American Bankers Association
Financial Services Roundtable
The New York Clearing House Association L.L.C.
February 18, 2003
Jonathan G. Katz, Secretary,
Securities and Exchange Commission,
450 Fifth Street, NW,
Washington, D.C. 20549-0609.
Re: Proposed Amendments to Rule 10b-18: File No. S7-50-02
Dear Mr. Katz:
The American Bankers Association, the Financial Services Roundtable and The New York Clearing House Association L.L.C. (the "Clearing House") appreciate the opportunity to comment on the Securities and Exchange Commission's proposed revision of its Rule 10b-18 (the "Proposal").* 67 Fed. Reg. 77594 (Dec. 18, 2002). Our comments focus on a single proposed revision -- an expansion of the "blackout" period for the Rule 10b-18 safe harbor to cover the entire period from the time of the announcement of a merger, acquisition or similar transaction until its completion.
Although the Proposal refers to this revision as "mak[ing the extent of the blackout period] clear", the revision would actually represent a substantial expansion of the duration of the blackout period. 67 Fed. Reg. at 77597. For the reasons set forth below, we believe that this expanded limitation of the Rule 10b-18 safe harbor is unnecessary for the protection of investors, particularly in light of the enhanced disclosure regime contemplated by the Proposal, and will have a negative impact on banking organizations and other companies in consolidating industries, their shareholders and the markets. (
In this letter, we have used the term "blackout period" because issuers generally do not make repurchases unless they are in compliance with Rule 10b-18. Although styled a "nonexclusive" safe harbor, the Rule is usually followed as if it were an actual requirement.
The U.S. banking industry was highly fragmented for many years as a result of rigid geographic limitations and various other statutes, regulations and policies that restricted competition. The elimination or liberalization of these restrictions and economic considerations have resulted in, and continue to result in, significant consolidation in the banking industry. Between 1980 and 2001, it is estimated that there were over 4600 mergers in the industry involving almost $800 billion in consideration.
In large part because of regulatory capital considerations, the vast majority of bank mergers utilize stock as the form of consideration. The resultant registration/proxy review process with the Commission often takes considerable time, in large part because of the comprehensive reports that banking organizations file with the Commission. Preparation of a draft registration/proxy statement frequently requires 30 days or more. If there is Commission review, the review process often takes more than 30 days. The typical proxy solicitation period is 30-35 days. The combination of these three processes means that the total period from announcement of a bank merger until the shareholder vote generally ranges from 95-120 days.
In a regulated industry such as banking, the period from announcement until consummation will often extend beyond even 120 days. The regulatory review process, which for bank mergers includes a mandatory 15-30 day waiting period even after federal regulatory approval is received, can delay the closing of a merger until 150-180 days after announcement -- particularly if divestitures are required or specific regulatory issues arise.
These time periods are likely to be significantly increased in the event of a hostile proposal made into an announced transaction. Experience indicates that a hostile proposal will delay both the SEC review and the regulatory approval process.
Consequently, the Proposal will effectively force many banks to eliminate stock buy-back programs for very substantial periods of time. That consequence alone is of great concern to our member banks. The potential negative impact of the Proposal is, however, even more severe than suggested by an analysis of individual transactions. A number of banks engage in a series of sequential acquisitions, and, as a result, they would be almost continuously blacked out of the safe harbor. For these institutions, the Proposal would not mean occasional interruptions in the availability of the 10b-18 safe harbor. Rather, it would mean that the safe harbor is only occasionally available and that the ultimate consequence of the Proposal is the loss of the safe harbor for companies pursuing an acquisition strategy.
2. Protection of Investors: General.
Rule 10b-18 has been in effect for over 20 years. During that period, we are not aware of any suggestion that the repurchase blackout period imposed under the former Rule 10b-6 and Regulation M, which applies during only the actual proxy solicitation process, has harmed investors.( This is the period during which actual investment decisions regarding the transaction are being made.
The Proposal would nonetheless apply a blackout period "during the [entire] period from the time of the public announcement of the merger . . . until the completion of such transaction." The Proposal's rationale for this major revision -- in the absence of any demonstrated abuse -- is that "[o]nce a merger or acquisition is announced, an issuer has considerable incentive to support or raise the price of its stock". 67 Fed. Reg. at 77597.
