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Morrison & Foerster LLP Capital Markets

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Morrison & Foerster LLP Capital Markets 4 Contents

Liability Management Overview 7

Summary of Options 35

Liability Management Continuum 39

Cash Debt Tenders 41

An Overview and Summary of No-Action Advice

More on 3(a)(9) 57

Tender and Guidance 69

Recent Tax Developments 85

Rating Agency Materials 91

5 Morrison & Foerster LLP Capital Markets

liability management overview

7 Morrison & Foerster LLP Capital Markets Liability Management: is now the time to rebalance your balance sheet?

We really do live in interesting times. Over the last debt exchanges registered with the Securities and two years, most Americans have come to reduce or Exchange Commission (the “SEC”) and subject to defer personal expenditures of one kind or another. the tender offer rules. Homeowners are sharply focused on the burden of mortgage payments, and record numbers of leased One-off exchanges automobiles are showing up back at the dealerships. In • Exchanges involving non-debt securities – short, Americans are rethinking and restructuring their exchanges of securities that are subject to the personal balance sheets. Some by choice and others tender offer rules. out of necessity. It’s essentially the same for issuers. Thinking hard about balance sheet restructuring We also discuss related matters such as consent has become an imperative for a large proportion of solicitations, both on a standalone basis and as “exit issuers in the United States. The following discussion consents” in connection with an exchange offer. highlights a number of balance sheet restructuring approaches on which issuers currently are focused. Why consider repurchases, exchanges or Repurchases for cash tenders? • Redemptions – a purchase of outstanding debt New business and market realities. With the securities for cash in accordance with the terms of prolonged financial crisis resulting in market the ; volatility, declining prices, ratings downgrades, asset write downs and modified earnings projections, • Repurchases – opportunistic repurchases of debt this is the time for an issuer to recalibrate its debt/ securities for cash, including privately negotiated equity mix. and open market repurchases; and Deleveraging efficiently. Many debt securities and • Tender offers – offers made to all bondholders to hybrids are trading at significant discounts. An issuer repurchase outstanding debt securities for cash. may be able to effect an efficient repurchase/tender given market conditions—optimize its balance sheet, Tenders not involving cash reduce its interest expense, etc. Exchange offers, including: Tax considerations. Recent changes to the tax laws • Private exchange offers – unregistered debt-for- facilitate the repurchase of debt securities. debt exchanges pursuant to Section 4(2), usually Investor perceptions. Investors may be more willing made to qualified institutional buyers (“QIBs”) as to consider exchange and restructuring opportunities. defined under Rule 144A under the Securities Act Investors may seek liquidity or appreciate the of 1933, as amended (the “Securities Act”), and opportunity to move up in the . non-U.S. persons under Regulation S; • Section 3(a)(9) exempt exchange offers – exempt debt for debt exchanges; and Tax considerations • Registered exchange offers – public debt for Each restructuring transaction we discuss herein

Morrison & Foerster LLP Capital Markets 8 may have federal income tax consequences. We to COD income in the Code may be unavailable. discuss below the general tax considerations Special rules apply to pass-through entities, such as applicable to these transactions as well as provide a partnerships. more specific discussion of the tax consequences for With respect to the AHYDO provisions, the Recovery each transaction. Act suspends these rules for AHYDOs issued in exchange for non-AHYDOs of the same Issuers between August 31, 2008 and January 1, 2010. The Central to the tax considerations for an issuer Recovery Act grants the Treasury the authority to restructuring its debt is the potential recognition of extend the suspension and also expands the Treasury’s cancellation-of-indebtedness (“COD”) income. Under ability to adjust the base rates used to determine the Internal Revenue Code (the “Code”), taxpayers whether an instrument is an AHYDO. The suspension with outstanding debt are often subject to tax on COD does not apply to certain obligations with contingent income when all or a portion of such debt has been interest determined, among other things, by reference economically cancelled unless special exceptions apply to the income, value or dividends of the debtor (or (for example, in the event of bankruptcy or insolvency a related person), nor does the suspension apply to of the taxpayer). In addition, corporations that issue obligations issued to related persons. obligations with original issue discount (“OID”) as part of their restructuring also must consider potential Debtholders limitations on the deductibility of such discount. For In part, the tax consequences to debtholders depend on corporations that issue certain high-yield obligations whether the restructuring constitutes a “” with significant OID (“AHYDOs”), a portion of such within the meaning of Section 368(a)(1)(E) of the Code. discount is treated as a nondeductible dividend under Generally, debt exchanges involving debt securities Section 163(e)(5) of the Code, while the remaining with terms longer than five years will qualify as discount may not be deducted until actually paid. . On the other hand, a repurchase Issuers should be aware that the American Recovery of debt securities will result in gain or loss to the and Reinvestment Act of 2009 (the “Recovery Act”), debtholder equal to the difference between the amount signed into law on February 17, 2009, provides of cash received and the holder’s adjusted tax basis temporary relief from these COD and AHYDO in the debt security. If the holder acquired the debt rules. Generally, these provisions should make the security with market discount, a portion of any gain refinancing and restructuring of existing corporate may be characterized as ordinary income. debt more attractive. With respect to COD income, at the election of the taxpayer, the Recovery Act defers the recognition of Repurchases for Cash such income in connection with certain repurchases, modifications, and exchanges (referred to as Redemptions “reacquisitions”) of debt instruments after December 31, 2008 and before January 1, 2011. For reacquisitions An issuer may redeem its outstanding debt securities in 2009, the deferral is five years; for reacquisitions in in accordance with their terms, assuming that the debt 2010, the deferral is four years. At the end of the deferral securities do not prohibit redemption. A credit line period, the taxpayer must include the COD income may prohibit prepayment; the debt securities may have ratably over the next five years. Among other things, absolute call protection and may not be redeemable. the deferral applies only to the debt of C corporations, An issuer also may find that other debt securities and in the case of all other taxpayers, trade or business have limited call protection, and may be redeemable debts. Original issue discount on certain new debt following expiration of a certain period of time after instruments issued as part of, or in connection with, the issuance, often five or ten years. Specific kinds of debt reacquisition will not be deductible during the deferral securities also may be more or less likely to contain period but will be deductible during the period in redemption provisions—for instance, zero coupon which deferred COD income is recognized. The death bonds generally are not by their terms redeemable. of, liquidation of, or other similar event with respect to, a taxpayer will accelerate deferred COD income. Contractual and other approvals If a taxpayer elects deferral, other possible exceptions Prior to deciding to redeem outstanding debt securities,

9 Morrison & Foerster LLP Capital Markets an issuer must ensure that the redemption is permitted, debt securities, an issuer also must ensure that it has not just under the terms of the debt security in question, complied with securities law antifraud provisions. In but also under the issuer’s other debt instruments. Many particular, if in the offering documents an issuer has not credit agreements limit an issuer’s ability to redeem adequately disclosed, for instance, that a specific series other outstanding debt. The usual areas of concern of debt securities may be redeemed, the issuer may be include definitions of, and restrictions on, “permitted liable under Rule 10b-5 of the Securities Exchange Act indebtedness,” “permitted refinancings,” “permitted of 1934, as amended (the “Exchange Act”) for material liens” and “restricted payments,” as well as covenants misstatements or omissions in the prospectus as they 1 regarding incurrence of indebtedness. An issuer should relate to the redemption. review carefully its existing debt instruments to ensure As we discuss above, the terms of the indenture typically that a redemption is permitted and that a redemption will require the issuer to distribute a redemption would not trigger repayment obligations. There also notice. In connection with delivery of this notice, an may be other, non-financial agreements, such as lease issuer often will announce via press release that it has agreements or even acquisition agreements, that may decided to redeem the debt securities in accordance affect an issuer’s ability to redeem its securities. In with their terms. An issuer should publicly disclose addition, redemption may require prior approval by a redemption, to the extent that its broader impact on the issuer’s board of directors. an issuer’s financial condition would be viewed as The process for redeeming an outstanding debt security material, prior to contacting debtholders. We discuss is spelled out in the instrument governing the debt disclosure considerations below. security, usually the indenture. Typically, an issuer must give holders not more than 60 and not less than Privately negotiated and open market 30 days’ prior notice of redemption. This notice also debt repurchases may require that the issuer include other information, An issuer that has cash, or can obtain it quickly, may such as the redemption price, the redemption date, determine that a privately negotiated or open market and identify the securities (if not all) which are being repurchase (or repurchases) of its debt securities is an selected for redemption. If not all of the securities efficient use of capital. In the context of a debt repurchase, are being redeemed, the securities will be redeemed an issuer also will need to review the terms of all of its either on a pro rata basis or by lot; the process usually is outstanding debt instruments and other securities to determined by the trustee. determine that repurchases are permissible. The terms of the indenture will not dictate the purchase price The terms of the debt securities, which were negotiated payable by an issuer in connection with repurchases. at the time of issuance, usually will specify the As a result, an issuer may (and should) negotiate the redemption price. The redemption price typically purchase price with securityholders in order to achieve will reflect the holders’ “yield to maturity” on the the best possible pricing. outstanding debt securities and debtholders will be made whole. The price typically will equal the face amount of the debt security, plus the present value of How to choose among the various options? future interest payments. The effect of this is that the Legal, accounting, ratings, regulatory capital and tax debt securities will be redeemed at a premium. For considerations should all be factored into the choice. issuers with limited cash on hand, redemption may not be a viable option. In addition, as we discuss Cash? If the issuer has cash on hand, open market above, an issuer is required to provide at least 30 days’ repurchases or a tender will be possible. prior notice of redemption. If the issuer announces a No cash? If the issuer does not have cash on hand, or redemption on fixed rate debt securities, it runs the risk a repurchase would not be considered a prudent use of that the proceeds it intends to use for the redemption, resources, an issuer should consider an exchange. which at the time the notice was issued were at a lower cost, may have increased, and may even increase above Holders? The issuer will have to consider whether the the redemption cost. securities are widely held and the status (retail versus

Disclosure and other considerations 1 Harris v. Union Electric Co., 787 F. 2d 355 (8th Cir. 1986), cert. In connection with any redemption of outstanding denied, 479 U.S. 823 (1986).

Morrison & Foerster LLP Capital Markets 10 institutional) of the holders. able to increase its Tier 1 capital levels by doing so. Buying back a whole class of debt securities? Open An issuer often may engage a financial intermediary market repurchases will provide only selective or to effect open market repurchases. This entity usually limited relief. A tender may be necessary to buy all of will be the same entity that acted as an underwriter a class of outstanding bonds. for the initial issuance of the debt securities because the investment bank’s sales force will have better Straight debt? Convertible debt? Hybrid? The knowledge regarding the secondary market for issuer’s options will depend on the structure of the the issuer’s debt securities, including the most outstanding security. A repurchase/tender for straight appropriate pricing. The financial intermediary will debt typically will be more streamlined. be able to contact holders and easily negotiate the Tender? Again, the structure and rating of the terms of the transaction. outstanding security will drive whether the issuer can conduct a fixed spread or fixed price offer. Regulation FD Covenants? Is the issuer concerned about ongoing In connection with a privately negotiated or open covenants as well as de-leveraging? market repurchase, an issuer needs to ensure that it complies with all applicable laws, including those Part of a broader effort? The issuer should consider enacted under the Securities Act and the Exchange whether a buyback is only a precursor to a restructuring Act. Among other things, these rules and regulations or recapitalization or whether an exchange offer/ affect the information that an issuer must provide to its tender is only one element of a bigger process. The securityholders in connection with debt repurchases. issuer should keep the bigger picture in mind. Private negotiations with creditors, including Mix and match? Well, not really. It may be possible to debtholders, can trigger disclosure or other obligations structure a variety of transactions. However, an issuer under Regulation FD. In particular, concerns may arise should be careful to structure any liability management when an issuer conducts discussions with one or more transactions carefully. Open market repurchases in bondholder or lender groups to “test the waters” with contemplation of a tender may be problematic. respect to a particular repurchase plan. Regulation FD provides, subject to certain exceptions, that whenever an issuer, or any person acting on its behalf, Benefits of a debt repurchase such as a financial adviser, discloses any material nonpublic information regarding that issuer or its Repurchases may be conducted with little advance securities to market professionals or holders of the preparation, they require limited or no documentation issuer’s securities who may trade on the basis of such and generally can be conducted for little cost to the issuer information, the issuer shall make public disclosure (outside of the purchase price). Privately negotiated and of that information either simultaneously, in the case open market purchases usually are most effective if the of an intentional disclosure, or “promptly,” in the issuer is seeking only to repurchase a small percentage case of a non-intentional disclosure. In the context of of an outstanding series of debt securities, or if the class privately negotiated repurchases, the fact that an issuer of debt securities is held by a limited number of holders. is conducting these repurchases may be considered Repurchases may be conducted in a number of different material nonpublic information in and of itself. A ways – the issuer may negotiate the purchase price repurchase that is part of a restructuring, because of directly with securityholders; the issuer may purchase its broader impact on an issuer’s financial condition the debt securities on the secondary market; the and in many circumstances, its ability to operate, may issuer may engage a financial intermediary to identify be viewed as material. Disclosure of the repurchases holders, negotiate with holders and repurchase the to a debtholder may trigger a disclosure obligation on debt securities; or the issuer may agree with a financial the issuer’s part. However, the issuer may avoid the intermediary to repurchase debt securities that the obligation to disclose such information if the person financial intermediary purchases on a principal basis. If that receives the information is either under a duty of the issuer’s debt securities are trading at a discount, a trust or confidentiality or such person expressly agrees repurchase will be efficient. An issuer that repurchases to keep the information confidential. An issuer should its debt securities at a discount and cancels the debt consider whether to use a confidentiality agreement. securities will be able to improve its overall capital position. For a financial institution, the issuer may be An issuer also should consider when it will disclose

11 Morrison & Foerster LLP Capital Markets information regarding a repurchase to the public. If the be accomplished by filing a Current Report on Form 8-K. issuer engages in private repurchases over time, it may In addition, if an issuer engages in privately negotiated not be appropriate to disclose each repurchase until the or open market repurchases in advance of conducting process ends. Similarly, negotiations over the terms of a tender offer, it may be considered manipulative – the a restructuring (including a tender or exchange offer) issuer will have prior knowledge of its intention to may take time or may ultimately be fruitless. In those commence a tender that it did not disclose to holders cases, debtholders may object to being kept out of the from whom it is purchasing. market for such an extended time, and may negotiate a specific time or event by which disclosure must be Regulation M and other considerations made public by the issuer or a determination made Although Regulation M does not apply to investment that the information is no longer material or current grade non-convertible debt securities, it does apply for any reason, including because of the occurrence of to equity securities, non-investment grade and superseding events. convertible debt securities. An issuer that is engaged An issuer should consider the benefits of disclosing, in a distribution while effecting a repurchase program either in general terms or specific terms, its restructuring must ensure that it complies with Regulation M. Rule goals, and giving up some negotiating flexibility 102 under Regulation M makes it unlawful for an for disclosure protection. The issuer may consider issuer or its affiliates “to bid for, purchase, or attempt announcing the program (if there is to induce any person to bid for or purchase, a covered a program, as opposed to opportunistic repurchases) security during the applicable restricted period.” This prohibition is intended to prevent an issuer with a press release and file the release as an exhibit from manipulating the price of its securities when to a Current Report on Form 8-K. The issuer may the issuer is about to commence or is engaged in a disclose its intentions in a periodic report, such as in its distribution. A distribution may be deemed to take Annual Report on Form 10-K or a Quarterly Report on place in connection with a proxy mailing. In addition, Form 10-Q. However, this may raise concerns about issues under Regulation M arise when an issuer a “tender,” which we discuss below. The disclosure uses the proceeds from a new offering to repurchase need not be very detailed and may simply state that outstanding debt securities. The new offering may the issuer will repurchase its debt securities in the be a distribution under Regulation M and any open market or in privately negotiated transactions if purchases under the buyback may be prohibited. An market conditions . More specific disclosure issue also arises if the debt repurchases are for debt may be problematic. securities that are convertible into the issuer’s equity An issuer also should take care to avoid entering into securities. Under certain circumstances, repurchases discussions with debtholders that may rise to the of convertible debt securities could be deemed a level of an “offer” under the securities laws. If this forced conversion and, therefore, a “distribution” occurs, the “offer” must: qualify as a bona fide private of the underlying equity security for purposes of offer; be registered with the SEC, or be exempt from Regulation M. the registration requirements of the Securities Act by virtue of Section 3(a)(9). Avoiding the tender offer rules An issuer repurchasing its debt securities, either in Prior public disclosure privately negotiated transactions or in open market To avoid violating the antifraud provisions of the purchases runs the risk that it may inadvertently trigger federal securities laws, particularly Rule 10b-5 under the the tender offer rules. The tender offer rules were Exchange Act, by purchasing a security and/or issuing adopted to ensure that issuers, and others, tendering for a security at a time when the issuer has not disclosed equity securities would be prohibited from engaging material nonpublic information, whether or not related in manipulative practices in respect of those tenders. to the repurchase, the issuer should plan to disclose all With equity securities, in particular, the market price is material nonpublic information in advance. Examples subject to manipulation as it fluctuates based on market of material information include unreleased earnings or pressures. However, debt securities are not subject to the an unannounced merger, both of which may need to be same considerations as equity securities and, therefore, disclosed before purchasing securities from a debtholder. a debt tender poses less risk than one for equity. For a This can usually be done in an Annual Report on Form debt tender, it is possible to structure the purchases to 10-K or a Quarterly Report on Form 10-Q but may also avoid the application of these rules.

Morrison & Foerster LLP Capital Markets 12 Section 14(e) of the Exchange Act does not define no pressure for holders to sell), and prices should be “tender offer.” Without a clear definition from the privately, and individually, negotiated with each holder, SEC, courts have provided a set of eight factors to with offers that are independent of one another. help differentiate between a tender offer and other public solicitations. The eight-part test (and the case implementing that test) involved equity securities. How can an issuer benefit from a repurchase It is likely, though, that any discussion on debt or exchange of debt securities? securities and tender offers would begin with the eight characteristics listed below. An issuer considering an • Perception. A buy back may signal that an issuer open market or privately negotiated repurchase of its has a positive outlook. debt securities should review carefully the impact of • Deleveraging. the eight factors and structure the transaction to avoid • Recording of accounting gains if securities are the tender offer rules. Courts have found the following repurchased at a discount to par. The issuer will eight characteristics typical of a tender offer: have to consider the structure of its buyback, 1. active and widespread solicitation of public exchange or tender. shareholders for the shares of an issuer; • Reducing interest expense. 2. solicitation is made for a substantial percentage of • Potential EPS improvement. the issuer’s stock; • Potential regulatory and ratings benefits. 3. offer to purchase is made at a premium over the prevailing market price; • Alternative to more fundamental restructuring or potential bankruptcy. 4. terms of the offer are firm rather than negotiable; 5. offer is contingent on the tender of a fixed number of shares, often subject to a fixed maximum Debt tenders number to be purchased; In some cases, privately negotiated or open market 6. offer is open only for a limited period of time; repurchases of debt securities may not provide an 7. offeree is subjected to pressure to sell his stock; and issuer with the desired results, particularly if the 8. public announcements of a purchasing program issuer wishes to retire all or a significant portion concerning the target issuer precede or accompany of a series or class of outstanding debt securities. a rapid accumulation of large amounts of the Privately negotiated or open market purchases may target issuer’s securities.2 not be efficient for an issuer if the debt securities are widely held or the issuer plans a simultaneous These elements need not all be present for a transaction consent solicitation. In those situations, a tender to constitute a tender offer, and the weight given to offer may be the most appropriate way to restructure each element varies with the individual facts and the indebtedness. A tender offer allows an issuer to circumstances.3 To ensure that a debt repurchase does approach or make an offer to all of the holders of a not trigger application of these rules, it should be made series of its debt securities. Because tender offers for a limited amount of securities and to a limited do not have to close until specified (and disclosed) number of holders, preferably sophisticated investors, conditions are satisfied (including receipt of consents should be made over an extended period of time (with from the debtholders to modify the terms of the debt securities that remain outstanding, completion of any 2 Wellman v. Dickinson, 475 F. Supp. 783, 823–24 (S.D.N.Y. 1979). necessary financing for the tender offer and receipt of other necessary consents from third parties), it may 3 For example, an open-market purchase of 25% of an issuer’s stock was held not to constitute a tender offer because: (1) the purchaser be possible to conduct a tender offer and achieve the contacted only six of the 22,800 securityholders; (2) all six of those issuer’s objectives. securityholders were highly sophisticated; (3) the purchasers did not pressure the securityholders in any way that the tender offer rules were Cash tenders for straight debt securities designed to prevent; (4) the purchasers did not publicize the offer; (5) the purchasers did not pay a significant premium; (6) the purchasers Cash tender offers for straight debt securities may be did not require a minimum number of shares or percentage of stock; and (7) the purchasers did not set a time limit for the offer. Hanson completed more quickly and at a lower cost than other Trust PLC v. SMC Corp., 774 F. 2d 47, 57–59 (2d Cir. 1985). tenders because of the absence of specific disclosure or

13 Morrison & Foerster LLP Capital Markets structuring requirements. In a cash tender for straight announcement must disclose the approximate debt securities, an issuer typically will mail tender number of securities tendered to date.6 offer materials to holders describing the terms of the • Prompt Payment – The offeror must either offer and providing them with material information. pay the consideration offered or return the An issuer often will announce the commencement securities tendered promptly after termination or of a tender offer in a press release, and may even withdrawal, respectively, of the offer. supplement that announcement by publishing notice of the tender in a nationally circulated newspaper. Under Regulation 14E, an issuer is not required to file tender offer documents with the SEC and the rules do not Certain rules apply to tender offers. These rules were prescribe any form requirements. Any offer to purchase, adopted in 1968 and are referred to collectively as the and other tender offer documentation, is subject to Williams Act. Regulation 14E and Rules 14e-1, 14e-2 the general antifraud provisions of the Exchange Act, and 14e-3 under the Exchange Act apply to all tender notably Rule 10b-5 and Section 14(e) and, therefore, may offers – both equity and debt. These rules do not apply not contain any material misstatement or omission. to tenders or exchanges of securities that are exempt securities under Section 3(a) of the Securities Act. In While a cash tender for straight debt securities can be a addition, the SEC has provided no-action guidance that relatively straightforward transaction, if a cash tender limits the applicability of some of these rules to tenders is combined with a consent solicitation, the process of investment grade debt securities. If the tender may become more complicated. Further, because cash involves equity securities (which for purposes of the tender offers for straight debt securities are not subject to tender offer rules includes debt securities with equity the “best price” rules applicable to equity tender offers components, such as convertible or exchangeable notes) (discussed below), it is common practice to encourage additional rules apply. We discuss these rules below participation in the tender by providing for an “early under “Cash tenders for convertible debt securities.” tender premium.” Holders that tender early in the offering period, typically within the first 10 business Rule 14e-1 sets forth certain requirements for tender days, may receive the “total consideration.” Holders offers generally. that tender after the early tender period terminates • Offer Period – Rule 14e-1 provides that a tender will receive lesser consideration for their securities. offer must generally be held open for at least The early tender feature benefits the issuer because it 20 business days from the date the tender offer may have greater visibility regarding the success of the commences.4 The offer must also stay open for tender offer. An issuer needs to be mindful that the at least 10 business days from the date of a notice falling away of the “premium” may, under in certain of an increase or decrease in: (1) the percentage of circumstances, constitute a change in consideration that securities to be acquired pursuant to the tender (if may require that the tender stay open for an additional the change exceeds 2% of the original amount); (2) 10 days as discussed above. the consideration offered, without any de minimis Rule 14e-1 does not specifically require withdrawal rights. exception; or (3) any dealer-manager’s solicitation However, it is standard practice to provide holders with fee, is first published or sent to the holders of the withdrawal rights for tender offers for straight debt relevant securities. A tender offer subject only to securities. These withdrawal rights typically expire after Regulation 14E must remain open for a minimum an initial period, often after the first 10 business days. An of five business days for any other material change issuer also should consider whether it should reinstate 5 to the offer or waiver of a material condition. limited withdrawal rights following the occurrence of • Extension of Offering Period – Rule 14e-1 also any material change in the terms of the tender offer or the provides that any extension of the offer period waiver of a material condition. must be made by a press release or other public Rule 14e-2 requires that the issuer subject to a tender announcement by 9:00 a.m., Eastern time, on the offer disclose to its securityholders its position with next business day after the scheduled expiration respect to the bidder’s tender – whether it recommends date of the offer, and the press release or other it, expresses no opinion or is unable to take a position. Interestingly, Rule 14e-2 does not contain an explicit 4 The date on which the tender offer is first published or sent or given to the holders of the relevant securities is the first business day. 6 If the securities are registered on one or more national securities 5 See SEC Release No. 34-42055 (Oct. 22, 1999), available at http:// exchanges, the announcement must be made by the first opening of any www.sec.gov/rules/final/33-7760.htm. one of such exchanges on the business day following expiration.

