Recommendations to the SEC on Tender Offer Rule Exemptive Relief

SUMMARY

The Securities Regulation Committee (Christian O. Nagler, Chair) sent a letter to the Securities and Exchange Commission with recommendations for exemptive relief with respect to the tender offer rules. The Committee suggests that the Commission consider exemptive relief from the requirements under the rules emanating from Section 14(d) and Section 14(e) of the Exchange Act, including revisiting and updating some of the conditions or requirements outlined in the Commission’s Division of Corporation Finance’s no-action letter dated January 23, 2015 (the “2015 No-Action Letter”). The recommendations include: eliminating or modifying the condition that the offer not be made in connection with a solicitation of consents to amend the indenture; modifying the condition that the tender offer not be financed with the proceeds of any “Senior Indebtedness”; eliminating or modifying the condition that the tender offer be made for any and all of the subject debt securities; modifying the definition of “Qualified Debt Securities” in the context of an exchange offer; modifying the condition that the offer not be made in anticipation of or in response to a change of control or other extraordinary transaction involving the issuer, such as a merger, reorganization, liquidation, or sale of all or substantially all of its consolidated assets; reconsidering the definition of equity security so that more securities fall within the scope of the current relief, as certain equity securities are in substance treated as debt, such as non-convertible preferred stock, regulatory capital instruments and, subject to compliance with certain tests, convertible debt; reconsidering publication requirements for equity tender offers, with a focus on an “access equals delivery” framework; and considering extending relief to private companies, which is consistent with the broader regulatory agenda to help companies go public.

REPORT

By Email
Ms. Tiffany Posil
Chief of the Office of Mergers and Acquisitions
Division of Corporation Finance
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549

Mr. Ted Yu
Associate Director, Specialized Policy and Disclosure
Division of Corporation Finance
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549

Re: Recommendations For Exemptive Relief with respect to the Tender Offer Rules

Dear Ms. Posil and Mr. Yu:

This letter is submitted on behalf of the New York City Bar Association (the “City Bar”) through its Securities Regulation Committee (the “Committee”).

Members of the Committee include a wide range of practitioners whose areas of interest and expertise include securities laws and the regulation of the U.S. capital markets, and who are employed by or advise public companies, both domestic and foreign private issuers.  The Committee does not represent any client and the views expressed by the City Bar are those of the City Bar and not necessarily the views of any of its individual members or their respective firms or institutions.

The City Bar writes to provide recommendations for modifications to, or exemptive relief from, the requirements of the tender offer rules.  We hope you will consider these as you advance the mission of the Securities and Exchange Commission (the “Commission”) to protect investors, facilitate capital formation, and maintain fair, orderly, and efficient markets.

On January 23, 2015, the Commission’s Division of Corporation Finance (the “Division”) issued a no-action letter dated January 23, 2015 (the “2015 No-Action Letter”) addressing Rules 14e-1(a) and 14e-1(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which rules generally require a minimum 20 business-day offer period for all tender offers and that a tender offer remain open for at least ten business days after any change in the consideration offered. In the 2015 No-Action Letter, the Division’s staff (the “Staff”) confirmed that it would not recommend enforcement action if an issuer conducted a tender offer for non-convertible debt securities that remained open for at least five business days, provided that the offer satisfied certain conditions.  The letter also permitted a shortened timeframe for exchange offers in which non-convertible debt securities are issued for nearly identical debt securities that are the subject of the tender offer, provided certain additional conditions are satisfied.

The Committee notes that the Williams Act which enacted Sections 14(d) and 14(e) of the Exchange Act in 1968, was a response to a number of hostile coercive takeover attempts with no apparent intention to regulate offers for debt securities.  The suggested exemptive relief has little if any effect on hostile tender offers for control stakes in publicly traded companies.

In light of this, the Committee suggests, based on the vast experience of its members advising issuers and other participants in capital markets transactions, that the Commission consider exemptive relief from the requirements under the rules emanating from Section 14(d) and Section 14(e) of the Exchange Act, including revisiting and updating some of the conditions or requirements outlined in the 2015 No-Action Letter, as follows:

A. Eliminate or modify the condition that the offer not be made in connection with a solicitation of consents to amend the indenture.

The presence of a consent solicitation in a tender offer should not be a disqualifying event for participants to avail themselves of the five business day or abbreviated tender offer relief.

