mergers was established, originally as an advisory body, the City Working Group. Like in many other areas mission creep soon set in and what starts out as voluntary or advisory soon becomes binding. The first version of the Takeover Code was formally adopted in 1968, 15 years after Britain's first takeover, the acquisition of J. Sears & Co by Charles Clore in 1953. By the late 1950s, takeovers had become regular occurrences, and with them, many instances in which shareholders were left holding the bag. Among the more notorious instances was the 1959 takeover of Harrods, in which the priority of claims of preferred shareholders over holders of ordinary shares was violated. Throughout the 1960s, takeovers were occurring at a rate of 500 to 1,000 public companies per year. In order to preempt government regulation, the City Working Group proposed the first version of the Takeover Code in 1968. At the time, enforcement was assured through trade associations. Further improvements followed in the 1970s and 1980s. With the implementation of the EC Directive on Takeover Bids in 2004, the Panel has acquired statutory powers and both the Panel and the Code are now incorporated into the Companies Act. It should be noted that this U.K. regulation precedes the landmark Delaware rulings that govern U.S. mergers today and which I will address later.

The Takeover Code is based on six fundamental principles:

1. Shareholders must be treated equally.
2. There must be adequate and timely information.
3. An orderly market must be maintained.
4. Management cannot frustrate an offer against shareholder wishes.
5. Offers have to be realistic.
6. Disruption of the target company's business must be minimized.

In parallel to the implementation of the Takeover Code, a panel was established, officially named the Panel on Takeovers and Mergers (PTM), to supervise and regulate takeovers and the Code through an executive and two committees, the Hearings and Code committees. Decisions regarding pending takeovers are taken by the executive, which is the most relevant aspect from the point of view of an arbitrageur. The Code committee is charged with rule making while the Hearings committee handles appeals to executive decisions as well as hearing about breaches of the Code. The executive is composed of industry professionals from investment banking, brokerage, accounting and legal firms.

The Code applies to all companies incorporated in the United Kingdom as well as companies incorporated elsewhere but listed on the London Stock Exchange. AIM-listed companies are exempted.

Many of the principles of the Takeover Code have been incorporated into the laws of other members of the European Union. The Directive on Takeovers (2004/25/EC), which seeks to harmonize takeover procedures across the EU, borrows heavily from the principles underlying the U.K. Takeover Code. As a result, it is not surprising that there is a significant amount of similarity overall in takeover regimes across the European Union.

At first sight, a striking feature of the Takeover Code is the disproportionate space that rules around hostile takeovers take up. Hostile transactions represent only a small fraction of the overall merger universe, as outlined in Chapter 5. However, considering the potential for target shareholders to be forced into a transaction that undervalues the firm, it is absolutely justified that what appears to be a fringe issue generates a large amount of regulation. For comparison, while there are few formal rules about hostile transactions in the United States under Delaware General Corporate Law or SEC regulations, the ease with which transactions can be litigated in reliance on prior court rulings gives U.S. investors a comparable level of protection. The fact that the United Kingdom has codified rules about hostile transactions whereas Delaware has not is simply a reflection of the difference in the court system and should not be misconstrued as different level of protection for shareholders.

For arbitrageurs, mergers subject to the Takeover Code have several advantages over U.S. mergers in that they provide more certainty. First, the timeline of transactions subject to the Takeover Code is subject to very clear deadlines, shown in Figure 8.3(a) and 8.3(b) for schemes of arrangement and takeover offers, respectively. Of course, transactions can still be held up for regulatory reasons—in particular, delays due to competition investigations. But plain-vanilla mergers without competition risks benefit from this well-defined timing advantage.

The other area in which more certainty exists is clarity around the existence or nonexistence of a takeover proposal. Under the Takeover Code, target companies have to respond to market rumors and inform the market when they receive a proposal. In the United States, while there are clear disclosure requirements for material information, companies have some leeway in classifying takeover discussions as tentative or hiding behind a policy of not commenting on market rumors.

