6 June 2000
BY E-MAIL: RULE-COMMENTS@SEC.GOV
Jonathan G. Katz, Esq.
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Dear Mr. Katz:
Re: File No. S7-7-99
This letter supplements our comment letter to the Commission dated July 15, 1999 (the "1999 Letter") relating to the proposed revisions to Rule 3-10 of Regulation S-X (Release No. 33-7649, 34-41118) (the "Proposal"). This supplement updates the Commission on transaction structuring issues in the European leveraged acquisition market, and reiterates our continuing concerns about the potential adverse impact of the Proposal on the flexibility of transaction participants in devising optimal leveraged transaction structures in Europe.
Since the 1999 Letter, the European leveraged acquisition market has continued to grow, with U.S.-based investment banks and merchant banks leading the market. Further growth in the market for these transactions is widely expected as many European countries and large industrial conglomerates in Europe begin to restructure their operations to remain competitive in the global marketplace.
As indicated in the 1999 Letter, these transactions are frequently financed in part through the issuance of "high yield" debt securities, generally in transactions exempt from registration under the Securities Act of 1933, as amended (the "1933 Act") pursuant to Rule 144A and Regulation S thereunder. U.S-based investment banks and their European affiliates are leading the market in structuring these transactions with U.S. and European-based buyout and merchant-banking firms. There has also been expansion of the "buy side" in Europe, as more institutional investment vehicles, including mutual funds, have been established to focus on "high yield" securities issued in the capital markets.
As discussed in the 1999 Letter, one of the key structuring issues in European buyouts has been structural subordination, where the high yield issuer is a holding company of a bank borrower established to effect the acquisition, and where the high yield bondholders rarely benefit from upstream subsidiary guarantees. As a result, in any insolvency proceeding involving the operating subsidiaries, the high yield bondholders will not be creditors, and there is little likelihood that assets of those subsidiaries will be available to distribute to the high yield issuer after the subsidiaries' creditors are satisfied.
At a recent meeting in London sponsored by one of the leading European investors in high yield debt, many investors expressed continuing frustration with the structural subordination generally imposed by senior lenders on high yield bondholders in European buyout structures, as discussed in the 1999 Letter. Among other suggestions, the high yield investors attending this meeting are advising the investment banks and senior lenders that they expect enhanced yields on their investments and other structural concessions in the terms of the notes if the high yield debt continues to be subject to structural subordination.
These investors are pressing senior lenders, buyout sponsors and investment banks to replace structural subordination with contractual subordination, based on the well-established U.S. model for high yield structures where noteholders generally have contractually subordinated upstream guarantees from some or all of the subsidiaries that are borrowers or guarantors of the bank borrowings. As discussed in the 1999 Letter, in the European deals that have included upstream guarantees of high yield notes from operating subsidiaries and bank borrowers, the senior lenders have usually required "standstill" provisions that would delay the effectiveness of the guarantee provisions for an agreed period (generally 120-180 days) and thereby prevent the high yield noteholders from bringing guarantee claims for a specified time period after default on the high yield notes.
The proposing release appears to indicate that, in a U.S.-registered high yield offering, every one of the guarantors that has a "standstill" period before its guarantee becomes effective would be required under the Proposal to file separate audited financial statements reconciled to U.S. GAAP. Very few high yield issuers will be willing to bear such a burden because of the cost and complexity of completing multiple audits with U.S. GAAP reconciliation. The Proposal therefore could have several adverse effects on the growing market for leveraged transactions in Europe, and on the use of the U.S. capital markets to finance those transactions. These adverse effects include:
As discussed in the 1999 Letter, we see no meaningful disclosure rationale for requiring full audited financial statements from guarantors that have "standstill" provisions, while permitting combined footnote disclosure for other subsidiary guarantors under the circumstances contemplated by Rule 3-10 and the Proposal. The Commission has historically shown great sensitivity to the differences between foreign private issuers and domestic issuers, most recently in adopting International Disclosure Standards and amendments to Form 20-F in Release No 33-7745. As suggested in the 1999 Letter, we strongly urge the Commission to permit foreign private issuers to present guarantor financial statement disclosure in the combined footnote presentation format suggested by the Proposal, even if market forces continue to require "standstill" periods before those guarantees become effective.
Please call the undersigned or Gay Bronson of this office at +44-207-710-1000 or John Huber of our Washington, D.C. office at (202) 637-2242 if you would like to discuss the foregoing.
/s/Mark A. Stegemoeller
of LATHAM & WATKINS