Morrison & Foerster LLP Capital Markets 14 exemption for issuer tenders, though the subject issuer and the bidder would be the same entity. It is common Challenges to consider for an issuer to include in its tender offer materials a statement that the issuer makes no recommendation as Holdouts to the tender. The issuer and its advisers should consider how to Rule 14e-3 contains an antifraud prohibition on address potential holdouts—one approach may be to activities of a person conducting a tender offer. If include a high minimum tender or exchange condition such person is in possession of material nonpublic (such as 90% or higher). information that he knows or has reason to know is nonpublic and knows or has reason to know was Timetable acquired from the offering person, the issuer or any of Starting out with a timetable that complies with both its directors, officers or employees, it is unlawful for contractual deadlines and tender offer rules is key to a that person to purchase or sell or cause to be purchased successful process. or sold any of the securities being tendered. In the case of an issuer tender, an issuer must be careful not to Bondholder committees conduct a tender at a time when it possesses material nonpublic information. This information may include A bondholder committee may be helpful in the context unreleased earnings, a potential change in an issuer’s of a broad restructuring or recapitalization. However, credit ratings or an unannounced merger. The issuer the interests of bondholders may not be aligned. should, to avoid any issues, disclose this information For example, the interests of hedge fund holders of prior to commencing a tender offer. convertible debt may not be compatible with the interests of institutional investors that hold straight Pricing considerations debt or hybrid securities. Disagreements among committee members can delay or prevent a successful Typically, in its tender offer documents, an issuer tender or exchange offer. will specify the amount of securities it is seeking to purchase, as well as the price at which it will purchase these securities (or the method, as we discuss below, of calculating the purchase price). However, in Cash tenders for investment grade debt securities some cases, an issuer may specify the amount of The requirements of Regulation 14E may be limiting securities to be tendered, but may set the price using for an issuer conducting a tender offer. Specifically, if a modified “Dutch auction” pricing structure. In an issuer must keep the offer open for 20 business days this structure, the issuer sets a cascading range of or extend the offer period if there are any changes in the prices at which a holder may tender its securities. consideration or percentage sought, it can adversely The purchase price will be the highest price at which affect the tender because the issuer is subject to market the issuer is able to buy all of the securities for risk during this time. Most debt tender offers occur which it has solicited a tender (or a smaller amount, when interest rates are low – the issuer is trying to if not all the securities are tendered). This price is lower its cost of funds by retiring high interest rate debt often referred to the “clearing price.” The SEC has securities with the proceeds from new securities issued permitted tender offers to proceed without the issuer at a lower rate, or a lower-interest rate credit facility. If disclosing this range in the tender offer documents, interest rates decline during the offer period, an issuer so long as the aggregate amount of securities to be will not retire as much debt and if rates increase, the purchased is disclosed (and the range of securities retired debt will come at a higher price. Longer offer to be purchased if the offer were fully subscribed).7 periods translate into increased uncertainty. Usually the permitted price range is very narrow – Because the SEC staff believes that issuer debt tender often no more than 15% of the minimum price. offers for cash for any and all non-convertible, investment grade debt securities may present considerations that differ from any and all or partial issuer tenders for a class or series of equity securities or non-investment grade debt, it consistently has granted relief to issuers of investment grade debt in the context 7 See SEC No-Action Letter, Alliance Semiconductor Corporation (Sep. of tenders for their debt securities. An issuer need not 22, 2006).

15 Morrison & Foerster LLP Capital Markets keep the tender open for 20 business days, provided security as of the date, or date preceding the date, of the following conditions are met:8 tender. This is referred to as a “real-time fixed-spread” tender offer. The SEC imposed the following additional • Offers to purchase were made for any and all of requirements for a real-time fixed spread tender: the investment grade debt, non-convertible debt of a particular series or class; • The offer must clearly indicate the benchmark • The offer is open to all record and beneficial interest rate to be used and must specify the fixed holders of that series or class; spread to be added to that yield; • The offer is conducted so as to afford all record • The offer must state the nominal purchase and beneficial holders of that series or class the price that would have been payable under the reasonable opportunity to participate, including offer based on the applicable reference yield dissemination of the offer on an expedited basis immediately preceding commencement of the in situations where the tender offer is open for a tender offer; period of less than ten calendar days; and • The offer must indicate the reference source to • The tender offer is not being made in anticipation be used during the offer to establish the current of or in response to other tender offers for the benchmark yield; issuer’s securities. • The offer must describe the methodology used to Following these no-action letters, investment grade calculate the purchase price; and debt issuers were no longer subject to the 10- and • The offer must indicate that the current benchmark 20-business day requirements. In 1990, the SEC staff yield and the resulting nominal purchase price expanded this no-action relief for investment grade of the debt securities will be available by calling debt. Salomon Brothers Inc. proposed to conduct a toll-free phone number established by the an offer wherein the issuer would offer to purchase dealer-manager.10 its debt securities from tendering holders at a price With the assistance of counsel, an issuer should be determined on each day during the offer period by able to structure its tender offer for investment grade reference to a fixed spread over the then – current debt securities to fit within existing no-action letter yield on a specified benchmark U.S. Treasury security guidance. Structuring within the guidance will relieve determined as of the date, or a date preceding the issuer of the burden of complying with the 10- and the date, of tender. This is referred to as a “fixed- 20-business day requirements.11 spread” tender offer. In connection with a fixed spread tender, the SEC staff required that the offer We believe the staff’s no-action guidance will have provide that information regarding the benchmark particular importance over the next several years as Treasury security will be reported each day in a financial institutions that have issued debt guaranteed daily newspaper of national circulation and that all by the Federal Deposit Insurance Corporation (the tendering holders of that class will be paid promptly “FDIC”) address the impending maturity dates of for their tendered securities after the securities are those government guaranteed debt securities. Under accepted, within the standard settlement period the terms of the FDIC’s temporary liquidity guarantee (now, three days).9 program, the guarantee must mature no later than June 30, 2012.12 The SEC followed by expanding the breadth of the no-action relief for tenders of investment grade debt securities. This relief applies to tenders for investment grade debt securities for which the nominal purchase price would be calculated by reference to a stated fixed spread over the most current yield on a benchmark U.S. Treasury security determined at the time the holder 10 SEC No-Action Letter, Merrill Lynch, Pierce, Fenner & Smith Inc. tenders, rather than by reference to a benchmark (July 19, 1993). 11 The SEC also has granted no-action relief in the context of preferred and hybrid securities that behave more like debt securities than equity 8 See SEC No-Action Letter, Salomon Brothers Inc. (Mar. 12, 1986); SEC securities. See SEC No-Action Letter, BBVA Privanza International No-Action Letter, Goldman Sachs & Co. (Mar. 26, 1986) and SEC No- Limited and Banco Bilbao Vizcaya Argentaria, S.A. (Dec. 23, 2005). Action Letter, Merrill Lynch, Pierce, Fenner & Smith Inc. (July 2, 1986). 12 However, the FDIC does not permit the proceeds of FDIC- 9 SEC No-Action Letter, Salomon Brothers, Inc. (Oct. 1, 1990). guaranteed debt to repay or redeem non-FDIC guaranteed debt.

Morrison & Foerster LLP Capital Markets 16 the information provided in the Schedule TO A Comparison: Investment Grade v. Non- must be included in an amendment filed with Investment Grade Debt the SEC. Rule 13e-4 also requires that all written communications regarding the tender offer be filed with the SEC.14 By reason of the Schedule TO filing Investment Grade Debt: obligation, the tender offer then becomes subject to • Generally must remain open for 7-10 calendar days; the requirements of Regulation 14D, which governs • Offer must be extended 5 calendar days for certain the form and content of the Schedule TO. modifications to terms; • Offers to all holders – Under Rule 14e-4, generally, • Must be conducted to afford all holders the tender offers must be made to all holders of the reasonable opportunity to participate, including relevant securities. dissemination of the offer material on an expedited • Best price – The consideration paid to any basis (within two days after commencement); and securityholder for securities tendered in the tender • Able to price using a fixed-price spread or a real- offer must be the highest consideration paid to time fixed price spread. any other securityholder for securities tendered in the tender offer. Note that this does not prevent Non-Investment Grade Debt: an issuer from offering holders different types of • Must remain open for 20 business days; consideration as long as the holders are given an equal right to elect among each type of consideration, and • Offer must be extended 10 business days for the highest consideration of each type paid to any certain modifications to terms; and securityholder is paid to any other securityholder • Able to use a fixed-price spread that is set two receiving that type of consideration. days prior to expiration of the exchange offer. • Dissemination – Rule 13e-4 provides alternative methods for disseminating information regarding an issuer tender offer. The most common method Cash tender offers for convertible debt securities of dissemination is to publish a “tombstone” As we discuss above, certain provisions of the Williams advertisement in The Wall Street Journal or other Act, such as Rule 13e-4, are applicable only to tenders daily newspaper with national circulation.15 of equity securities, including tenders of convertible • Withdrawal rights – Rule 13e-4 requires that the tender or exchangeable debt. If an issuer has a class of equity offer permit tendered securities to be withdrawn at any securities registered under the Exchange Act or is time during the period that the tender offer remains open. otherwise reporting under the Exchange Act, tenders for In addition, Rule 13e-4 specifically permits withdrawal a debt security with equity features must comply with after 40 business days from the commencement of the the provisions of Rule 13e-4. The obligation to comply tender offer if the securities have not yet been accepted with these provisions makes tender offers for convertible for payment. or exchangeable debt securities more complicated and time-consuming, and subject the offer to SEC review, • Purchases outside the tender offer – Rule 13e-4(f) which could result in additional time delays. (6) provides that until the expiration of at least 10 business days after the date of termination of We discuss below the principal additional requirements the issuer tender offer, neither the issuer nor any for a tender subject to Rule 13e-4. affiliate shall make any purchases, otherwise than • Filing with the SEC – Rule 13e-4 requires that pursuant to the tender offer, of: (1) any security an issuer file a Schedule TO for a self tender that is the subject of the issuer tender offer, or any for convertible or exchangeable debt securities on the day that such tender offer commences. Schedule TO has a number of specific disclosure provide any comments within the first ten days. requirements; disclosures must be made either 14 Issuers should be sensitive to whether there are written in the Schedule TO itself or in the documentation communications, such as in a press release or a Form 10-K, Form 10-Q or Form 8-K, that are often made in advance of the “commencement” of sent to securityholders. Schedule TOs are subject the tender offer, and that must be filed pursuant to Rule 13e-4(c) – for 13 to review by the SEC, and material changes in example, by “checking the box” on the cover of Form 8-K. 15 The tender offer rules have not been revised or amended to take 13 The SEC, aware of the length of the offer period, will typically into account greater reliance on the Internet.

17 Morrison & Foerster LLP Capital Markets security of the same class and series, or any right to must not only focus on the various considerations purchase any such securities; and (2) in the case of spelled out above, but also must be cautious that its an issuer tender offer that is an exchange offer, any tender does not violate any rules in the home country security being offered pursuant to such exchange of its securityholders. offer, or any security of the same class and series, or In the EU, there are two directives about which an any right to purchase any such security.16 issuer should be concerned. First, The Market Abuse The requirements of Rule 13e-4 result in less flexibility Directive (“MAD”). As its name suggests, MAD is for tenders for convertible or exchangeable debt intended to prevent abuses relating to . securities compared to tenders for straight debt Similar to Regulation FD, MAD requires that an securities. A good illustration of this reduced flexibility issuer announce without delay information directly is that it is not possible for issuers to “sweeten” the concerning it. MAD applies to financial instruments tender offer for convertible or exchangeable debt admitted to trading on a regulated market or for securities with an “early tender premium” as is the which a request for admission to trading has been case for straight debt securities. made. The statute is intended to address insider dealing, market manipulation and the dissemination Accounting and other considerations of false or misleading information. Under MAD, an Convertible or exchangeable debt securities raise issuer should perform an analysis similar to that under special accounting issues and issuers should carefully Regulation FD – is the insider in possession of material consider the accounting aspects of repurchasing their nonpublic information. In the case of a debt tender, the convertible debt before doing so. While some effects terms of the transaction likely were announced, so an (such as the elimination of the retired debt from issuer need only consider whether it possesses other the issuer’s balance sheet) may be more intuitive, information that may be considered material. others may not be. Issuers may wish to consult their In the EU, an issuer need also be mindful of anti- accountants early on, even more so because accounting restrictions contained in Directive 2004/25/ for convertible debt securities has changed recently.17 EC. This directive pertains to takeover bids for the Issuers that intend to restructure their outstanding securities of issuers governed by the laws of a member convertible debt also should consider the effects of state, where all or some of the securities are admitted to such tender on any of their “call spread” transactions trading on a regulated market. A takeover bid means a or share lending agreements. public offer (other than by the offeree issuer itself) made to the holders of securities to acquire all or some of the Special rules for European tenders securities with the objective of acquiring control. Though It may be the case that the holders of an issuer’s debt not directly applicable, the directive provides guidance securities are located in foreign jurisdictions. For that an issuer should follow in conducting a tender for its instance, if an issuer sold its securities pursuant to Rule own securities. In particular, all holders must be treated 144A in the United States and pursuant to Regulation S equally and must have sufficient time and information to outside the United States. Many frequent debt issuers enable them to reach an informed decision. issue and sell their debt securities pursuant to Euro medium-term note programs or market and sell U.S. Regulation M registered securities into the European Union (“EU”) or Although Regulation M does not apply to investment other foreign jurisdictions. For these tenders, an issuer grade non-convertible debt securities, it does apply to equity securities, non-investment grade debt and 16 This requirement is in addition to the prohibition in Rule 14e-5 convertible debt. An issuer that engages in a tender that, with certain exceptions, prohibits “covered persons” from, directly or indirectly, purchasing or arranging to purchase any subject securities offer must ensure that it complies with Regulation M. or any related securities (that is, securities immediately convertible or Rule 102 under Regulation M makes it unlawful for an exchangeable for the subject securities) except as part of the tender issuer or its affiliates “to bid for, purchase, or attempt offer. “Covered persons” include the offeror, its affiliates andthe to induce any person to bid for or purchase, a covered dealer-manager and its affiliates. security during the applicable restricted period.” This 17 Please see our Client Alert, “New FASB Accounting Rules on prohibition is intended to prevent an issuer from Convertible Debt” for a discussion of accounting changes related to convertible debt at http://www.mofo.com/news/updates/files/Client_ manipulating the price of its securities when the issuer Alert_FASB_Accounting.pdf. is about to commence or is engaged in a distribution.

Morrison & Foerster LLP Capital Markets 18 Tax considerations the offer of new securities, it also must comply with, An issuer that repurchases its debt securities at a discount or be exempt from, the registration requirements of the to its adjusted issue price generally will recognize Securities Act. For this reason, documentation for an ordinary COD income in the amount of the discount. exchange offer must be more detailed than that for a This results whether the issuer repurchases the debt cash tender offer and must describe the terms of the securities directly or repurchases the debt securities new securities. In addition, because the exchange through a related party, such as an intermediary. We involves the offer of new securities, participants are discuss certain exceptions to the recognition of COD liable under the antifraud protections of Section 11 of income, including under the Recovery Act above under the Securities Act. To the extent an issuer engages a “Introduction—Tax consideration.” financial intermediary to assist with the solicitation of tenders, that entity may be subject to statutory A debtholder whose debt security is repurchased underwriter liability and will conduct its own diligence by the issuer will recognize gain or loss equal to the review of the issuer and will require delivery of legal difference between the amount of cash received in the opinions and comfort letters. repurchase and the holder’s adjusted tax basis in the debt security. If the holder acquired the debt security An exchange offer may either be exempt from with market discount, a portion of any gain may be registration or registered with the SEC. An issuer characterized as ordinary income. may rely on the exemptions provided under Section 4(2) of the Securities Act or the exemption provided by Section 3(a)(9) of the Securities Act. In addition, an exemption pursuant to Regulation Non-cash Tender Offers S for offers and sales to non-U.S. persons may be available on a standalone basis or combined with other If an issuer does not have or want to use its available applicable securities exemptions. cash resources, an alternative to a cash tender is an exchange offer. In an exchange offer, the issuer offers to exchange a new debt or equity security for its Incentives and disincentives outstanding debt or equity securities. For distressed As we discuss, there are a number of structural considerations issuers, an exchange offer may be the best non- that may create incentives to tender or to tender early. A bankruptcy restructuring option. Exchange offers company should consider the following: enable an issuer to reduce interest payments or cash • Minimum threshold. To discourage holdouts, interest expense (by exchanging debt securities with a as a condition to the tender or exchange, high rate for debt securities with a lower one), reduce require that a substantial percentage (typically the principal amount of outstanding debt (in the case 90% or higher) of the outstanding securities of a debt equity swap), manage its maturity dates (by be tendered. exchanging debt securities that are coming due for debt securities with an extended maturity) and reduce • Sweeteners. Encourage acceptance of the tender or eliminate onerous covenants (if coupled with an or exchange offer by providing a cash payment exit consent). We discuss these alternatives below. or better terms for the new securities. Consider Another benefit to conducting an exchange offer is that offering tendering/exchanging holders an the issuer may “sweeten” the deal by providing a cash inducement in the form of a warrant “kicker” payment to the holder as an inducement to exchange. or common stock (if there is potential for future It is important for issuers to note that a cash tender may upside), or exchanging high coupon, unsecured debt for low coupon, secured debt. In addition, trigger disclosure obligations under the Exchange Act. consider providing recourse to collateral. An issuer may need to file a Form 8-K for a cash tender if, under Item 2.04, the tender may be considered an • Exit consents. Solicit “exit consents” simultaneous acceleration of a financial obligation. with the tender or exchange offer to penalize holdouts (by stripping protective covenants and Securities Act considerations events of default from the old securities). An exchange offer must comply with the tender offer • Early tender premium or consent payment. rules. However, because an exchange offer involves Motivate holders to tender early by establishing an

19 Morrison & Foerster LLP Capital Markets early tender premium or early consent payment. registered exchange. In light of recent amendments to The “best price” rule does not apply to tender and Rule 144 that shortened the holding period for restricted exchange offers for straight debt securities. securities, holders may no longer require an issuer to register their securities issued in the exchange. Under • The bankruptcy threat. In a restructuring, convey the Rule 144 amendments, unaffiliated holders may that bankruptcy is unavoidable if the tender or sell their securities without restriction after a six-month exchange offer fails and that debtholders will be holding period, provided the issuer is a reporting in a better position if bankruptcy is avoided. This company and has current information. Whether involves a delicate balancing act. registration rights are requested may depend on the type of security issued (for instance, holders exchanging equity for debt may want liquidity sooner than holders Regulation M exchanging debt for debt). Rule 144(d)(3)(ii) provides As we discuss above with respect to cash tenders, an that a holder of a security may tack the holding period issuer must be mindful of Regulation M’s prohibitions of the underlying security to its holding period for on bidding for, or purchasing, its securities when it is an exchanged security in certain circumstances. Rule engaged in an offer. If the debt being exchanged is 144(d)(3)(ii) states: “If the securities sold were acquired convertible into the issuer’s equity securities, under from the issuer solely in exchange for other securities certain circumstances, repurchases of convertible debt of the same issuer, the newly acquired securities shall securities could be deemed a forced conversion and, be deemed to have been acquired at the same time as therefore, a “distribution” of the underlying equity the securities surrendered for conversion or exchange, security for Regulation M purposes. even if the securities surrendered were not convertible or exchangeable by their terms.” Private exchange offers An exchange offer may be conducted as a private Section 3(a)(9) exchange offers placement. Because the issuer must structure the Another option is an exchange offer exempt pursuant exchange within the confines of Section 4(2), it to Section 3(a)(9). Section 3(a)(9) of the Securities Act may not engage in a “general solicitation” of its applies to “any securities exchanged by the issuer securityholders. In addition, any offerees must be with its existing securityholders exclusively where no “sophisticated investors.” Typically, if an issuer is commission or other remuneration is paid or given relying on Section 4(2) for its exchange, it will limit directly or indirectly for soliciting such exchange.” its offer only to QIBs as a precaution. To ensure that Section 3(a)(9) has five requirements: the offer restrictions are satisfied, an issuer often will “pre-certify” its holders to ensure that they meet the • Same issuer – the issuer of the old securities requirements (either QIB or accredited investor status). surrendered is the same as the issuer trying to If the issuer has engaged a financial intermediary, this effectuate an exchange of the new securities; entity will identify debtholders and contact them in • No additional consideration from the holder – advance. Often, the financial intermediary will have the securityholder must not be asked to part with certifications on file for the debtholder and verify its anything of value besides the outstanding security; status, or it may obtain the requisite certification on the issuer’s behalf. This typically can be accomplished • Offer only to existing holders – the exchange by requiring that the holder sign a letter confirming must be offered exclusively to the issuer’s existing its status. As with any other restructuring, an issuer securityholders; must ensure that the transaction is permitted under the • No remuneration for solicitation – the issuer governing debt instrument, as well as under its other must not pay any commission or remuneration financial arrangements. for the solicitation of the exchange; and If an issuer conducts a private exchange, the newly • Good faith – the exchange must be in good issued securities will not be freely tradable, as faith and not as a plan to avoid the registration they were issued pursuant to an exemption from requirements of the Securities Act. registration. In the past, an issuer covenanted with the Same issuer holders to register the securities issued in the exchange, either through a resale registration statement or via a Section 3(a)(9) exempts any securities exchanged

Morrison & Foerster LLP Capital Markets 20 by the issuer with “its” securityholders. The SEC at the underlying economic reality when confronted with has interpreted the word “its” to mean that the new an identity of issuer question. There are a number of other securities being issued and the securities that are being no-action letters and other SEC guidance that provide surrendered must originate from a single issuer. While additional interpretation in satisfying the conditions of this concept may seem relatively straight forward, Section 3(a)(9).21 there are a number of scenarios that can complicate an identity of issuer analysis. The SEC has granted no- No additional consideration from the holder action relief in response to facts and circumstances that The term “exclusively” in Section 3(a)(9) refers to the do not fit neatly within the “single issuer” requirement. consideration that securityholders are required to For example, the SEC has granted no-action relief for an exchange. This excludes from the safe harbor of Section exchange of guaranteed debt securities of a subsidiary 3(a)(9) all exchange offers where the holder must give 18 for the securities of the parent issuer guarantor. The up anything other the than old securities. Conversely, SEC concluded that the exchange as a whole involved a an issuer relying on Section 3(a)(9) is free to include single issuer. In its analysis, the SEC first held that as a cash in what it gives to the securityholders. matter of economic reality, the holders of the subsidiary’s securities were in fact holders of the parent issuer’s Rule 149 under the Securities Act provides an exception securities. Next, the SEC placed heavy emphasis on the to the no-cash payment rule “to effect an equitable relationship between the parent issuer and the subsidiary. adjustment, in respect of dividends or interest paid or The subsidiary was established by the parent issuer to payable on the securities involved in the exchange, as issue securities and finance the activities of the parent between such securityholder and other securityholders issuer. The subsidiary had minimal assets and liabilities of the same class accepting the offer of exchange.” An that were tied to the issuance of securities. “In economic example of an equitable adjustment is when, due to the reality, it is the [parent issuer’s] financial position and timing of interest payments and intra-securityholder business prospects and the value of the [parent issuer’s] sales (that is, sales not involving the issuer), one securities to be issued … that will be of interest to investors securityholder may get the benefit of an interest in making their investment decisions.”19 payment due to another securityholder. Should this be the case, the issuer may, in an exchange offer, require In another no-action letter, an issuer transferred its an unjustly enriched securityholder to reimburse the 20 common stock to a trust. The issuer wanted to execute an issuer for an extra interest payment. Section 3(a)(9) exchange whereby the trust would facilitate an exchange does permit an issuer to require that the securityholders of old securities for new ones. The issue was whether the waive the right to receive an interest payment or other issuance by the trust, which is ostensibly a different issuer, consideration accruing from a security.22 would preclude the issuer from relying on Section 3(a)(9). The SEC found this exchange exempt under Section 3(a) Offer only to existing holders (9), finding that the trust was a “special purpose entity Any exchange offer conducted in reliance on Section established for the sole purpose of allowing … investors 3(a)(9) may be made only to existing holders. Though to obtain the economic right in [a security]. The [trust] it appears simple, this requirement can sometimes does not engage in any activities unrelated to this purpose be breached if an issuer is conducting a simultaneous and has no independent financial or economic activity.”

These two no-action letters, which we discuss only for 21 See SEC Division of Corporation Finance, Compliance and Disclosure illustrative purposes, demonstrate that the SEC will look Interpretations: Securities Act Sections, available at http://www.sec. gov/divisions/corpfin/guidance/sasinterp.htm, See SEC Division of Corporation Finance, Compliance and Disclosure Interpretations: Securities 18 See SEC No-Action Letter, Echo Bay Resources Inc. (May 18, 1998). Act Rules, available at http://www.sec.gov/divisions/corpfin/guidance/ securitiesactrules-interps.htm, see SEC Division of Corporation Finance, 19 However, the SEC did not find a single identity of issuer between Compliance and Disclosure Interpretations: Exchange Act Sections, available a subsidiary and its parent where the subsidiary had outstanding a class at http://www.sec.gov/divisions/corpfin/guidance/exchangeactsections- of debentures guaranteed by its parent and the subsidiary proposed interps.htm, and see SEC Division of Corporation Finance, Compliance to offer a new debenture in exchange for the guaranteed debenture and Disclosure Interpretations: Exchange Act Rules, available at http:// that would not be guaranteed by its parent. See SEC Division of www.sec.gov/divisions/corpfin/guidance/exchangeactrules-interps.htm. Corporation Finance, Compliance and Disclosure Interpretations: Securities Act Sections (#125.05) (November 26, 2008), available at 22 See SEC Division of Corporation Finance, Compliance and http://www.sec.gov/divisions/corpfin/guidance/sasinterp.htm. Disclosure Interpretations: Securities Act Sections (#125.04) (Nov. 26, 2008), available at http://www.sec.gov/divisions/corpfin/guidance/ 20 See SEC No-Action Letter, Grupo TMM, S.A. de C.V. (June 27, 2002). sasinterp.htm.

