Reaction to Steven M. Davidoff’s Article:
“The SEC and the Failure of Federal Takeover Regulation”
By: Robert Bruner
A. Introduction
Professor Steven M. Davidoff from Ohio State University published an article
discussing how the SEC has become dormant in the area of takeover regulation since the
late 1980’s.1 The paper begins with a historical look at the SEC’s pre-1990 involvement
in promulgating takeover law along with supervising and regulating takeovers. Davidoff
evaluates the SEC’s actions decade by decade and tells the story about how this
patchwork of federal regulations was created in response to different situations that arose.
The article then turns to the SEC’s post-1990 disappearance as a takeover regulator and
how the Delaware courts have become the nation’s primary takeover regulator.
This article makes a compelling argument for the SEC to revise their outdated
takeover regulations and reengage in this area of regulation. This call to arms was mostly
directed at lawyers and politicians who are charged with setting SEC policy and looking
out for the best interests of the investing public. Less persuasive was Davidoff’s
argument that future SEC involvement in takeover regulation would create a
“competitive” environment between the SEC and the Delaware courts, which would
promote shareholder interests. In response, it is arguable whether increased shareholder
choice would benefit the takeover market. Also, the two regulatory bodies operate in
different regulatory spheres, with the SEC regulating disclosure and the Delaware courts
deciding corporate governance issues. For these reasons, there may not be strong
“competition” between the two. Instead, I would posit that a duopoly with the two
regulatory bodies working together would create optimal regulations by regulating in
their distinct areas of expertise.
B. American Takeover Law Pre-1990
From the 1960’s to the 1990’s there was a sharp increase in the number of hostile
takeover attempts, and SEC was a significant regulator of the takeover issues that arose
from these situations. The only enacted legislation, however, was the Williams Act,
which both substantively and procedurally regulated tender offers.2 The Act was created
to respond to the perceived abuses of the time, and required disclosure as well as
establishing other rules regarding tender offers. Other than the Williams Act, federal
takeover regulation was largely piecemeal legislation that was narrowly tailored by the
SEC to address distinct issues and abuses.
After the SEC passed regulations curbing abuses with cash tender offers, new
issues and abuses began to arise in the late 1970’s with going-private transactions. The
Delaware courts used their decisions to remedy these issues and, additionally, the SEC
adopted rules in response to abuses that still lingered. This example of the SEC and
1
Delaware courts working in tandem to address abuses in the market is what I would
advocate for the future of takeover regulation.
The 1980’s saw another wave of takeover activity with the creation of “junk
bonds” that allowed corporate raiders to embark on hostile takeovers. This wave was
different, however, since targets were now equipped with takeover defenses, like poison
pills, that had been upheld by Delaware courts. Though the SEC did not affirmatively act
during this time, they were increasingly vocal about their views. The Delaware courts
were left to create the laws, but Davidoff argues that they were threatened by possible
SEC preemption of their decisions. From this competitive atmosphere, Davidoff argues,
the Delaware courts crafted their best decisions, Unocal and Revlon.3 I would argue,
however, that the SEC as an active regulator, coupled with the Delaware court decisions
created these effective takeover laws. This duopoly of the SEC and the Delaware courts
did not last, however, and after 1990 the SEC became silent on the issue of takeover
regulation.
C. American Takeover Law Post-1900
After examining the formation of the takeover law until 1989, where the SEC
acted alongside Delaware courts in creating the takeover standards, Davidoff turns to the
current state of takeover law. First, Davidoff discusses the SEC’s noted absence from
this area after 1990. Then, the article looks at how the Delaware courts have filled this
regulatory void and have shifted the structure of takeover regulation.
1. The Absence of Federal Takeover Laws
From 1990 through the present day, the SEC has rarely adopted new domestic
takeover rules. Further, the SEC no longer publicly comments on the current takeover
issues. Even when the SEC was not enacting new regulations, these public comments
helped to guide SEC policy and give feedback to other regulators, like the Delaware
courts. This disappearance of the SEC left the Delaware courts as the nation’s primary
takeover regulator, since most other states simply toe the line drawn by Delaware.
2. The Pro-Management Delaware Court Decisions
Since the departure of the SEC, the Delaware courts have shifted the structure of
takeover regulation in four different areas. First, takeover standards first articulated in
Unocal and Revlon have been restricted in the subsequent Delaware court decisions
Paramount v. Time and Paramount v. QVC.4 These decisions essentially eliminated
stock-for-stock acquisition transactions from review under Revlon’s higher standard, and
the result is that stock-for-stock “mergers of equals” is now the main form of M&A
transactions in the US.
