©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - -...

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston

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The Legal and Regulatory Framework


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Federal Securities Law• Seven main pieces of federal legislation

– Securities Act of 1933– Securities Exchange Act of 1934– Public Utility Holding Company Act of 1935– Trust Indenture Act of 1939– Investment Company Act of 1940– Investment Advisers Act of 1940– Securities Investor Protection Act of 1970


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• More recent developments– Securities Act Amendments of 1975– Shelf registration (Rule 415) [1982] — allows

registration of total amount of securities planned over two-year period; actual issuance date(s) chosen by firm according to its needs for funds or to market conditions

– Private Securities Litigation Reform Act (1995)– Securities Litigation Uniform Standard Act of

1998


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Operation of Securities Acts

• Securities Act of 1933 — recording of information

• Securities Exchange Act of 1934 — basis of later amendments applicable to takeover activities


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Tender Offer Regulation — The Williams Act of 1968

• Section 13(d) [amended 1970] — must file Schedule 13D with SEC within 10 days of acquiring 5% or more of the stock of any public corporation

• Public tender offer for ownership of more than 5% must file Schedule 14D


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• Acquiring firms must disclose in Schedule 14D-1 intentions/business plans for target

• Section 14(d)(4)-(7) — regulates terms of tender offer

• Target management — as advisors to target shareholders must file Schedule 14D-9 with recommendations

• Section 14(e) prohibits misrepresentation or deceptive practices in connection with tender offers


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Insider Trading

• Three broad categories of insider trading regulation– Rule 10b-5 — defines fraud, deceit– Rule 14e-3 — insider trading in context of

tender offer– Insider Trading Sanctions Act of 1984 —

more general


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• Traditional insider trading rules– Section 16(a) — insiders and 10% owners

must report transactions – Section 16(b) — can bring suit to return

profits of insider trades completed within a six-month period


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The Racketeer Influenced and Corrupt Organization Act of 1970

(RICO)

• Requirements: Conspiracy and repeated acts

• Allows seizure of assets of accused when suit is filed

• Provides for treble damages for winning plaintiffs


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Court Cases and SEC Rules

• Liability under Rule 10b-5 (fraud, deceit)

• Two principles of insider trading– Illegal for insiders to trade on basis of

inside information– Illegal for outsiders to trade on basis of

information which they have "misappropriated"


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Other Disclosure Requirements

• Notification of stock exchanges of any material development

• Disclosure of merger talks– Management must inform investors of

material developments affecting stock price– Boards may not deny substantive merger

talks– Either keep information secret so none

leaks or fully disclose accurate information


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State Regulation of Takeover Activity

• States are primary regulators of corporate activity

• Limitation — states cannot restrict interstate commerce


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• State legislation– Illinois antitakeover law [1982] — struck

down as too favorable to target management over shareholders, bidders

– Indiana act [1987] — upheld that majority of shareholders must approve transfer of voting rights

– New York/New Jersey act — five-year moratorium on second-step transactions

– Delaware law [1988] — three-year moratorium on second-step transactions


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• Rationale — to permit more considered response to two-tier and partial tender offers

• Antitakeover laws have negative effects on share prices of firms

• Laws should balance shareholder protection and competition between bidders vs. discouraging "abusive" takeovers


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Antitrust Policy

• Antitrust regulations reflect two opposing views– Merger activity as anticompetitive– Merger activity as an expression of

competitive processes

• Main regulatory bodies– Department of Justice (DOJ)– Federal Trade Commission (FTC)


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Antitrust Statutes

• Sherman Act of 1980– Section 1 — prohibits mergers that would

tend to create monopoly or market control– Section 2 — directed against firms that have

already become dominant in the view of the government


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• Clayton Act of 1914– Original Act

• Created the Federal Trade Commission (FTC)• Section 5 — Gives FTC power to prevent firms

from engaging in harmful business practices• Section 7 — Illegal for a company to acquire

the stock of another company if competition could be adversely affected

• Loophole — companies circumvent by using asset acquisitions


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– 1950 amendment• Federal Trade Commission (FTC) has power to

block asset purchases as well as stock purchases

• Incipiency doctrine — FTC could block mergers if it judges there is a tendency toward increased concentration


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• Hart-Scott-Rodino Act of 1976– Title I — Department of Justice (DOJ) has

power to issue civil investigative demands (CIDs) in antitrust investigation


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– Title II — premerger notification provision• Applies to acquiring firms with sales or assets of

$100 million or more and acquired firms with sales or assets of $10 million or more, or vice versa

• Information submitted to DOJ and FTC to determine legality

• Thirty-day waiting period for mergers and 15 days for tender offers

• Either agency may request 20-day extension of waiting period for mergers and 10 days for tender offers


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– Title III — Parens Patriae Act• Each state is the parent or protector of

consumers and competitors• State attorneys general are given power to

initiate triple damage suits• State itself does not need to be injured by

violation


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Antitrust Guidelines

• Merger guidelines of 1968– Mechanical application of concentration

tests– Antitrust could be triggered if share of the

top four firms exceeded 10-20%


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• Merger guidelines of 1982 and later years– Quantitative test shifted to Herfindahl-

