This digression will be familiar to California lawyers,but maybe a little foreign for others. When doing a deal for stock, it is key that the stock be registered withthe SEC so that recipients can freely trade it. This entails the time and expense of filing an S-4 with the SEC andgoing through rounds of comments before the registration statement becomeseffective and the stock can then be traded. That means months of additional delay. But, if the goal is to use stockthat can be freely traded the day after the transaction closes, registrationisn’t the only option.
Pursuantto Section 3(a)(10)there is a valid exemption from the registration requirement for any securitiesthat have been issued in exchange for other securities where the terms and conditionsof such exchange have been approved after a fairness hearing by a court ofgovernmental authority. At such ahearing (which must be open to shareholders), the reviewer must find that theterms and conditions of the exchange are fair (both procedurally and substantively)to those to whom securities will be issued; and must be advisedbefore the hearing that the issuer will rely on the Section 3(a)(10) exemptionbased on the reviewer’s approval of the transaction. The SEC’s most recent staff interpretation ofthe rules relating to 3(a)(10) fairness hearings can be found here.
TheCalifornia Department of Corporations is authorized under California law toconduct fairness hearings (CCC:25142). Such hearings are conductedby officers of the Department in both San Francisco and Los Angeles. The Department of Corporations reports doingsome 423 fairness hearingsover the past ten years, with the bulk occurring during the dot com bubble whenstock ruled as consideration.
ALthough the reliance on fairness hearings has declined recently, the fairness hearing is not entirely a product of the bubble. It was used by Aruba Networks in theiracquisition of Airwave last year. The application as well as the hearingtranscript are available through the CALEASI database here. The merger agreement is unfortunately notincluded in the materials made available online.
Thehearing took place less than two months after the deal was signed – so about amonth faster than an S-4 process. Theexpense was also likely considerably less – no late nights at the printer andno lengthy comment letters before the hearing. However, there was a hearing and it was more than just a check the boxexercise. If you take a look at thetranscript of the hearing, you’ll see that the hearing officer spends a lot oftime on procedure, but then delves into the substance of the transaction. Here’s a sample of his questioning of the buyerand counsel:
Q: Let’s discuss the economic terms ofthe merger. What was the purchase pricethat the parties agreed on?
A: Gross level of 37 million.
Q: Okay, how was that determined?
A: So we went through an economicanalysis. We looked at if we were tobring this in-house, where would the revenues come from. So we looked at what revenues could Airwavecontribute. We looked at selling theAirwave product with the Aruba product. What that would generate. We looked at selling their technology intoour install base; and then the reverse, selling their technology into ourinstall base….
Q: And how is the purchase price going tobe paid?
A: It’s a mixture of cash and stock.
Q: Okay, What’s the appropriate mix?
A: So we ended up at 45% cash and 55%stock.
Q: And was the agreement amended toreflect that ratio?
A: Yes, it was. We started at 35% cash and incremented thatto 45 as one of the amendments.
Q: Why was that change made?
A: So, there has been a decrease in ourshare price. Partly just bymacroeconomics, partly we’re in a high tech basket. We had downward pressure on it.
and so on…
Although in the current deal environment, there aren’t manytransactions getting done for stock at some point when things turn around thefairness hearing may make a come-back. In any event, it’s worth keeping the fairnesshearing in one’s tool-kit of potential solutions.
-bjmq
UPDATE: Steven Davidoff at The Deal Professor notes that pursuant to a 1999 staff interpretation that a foreign scheme of arrangement can qualify for the 3(a)(10) exemption.