Second, since the SEC’s disappearance, Delaware courts have relaxed their
review of takeover defenses adopted by management. In this post-Time/QVC world,
except in a change of control context, anti-takeover and transaction defenses adopted by a
2
target board do not implicate Revlon and are not subject to strict scrutiny.5 Further, the
Time decision restricted Unocal’s review of a board’s defensive actions and have upheld
a “just say no” defense as a reasonable takeover response.6 The Delaware courts further
relaxed review under the Unocal standard of review in Unitrin, which provided target
boards with even wider latitude in adopting takeover defenses.7
Third, Delaware courts have asserted their influence over transaction defenses,
which place a termination fee on a transaction and effectively gives an advantage to the
target board’s favored acquirer. Though Omnicare placed limits on the ability of a
majority stockholder to adopt these transaction defenses, they are still widely used in
current transactions.8 This is another example of the Delaware courts taking the reigns as
the primary takeover regulator.
Fourth, going-private transactions, which were evaluated under the “entire
fairness” test when the SEC was active regulator of takeovers, are now given almost no
review. In Pure Resources the Delaware courts held that the “entire fairness” standard
was applicable only to merger transactions, not tender offers.9 As long as certain
procedures were followed, going-private transactions through a tender offer will only be
reviewed under the business judgment rule. Under this relaxed standard of review,
approval by a special committee or entire board of the acquire was no longer required.
As a result, going-private transactions now escape any judicial review by using a tender
offer structure.
These relaxed requirements have shifted the law towards management control
over the takeover decision, since management now has the ability to defeat any hostile
bidder by adopting both a poison pill and a staggered board. Davidoff argues that this
“pro-management” shift in the law resulted from the lack of “competition” between the
SEC and the Delaware courts. He argues that this “pro-management” shift in the law
needs to be reversed, and relies on the assumption that the market for corporate control
would benefit from a balancing of shareholder and manager interests.
I am not convinced by Davidoff’s argument, however, since the SEC and
Delaware courts traditionally regulate different areas of the law, so it is arguable whether
this lack of “competition” was the reason for this shift. Also, there is empirical evidence
that shows the highest levels of innovation result from takeover laws that effectively
deter takeovers, which is the current state of Delaware takeover law.10 Finally, this new
standard may actually be beneficial to the M&A market, since the number and size of
transactions have skyrocketed in the aftermath of this shift. Therefore, I would push for
SEC review of the macro effects of the current takeover standard in order to evaluate
whether it truly has negative effects on the M&A market.
D. Possible Changes to Takeover Law
In response to Davidoff’s prior arguments, it is clear that the only federal
legislation on takeovers, the Williams Act, is now outdated due to substantial changes in
today’s takeover environment. Further, the SEC regulations are also in need of revision,
3
in order to keep their application relevant in todays market. The SEC must reengage as
an active takeover regulator to keep these revisions from quickly becoming outdated. I
would push for SEC review of these rule changes every four years in order to make sure
they have not become outdated. Finally, the SEC and Delaware courts usually regulate
different aspects of takeover law, and I think that a duopoly would best protect the
investing public by streamlining the takeover laws to maximize efficiency and effectively
curb abuses.
1. Potential SEC Amendments to the Williams Act
The article next turns to different SEC regulations that could be deleted or
amended in order to better function in the current takeover environment. The minimum
offer period for a full tender offer is currently set by the SEC at twenty business days.11
The poison pill, however, didn’t exist when this rule was made. The poison pill requires
a hostile bidder to go through a time consuming proxy contest if the target board doesn’t
consent to the proposed transaction. Therefore, the poison pill now effectively precludes
unsolicited, coercive offers that this regulation was originally trying to remedy. Since the
original rationale underlying the rule no longer exists, I agree with Davidoff’s argument
that the SEC should remove this restriction.
Next, the article points out another SEC rule that may need to be reevaluated.
Federal regulations currently prohibit bidder purchases outside of a tender offer from the
time of announcement until completion.12 The primary reason for barring these
purchases was that they disadvantaged security holders who could not withdrawal their
securities to take advantage of higher market prices. Now, however, bidders are
obligated to offer unlimited withdrawal rights throughout the offer period.13 The
coercive and abusive bidder tactics that the rule was trying to remedy are no longer
feasible today due to poison pills and some state anti-takeover statutes. Further, recent
research has shown that these purchases should be encouraged, so the SEC should
consider loosening the restrictions on bidder toeholds and post-announcement purchases.