A buyer planning to acquire a company is required by the Takeover Code to make the proposal first to the board of directors of the target company, or the board's advisers. Only after this first step can a public announcement be made. As a result of the acquisition of Cadbury by Kraft, so-called virtual bids have been curtailed. This refers to statements made by a would-be acquirer that it might consider making an acquisition proposal. Investors have wide-ranging information rights. If rumors appear in the press about a proposal, the target must disclose any discussions. A buyer has to make a public statement even before it has approached the target company's board if the information is leaked in a rumor. An example of an announcement relating to market rumors is shown in Exhibit 8.1. In addition, even unexplained movements in a target's share price can give rise to information responsibilities. Under the Takeover Code, if shares move 5 percent in a single day the movement is considered “untoward” and a target company or the acquirer will have to publicize any planned proposals. In any announcement of a proposal, the target company must be specific and name the acquirer. The equivalent French regulations are shown in Exhibit 8.2.

Proposals must be fully financed to prevent the creation of a false market. However, other conditions may be included in an offer, in particular, material adverse change clauses. Another typical condition is a minimum acceptance threshold. Conditions deemed “subjective” are not permitted.

The offer document or scheme circular must be sent to target shareholders within 28 days of the announcement. This is also referred to as a “put up or shut up” regime. If two acquirers make a proposal for a target, then the “put up or shut up” deadline no longer applies. Instead, the acquirers must announce their firm intentions by the 53rd day of the first party's announcement. The panel distinguishes between unsolicited acquisition proposals and formal processes to sell a company. In the latter case, the panel will exempt the companies from both the requirement to name potential acquirers and from the 28-day rule. Nevertheless, once a firm intention has been declared, an offer must be made within 28 days.

Once the offer document or scheme circular has been sent, the timelines differ slightly between schemes of arrangement and takeover offers.

Within 14 days of the publication of the offer document, the target must respond with its views, including the opinions given by its advisers. In recommended offers, this information is normally included in the offer document, so that this deadline in practice only applies to hostile transactions and not to schemes of arrangement, which are friendly by design.

A takeover offer must be open for at least 21 days. The analogous rule for a scheme of arrangement demands that the shareholder meeting to approve the scheme is held no sooner than 21 days after the date of the scheme circular. Revisions to a scheme can be made no later than 14 days prior to the shareholder meeting.

For takeovers, material new information cannot be published more than 39 days after the offer document is sent. The price paid cannot be increased more than 46 days after the document is sent or 14 days before its final closing date.

Once a takeover offer becomes unconditional as to acceptances, it must remain open for at least another 14 days. “Unconditional as to acceptances” refers to a sufficient number of shares having been tendered into the offer to meet the minimum acceptance threshold. This rule allows shareholders who had been holding out to tender their shares anyway.

Extensions are possible, but not beyond the 60th day after the document has been sent. Once the condition as to the acceptance threshold has been fulfilled, all other conditions must be met within 21 days or the offer will lapse by law.

Payment of the merger consideration must be made within 14 days of the closing date for acceptances.

It should be noted that the Takeover Code has no automatic provision for regulatory delays. It is up to the Panel to decide on a case-by-case basis whether to grant an extension when Britain's competition authorities or the European Commission initiate Phase 2 proceedings.

For a scheme of arrangement, the timetable is mostly determined by the court approval of the scheme. While the shareholder meeting to approve the scheme must be held no sooner than 21 days after the circular has been published, which is similar to the 21-day minimum period during which a takeover offer must be open, there is no maximum date for a scheme. Conditions can also remain unsatisfied indefinitely. However, the circular may define a long-stop date after which the scheme will lapse.

