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One of the more difficult hurdles to overcome in many M&A transactions in which securities are being issued by the acquirer as part or all of the consideration is compliance with
applicable federal and state securities laws in connection with the issuance of those securities. Under prevailing state and federal securities laws, such securities must either qualify
for a registration exemption or be registered with the Securities and Exchange Commission (the "SEC") and all applicable state securities regulatory agencies. Utah's recently
enacted "fairness hearing" statute will dramatically simplify issuing securities in connection with M&A transactions, and will save Utah companies substantial amounts of
time and money, while increasing the available structuring alternatives for proposed M&A transactions.
The Problem
In M&A transactions where securities are being
issued by the acquirer as part or all of the consideration, those securities must either qualify for a registration exemption or be registered with the SEC. The problem is that in many
M&A transactions the securities being issued do not qualify for a federal registration exemption, necessitating the filing of a Form S-4 registration statement. However, the cost to
prepare a Form S-4 can often exceed $250,000 and take up to four months to navigate through the SEC review process. Moreover, another cost of filing a Form S-4 that should not be
overlooked is the SEC filing fee, which is based on the value of the securities being registered and can be several thousand additional dollars.
The "Fairness Hearing" Statute
Thanks to a recently enacted Utah statute, many of the problems that are presented when issuing securities in connection with an M&A
transaction have been alleviated, making M&A transactions easier, less expensive and quicker to complete, while at the same time increasing the available structuring alternatives for
such transactions. House Bill 290 was signed into law by Governor Leavitt on March 19, 2003 and has been codified as Utah Code Annotated Section 61-1-11.1, which became effective on May
5, 2003 (the "Fairness Hearing Statute"). With the adoption of the Fairness Hearing Statute, Utah now joins a handful of states in providing an exemption from federal
registration for securities issued in connection with M&A transactions.1
The Fairness Hearing Statute allows Utah companies2 to request a "fairness hearing" with the Utah Division of Securities (the "Utah Securities Division"). If the Utah Securities Division determines that the securities (and any other consideration) proposed to be issued in a transaction are "fair",3 the transaction will be allowed to proceed and the securities that are issued in connection with the transaction will generally be freely transferable (unless such securities are issued to an affiliate of the acquirer/insurer).4 The Fairness Hearing Statute was specifically drafted to satisfy the exemption requirements provided by Section 3(a)(10) of the Securities Act of 1933, as amended (the "1933 Act").5
Section 3(a)(10) of the 1933 Act
Section 3(a)(10) exempts from the registration requirements of the 1933 Act:
any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms
and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by ... any State ... or other governmental authority expressly authorized by law to grant such approval. (Emphasis added.)
As noted, prior to the adoption of the Fairness Hearing Statute, Utah companies undertaking M&A transactions in which securities were being issued were required to either find a
registration exemption for those securities or register them with the SEC. However, the registration exemptions available to acquirers/issuers in M&A transactions are very limited,
and generally consist of the following:
- Regulation D -
In certain M&A transactions the "safe harbor" exemptions under Regulation D of the 1933 Act will provide an exemption for the securities being issued but such securities will generally be restricted and not be freely transferable. However, because of the restrictions imposed by Regulation D on the number and type of investors, the prohibitions against general solicitation and advertising, the disclosure requirements imposed, and the requirement to comply with applicable state securities or "blue sky" requirements, Regulation D often is not available to many acquirers/issuers for securities issued in M&A transactions, especially when the target has several unsophisticated shareholders.
- Section 4(2) -
Section 4(2) of the 1933 Act, the so-called "private placement exemption," provides an exemption for securities offerings that do not involve a public offering. However, because of the restrictions imposed on the number of offerees and the requirement that they be sophisticated, as a practical matter Section 4(2) is not available for most M&A transactions. Furthermore, securities issued under Section (4)(2) are restricted securities and, therefore, are not freely transferable.
While securities may be issued pursuant to Regulation D or Section 4(2) in an M&A transaction, they will be restricted securities and, therefore, will not be able to be resold except
in accordance with Rule 144 under the 1933 Act. In order to remove the resale restriction a shelf registration statement on Form S-3 will need to be filed with the SEC, thus allowing the
target's shareholders to resell their securities. However, a Form S-3 has many of the same problems as a Form S-4 (i.e. substantial legal and accounting fees, printing costs and filing fees, and possibly several months of SEC review). Moreover, because a Form S-3 registration statement will generally need to remain effective for at least the Rule 144 holding period,6 additional costs will be incurred and heightened disclosure obligations presented while the Form S-3 remains effective. As a result, acquirers in M&A transactions are often faced with the expensive and time consuming task of filing a Form S-4 registration statement with the SEC to register the securities being issued to the target company's shareholders. However, the cost for legal and accounting fees, printing costs and filing fees for a Form S-4 can often exceed $250,000 and take up to four months to process through the SEC.