Finally, the takeover environment has changed, and there are areas where the
federal rules are silent but the potential for abuse abounds. For example, the federal
going-private rules do not apply if stock is offered, instead of cash, as consideration.14
The original reason for this exception was that the protections of the going-private rules
were unnecessary, since the stockholder continues to maintain an interest in the surviving
company. However, the possible abuses in a going-private transaction remain, regardless
of the type of consideration. Further, the possibility for abuses is even greater now, in the
wake of the Delaware court’s decision in Pure Resources, since an acquirer can now
side-step both federal and state requirements for going-private transactions. Additionally,
the safeguard of dissenters’ rights is usually unavailable in stock-for-stock going private
transactions. Therefore, I believe that the SEC should amend the federal going-private
rules and have them apply to stock-for-stock going-private transactions in order to
prevent and mitigate abusive practices that may occur.
2. Potential SEC Amendments to the Federal Takeover Structure
4
Davidoff next argues that the shifting legal and structural landscape has rendered
the fundamental structure of federal takeover regulation obsolete. One structural problem
that could be remedied is the disconnect in the federal regulation of tender offers and
mergers. This occurred since the activity regulated by the SEC before 1990 was mainly
tender offers. The emergence of the poison pill, however, has rendered this federal
regulatory bias moot, since a proxy contest is now the only viable way for a hostile
bidder to acquire a target. Delaware law, however, favors target bidders in proxy
contests to the possible detriment of stockholder choice, since a staggered board
combined with a poison pill effectively prevents a hostile takeover. In effect, this creates
a law that favors mergers and essentially prevents hostile takeovers. The SEC has not
acted to revise these federal takeover rules in response to this shift in the law favoring
mergers over tender offers. Therefore, I believe that the regulatory bias against tender
offers should be repealed, and the revised federal regulations should harmonize the
divergent standards.
Federal takeover law has traditionally distinguished between tender offers and
mergers in setting the scope and manner of its regulations. Some examples of this are the
timing advantage tender offers have over mergers. Tender offers currently have a
minimum offer period of twenty business days, while there is a two to three month
minimum period to complete a merger. The federal disclosure requirements in mergers
and tender offers also diverge, with increased or lessened disclosure required for each.
The rational for this distinction, the possibility of a hostile takeover, is no longer viable in
today’s takeover environment. Thus, I don't think there is still any reason to treat tender
offers and mergers differently, so the federal regulations should be updated to harmonize
these two regulatory structures. This change would help to promote merger activity as
well as decreasing the bias against tender offers.
3. Possible New Areas of SEC Regulation
The current federal takeover laws need to be revised, but there are also emerging
and lingering issues that need to be addressed by the SEC. Change in control
compensation is one area ripe for SEC action. Abuses can occur when, after a takeover,
the officers and other executives of the acquired company are compensated
disproportionally more than their stockholders. The Delaware courts and other potential
regulators have refused to confront this issue, and the SEC has not addressed it in any
substantive manner. However, the large sums of money involved, the public outcry
against excessive executive compensation, and the possible bias that these payments
inject into the takeover system make this issue ripe for SEC investigation, study, and
possibly even substantive or procedural rulemaking.
Though there is a strong debate over the benefits and drawbacks of change of
control compensation, I would argue that the SEC should conduct further research on
whether this compensation promotes stockholder value. Managers should be
compensated based on the value they create for stockholders, which is shown by the
widespread use of incentive based compensation. The SEC should, at a minimum,
5
require disclosure of this compensation. This would be similar to the recent say-on-pay
disclosure that is now required, so it should not be an excessive burden on regulators or
companies to implement.
Due diligence by prospective and actual acquirers is another area that is lightly
regulated, but raises complex issues that may require SEC action. The first issue involves
bidder equality. Current federal takeover laws have no rules on information equality
given to prospective bidders. As a result, target boards can discriminate among bidders
in providing them information. The second issue is stockholder equality. Regulation FD
prohibits selective disclosure, but it does not apply to bidder due diligence. Therefore, a
prospective bidder receives an informational advantage over the market when they obtain
access to a target’s nonpublic information during the due diligence period. The third
issue is raised after an acquirer receives nonpublic information during this due diligence
period and the acquisition has been completed. The acquirer must comply with the
federal securities law antifraud disclosure requirements, but the SEC has not created
specific disclosure requirements for the nonpublic information acquired during the due
diligence process. Thus, projections relied on by acquirers are often not disclosed or are
disclosed in a summarized and rarely useful form.