21 Morrison & Foerster LLP Capital Markets offering of new securities for cash. In this case, the issuer manager and conducting solicitation activities.28 must take care to keep the two offerings separate. Other considerations No remuneration for solicitation Securities issued in a Section 3(a)(9) exchange may be Section 3(a)(9) expressly prohibits an issuer from subject to limitations on transfer because Section 3(a) paying a “commission or other remuneration … (9) is a transactional exemption only. In a Section 3(a) directly or indirectly for soliciting such exchange.” In (9) transaction, the newly issued securities are subject conducting a “commission … remuneration” analysis, to the same restrictions on transferability, if any, as it is important to consider: the original securities.29 An issuer also needs to be cautious of having its exchange offer “integrated” with • the relationship between the issuer and the person other securities offerings conducted in close proximity furnishing the services; to the exchange. In making a determination regarding • the nature of the services performed; and integration, an issuer must apply the SEC’s five factor 30 • the method of compensation for those services. integration test. An issuer’s officers, directors and employees may solicit participation, provided that they were not hired Why are repurchases and exchanges (debt for for such purpose, have responsibilities other than debt; hybrid; debt/equity) particularly important soliciting participation and are not paid a bonus or special compensation for such solicitation.23 Issuers for financial institutions? also are permitted to engage third parties, such as Many qualifying financial institutions have relied financial advisers and investor relations firms, to assist on government guarantee programs to issue three- in a Section 3(a)(9) exchange, however, restrictions year debt. Financial institutions are facing a “cliff” of apply. The services provided by the third party must coming maturities. be “ministerial”24 or “mechanical.”25 Any services not deemed mechanical must be “by [their] nature New government programs (such as the Treasury ancillary to the effective mechanical operation of CAP and modifications to the FDIC’s TLGP) permit the process of formulating a restructuring proposal the issuance of mandatory convertible in a work-out situation.”26 An issuer needs to be and mandatory convertible debt securities. Qualifying particularly mindful of firms, such as investor relations issuers may consider using the CAP to exchange out of firms, that communicate with securityholders. Hiring the original Treasury CaPP securities. a firm to communicate with securityholders could Rating agencies, analysts and commentators are be construed as payment for solicitation. The SEC focused on “tangible common equity” and similar allows investor relations firms to participate in measures. This may motivate financial institutions to exchanges in a limited capacity. We discuss the role restructure exchange offers in order to create higher of a financial intermediary in Appendix B. Third quality regulatory capital. parties assisting in an exchange are not permitted to make any recommendations to securityholders • A financial institution will benefit (from a capital regarding the exchange offer,27 though an investment perspective) by buying back debt securities that are bank may provide a in connection trading at a discount and cancelling such securities. with an exchange, provided it is not acting as a dealer 28 See SEC Telephone Interpretation No. 25 of Securities Act Sections (July 1997), available at http://sec.gov/interps/telephone/cftelinterps_ securitesactsections.pdf. 23 See SEC No-Action Letter, URS Corporation (May 8, 1975). 29 See e.g., SEC Division of Corporation Finance, Compliance and 24 See SEC Division of Corporation Finance, Compliance and Disclosure Interpretations: Securities Act Sections (#125.08) (Nov. 26, Disclosure Interpretations: Securities Act Sections (#125.03) (Nov. 26, 2008), available at http://www.sec.gov/divisions/corpfin/guidance/ 2008), available at http://www.sec.gov/divisions/corpfin/guidance/ sasinterp.htm. sasinterp.htm. 30 The five factor test requires that an issuer consider: whether the 25 See SEC No-Action Letter, Exxon Mobil Corp. (June 28, 2002). offerings are part of a single plan of financing; whether the offerings 26 SEC No-Action Letter, Seaman Furniture Co., Inc. (Oct. 10, 1989). involved issuances of the same class of securities; whether the offerings were made at or about the same time; whether the same type of 27 SEC No-Action Letter, Dean Witter & Co., Inc. (Nov. 21, 1974). See consideration is received; and whether the offerings were made for the also SEC No-Action Letter, Stokley-Van Camp, Inc. (Mar. 31, 1983). same general purposes. See SEC Release No. 33-4552 (Nov. 6, 1962).

Morrison & Foerster LLP Capital Markets 22 • May be a component of insurance company and effective.33 An issuer may begin the offering period bank “reorganizations” and/or good bank-bad prior to effectiveness (shortening the time after bank or other split offs. effectiveness that it must remain open), provided that • As potential “exit” from government support. no securities are actually exchanged/purchased until the registration statement is effective and the tender offer has expired in accordance with the tender offer rules. Rule 162 is available for exchange offers that Registered exchange offers comply with Rule 13e-4 and Regulation 14D. If an issuer is unable to conduct a private exchange, or rely on Section 3(a)(9), it may instead conduct a Early commencement of exchange offers for straight registered exchange offer. As with a tender offer, debt securities additional Exchange Act rules will apply to exchanges In December 2008, Rule 162 was amended so that it of debt with equity characteristics, such as convertible might be available for exchange offers for straight debt debt. We discuss below the rules applicable to securities provided that: (1) the offeror provides the exchanges of equity securities. same withdrawal rights as it would if the offering were for equity securities; (2) if a material change occurs The registration statement in the information published, sent or given to the A registered exchange offer must be registered on a debtholders, the offeror disseminates information about Form S-4 registration statement (Form F-4 for foreign the material change to the debtholders in compliance private issuers).31 It may be time consuming to prepare with Rule 13e-4; and (3) the offer is held open with a registration statement, particularly if the issuer withdrawal rights for the minimum periods specified does not have the ability to incorporate by reference in Rule 13e-4 and Regulation 14D. For exchange information from its Exchange Act filings. Also, offers of straight debt securities, an issuer must decide unlike a Form S-3, a Form S-4 registration statement whether the benefits of early commencement outweigh does not become effective automatically upon filing,32 the ability to provide no or limited withdrawal rights, and except to the limited extent described below, or to provide for an early tender option. the exchange offer may not be commenced until the registration statement is declared effective. The SEC Consent solicitations review process and uncertainty concerning timing Often, an issuer may wish to solicit consents from its may make a registered exchange offer a less desirable debtholders, whether on a standalone basis or coupled option for an issuer. with a tender offer or exchange offer. The purpose of The registration statement must include descriptions of soliciting such a consent is to modify the terms of the the securities being offered, the terms of the exchange debt security being tendered or exchanged. The first offer, a description of the issuer and its business and step is to undertake a review of the applicable indenture risk factors. In addition, depending on the extent of provisions to determine the consent requirements for the restructuring, the issuer may be required to provide amendments or waivers. In addition, amendments pro forma financial information statements reflecting involving a significant change in the nature of the the affects of the exchange. investment to the remaining holders may result in the remaining securities being deemed “new securities” Early commencement activities which would have to be registered under the Securities 34 Rule 162 under the Securities Act provides some Act or be subject to an exemption from registration. flexibility by allowing an issuer to elect “early commencement” of its exchange offer. Rule 162 33 Many market participants and commentators note that there permits solicitations of tenders in certain exchange remains a need to examine the registration requirements for exchange offers before the registration statement is declared offers, particularly as they affect WKSIs. In particular, market participants have suggested that registration statements on Form S-4 filed by WKSIs become effective immediately upon filing. See Letter 31 Because Forms S-3 and F-3 are available only for offerings for cash, from Securities Industry and Financial Markets Association to the they are not available for an exchange offer. Securities and Exchange Commission, dated January 27, 2009. 32 This is a particular issue for “well known seasoned issuers” or 34 An attempt to revise key payment terms such as maturity, interest “WKSIs,” who may be used to automatic effectiveness of their rate or type of interest paid may be considered an offer and sale of a registration statements. “new security” under SEC interpretations, which would be treated as

23 Morrison & Foerster LLP Capital Markets There are a few limitations with respect to consents, in to address “holdout” problems. These amendments that under most indentures and under Section 316(b) or waivers generally will not affect the tendering of the Trust Indenture Act of 1939, consents cannot holders that receive cash or new securities upon the reduce principal or interest, amend the maturity date, consummation of the offer.35 However, the result of change the form of payment or make other economic obtaining the requisite consents is that non-tendering changes to the terms of the debt securities held by non- holders will be bound by the changes. Accordingly, tendering debtholders. when an issuer announces that the requisite number of holders (for example a majority) have decided to Standalone consents participate in the tender offer or exchange offer, for In certain situations, for example, in order to permit all practical purposes the remaining debtholders must a potential transaction, such as an acquisition, decide whether to tender/exchange, or be left with a reorganization or refinancing, an issuer may want debt obligation with significantly reduced protections. to conduct a “standalone” consent solicitation as a Generally, a consent solicitation is not subject to any means of amending restrictive covenants or events legal framework other than that applicable to tender of default provisions under an existing indenture offers and exchange offers. U.S. courts have viewed that otherwise would limit its ability to engage in exit consents as permissible contract amendments the transaction. In the current environment, some governed by basic contract law principles.36 The total issuers must modify indenture covenants that restrict consideration offered in a tender or exchange may or prohibit a restructuring of other debt in order to include a consent payment available only to holders that preserve “going concern” value and avoid bankruptcy. tender on or prior to the consent deadline, typically 10 Because consenting holders will remain subject to business days after the commencement of the offer and the terms of the indenture as amended or waived, consent solicitation (a tender offer or exchange offer holders may be reluctant to agree to significant must be kept open for 20 business days). Typically, changes. Standalone consent solicitations typically the payment deadline also is the expiration time for remain open for a minimum of ten business days, withdrawal rights, unless such rights are required by although a supplemental indenture giving effect to statute to remain available longer. the amendments or waivers sought may be executed and delivered as soon as the requisite consents from In some instances, the modifications effected by the securityholders are obtained. consent solicitation or exit consent may rise to the level of a modification for tax purposes. We discuss the Exit consents consequences of such a determination above, under “Non-cash tenders – Tax consequences.” If an issuer would like to change significantly restrictive indenture provisions, a tender offer or exchange offer coupled with a consent solicitation can be an attractive Tax considerations option. “Exit consents” are different from standalone or An issuer that exchanges new debt for old debt will ordinary consent solicitations because they are given by recognize ordinary COD income to the extent the tendering or exchanging debtholders (who are about adjusted issue price of the old debt exceeds the issue to give up the old securities) as opposed to continuing price of the new debt. A modification of existing debt holders of the old debt securities. The tendering will be treated as an exchange of such debt for new debtholders will be required to consent to the requested debt if the modification is “significant.” Generally, amendments as part of the tender of securities pursuant modifications are significant if, among other things, (1) to the tender offer or exchange offer. the yield changes by the greater of 25 basis points and If the requisite percentage of holders (specified in the 5% of the existing yield, (2) scheduled payments are indenture) tender their securities, the issuer will be materially deferred, (3) modified credit enhancements able to amend the terms of the indenture and bind change payment expectations, or (4) the nature of the all the holders. Exit consents can prove to be a useful security changes (e.g., from debt to equity or from incentive to participate in a tender or exchange offer and 35 The effectiveness of the amendments and waivers is typically subject to the condition that the tendered securities have been accepted an exchange offer for securities law purposes. See Bryant B. Edwards for payment or exchange pursuant to the offer. and Jon J. Bancone, “Modifying Debt Securities: The Search for the Elusive ‘New Security’ Doctrine,” 47 Bus. Law, 571 (1992). 36 See e.g., Katz v. Oak Industries, 508 A.2d 873 (Del. Ch. 1986).

Morrison & Foerster LLP Capital Markets 24 recourse to nonrecourse). By contrast, certain consent Securities law considerations solicitations that seek to change “customary accounting There are a number of considerations that an issuer must or financial covenants” would not, in themselves, bear in mind in carrying out a debt equity swap. The constitute significant modifications. For a discussion issuer must be mindful that any exchange of securities of certain exceptions to the recognition of COD income must comply with the tender offer and exchange rules and relief from the AHYDO rules, see “Introduction— described above. If a lender extinguishes a bank line in Tax consideration,” above. exchange for equity, the issuance of the equity securities Assuming the exchange or modification constituted must comply with all applicable securities laws – a recapitalization, such exchange or modification namely it must either be registered or exempt from generally should not result in gain or loss to the registration. In addition, an issuer needs to be mindful debtholder. However, depending on the terms of of the disclosure obligations that may be triggered by the new debt relative to the old debt, certain tax such an event, as it may constitute a material event. consequences could follow. For example, if the principal Corporate governance and other considerations amount of the new debt exceeded that of the old debt the holder could recognize gain equal to the fair market The number of shares to be issued depends on the value of such excess. Exchanges and modifications also value of outstanding debt to be exchanged. An issuer can create OID or, conversely, an amortizable premium, seeking to engage in a debt equity swap must ensure due to differences in the issue price of the new debt and that it has sufficient authorized capital available prior to the stated redemption price at maturity. commencing the exchange. If the issuer lacks sufficient authorized capital, it may be necessary to amend the In each case, particular attention must be paid to terms issuer’s certificate of incorporation to increase the share of art like issue price, the meaning of which may vary capital. This can often be a time consuming process depending on a number of factors. For example, if since it entails seeking shareholder approval. An existing debt is publicly traded, the “issue price” of issuer also needs to determine the percentage of equity new debt issued (or constructively issued, in the case securities that may be issued; an issuance of over 20% of a modification) in exchange for such debt is deemed of pre-transaction total shares outstanding may trigger the current market price. Given current economic national securities exchange limits,37 and may require conditions, debt exchanges or modifications will often shareholder approval. Because the issuance of equity result in COD income because the market prices of securities as part of a debt equity swap will be dilutive many existing debt securities are steeply discounted to existing holders, this may prove difficult. from their adjusted issue prices. Because the lender or debtholder will be effectively subordinating its position by giving up its creditor status, it may require a “sweetener” – this may come Other Exchanges in the form of issuing preferred stock or convertible preferred stock, or issuing participating preferred. Debt equity swaps An issuer needs to consider carefully the terms of the security it will offer, including the class, voting rights A debt equity swap is another means of recalibrating and dividend. an issuer’s balance sheet. In a debt equity swap, the issuer exchanges already outstanding debt for newly Tax considerations issued equity securities. It is, in essence, an exchange offer. A debt equity swap may be executed with a bank An issuer that engages in a debt equity swap will lender, or it may be executed with holders of an issuer’s recognize ordinary COD income to the extent the debt securities. In fact, in recent years, it has become adjusted issue price of the debt exceeds the market value more common for a bank or other lender to engage in a of the equity it issues. We discuss certain exceptions to the recognition of COD income, including under the Recovery debt equity swap rather than force a defaulting issuer Act, above under “Introduction – Tax considerations.” into bankruptcy. Lenders often hope that they will Similar to debt for debt exchanges, a debt for equity receive a higher return on their investment by taking swap also should not result in gain or loss to the holder an equity position. The issuer, by changing its debt to equity ratio, benefits financially from the exchange, and may improve its ratings. 37 We discuss these issues in Appendix A.

25 Morrison & Foerster LLP Capital Markets if the exchange constitutes a recapitalization. It should to be quoted on Nasdaq (if the tendered security also be noted market discount accrued on the exchanged debt was so listed or quoted). will carry over to the equity. If an equity exchange involves a “distribution” under Regulation M, the issuer is prohibited from making Equity for equity exchanges bids for, or purchasing, the offered security. These When an issuer tenders for its own equity securities, a prohibitions will not apply to investment grade rated, number of considerations arise. First, an issuer must nonconvertible preferred stock, however. These ensure that it is permitted to engage in the exchange restrictions typically commence when the exchange under state law. Section 160(a)(1) of the Delaware offer materials are mailed and continue through the General Corporation Law prohibits a corporation conclusion of the offer. from purchasing its own stock if the entity’s capital is impaired or if such purchase would impair capital. In the context of an equity for equity exchange, an Liability Considerations issuer must be mindful of its disclosure obligations under Regulation FD and the securities law antifraud Restructuring transactions, whether redemptions, provisions, particularly Rule 10b-5. Under Rule 10b-5 privately negotiated or open market purchases, or an issuer is prohibited from purchasing its stock when tender or exchange offers, involve the “purchase and it is in possession of material nonpublic information. sale of [a] security.” Therefore, these transactions are The same considerations that apply to a purchase subject to the general antifraud provisions of Section of debt securities are applicable in this context. An 10(b) of the Exchange Act and Rule 10b-5. Section issuer must determine whether the transaction itself 10(b) of the Exchange Act is an implied cause of action constitutes material nonpublic information. An issuer covering all transactions in securities and all persons also must determine whether it is in possession of who use any manipulative or deceptive devices in other information, such as unreleased earnings or an connection with the purchase or sale of any securities. unannounced acquisition, that must be disclosed prior Rule 10b-5 covers substantially the same ground as to commencing an exchange. Section 10(b) and prohibits, among other matters, the In addition, an issuer must comply with all tender offer making of any untrue statement of a material fact or rules when conducting an equity exchange. Sections the omission of a material fact necessary to make the 13(d), 13(e), 14(d), 14(e) and 14(f) all are applicable to statements made not misleading. Under Rule 10b-5, an equity exchange. An issuer also is required, as it is the issuer, its directors, officers and employees, and its with an exchange of convertible debt, to file a Schedule agents, including financial intermediaries retained by TO with the SEC. the issuer, may be held liable. An issuer must be cautious that its equity exchange Tender and exchange offers are also subject to does not inadvertently trigger the “going private” Section 14(e) of the Exchange Act and the rules rules under Rule 13e-3 of the Exchange Act. These promulgated thereunder. In addition to specific rules apply if any purchase of an issuer’s equity procedural requirements, Section 14(e) contains securities is intended to cause the equity security of substantially identical prohibitions regarding material an issuer registered under Section 12(g) or Section misstatements and omissions as Section 10(b) and 15(d) of the Exchange Act to be held by fewer than Rule 10b-5. 300 persons. Rule 13e-3(g)(2) contains an exemption If the exchange offer is registered under the Securities from the “going private” rules if the securityholders Act, participants, in addition to liability under the are offered or receive only an equity security that: Exchange Act, will be subject to liability under the (1) has substantially the same rights as that being Securities Act, including Section 11 liability (with tendered, including voting, dividends, redemption respect to registration statements) and Section 12 and liquidation rights (except that this requirement is liability (with respect to the prospectuses and oral deemed satisfied if non-affiliated holders are offered communications).38 Financial intermediaries in common stock), (2) is registered pursuant to Section 12 of the Exchange Act (or reports are required to be 38 Cash tender offers are not registered under the Securities Act. filed by the issuer pursuant to Section 15(d)), and (3) is Therefore, none of the participants, including financial intermediaries, listed on a national securities exchange or authorized will have Securities Act liabilities.

Morrison & Foerster LLP Capital Markets 26 particular may be subject to liability as “statutory Realogy to incur additional indebtedness under underwriters” in connection with solicitations of the credit facility. The new term loans would be participation in the exchange offer.39 It is therefore secured, whereas existing notes were unsecured. The customary for a dealer-manager, in order to avail terms of the offer set a priority as to which holders itself of a due diligence defense to Securities Act were entitled to accept the offer – holders of Senior liability, to engage in appropriate due diligence Subordinated Notes ($125 million), then holders of regarding the issuer and its operations, financial Senior Notes ($500 million) and then holders of Toggle status and prospects as well as to receive legal Notes ($500 million, less any amounts tendered by opinions and comfort letters from the issuer’s the other classes). As a result of this priority, holders accountants. The diligence process also adds time of Toggle Notes would likely be unable to participate and cost to the exchange offer. in the exchange offer and would, effectively, be subordinated to tendering holders from the other Legal Challenges classes who would receive secured debt. Restructurings may lead to legal challenges. The legal The trustee and a noteholder controlled by Carl challenges usually come from holders of securities that Icahn, High River L.P., sued Realogy on the basis do not participate in the restructuring and believe the that, among other things, the exchange offer violated value of these securities or the protections afforded the terms of the indenture, specifically the “negative by their securities are adversely affected. In addition, pledge” covenant. The senior credit facility allowed because the “all holders” rule does not apply to tender “Permitted Refinancing Indebtedness” to refinance offers for straight debt securities, holders who are not the notes, provided the refinancing indebtedness had offered the right to participate (for example, because no greater security than the debt being refinanced. the offering is limited to QIBs) may also claim that Because the new loans were secured, and the notes their securities are impaired. The effects of litigation being exchanged were not, the court found in favor can be burdensome. In some instances, the litigation of the trustee, reasoning that the new loans were not will enjoin the issuer from completing the tender or “Permitted Refinancing Indebtedness” and, as a result, exchange offer. However, if litigation is resolved after the liens securing the new loans were not “Permitted the completion of the transaction, it is unclear how the Liens” under the indenture. The court granted the violation would be remedied because in the case of an plaintiffs summary judgment and the exchange offer exchange, holders already hold the new securities. did not proceed.

Realogy Case This case turned on contract negotiation and the specific terms of the contracts, and it highlights the A recent Delaware court case crystallizes some of the need to ensure that a thorough and complete review challenges associated with debt restructurings. In of the underlying documents, other debt instruments 40 the Realogy case, Realogy Corporation (“Realogy”) and an issuer’s capital structure is completed before announced an exchange offer for its outstanding commencing any refinancing. notes (Senior Notes due 2014, Senior Toggle Notes due 2014 and Senior Subordinated Notes due 2015) for up to $500 million of additional term loans issued pursuant to an accordion feature under Realogy’s Conclusion senior credit facility. This accordion feature allowed For balance sheet restructuring, like so many other 39 Section 2(a)(11) of the Securities Act defines “underwriter” broadly things in life, timing can be everything. Issuers as: “Any person who has purchased from an issuer with a view to, or are cautioned not to wait too patiently for their offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any fortunes to improve. The most effective balance sheet such undertaking, or participates or has a participation in the direct or restructuring occurs when an issuer’s balance sheet indirect of any such undertaking; but such term shall is neither too healthy nor too stressed. It’s a bit like not include a person whose interest is limited to a commission from an underwriter or dealer not in excess of the usual and customary Goldilocks’ porridge – best eaten when not too hot distributors’ or sellers’ commission.” (emphasis added) and not too cold. 40 The Bank of New York Mellon and High River Limited Partnership v. Realogy Corporation, Court of Chancery of the State of Delaware, C.A. No. 4200-VCL, Memorandum Opinion, Dec. 18, 2008.

27 Morrison & Foerster LLP Capital Markets Contacts

Capital Markets and Corporate

Nilene Evans (212) 468-8088 | [email protected] David Lynn (202) 887-1563 | [email protected] Brandon Parris (415) 268-6617 | [email protected] Anna Pinedo (212) 468-8179 | [email protected] Jim Tanenbaum (212) 468-8163 | [email protected]

Tax Stephen Feldman (212) 336-8470 | [email protected] Thomas A. Humphreys (212) 468-8006 | [email protected] Shane Shelley (858) 720-5169 | [email protected]

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

Morrison & Foerster LLP Capital Markets 28 A P P E N D I X

A. Other Considerations

B. The Role of Financial Intermediary

29 Morrison & Foerster LLP Capital Markets OTHER CONSIDERATIONS

Review of Exchange requirements will not be required unless the number of shares The securities exchanges – the New York Stock Exchange of common stock to be issued (or into which (“NYSE”), the Nasdaq Stock Market (“Nasdaq”) the security may be convertible or exercisable), and the NYSE AMEX (“AMEX” and, collectively, the exceeds either 5% of the outstanding common “Exchanges”) require shareholder approval for the stock before the issuance, or issuance of equity securities by their listed issuers • 20% or more of the current outstanding common in various situations.1 Each Exchange also applies stock other than an issuance involving a public these shareholder approval provisions to offerings of offering or a “bona fide private financing” (as securities that are convertible into or, in the case of the defined in NYSE Rule 312.04(g)). NYSE and Nasdaq, exchangeable for, common stock, The percentages in all cases apply both to outstanding such as convertible debt. An issuer must carefully common equity and common voting power.2 review the Exchange provisions if the security to be exchanged in a restructuring is either actual equity or Each Exchange also requires shareholder approval convertible or exchangeable debt, or if the transaction when an issuance will result in a “change of control” 3 cannot be categorized as a “.” of the issuer. None of the Exchanges, however, have adopted a definition of “change of control.” A Under Nasdaq Rule 5635(d) and AMEX Rules 712 and general rule of thumb (there are variations between 713, shareholder approval is required for transactions the Exchanges) is that purchases of between 20% and involving the issuance of: 30% of the outstanding voting stock may be deemed a • 5% or more of the current outstanding common change of control, unless preexisting control positions stock in an acquisition, if a director, officer, or are not displaced by the transaction. It is prudent to substantial securityholder of the issuer has a 5% consider both the change of control rule and the 20% interest (10% if a group) in the company or assets rule in any transaction that involves an issuance close to be acquired, to 20%. In many cases, it will be appropriate to consult the relevant Exchange early in the transaction process. • 20% or more of the current outstanding common stock in an acquisition, or Shareholder approval is not required for financing • 20% or more of the current outstanding common transactions (involving share issuances) that are stock in any transaction other than a public structured as “public offerings” under the rules or offering. policies of any of the Exchanges. It is important to note that an offering is not deemed to be a “public Under NYSE Rule 312.03, shareholder approval is a offering” for these purposes merely because it is prerequisite to issuing additional shares equal to: effected under a registration statement. The Nasdaq • more than 1% of the current outstanding common and AMEX staffs will consider all relevant factors stock to an insider (an officer or director, or an when determining whether an offering will qualify entity affiliated with an officer or director) ora for the public offering exemption, including, but not substantial holder; however, if the purchaser is only a substantial holder (and not an officer or director) and the cash purchase price is at least as 2 Nasdaq Rule 5635(e)(1) and NYSE Rule 312.04(d) each provide great as each of the book and market value of the that only shares actually issued and outstanding (excluding treasury issuer’s common stock, then shareholder approval shares or shares held by a subsidiary) are to be used in making any calculation of shares outstanding. Unissued shares reserved for issuance upon conversion of securities or upon exercise of options or warrants will not be regarded as outstanding. AMEX does not have a 1 See, e.g., Nasdaq Marketplace Rule 5635 (the “Nasdaq Rules”) and similar rule. related publicly available interpretive guidance; NYSE Rule 312.00 – 312.07 (the “NYSE Rules”); and AMEX Sections 710-713 (the 3 See Nasdaq Rule 4350(i)(1)(B), AMEX Section 713(b) and NYSE “AMEX Rules”). Rule 312.03(d).

Morrison & Foerster LLP Capital Markets 30 limited to: (i) the type of offering;4 (ii) the manner may also apply. FINRA Rule 5110,7 known as the in which the offering is marketed; (iii) the extent of Corporate Financing Rule, requires certain filings with the offering’s distribution, including the number of FINRA to determine whether the compensation to the investors who participate in the offering; (iv) the financial intermediary is fair. However, the financial offering price; and (v) the extent to which the issuer intermediary does not have to file (although it will be controls the offering and its distribution. The NYSE required to comply with the substantive provisions does not offer formal guidance to determine when a of FINRA Rule 5110) if the transaction is an exchange particular offering would qualify as a public offering offer where the securities to be issued are listed on in the context of a restructuring. It should also be Nasdaq, the NYSE or the AMEX; or the issuer qualifies noted that restructurings effected under Rule 144A to register an offering on Form S-3, F-3, or F-10 under of the Securities Act are, by definition, not “public the Securities Act.8 FINRA Rule 5110 will not apply at offerings” despite the fact that such offerings typically all if the transaction is a tender offer made pursuant having many of the indicia of a public offering. to Regulation 14D, which regulates tender offers for equity securities. Absent any such exception, a Each of the NYSE, Nasdaq and AMEX have indicated5 registered exchange offer has to be filed with FINRA that mere filing of tender offer documents with the for review. SEC does not necessarily make the tender offer a “public offering,” and that they should be contacted when a particular transaction arises for a definitive Involvement of affiliates determination. AMEX suggested that two factors to Under certain circumstances, affiliates of an issuer be considered are (i) the market price of the security may seek to purchase the issuer’s debt securities. when issued compared to the price at which it is This may occur on the corporate level, such as when a being exchanged; and (ii) the original price the debt parent purchases securities of its subsidiaries or when was being issued and what the reset is for the debt. subsidiaries purchase securities of its parent or other Because of the uncertainty regarding whether a subsidiaries. It may also occur if officers, directors or registered exchange offer will be categorized as a significant shareholders seek to purchase the securities. “public offering,” exchange offers may be structured In these instances, the “affiliates” would generally be with a “cap” (that is, the exchange is capped at 19.9% considered insiders of the issuer and subject to the same and the remaining percentage above 20% is subject to disclosure obligations as the issuer. The issuer should shareholder approval).6 coordinate closely with the affiliate in structuring any repurchase program, including to ensure that other Review FINRA requirements corporate requirements are not implicated, such as an affiliate running afoul of the “corporate opportunity” If a financial intermediary (such as a dealer-manager) is doctrine. In many circumstances, involvement of an involved in the restructuring, the requirements of The affiliate may preclude reliance on the Section 3(a)(9) Financial Industry Regulatory Authority (“FINRA”) exemption for an exchange offer.