In connection with the 2015 No-Action Letter, the incoming letter requesting relief stated the following rationale:

“Furthermore, in a tender offer that meets the criteria applicable for a Five Business Day Tender Offer, the holder does not have to evaluate the non-economic characteristics of an amended or new security that the holder would own, such as in the case of a tender offer accompanied by a consent solicitation or an exchange offer for new debt securities that are not Qualified Debt Securities. As a result, holders of debt securities in a Five Business Day Tender Offer can make the decision to sell or hold relatively quickly on a purely financial basis—in much the same manner investors make ordinary trading decisions in time periods that are much shorter than five business day.” (Emphasis added)

The underlying premise was that a holder of non-convertible debt securities in a concurrent tender offer and consent solicitation (1) needed more time to evaluate the non-economic characteristics of the security being amended through the consent solicitation, and (2) that such holder would continue to own the amended security after the concurrent tender offer and solicitation.  However, market practice with respect to a standalone consent solicitation vis-à-vis a concurrent tender offer and consent solicitation puts into question the accuracy of these two assumptions.

First, there is no minimum period for which a standalone consent solicitation needs to remain open.  Indentures do not typically impose a minimum period by which a proposed amendment needs to be open for consideration or discussion by holders of non-convertible debt securities.  Once the required threshold of holders (typically, a majority of aggregate principal outstanding amount of a particular series) is met, then the amendment to the indenture can be made and entered into by the issuer with the indenture trustee, as a matter of course, without the need for a minimum period or prescribed timeline.  Holders of non-convertible debt securities, which are often institutional investors, qualified institutional buyers and other sophisticated investors can evaluate the economic and non-economic characteristics of the amended security, and can decide whether to consent to the proposed amendment.  Furthermore, in a standalone consent solicitation, the holders will, after the consent solicitation, remain holders of the now-amended debt securities.

In contrast, in a concurrent tender offer and consent solicitation, investors who choose to tender will no longer hold the subject debt securities after the tender offer, so the terms that remain in any debt securities remaining outstanding after a tender offer are not relevant.  Most concurrent consent solicitations in the US capital markets are significant covenant strips rather than specific covenant modifications.  These covenant strips offer binary outcomes to investors that do not require the same detailed analysis as bespoke covenant modifications intended to permit particular transactions.  Issuers desire uniformity in covenant packages, on the theory that, in a concurrent tender offer and consent solicitation, an investor’s decision whether to consent in the consent solicitation is inherently secondary to the decision of whether to tender in the tender offer.

Considering that a standalone consent solicitation does not require a minimum period to be completed, even if the consenting holders in such a solicitation would thereafter remain holders of the amended debt securities, then why require a minimum 20 business day period for a consent solicitation coupled with a tender offer, when the consenting holders would thereafter cease to hold, and have no interest in, the remaining debt securities?

The Committee notes that there is no minimum timeline for amendments to indentures. Therefore, just because a consent solicitation is associated with or paired with a tender offer should not mean that a new timeline should be imposed.  Holders of debt securities in a standalone tender offer and holders of debt securities in a concurrent tender offer and consent solicitation are essentially faced with the same fundamental decision on whether to sell or hold the debt security subject to the tender offer.  Hence, holders of debt securities should be able to tender using the same five business day or abbreviated tender offer period, regardless of whether the tender offer is accompanied by a concurrent consent solicitation process.

B. Modify the condition that the tender offer not be financed with the proceeds of any “Senior Indebtedness.”

This condition conflates what are two independent decisions: (i) whether to tender existing junior notes and (ii) whether to invest in new senior notes. Similar to the discussion above regarding consent solicitations, investors who choose to tender no longer hold the subject debt securities after the tender offer – therefore, where the subject debt securities rank in the post-tender capital structure should not be relevant to their tender decision.

If the investors who hold subject debt securities are also considering an investment in the new senior financing, that decision may not be impacted by the fact they are disposing of existing junior notes in the tender offer.  In short, the decisions to tender and to invest in new senior debt should be made independently of each other.

C. Eliminate or modify the condition that the tender offer be made for any and all of the subject debt securities.

This condition limits the ability of issuers to utilize the five business day framework as a means to repurchase a portion of a tranche of securities when they trade below existing redemption prices, exposing issuers who are looking to make selective repurchases to market risk by requiring a capped tender offer to remain open for 20 business days. Issuers who look to make selective repurchases of their securities are exposed to market risk by the requirement to have a capped tender offer open for 20 business days.