In many other jurisdictions, a similarly well-defined timetable determines how a takeover evolves. Overall, the timing resembles that of the U.K. Takeover Code, but details vary. For example, in the case of Switzerland, the timing of a squeeze-out action after a successful takeover is well defined. Moreover, another specificity of Swiss takeover timing is that there is a three-trading-day window between electronic publication of information and its publication in traditional print media. In Figure 8.4 (a) this is indicated only for the preannouncement date, but it also applies to the other announcements that are required to be made.

It can be noted from the timetables that courts play a less important role in the countries listed in the merger process than in the United Kingdom. In contrast, securities regulators like Italy's CONSOB (Commissione Nazionale per le Società e la Borsa) or Spain's CNMV (Comisión Nacional del Mercado de Valores) play a more important role or are even the driving force behind the process. In the United Kingdom, it is not the securities regulator but the Takeover Panel that assumes this function.

Key U.S. Court Decisions

The United States follows a different philosophy from the detailed prescriptions of the Takeover Code and the various rules derived from it throughout the world. State corporation codes leave considerable freedom to management in the handling of takeover offers. Over the years, court decisions have somewhat restricted and significantly professionalized takeovers, and SEC regulations further narrow the range of possibilities. Overall, however, the merger process retains much more flexibility and variability in the United States than in countries that follow a takeover code regime.

With legislators staying uncharacteristically mute about the details of the merger process, over time judges have come to fill the legislative void. Courts try to stay out of business decisions and give the benefit of the doubt to management. This principle is known as the business judgment rule. Judges do not want to second guess every decision taken by boards and expect boards to act in good faith in their decision-making process and to exercise care and loyalty to shareholders. However, the courts do recognize that mergers and acquisitions present a particular challenge to boards. Through a number of key decisions, the merger process has become a highly structured undertaking. Courts in Delaware have taken the lead; those in other states often use similar approaches when faced with merger-related litigation. Even in states where little established case law exists, legal counsel will advise boards to follow Delaware's lead as a best practice. Therefore, understanding Delaware's requirements helps following the process in other states. We will refer to these requirements as six rules.

At the center of all decisions is the question of fairness in two dimensions: fairness of price and fairness in the procedure of the merger. Courts do not like to rule on the fairness of a price—judges are lawyers, after all, not business executives. They defer to the business judgment of the board for that question by default. This gives a significant amount of protection to board members in the day-to-day management of a firm. Instead of second-guessing price, courts will focus on how it was determined. The assumption is that if the procedures were deficient and unfair, then it can be concluded that the price cannot be fair. Some relevant factors are how the merger was negotiated and structured, how information is disclosed to shareholders, and how shareholder votes were conducted. The rest of this section gives an overview of the principles underlying these procedures.

The year 1985 was one of high activity for Delaware's courts, which set the groundwork for modern merger and acquisition (M&A) court decisions. The first decision that year involved the leveraged buyout of rail car leasing firm Trans Union by its chief executive officer, Van Gorkom. The board was confronted with the buyout and was led by Van Gorkom to adopt the merger agreement only minutes after learning that a leveraged buyout was planned. Delaware's supreme court ruled:

[…] we must conclude that the Board of Directors did not reach an informed business judgment on September 20, 1980 in voting to “sell” the Company for $55 per share pursuant to the Pritzker cash-out merger proposal. Our reasons, in summary, are as follows:

The directors (1) did not adequately inform themselves as to Van Gorkom's role in forcing the “sale” of the Company and in establishing the per share purchase price; (2) were uninformed as to the intrinsic value of the Company; and (3) given these circumstances, at a minimum, were grossly negligent in approving the “sale” of the Company upon two hours consideration, without prior notice, and without the exigency of a crisis or emergency.

488 A.2d 858 (Del. 1985)

The Van Gorkom decision is Rule #1: The board must make an informed decision.