4 For example, this may include: (1) whether the offering is conducted by an underwriter on a firm commitment basis; (2) whether the offering is conducted by an underwriter or placement agent on a best efforts basis; or (3) whether the offering is self-directed by the issuer. See Nasdaq Interpretive Material 5635-3; Commentary to AMEX Section 713. 5 Telephone conversations between this firm and each of the Exchanges in February 2009.

6 In certain circumstances, if the issuance of the original securities 7 Formerly, NASD Rule 2810. was structured to comply with the 19.9% cap, the Exchanges may, unless the issuer can demonstrate a change of circumstances, 8 For FINRA purposes only, an issuer’s qualification to register aggregate any securities issued in the exchange with the remaining an offering on Form S-3, F-3 or F-10 is based on the eligibility outstanding non-tendered securities for purposes of calculating the requirements prior to October 21, 1992, which were conditioned percentage. In addition, the exchange may calculate the percentage on a 36-month reporting history and $150 million aggregate market based on the issuer’s outstanding share capital as of the original issue value of the voting stock held by non-affiliates (or $100 million and an date as opposed to the exchange date. annual trading volume of 3 million shares).

31 Morrison & Foerster LLP Capital Markets THE ROLE OF FINANCIAL INTERMEDIARY

When should an issuer engage an investment bank Tender offers or other financial intermediary to assist with liability The investment bank’s role varies in tender offers. In management transactions? The short answer is that a cash tender offer for straight debt, an issuer may it depends – it depends on the issuer’s situation engage an investment bank in an advisory role. In and the transaction contemplated. Generally, the a tender offer for convertible debt securities, which more complex and significant a restructuring, the is subject to additional tender offer rules, an issuer more helpful it may be to engage an investment may choose to engage an investment bank in an bank as financial adviser. The bank will help advisory role to contact and negotiate the terms with formulate a restructuring plan, locate and identify debtholders or to act as a more active dealer-manager. securityholders, structure the transaction, solicit In a tender offer coupled with a consent solicitation or participation, assist with presenting the structure to a public tender offer for all outstanding debt securities, the various stakeholders, assist with rating agency issuers usually engage a dealer-manager to manage discussions and manage the marketing efforts to the process. In these transactions, issuers also often achieve a successful restructuring. Issuers should use an investor relations firm to act as information consider a number of factors, such as the number of agent during the process. There are no specific rules debtholders, their organization and sophistication regarding compensation preventing issuers from using and whether the issuer has information about, and – and paying – an investment bank to solicit tenders. any contact with, its debtholders. In a distressed situation, the challenges that many issuers face Exchange offers often lead them to contact an investment bank. Typically, such banks have “liability management,” Private exchange offers “restructuring” or “workout” teams specialized An issuer may choose to engage an investment bank in in debt restructurings. Issuers that wish to take an advisory role for a private exchange offer, however, advantage of declining secondary market prices because the exchange involves a limited number of for debt securities also may benefit from engaging debtholders, a more active dealer-manager is not an investment bank to locate, contact and negotiate always needed. Issuers may engage the bank that with debtholders to sell (or exchange) their debt acted as the initial purchaser for the old debt securities, securities. The type of transaction will dictate the this way, in an exchange offer under Rule 144A, the investment bank’s role, which ranges from merely bank may have existing “QIB” letters on file to pre- an advisory role or responsibilities as an agent, qualify holders. The investment bank’s activities principal or as dealer-manager, as well as any cannot include any “general solicitation.” There are limitations on its activities. no specific rules regarding compensation preventing issuers from using, or paying, an investment bank to Debt repurchases solicit private exchanges. If the issuer has few debtholders that are already known Section 3(a)(9) exchange offers to it, it may not need assistance from an investment bank. However, an investment bank may be involved Issuers are permitted to engage third parties, such as in these transactions, for example, to contact and bring financial advisers and investor relations firms, to assist unknown debtholders to the table, acting either as an with Section 3(a)(9) exchanges, but their role must agent (acting as a broker for the issuer) on behalf of the be limited. Under Section 3(a)(9), an issuer cannot issuer, or as principal (buying the debt securities from pay anyone, including a financial adviser or dealer- the debtholder and selling them back to the issuer). manager, to solicit exchanges. Pursuant to SEC no- Both the issuer and its advisers must be mindful of any action guidance, a financial adviser may undertake activities that put a repurchase at risk of being deemed certain activities so long as it is not paid a success fee. a “tender offer.” Issuers facing a complex restructuring may decide

Morrison & Foerster LLP Capital Markets 32 that they need a dealer-manager to solicit exchanges offer.3 Under this arrangement, however, payment and manage the process to ensure a successful would have to be made on a flat, per-contact basis, restructuring. and communications with securityholders may not include any recommendation regarding the decision The SEC has provided guidance as to how an to accept or reject the exchange offer.4 An issuer investment bank may be compensated in a Section 3(a) should instruct its agents to defer on all questions (9) exchange. In general, an investment bank can: relating to the merits of the offer if the issuer wishes • engage in pre-launch discussions or negotiations to use the Section 3(a)(9) exemption. with legal and financial representatives of bondholder committees; Registered exchange offers • provide a fairness opinion;1 and In a registered exchange offer, there is more flexibility regarding the investment bank’s role. Often, an issuer • only provide debtholders with information that engages an investment bank to act both as adviser and was included in communications sent directly by dealer-manager (which includes soliciting holders if the issuer. the exchange offer is coupled with a consent). The In general, an investment bank cannot: dealer-manager for a registered exchange offer (or • solicit (directly or indirectly) exchanges or public tender offer) may actively solicit acceptances consents; and and be compensated for these activities, including with a success fee. Because of the heightened liability • make recommendations regarding the exchange standard involved with a registered exchange offer, offer to debtholders or their advisors. the dealer-manager will want to conduct due diligence If an investment bank is involved in a Section 3(a)(9) comparable to the diligence conducted for an ordinary exchange offer, it should be paid a fixed advisory fee, registered offering. In addition, the dealer-manager as opposed to a success fee for its services. Although, may require delivery of legal opinions, a 10b-5 paid promotion is strictly off-limits, the issuer can negative assurance letter with respect to disclosure, still reimburse an advisor for expenses related to the and a comfort letter or agreed upon procedures letter.5 exchange. The dealer-manager must keep in mind all rules relating to pre-filing or pre-launch communications The issuer may rely on an investor relations firm or with debtholders to avoid gun-jumping issues and other sales force, such as engaging an information Regulation FD issues. agent, to inform securityholders of the exchange offer.2 Filling this role with an investment bank is efficient as the firm that sold the securities in the first place may be in the best position to contact its former customers. The permitted activities are limited to contacting securityholders to confirm that the issuer’s mailings were received, that the securityholder understands the mechanical requirements necessary to participate in the exchange and to determine whether or not the securityholder intends to participate in the exchange

1 An issuer is permitted to hire an investment bank to render a fairness opinion on the terms of the exchange; however, if the investment bank 3 SEC No-Action Letter, Dominion Mortgage & Realty Trust (April also is acting as a dealer-manager and conducting solicitation activities, 3, 1975). the SEC has held that obtaining a fairness opinion would violate Section 3(a)(9). See SEC Division of Corporation Finance, Compliance 4 This second requirement applies to any of the issuer’s agents and Disclosure Interpretations: Securities Act Sections (#125.07) (Nov. who contact the securityholders, and not only to dedicated sales 26, 2008), available at http://www.sec.gov/divisions/corpfin/guidance/ departments. sasinterp.htm. 5 These deliverables are usually also requested by the dealer-manager 2 Other permitted activities involve confirming debtholder contact in a tender offer. The scope of these deliverables can significantly details, confirming their receipt of all requisite materials and reminding increase the cost of the tender offer or exchange offer and are often debtholders of approaching deadlines. negotiated between the parties.

33 Morrison & Foerster LLP Capital Markets Morrison & Foerster LLP Capital Markets 34 summary of options

35 Morrison & Foerster LLP Capital Markets Advantages Disadvantages

Redemptions • Speed (no registration required, no • Requires cash on hand documentation needed) • Expensive (redemption price • Flexible (may redeem all or part of an usually preserves yield to maturity) outstanding class) • Notice must be outstanding not less than 30 nor more than 60 days (rates may fluctuate)

Repurchases • Speed (no registration required, no • Requires cash on hand documentation needed) • May only retire a small percentage • Privately negotiated; pricing takes advantage of securities from a limited number of market fluctuations of holders • Less visibility to the market • May trigger disclosure obligations • May help improve Tier 1 position • May trigger tender offer rules • May be part of an ongoing repurchase program • May engage investment bank to assist

Debt Tenders • Speed (no registration required, not subject to • Requires cash on hand SEC review, unless convertible debt) • If subject to the tender offer rules, • Flexible (able to retire an entire series or class of must be held open for 20 business debt securities) days (for non-investment grade • Able to approach all holders (subject to debt) and 7-10 calendar days for compliance with the tender offer rules) investment grade debt • May engage investment bank to solicit • Holdout issue • Can pair with a consent solicitation • Convertible debt tenders are subject to the tender rules for equity securities • Must pay all investors of the same class the same price (if subject to the tender offer rules regarding any equity derivative)

Private • Speed (no registration required, not subject to • Generally limited to QIBs and non- Exchange SEC review, unless convertible debt) U.S. investors Offer • Does not require cash on hand (only minimal • No “general solicitation” permitted costs) • Holdout issue • Flexible (able to retire an entire series or class of • New securities may be “restricted” debt securities) (but holder may be able to tack) • May engage investment bank to solicit • Holders may request registration • Able to pre-certify investor status • No Section 11 liability in respect of offering memorandum • Can pair with a consent solicitation • Limitations on OID tax deductions for certain high-yield obligations issued during 2009 have been suspended • Often can be accomplished largely tax-free for debtholders

Morrison & Foerster LLP Capital Markets 36 Advantages Disadvantages

3(a)(9) Exchange • Speed (no registration required, not subject to • New securities may be “restricted” Offer SEC review) (but holder may be able to tack) • Flexible (able to retire an entire series or class of • Limited ability to engage and debt securities) compensate investment bank • Does not require cash on hand (only minimal • Holdout issue costs) • May be integrated with offers done • Able to approach all holders (subject to in close proximity compliance with the tender offer rules) • Must pay all investors of the same • No Section 11 liability with regard to offering class the same price (if subject to memorandum the tender offer rules) • Can pair with a consent solicitation • Limitations on OID tax deductions for certain high-yield obligations issued during 2009 have been suspended • Often can be accomplished largely tax-free for debtholders

Registered • Flexible (able to retire an entire series or class of • Time consuming (subject to SEC Exchange debt securities) review and filing requirements) Offer • Does not require cash on hand • Must remain open for 20 business • New securities are freely transferable days (if subject to the tender offer rules) • May engage an investment bank to solicit (no restrictions on compensation) • Section 11 liability • Able to approach all holders (subject to • More expensive than an compliance with the tender offer rules) unregistered exchange offer or repurchase • Can pair with a consent solicitation • Holdout issue • Limitations on OID tax deductions for certain high-yield obligations issued during 2009 have • Must pay all investors of the same been suspended class the same price (if subject to the tender offer rules) • Often can be accomplished largely tax-free for debtholders

Debt for • Used by issuers as an alternative to bankruptcy • If registered, can be time Equity because of upside potential for investors consuming (subject to SEC review Exchanges • Improves debt/equity ratio, potentially and filing requirements) improving credit ratings • Must remain open for 20 business • Does not require cash on hand (only minimal days (if subject to the tender offer costs) rules) • Can pair with a consent solicitation • Equity issuance may trigger securities exchange issuance • Often can be accomplished largely tax-free for limitations debtholders • If insufficient share capital, may require shareholder approval • Terms of equity securities may be onerous • Must pay all investors of the same class the same price (if subject to the tender offer rules)

37 Morrison & Foerster LLP Capital Markets Advantages Disadvantages

Equity for • Does not require cash on hand (only minimal • Must be permitted under state law Equity costs) • If registered, can be time Exchanges • Terms of new securities may be less onerous consuming (subject to SEC review • Generally a tax free transaction and filing requirements) • Able to approach all holders (subject to • Must remain open for 20 business compliance with the tender offer rules) days (if subject to the tender offer rules) • No balance sheet impact • Must pay all investors of the same class the same price (if subject to the tender offer rules)

Consent • May be done alone or with a tender or • May require a supermajority to Solicitation exchange offer enact modifications • Able to modify onerous or restrictive covenants • TIA does not permit modification • Not subject to SEC review or tender offer rules of interest, principal, maturity and other provisions without 100% • No Section 11 liability approval • Does not require cash on hand (only minimal • Modifications may result in costs) the remaining securities being • Generally tax-free unless considered a considered “new” for Securities Act “significant modification” of the debt purposes • Holdout issue

Morrison & Foerster LLP Capital Markets 38 liability management Continuum

39 Morrison & Foerster LLP Capital Markets Least Documentation Most Documentation

3(a)(9) Exchange Debt for Equity Redemptions Debt Tenders Offers Swaps

Repurchases Private Exchange Registered Equity for Equity Offers Exchange Offers Exchanges

Least Time Consuming Most Time Consuming

Morrison & Foerster LLP Capital Markets 40 cash debt tenders: an overview and summary of no-action advice

41 Morrison & Foerster LLP Capital Markets cash debt tenders: an overview an d s u mm a r y o f no-action advice

An issuer considering debt repurchases faces a series those governing zero-coupon obligations or debt with a of important decisions regarding the scope of the relatively short maturity, have absolute call protection repurchases, the terms, and other related matters. and do not permit redemption. Other indentures For example, an issuer may purchase the securities include restrictions on the time period during which consensually in open market transactions or, conversely, issuers can redeem the securities. An issuer may in a non-consensual redemption pursuant to the encounter the most difficulty with indenture provisions terms of the applicable indenture or note purchase that restrict the source of funds the issuer may use agreement. Alternatively, the issuer may exchange to redeem the securities. These provisions typically existing securities for a new series of securities.1 prohibit an issuer from financing the redemption of its Depending on the path taken, issuers will have to securities with the proceeds of offerings of lower-cost be mindful of various requirements and obligations. debt securities. In addition, an issuer should consider Some, such as the anti-fraud provisions of the securities the provisions of its credit agreements or bank facilities, laws, apply regardless of the route taken; others, such which may contain prohibitions on redemptions of as the conditions relating to reliance on the Section 3(a) debt securities. (9) exemption from registration under the Securities Fortunately, courts permit an issuer to demonstrate Act of 1933, as amended (the “Securities Act”), affect that, despite a concurrent lower cost offering of only certain exchanges. We discuss the advantages securities, the direct source of the funds used to and disadvantages associated with different liability repurchase the old debt originated elsewhere.2 One management transactions as well as anti-fraud concerns court permitted an issuer to make a tender offer for its more fully in our alert titled “Liability Management: Is own debt securities using the proceeds of the “tainted,” Now the Time to Rebalance Your Balance Sheet.” In this lower cost securities, while simultaneously redeeming memorandum we focus principally on the issues arising the securities not tendered with “clean” cash raised in connection with redemptions, repurchases and cash through other means.3 Nevertheless, these cases hinge tenders for debt securities. on the contractual terms of the relevant indenture, and an issuer redeeming its securities should not mistake favorable judicial precedent for a guarantee that its Redemptions own indenture permits a particular strategy. At the very least, an issuer must be exceedingly careful to Complying with the terms of the segregate the “clean” funds used to redeem securities governing indenture from the proceeds of any other lower cost securities offerings. Even if an issuer takes such precautions, Depending on the terms of the governing indenture, however, it is possible that the market will perceive the an issuer may be able to redeem its debt securities at a pre-determined price without the holder’s consent. The redemption price will most likely be based on the 2 Morgan Stanley & Co. Inc. v. Archer Daniels Midland Co., 570 F. Supp. 1529, 1536 (S.D.N.Y. 1983); Franklin Life Ins. Co. v. Commonwealth holder’s yield to maturity. Some indentures, typically Edison Co., 451 F. Supp. 602, 614 (S.D. Ill. 1978). 3 Mutual Savings Life Ins. Co. v. James River Corp of Virginia, 716 So. 1 See “More on 3(a)(9).” 2d 1172, 1178 (Ala. 1998). See also Part II of this memorandum.

Morrison & Foerster LLP Capital Markets 42 issuer as having played fast and loose with the terms fraudulent or misleading acts in connection with of the indenture. The boundaries of activity that is any tender offer. These two sections, and the rules contractually permissible do not always overlap with promulgated under these sections, apply only when a the boundaries of activity that is reputationally sound. transaction constitutes a tender offer. Congress, in adopting the William Act and Section 14(d) Providing adequate disclosure did not define tender offer in order to give the courts An issuer that redeems its securities must comply with and the SEC flexibility.5 In its rules under Sections the anti-fraud provisions of securities laws. Though 14(d) and 14(e), the SEC has also not defined “tender the terms of the relevant indenture may permit offer” in order to give itself flexibility in applying the various activities, no private contract can waive the rules. Courts have filled this gap, providing a set of anti-fraud protections afforded by the Securities Act factors useful in differentiating between and among and the Securities Exchange Act of 1934, as amended tender offers and other public solicitations. The test (the “Exchange Act”). For example, one court found used by a majority of courts lists eight characteristics that despite the issuer’s compliance with the terms of that are typical of a tender offer: the indenture, its failure to disclose all relevant facts • active and widespread solicitation of public 4 regarding the redemption violated Rule 10b-5(b). An shareholders for the shares of an issuer; issuer must comply with the terms set forth in the indenture as well as with the anti-fraud provisions of • solicitation made for a substantial percentage of securities laws. the issuer’s stock; • offer to purchase made at a premium over the prevailing market price; Repurchasing debt securities in • terms of the offer are firm, rather than negotiable; the open market • offer contingent on the tender of a fixed number of shares, often subject to a fixed maximum number Unlike a redemption, where an issuer repurchases its to be purchased; securities without the consent of the holders, an open- • offer open only a limited period of time; market purchase is a voluntary transaction between the issuer and a willing debt holder. The primary • offeree subjected to pressure to sell his stock; and challenge for an issuer undertaking an open market • public announcements of a purchasing program purchase is to lessen the possibility that the transaction concerning the target company precede or will be regarded by the SEC as a tender offer. Tender accompany rapid accumulation of large amounts offer or not, however, an issuer repurchasing securities of the target company’s securities.6 in the open market must be mindful of the SEC’s These elements need not all be present for a transaction disclosure requirements. to constitute a tender offer, and the weight given to each element varies with the circumstances. For example, Avoiding the definition of “tender offer” an open-market purchase of 25% of a corporation’s Section 14(d) of the Exchange Act requires certain stock was held not to constitute a tender offer because filings and disclosures when any person or group (1) the purchaser contacted only six of the 22,800 makes a “tender offer” resulting in the ownership of security holders; (2) all six of those security holders greater than five percent of a given class of securities. were highly sophisticated; (3) the purchaser did not Section 14(e) of the Exchange Act is an anti-fraud pressure the security holders in any way that the tender provision that forbids misstatements, omissions and offer rules were designed to prevent; (4) the purchaser did not publicize the offer; (5) the purchasers did not pay a significant premium; (6) the purchasers did not 4 Harris v. Union Electric Co., 787 F. 2d 355, 370 (8th Cir. 1986). Harris provides a lesson in the need for careful drafting of the original offering document, although the tone in Harris is so harsh that there 5 Hanson Trust PLC v. SMC Corp., 774 F. 2d 47, 56 (2d Cir. 1985). is an inference that there was more to the Court’s decision than merely TheHanson Court noted Congressional concern that a “rigid definition failure to disclose material information (an earlier Missouri Court of would be evaded”). Appeals decision in the matter had held that the redemption process complied with the indenture. See Harris v. Union Electric Co., 622 6 Wellman v. Dickinson, 475 F. Supp. 783, 823-24 (S.D.N.Y. 1979); S.W.2d 239 (Mo. Ct. App. 1981). see also the discussion in Hanson Trust, supra, note 5.

43 Morrison & Foerster LLP Capital Markets require a minimum number of shares or percentage of material event so long as a significant principal amount stock; and (7) the purchasers did not set a time limit of debt remains outstanding after the repurchase, or if for the offer.7 In determining whether a “tender offer” the public float of a given series remains constant (that has occurred, this Court noted that courts should be is, if the issuer repurchases bonds only from insiders). guided by the statutory purpose to protect the “ill- An issuer should work with counsel if it is concerned informed solicitee.”8 about the materiality of a planned transaction. The eight-part test and the above case implementing An issuer has at least two options should it determine that test both involved equity securities. Congress and that it must disclose its plan to repurchase debt securities. the SEC have acknowledged that tender offers for non- The issuer may announce the debt repurchase program convertible debt securities are usually less problematic with a press release and file the release as an exhibit to from both a tender offer and public policy perspective.9 a Current Report on Form 8-K. A more subtle approach However, any discussion of an acquisition of debt would be for the issuer to disclose its intentions in securities should begin with consideration of the eight a periodic report, such as in the liquidity discussion characteristics listed above. An issuer considering an in the MD&A section of a Form 10-K or Form 10-Q. open-market repurchase of its debt securities should Debt repurchase programs will likely proceed more therefore be mindful of the eight factors if it wishes to smoothly when the program has been planned for and avoid the strictures of the tender offer rules. the marketplace has been informed of it in the issuer’s MD&A. This is not always possible, however, and a Disclosure requirements for open- Form 8-K filing is an acceptable alternative. market transactions An issuer that repurchases securities in the open market must comply with the anti-fraud provisions of the Structuring a Debt Tender Offer in securities laws. For repurchase programs, the primary Light of No-Action Letter Guidance concern is adequate disclosure. Before repurchasing securities, an issuer must consider whether it is in It may not be possible for an issuer to ensure that possession of material non-public information that the the SEC will not regard an open-market repurchase securities laws require it to disclose. Both Rule 10b- program as a tender offer. In that case, the issuer/buyer 5 and Regulation FD place disclosure obligations on and any dealer-manager would have to comply with parties who possess material non-public information the requirements of Rules 14e-1, 14e-2 and 14e-3 of the about the securities they purchase. Examples of Exchange Act, each of which is applicable to all tender material information include unreleased earnings or offers (Rule 13e-4 applies only to tender offers for an unannounced merger, both of which would need equity securities).10 The most problematic requirements to be disclosed before purchasing securities from a of these rules are that the offer must remain open for bondholder. twenty business days and that following any changes It is possible that the repurchase program itself in consideration or amount of securities sought, the constitutes material, non-public information. For offer must remain open for ten business days. The example, an issuer that drastically reduces the total reason these requirements are troubling is that most amount of its outstanding debt through a repurchase debt tender offers occur when interest rates are low program should consider disclosing the program as — the issuer is trying to retire its higher interest debt material. This would also be true if the repurchase using proceeds from current, lower interest bonds. If program is likely to significantly reduce the issuer’s the interest rates decline during the offer period, the cash reserves. Generally speaking, an issuer’s plans issuer will not retire as much debt as hoped for; if rates to repurchase some of its debt will not constitute a increase, the debt that the issuer will retire will come at a higher price. Longer offer periods translate into increased uncertainty for debt tender offers, which in 7 Hanson Trust, supra, note 5 at 57-59. turn leads to fewer debt tender offers.11 8 Id. at 57.

9 While both equity and debt tender offers are subject to Sections 10 See Appendix A for the texts of Rules 14e-1, 14e-2 and 14e-3. 14(d) and 14(e) and the rules thereunder, equity tender offers are also subject to the requirements of Rule 13e-4. See also Part III and note 11 The Staff acknowledged these concerns in response to a series of no- 13, infra. action letter requests in 1986. See the no-action letters cited in note 15.

Morrison & Foerster LLP Capital Markets 44 In light of this, the SEC Staff (the “Staff”) consistently holders of that class or series of debt; 12 grants relief from the requirement that non-convertible • the offers are conducted in a manner designed debt tender offers be held open for twenty business to afford all record and beneficial holders of that days, provided certain conditions are met, and has class or series of debt a reasonable opportunity provided additional relief from other provisions of to participate in the tender offer, including paragraphs (a) and (b) of Rule 14e-1 as issuers and their dissemination of the offer on an expedited basis dealer-managers have proposed new methodologies in situations where the tender offer is open for a for tender offers. In many of the no-action letters, period of less than ten calendar days; and particularly the early ones establishing general relief, the Staff has stated its belief, often without elaboration, • the offers are not made in anticipation of or in that issuer debt tender offers for cash for any and all response to other tender offers for the issuer’s 15 non-convertible debt securities of a particular class or securities. series may present considerations that differ from any In many of the no-action letters, the proposed debt and all or partial issuer tender offers for a class or series tender offers are open for ten calendar days (or seven of equity securities or non-investment grade debt.13 calendar days if the expedited procedure indicated above is used), and any extension following a change With the assistance of counsel, an issuer should be in number of securities sought or consideration offered able to structure a tender to fit within existing no- can be less than ten business days. However, not all action guidance and avoid the need to file for its own of these no-action letters requested relief from the no-action relief. Structuring within the guidance will 20-business day requirement. spare the issuer from the ten- and twenty-business day requirements. The no-action letters that established these basic conditions did not indicate whether the debt was The following discussion addresses the different investment grade. However, in a 1990 no-action letter methodologies for debt tender offers in light of existing response, the Staff advised Salomon Brothers that its SEC no-action letter guidance.14 1986 response letters were limited to investment grade debt securities only.16 Non-convertible Debt Tender for Cash – Basic Conditions Investment Grade Debt – Fixed Spread In its no-action relief, the Staff has consistently required Pricing the following four basic conditions, which were As discussed earlier in this memorandum, the principal established in a series of nearly identical 1986 no-action concern when conducting a debt tender offer is that letters from investment banks following amendments prevailing market interest rates will change so that to Sections 14(d) and 14(e) of the Exchange Act that holders will not tender or a tender will become more required that all tender offers remain open for twenty expensive. In addition to shortening the time period business days: for the tender offer in order to limit exposure to interest • offers to purchase are made for any and all rate fluctuations, another protective measure is to price nonconvertible debt of a particular class or series; the tender using fixed spread pricing. • the offers are open to all record and beneficial Fixed spread pricing permits an issuer/offeror to choose a specific yield spread between the debt being 12 Tender offers for debt securities that are convertible into equity tendered for and a benchmark U.S. Treasury security securities, such as common stock, are treated as equity tender (“benchmark treasury security”) that matures at or offers, which raise different concerns and are not discussed inthis memorandum. near the earliest redemption date for such debt security. The purchase price is calculated as the present value of 13 See, for example, SEC No-Action Letter, Merrill Lynch, Pierce, Fenner & Smith Inc. (July 2, 1986) (“For example, because of the the security subject to the tender offer discounted at an modest premiums typically offered in an Issuer Debt Tender Offer, it is not clear that participation in the tender offer by individual non- institutional debtholders would be materially increased by requiring 15 SEC No-Action Letters, Salomon Brothers Inc. (March 12, 1986); that tender offer be held open for twenty business days.”). Goldman Sachs & Co. (March 26, 1986); First Boston Corporation (April 17, 1986); Kidder, Peabody, & Co Inc. (May 5, 1986); and 14 The following discussion highlights the most significant no-action Merrill Lynch, Pierce, Fenner & Smith Inc. (July 2, 1986). letters concerning structuring debt tender offers and is not exhaustive of all the no-action guidance. 16 See SEC No-Action Letter, Salomon Brothers Inc. (Oct. 1, 1990).