Section 3(a)(10) provides a transactional exemption for securities issued in connection with an M&A transaction. If the requirements of Section 3(a)(10) are met, the securities issued to the target's shareholders in the transaction will be exempt from the registration requirements of the 1933 Act.7 Generally to comply with the requirements of Section 3(a)(10), an M&A transaction must be submitted to a hearing upon the fairness thereof before a governmental authority expressly authorized by law to conduct such a hearing.
This exemption is available regardless of the number of persons being issued securities in the transaction or their level of sophistication. More importantly, upon the successful
completion of a fairness hearing, the securities issued in connection with the M&A transaction will generally be freely tradable (unless such securities are issued to an affiliate of
the acquirer/issuer). It should be emphasized, however, that while the issuance of securities under Section 3(a)(10) are exempt from the registration requirements of the 1933 Act, that
exemption does not exempt the issuer from the antifraud provisions of applicable state and federal securities laws. Additionally, if the securities being issued in the transaction are not
nationally traded securities under Section 18(b)(1) of the 1933 Act, the issuer will need to comply with applicable state securities or "blue-sky" laws if the recipient of such
securities resides outside of the jurisdiction of the state conducting the fairness hearing.8
Adoption of Utah Rules
The Utah Securities Division is currently
drafting rules for the implementation of the Fairness Hearing Statute and to provide for the administrative procedures to be followed in conducting fairness hearings. No time frame for
the adoption of final rules has been set, but the Utah Securities Division is working diligently to adopt final rules. Once adopted, those rules will be subject to a 60-day public hearing
requirement. The Fairness Hearing Statute, as well as the requirements of Section 3(a)(10) of the 1933 Act, do provide, however, some general guidance regarding the administrative
procedures for fairness hearings that are expected to be adopted. In that regard, a fairness hearing must involve (a) an application to the Utah Securities Division, (b) a hearing on the
fairness of the terms and conditions of the transaction (at which all persons to whom it is proposed to issue securities or other consideration may appear), (c) adequate notice of the
hearing to all such persons,9 and (d) a determination by the Utah Securities Division regarding the fairness of the terms and conditions of the exchange. Finally, while the amount of the filing fee for a fairness hearing will be established by the Utah Securities Division in the rules, that fee is expected to be nominal in amount, and probably in the $1,000 - $3,000 range.10
California Fairness Hearing Provisions
Because the Fairness Hearing Statute is so new (having become effective on May 5, 2003) and because no implementing rules
have yet been adopted by the Utah Securities Division, the exact mechanics and procedures for conducting a fairness hearing in Utah are unclear. However, because California has one of the
most established administrative procedures for conducting fairness hearings, and furthermore because the California Corporation Commissioner has conducted over 300 fairness hearings since
1998,11 the Utah Securities Division will likely look closely at the California fairness hearing provisions in adopting the rules for the Fairness Hearing Statute. It is anticipated that many of the administrative procedures that will be adopted by the Utah Securities Division will be designed, at least in part, after the corresponding California provision. Therefore, much can be learned from a review of the California fairness hearing provisions. Accordingly, a brief summary of the California fairness hearing provisions follows.
The California fairness hearing statute has been codified at Section 25142 of the California Corporations Code. California has established a relatively low nexus requirement in
order for an acquirer/ issuer to take advantage of its fairness hearing statute.12 If the nexus requirements are met, a company must complete an application that describes the proposed transaction in detail. Companies must then give their shareholders written notice of the hearing. The hearing is somewhat similar to an administrative proceeding, with the California Corporation Commissioner being required to make a determination whether the proposed transaction is "fair, just and equitable."13 In making that determination, the California Commissioner considers the evidence presented by the acquirer/issuer and the target, as well as any fairness opinion evidence that may have been presented, in addition to hearing testimony from each of the parties and any of the target's shareholders who may have attended the hearing. The California Commissioner has significant discretion in its ruling. A proposed transaction that is found to be "fair, just and equitable" will be allowed to go forward, while a transaction that is not found to be "fair, just and equitable" may be delayed or prevented. Alternatively, the California Commissioner can order that the proposed transaction be restructured before it will be deemed to be fair. In addition, it's not uncommon for the California Commissioner to impose additional conditions14 on a transaction before it will be deemed to be fair and allowed to go forward or to place restrictions on the transferability of the securities being issued in the transaction.
Conclusion
While it is too early to determine the exact nature of the administrative procedures the Utah Securities Division will ultimately adopt to determine the
"fairness" of an M&A transaction, the relative ease, cost savings and speed, in comparison with a federal registration, will be dramatic. It is clear, however, that the
adoption of the Fairness Hearing Statute will offer Utah companies a valuable tool in undertaking M&A transactions. Utah companies conducting an M&A transaction should explore
with experienced counsel the applicability of the Fairness Hearing Statute and the advisability of conducting a fairness hearing.
Footnotes
1.
