When do M+A Discussions Constitute MNPI? Recent SEC Guidance May Shed Some LightLast month, the SEC announced that a public company had agreed to pay a $20 million penalty to resolve charges related to its repurchase of stock while supposedly in possession of material, non-public information (“MNPI”) that it might be acquired by another company. The SEC’s cease and desist order offers important lessons for assessing whether a company is in possession of MNPI in the context of ongoing M&A discussions.
BACKGROUND ON MERGER NEGOTIATIONS AND LIKELIHOOD OF A TRANSACTIONAccording to the SEC, starting in March 2017, the company engaged in “significant discussions” with a potential acquiror about a change of control transaction. The target and the potential acquiror executed a confidentiality agreement, shared confidential financial information, analyzed potential synergies, and prepared a timeline for the possible public announcement of a transaction. The parties agreed that the acquiror’s stock would be used to purchase the target and in negotiations of a potential exchange ratio, the target sought a ratio implying at least a 20% premium to its current market price, while the acquiror sought to pay a 15% premium. The potential acquiror also began drafting a merger agreement. In October 2017, however, the discussions were suspended because the potential acquiror was concerned about the dilutive impact of a transaction on its cash flow per share. While a transaction at either a 15% or 20% premium to the target’s current stock price would have been immediately accretive to the acquiror’s earnings per share, it would have diluted the acquiror’s cash flow per share at that time. The target’s CEO told its financial advisor that he expected discussions to resume in early 2018. During the suspension of discussions, the financial advisor provided weekly updates regarding the potential transaction, including the potential exchange ratio as the companies’ share prices changed.
By late January 2018, the potential acquiror’s share price had increased, reducing its concern about the impact of a transaction on its cash flow per share. On January 30, 2018, the target’s CEO and the potential acquiror’s CEO made plans to meet on February 23, 2018 to resume their discussions. The target’s CEO recognized that those discussion would not require “start[ing] over” but instead simply “refresh[ing]” the prior discussions. He told the target’s directors that the target was “still positioned to advance” its objectives with the potential acquiror in 2018. The target’s CEO’s discussions with its financial advisor suggested that he believed that the potential acquiror’s concern about its cash flow per share was no longer an impediment to a deal. Based on the then-current share prices, a deal would be accretive to the potential acquiror’s earnings and cash flow per share at up to a 40% premium, and on February 14, 2018, the target’s board expressed support for continuing transaction discussions.
CLOSE TEMPORAL PROXIMITY WAS SUSPICIOUS IN HINDSIGHT
On February 21, 2018 – two days before the scheduled meeting between the CEOs to resume transaction discussions – the target’s CEO directed its CFO to initiate a repurchase of $250 million of shares pursuant to a prior authorization by the target’s board years earlier. The CFO asked the target’s in-house legal team to determine whether such a repurchase could proceed under the target’s securities trading policy, as was required under the target’s share repurchase program authorized by the board. Upon concluding that the target’s negotiations with the potential acquiror did not then constitute MNPI, on February 22, 2018, the target’s legal team approved a Rule 10b5-1 plan to facilitate the repurchase. From February 23, 2018 to March 28, 2018, the target repurchased stock at prices ranging from about $90 to $103 per share. At the same time, discussions between the companies continued and on April 30, 2018, a deal was publicly announced that valued the target at over $150 per share.
Upon this factual backdrop, the SEC found that the approval of the Rule 10b5-1 plan based on the conclusion the merger discussions did not constitute material non-public information reflected “a deficient understanding of all relevant facts and circumstances regarding the two companies’ discussions.” In particular, the SEC determined that the target had used:
an abbreviated and informal process to evaluate the materiality of the acquisition discussions that did not allow for a proper analysis of the probability that [the target] would be acquired. [The] informal process did not require conferring with persons reasonably likely to have potentially material information regarding significant corporate developments prior to approval of share repurchases. As a result, for example, despite [the target]’s CEO’s leadership role at the [target] and the fact that he was the primary negotiator with [the potential acquiror], no one involved in [the target]’s process discussed with him the prospects that [the target] and [the potential acquiror] would agree to a deal. Because they did not do so, the [target] failed to appreciate that the probability of [the potential acquiror]’s acquisition of [the target] was sufficiently high at that time as to be material to investors.
The SEC concluded that because the target “lacked an effective process for obtaining an accurate and complete understanding of the facts and circumstances necessary to determine whether it was in possession of [MNPI],” the target had “engaged in buyback transactions that were not . . . in accordance with management’s authorization.” Accordingly, the SEC charged the target with violating Section 13(b)(2)(B) of the Securities Exchange Act of 1934 for failing to maintain adequate internal accounting controls.
M+A DISCUSSIONS AND MNPI
Because it chose to pursue an accounting controls violation, the SEC did not affirmatively find in the cease and desist order that the target had traded while in possession of MNPI. The question of whether merger discussions or other circumstances constitute MNPI is always a facts and circumstances assessment, so this case is not dispositive of that question under other sets of facts. But the SEC’s cease and desist order offers important lessons for assessing whether a company is in possession of MNPI in the context of ongoing M&A discussions.
First, the order highlights the importance of the process used to determine the existence of MNPI. The SEC found that the target had used an “abbreviated and informal process” that “did not require conferring with the persons reasonably likely to have potentially material information regarding significant corporate developments.” While the order does not detail steps that the target did take, it highlights that the target’s process took at most one day and did not include discussing the likelihood of a transaction with the target’s CEO, who was the “primary negotiator” of the transaction. The SEC’s position is that a company should employ a formal process that includes “conferring with persons reasonably likely to have potentially material information regarding significant corporate developments” and yields “an accurate and complete understanding of the facts and circumstances necessary to determine whether [the company is] in possession of material non-public information.”
Second, the order highlights certain considerations relevant to determining whether a potential M&A transaction is sufficiently likely as to constitute MNPI. The SEC criticized the target’s failure “to appreciate that the probability of [a transaction] was sufficiently high as to be material to investors.” Citing Basic, Inc. v. Levinson, 485 U.S. 224 (1988), the SEC noted that “an acquisition need not be more likely-than-not to occur for it to be material” to investors.
The order suggests that the following factors were relevant to the SEC’s determination that the probability of a transaction was sufficiently high as to constitute MNPI when negotiations resumed:
- The length of the pre-“pause” negotiations;
- The execution of a confidentiality agreement and the sharing of confidential information;
- The preparation of a draft public announcement timeline;
- The drafting of a merger agreement;
- The continued evaluation of a potential transaction during the pause in negotiations;
- The apparent resolution of the issue that had caused the negotiations to be paused; and
- The parties’ recognition that post-pause negotiations were a continuation of the pre-pause negotiations.
These factors appear to have persuaded the SEC under these facts that the probability of the potential acquisition was sufficiently high as of February 22, 2018 to constitute MNPI, and thus that the target had repurchased its stock while in possession of MNPI. Despite these findings, the SEC did not charge violations of the insider trading laws or pursue charges against any of the target’s officers. Nevertheless, the size of the penalty ― and the creation of a Fair Fund under the Sarbanes-Oxley Act of 2002 ― suggest that the SEC recognized that investors were harmed and sought to mimic the disgorgement remedy that would be expected in an insider trading case.
Please contact Alexis Coll-Very, Deborah Birnbach, Ezekiel Hill, or any member of the Goodwin team if you have questions about assessing the existence of MNPI in connection with a stock repurchase program or otherwise.
Deborah S. Birnbach
Ezekiel L. Hill