45 Morrison & Foerster LLP Capital Markets interest rate equal to the applicable spread.17 While the that the holder of the debt security tenders the security, actual price to be paid in the tender offer is not fixed, the rather than by reference to the yield on a benchmark formula for determining the price is fixed. The greater treasury security as of the date, or date preceding the the spread, the higher the discount rate, resulting in a date, of tender. Merrill Lynch called this a “Real-Time lower present value and lower purchase price. Fixed Spread Offer.” The no-action letter guidance has focused on the The Staff indicated that it would not recommend timing of the calculation of the fixed spread and enforcement action in respect of a Real-Time Fixed has required additional conditions for these kinds Spread Offer, subject to the following additional of tenders. All of these no-action letters involve conditions that the offer: investment grade securities.18 • identifies the specific benchmark treasury security Date of, or Date Immediately Preceding Date of, and specifies the fixed spread to be added to the Tender–Salomon Brothers Inc. (October 1, 1990) yield on the benchmark treasury security; Salomon Brothers Inc. proposed that the issuer would • states the nominal purchase price that would have offer to purchase its debt securities from tendering been payable under the offer must be based on the holders at a price determined on each day during applicable reference yield immediately preceding the tender period by reference to a fixed spread over commencement of the offer; the then-current yield on a specified benchmark U.S. • indicates the daily newspaper of national Treasury security determined as of the date, or date circulation that will provide the closing yield of preceding the date, of tender. the benchmark treasury security on each day of the offer; The Staff, in granting no-action relief, required the following additional conditions: • indicates the reference source to be used during the offer to establish current yield information on • information regarding such benchmark treasury the benchmark treasury security; security will be reported each day in a daily newspaper of national circulation; and • describes the methodology to be used to calculate the purchase price to be paid for the tendered • all tendering holders of that class or series of debt securities; are paid promptly for their tendered securities after such securities are accepted for payment • indicates that the current yield on the benchmark (in this no-action letter, daily settlement was treasury security and the resulting nominal contemplated). purchase price of the debt securities will be accessible on a real-time basis by either calling Real-Time Fixed Spread Offer – Merrill Lynch, Pierce, the dealer-manager collect or through an “800” Fenner & Smith Incorporated (July 19, 1993) telephone number established for each offer;19 Merrill Lynch refined the fixed spread pricing initially and created by Salomon Brothers and proposed to use a • provides that all tendering holders of that fixed spread pricing methodology in connection with class or series of debt will be paid promptly for issuer tender offers; however, the nominal purchase their tendered securities after such securities price in the offer would be calculated by reference to are accepted for payment, within the standard a stated fixed spread over the most current yield on settlement timeframe for broker-dealer trades a benchmark treasury security determined at the time (then five and now three business days from the date of tender). 17 See id. The total purchase price for a debt security would be the In addition to the foregoing conditions, in connection sum of (1) the present value as of the payment date of (a) the interest with any Real-Time Fixed Spread Offer, the dealer- payments on the debt from the payment date until maturity or the earliest call date and (b) any principal payments to and redemption manager must: premium at the earliest call date or maturity plus (2) any accrued and • make and maintain records showing at least the unpaid interest to the purchase date. following information: 18 It is interesting to note that in the first of the fixed price spread requests, SEC No-Action Letter, Salomon Brothers Inc. (October 1, 1990), Salomon did not refer to “investment grade” but the Staff’s 19 In 2009, this methodology should also include access to a website response was specifically limited to “investment grade” debt securities. with such information.

Morrison & Foerster LLP Capital Markets 46 • the date and time of the tender, • no later than the next business day, send a • the current yield on the Benchmark Treasury confirmation to the tendering debt holder providing Security at the time of the tender and the specifics of the tender offer transaction, including the date and, upon request, the time of • the purchase price of the tendered securities the tender, the price to be paid for the tendered based on that yield; and securities and the settlement date. • no later than the next business day, send a confirmation to the tendering debt holder “Indirect Obligor” – Embassy Suites, Inc. (April 15, providing the specifics of the tender offer 1992) transaction, including, upon request, the time of Embassy Suites, Inc. requested confirmation that the the tender. Staff would not recommend that any enforcement action be taken under Rule 14e-1(b) in regard to a cash Continuously Priced Fixed Spread Tender Offer / tender offer for certain non-convertible investment Single Simultaneous Settlement – Goldman, Sachs grade debt securities. Embassy Suites was not the & Co. (December 3, 1993) direct obligor on the debt securities. The existing Goldman, Sachs & Co. created its own version of structure for the debt securities involved a direct pay Merrill Lynch’s Real-Time Fixed Spread Offer and letter of credit from a bank20 and, following a series named it a “Continuously Priced Fixed Spread Tender of spin-off and merger transactions, Embassy Suites Offer.” It was described as being similar to the Real- became one of the obligors on the Reimbursement Time Fixed Spread Offer described above, but with a Agreement, although Holiday Inns was still the nominal provision for simultaneous settlement. Although the obligor. The proposed transaction involved an offer target securities would be irrevocably accepted for to purchase any and all of the series of notes, which payment on a continuous basis throughout the tender Embassy Suites would then submit to the trustee for offer period, the issuer would pay for validly tendered cancellation. The tender offer would be a fixed spread securities on a single simultaneous settlement date issuer tender offer for non-convertible investment promptly after the termination of the tender offer if grade debt. The request letter stated that “from an economic standpoint Embassy and [its parent] have the holder were to make such election. The benefit assumed the primary repayment liability on the Notes to the holder of making the election is that the target through assumption of the Reimbursement Agreement securities would continue to accrue interest to the and the indemnification obligations.” settlement date. The Staff indicated that it would not recommend enforcement action in respect of Embassy Suites described the requirements of the a Continuously Priced Fixed Spread Tender Offer, Salomon Brothers Inc. No-Action Letter, dated October subject to the same conditions required in the Merrill 1, 1990, and indicated that it would comply with those Lynch 1993 letter. However, the Staff also required the requirements. The Staff indicated that it would not following slightly different conditions with respect to recommend enforcement action pursuant to Rule the dealer-manager’s obligations: 14e-1(b), and emphasized the following factors in addition to the ones already described in earlier no- • make and maintain records showing at least the action letters: following information: • the offer will be held open for at least 20 business • the date and time of the tender, days from the date the offer is first published or • the current yield on the benchmark Treasury sent or given to noteholders; security at the time of the tender, • since the pre-offer agreements between the • the purchase price of the tendered securities issuer and the bidder eliminate any risk that the based on that yield and bidder could use the notes acquired in the offer • the date when the simultaneous settlement to attempt to influence the issuer, there are no procedure is made available, whether or not the holder tendering securities elected to 20 In a direct pay letter of credit transaction, the letter of credit bank receive payment on a single settlement date makes the payments on the securities and then seeks reimbursement rather than within the standard settlement from the ultimate obligor. This credit-enhancing structure results in the debt security taking on the credit rating of the bank and not of the timeframe; and ultimate obligor.

47 Morrison & Foerster LLP Capital Markets control implications to the offer; and • the tender offer will remain open for at least 20 • the bidder has the same economic interests in business days; the pricing and completion of the offer and • existing debt securities tendered pursuant to a the retirement of the notes as an issuer of debt tender offer may be withdrawn at any time until securities would have in an issuer debt tender the expiration of such tender offer; and offer. • if for any reason the price to be offered to holders • it will be a condition of the offer that information in a tender offer is increased after such tender regarding the benchmark. offer is made, such increased price will be paid to all holders tendering pursuant to such tender Corporate Restructurings / Multiple offer. Series of Debt Securities Consent Solicitation – The Times Mirror Company The Staff has also provided no-action letter guidance (November 15, 1994) for debt tender offers in the context of corporate The Times Mirror Company had entered into a merger mergers, acquisitions and divestitures, particularly agreement to dispose of its cable television business when the issuer is tendering for more than one series to Cox Cable. As part of the merger, The Times of debt or there are other factors involved, including Mirror Company was to spin-off New Times Mirror. consent solicitations and exchange offers (rather than In connection with this spin-off, The Times Mirror solely cash tender offers). Because of the potential Company proposed to conduct a cash tender offer for a complexity of these transactions, the Staff imposes series of notes, a separate exchange offer for a different additional conditions. series of notes and a related exit consent solicitation. Multiple Transactions – Playtex FP Group Incorporated, The cash tender offer would be priced as a stated et al. (November 22, 1988) fixed spread over the yield on a specified benchmark In connection with certain acquisitions, divestitures and treasury security as of 2:00 p.m., New York time, on mergers pertaining to the Playtex group of companies, the business day immediately preceding the expiration four Playtex entities sought an exemption from Rule date of the tender offer. As a condition to accepting 10b-6 with respect to concurrent cash tender offers for the tender offer, tendering noteholders would be three series of existing debt securities, an exemption required to give their consent to certain indenture under Rule 10b-6 with respect to a public offer of a new amendments. In the exchange offer, notes of an old series of notes that would include change of control series would be exchanged for new notes issued by the provisions, and confirmation that the Staff would not New Times Mirror. Exchanging noteholders would be recommend enforcement action under Rule 14e-1(b).21 required to give the same consent to certain indenture amendments as in the cash tender offer. Notes that The Staff indicated that it would not recommend were not repurchased or exchanged would remain enforcement action under Rule 14e-1(b), if Playtex outstanding obligations of the Times Mirror Company. complied with the following tender offer features that The exit consent solicitation was intended to avoid the Playtex described: situation where both Cox Cable and New Times Mirror • notice of the offering and the tender offer will would become co-obligors with respect to the notes be given to all holders of the pertinent class of that remained outstanding after completion of the cash existing debt securities, and the tender offer will tender offer and exchange offer. The Times Mirror be made to all holders of such class; Company indicated that previous no-action letters had not specifically allowed for tender offer structures 21 Prior to the repeal of Rule 10b-6 and the adoption of Regulation where a debtholder’s right to tender is conditioned on M, it was necessary to obtain an exemption under Rule 10b-6 if an such holder giving an exit consent. issuer engaged in a “distribution” of new debt securities at or about the same time as it made a tender offer for outstanding debt securities The Staff indicated that it would not recommend of the same class and series. See Johnson and McLaughlin, Corporate enforcement action under Rule 14e-1(b) if Times Finance and the Securities Laws, Section 13.02 (2009). The restrictions Mirror conducted a cash tender offer for the notes at of Rules 101 and 102 promulgated under Regulation M apply only to a price determined as described above, subject to the securities that are identical in all of their terms to the securities being distributed. The Staff granted no-action relief in Playtex with respect conditions that apply for a fixed price spread offering to Rule 10b-6. (as described above), plus an additional requirement

Morrison & Foerster LLP Capital Markets 48 that withdrawal of the tendered notes shall be deemed • the final offer price will be set at least two trading a withdrawal of the exit consent solicitation. days prior to the scheduled expiration of the offer; and Debt-Like Securities • the offerors will issue a press release to publicly The Staff has also provided no action guidance for announce the final offer price prior to the close of securities that are not denominated as debt, but have business on the pricing date. debt-like characteristics, such as certain kinds of Trust Preferred Securities preference shares. The Staff has also provided informal, oral advice that Preference Shares – BBVA Privanza et al. (December trust preferred securities are sufficiently “debt-like” so 23, 2005) that tender offers for trust preferred securities would In BBVA Privanza International Limited and Banco Bilbao be subject to the requirements applicable to debt tender offers or exchange offers, and not the more restrictive Vizcaya Argentaria, S.A., BBVA and Banco Bilbao requirements applicable to equity tender offers under proposed to make a cash tender offer for all of the Rule 13e-4. The Staff’s position is predicated on the outstanding Non-Cumulative Guaranteed Preference applicable instruments being qualified under the Trust Shares, Series D of BBVA Privanza International Indenture Act.22 (Gibraltar) Limited, including Preference Shares represented by American Depositary Shares. It was a condition to the tender that all such shares be validly Non-Investment Grade Debt tendered and not withdrawn. The intention was to The SEC has not, to date, issued written no-action price the tender offer based on a stated fixed spread relief for tender offers for non-investment grade debt over the yield on a specified benchmark U.S. Treasury securities. However, the SEC has given informal, security as of 2:00 p.m., New York time, on the second oral advice on structuring such tenders. If an issuer business day immediately preceding the expiration proposes to conduct a tender offer for non-investment date of the tender offer (the 18th business day of the grade debt securities, it should consider seeking advice offer period). from the SEC directly.

BBVA and Banco Bilbao described that the tender Based on such informal advice, fixed spread tender offer would be made consistent with the principles offers for non-investment grade debt securities have established in prior no-action letters relating to formula different characteristics than those for investment pricing in issuer tender offers for equity securities, and grade securities and less flexible pricing terms. The that the offer would be substantially similar to the pricing must be fixed on a “pricing date,” which is tender offers covered by no-action letters relating to not later than the second business day preceding the 23 the use of fixed spread pricing methodologies for non- offer’s expiration. This results in all holders receiving convertible, investment grade debt tender offers. the same purchase price. While not providing “real time” pricing as with investment grade tenders, this The Staff stated that it would not recommend pricing mechanism does mitigate the interest rate risks enforcement action under Rule 14e-1(b) against BBVA faced by both the issuer/purchaser and the holder. In or Banco Bilbao if the tender offer uses the pricing mechanism described and if the tender offer was 22 The Staff has previously indicated that “[the Trust Indenture] otherwise conducted in the manner represented. Act generally would apply . . . to preferred securities issued by a trust that represent an interest in debt issued by a single obligor.” See In granting the requested relief, the Staff noted, in SEC Division of Corporation Finance, Compliance and Disclosure addition to the typical conditions for fixed spread Interpretations: Trust Indenture Act of 1939 (#101.04) (March 30, transactions, that: 2007), available at http://www.sec.gov/divisions/corpfin/guidance/ tiainterp.htm. • the subject securities are represented as being 23 The Staff has allowed some alternatives to this second business valued by investors on the basis of their yield, day pricing models but its goal appears to be to ensure that holders taking into account the issuer’s credit spread, of non-investment grade debt have information early in the process compared to a benchmark yield, and the yield regarding the final expected price rather than a price to be calculated based on yield. This reflects the Staff’s concern that the market for of the subject securities fluctuates in response to non-investment grade (or “high yield”) debt securities is less liquid and changes in prevailing interest rates; may be more susceptible to manipulation.

49 Morrison & Foerster LLP Capital Markets addition to this pricing mechanism, the Staff requires the business day immediately following the date the following conditions, which the issuer/purchaser such threshold has been reached; must agree in writing to undertake: • if an exit consent is required in order to tender, • the securities: the offer must specify that the withdrawal of the tendered securities will be deemed a withdrawal • are traded on a basis of a spread over the U.S. of the consent; treasury market; • if the consent fee is payable only until the later of • are liquid based on trading volume and the a specified date (the “consent expiration date”) or number of market makers; and the date that a majority of consents is obtained, if • are widely followed (evidence include a the majority is not obtained by the consent date, rating by at least one nationally recognized withdrawal rights for tendered securities and statistical rating organization); consents must be extended until at least 6:00 p.m. • the offer to purchase and each press release on the business day following the issuer’s public regarding the tender will provide a toll-free announcement (in a press release) that the issuer number to permit holders to ask questions about has received consents from holders representing the offer; a majority in principal amount of the outstanding securities tendered for; • the offer must be open for at least twenty business days; and • that the revised covenant terms (which are typically set forth in a supplemental indenture) • a press release announcing the purchase price will not become effective until the tender offer is will be issued not later than the business day consummated; and immediately following the pricing date. • if the consent solicitation is amended so as to The SEC has also required additional conditions if a result in a material adverse change to the rights consent solicitation is part of the non-investment grade of security holders, the solicitation period will be debt tender offer, including the following: extended for ten business days to permit holders • withdrawals of tenders and consents are allowed to revoke their consents. until the consents from holders of the required amount of securities are obtained; • if consent to deletion of indenture covenants is sought, the issuer/purchaser must represent that the changes to the covenants should not have a material effect on the trading value of the securities not tendered in the offering; • if a consent fee is paid and the consent period ends prior to expiration of the tender itself, the tender offer will remain open for five business days following the end of the consent solicitation period;24 • if the consent solicitation period expires on the tenth business day of the tender but the tender price is not fixed until later (day 18), the offering materials state when the consent payment will be made; • a press release announcing that the requisite number of consents has been received must be issued no later than the opening of business on

24 See also SEC No-Action Letter, Playtex FP Group Incorporated, et al. (November 22, 1988).

Morrison & Foerster LLP Capital Markets 50 APPENDIX A

Rule 14e-1

Unlawful Tender Offer Practices

Rule 14e-2

Position of Subject Company with Respect to a Tender Offer

Rule 14e-3

Transactions in Securities on the Basis of Material, Nonpublic Information in the Context of Tender Offers

51 Morrison & Foerster LLP Capital Markets RULE 14e -1

Unlawful Tender Offer Practices

As a means reasonably designed to prevent fraudulent, deposited to date and shall be issued no later than deceptive or manipulative acts or practices within the the earlier of: meaning of section 14(e) of the Act, no person who i. 9:00 a.m. Eastern time, on the next business makes a tender offer shall: day after the scheduled expiration date of the a. Hold such tender offer open for less than twenty offer or, business days from the date such tender offer is first ii. if the class of securities which is the subject published or sent to security holders; provided, of the tender offer is registered on one or however, that if the tender offer involves a roll-up more national securities exchanges, the first transaction as defined inItem 901(c) of Regulation opening of any one of such exchanges on S-K and the securities being offered are registered the next business day after the scheduled (or authorized to be registered) on Form S-4 or expiration date of the offer. Form F-4, the offer shall not be open for less than sixty calendar days from the date the tender offer e. The periods of time required by paragraphs is first published or sent to security holders; (a) and (b) of this section shall be tolled for any period during which the bidder has failed to file b. Increase or decrease the percentage of the class in electronic format, absent a hardship exemption of securities being sought or the consideration (Rules 232.201 and 232.202 of this chapter), offered or the dealer’s soliciting fee to be given the Schedule TO Tender Offer Statement (Rule in a tender offer unless such tender offer remains 240.14d-100), any tender offer material required open for at least ten business days from the date to be filed by Item 12 of that Schedule pursuant that notice of such increase or decrease is first to paragraph (a) of Item 1016 of Regulation M-A , published or sent or given to security holders. and any amendments thereto. If such documents Provided, however, That, for purposes of this were filed in paper pursuant to a hardship paragraph, the acceptance for payment of an exemption (see Rule 232.201 and Rule 232.202(d)), additional amount of securities not to exceed the minimum offering periods shall be tolled for two percent of the class of securities that is the any period during which a required confirming subject of the tender offer shall not be deemed to electronic copy of such Schedule and tender offer be an increase. For purposes of this paragraph, material is delinquent. the percentage of a class of securities shall be calculated in accordance with section 14(d)(3) of the Act. c. Fail to pay the consideration offered or return the securities deposited by or on behalf of security holders promptly after the termination or withdrawal of a tender offer. This paragraph does not prohibit a bidder electing to offer a subsequent offering period under Rule 14d-11 from paying for securities during the subsequent offering period in accordance with that section. d. Extend the length of a tender offer without issuing a notice of such extension by press release or other public announcement, which notice shall include disclosure of the approximate number of securities

Morrison & Foerster LLP Capital Markets 52 RULE 14e -2 Position of Subject Company with Respect to a Tender Offer

a. Position of subject company. As a means reasonably subject company shall be exempt from this section designed to prevent fraudulent, deceptive or with respect to a tender offer conducted under manipulative acts or practices within the meaning Rule 14d-1(c). of section 14(e) of the Act, the subject company, no later than 10 business days from the date the tender offer is first published or sent or given, shall publish, send or give to security holders a statement disclosing that the subject company: 1. Recommends acceptance or rejection of the bidder’s tender offer; 2. Expresses no opinion and is remaining neutral toward the bidder’s tender offer; or 3. Is unable to take a position with respect to the bidder’s tender offer. Such statement shall also include the reason(s) for the position (including the inability to take a position) disclosed therein. b. Material change. If any material change occurs in the disclosure required by paragraph (a) of this section, the subject company shall promptly publish or send or give a statement disclosing such material change to security holders. c. Any issuer, a class of the securities of which is the subject of a tender offer filed with the Commission on Schedule 14D-1F and conducted in reliance upon and in conformity with Rule 14d-1(b) under the Act, and any director or officer of such issuer where so required by the laws, regulations and policies of Canada and/or any of its provinces or territories, in lieu of the statements called for by paragraph (a) of this section and Rule 14d-9 under the Act, shall file with the Commission on Schedule 14D-9F the entire disclosure document(s) required to be furnished to holders of securities of the subject issuer by the laws, regulations and policies of Canada and/or any of its provinces or territories governing the conduct of the tender offer, and shall disseminate such document(s) in the United States in accordance with such laws, regulations and policies. d. Exemption for cross-border tender offers. The

53 Morrison & Foerster LLP Capital Markets RULE 14e -3

Transactions in Securities on the Basis of Material, Nonpublic Information in the Context of Tender Offers

a. If any person has taken a substantial step or paragraph (a) of this section, which policies steps to commence, or has commenced, a tender and procedures may include, but are not offer (the “offering person”), it shall constitute limited to, a fraudulent, deceptive or manipulative act or c. Notwithstanding anything in paragraph (a) of this practice within the meaning of section 14(e) of section to contrary, the following transactions shall the Act for any other person who is in possession not be violations of paragraph (a) of this section: of material information relating to such tender offer which information he knows or has reason 1. Purchase(s) of any security described in to know is nonpublic and which he knows or paragraph (a) of this section by a broker or has reason to know has been acquired directly or by another agent on behalf of an offering indirectly from: person; or 1. The offering person, 2. Sale(s) by any person of any security described in paragraph (a) of this section to 2. The issuer of the securities sought or to be the offering person. sought by such tender offer, or d. 3. Any officer, director, partner or employee or any other person acting on behalf of the 1. As a means reasonably designed to prevent offering person or such issuer, to purchase or fraudulent, deceptive or manipulative acts sell or cause to be purchased or sold any of or practices within the meaning of section such securities or any securities convertible 14(e) of the Act, it shall be unlawful for any into or exchangeable for any such securities or person described in paragraph (d)(2) of this any option or right to obtain or to dispose of section to communicate material, nonpublic any of the foregoing securities, unless within information relating to a tender offer to a reasonable time prior to any purchase or sale any other person under circumstances in such information and its source are publicly which it is reasonably foreseeable that such disclosed by press release or otherwise. communication is likely to result in a violation of this section except that this paragraph b. A person other than a natural person shall not shall not apply to a communication made in violate paragraph (a) of this section if such person good faith, shows that: i. To the officers, directors, partners or 1. The individual(s) making the investment employees of the offering person, to its decision on behalf of such person to purchase advisors or to other persons, involved in or sell any security described in paragraph (a) the planning, financing, preparation or of this section or to cause any such security execution of such tender offer; to be purchased or sold by or on behalf of ii. To the issuer whose securities are sought others did not know the material, nonpublic or to be sought by such tender offer, to its information; and officers, directors, partners, employees 2. Such person had implemented one or a or advisors or to other persons, involved combination of policies and procedures, in the planning, financing, preparation reasonable under the circumstances, taking or execution of the activities of the issuer into consideration the nature of the person’s with respect to such tender offer; or business, to ensure that individual(s) making iii. To any person pursuant to a requirement investment decision(s) would not violate

Morrison & Foerster LLP Capital Markets 54 of any statute or rule or regulation promulgated thereunder. 2. The persons referred to in paragraph (d)(1) of this section are: i. The offering person or its officers, directors, partners, employees or advisors; ii. The issuer of the securities sought or to be sought by such tender offer or its officers, directors, partners, employees or advisors; iii. Anyone acting on behalf of the persons in paragraph (d)(2)(i) of this section or the issuer or persons in paragraph (d)(2)(ii) of this section; and iv. Any person in possession of material information relating to a tender offer which information he knows or has reason to know is nonpublic and which he knows or has reason to know has been acquired directly or indirectly from any of the above.