Takeover Defenses

In the 1980s, the stock market witnessed a buyout wave, during which corporate raiders such as Nelson Peltz, Samuel Heyman, Carl Icahn, T. Boone Pickens, Sir James Goldsmith, and Henry Kravis acquired many established and venerable companies. In popular culture, these raiders were immortalized by Gordon Gekko in the movie Wall Street. Raiders purchased a company with different lines of business or with assets on its balance sheet that were not valued correctly by its market value. After the purchase, which involved usually a long battle with the company's existing management, the raider sold off its components separately. Raiders were an important factor in the unwinding of the conglomerate boom. One effect of this new trend in business was the emergence of the idea that investors best diversify their portfolios themselves, while companies specialize in their core business. Another effect, and an unintended consequence, was the creation of defense mechanisms by management to prevent outsiders taking control of a firm without the consent of the board.

Such takeover defenses are a double-edged sword. The principal justification is that they provide a company's management team with the ability to make long-term decisions. Others argue that if a company receives an unsolicited proposal, takeover defenses give management time and leverage to negotiate a better deal. Relationships with customers and employees are also cited as justification for strong takeover defenses.⁴ According to this theory, they have the potential of reassuring customers: During the hostile takeover of Peoplesoft by Oracle, customer orders for Peoplesoft products declined because Oracle had announced it would discontinue Peoplesoft's product line after the merger. Strong takeover defenses might have convinced customers to continue buying Peoplesoft's software. Similarly, it is argued that employees prefer to join a company that is less likely to be taken over. Both arguments appear far-fetched. It is doubtful that takeover defenses actually enter any purchasing or employment decisions, and there is no evidence from surveys or other data.

Some academic studies have questioned the benefits of takeover defenses for shareholders. In a 2003 study, Lucian A. Bebchuk and Alma Cohen of Harvard Law School⁵ found that companies with staggered boards (to be described) suffer on average from a 6 percent lower valuation. Another study,⁶ while not addressing the question of company valuation directly, found that analysts do not adjust their earnings forecasts following the adoption of a poison pill (to be described). However, the same study found that poison pills are adopted in response to several downward revisions of earnings, which suggests that they are adopted by boards fearful of losing their jobs.

From any investor's point of view, takeover defenses are a reason for concern. Stocks trade often with a premium if they are takeover candidates, and companies with strong takeover defenses will not be able to get such a premium. Even worse, it will be more difficult for shareholders to organize a change of management in the event the company does poorly. Put simply, takeover defenses entrench management and may even signal to the market that management fears it may become ousted, which means that it is not optimistic for the company's future.

For a merger arbitrageur, takeover defenses generally are not a serious problem. Companies that get acquired will already have waived their defenses in favor of the acquirer. Nevertheless, arbitrageurs can forgo some extra return if the takeover defenses hold other potential acquirers at bay. As discussed in Chapter 2, some of the best opportunities for extra returns come from bidding wars. But in the presence of takeover defenses, another acquirer is not very likely to come forward with a hostile offer. Since inaction does not generate headlines or statistics, it is impossible to quantify how serious this issue is.

As mentioned above, the U.K. Takeover Code restricts takeover defenses severely. Most of the tools and techniques available to U.S. companies to thwart unsolicited and unwelcome acquisition proposals are not available. The Takeover Code explicitly bans the following defenses:

• issue shares or grant options or convertible securities;
• sell assets; and
• enter into contracts other than is the ordinary course of business.

Other, more subtle defenses are also banned. For example, any confidential information provided to one bidder must be made available to all other bidders, too, irrespective of whether they are hostile or friendly. In addition, the Takeover Panel has opined that bringing litigation to frustrate a bid would not be allowed.

Nevertheless, some practices have been allowed, such as promising the payment of a special dividend should a takeover proposal be rejected by shareholders or simply convincing shareholders that a proposal undervalues the company.

Creeping Takeovers and Mandatory Acquisitions

A special feature of the Takeover Code that has found its way into many countries' laws is the requirement for an investor to make an offer to acquire a company when they acquire more than 30 percent of the voting interest in a company. For any increases in holding between 30 percent and 50 percent, the same applies (Rule 9.1).