With all due respect, we believe that the Proposal's basic premise is invalid. As the Proposal recognizes, "an issuer has a strong interest in the market performance of securities", and this continuously exists. 67 Fed. Reg. at 77594. This is true not only for the reasons enumerated in the Proposal, but because of the many other tangible and intangible benefits that a strong stock price provides. These benefits exist even if the company has no interest in acquisitions or is actually interested in being acquired.
Indeed, even in the case of acquirors, they may often have as a great, if not greater, interest in their stock price before a transaction is announced than afterwards. Although a strong price is important in the aftermath of an announcement if there is a serious risk of rejection by shareholders, that risk is only occasionally present. The more significant risk to a potential acquiror is that its stock price will not be sufficiently high to provide an attractive offer to potential targets.
It should also be recognized that prolonged blackout periods for Rule 10b-18 could create significant market distortions during non-blackout periods. In order to take advantage of the many legitimate reasons for stock repurchases, issuers would need to crowd their repurchases into the limited non-blackout periods rather than spreading them out over normal market cycles.
In considering the question of investor protection, we believe that the Commission's approach in Regulation M is directly relevant. In Regulation M, the Commission concluded that the risk of manipulation by an issuer is of sufficient magnitude to require an exclusion only during the proxy solicitation period. Conversely, the Commission has determined that any risk of manipulation that may exist at other times during the pendency of the transaction is insufficient to justify keeping the issuer out of the market. Given the similarity of the policy goals underlying Regulation M and Rule 10b-18, we do not understand why Rule 10b-18 should be revised to be much more restrictive in its duration. Indeed, there is an argument that Rule 10b-18 can be less restrictive because it imposes price, time, volume and manner restrictions. (
3. Investor Protection: Proposed Disclosure.
The basic theme underlying the federal securities laws is that investors and the markets are, as a general rule, best protected by full and fair disclosure, with specific restrictions necessary only in those limited cases where the risk of manipulation cannot be adequately compensated for by disclosure. We believe that the Commission should not depart from this basic theme here.
The Commission proposes additional disclosure requirements with respect to stock repurchases on Form 10-Qs. If the Commission is concerned that this is not sufficient, the registration/proxy statement could also contain disclosure about the repurchases so that shareholders can evaluate the impact of these repurchases prior to their vote.
4. Harm to Issuers and Stockholders.
As the Proposal notes, there are "many legitimate business reasons" (emphasis added) for issuers to repurchase their stock. 67 Fed. Reg. at 77594. Some of those reasons relate to the general welfare of the company, such as share availability for benefit programs and reductions in shares following cash sales of businesses. Others relate directly to shareholders, such as returns of capital and liquidity. If, absent clearly compelling reasons, these legitimate business reasons are choked off by artificial restraints such as prolonged 10b-18 blackout periods, issuers and their stockholders will suffer.
Issuers are best able to fulfill these legitimate business objectives, and benefit their stockholders, if they can repurchase their stock when they believe that it is at a relatively low price and thereby represents a particularly attractive option in relation to other possible uses of cash. An issuer may believe that its stock is relatively low because of general market conditions or because of specific circumstances relating to the issuer.
Certain of these specific circumstances often occur in a merger situation. Arbitrageurs typically build positions based on the differential between the deal price and the trading price of the acquiree's common stock, and this results in heavy short selling of the acquiror's stock. Concern about mergers in general can often cause virtual reflexive selling by investors upon announcement. The depressant impact on the acquiror's stock from one or both of these two factors creates a very special, even unique, repurchase opportunity. If companies are to be deprived of the opportunity to take advantage of these situations, not only they, but their shareholders, will be disadvantaged. Of particular concern, liquidity will be limited, harming individual shareholders who are unable to move as promptly as arbitrageurs and institutional investors.
5. Harm to Issuers and Stockholders: Specific Example.
One example of the harm that would be created for issuers and stockholders is the negative impact of the 10b-18 blackout on a frequently used type of transaction structure. In a number of transactions, the acquiree's stockholders are insistent upon a tax-free transaction, but the acquiror believes that a straight stock merger will be unduly dilutive. Both objectives can be satisfied by a structure in which the acquiror will offer stock to the acquiree and will announce and engage in a stock buyback program for an amount of stock equivalent to the amount of stock being issued. In such a structure, the acquiror may be relatively indifferent to the price of its stock because a lower price would enable it to repurchase its stock more cheaply.