55 Morrison & Foerster LLP Capital Markets Morrison & Foerster LLP Capital Markets 56 more on 3(a)(9)

57 Morrison & Foerster LLP Capital Markets S e c t i o n 3(a)(9) Exchange Offers

Many issuers are now focused on liability management (in the case of a debt-equity swap); transactions as part of a new and increased effort to • manage the maturity dates of outstanding debt restructure and strengthen their balance sheets in light (by exchanging debt securities that are coming due of the recent financial crisis. Financial institutions also for debt securities with an extended maturity); are engaging in liability management transactions in order to meet Tier 1 and other capital requirements. • modify the terms of securities (for example, In addition, debtors and creditors recently have interest payment dates, conversion ratios and been more receptive to pursuing voluntary, out-of- redemption provisions); and court restructurings as an alternative to bankruptcy. • reduce or eliminate onerous covenants (if coupled Liability management is attractive for many issuers as with an exit consent). there are a wide array of transactions and restructuring An issuer may need to comply with the tender offer options available for issuers, including redemptions, rules in connection with an exchange offer, depending repurchases, debt tenders, private exchange offers, on the facts and circumstances.2 Because an exchange Section 3(a)(9) exchange offers, registered exchange offer also involves the offer of new securities, it offers, debt for equity swaps, equity for equity must comply with, or satisfy an exemption from, the exchanges, and consent solicitations.1 registration requirements of the Securities Act.3 An issuer may rely on the private placement exemption provided under Section 4(2) of the Securities Act or the Background exemption provided by Section 3(a)(9) of the Securities Act. In addition, an exemption pursuant to Regulation In an exchange offer, the issuer offers to exchange new S for offers and sales to non-U.S. persons may be debt or equity securities for its outstanding debt or available on a stand-alone basis or combined with other equity securities. An exchange offer often is used as applicable exemptions from registration. An issuer an alternative to a cash tender offer if an issuer does also must be mindful of Regulation M’s prohibitions not have or want to use its available cash resources to on bidding for, or purchasing, its securities when it is 4 repurchase outstanding debt or equity securities. For engaged in an exchange offer. distressed companies, an exchange offer may be the best Section 3(a)(9) exchange offers present a number of non-bankruptcy restructuring option. An exchange offer enables an issuer to, among other things: • reduce interest payments or cash interest expense 2 This Client Alert does not discuss the tender offer rules. For more information regarding the tender offer rules,see Liability Management (by exchanging debt securities with a high rate for Client Alert, supra note 1. a lower rate); 3 For this reason, the documentation for an exchange offer (including • reduce the principal amount of outstanding debt the offer to exchange) must be more detailed than that for a cash tender offer; for example, the offering materials must describe the terms of the new securities. 1 For more information regarding liability management, see our 4 If the securities being exchanged are debt securities convertible Client Alert entitled “Liability Management: Is Now the Time to into equity securities, under certain circumstances, repurchases of Rebalance Your Balance Sheet?” (Mar. 5, 2009) [hereinafter, “Liability the convertible debt securities could be deemed a forced conversion Management Client Alert”], available at http://www.mofo.com/news/ and, therefore, a “distribution” of the underlying equity securities for updates/files/090305DebtRepurchases.pdf. Regulation M purposes.

Morrison & Foerster LLP Capital Markets 58 advantages compared to other types of exchange offers other important considerations. and restructuring options, including the following: • can be completed quickly, as there is no registration required and, therefore, no SEC Staff review Requirements under Section 3(a)(9) (however, if the exchange offer is subject to the tender offer rules, then it is likely that the Schedule Section 3(a)(9) of the Securities Act applies to “any 5 TO would be reviewed); securities exchanged by the issuer with its existing • are flexible (an issuer can retire an entire series or security holders exclusively where no commission or class of debt securities); other remuneration is paid or given directly or indirectly for soliciting such exchange.”6 The exemption from • do not require cash on hand (there are only registration provided by Section 3(a)(9) is a transactional minimal costs); exemption only. This means that the new securities issued • there is no Section 11 liability with regard to are subject to the same restrictions on transferability, if an offer to exchange, as there is no registration any, of the old securities, and any subsequent transfer statement required; of the newly issued securities will require registration 7 • can be paired with a consent solicitation; or another exemption from registration. For example, if the old securities were issued without registration • the limitations on OID tax deductions for certain in a Section 4(2) private placement and then were high-yield obligations issued during 2009 have exchanged by a holder for new securities, the holder been suspended; and could only sell or transfer the new securities without • often can be accomplished largely tax-free for registration pursuant to Rule 144, pursuant to Section debt holders. 4(1), or, with respect to securities held by affiliates, in a However, Section 3(a)(9) exchange offers also have a Section 4(1-1/2) private placement. number of disadvantages compared to other exchange The four main requirements of Section 3(a)(9) are as offers and restructuring options, including the following: follows: • the new securities issued in the exchange offer • Same issuer. The issuer of the old securities being may be “restricted,” depending on the status of surrendered is the same as the issuer trying to the securities surrendered for exchange; effectuate an exchange of the new securities. • there is a limited ability to engage and compensate • No additional consideration from the security an investment bank or other third parties in holder. The security holder must not be asked connection with the exchange offer; to part with anything of value besides the • there may be holdout issues; outstanding securities. • the exchange offer may be integrated with other • Offer only to existing security holders. The exchange offers done in close proximity; must be offered exclusively to the issuer’s existing security holders. • if the exchange offer is subject to the tender offer rules, the offer must be made to all existing • No remuneration for the solicitation. The issuer must security holders; and not pay any commission or remuneration for the solicitation of the exchange. • if the exchange offer is subject to the tender offer rules, all investors of the same class must be paid In addition, as a general matter and similar to other the same price. exempt offerings, any exchange offer under Section This client alert provides (1) a general overview of the requirements under Section 3(a)(9), (2) guidance 6 The exemption does not apply with respect to a security exchanged regarding permissible and impermissible activities and under Chapter 11 of the U.S. Bankruptcy Code. Other exemptions, fees with respect to solicitation, and (3) a discussion of such as Section 1145 of the U.S. Bankruptcy Code, may apply with respect to securities exchanged pursuant to a plan of reorganization. 7 See e.g., SEC Division of Corporation Finance, Compliance and 5 When debt securities are offered, an indenture may need to be Disclosure Interpretations: Securities Act Sections (#125.08) (Nov. 26, qualified under the Trust Indenture Act and the Form T-3 filed for the 2008), available at http://www.sec.gov/divisions/corpfin/guidance/ purpose of qualifying the indenture may be subject to SEC Staff review. sasinterp.htm.

59 Morrison & Foerster LLP Capital Markets 3(a)(9) must be made in good faith and not as part of of a newly formed trust were deemed to constitute a plan to avoid the registration requirements of the securities of their parent, given that the trusts had Securities Act. limited purposes and the obligations of the trusts were guaranteed under back-up arrangements between the 11 Same issuer parent and the trusts. Section 3(a)(9) exempts any securities exchanged by Further, In Grupo TMM, S.A. de C.V., an issuer the issuer with its security holders. This means that the transferred its common stock to a trust in order to new securities being issued and the securities that are facilitate the exchange of old securities for new ones.12 being surrendered must originate from a single issuer. The issue in the no-action request was whether the Although this concept seems relatively straight forward, issuance by the trust, which was ostensibly a different there are a number of scenarios that can complicate the issuer, would preclude the issuer from relying on the identity of issuer analysis. In fact, over the years, the Section 3(a)(9) exemption. The SEC Staff, without SEC Staff has granted no-action relief in response to agreeing with counsel’s analysis (and noting “policy facts and circumstances that do not fit neatly within considerations”) provided no-action relief from the “single issuer” requirement. For example, in Echo Securities Act registration requirements. The incoming Bay Resources Inc., the SEC Staff granted no-action relief letter noted that the trust was a special purpose entity under Section 3(a)(9) for an exchange of guaranteed established for the sole purpose of allowing investors to debt securities of a finance subsidiary for the securities obtain the economic right in a security and the trust did of the parent-issuer guarantor.8 The incoming letter in not engage in any activities unrelated to this purpose Echo Bay Resources emphasized the economic reality and has no independent financial or economic activity. of the transaction, including the relationship between More significantly, the SEC Staff’s approach, along with the parent issuer and the subsidiary, noting that the the approach taken in Echo Bay Resources Inc., Suntrust subsidiary was established by the parent-issuer to issue Banks, Inc. and similar no-action letters, indicates that securities and finance the activities of the parent-issuer the SEC will often focus on the underlying economic and the subsidiary had minimal assets and liabilities reality of the exchange for the purposes of the identity that were tied to the issuance of securities.9 However, of issuer analysis.13 it should be noted that the SEC Staff takes the view Consistent with these precedents, issuers have relied that there is no identity of issuer between a subsidiary on Section 3(a)(9) to exchange common or preferred and its parent where the subsidiary had outstanding stock for trust preferred securities. For example, on a class of debentures guaranteed by its parent and the June 3, 2009, KeyCorp announced an offer to exchange, subsidiary proposed to offer a new debenture that in reliance on Section 3(a)(9), its common shares for any would not be guaranteed by its parent in exchange for and all trust preferred securities of KeyCorp Capital I, 10 the guaranteed debenture. KeyCorp Capital II, KeyCorp Capital III and KeyCorp In Suntrust Banks, Inc., the SEC Staff provided no- Capital IV,14 and on June 30, 2005, Foster Wheeler Ltd. action relief in connection with the “same issuer” requirement under Section 3(a)(9), in a situation where 11 See SEC No-Action Letter, Suntrust Banks, Inc. (July 16, 1999). the trust preferred securities of an existing trust and 12 See SEC No-Action Letter, Grupo TMM, S.A. de C.V. (June 27, 2002). the substantially similar trust preferred securities 13 There are a number of other no-action letters and additional SEC materials that provide additional guidance regarding the Section 3(a)(9) 8 See SEC No-Action Letter, Echo Bay Resources Inc. (May 18, 1998). requirements. See SEC Division of Corporation Finance, Compliance and Disclosure Interpretations: Securities Act Sections, available at http:// 9 The incoming letter stated: “In economic reality, it is the [parent www.sec.gov/divisions/corpfin/guidance/sasinterp.htm, SEC Division issuer’s] financial position and business prospects and the value of the of Corporation Finance, Compliance and Disclosure Interpretations: [parent issuer’s] securities to be issued … that will be of interest to Securities Act Rules, available at http://www.sec.gov/divisions/ investors in making their investment decisions.” corpfin/guidance/securitiesactrules-interps.htm, and SEC Division of Corporation Finance, Compliance and Disclosure Interpretations: 10 See SEC Division of Corporation Finance, Compliance and Trust Indenture Act of 1939, available at http://www.sec.gov/divisions/ Disclosure Interpretations: Securities Act Sections (#125.05) (Nov. 26, corpfin/guidance/tiainterp.htm. 2008), available at http://www.sec.gov/divisions/corpfin/guidance/ sasinterp.htm. In this circumstance, the SEC Staff views the guarantee 14 See Press Release, “KeyCorp Commences Separate Exchange Offers and the debenture as separate securities, thus the exchange of the old for $503,530,000 of its Series A Preferred Stock and for $797,647,000 parent guarantee for the subsidiary’s new debenture would not involve Trust Preferred Securities of Four Affiliated Trusts” (June 3, 2009), and exchange between the same issuer, even though the exchange of available at http://finance.yahoo.com/news/KeyCorp-Commences- the primary security is exempt from registration. Separate-prnews-15424331.html?.v=1.

Morrison & Foerster LLP Capital Markets 60 announced an offer to exchange, in reliance on Section an interest payment due to another security holder. 3(a)(9), its common shares for all outstanding shares of In this case, the issuer can require the unjustly its 9.00% trust preferred securities.15 enriched security holder to reimburse the issuer for the extra interest payment. In addition, an issuer can Another frequent concern with the identity of an issuer also require the security holders to waive the right to arises when, through a merger, acquisition or other receive an interest payment or other consideration transaction, an issuer has unconditionally assumed the accruing from a security.19 obligations of the securities of another issuer. The SEC Staff is of the view that the Section 3(a)(9) exemption is available for the exchange of the securities of one Offer only to existing security holders issuer for the debt securities of another issuer when Any exchange offer conducted in reliance on Section the obligations on those debt securities have been 3(a)(9) may be made only to existing security fully and unconditionally assumed by the issuer of holders. Although this requirement also appears the new security.16 straight forward, it may not be satisfied if an issuer is conducting an offering of new securities for cash No additional consideration from at the same time as the exchange offer. In this case, the security holder the issuer must take care to keep the two offerings separate and avoid their “integration,” which would Under Section 3(a)(9), the consideration that require the registration of the combined offerings security holders exchange must consist only of or the application of another exemption from the old securities. However, there are two limited registration. The determination regarding integration exceptions to this requirement. First, under Rule is fact specific, and the issuer must apply the SEC’s 150 under the Securities Act, an issuer can make five-factor test.20 payments to its security holders “in connection with an exchange of securities for outstanding securities, Further, if any part of the issue in the same transaction when such payments are part of the terms of the as the exchange is sold for cash, or intended to be offer of the exchange.” The SEC Staff has provided sold for cash, or provided to creditors (as opposed no-action relief where these payments included to security holders), even if those portions of the cash or a cash equivalent17 and even when paid by transaction are exempt pursuant to another exemption an affiliate of the issuer.18 Second, under Rule 149 or are registered, then Section 3(a)(9) would not be under the Securities Act, a security holder can make available.21 any cash payments that may be necessary “to effect There is no requirement, however, that a Section an equitable adjustment, in respect of dividends or 3(a)(9) offering be made to all members of a given interest paid or payable on the securities involved in class of security holders (assuming that tender offer the exchange, as between such security holder and rules do not apply to the transaction). As a result, other security holders of the same class accepting an issuer may choose to rely on Section 3(a)(9) to the offer of exchange.” For example, an equitable exchange with securities with one or a limited group adjustment may be necessary when, due to the timing of investors. of interest payments and sales between security holders, one security holder receives the benefit of

15 See Press Release, “Foster Wheeler Launches New Equity-for-Debt Exchange” (June 30, 2005), available at 19 See SEC Division of Corporation Finance, Compliance and http://phx.corporate-ir.net/phoenix.zhtml?c=80422&p=irol- Disclosure Interpretations: Securities Act Sections (#125.04) (Nov. 26, newsArticle&ID=725266&highlight=. 2008), available at http://www.sec.gov/divisions/corpfin/guidance/ sasinterp.htm. 16 See SEC Division of Corporation Finance, Compliance and Disclosure Interpretations: Securities Act Sections (#125.02) (Nov. 26, 20 The five-factor test requires that an issuer consider: (1) whether 2008). the offerings are part of a single plan of financing; (2) whether the offerings involve issuances of the same class of securities; (3) whether 17 See SEC No-Action Letter, The News Corporation Limited the offerings are made at or about the same time; (4) whether the same (May 15, 1992) and SEC No-Action Letter, International Controls type of consideration is received; and (5) whether the offerings are Corp. (Aug. 6, 1990). made for the same general purposes. See SEC Release No. 33-4552 (Nov. 6, 1962). 18 See SEC No-Action Letter, Carolina Wholesale Florists, Inc. (Aug. 17, 1976). 21 See Release No. 33-2029 (Aug. 8, 1939).

61 Morrison & Foerster LLP Capital Markets No remuneration for solicitation intermediary, such as an investment bank. The type of transaction will dictate an investment bank’s role Section 3(a)(9) expressly prohibits an issuer from paying (including any limitations on its activities), which a person or entity a commission or other remuneration ranges from merely an advisory role to responsibilities either directly or indirectly for soliciting the exchange. as an agent or principal. However, an issuer merely When determining what activity and/or commission interested in taking advantage of declining secondary or other remuneration is permissible under Section market prices for debt securities also may benefit from 3(a)(9), an issuer or a third party involved in the engaging an investment bank to locate, contact, and exchange should consider the following factors: negotiate with security holders to retire (or exchange) • the relationship between the issuer and the person their securities on favorable terms. In either case, or entity furnishing the services; an investment bank, which typically has a “liability • the nature of the services performed; and management,” “restructuring,” or “workout” team specializing in debt restructurings, will help create a • the method of compensation for the services. restructuring plan, structure the transaction, solicit participation, and manage the marketing efforts to Issuer’s activities achieve a successful restructuring. Some important As a general rule, an issuer may solicit holders of target factors to consider in determining whether to engage a securities without jeopardizing the use of the Section third party include the number of security holders and 3(a)(9) exemption. An issuer soliciting holders of target their organization and sophistication and whether the securities should adhere to the following guidelines: issuer has information about, or any contact with, its • the personnel chosen to contact the security security holders. holders, which may include the issuer’s directors, Impermissible activities. Services may be provided by officers, and key employees (the “corporate persons or entities other than the issuer in a Section solicitors”), should have significant responsibilities 3(a)(9) exchange, subject to the following limitations: with the issuer other than the solicitation of the exchange and should not be hired for the purpose • cannot make any recommendation regarding the of soliciting the exchange; exchange to any security holder, or to any adviser or other representative of any such security holder; 23 • no special bonus, commission, fee, or any other type of remuneration should be paid to the • when communicating with security holders, can corporate solicitors for their solicitation activities, provide only that information which is included which means they should be paid no more than in the various communications sent by the issuer their regular salary; and to the security holders; and • the corporate solicitors should attend to their • should limit its activities to performing functionary regular duties, with their solicitation efforts only services or administrative assistance in the being additional assignments.22 distribution of exchange materials and providing information about the mechanics of the exchange. Third party activities If any security holder or any adviser or other An issuer also may engage third parties, such as representative to any security holder asks for a third financial advisers, investment banks, and investor party’s opinion on an investment-related attribute of relations firms, to assist in the exchange offer, subject the exchange, the third party should direct the holder to certain limitations. Whether an issuer should of the target securities to contact the appropriate engage a third party for assisting with an exchange officer or employee of the issuer. The third party may offer and the services that the third party will provide respond to questions from security holders regarding depend on the issuer’s particular situation and the substantive elements of the exchange that are type of transaction contemplated. Generally, the more addressed in the exchange materials by directing the complex and significant a restructuring (for example, security holder to the pertinent portion of the exchange a restructuring for a distressed company), the more materials; however, the third party must not convey helpful it may be for an issuer to engage a financial

23 See SEC No-Action Letter, Dean Witter & Co., Inc. (Nov. 21, 1974). See also SEC No-Action Letter, Stokley-Van Camp, Inc. (Mar. 22 See SEC No-Action Letter, URS Corporation (May 8, 1975). 31, 1983).

Morrison & Foerster LLP Capital Markets 62 management’s views or recommendations on the fairness opinion with respect to the Exchange Offer; or exchange, even if those views and/or recommendations (3) communicate directly with any holder of Existing are contained in the exchange materials. Sub Debt with respect to substantive matters relating to the restructuring or the Exchange Offer. The Company Permissible activities. Permissible activities can be understands that during the aforementioned telephone grouped into two broad categories: (1) advice to the conversations and meetings its financial advisers have: issuer with respect to the terms and mechanics of the (1) outlined the current status of negotiations between exchange; and (2) services that are administrative, the Company and the other creditors of the Company; ministerial, or mechanical in nature in furtherance of the (2) discussed the Company’s financial statements exchange.24 Any services not deemed administrative, and projections; (3) presented the Company’s current ministerial, or mechanical must be ancillary to the proposals with respect to the terms of the Exchange effective mechanical operation of the process of Offer and the restructuring to the banks and the formulating a restructuring proposal.25 legal and financial advisers to the Committee; and For example, in Seaman Furniture Co., Inc., the SEC granted (4) received and discussed the counterproposals of no-action letter relief in connection with a proposed the banks and the legal and financial advisers to the exchange offer for which the issuer hired investment Committee and relayed such counterproposals to bankers from Merrill Lynch to act as its financial the Company. We understand that the Company’s advisers.26 The issuer characterized the services and financial advisers have not (1) expressed to the banks activities provided by its financial advisers as follows: or the legal or financial advisers to the Committee their views as to (a) the fairness of the proposed restructuring or the Exchange Offer or (b) the value of the securities Since their engagement by the Company in July 1989, to be issued in connection with the Exchange Offer or the investment bankers from Merrill Lynch Capital (2) made any recommendation to the banks or the legal Markets who have acted as the Company’s financial and financial advisers to the Committee with respect to advisers have performed the following services for the restructuring or the Exchange Offer.27 the Company: (1) performed financial analyses; (2) assisted the Company in formulating a restructuring proposal; (3) advised the Company with respect to the The argument made by the issuer that such services terms of the new securities to be issued in connection and activities were permitted under Section 3(a)(9) was with the restructuring and the new capital structure that there was no direct contact between the issuer’s of the Company; (4) participated in meetings between financial advisers and any debt holder with respect representatives of the Company, on the one hand, to substantive matters relating to the exchange offer.28 and the banks, on the other hand; (5) participated in In addition, the issuer stated that the activities of meetings between representatives of the Company, on the issuer’s financial advisers constituted activities the one hand, and the legal and financial advisers to “effecting” rather than “promoting” an exchange the Committee, on the other hand; and (6) conversed because (1) the exchange offer had not been made, by telephone with representatives of the banks and the (2) the issuer’s financial advisers had not and would legal and financial advisers to the Committee. Merrill not make any recommendation to the debt holders or Lynch Capital Markets will not: (1) be named as a their advisers with respect to the proposed exchange dealer-manager of the Exchange Offer; (2) deliver a offer, and (3) it is customary for an issuer involved in a complex financial transaction to engage an investment banker to act as an intermediary among the parties to 24 See SEC Division of Corporation Finance, Compliance and Disclosure Interpretations: Securities Act Sections (#125.03) (Nov. 26, a negotiation, especially when the other parties are 2008), available at http://www.sec.gov/divisions/corpfin/guidance/ professional legal and financial advisers.29 sasinterp.htm. A financial adviser may advise the issuer with respect 25 See SEC No-Action Letter, Seaman Furniture Co., Inc. (Oct. to virtually all aspects of developing and executing the 10, 1989). An issuer also needs to be particularly mindful of those third parties, such as investor relations firms, that communicate with exchange. The SEC has taken a no-action position with security holders. Hiring a firm to communicate with security holders could be construed as payment for solicitation. The SEC, however, 27 See id. allows investor relations firms to participate in exchange offers ina limited capacity. 28 See id. 26 See id. 29 See id.

63 Morrison & Foerster LLP Capital Markets respect to each of the following advisory services:30 security holders:32 • performance of financial analysis for the issuer; • obtain a list of the issuer’s security holders • formulation or assistance in the formulation of a from the issuer, and confirm the accuracy of the restructuring proposal for the issuer’s approval; addresses of the security holders; • advice on the issuer’s capital structure following • mail or otherwise assist in the distribution of the restructuring; exchange materials; • advice on the timing and organization of the • maintain records on the exchange; restructuring proposal; • be named as a financial intermediary in the • advice on the proposed terms and mechanical exchange materials; procedures for the exchange; • contact nominees holding target securities and • advice on the proposed terms of the new securities; ascertain the number of the exchange materials needed by each brokerage house for transmittal • assistance in the preparation of the various to beneficial holders; exchange materials to be sent by the issuer to the security holders; • deliver sufficient quantities of the exchange materials to brokerage houses, trust officers, other • advice to employees of the issuer on the procedures banks, and other nominees for distribution to to be used in conversations with security holders beneficial holders of the target securities; and concerning the exchange; • mail duplicate copies of exchange materials • engagement in pre-launch discussions or to security holders who appear to have lost or negotiations with legal and financial representatives mislaid those originally sent to them. of debt holder committees; and The issuer may rely on a third party, such as an investor • provision of a fairness opinion regarding the relations firm or other sales force or an information 31 exchange. agent, to inform security holders of the exchange A third party can engage in administrative, ministerial, offer.33 A third party can contact security holders or mechanical services designed to convey the directly for the following administrative, mechanical, information in the exchange materials to security or ministerial purposes, subject in all instances to the holders. These activities can be divided into two requirement that no solicitation take place as a result of groups: (1) those in which the third party merely any such contacts:34 services as a functionary in disseminating information; • to determine whether the security holders received and (2) those in which the third party communicates the exchange materials; directly with security holders or their advisers or other representatives. However, the latter group of services • to determine whether the security holders should be conducted with great care. understand the procedures for participating in the exchange (for example, expiration dates and The SEC Staff has acknowledged in no-action letters to whom to forward documents); that third parties may provide each of the following functionary services in disseminating information to • to answer questions or resolve any confusion about the procedures for participating in the exchange; • to contact back-office personnel of nominees 30 See, e.g., SEC No-Action Letter, Seaman Furniture Co., Inc. (Oct. 10, 1989); SEC No-Action Letter, Mortgage Investors of Washington (Sept. 8, who hold securities for the benefit of others to 1980); SEC No-Action Letter, Hamilton Brothers Petroleum Corp. (Aug. 14, 1978); SEC No-Action Letter, Valhi, Inc. (Sept. 15, 1976); and SEC No- Action Letter, Dean Witter & Co., Inc. (Jan. 22, 1975). 32 See, e.g., SEC No-Action Letter, Mortgage Investors of Washington 31 An issuer is permitted to hire an investment bank to render a fairness (Sept. 8, 1980); SEC No-Action Letter, Barnett Winston Investment opinion on the terms of the exchange; however, if the investment bank Trust (Oct. 11, 1977); and SEC No-Action Letter, Dominion Mortgage also is acting as a dealer-manager and conducting solicitation activities, & Realty Trust (Apr. 3, 1975). the SEC has held that obtaining a fairness opinion would violate 33 Relying on an investment bank in this instance may be efficient Section 3(a)(9). See SEC Division of Corporation Finance, Compliance because the firm that initially sold the securities may be in the best and Disclosure Interpretations: Securities Act Sections (#125.07) (Nov. position to contact its former customers. 26, 2008), available at http://www.sec.gov/divisions/corpfin/guidance/ sasinterp.htm. 34 See supra note 27.

