Federal court rulings have affirmed the permissibility of the common practice among U.S. public companies to generally not disclose ongoing merger negotiations. Of particular note, the December 2009 decision of the United States District Court for the Northern District of Illinois in Levie v. Sears Roebuck & Co.1 and the April 2010 decision of the U.S. Court of Appeals for the Second Circuit in Thesling and Johnson v. Bioenvision, Inc.2 each confirmed the widely followed principle that, notwithstanding the existence of active merger negotiations, public disclosure is not generally required until a definitive agreement is signed and a Form 8-K is accordingly required to be filed with the SEC. Importantly, these recent decisions also discuss the circumstances in which a company may find itself falling outside of the application of this general principle and therefore be required to disclose ongoing merger negotiations.
Levie v. Sears Roebuck & Co.
The action that resulted in the Levie decision originated from the 2005 merger between retail giants Sears and Kmart. The plaintiffs alleged that Sears violated Rule 10b-5 by failing to disclose the existence of the merger negotiations with Kmart. In its defense, Sears argued that merger negotiations do not become ‘material’ and thereby required to be disclosed under Rule 10b-5 until basic deal terms such as price and structure are agreed upon. In ruling for the defendants, the District Court did not adopt this standard but instead repeated and applied the following guidelines from the United States Supreme Court in Basic, Inc. v. Levinson,3 which are helpful to any public company weighing whether or not to disclose merger negotiations:
Thesling and Johnson v. Bioenvision, Inc.
In the Thesling case, the plaintiff took the position that Bioenvision, Inc.’s failure to disclose the existence of merger negotiations with Genzyme Corporation had the effect of “artificially” suppressing the price of Bioenvision stock during a period in which the plaintiff had sold Bioenvision shares. The Court of Appeals ruled in favor of Bioenvision, stating that an omission is only actionable if securities laws “impose a duty to disclose the omitted information” and that no express duty requires the disclosure of “merger negotiations, as opposed to a definitive merger agreement.” Consistent with the guidelines set forth in the Basic decision, the Court of Appeals examined the specific facts and found that Bioenvision’s failure to disclose the negotiations did not make prior disclosures misleading. In repeating the axiom that “a corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact,”4 the Court of Appeals further reiterated the principle from the Basic ruling that materiality alone does not give rise to a duty to disclose. While an issuer may have an explicit duty to disclose a merger agreement, the same standard does not govern the disclosure of merger negotiations.
The Court of Appeals in Thesling also suggested support, via its affirmation of the lower court’s decision, for the principle that a duty to disclose merger negotiations arises when a company or a corporate insider trades on the basis of material, non-public information and explicitly stated that such a duty exists when disclosure is required to “avoid rendering existing statements misleading.” Accordingly, while there is no general duty to disclose merger negotiations, if an issuer publicly addresses matters related to a possible merger, it must do so honestly. In this vein, publicly denying merger negotiations while they are in fact ongoing could be materially misleading. However, an obligation to disclose is not created by general statements regarding an issuer’s financial, business or strategic plans, even if ongoing merger negotiations might materially affect those plans. Alternatively, publicly asserting that financial, business or strategic plans are not changeable may give rise to a duty to disclose. When asked a question concerning merger negotiations at a time when a duty to disclose negotiations has not otherwise arisen, a company may remain silent (i.e., say “no comment”) without incurring a disclosure obligation.
Weighing the Benefits of Silence
The jurisprudence represented by the Basic, Levie and Thesling decisions has created an environment in which management may carefully explore business combinations without as much fear that stock prices may be artificially impacted by the disclosure of premature information. By giving companies the right to remain silent during merger negotiations, courts have given business leaders significant freedom to explore the commercial benefits of proposed combinations. This policy may arguably allow the value of a proposed merger to ripen before it is presented to the public, which may ultimately have a more positive effect on stock price than if investors were informed of merger negotiations from the outset. It also protects the transaction at a stage when it is still nascent and subject to the risk of crumbling altogether as a result of rumors setting false or unrealistic expectations.
However, the benefits of silence are not universally agreed upon, as evidenced by the varying degrees to which other jurisdictions permit silence during merger negotiations. For example, in Ontario, Canada, while the Ontario Securities Commission (OSC) has provided guidance that, in normal circumstances, public disclosure is only required under the Ontario Securities Act once both parties have received requisite board approvals and a definitive merger agreement is executed, the practice of many companies listed on the Toronto Stock Exchange (TSX) has been to disclose a broader range of information to the public pursuant to the TSX’s timely disclosure policy than may otherwise be required under the Ontario Securities Act.5 So while merger negotiations must only be disclosed under the Ontario Securities Act if they amount to a “material change” in the business, operations or capital of an issuer, as opposed to representing just a “material fact,” the application and enforcement of the rules of the TSX seem to have resulted in merger negotiations being disclosed in situations in Canada where such disclosure would not be required in the U.S. under the rules of the SEC. Similarly, the involvement of the U.K. Takeover Panel at the relatively early stages of proposed merger transactions in Great Britain seems to have resulted in more frequent disclosure of merger negotiations there as well. These examples of more onerous disclosure policies illustrate an approach to investor protection that seems to trust more in the power of information than in the ability of management to create value. These examples also demonstrate that in order to avoid any unpleasant surprises during the middle of the negotiations process, a U.S. company seeking to acquire an entity that is publicly traded in a foreign market should seek the advice of foreign counsel regarding the applicable disclosure obligations to which that target is subject as soon as interest in acquiring that target is first raised.
In interpreting the SEC’s rules regarding disclosure to allow companies to keep merger negotiations confidential, U.S. courts may have viewed as a safeguard the ability of public stockholders to generally reject a proposed merger even after the company’s execution and delivery of a definitive agreement. In that vein, U.S. courts may have been trying to strike an appropriate balance between the desires of management to discretely explore potential transactions and the interest of investors to be fully informed.
Conclusion — The Decision Whether to Disclose
While public disclosure of a potential merger is not generally required until a definitive agreement is signed, companies should not be cavalier in assuming that disclosure is not required. The opinions given by the courts in the Basic, Levie and Thesling decisions emphasize the fact-specific nature of a company’s disclosure obligations. Accordingly, the decision whether or not to disclose merger negotiations should be made in consideration of all the pertinent circumstances, including other statements previously made by the company and other actions the company may be taking. Moreover, at times, there may be strategic or business reasons for a company to disclose merger negotiations, even when it has no legal obligation to do so. However, given the obligation of the company to not mislead the public, it may be difficult to selectively disclose only those aspects of the negotiations that a company deems have strategic value in being publicly known. It may be that the SEC’s rules and the jurisprudence pertaining thereto have created a landscape where the only alternative to full disclosure of the status of negotiations, no matter how preliminary, is to issue a “no comment” statement. Consultation with corporate counsel is crucial as issuers attempt to determine their disclosure obligations when faced with the prospect of a potential merger.
The information provided in this client alert is general in nature and may not be relevant in all circumstances. Such information should not be relied on without specific legal advice based on individual facts. Any commentary or analysis provided in this client alert should not be viewed as advice given with respect to any pending or potential acquisition or transaction. It is the policy of Bingham McCutchen LLP to not comment on pending or potential matters in publications such as this client alert.
For additional information concerning this alert, please contact your regular Bingham contact or the following lawyers:
Evan G. Smith, Counsel
This article was originally published by Bingham McCutchen LLP.