Disclosure of Merger Negotiations: Formulating a Proper Response Under the Federal Securities Laws
| Publication year | 1988 |
| Pages | 835 |
1988, May, Pg. 835. Disclosure of Merger Negotiations: Formulating a Proper Response Under the Federal Securities Laws
Corporate lawyers representing publicly held corporations engaged in confidential merger negotiations frequently are faced with a dilemma regarding the timing and content of merger disclosure.(fn1) The impetus giving rise to the dilemma can take many forms, which have frequently included responses to inquiries from stock exchange officials regarding the unusual trading activity in a corporation's stock, or responses to inquiries from stock analysts or the press regarding rumors related to possible corporate mergers.
The U.S. Supreme Court's recent pronouncement in Basic Inc. v. Levinson(fn2) resolved the variety of conflicting precedents governing proper responses to such inquiries. The U.S. Court of Appeals for the Third Circuit has espoused the position that preliminary merger negotiations are not required to be disclosed until an agreement in principle has been reached as to the price and structure of the merger.(fn3) However, the Sixth Circuit has held that a corporation may not deny knowledge of corporate developments resulting in heightened trading activity when the corporation is involved in ongoing merger negotiations.(fn4) The Securities and Exchange Commission ("Commission") advocated a middle ground, arguing that disclosure of confidential merger negotiations should be determined after balancing the magnitude of the merger against the probability that the merger will be consummated.(fn5) This article discusses these conflicting views, focusing on the Supreme Court's resolution in Basic Inc.
At the center of the debate is whether the federal securities laws require the disclosure of certain information.(fn6) With limited exceptions, it is generally uncontroverted that the federal securities laws do not require a corporation to disclose material information beyond the disclosure requirements mandated by the various forms or statements filed with the Commission in connection with certain corporate transactions.(fn7) The exceptions which give rise to an affirmative duty to disclose material information include insider trading, prior mis-statements or rumours attributable to the issuer.(fn8) It is equally uncontroverted that once a corporation chooses to speak, it has a duty not to make materially misleading statements. This principle was articulated in the landmark decision in SEC v. Texas Gulf Sulphur Co., where the Second Circuit noted:
We do not suggest that material facts must be disclosed immediately; the timing of disclosure is a matter for the business judgment of the corporate officers entrusted with the management of the corporation within the affirmative disclosure requirements promulgated by the exchanges and the SEC.(fn9)
The Second Circuit did hold, however, that corporations which nevertheless voluntarily issue public statements have a duty to disclose sufficient information so that the issued statement is not false or misleading. The proscription requiring accurate disclosure stems from the antifraud provisions of the federal securities laws, most notably Rule 10b-5 promulgated under the Securities Exchange Act of 1934 ("1934 Act"), which requires that if a corporation voluntarily chooses to speak, its statements must be accurate and complete in all material respects.(fn10)
The seminal case defining materiality is TSC Industries, Inc. v. Northway, Inc.,(fn11) in which the U.S. Supreme Court held that information is material if there is a "substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision. In order to prevail under the Northway materiality standard, there must be a "substantial likelihood that . . . the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder."(fn12) If the parties to a potential corporate transaction are contractually bound by its terms, the materiality of such information under the Northway standard is axiomatic. In contrast, if the terms of a
Whether preliminary merger negotiations constitute material information under the federal securities laws was squarely before the Third Circuit in Staffin v. Greenberg.(fn13) In Staffin, former shareholders of Bluebird, Inc. brought an action alleging that Bluebird unlawfully failed to disclose the fact that it was engaged in preliminary merger negotiations with Northern Foods, Ltd. Declaring that disclosure of preliminary merger negotiations in itself may be misleading, the court held that disclosure of initial merger negotiations was not required because preliminary merger discussions are immaterial as a matter of law.
Whereas the holding in Staffin is limited to the materiality of preliminary merger negotiations generally, the Third Circuit extended the holding to voluntary corporate misstatements in Greenfield v. Heublein.(fn14) In Greenfield, Heublein was the subject of several unwanted takeover attempts by hostile third parties. In response, Heublein sought the protection of a "white knight," R.J Reynolds. During the negotiations, activity in Heublein's stock increased significantly. An official from the New York Stock Exchange contacted Heublein to determine the source of the activity. In response, Heublein voluntarily issued a press release stating that the company was "aware of no reason that would explain the activity in its stock in trading on the NYSE today." Eleven days later, Heublein announced a merger with R.J. Reynolds at $60 per share. A shareholder who sold his shares for $45.25 in reliance on the prior statement brought an action against Heublein, alleging violations of Rule 10b-5.
The Third Circuit affirmed the judgment of the district court and held that, as a matter of law, preliminary merger discussions are not material until an agreement in principle is reached as to the price and structure of the merger. The court expressed its concerns that premature disclosure of merger negotiations will inevitably be misleading because of the likelihood that an eventual merger...
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