Morrison & Foerster LLP Capital Markets 64 make sure that they promptly forward exchange when it plans to force the conversion of convertible materials to the nominees; debentures (or other similar instruments) by calling the • to urge back-office personnel to check with the debentures for redemption but would like to protect beneficial holders of the target securities about itself from having to make substantial cash outlays whether such holders have received the exchange in the event that the issuer’s stock price declines in materials, understand procedurally how to the period between the redemption notice and the participate in the exchange, and are generally redemption date and the holders elect for redemption. aware of the relevant dates and deadlines; A standby agreement between an issuer and an • to determine whether the security holders intend investment bank is similar to an underwriting to participate in the exchange and to communicate agreement for a primary distribution of securities. The their responses to the issuer; investment bank agrees, for a fee, to purchase at a price slightly above the redemption price all of the debt • to remind the security holders of all appropriate securities that are offered to it before the redemption deadlines; and date, and then to convert those debt securities into • to respond to the questions of security holders common stock. The issuer can rely on Section 3(a)(9) to that do not concern the mechanical aspects of the exempt the exchange of its common stock for the debt exchange by directing the security holders to the securities acquired by the investment bank.36 relevant portions of the exchange materials. Open market purchases Fees paid to third parties An investment bank also can itself effect open market Section 3(a)(9) does not specify the types of fees that purchases of an issuer’s securities as a principal and third parties can receive in an exchange. However, then later exchange those securities with the issuer for the SEC Staff has indicated through various no-action new securities in reliance on Section 3(a)(9). However, letters that a financial adviser may receive a fixed fee all of the conditions under Section 3(a)(9) must be for its services, not contingent upon the success of satisfied, which means that the investment bank cannot the exchange, plus reasonable expenses related to the receive any commission or remuneration in connection exchange. A fixed fee arrangement eliminates one with the open market purchases. factor which might otherwise support the inference that the financial adviser had an incentive to engage in a solicitation of security holders. Therefore, whenever Other considerations paid third parties are contacting security holders within permissible guidelines, it is advisable that their fees be a fixed amount not tied to the success of the exchange. Involvement of affiliates Nevertheless, determining whether a paid solicitation In some circumstances, affiliates of an issuer may has occurred is a fact-specific analysis that will turn on seek to exchange the issuer’s debt or equity securities. the facts present in a particular transaction. Note that this This may occur on the corporate level, such as when a determination is not necessarily based upon the method parent exchanges securities of its subsidiaries or when of payment of fees to the third party. In addition, if the subsidiaries exchange securities of their parent or issuer relies on an investor relations firm, sales force, other subsidiaries, or if officers, directors or significant information agent or others to inform security holders shareholders seek to exchange the issuer’s securities. of the exchange, then the issuer can only pay a fee on a In these instances, the “affiliates” would generally be 35 flat, per-contact basis to that financial intermediary. considered insiders of the issuer and subject to the same disclosure obligations as the issuer. In many Redemption standby agreement circumstances, the involvement of an affiliate may A redemption standby agreement between an issuer preclude reliance on the Section 3(a)(9) exemption for and an investment bank can be combined with an an exchange offer. exchange of securities under Section 3(a)(9). An issuer engages an investment bank as a standby purchaser 36 See SEC No-Action Letter, TransTechnology Corp. (Feb. 23, 1983); SEC No-Action Letter, Foster Wheeler Corp. (July 2, 1973); SEC No- 35 This second requirement applies to any of the issuer’s agents who Action Letter, Kewanee Oil Co. (Feb. 5, 1973); and SEC No-Action contact the security holders, and not only to dedicated sales departments. Letter, Squibb Corp. (June 23, 1971).

65 Morrison & Foerster LLP Capital Markets Qualification under the Trust Indenture Act stock, a volume weighted average price (“VWAP”) Exchange offers of debt securities that are exempt from or a maximum amount of common stock issued just registration under Section 3(a)(9) are not exempt from below the appropriate threshold. An issuer also must qualification under the Trust Indenture Act.37 Unless an carefully review the securities exchange rules if the indenture for a debt security is qualified under Section security to be exchanged is either actual equity or 305 of the Trust Indenture Act, which covers registered convertible or exchangeable debt, or if the exchange offerings, or is exempt from qualification under Section offer cannot be categorized as a “public offering.” In 304 (which does not include an exemption for Section addition, the securities exchanges require shareholder 3(a)(9) exchange offers), the sale of a debt security approval when an issuance will result in a “change of 40 pursuant to a Section 3(a)(9) exchange would generally control” of the issuer. violate Section 306 of the Trust Indenture Act unless Tax considerations41 an application for qualification of the related indenture has been filed with the SEC.38 Qualification under the An issuer that exchanges new debt for old debt in an Trust Indenture Act is accomplished by filing a Form exchange offer will recognize ordinary cancellation T-3 with the SEC, which is subject to review by the SEC of indebtedness (“COD”) income to the extent the Staff. The solicitation of the exchange offer may not adjusted issue price of the old debt exceeds the issue commence until the Form T-3 is filed, and no sales may price of the new debt. A modification of existing be made until the Form T-3 is declared effective by the debt, as part of an exchange offer, also will be treated SEC Staff. as an exchange of existing debt for new debt if the modification is “significant.” Generally, modifications Securities exchange requirements are significant if, among other things, (1) the yield The securities exchanges, including the New York changes by the greater of 25 basis points or 5% of the Stock Exchange (“NYSE”), the Nasdaq Stock Market existing yield, (2) scheduled payments are materially (“Nasdaq”) and the NYSE Alternext US (“Amex”), deferred, (3) modified credit enhancements change require shareholder approval for the issuance of equity payment expectations, or (4) the nature of the security securities by listed issuers in various situations.39 Each changes (for example, from debt to equity or from exchange also applies these shareholder approval recourse to nonrecourse). provisions to offerings of securities that are convertible Assuming the exchange or modification constituted into, or in the case of the NYSE and Nasdaq, a recapitalization, the exchange or modification exchangeable for, common stock, such as convertible generally should not result in gain or loss to the debt debt. For example, the requirement for shareholder holder. However, depending on the terms of the new approval for issuances of common stock in an amount debt relative to the old debt, certain tax consequences more than 20% of the current outstanding common could follow. For example, if the principal amount of stock, at a price below the greater of book or market the new debt exceeded that of the old debt, the holder value, has resulted in many Section 3(a)(9) exchange could recognize gain equal to the fair market value offers structured with a price floor for the common of the excess. Exchanges and modifications also can create OID or, conversely, an amortizable premium, due to differences in the issue price of the new debt 37 See SEC Division of Corporation Finance, Compliance and 42 Disclosure Interpretations: Trust Indenture Act of 1939 (#101.05) (Mar. and the stated redemption price at maturity. 30, 2007), available at http://www.sec.gov/divisions/corpfin/guidance/ tiainterp.htm. See also SEC No-Action Letter, Mississippi Chemical Corp. (Nov. 25, 1988) and SEC No-Action Letter, Mississippi Chemical 40 See Nasdaq Rule 5635(b); NYSE Rule 312.03(d); and Amex Corp. (June 23, 1989). Section 713(b). 38 Section 306 of the Trust Indenture Act does not apply to exchange 41 For a more detailed discussion of the tax considerations in offers that are exempt under Section 3(a)(9) where the offering does not connection with exchange offers, see our Client Alert entitled “Tax exceed $5 million and Section 304(a)(8) and Rule 4a-1 under the Trust Provisions of the Stimulus Bill” (Feb. 17, 2009), available at http://www. Indenture Act otherwise are available. See SEC Division of Corporation mofo.com/news/updates/files/CMGTaxStimulus.pdf; and our Legal Finance, Compliance and Disclosure Interpretations: Trust Indenture Act Update entitled “Temporary Deferral of Cancellation-of-Indebtedness of 1939 (#207.01) (Mar. 30, 2007), available at http://www.sec.gov/ Income Under the Recovery and Reinvestment Act of 2009” (Feb. 2009), divisions/corpfin/guidance/tiainterp.htm. available at http://www.mofo.com/news/updates/files/15268.html. 39 See, e.g., Nasdaq Marketplace Rules 5635(a)-(f), and related publicly 42 In each case, particular attention must be paid to terms of art available interpretive guidance; NYSE Rule 312.00 – 312.07; and Amex including “issue price,” the meaning of which may vary depending on a Sections 710-713. number of factors. For example, if existing debt is publicly traded, the

Morrison & Foerster LLP Capital Markets 66 Under the American Recovery and Reinvestment Act David Lynn of 2009, issuers often will be able to elect to defer any (202) 887-1563 | [email protected] COD income recognized during exchanges in 2009 and Brandon Parris 2010. In addition, the limitations on OID deductions (415) 268-6617 | [email protected] for certain applicable high-yield discount obligations (“AHYDOs”) issued in exchanges during 2009 have Anna Pinedo been suspended. Taken together, the deferral of COD (212) 468-8179 | [email protected] income and the suspension of limitations applicable Jim Tanenbaum to AHYDOs can create significant tax benefits for debt (212) 468-8163 | [email protected] exchanges occurring this year.

Liability considerations Tax Restructuring transactions, including exchange Stephen Feldman offers, involve the purchase and sale of securities. (212) 336-8470 | [email protected] Therefore, these transactions are subject to the general antifraud provisions of Section 10(b) of the Exchange Thomas A. Humphreys Act and Rule 10b-5 under the Exchange Act. Section (212) 468-8006 | [email protected] 10(b) provides an implied cause of action covering Shane Shelley all transactions in securities and all persons who use (858) 720-5169 | [email protected] any manipulative or deceptive devices in connection with the purchase or sale of any securities. Rule 10b-5 covers substantially the same ground as Section 10(b) and prohibits, among other things, the making of any untrue statement of a material fact or the omission Because of the generality of this update, the information of a material fact necessary to make the statements provided herein may not be applicable in all situations and made not misleading. Under Rule 10b-5, the issuer, should not be acted upon without specific legal advice based its directors, officers and employees, and its agents, on particular situations. including third parties retained by the issuer, may be held liable. Exchange offers may also be subject to Section 14(e) of the Exchange Act, which, in addition to specific procedural requirements, contains prohibitions regarding material misstatements and omissions similar to those in Section 10(b) and Rule 10b-5.

Contacts

Capital Markets and Corporate

Ze’-ev Eiger (212) 468-8222 | [email protected] Nilene Evans (212) 468-8088 | [email protected]

“issue price” of new debt issued (or constructively issued, in the case of a modification) in exchange for existing debt is deemed the current market price. Given current economic conditions, debt exchanges or modifications will often result in COD income because the market prices of many existing debt securities are steeply discounted from their adjusted issue prices.

67 Morrison & Foerster LLP Capital Markets Morrison & Foerster LLP Capital Markets 68 tender and Dutch auction guidance

69 Morrison & Foerster LLP Capital Markets Tender and Dutch Auction Guidance

A key consideration in developing any liability about with the enactment of the Williams Act in management strategy is the extent to which the 1968. The Williams Act and the SEC’s implementing SEC’s tender offer rules apply to any contemplated regulations are designed to require the dissemination transactions, given that these rules can substantially of material information about a tender offer, while affect the manner in which a transaction is conducted, providing sufficient procedural protections so that the timing of the transaction, as well as the issuer’s security holders get the opportunity to consider the ability to conduct other transactions in its securities disclosure when making a decision about whether to around the time of the tender offer. The tender offer tender their securities in the offer. The tender offer rules can apply when a company is offering securities rules apply in the case of a third-party tender offer for and/or cash for its outstanding securities, and the the securities of another issuer, as well as to a tender level of regulation of the offer (in terms of timing and offer by an issuer for its own securities. mandated procedural protections) varies depending The term “tender offer” is not specifically defined in on the type of security that is the subject of the offer. the statute or in the SEC’s regulations. The lack of a In the case of exchange offers, the tender offer rules specific definition has permitted the SEC and the may apply in addition to the requirement that the courts to apply tender offer rules to a broad range of issuer must either register the transaction or meet the transaction structures. The analysis of whether an conditions for an exemption under the Securities Act offer constitutes a tender offer begins with the often- of 1933, as amended (the “Securities Act”). We discuss cited “eight factor” test cited in the case of Wellman other federal securities law and tax considerations for 2 liability management transactions in our alert titled v. Dickinson : “Liability Management: Is Now the Time to Rebalance • An active and widespread solicitation of public Your Balance Sheet.” In this memorandum, we focus shareholders for the shares of an issuer; on the applicability of tender offer rules to potential • A solicitation is made for a substantial percentage liability management alternatives, including cash of the issuer’s securities; tender offers and exchange offers for outstanding securities.1 • The offer to purchase is made at a premium over the prevailing market price; • The terms of the offer are firm rather than Tender Offer Requirements negotiable; • The offer is contingent on the tender of a fixed Defining the Tender Offer number of shares, often subject to a fixed maximum number to be purchased; The comprehensive regulation of tender offers came • The offer is open only for a limited period of time;

1 See also “Cash Debt Tenders: An Overview and Summary of No- Action Advice” for a more detailed discussion of tender offer issues 2 475 F. Supp. 783, 823–24 (S.D.N.Y. 1979), aff’d on other grounds, arising in cash tender offers for debt securities. This piece does not 682 F.2d 355 (2d. Cir. 1982), cert. denied, 460 U.S. 1069 (1983). See address tender offer rules applicable to third-party tender offers for an also SEC v. Carter Hawley Hale Stores, Inc., 760 F.2d 945, 950 (9th issuer’s securities, such as Rules 14d-1 through 14d-11. Cir. 1985).

Morrison & Foerster LLP Capital Markets 70 • The offeree is subjected to pressure to sell his or Pursuant to the authority specified in Section 14(e), her security; and the SEC has adopted Regulation 14E.4 Regulation 14E • Public announcements of a purchasing program specifies requirements applicable to all tender offers, and concerning the target issuer precede or accompany for those tender offers where additional requirements a rapid accumulation of large amounts of the apply (such as tender offers for equity securities), the requirements of Regulation 14E must still be satisfied. target issuer’s securities. Regulation 14E applies to cash tender offers, as well as These eight factors need not all be present for a exchange offers subject to the tender offer requirements. transaction to be deemed a tender offer, and the weight In addition, Regulation 14E applies to both third-party given to each element varies with the individual facts tender offers as well as issuer tender offers. and circumstances. While these factors were cited in the context of an offer for equity securities, the principles What is Required by Regulation 14E? would equally apply to tender offers involving debt Regulation 14E sets forth certain requirements for tender securities or equity securities other than common stock. offers that must be carefully followed throughout the The eight factor test may be applied both in the context course of an offer. These requirements seek to prevent of third-party offers, as well as offers by an issuer for practices that would be deemed fraudulent, deceptive its own securities. or manipulative acts in connection with a tender offer. Courts have also applied a “totality of the circumstances” Regulation 14E requires that: test in determining whether a transaction involves • A tender offer must be held open for at least 20 a tender offer that should be subject to the statutory business days; requirements and the SEC’s rules. In this context, the courts have examined whether, in the absence of • The percentage of the class of securities being disclosure and procedures required under the tender sought or the consideration being offered may offer rules, there will be a substantial risk that the not be increased or decreased unless the tender offeree will lack the information needed to make an offer remains open for at least 10 business days investment decision with respect to the offer.3 The from the date that the notice of such increase or SEC Staff has historically focused on whether a tender decrease is first published or sent or given to offer involves an investment decision on the part of security holders; the offeree, particularly where the protections afforded • The offeror promptly pay the consideration, or by the tender offer requirements would appear to be return tendered securities, upon termination or necessary based on the nature of the transaction. withdrawal of the tender offer; • Public notice be provided in connection with the Requirements Applicable to All Tender extension of a tender offer, and such notice must Offers include disclosure of the amount of securities Section 14(e) of the Securities Exchange Act of 1934 already tendered; (the “Exchange Act”) is an antifraud provision that • The issuer subject to a tender offer disclose to its establishes the “baseline” for tender offer regulation. security holders its position with respect to the Section 14(e) prohibits an offeror from making any offeror’s tender offer; untrue statement of a material fact, or omitting to • Certain trading be avoided when a person is in state any material fact necessary in order to make the possession of material nonpublic information statements made, in light of the circumstances in which relating to the tender offer; they were made, not misleading. Section 14(e) also prohibits any fraudulent, deceptive or manipulative • Tendering person must have a net long position in acts in connection with a tender offer. Section 14(e) the subject security at the time of tendering and at applies to cash tender offers, as well as to exchange offers subject to the tender offer requirements. 4 Regulation 14E applies to tender offers for any securities other than “exempt securities” as defined by Section 3(a)(12) of the Exchange Act. As a result, the rules that comprise Regulation 14E apply to tender offers for debt securities, equity securities, and the securities 3 See Rand v. Anaconda-Ericsson, Inc., 794 F.2d 843, 848-49 (2d Cir. of companies that do not have a class of securities registered under 1986), cert. denied, 479 U.S. 987 (1986) (citing Hanson Trust PLC v. Section 12 of the Exchange Act or are otherwise required to file reports SCM Corp., 774 F.2d 47 (2d Cir. 1985)). under the Exchange Act.

71 Morrison & Foerster LLP Capital Markets the end of the proration period in connection with period must be made by a press release or other public partial tender offers (and not engage in “short- announcement by 9:00 a.m., Eastern time, on the next tendering” and “hedged tendering” in connection business day after the scheduled expiration date of with their tenders); and the offer, and the press release or other announcement • No covered person directly or indirectly purchase must disclose the approximate number of securities or arrange to purchase any subject securities or tendered to date. If the securities are registered any related securities except as part of the tender on one or more national securities exchange, the offer, from the time of public announcement of the announcement must be made by the first opening of tender offer until the tender offer expires. any one of such exchanges on the next business day following the scheduled expiration date of the tender Each of these requirements is described in more offer. detail below. Disclosure of Position Regarding the Offer Minimum Offer Period Rule 14e-2 requires that an issuer that has securities Rule 14e-1(a) provides that a tender offer must remain subject to a tender offer disclose to its security holders open for at least 20 business days from the date the its position with respect to the offeror’s tender offer, tender offer commences.5 Rule 14e-1(b) provides that i.e., whether the issuer recommends the offer, expresses the offer must also stay open for at least ten business no opinion with respect to the offer or is unable to days from the date a notice is first published or sent take a position. The disclosure must be provided no or given to the holders of the subject securities of an later than ten business days after the tender offer is increase or decrease in: (i) the percentage of securities first disseminated to security holders. In the event to be acquired pursuant to the tender offer (if the of any material change in the disclosure, the subject change exceeds two percent of the original amount); company must promptly disseminate a statement to (ii) the consideration offered, without any de minimis security holders noting the material change. Given exception; or (iii) any dealer-manager’s solicitation fee. that Rule 14e-2 is not expressly limited to third party The SEC has stated that a tender offer subject only to tender offers, it is common for an issuer conducting Regulation 14E must remain open for a minimum of an issuer tender offer to include in its tender offer five business days for any other material change to the materials a statement that the issuer makes no offer or waiver of a material condition.6 recommendation as to the tender. Prompt Payment Prohibited Trading Rule 14e-1(c) provides that the offer must either pay Rule 14e-3 contains an antifraud prohibition on the consideration offered or return the securities activities of a person conducting a tender offer. If tendered promptly after termination or withdrawal, such person is in possession of material nonpublic respectively, of the tender offer. information that he or she knows or has reason to The SEC Staff has generally taken the view that “prompt know is nonpublic and knows or has reason to know payment” under Rule 14e-1(c) requires the payment of was acquired from the offering person, the issuer consideration or the return of tendered securities no or any of its directors, officers or employees, it is later than three business days after the conclusion of unlawful for that person to purchase or sell or cause the tender offer. to be purchased or sold any of the securities that are the subject of the tender offer. The prohibition applies Extension of Offering Period even if the trading does not occur in breach of a duty or Rule 14e-1(d) provides that any extension of the offer trust or confidence. In the case of an issuer tender, an issuer must be careful not to conduct a tender at a time when it possesses material nonpublic information. 5 Rule 14d-1(g) states that when “computing any time period under Material nonpublic information for this purpose may section 14(d)(5) or section 14(d)(6) of the Act or under Regulation include unreleased earnings, a potential change in an 14D or Regulation 14E, the date of the event which begins the running of such time period shall be included.” Therefore, the date on issuer’s credit ratings or an unannounced merger. The which the tender offer is first published or sent to holders of the subject issuer should, to avoid any issues, disclose any such securities is counted as the first day of the 20 business day period. material nonpublic information prior to commencing 6 See SEC Release No. 34-42055 (Oct. 22, 1999). a tender offer.

Morrison & Foerster LLP Capital Markets 72 Prohibited Transactions in Connection with Partial announcement” is defined for the purposes of Rule Tender Offers 14e-5 as “any oral or written communication by the offeror or any person authorized to act on the offeror’s Partial tender offers typically involve the risk to behalf that is reasonably designed to, or has the effect security holders that not all of the securities that the of, informing the public or security holders in general security holder tenders will be accepted in the tender about the tender offer.” Given the potentially broad offer (commonly referred to as proration risk). Rule reach of this definition, offerors must be very careful 14e-4 prohibits security holders from engaging in the about what is stated in advance of any potential cash practice of “short tendering,” which occurs when the tender offer or exchange offer, particular when it is security holder tenders more shares than they own contemplated that purchases of subject securities in order to avoid or mitigate the proration risk, or or any related securities may occur in advance of “hedged tendering,” which occurs when a security commencement of the offer. holder tenders securities but then sells a portion of their shares before the proration deadline to a person Exceptions to the Rule 14e-5 prohibition on purchases that could then tender those shares. Under Rule 14e-4, outside of the tender offer include: a tendering person must have a net long position in the • The exercise, conversion or exchange of related subject security at the time of tendering and at the end securities into subject securities, as long as the of the proration period. related securities were held prior to public Prohibited Purchases Outside of a Tender Offer announcement of the tender offer; • Purchases or arrangements to purchase by or for Rule 14e-5 provides that, subject to certain exceptions, a plan that are made by an agent independent of no covered person may directly or indirectly purchase the issuer; or arrange to purchase any subject securities or any related securities except as part of the tender offer. The • Purchases during odd-lot offers; prohibition in Rule 14e-5 applies from the time of public • Purchases by or through a dealer-manager or its announcement of the tender offer until the tender affiliates that are made in the ordinary course of offer expires, but does not apply to any purchases or business and made either on an agency basis not arrangements to purchase made during the time of for a covered person; or as principal for its own any subsequent offering period as provided for in Rule account if the dealer-manager or its affiliate is not 14d-11, as long as the consideration paid or to be paid a market maker, and the purchase is made to offset for the purchases or arrangements to purchase is the a contemporaneous sale after having received an same in form and amount as the consideration offered unsolicited order to buy from a customer who is in the tender offer. not a covered person; For the purposes of Rule 14e-5, the term “covered • Purchases or arrangements to purchase a basket of person” is defined broadly to include: (i) the offeror securities containing a subject security or a related and its affiliates; (ii) the offeror’s dealer-manager and security under specified conditions; its affiliates; (iii) any advisor to any of the persons • Purchases or arrangements to purchase to cover specified in paragraph (i) and (ii) above, whose a short sale or the exercise of an option by a non- compensation is dependent on the completion of the covered person, if (i) the short sale or option offer; and (iv) any person acting, directly or indirectly, transaction was made in the ordinary course of in concert with any of these persons in connection with business and not to facilitate the offer; (ii) the short any purchase or arrangement to purchase any subject sale was entered into before public announcement securities or any related securities. “Subject securities” of the tender offer; and (iii) the covered person are defined for the purposes of Rule 14e-5 to include wrote the option before public announcement of the securities or class of securities that are sought to the tender offer; be acquired in the transaction or that are otherwise the • Purchases or arrangements to purchase pursuant to subject of the transaction. a contract, if an unconditional and binding contract The period during which purchases outside of the was entered into before public announcement of tender offer are prohibited runs from the potentially the tender offer, and the existence of the contract earlier date of “public announcement” as compared to and all material terms including quantity, price and commencement of the tender offer. The term “public parties are disclosed in the offering materials;

73 Morrison & Foerster LLP Capital Markets • Purchases or arrangements to purchase by an affiliate a tender offer for, or a request or invitation for tenders of a dealer-manager under specified conditions; of, any class of equity security made by the issuer of • Purchases by connected exempt market makers or that class of security or by an affiliate of that issuer. connected exempt principal traders under certain An soon as practicable on the commencement date of conditions; and the issuer tender offer, the issuer or affiliate making the offer must comply with the filing, disclosure and • Purchases made during cross-border tender offers dissemination requirements specified in the rule. under specified circumstances. Applicability of Rule 13e-4 to Equity Securities What is Not Required by Regulation 14E? The term “equity securities” used in Rule 13e-4 Under Regulation 14E, an issuer is not required is not defined in the rule. Section 3(a)(11) of the to file any tender offer documents with the SEC, Exchange Act provides a general definition of the and Regulation 14E does not prescribe any form term “equity security,” which includes “any stock or requirements with respect to offering materials. Any similar security; or any security future on any such offer to purchase, and other tender offer documentation, security; or any security convertible, with or without is subject, however, to the general antifraud provisions consideration, into such a security, or carrying any of the Exchange Act, notably Section 10(b), Rule 10b-5 warrant or right to subscribe to or purchase such a and Section 14(e), and, therefore, may not contain any security; or any such warrant or right; or any other material misstatement or omission. security which the Commission shall deem to be of a Regulation 14E does not specifically require that similar nature and consider necessary or appropriate, an offeror provide withdrawal rights to offerees.7 by such rules and regulations as it may prescribe in Similarly, the proration, “best price,” “all holders” and the public interest or for the protection of investors, other provisions set forth in Section 14(d) and Rule to treat as an equity security.” Under the statute, 13e-4 of the Exchange Act are only applicable to tender the SEC has discretion to evaluate the “nature” of a offers conducted pursuant to Regulation 14D and Rule security and to consider public policy implications in 13e-4, and do not apply to tender offers subject only to determining the characterization of the security. Based Regulation 14E. on this definition, the term “equity securities” for the purposes of the applicability of Rule 13e-4 includes Requirements Applicable to Issuer debt securities convertible or exchangeable for equity Tender Offers for Equity Securities securities. Pursuant to Rule 13e-4 under the Exchange Act, an In the past, the Staff has provided limited no-action issuer with equity securities registered under Section letter relief in respect of offers that should be excluded 12 of the Exchange Act or that is required to file from the application of Rules 13e-3 and 13e-4 based on periodic reports with the SEC pursuant to Section whether the subject securities were deemed “equity 15(d) of the Exchange Act is required, in connection securities” for the purposes of those rules. In a no- 8 with any tender offer for its own equity securities, to action letter to American Financial Corporation, the file a tender offer statement (on Schedule TO) to make Staff concluded it would not recommend enforcement certain disclosures to offerees. Rule 13e-4 is intended action if, in reliance on an opinion of counsel, the issuer to prevent fraudulent, deceptive or manipulative acts proceeded with an exchange offer relating to non- in connection with issuer tender offers. voting, non-participating, mandatorily redeemable preferred stock without compliance with either In general, Rule 13e-4 imposes disclosure, filing, and Rule 13e-3 or Rule 13e-4. Counsel to the issuer had procedural requirements on issuers and their affiliates concluded that in economic substance the preferred in connection with issuer tender offers. For the purposes stock was equivalent to a debt security. The Staff of this rule, the term “issuer tender offer” is defined as later affirmed this view in a subsequent no-action letter issued to American Financial Corporation.9 In between these two letters, the Staff issued no-action 7 In tender offers for straight debt securities, it is standard practice to provide holders with withdrawal rights. These withdrawal rights typically expire after an initial period, often after the first ten business 8 SEC No Action Letter, American Financial Corporation (Dec. 20, 1982). days. An issuer also should consider whether it should reinstate limited withdrawal rights following the occurrence of any material change in 9 SEC No Action Letter, American Financial Corporation (Mar. 9, the terms of the tender offer or the waiver of a material condition. 1989).