If, however, the acquiror is blocked out from stock repurchases throughout the entire course of the merger process, the resultant loss of flexibility may make this structure unduly risky and consequently unattractive to the potential acquiror.
6. Hostile Acquisitions.
In situations involving hostile bids into agreed mergers, the Proposal could substantially tip the balance in favor of the hostile bidder. If both the acquiror in the agreed merger and the hostile bidder are offering stock as the consideration, the hostile bidder, but not the agreed acquiror, would apparently be permitted to continue to repurchase its stock within the Rule 10b-18 safe harbor. Yet, both parties would have an equal incentive to maintain their stock price at a high level.
This competitive disadvantage cannot be remedied by interpreting paragraph (a)(13)(iv) to apply to a hostile bidder that makes a formal offer. A potential hostile suitor could simply say that it was prepared to make an attractive bid for the acquiree if its shareholders rejected the agreed merger or, alternatively, the potential hostile suitor could say that it was considering a bid. In either event, the hostile acquiror could repurchase its stock during the period before a formal hostile offer. More subtly, but perhaps equally effectively, a hostile bidder could purposely not discourage market speculation about a hostile bid while continuing to repurchase its stock.
7. Repurchases Outside the Safe Harbor.
Although the Rule 10b-18 safe harbor is not technically the exclusive means for issuer repurchases, its promulgation and usage for 20 years have made it, for all practical purposes, virtually exclusive. As the Proposal acknowledges, "issuers generally are reluctant to undertake any repurchases without the certainty that their repurchases come within the Rule's safe harbor". 67 Fed. Reg. at 77595. Accordingly, the practical effect of the Commission's Proposal would be to bar all repurchases throughout the entire merger period.
* * * *
In conclusion, we urge the Commission not to adopt a blackout period for Rule 10b-18's safe harbor throughout the entire merger process. The prolonged blackout, which for some issuers will be almost continuous, is not necessary to protect investors and will deprive investors, issuers and the marketplace of the many legitimate and substantial benefits of stock repurchase programs. If the Commission believes that special rules are necessary in the merger context, they should relate to enhanced and more frequent disclosure. Repurchase will still, of course, be subject to the basic requirement that there be no plan or scheme to evade the law or unlawfully manipulate the stock price.
We appreciate your consideration of these comments. If you have any questions, please call Norman Nelson, General Counsel of the Clearing House, at 212-612-9205, James McLaughlin at the American Bankers Association at 202-663-5324 or Richard Whiting at the Financial Services Roundtable at 202-289-4322.
Very truly yours,
- The American Bankers Association is the largest banking trade association in the country.
- The Financial Services Roundtable represents 100 of the largest integrated financial services companies providing banking, insurance, and investment products and services to the American consumer.
- The member banks of the Clearing House are: Bank of America, National Association; The Bank of New York; Bank One, National Association; Citibank N.A.; Deutsche Bank Trust Company Americas; Fleet National Bank; HSBC Bank USA; JPMorgan Chase Bank; LaSalle Bank National Association; Wachovia Bank, National Association; and Wells Fargo Bank, National Association.
* See Annex A.
( Although not central to our concern, we also note the potential ambiguity in the Proposal's reference to a "merger, acquisition or similar transaction involving a recapitalization". It is far from clear as to which transactions are covered. For example, are only stock-for-stock transactions included? Is a transaction covered if there is no shareholder vote required? Does the exclusion apply to the stock of the "target" company?
( See paragraph (3) of the definition of "restricted period" in Rule 100 of Regulation M. See also Staff Legal Bulletin No. 9, Frequently Asked Questions About Regulation M (revised April 12, 2002).
( Indeed, we believe that even the current rule deprives stockholders, issuers and the markets of the "many legitimate reasons" for stock repurchases (discussed below) for an overly long period. Particularly if there are enhanced disclosure requirements, we believe that serious consideration should be given to restricting the Rule 10b-18 blackout, and the related Regulation M restriction, to a one-week period immediately before the scheduled shareholder vote.