The goal of this rule is to prevent a creeping takeover by a shareholder and provide liquidity to all investors with the protection of an orderly takeover process under the rules of the game. In this spirit, an area that has come under scrutiny recently is the use of derivatives to acquire control of a company. This controversy is mostly limited to continental Europe. Aside from the well-publicized purchase of call options on Volkswagen by Porsche SE, an attempt that ultimately backfired, there are several cases in which acquirers successfully bought a majority of shares in this way.

The United Kingdom's mandatory bid rules have been copied by many other jurisdictions. Austria and Germany, for example, both have a 30 percent threshold, whereas Switzerland has a threshold of 33.33 percent. The price to be paid in such an offer is the higher of a VWAP (volume-weighted average price) and the highest price recorded in the market. The time periods vary between countries. Of the above-mentioned examples, Austria has a six-month lookback on the VWAP and a 12-month lookback for the highest price, whereas Germany considers shorter time periods, three months for the average exchange price and six months for the highest price. Switzerland has a lookback of 60 stock exchange trading days for the VWAP calculation, and 12 months for the highest price, with the additional limitation that the price paid cannot be more than 25 percent below this highest price. Table 8.1 gives an overview of key aspects of mandatory bid rules in various countries.

India implements an interesting variation of this rule: when an acquirer reaches a 25 percent ownership threshold it must make an offer to purchase at least an additional 26 percent of shares. Owners of 25 percent who acquire an additional 5 percent of shares during a year must also make a mandatory offer.

The United States has no provisions for mandatory acquisitions or to prevent creeping acquisitions. Disclosure requirements are the only protection available to investors. The market can observe share purchases of any 10 percent owner through Form 4 filings. In theory, the share price should rise in response to any attempt to buy shares in a creeping takeover. In practice, a point will be reached at which liquidity in the shares declines and any additional purchases by a majority owner lead to a further deterioration in liquidity, which will affect the stock price adversely. Which of the two effects dominates is difficult to tell because such cases are extremely rare and limited to firms with small capitalization. However, while investors have limited protections, company management has access to a wide array of anti-takeover measures to frustrate creeping takeovers. Overall, it is clear that shareholders in the United States are less protected than in countries that follow a variant of the Takeover Code, while management is better protected. Enhanced protections may not be necessary as management owed a fiduciary duty to shareholders and domination agreements as they are common in Europe are not possible.

Best Price Rule

As shown in Table 8.1, many jurisdictions impose minimum prices on acquisition proposals. A recurring theme across different countries is the best price rule, whereby an acquirer must pay the highest price to every investor from which it purchases shares during an acquisition. The reason for this principle is greenmailing during the 1980s, when some shareholders negotiated better prices for themselves if they committed to tendering their shares. The regulatory counteraction was to force acquirers to pay the highest price that is paid to any shareholder to all shareholders. This is the best price rule.

To prevent abusive avoidance action of the best price rule, many jurisdictions have extended the time frame during which the best price is calculated beyond the duration of the offer. Frequently, the clock starts ticking one year prior to the announcement of the offer.

The U.S. market takes a special place in the implementation of the best price rule. As with many merger regulations, it is not legislated but has become a de facto rule through a series of Delaware court decisions. Nothing prevents a buyer from paying different prices for shares bought from different sellers during an acquisition; however, damages actions are very likely to ensue and stand a good chance of succeeding. The plaintiff bar effectively has created a private enforcement mechanism that acts as a powerful deterrent.

The best price rule is the single most important reason why acquirers do not engage in their own merger arbitrage. Since an acquirer knows with a high degree of certainty whether its acquisition will succeed, it would make sense to purchase shares of the target at a discount were it not for the best price rule.

In rare cases, acquirers do purchase shares during an offer, as did Glencore Xstrata plc when it was trying to acquire Canadian firm Caracal Energy Inc. in the year 2014 through a plan of arrangement for GBP 5.50 per share. Glencore purchased additional shares on the London Stock Exchange for the same price, GBP 5.50, thereby avoiding problems with the best price rule.

