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©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - - - - Chapter 2 - - - - - - - - The Legal and Regulatory.

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Presentation on theme: "©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1 - - - - - - - - Chapter 2 - - - - - - - - The Legal and Regulatory."— Presentation transcript:

1 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston Chapter The Legal and Regulatory Framework

2 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2 Federal Securities Law Seven main pieces of federal legislation –Securities Act of 1933 –Securities Exchange Act of 1934 –Public Utility Holding Company Act of 1935 –Trust Indenture Act of 1939 –Investment Company Act of 1940 –Investment Advisers Act of 1940 –Securities Investor Protection Act of 1970

3 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3 More recent developments –Securities Act Amendments of 1975 –Shelf registration (Rule 415) [1982] allows registration of total amount of securities planned over two-year period; actual issuance date(s) chosen by firm according to its needs for funds or to market conditions –Private Securities Litigation Reform Act (1995) –Securities Litigation Uniform Standard Act of 1998

4 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4 Operation of Securities Acts Securities Act of 1933 recording of information Securities Exchange Act of 1934 basis of later amendments applicable to takeover activities

5 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5 Tender Offer Regulation The Williams Act of 1968 Section 13(d) [amended 1970] must file Schedule 13D with SEC within 10 days of acquiring 5% or more of the stock of any public corporation Public tender offer for ownership of more than 5% must file Schedule 14D

6 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6 Acquiring firms must disclose in Schedule 14D-1 intentions/business plans for target Section 14(d)(4)-(7) regulates terms of tender offer Target management as advisors to target shareholders must file Schedule 14D-9 with recommendations Section 14(e) prohibits misrepresentation or deceptive practices in connection with tender offers

7 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7 Insider Trading Three broad categories of insider trading regulation –Rule 10b-5 defines fraud, deceit –Rule 14e-3 insider trading in context of tender offer –Insider Trading Sanctions Act of 1984 more general

8 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8 Traditional insider trading rules –Section 16(a) insiders and 10% owners must report transactions –Section 16(b) can bring suit to return profits of insider trades completed within a six-month period

9 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9 The Racketeer Influenced and Corrupt Organization Act of 1970 (RICO) Requirements: Conspiracy and repeated acts Allows seizure of assets of accused when suit is filed Provides for treble damages for winning plaintiffs

10 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10 Court Cases and SEC Rules Liability under Rule 10b-5 (fraud, deceit) Two principles of insider trading –Illegal for insiders to trade on basis of inside information –Illegal for outsiders to trade on basis of information which they have "misappropriated"

11 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11 Other Disclosure Requirements Notification of stock exchanges of any material development Disclosure of merger talks –Management must inform investors of material developments affecting stock price –Boards may not deny substantive merger talks –Either keep information secret so none leaks or fully disclose accurate information

12 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12 State Regulation of Takeover Activity States are primary regulators of corporate activity Limitation states cannot restrict interstate commerce

13 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13 State legislation –Illinois antitakeover law [1982] struck down as too favorable to target management over shareholders, bidders –Indiana act [1987] upheld that majority of shareholders must approve transfer of voting rights –New York/New Jersey act five-year moratorium on second-step transactions –Delaware law [1988] three-year moratorium on second-step transactions

14 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14 Rationale to permit more considered response to two-tier and partial tender offers Antitakeover laws have negative effects on share prices of firms Laws should balance shareholder protection and competition between bidders vs. discouraging "abusive" takeovers

15 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15 Antitrust Policy Antitrust regulations reflect two opposing views –Merger activity as anticompetitive –Merger activity as an expression of competitive processes Main regulatory bodies –Department of Justice (DOJ) –Federal Trade Commission (FTC)

16 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16 Antitrust Statutes Sherman Act of 1980 –Section 1 prohibits mergers that would tend to create monopoly or market control –Section 2 directed against firms that have already become dominant in the view of the government

17 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17 Clayton Act of 1914 –Original Act Created the Federal Trade Commission (FTC) Section 5 Gives FTC power to prevent firms from engaging in harmful business practices Section 7 Illegal for a company to acquire the stock of another company if competition could be adversely affected Loophole companies circumvent by using asset acquisitions

18 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 18 –1950 amendment Federal Trade Commission (FTC) has power to block asset purchases as well as stock purchases Incipiency doctrine FTC could block mergers if it judges there is a tendency toward increased concentration

19 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 19 Hart-Scott-Rodino Act of 1976 –Title I Department of Justice (DOJ) has power to issue civil investigative demands (CIDs) in antitrust investigation

20 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 20 –Title II premerger notification provision Applies to acquiring firms with sales or assets of $100 million or more and acquired firms with sales or assets of $10 million or more, or vice versa Information submitted to DOJ and FTC to determine legality Thirty-day waiting period for mergers and 15 days for tender offers Either agency may request 20-day extension of waiting period for mergers and 10 days for tender offers