I would argue that the SEC should promote merger activity by requiring
information equality to all prospective bidders. Second, the SEC should promote
efficient markets by applying Regulation FD to bidder due diligence, but not until the
transaction has been finalized. A bidder should not have to disclose their findings during
the negotiation process, since it would hurt their bargaining power and would give other
parties the research to allow them to bid at the eleventh hour and steal the catch. After
the takeover has taken place, the market should have access to the bidder’s findings in
order to prevent informational advantages. Finally, the SEC should further promote
efficient markets by requiring disclose, after the takeover is complete, of the projections
and other nonpublic information that were material in the acquirer’s decision to purchase.
These changes would promote merger activity and efficient markets without placing
barriers on takeover activity.
4. Reaction to Increased Regulatory Competition by Delaware Courts
Issues that were previously regulated by the SEC are now primarily, if not
entirely, regulated by the Delaware courts. Further, the position taken by the Delaware
courts has shifted since the disappearance of the SEC as a takeover regulator. Davidoff
argues that the Delaware courts have set takeover standards and allowed takeover
defenses in order to circumscribe stockholder protection and choice. The article argues
that “the national takeover code structured by the Delaware courts in the SEC absence is
not an optimal one for the nation and is adverse not only to the congressional intent
underlying federal securities regulation but is also contrary to the SEC’s congressional
mandated role in the regulation of takeovers.”
I would agree that duopoly, between the SEC and Delaware courts, would lead to
greater investor protection and more efficient regulations. However, the SEC regulations
6
mostly deal with disclosure, while the Delaware courts regulate the nature and range of
board decisions. Thus, the two, acting together, create better regulations due to the
distinct nature of their sphere of influence. These divergent regulatory schemes do not
support Davidoff’s argument that there is strong “competition” between the two.
Therefore, in response to this article, I believe that SEC oversight coupled with the
Delaware courts can have a beneficial effect on the US takeover market, though not
through the “competition” that Davidoff advocates.
E. Conclusion
This article needs to find its way into the hands of politicians in order to spur SEC
review of federal regulations and reengage the SEC as an active takeover regulator. It is
evident from Davidoff’s arguments that federal takeover regulations are outdated given
the current takeover market and the shift in takeover laws. Though the SEC is short on
resources, it is important that the takeover laws are updated to promote the M&A market
which is crucial to the economic recovery our country is desperate for.
Also, though it is true that “competition is the mother of innovation,” the SEC and
the Delaware courts may be better suited to work together, rather than in competition, to
regulate takeovers, since they have different areas of regulatory expertise. Though
Davidoff argues that “competition” between the two would shift the law towards
shareholder interests, I am not convinced that this is best for the takeover market.
Therefore, the federal takeover regulations need to be updated and a duopoly between an
active SEC and the Delaware courts is best suited to keep these revisions up to date and
craft economically beneficial regulations in the future.
7
Endnotes
1
Steven M. Davidoff, The SEC and the Failure of Federal Takeover Regulation, 34 FLA.
ST. U. L. REV. 211, 211 (2007) available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=927858 [hereinafter Davidoff].
2
Williams Act, Pub. L. No. 90-439, 82 Stat. 454 (1968).
3
See Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 949 (1985); Revlon, Inc. v.
MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 175 (1986).
See Paramount Commc’ns., Inc. v. Time Inc., 571 A.2d 1140, 1142 (1989); Paramount
Commc’ns. Inc. v. QVC Network Inc., 637 A.2d 34, 36 (1993).
4
5
See id.
6
See Paramount Commc’ns., Inc. v. Time Inc., 571 A.2d 1140, 1142 (1989).
7
See Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1366 (1995).
8
See Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914, 918 (2003).
9
See In re Pure Resources, Inc., 808 A.2d 421, 423 (2002).
10
See Haresh Sapra, Ajay Subramanian & Krishnamurthy Subramanian, Corporate
Governance and Innovation: Theory and Evidence, J. OF FIN. AND QUANTITATIVE
ANALYSIS, Feb. 1, 2013, available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2210609 (arguing that there is a Ushaped relation between innovation and external takeover pressure, which arises from the
interaction between expected takeover premia and private benefits of control) [hereinafter
Sapra].
11
17 C.F.R. § 240.14e-1(a) (1980).
12
17 C.F.R. § 230.14e-5 (2006).
13
17 C.F.R. § 230.14d-7.
14
17 C.F.R. § 230.13e-3(g)(2).
8