It should be noted that while the best price rule has been implemented in most jurisdictions, some important markets lack this provision. For example, when Italy reformed its takeover regime to comply with the European Directive on Takeovers in the year 2004, it did not implement a best price rule, probably because it was not required by the directive. This is not necessarily a deliberate design for Italy's takeover laws but most likely a legislative oversight. As a result, shareholders can acquire sufficient shares to prevent an acquirer from getting to the 95 percent squeeze-out threshold and then sell these shares at a premium to the acquirer. As long as these shares are bought at a premium outside of the takeover then this would be a perfectly legal greenmailing strategy. Anyone tendering shares in the takeover would receive the lower takeover consideration.

Market Manipulation

Trading activity surrounding merger announcements lends itself to manipulation. But it is not only market participants who may try to influence stock prices through rumors. The most power to influence the market lies with the management of the target company and the buyer. The buyer's management has an incentive to keep the target company's stock price low in order to make a lowball offer appear attractive. The target company's management generally has the opposite incentive—except when they team up with a private equity buyer, in which case they have an interest in keeping the purchase price low.

The United States has no specific laws against market manipulation during takeovers. General liability against market manipulation under Section 10-b-5 applies, and takeovers are merely one instance of all conceivable cases where markets can be manipulated. Shareholders have information rights under Section 13 of the Securities Exchange Act as well as under Regulation FD, which ensures fair disclosure. These reports are filed on Form 8-K within three business days.

The Takeover Code contains a body of rules that seek to eliminate market manipulation specifically in the case of takeovers. Shareholders are awarded information rights from the target, potential acquirers and even other shareholders.

Target companies are required to disclose a material change in published information.

Acquirers who propose to issue shares to target company shareholders must disclose profit forecasts.

Other shareholders have to disclose their positions in shares of the target if they exceed a certain size. The thresholds for filing holdings reports by investors are reduced during takeovers. In the United Kingdom, investors owning 3 percent of shares must normally disclose their holdings, but during a takeover the threshold is lowered to 1 percent, a level that also applies in Ireland during a takeover.

Even employees can have substantial information rights, in particular in continental European countries with strong trade unions. In Italy, for example, consultation of worker representatives is well defined within the takeover timeline. But the Takeover Code also has employee-friendly provisions, such as a clause that employees must be informed about plans for the future of the workforce. A bidder is bound to any statements made in this context, including that of a “negative statement” if no plans regarding the workforce exist.

Shareholder Votes

As discussed earlier, in contrast to tender offers, shareholders get to vote in mergers and schemes of arrangements. The percentage of shareholders needed to approve a transaction differs between jurisdictions. In the United States, the approval threshold of 50 percent is the lowest of all countries considered here. The United Kingdom and Canadian level of two-thirds of shareholders, or 66⅔ percent, is typical for most countries. At the other extreme is Israel, which requires approval of 75 percent of shareholders for court-approved mergers as well as for mergers of companies incorporated before the current Companies Law took effect. For newer companies a lower threshold of 50 percent applies. Exhibit 8.5 shows an excerpt of the merger agreement of the acquisition of Given Imaging Ltd., which was incorporated in Israel, by Covidien. As part of a shareholder agreement approximately 44 percent of the insider votes had irrevocably committed to support the transaction. Therefore, only 55 percent of the noninsider shares had to vote in favor of the merger to reach an overall level of 75 percent.

The Given Imaging merger agreement is also notable in that it contains a provision that no more than 2 percent of shareholders may vote against the merger or the merger will not be approved. However, since 44 percent of the shares had already been locked up that means that almost 3.6 percent of the remaining shares can vote against and the merger will still go through. This is calculated as:

8.1

where

1. is the percentage of unaffiliated shares that can vote against (or abstain).
2. is the maximum percentage of all shares that can vote against, as stated in the merger agreement.
3. is the percentage of shares that have been locked up.