Disclosure of mergers and acquisitions

The disclosure regime in the Philippines for corporate mergers and acquisitions is quite murky: aside from the general standards for materiality, it does not address what specific test to follow in making disclosures to the Securities and Exchange Commission (SEC) and the Philippine Stock Exchange (PSE).

In practice, disclosure is made only after the board of the listed company approves the transaction. In the meantime, rumors abound and unusual trading activity of the company’s shares takes place. When queried by the PSE, the company invariably replies that it is unaware of any development that accounts for the unusual trading activity of its shares in the stock market.

In the process, investors sell their shares in the market, only to find out later on that they should have held on to their shares or could have sold them at a much higher price had disclosures been made.

I recall at least one instance where, because of unusual trading in the shares of the target company, we at the PSE published in a newspaper of general circulation a notice to guide the investing public even before an agreement could be reached between the two companies.

Our disclosure people invariably sought my guidance, and at the back of my mind was the case of Basic Inc. v. Levinson, 435 US 224 (1988), which was decided by the US Supreme Court at the height of a merger mania in the United States.

In the Basic case, sometime in 1966 or 1967, Combustion Engineering Inc. expressed interest in acquiring Basic Incorporated, an NYSE-listed company. Combustion shelved the plan because of antitrust concerns. In September 1976, however, Combustion resumed discussions and negotiations with Basic officers and directors regarding the possibility of a merger.

Between 1977 and 1978, in response to increased market activity of its shares in the stock market, Basic made three public statements denying any discussions or negotiations regarding any possible merger with another company.

On Dec. 18, 1978, Basic asked the NYSE to suspend trading in its shares and issued a release stating that it was “approached” by another company concerning the possibility of a merger. On Dec. 19, 1978, Basic’s board endorsed Combustion’s offer of $46 per share for its common stock and, the following day, publicly announced its approval of Combustion’s tender offer for all outstanding shares.

The plaintiffs, who sold their shares after Basic made the first public statement on Oct. 21, 1977, and before the trading suspension on Dec. 18, 1978, sued Basic and its directors for issuing false or misleading statements.

One issue was whether Basic’s public statements were misleading as to a material fact.

To resolve this issue, the court had to determine “standard of materiality applicable to preliminary merger discussions.”

‘Agreement-in-principle’ test

Basic argued that “preliminary merger negotiations do not become material until an “agreement in principle” as to the price and structure of the transaction has been reached between the would-be merger partners.”

The Supreme Court pointed out that the following rationales had been offered over the years to support the “agreement-in-principle” approach:

1.) An investor should not be overwhelmed by excessively detailed and trivial information, and disclosure of the existence of preliminary merger discussions could mislead investors and foster false optimism;

2.) It preserves the confidentiality of merger discussions where earlier disclosure might prejudice the negotiations;

3.) The test provides a usable, bright-line rule for determining when disclosure must be made.

The Supreme Court held that none of the three reasons “purports to explain why drawing the line at agreement-in-principle reflects the significance of the information upon the investor’s decision.”

The court rejected first rationale as it assumes that investors are nitwits, unable to appreciate—even when told—that mergers are risky propositions up until the closing.

The court held that disclosure, and not paternalistic withholding of accurate information, is the policy chosen and expressed by Congress.

The court junked the “secrecy” rationale for being irrelevant to an assessment whether the existence of merger discussions is significant to the trading decision of a reasonable investor.

The court also threw out the “bright-line” rationale, stating that it is “directed at the comfort of corporate managers” and that while it is easier to follow, ease of application alone is not an excuse for ignoring the policy of full disclosure behind the securities laws.

‘Probability/magnitude ’ test

Instead, the Supreme Court adopted the “probability/magnitude” test, emphasizing that “materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information.” In a merger context, materiality depends on the probability that the transaction will be consummated, and its significance to the company, taking note that a merger in which it is bought out is the “most important event that can occur in a small corporation’s life, to wit, its death.”

This standard obviously requires the exercise of judgment in the light of all circumstances and a “fact-specific” inquiry will have to be conducted on a case-to-case basis in assessing the materiality of merger negotiations.

The question, of course, is whether the “probability/magnitude” test should be officially adopted in the Philippines as the appropriate yardstick for the disclosure of corporate mergers and acquisitions.

That is not for me to determine. I am now a legal practitioner and I leave the matter to the SEC and PSE.

(The author, former president and CEO of the Philippine Stock Exchange, is now the co-managing partner and the head of the corporate and special projects department of Accralaw. He may be contacted at [email protected].)