California, Idaho, Ohio, Oregon and North Carolina are among the states that have adopted fairness hearing statutes for M&A transactions conducted in accordance with Section 3(a)(10) of the Securities Act of 1933, as amended. While each of those statutes is designed to qualify for the exemption provided by Section 3(a)(10), the provisions of each of those states' statutes differ in certain respects and require that varying standards and procedures be applied by the hearing officer.
2.
What will constitute a "Utah company" authorized to file an application with the Securities Division for a fairness hearing remains to be determined by the Securities Division and will be provided for in the rules being drafted to implement the Fairness Hearing Statute. However, at a minimum we believe that a "Utah company" for purposes of the Fairness Hearing Statute will include companies incorporated in Utah and companies having their principal place of business in Utah. The rules may also allow companies with a significant percentage of their shareholders residing in Utah to qualify for fairness hearings. Furthermore, the definition of "Utah company" will likely not be limited to corporations. California, for instance, holds fairness hearings for exchanges involving limited liability company membership interests and partnership interests, as well as for exchanges involving shares of stock in corporations.
3.
What constitutes "fair" is not set forth in the Fairness Hearing Statute. The criteria for what constitutes "fairness" will be set forth in the rules governing the Fairness Hearing Statute, which rules are currently being drafted by the Securities Division.
4.
Securities issued to an affiliate of the acquirer/insurer will not be freely tradable and can only be transferred in compliance with Rule 144 under the Securities Act of 1933, as amended. Securities issued to an affiliate of the target (who does not become an affiliate of the acquirer/issuer) are also restricted to a certain extent and can only be transferred in compliance with Rule 145(d) under the Securities Act of 1933. Additionally, because the Section 3(a)(10) exemption is a transactional exemption and not a securities exemption, there may be resale restrictions that must be met under state law when the surviving company is not a publicly reporting company.
5.
In this regard, Section 61-1-11.1(10) of the Fairness Hearing Statute specifically provides that it "is intended to provide for a fairness hearing that satisfies the requirements of Section 3(a)(10) of the [1933 Act]."
6. Rule 144(d)(1) under the 1933 Act imposes a minimum one year holding period before restructured securities acquired from the issuer or an affiliate of the issuer can be resold.
7. The general requirements of the SEC to perfect an exemption under Section 3(a)(10) are:
(a) Exchange Requirement - The securities must be issued in exchange for
securities, claims or property interests (and not solely for cash);
(b) Approving Entity - An authorized governmental entity must approve the fairness of the terms and conditions
of the exchange;
(c) Fairness Determination - The approving entity must find, before approving the transaction, that the terms and conditions of the exchange are "fair"
to the target shareholders to whom the securities will be issued;
(d) Reliance on Section 3(a)(10) - The approving entity must be advised before the hearing that the
acquirer/issuer will be relying on the Section 3(a)(10) exemption;
(e) Hearing - The approving entity must hold a hearing before approving the fairness of the transaction;
(f) Authorized Governmental Entity - A governmental entity must be expressly authorized by law to hold the hearing (although it is not necessary that the law require such a hearing);
(g) Open Hearing - The hearing must be open to anyone to whom securities will be issued in the proposed transaction;
(h) Notice - Adequate notice must be given to all such persons; and
(i) Procedural Due Process - There cannot be any improper procedural impediments to the appearance by such
persons at the hearing.
8.
Issuers should also conduct a "blue sky" survey even if the consideration being issued consists of nationally traded securities. While states are preempted by federal law from requiring registration of a covered security, there is no such preemption of licensing requirements for issuer agents that offer or sell covered securities. In March 2000 Utah adopted Rule R164-14-26s under its Uniform Securities Act to create a self-executing exemption in such an instance so issuers that participate in an M&A transaction whose securities are, or will be upon completion of the transaction, covered securities pursuant to Section 18(b)(1) of the 1933 Act, will not be required to license agents who meet the exclusion requirements of Subsection 61-1-13(2) of the Utah Uniform Securities Act.
9. While the length of the notice period will be set forth in the rules, the notice period is expected to be a minimum of 10 days but not more than 30 days.
10. The filing fee in California, for example, is a maximum of $2,500 plus certain administrative expenses.
11. The fairness hearings conducted by the California
Corporation Commissioner since 1998 represent securities transactions valued in excess of $33.7 billion.
12. The scope of the nexus requirement is perhaps the most difficult
issue facing the Securities Division in adopting the Utah rules. Because the Utah Legislature has not appropriated additional funds to the Securities Division with which to conduct
fairness hearings, the Securities Division will likely set a relatively high nexus requirement in order to administratively limit the number of fairness hearings that can be conducted
under the Fairness Hearing Statute.
13. Under the Fairness Hearing Statute the standard to be applied by the Securities Division is simply that the transaction be
"fair." Other states have variations on this standard. Idaho and Oregon, for example, also require that the M&A transaction be "free from fraud" in order to be
approved.
14. Such as imposing a greater shareholder approval requirement for the transaction than is otherwise required by the target's bylaws or other governing documents.
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