Enforcement Division Acts on Disclosure Rules in Control Contests

SEC HQs 2Exchange Act Rule 14d-9 is a tender offer rule that requires an issuer who is subject to an offer to file its response to the tender offer with the SEC on Schedule 14D-9. Prior to last month, the SEC had used Rule 14d-9 only once in more than 20 years as the basis for an enforcement action. That pace has certainly picked up, as the Enforcement Division brought and settled two Rule 14d-9 cases in the last four weeks. The Commission also filed and settled enforcement actions based on the ownership disclosure requirements under Exchange Act Sections 13(d) and 16(a).

In January 2017, Allergan agreed to pay $15 million to settle SEC charges that it failed to properly disclose talks with potentially friendly merger partners after rejecting a hostile tender offer in its Schedule 14d-9. This week, the SEC charged that CVR Energy Inc., a fuel refiner and marketer, failed to adequately disclose “success fee” arrangements the issuer made with two investment banks retained by the company to fend off a hostile takeover bid that resulted in payments to the banks of nearly $36 million.

It is not unusual for a company to agree to pay success fees to an investment bank in an attempt to align the bank’s interests with those of the company. It is unusual, however, for “success” to be defined so broadly as to include the failure to produce a white knight investor or to prevent the hostile acquisition of the issuer by the tender offeror at a price considered by the issuer to be “woefully inadequate.” According to the SEC, due to the potential conflicts of interest created by the payment arrangements, CVR should have disclosed the fee agreements in greater detail in its Schedule 14d-9.

Information about the fee structure was material, alleged the SEC, because the banks’ fees increased dramatically if the company was sold, regardless of whether the sale price was deemed by the board to be adequate, whether the banks succeeded in defending against the activist bid or whether the banks were successful in causing the activist to raise his bid. In a typical case, banks receive success fees in tender offer situations only when the banks’ services result in the shareholders retaining their shares or obtaining appropriate value for their shares through a tender offer or other sale of the company.

CVR fared far better than Allergan in the penalty department, however. Unlike the $15 million penalty imposed on Allergan, the SEC did not require CVR to pay a penalty.  The Commission did not impose a civil penalty on CVR based upon its cooperation in the investigation, but did issue a cease and desist order.

The SEC’s order in the other case settled this week found that investor groups failed to properly disclose their ownership interests during five campaigns to influence or exert control over microcap companies. In its order, the SEC found that the required ownership filings to disclose ownership information to the investing public "were either incomplete, untimely, or altogether absent."

According to the SEC, two individual investors, Jeffrey E. Eberwein and Charles M. Gillman, collaborated with Heartland Advisors, a mutual fund adviser, Lone Star Value Management, a hedge fund adviser headed by Eberwein and a private fund advised by Gillman, Boston Avenue Capital. The investors regularly failed to either file a Schedule 13D or to completely and accurately disclose their ownership interests as required by Exchange Act Section 13(d). Several of the investors also failed to comply with the 10-percent ownership disclosure requirements under Exchange Act Section 16(a).

Without admitting or denying the findings, all respondents consented to the SEC’s order and agreed to a cease and desist order. The SEC also imposed penalties of $90,000 on Eberwein, $30,000 on Gillman, $120,000 on Lone Star Value Management, and $180,000 on Heartland Advisors. Boston Avenue Capital did not receive a civil penalty.

As described by Gerald Hodgkins, associate director of the Enforcement Division, “full, fair, and accurate disclosures from all parties in a battle for corporate influence or control are critically important to investors particularly when they are called upon to make decisions about their investments.” He added that “investors in these companies were deprived of key facts needed to make informed investment decisions.”

It is too early to determine whether the division’s use of these disclosure provisions indicates the beginning of a trend toward heightened disclosure enforcement. This is particularly true given that the Commission will eventually have a majority of commissioners appointed by President Trump. It is certainly safe for companies engaged in control contests to assume for now, however, that their shareholders are not the only ones closely scrutinizing their tender offer and ownership disclosures.