The potential to be pro-rated and investors remaining in a smaller tranche of securities is a secondary consideration that does not merit capped tenders being subject to the full 20 business day period.  If there is a concern that liquidity would be reduced on short notice, there could be a requirement that a Five Business Tender Offer for less than “any and all” not result in less than a specified minimum amount of the subject debt securities remaining outstanding following the tender offer.

D. Modify the definition of “Qualified Debt Securities” in the context of an exchange offer.

The requirement that the covenants in any debt securities offered in an exchange offer be identical in all material respects to the covenants in the existing debt securities is impractical and makes it difficult to use the five business day tender offer framework.

Currently, few debt securities offerings price more than five business days after the offering launches.  Our experience is that most debt offerings launch and price on the same day, and investors are able to assess covenant packages in a very short time.

Under the current definition of “Qualified Debt Securities,” neither issuers nor investors are able to update covenants to align with an issuer’s current operating and financial position.  As such, issuers are effectively forced to instead pursue new issuances to refinance existing debt securities rather than more efficient exchange offers.

Additionally, the requirement that the Qualified Debt Securities have the same issuer, guarantors, collateral and lien priority as the debt securities sought to be exchanged similarly limits the utility of Five Business Day Tender Offers in all but the most routine transactions.

The credit quality of issuers can change significantly during the tenure of a debt security, sometimes positively and sometimes negatively.  Current requirements do not recognize this fact sufficiently in that they effectively freeze the structure of debt securities.  Issuers would be better served if these structuring requirements included optionality where the structure of any of the issuer’s existing debt securities (rather than just the debt securities subject of the exchange) could be mirrored, which would provide investors a readily available comparison point for the new Qualified Debt Securities to be issued in the exchange offer.

E. Modify the condition that the offer not be made in anticipation of or in response to a change of control or other extraordinary transaction involving the issuer, such as a merger, reorganization, liquidation, or sale of all or substantially all of its consolidated assets.

Change of control put rights and other covenant restrictions pose significant impediments to M&A transactions, and debt commitments to backstop consent processes come at significant costs to borrowers.  Allowing issuers the flexibility to address these restrictions via accelerated five business day tender offers would increase certainty for issuers in the context of significant M&A transactions.

F. Reconsider the definition of equity security so that more securities fall within the scope of the current relief, as certain equity securities are in substance treated as debt, such as non-convertible preferred stock, regulatory capital instruments and, subject to compliance with certain tests, convertible debt.

Some instruments that fall into the definition of equity for purposes of the tender offer rules, such as non-convertible preferred stock, are viewed by the market as debt instruments.  Treating such securities as debt for purposes of the tender offer rules would better reflect market reality and bring the law in line with the economic viewpoint of the investors the rules seek to protect.

The Committee notes that such treatment is not unprecedented.  For example, non-convertible preferred securities have always been treated in the same manner as non-convertible debt securities under Regulation M.  The Commission, in the adopting release for its latest amendments to Regulation M in 2023, referred to both non-convertible debt securities and non-convertible preferred securities as “fixed income securities” that “trade primarily on the basis of yield and creditworthiness (traditionally measured by credit ratings” rather than the identity of a particular issuer).  From 1996 up to 2023, Regulation M exempted non-convertible debt securities and non-convertible preferred securities that are rated investment grade from the application of Rules 101 and 102 of Regulation M.  From 2023 to present, non-convertible debt securities and non-convertible preferred securities of issuers for which the probability of default is 0.055% or less as defined and described in Regulation M are now similarly exempt. The concept of indebtedness, default and probability of default are widely understood to pertain to debt securities instead of equity securities.

As another example, Rule 144 under the Securities Act of 1933, as amended (the “Securities Act”) defines “debt securities” to also include “non-participatory preferred stock, which is defined as non-convertible capital stock, the holders of which are entitled to a preference in payment of dividends and in distribution of assets on liquidation, dissolution, or winding up of the issuer, but are not entitled to participate in residual earnings or assets of the issuer.”