21 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 21 –Title III Parens Patriae Act Each state is the parent or protector of consumers and competitors State attorneys general are given power to initiate triple damage suits State itself does not need to be injured by violation

22 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22 Antitrust Guidelines Merger guidelines of 1968 –Mechanical application of concentration tests –Antitrust could be triggered if share of the top four firms exceeded 10-20%

23 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23 Merger guidelines of 1982 and later years –Quantitative test shifted to Herfindahl- Hirschman Index (HHI) Concentration measure based on the sum of the squared market shares of each firm in the industry

24 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24 Examples –10 firms each with 10% market share: HHI = 10 (10 2 ) = 1,000 –10 firms each with 1% market share, 1 firm with 90%: HHI = (1) = 8,110 Critical concentration levels: –HHI less than 1,000 no challenge –Postmerger HHI between 1,000 and 1,800 investigation if HHI increased by 100 –Postmerger HHI more than 1,800 challenge if HHI increased by 50

25 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25 –Theory that high concentration results in tacit collusion is invalid because: Product differences heterogeneity Frequency of quality changes Frequency of new products Technological changes Contract complexities and variations Cost differences among suppliers

26 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 26 Nonhorizontal mergers less likely to cause competitive problems State antitrust activity –Increased power of states granted by Hart- Scott-Rodino Act of 1976 –National Association of Attorneys General (NAAG) active in lawsuits

27 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27 Private Antitrust Suits Business competitors have strong influence on antitrust policy Business firms can sue other firms under antitrust laws Private antitrust suits may be used as blackmail

28 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28 Regulatory Bodies Railroads –Surface Transportation Board (STB) established in 1995 –STB replaced Interstate Commerce Commission –STB must file notices to DOJ

29 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29 Commercial banks –Agencies Comptroller of the Currency national banks Board of Governors of the Federal Reserve System state banks Federal Deposit Insurance Corporation (FDIC) –Bank mergers subject to Section 7 of Clayton Act of 1914 Clayton Act modified by the Bank Merger Act of 1966 Attorney General has 30 days to challenge any merger approved by one of the three agencies

30 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30 Telecommunications –Federal Communications Commission (FCC) –Mergers are subject to FCC review, but FCC defers to DOJ and FTC

31 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31 International Antitrust International Competition Policy Advisory Committee recommends explicit antitrust policies United Kingdom –Director General of Office of Fair Trading –Secretary of State for Trade and Industry –Monopolies and Mergers Commission

32 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 32 Japan –Japanese government has 30 days (can extend by 60 days) to review transaction –Review not required in stock for stock deals Europe –Premerger notification to Minister of Competition of European Union –European Union renders decision within five months

33 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 33 Regulation by Publicity Pressure on government regulators to limit and penalize use of junk bonds Managers feared their use in takeovers Junk bonds fulfill several beneficial roles –Finance the takeover of underperforming firms –Fill financing gap for new risky growth firms –Use in takeovers lead to value enhancement for shareholders

34 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34 Illustrative Examples of Application of HHI 1a. Assume an industry dominated by a single large firm which controls 50% of the market. The remaining 50% of the market is controlled by five firms each with a 10% market share.

35 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35 What is the 4-firm concentration ratio? = 80% What is the HHI? 1(50) 2 + 5(10) 2 = 2, = 3,000 Whatever the measure of concentration, this market would be classified as highly concentrated.

36 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston b. Now suppose that two of the smaller firms in this industry merge. What would be the effect on the 4-firm concentration ratio? = 90% What would be the effect on the HHI? 1(50) 2 + 1(20) 2 + 3(10) 2 = 2, = 3,200

37 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37 Both measures of concentration have increased. The market was already highly concentrated, and the increase in the HHI is 200 points. A challenge of the merger between two of the smaller firms would occur based on the HHI tests.

38 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston c. Suppose that the merger in 1b increases the ability of the merged firm to compete with the dominant firm. For example, suppose the merged firm is able to take away 10% of the market from the larger firm.

39 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 39 What is the effect of this on the 4-firm concentration ratio? = 90% (no change from 1b) What is the effect on HHI? 1(40) 2 + 1(30) 2 + 3(10) 2 = 1, = 2,800

40 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 40 The HHI has declined by 400 points, reflecting reduction in market share of the dominant firm.

41 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston a. Now consider an unconcentrated industry (defined in the 1982 merger guidelines as an industry with an HHI below 1,000). Twenty-five firms in an industry each have a market share of 4%.

42 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 42 What is the 4-firm concentration ratio? = 16% What is the HHI? 25(4) 2 = 400

43 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston b. Two of the firms in the industry propose to merge. What is the effect on the 4-firm concentration ratio? = 20% What is the effect on the HHI? 23(4) 2 + 1(8) 2 = = 432

44 ©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 44 Using the 4-firm ratio, antitrust action might be taken. Using the HHI, the industry would still be classified as unconcentrated.


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