Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Best Price Rule in Takeovers

Two recent developments have brought into focus the right of all
shareholders to receive the same price in a takeover (the “best price”
rule). Many countries including India impose this requirement while the United
States imposes it in a very narrow and almost meaningless way. One of the developments
that I will talk about is that the United States is proposing to relax even
further the already minimal best price rule that it has.

But I would like to begin with the United Kingdom. The Lex column in the
Financial Times (“Lex: Virgin Mobile”, Financial
Times
, January 17, 2006) raises an interesting pricing issue in the
proposed sale of Virgin Mobile to NTL in the United Kingdom. Lex calculates that
if NTL rebrands its entire business as Virgin and pays the same royalty to
Richard Branson as what Virgin Mobile pays currently,
it would effectively add about 10% to what Richard Branson would get for selling
his 72% stake in Virgin Mobile. Lex believes however that minority shareholders
have no valid complaint:

Sir Richard does have more incentive
than other shareholders to back the takeover, but under the City Code minorities
do not have to sell out. They do not own the Virgin brand and have no independent
entitlement to its value.

This is fair enough particularly because the Virgin brand is indeed separable
from the cellular business. But in many other cases of this kind, there has been
a problem in valuing the brand. Moreover, the brand is often inextricably
intertwined with the business itself. There have been such instances
in India as well.

The United States is
proposing
to cut right through this Gordian knot. Under its
current regulations, the best price rule applies only to tender offers. If an acquirer
takes a statutory merger route to an acquisition, the regulation does not apply at all.
The two most important rules in tender offers are that:

  1. “The tender offer is open to all security holders of the class of
    securities subject to the tender offer ” (the all holders rule)
  2. “The consideration paid to any security holder pursuant to the
    tender offer is the highest consideration paid to any other security holder during
    such tender offer” (the best price rule)

Many (but not all) courts in the US have taken the view that the best-price
rule applies to all integral elements of a tender offer, including employment
compensation and other commercial arrangements that are deemed to be part of
the tender offer, regardless of whether the arrangements are executed and
performed outside of the time that the tender offer formally commences and
expires. The US SEC believes that this interpretation has led many acquirers
to disfavor tender offers in favor of statutory mergers where the best-price
rule is inapplicable.

The SEC is therefore proposing amendments that establish that the best-price
rule applies only to consideration “paid for securities tendered”
instead of “during such tender offer” or “pursuant to such
tender offer”. In addition, the SEC also proposes to introduce a blanket
exemption for employment compensation, severance or other employee benefit arrangements.

The US regulations have always been fatally flawed because they provide
almost no protection to minority shareholders in two step takeovers where
large shareholders are bought at a high price and then other shareholders are
bought out in a tender offer at a lower price. The best price rule looks only
at price paid in the tender offer and does not look back to the price paid
in transactions prior to the tender offer. Moreover, the ability to use the
statutory mergers instead of tender offers has provided another loophole.
It is strange that instead of plugging these glaring deficiencies in its
regulations, the SEC is proposing to relax whatever little protections
currently exist.

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