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Going Private Demands Transparency

08.26.15

A public company might choose to go private for the tax and accounting advantages, to reduce compliance costs, or to focus on long-term goals rather than satisfying Wall Street’s demand for short-term profits. Whatever the reasons, it’s important to handle going-private transactions with care.

Important Requirements

Among other requirements, a company that’s going private — together with its controlling shareholders and other affiliates — must file detailed disclosures pursuant to SEC Rule 13e-3. The SEC allows a public company to deregister its equity securities when they’re held by fewer than 300 shareholders of record, or fewer than 500 shareholders of record if the company doesn’t have significant assets.

Depending on the facts and circumstances, a company may no longer be required to file periodic reports with the SEC once the number of shareholders of record drops below the above thresholds.

Critical Disclosures

Going private is nearly as complex as going public, and the SEC scrutinizes such transactions to ensure that unaffiliated shareholders are treated fairly. To comply with SEC Rule 13e-3 and Schedule 13E-3, companies must disclose:

  • The purposes of the transaction (including any alternatives considered and the reasons they were rejected),
  • The fairness of the transaction, both substantive (price) and procedural, and
  • Any reports, opinions and appraisals “materially related” to the transaction.

Failure to act with the utmost fairness and transparency can bring harsh consequences. The SEC’s rules are intended to protect shareholders, and some states even have takeover statutes to provide shareholders with dissenters’ rights. Such a transition results in a limited trading market to be able to sell the stock.

Case In Point

Revlon, Inc. and its controlling shareholder, MacAndrews & Forbes Holdings Inc. (M&F), decided to go private in 2009 as a way to address the company’s liquidity needs in light of a $107 million loan — payable by Revlon to M&F — that would soon mature. Initially, M&F proposed a mandatory merger that would have taken Revlon private. The company’s independent board members formed a special committee to evaluate the merger proposal. But after a financial advisor retained by the board determined that the proposal wasn’t financially fair to the company and its minority shareholders, the proposal was scrapped.

Later the same year, M&F asked Revlon’s independent board members to consider a voluntary exchange offer under terms that were similar to those of the merger proposal. The company’s minority shareholders would exchange their common stock for newly issued preferred shares, and M&F would receive the surrendered common shares in exchange for reducing debt on the $107 million loan.

A small percentage of minority shareholders had invested in Revlon stock through the company’s 401(k) plan. In connection with the transaction, the trustee that administered the plan informed the company that, under the Employee Retirement Income Security Act (ERISA), the trustee couldn’t allow these shareholders to tender their shares absent an opinion from an independent financial advisor that the transaction provided “adequate consideration” to 401(k) participants.

The advisor retained by the trustee determined that the transaction didn’t provide adequate consideration. But Revlon had taken steps to “ring-fence” this determination. The company kept itself and the independent board members in the dark as to the advisor’s conclusions regarding adequate consideration. Of course, Revlon could infer those conclusions from the fact that the trustee refused to honor the 401(k) participants’ tender instructions.

The SEC found that Revlon’s disclosures in connection with the going-private transaction — in particular the disclosure that its independent directors had determined the transaction was fair to the company and its shareholders — were materially misleading to the minority shareholders. In a settlement with the SEC in June 2013, Revlon agreed to pay a penalty of $850,000 and to cease and desist from further violations of the going private rules under Sec. 13(e) of the Exchange Act. In addition to the SEC settlement, the company paid out more than $30 million to aggrieved investors.

Handle With Care

In light of cases like Revlon’s, companies that pursue going-private transactions should exercise extreme caution. To withstand SEC scrutiny and avoid lawsuits, it’s critical to structure these transactions in a manner that ensures transparency, procedural fairness and a fair price.

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