Further, the Staff has provided no-action guidance for securities not denominated as debt, but with debt-like characteristics such as certain kinds of preference shares.  In a December 2005 no-action letter,[1] the Staff stated it would not recommend enforcement action under Rule 14e-1(b) where the issuer proposed to make a cash tender offer for outstanding non-cumulative guaranteed preference shares where the tender offer price was based on fixed spread above a specified benchmark treasury security.  In granting the no action relief, the Staff noted a number of conditions, including the issuer’s representation that such securities were being valued by investors on the basis of their yield, taking into account the issuer’s credit spread, compared to a benchmark yield, and the yield of the securities fluctuates in response to changes in prevailing interest rates.

The Committee also notes that there are many registered and unregistered offerings of non-convertible preferred securities, that are handled by DCM desks of investment banks and marketed to fixed income investors, and the scheduled dividend payments in these structures are treated in the same manner as how debt investors would treat scheduled interest payments on principal.

In other words, current SEC rules treat non-convertible preferred securities as debt when it is traded, but as equity when it is tendered under the tender offer rules.  We believe such a distinction places form over substance and should be revisited in the context of the tender offer rules.

Additionally, the Staff has accepted that certain regulatory capital instruments issued by financial institutions, such as contingent convertible capital securities or Additional Tier One (“AT1”) contingent convertible securities, are akin to debt securities, in other SEC rule contexts.  In a March 2019 no-action letter,[2] the Staff stated it would not recommend enforcement action to the Commission if offers and sales of contingent convertible capital securities are made in reliance on Rule 144A.  In granting the no-action relief, the Staff noted a number of conditions, including the issuer’s representations that the contingent convertible securities: (i) would qualify as regulatory capital and issued for the purpose of satisfying regulatory capital requirements, (ii) would have either subordinated debt or non-participating preferred equity characteristics, (iii) are fundamentally different in economic terms (and therefore trading characteristics) from the issuer’s underlying common stock, (iv) would have regularly scheduled payments of interest or dividends, as applicable and (v) would automatically and mandatorily convert into common stock only upon the occurrence of a trigger event outside the relevant issuer’s and securityholders’ control and such a trigger event would be due to a regulator’s assessment of the issuer’s viability and/or insolvency.  Similarly, in SEC Release No. 34-82575 dated January 23, 2018, the Staff issued an order granting limited exemptions from Rules 101 and 102 of Regulation M in connection with distributions of AT1 contingent convertible securities. The ruling was premised on the applicant’s representations that (i) the AT1 contingent convertible securities to be offered are fundamentally fixed-income debt securities that are priced and traded by investors as such, and (ii) unlike traditional convertible debt instruments, these AT1 contingent convertible securities to be offered, automatically convert into shares only upon the occurrence of a remote, capital adequacy-related trigger event that is set forth in the terms of the relevant security.

Last, under current tender offer rules, convertible debt securities are treated altogether and quite simplistically, as equity.  We suggest replacing this rule with a test based on premium.  Contemporary theory of securities valuation considers that convertible debt securities have two components: a debt component and an embedded option.  However, when a convertible debt security has a conversion price that is below the prevailing market price (i.e., the convertible debt security is “out of the money”), the embedded option loses significance and market participants generally treat the security as straight debt.  For this reason, we suggest applying a market premium test to distinguish between those convertible debt securities befitting equity treatments and those befitting debt treatment.

G. Reconsider publication requirements for equity tender offers, with a focus on an “access equals delivery” framework.

Currently, Exchange Act Rule 14d-4 requires the bidder to publish, send or give the disclosure required by publishing in a newspaper or newspapers. Given the market relies on digital media, we suggest that this requirement be deemed satisfied by way of a press release.

H. Consider extending relief to private companies, which is consistent with the broader regulatory agenda to help companies go public.

The requirement under the tender offer rules to have offers open for 20 business days does not distinguish between public and private companies.  These requirements can be a hindrance for private companies that wish to exchange securities for various reasons in anticipation of going public.  We suggest that tender offers for private company securities only be required to be open for 10 Business Days.  In addition, private companies and their investors would benefit from clarity on whether and when the tender offer rules apply to them, when those rules can be relaxed if they apply, and what the information requirements are (e.g., whether the information requirements in Section 4(a)(7) of the Securities Act, for example, can be deemed sufficient information for holders of the private company securities, such as employees that are offered an opportunity to participate in company-sponsored liquidity opportunities).

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We thank you for the opportunity to express our views and recommendations. Members of the Securities Regulation Committee would be happy to discuss any aspect of this letter with the members of the Commission or the Staff.

Respectfully submitted,

Securities Regulation Committee
Christian O. Nagler, Chair