Hirschman Index (HHI)• Concentration measure based on the sum of

the squared market shares of each firm in the industry


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• Examples– 10 firms each with 10% market share:

HHI = 10 (102) = 1,000– 10 firms each with 1% market share, 1 firm with

90%:HHI = 902 + 10 (1) = 8,110

• Critical concentration levels:– HHI less than 1,000 — no challenge– Postmerger HHI between 1,000 and 1,800 —

investigation if HHI increased by 100– Postmerger HHI more than 1,800 — challenge if HHI

increased by 50


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– Theory that high concentration results in tacit collusion is invalid because:

• Product differences — heterogeneity• Frequency of quality changes• Frequency of new products• Technological changes• Contract complexities and variations• Cost differences among suppliers


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• Nonhorizontal mergers — less likely to cause competitive problems

• State antitrust activity– Increased power of states granted by Hart-

Scott-Rodino Act of 1976– National Association of Attorneys General

(NAAG) — active in lawsuits


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Private Antitrust Suits

• Business competitors have strong influence on antitrust policy

• Business firms can sue other firms under antitrust laws

• Private antitrust suits may be used as blackmail


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Regulatory Bodies

• Railroads– Surface Transportation Board (STB)

established in 1995– STB replaced Interstate Commerce

Commission– STB must file notices to DOJ


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• Commercial banks– Agencies

• Comptroller of the Currency — national banks• Board of Governors of the Federal Reserve

System — state banks• Federal Deposit Insurance Corporation (FDIC)

– Bank mergers subject to Section 7 of Clayton Act of 1914

• Clayton Act modified by the Bank Merger Act of 1966

• Attorney General has 30 days to challenge any merger approved by one of the three agencies


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• Telecommunications– Federal Communications Commission

(FCC)– Mergers are subject to FCC review, but

FCC defers to DOJ and FTC


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International Antitrust

• International Competition Policy Advisory Committee — recommends explicit antitrust policies

• United Kingdom– Director General of Office of Fair Trading– Secretary of State for Trade and Industry– Monopolies and Mergers Commission


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• Japan– Japanese government has 30 days (can

extend by 60 days) to review transaction– Review not required in stock for stock

deals

• Europe– Premerger notification to Minister of

Competition of European Union– European Union renders decision within

five months


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Regulation by Publicity

• Pressure on government regulators to limit and penalize use of junk bonds

• Managers feared their use in takeovers

• Junk bonds fulfill several beneficial roles– Finance the takeover of underperforming firms– Fill financing gap for new risky growth firms– Use in takeovers lead to value enhancement

for shareholders


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Illustrative Examples of Application of HHI

1a. Assume an industry dominated by a

single large firm which controls 50%

of the market. The remaining 50% of

the market is controlled by five firms

each with a 10% market share.


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What is the 4-firm concentration ratio?

50 + 10 + 10 + 10 = 80%

What is the HHI?

1(50)2 + 5(10)2 = 2,500 + 500 = 3,000

Whatever the measure of concentration,

this market would be classified as highly

concentrated.


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1b. Now suppose that two of the smaller

firms in this industry merge.

What would be the effect on the

4-firm concentration ratio?

50 + 20 + 10 + 10 = 90%

What would be the effect on the HHI?

1(50)2 + 1(20)2 + 3(10)2

= 2,500 + 400 + 300 = 3,200


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Both measures of concentration have

increased. The market was already

highly concentrated, and the increase

in the HHI is 200 points. A challenge

of the merger between two of the

smaller firms would occur based on

the HHI tests.


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1c. Suppose that the merger in 1b

increases the ability of the merged firm

to compete with the dominant firm. For

example, suppose the merged firm is

able to take away 10% of the market

from the larger firm.


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What is the effect of this on the

4-firm concentration ratio?

40 + 30 + 10 + 10 = 90%

(no change from 1b)

What is the effect on HHI?

1(40)2 + 1(30)2 + 3(10)2

= 1,600 + 900 + 300 = 2,800


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The HHI has declined by 400 points,

reflecting reduction in market share

of the dominant firm.


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2a. Now consider an unconcentrated

industry (defined in the 1982 merger

guidelines as an industry with an HHI

below 1,000). Twenty-five firms in an

industry each have a market share of

4%.


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What is the 4-firm concentration

ratio?

4 + 4 + 4 + 4 = 16%

What is the HHI?

25(4)2 = 400


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2b. Two of the firms in the industry

propose to merge.

What is the effect on the 4-firm

concentration ratio?

8 + 4 + 4 + 4 = 20%

What is the effect on the HHI?

23(4)2 + 1(8)2 = 368 + 64 = 432


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Using the 4-firm ratio, antitrust action

might be taken. Using the HHI, the

industry would still be classified as

unconcentrated.

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - -...

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