Morrison & Foerster LLP Capital Markets 74 letter guidance to Republic New York Corporation.10 established in prior no-action letters relating to formula In Republic New York Corp., the Staff concluded pricing in issuer tender offers for equity securities, and that it could not assure the company that it would that the offer would be substantially similar to the not recommend enforcement action if the issuer were tender offers covered by no-action letters relating to to undertake purchases of shares of its cumulative the use of fixed spread pricing methodologies for non- preferred stock without compliance with Rule 13e- convertible, investment grade debt tender offers. 3. The Staff will not necessarily take the same view The Staff stated that it would not recommend today with respect to preferred stock, particularly in enforcement action under Rule 14e-1(b) against BBVA situations where preferred stock which has debt-like or Banco Bilbao if the tender offer uses the pricing characteristics has not been treated as debt for the mechanism described and if the tender offer was purposes of matters such as compliance with the Trust otherwise conducted in the manner represented. Indenture Act of 1939 (the “Trust Indenture Act”) and legality opinions. In granting the requested relief, the Staff noted, in addition to the typical conditions for fixed spread On the other hand, the Staff has provided informal, oral transactions, that: advice that trust preferred securities are sufficiently “debt-like” so that tender offers for trust preferred • the subject securities are represented as being securities would be subject to the requirements applicable valued by investors on the basis of their yield, to debt tender offers or exchange offers, and not the more taking into account the issuer’s credit spread, restrictive requirements applicable to equity tender offers compared to a benchmark yield, and the yield or exchange offers under Rule 13e-4. The Staff’s position is of the subject securities fluctuates in response to predicated on the applicable instruments being qualified changes in prevailing interest rates; 11 under the Trust Indenture Act. • the final offer price will be set at least two trading Further, in a no-action letter for BBVA Privanza days prior to the scheduled expiration of the International Limited and Banco Bilbao Vizcaya offer; and 12 Argentaria, S.A, BBVA and Banco Bilbao proposed • the offerors will issue a press release to publicly to make a cash tender offer for all of the outstanding announce the final offer price prior to the close of Non-Cumulative Guaranteed Preference Shares, Series business on the pricing date. D of BBVA Privanza International (Gibraltar) Limited, including Preference Shares represented by American Filing Requirements Depositary Shares. It was a condition to the tender that Unlike under Regulation 14E, Rule 13e-4 requires all such shares be validly tendered and not withdrawn. that an issuer13 engaged in an issuer tender offer The intention was to price the tender offer based on must file a tender offer statement on Schedule TO a stated fixed spread over the yield on a specified with the Commission as soon as practicable on the benchmark U.S. Treasury security as of 2:00 p.m. New commencement date of the offer.14 In addition, the York time, on the second business day immediately issuer is required to file: preceding the expiration date of the tender offer (the 18th business day of the offer period). • Any of its written communications relating to the issuer tender offer, from and including the first BBVA and Banco Bilbao described that the tender public announcement, as soon as practicable on offer would be made consistent with the principles the date of the communication; • An amendment to the Schedule TO reporting 10 SEC No Action Letter, Republic New York Corporation (Mar. 5, promptly any material changes in the information 1985). 11 The Staff has previously indicated that “[the Trust Indenture] 13 The requirements of Rule 13e-4 applicable to issuers are also Act generally would apply . . . to preferred securities issued by a trust applicable to affiliates of the issuer. For the purposes of this discussion that represent an interest in debt issued by a single obligor.” See of Rule 13e-4, references made to the issuer also include affiliates of SEC Division of Corporation Finance, Compliance and Disclosure the issuer. Interpretations: Trust Indenture Act of 1939 (#101.04) (March 30, 2007), available at http://www.sec.gov/divisions/corpfin/guidance/ 14 For the purposes of Rule 13e-4, the term “commencement” means tiainterp.htm. 12:01 a.m. on the date that the issuer has first published, sent or given the means to tender to security holders. The “means to tender” includes 12 SEC No-Action Letter, BBVA Privanza International Limited and the transmittal form or a statement regarding how the transmittal form Banco Bilbao Vizcaya Argentaria, S.A., (Dec. 23, 2005). may be obtained.

75 Morrison & Foerster LLP Capital Markets disclosed in the previously filed Schedule TO and each pre-commencement written communication amendments thereto;15 and must include a prominent legend in clear, plain • A final amendment to the Schedule TO reporting language advising shareholders to read the tender promptly the results of the issuer tender offer. offer statement when it becomes available because it contains important information. A significant amount of disclosure is required to be filed under cover of Schedule TO.16 Most of the specific If pre-commencement communications are made in line item requirements are satisfied by reference to connection with an exchange offer that is registered a separate Offer to Purchase or Offer to Exchange under the Securities Act, then the issuer can file the document that is filed as an exhibit to the Schedule TO. communications solely under Rule 425 under the The information required by Schedule TO includes: Securities Act, and such communications will be deemed filed for the purposes of Rule 13e-4. • A summary term sheet; • Information about the issuer; Disclosure Requirements • The identity and background of filing persons; An issuer making an issuer tender offer under Rule 13e-4 must publish, send, or give to shareholders: • The terms of the transaction; • the summary term sheet required by Item 1 of • Any past contacts, transactions and negotiations; Schedule TO; and • The purposes of the transactions and plans or • the information required by the remaining proposals; Schedule TO items for issuer tender offers, except • The source and amount of funds or other for Item 12 (exhibits), or a fair and adequate consideration for the tender offer; summary of the information. • Interests in subject securities; To the extent that there are any material changes to • Persons/assets retained, employed, compensated the information previously disclosed to shareholders, or used; paragraphs (d)(2) and (e)(3) of Rule 13e-4 require that the issuer disclose those changes promptly to • Financial statements; shareholders in a manner reasonably calculated to • Additional information; inform them of the change. • Exhibits; and In the event that an the issuer disseminates the issuer • To the extent applicable, information required by tender offer by means of summary publication as Schedule 13E-3. discussed below, any summary advertisement used by the issuer must not include a letter of transmittal that In addition to the Schedule TO filing, an issuer would permit shareholders to tender securities, and conducting an issuer tender offer must file any pre- the advertisement must disclose at least the following commencement written communications under cover information: of Schedule TO, marking the box on the cover page to note the status of the materials as pre-commencement • the identify of the issuer (or affiliate); 17 communications. Pursuant to Instruction 3 to Rule 13e-4(c), • the material terms and purposes of the transaction, as specified in Items 1004(a)(1) and 1006(a) of 15 Instruction 1 to Schedule TO provides that information previously Regulation M-A; disclosed in the Schedule TO may be omitted in an amendment • instructions as to how shareholders can promptly disclosing a material change. obtain a copy of the disclosure statement required 16 At the time of making the initial Schedule TO filing, the issuer by Rule 13e-4(d)(1), at the issuer’s expense; and will be required to pay a filing fee computed in accordance with Rule 0-11 of the Exchange Act. If a fee has been paid under Section 6(b) • a statement that the information contained in of the Securities Act with respect to any of the securities issued in the disclosure statement discussed above is connection with the proposed transaction, then the required fee is incorporated by reference. reduced by that amount. Similarly, the fee required for a Securities Act registration statement would be reduced by the amount of any fee paid in connection with the Schedule TO filing. 17 See Instruction 1 to Rule 13e-4(c). The filing person need not commencement written communications, and no fee is required with respond to the specific line items of Schedule TO when filing pre- the filing.

Morrison & Foerster LLP Capital Markets 76 Dissemination Requirements solely or partly of securities that are registered under With respect to issuer tender offers in which the the Securities Act, then Rule 13e-4(e)(2) provides that consideration offered consists solely of cash and or the issuer must: securities exempt from registration under Section • File a registration statement containing all of 3 of the Securities Act, an issuer must disseminate the required information, including pricing the required disclosure to security holder by one or information; and more of these methods: long form publication of the • Deliver to shareholders a preliminary prospectus information, the use of security holder lists or through or a prospectus that meets the requirement of summary publication. Section 10(a) of the Securities Act, along with a Rule 13e-4(e)(1)(i) provides that dissemination may letter of transmittal.18 occur by making adequate “long form” publication of the tender offer in a newspaper or newspapers on the Material Changes commencement date of the issuer tender offer. For this Rule 13e-4(e)(3) specifies that when a material change purpose, the Instruction to paragraph (e)(1) specifies occurs in the information that the issuer has published, that adequate publication may require publication in sent or given to security holders, then the issuer must a newspaper with a national circulation, a newspaper promptly disseminate disclosure of the material change with a metropolitan or regional circulation, or a “in a manner reasonably calculated to inform security combination of the two, depending on the specific facts holders of the change.” and circumstances. In the case of a registered exchange offer, special Alternatively, Rule 13e-4(e)(1)(iii) permits publication timing provisions govern the dissemination of of a summary advertisement in a newspaper or material changes when the issuer has disseminated newspapers on the commencement date including a preliminary prospectus in accordance with Rule the disclosures referenced above, and by mailing or 13e-4(d)(2). Rule 13e-4(e)(3) specifies that the offer otherwise furnishing promptly the Rule 13e-4(d)(1) must remain open from the date on which the issuer disclosure statement and a transmittal letter to any disseminates material changes to the tender offer security holder upon request. materials to shareholders, as follows: Tender offer materials may also be disseminated • 5 business days for a prospectus supplement by using security holder lists and security position containing a material change other than price or listings. Under the procedures specified in 13e-4(e)(1) share levels; (ii), the materials may be distributed by: • 10 business days for a prospectus supplement • Mailing, or otherwise furnishing promptly, the containing a change in price, the amount of disclosure required by Rule 13e-4(d)(1) to each securities sought, the dealer’s soliciting fee, or security holder whose name appears on the other similarly significant change; issuer’s most recent security holder list; • 10 business days for a prospectus supplement • Contacting each participant on the most recent included as part of a post-effective amendment to security position listing of any clearing agency the registration statement; and within the possession or access of the issuer, • 20 business days for a revised prospectus when and inquiring of each participant as to the the initial prospectus was “materially deficient.” approximate number of beneficial owners of the subject securities held by the participant; Procedural Requirements • Furnishing to each participant a sufficient Rule 13e-4(f) prescribes the manner in which issuers number of copies of the Rule 13e-4(d)(1) disclosure statement for transmittal to the 18 Instruction 2 to Rule 13e-4(e)(2) provides that a preliminary beneficial owners; and prospectus cannot omit information under Rule 430 or 430A of the Securities Act. Instruction 3 to Rule 13e-4(e)(2) provides that when a • Agreeing to reimburse each participant promptly preliminary prospectus is used and the issuer must disseminate material for its reasonable expenses incurred in forwarding changes, the tender offer must remain open for the period specified in the statement to beneficial owners. Rule 14d-4(d)(2). If a preliminary prospectus is used, tenders may be requested in accordance with Securities Act Rule 162(a), pursuant to In an exchange offer where the consideration consists Instruction 4 to Rule 13e-4(e)(2).

77 Morrison & Foerster LLP Capital Markets may conduct an issuer tender offer, including Rule 13e-4(f)(3) does not prohibit the issuer making an specific requirements with respect to the period issuer tender offer from: during which the tender offer must remain open; the • Accepting all securities tendered by shareholders availability of withdrawal rights, pro rata acceptance, who own no more than a specified number of any increases in consideration, prompt payment for shares less than one hundred and who tender or return of securities tendered, purchases outside all of their securities, before pro rating securities of the tender offer and the “all holders” and “best tendered by others; or price” protections. • Accepting by lot securities tendered by Offering Period shareholders who tender all of their shares Rule 13e-4(f)(1)(i) specifies that, unless withdrawn, an and who elect to have all or none (or at least a issuer tender offer must remain open until expiration of: minimum amount and none) accepted, if the issuer or affiliate first accepts the securities tendered by • At least 20 business days from commencement of persons who have not made such an election. the issuer tender offer; and Increase in Consideration • At least 10 business days from the date that notice of an increase or decrease in one of the following is Rule 13e-4(f)(4) requires equal treatment of security first published, sent or given to security holders: holders in the event of an increase in the consideration offered. If the issuer increases the consideration offered • The percentage of the class of securities after the tender offer has commenced, then issuer must being sought;19 pay that increased consideration to all shareholders • The consideration being offered (subject to no whose tendered securities are accepted for payment. de minimis exception); or • The dealer’s soliciting fee to be given. Prompt Payment or Return Under Rule 13e-4(f)(5), an issuer must either pay the Withdrawal Rights consideration offered, or return the tendered securities, Rule 13e-4(f)(2) provides that the issuer making promptly after the termination or withdrawal of the an issuer tender offer must permit shareholders to tender offer. withdraw securities tendered pursuant to the issuer tender offer: Purchases Outside the Tender Offer • At any time during the period when the issuer Rule 13e-4(f)(6) prohibits purchases outside of the tender offer remains open; and tender offer. Until at least ten business days after the termination of the tender offer, the issuer and its affiliates • If tendered securities have not yet been accepted cannot purchase – other than pursuant to the tender offer for payment, after the expiration of 40 business – any subject security, any security of the same class and days from the commencement of the tender offer. series, or any right to purchase such securities. With respect to exchange offers, this prohibition applies to the Pro Rata Acceptance purchases of any security being offered in the exchange Rule 13e-4(f)(3) requires that the tender offer by the offer, any securities of the same class and series, and any issuer or affiliate is for fewer than all of the outstanding right to purchase such a security. equity securities of a class, and the number of securities tendered exceeds the number that the issuer is bound “All Holders” Requirement or willing to take up and pay for, the issuer or affiliate Rule 13e-4(f)(8)(i) provides that the tender offer must must accept and pay for the securities as nearly as be open to all security holders20 of the class of securities may be pro rata, disregarding fractions, according to subject to the tender offer.21 the number of securities tendered by each shareholder during the period that the offer remains open. 20 Rule 13e-4(a)(6) specifies that the term “security holders” means both holders of record and beneficial owners of securities of the class which is the subject of the tender offer. As a result, a tender offer 19 An issuer may accept for payment up to an additional two percent open to only holders of record would not satisfy the “all holders” of the class without triggering the additional 10 business days. For requirement. the purposes of this rule, the “percentage of the class” is calculated in accordance with Section 14(d)(3) of the Exchange Act. 21 The SEC has indicated that a tender offer may be made for fewer than

Morrison & Foerster LLP Capital Markets 78 This “all-holders” provision would not prohibit an manipulative practices in connection with an issuer issuer or affiliate from excluding all security holders tender offer, it is unlawful for an issuer or affiliate to in a state where the tender offer is prohibited by make an issuer tender offer unless it complies with the administrative or judicial action under a state statute requirements of Rule 13e-4(b), (c), (d), (e), (f), and (j). after a good faith effort to comply with the statute. In addition, the other antifraud and antimanipulation provisions of the Exchange Act would apply to an “Best Price” Requirement issuer tender offer, including Section 10(b) and Rule Rule 13e-4(f)(8)(ii) requires that the consideration paid 10b-5 thereunder, as well as Section 14(e). to any security holder for securities tendered in the tender offer is the highest consideration paid to any Exemptions other security holder for securities tendered in the Certain transactions are exempt from the application tender offer. of the rule under Rule 13e-4(h) from the issuer tender Rule 13e-4(f)(10) specifies that the “best price” offer provisions. Specifically, Rule 13e-4 does not requirement does not prohibit more than one type of apply to: consideration being offered in a tender offer, provided • Calls or redemptions pursuant to the governing that: (i) security holders have an equal right to elect instrument; among each of the types of consideration offered; and • Offers to purchase evidenced by a scrip certificate, (ii) the highest consideration of each type paid to any shareholder is paid to any other shareholder receiving order form, or similar document that represents a that type of consideration. fractional interest in a share of stock; • Offers to purchase shares of dissenting Under Rule 13e-4(f)(11), if the offer and sale of securities shareholders in accordance with a statutory constitute consideration offered in the tender offer, and procedure; the issuer or affiliate has made a good faith effort to register or qualify the offer and sale in a particular • Tender offers subject to Exchange Act Section state but is prohibited by the appropriate authority of 14(d); that state, the issuer or affiliate may offer shareholders • Offers to purchase from owners of up to a in that state an alternative form of consideration. The specified number of shares less than 100, provided alternative form of consideration need not be offered that the offer satisfies the “all holder” provisions or paid to shareholders in any other state. of the rule with respect to shareholders who own a number of shares equal to or less than the Antifraud Provisions specified number of shares (except that the issuer Rule 13e-4(j) specifies antifraud requirements can exclude participants in certain plans for applicable to issuer tender offers, prohibiting issuers employees or security holders, and can exclude and affiliates, in connection with an issuer tender security holders who do not own their shares as offer, from: of a specified date); and the equal consideration • Employing any device, scheme or artifice to provisions of rule are satisfied or consideration defraud any person; paid is determined on the basis of a uniformly applied formula based on the subject security’s • Making any false statement of material fact or market price; omission of material fact necessary to make the statements made, in light of the circumstances • Issuer tender offers made solely to effect a under which they were made, not misleading; or rescission offer, provided that: (1) the offer is registered under the Securities Act; and (2) the • Engaging in any act, practice, or course of business consideration equals the price paid by each that operates or would operate as a fraud or deceit on any person. security holder, plus legal interest if the issuer elects or is required to pay legal interest; Rule 13e-4(j) also states that, as a means reasonably designed to prevent fraudulent, deceptive, or • Offers by closed-end management investment companies to repurchase equity securities under Investment Company Act Rule 23c-3; all outstanding securities, but all security holders must be eligible to accept the offer if they choose. See Release No. 34-23421 (July 11, 1986). • Issuer tender offers by a foreign private issuer

79 Morrison & Foerster LLP Capital Markets under certain conditions relating to: (1) the maximum percentage of U.S. holders of the subject Considerations for Liability class of securities; (2) the equal treatment of U.S. Management Transactions holders and other holders; and (3) dissemination of informational documents; and Debt versus Equity Tender Offers • Transactions exempted by the SEC, on written request or on its own motion, either unconditionally The requirements of Rule 13e-4 result in significantly or subject to conditions. less flexibility for tender offers or exchange offers for convertible or exchangeable debt securities, common An offer may qualify for the “Tier I” exemption from stock and preferred stock, when compared to tender the tender offer rules if it can be established that 10% or less of the securities are held by U.S. resident offers or exchange offer for straight debt securities. holders, looking through to the beneficial owners. For For example, it is not possible for issuers to “sweeten” the purpose of this exemption, holders of notes held a tender offer or exchange offer for convertible or in bearer form may be presumed to be outside the exchangeable debt securities, preferred stock or United States unless the issuer “knows or has reason to common stock with an “early tender premium” as is know that these securities are held by U.S. residents.” sometimes the case in tender offers or exchange offers Under recently adopted amendments to the Tier I for straight debt securities. Holders that tender early exemption, an offeror may calculate ownership by in the offering period, typically within the first ten U.S. resident holders as of any date no more than 60 business days, may receive the “total consideration.” days before, and no more than 30 days after, the public Under this approach, holders that tender after the announcement of the transaction, rather than as of the early tender period terminates will receive lesser date that is 30 days prior to the publication of the offer consideration for their securities. The early tender document as was previously required. In situations feature benefits the issuer because it may have greater where the offeror is unable to conduct the necessary visibility regarding the success of the tender offer. analysis of beneficial holders within the 90-day period, An issuer needs to be mindful that the falling away the SEC now permits the use of a date not more than of the “premium” may, under certain circumstances, 120 days before the public announcement. Under the constitute a change in consideration that may require recently effective amendments, individual holders of that the tender stay open for an additional ten days, as more than 10% of the subject securities are no longer discussed above. excluded for the purposes of calculating the level of Moreover, in a straight debt tender offer, an issuer has U.S. ownership. the flexibility to choose to accept tenders of securities SEC Staff Review on a “first come, first served” basis, or offer limited or no withdrawal rights, or conduct a Dutch auction or When a Schedule TO is filed, the SEC Staff may review modified Dutch auction for pricing purposes. and comment on the disclosure in the Schedule TO, the offer to purchase or offer to exchange, and any other SEC Staff Relief for Investment Grade related documents, as well as compliance with Rule Debt Securities 13e-4 and Regulation 14E. The Staff Office of Mergers & Acquisitions in the Division of Corporation Finance The requirements of Regulation 14E may still be reviews the Schedule TO. Typically, the Staff tries to limiting for an issuer conducting a tender offer for issue comment quickly (within 5-7 business days), straight debt securities. Specifically, if an issuer must because the tender offer is only required to be open for keep the offer open for 20 business days or extend the 20 business days. The Staff’s comments may require offer period if there are any changes in the consideration that the issuer file amendments to the Schedule TO or percentage sought, it can adversely affect the tender and disseminate changes in order to address the because the issuer is subject to market risk during this Staff’s concerns. time. Most debt tender offers occur when interest rates are low – the issuer is trying to lower its cost of funds by retiring high interest rate debt securities with the proceeds from new securities issued at a lower rate, or a lower-interest rate credit facility. If interest rates decline during the offer period, an issuer will not retire

Morrison & Foerster LLP Capital Markets 80 as much debt and if rates increase, the retired debt will range of prices at which a holder may tender its come at a higher price. Longer offer periods translate securities. The purchase price will be the highest price into increased uncertainty. at which the issuer is able to buy all of the securities for which it has solicited a tender (or a smaller amount, if Because the SEC staff believes that issuer debt tender not all the securities are tendered). This price is often offers for cash for any and all non-convertible, referred to the “clearing price.”24 investment grade debt securities may present considerations that differ from any and all or partial The SEC Staff has permitted tender offers to proceed issuer tenders for a class or series of equity securities or without the issuer disclosing the range of prices range non-investment grade debt, it consistently has granted in the tender offer documents, so long as the aggregate relief to issuers of investment grade debt in the context amount of securities to be purchased is disclosed (and of tenders for their debt securities. An issuer need not the range of securities to be purchased if the offer were keep the tender open for 20 business days, provided fully subscribed). Usually, the permitted price range is the following conditions are met:22 very narrow – often no more than 15% of the minimum price. In this regard, modified issuer Dutch auction • Offers to purchase were made for any and all of tender offers have been permitted under Rule 13e-4, the investment grade debt, non-convertible debt subject to several additional conditions: of a particular series or class; • The offer is open to all record and beneficial • Disclosure in the tender offer materials reflects holders of that series or class; the minimum and maximum consideration to be paid; • The offer is conducted so as to afford all record and beneficial holders of that series or class the • Pro rata acceptance occurs throughout the offer reasonable opportunity to participate, including with all securities purchased participating equally dissemination of the offer on an expedited basis in prorationing; in situations where the tender offer is open for a • Withdrawal rights are available throughout the period of less than ten calendar days; and offer; • The tender offer is not being made in anticipation • The issuer makes a prompt announcement of of or in response to other tender offers for the the purchase price, if determined prior to the issuer’s securities. expiration of the offer; and Following these no-action letters, investment grade • The purchase of all accepted securities is made debt issuers were no longer subject to the 10- and at the highest price paid to any security holder 20-business day requirements. In 1990, the SEC under the offer.25 staff expanded this no-action relief for investment In prior no-action letter guidance, the Staff had noted 23 grade debt. its belief that issuers conducting modified Dutch auction tender offers could not satisfy the requirements Modified Dutch Auctions of (then) Schedule 13e-4 by stating a range of shares to Typically, in its tender offer documents, an issuer will be sought in the tender offer. In this regard, the Staff specify the amount of securities it is seeking to purchase, appeared to be concerned that an issuer would have as well as the price at which it will purchase these discretion to select a number from within that range securities (or the method of calculating the purchase price). However, in some cases, an issuer may specify the amount of securities to be tendered, but may set 24 Under the SEC’s guidance, all security holders whose securities are accepted in a modified Dutch auction issuer tender offer subject to Rule the price using a modified “Dutch auction” pricing 13e-4 must be paid the highest consideration paid to any other security structure. In this structure, the issuer sets a cascading holder whose securities are accepted. See Release No. 34-23421 (July 11, 1986). The Release also notes that “pure” dutch auctions are not permitted under Rule 13e-4, stating: “In a pure dutch auction cash 22 See SEC No-Action Letter, Salomon Brothers Inc. (Mar. 12, 1986); tender offer, the bidder invites security holders to tender securities to it SEC No-Action Letter, Goldman Sachs & Co. (Mar. 26, 1986); SEC No- at a price to be specified by the tendering security holder, rather than at Action Letter, Merrill Lynch, Pierce, Fenner & Smith Inc. (July 2, 1986). a price specified by the bidder. Securities are accepted, beginning with those for which the lowest price has been specified, until the bidder has 23 See “Cash Debt Tenders: An Overview and Summary of No-Action purchased the desired number of securities.” Advice” for a more detailed discussion of the Staff’s no-action positions with respect to tender offers for debt securities. 25 See Release No. 34-23421 (July 11, 1986) at note 64.

81 Morrison & Foerster LLP Capital Markets that might be purchased in the tender offer.26 Concerns with “Creeping” Tender Offers and Purchases Outside of the Offer More recently, in a recent no-action letter to Alliance Semiconductor Corporation,27 the Staff considered a In certain circumstances, purchases of securities in modified Dutch auction tender offer where the issuer the market or through negotiated transactions could suggested that the total number of securities may be be deemed to constitute tender offer that is not in disclosed in terms of the maximum number that can compliance with the rules described above. Further, be purchased, subject to the number of shares tendered when a tender offer commences around the time of and at which price those shares are tendered. In the open market or negotiated purchases, security holders proposed tender offer, the Offer to Purchase was to could potentially object to the terms of the transactions state that the maximum number of shares is 10,909,090, outside of the tender offer. and that if the offer was fully subscribed, the issuer Courts that have addressed the issue of tender offer would buy an amount of shares between 10,000,000 “integration” have taken disparate approaches. and 10,909,090, with exact number dependent on the Most claims have arisen in connection with claims terms of the offer, not a decision on the part of the of violations of the “best price” and “all holders” issuer. As a result of this structure, the amount that provisions applicable to tender offers, or violations of would be purchased in the tender offer is determined the prohibitions on purchases outside of a tender offer. as a function of the prices at which shares are validly Some courts have strictly construed the time frame tendered and the number of shares tendered. Alliance of the tender offer to start with public announcement Semiconductor argued that Rule 13e-3(f)(1)(ii) would or commencement and end with withdrawal or not require extending the offer for 10 days after the termination, while others have adopted an approach of purchase price – and hence exact number of shares to determining whether the questioned transaction was be purchased – was determined, and that the disclosure an integral part of the tender offer. More specifically, of the range of shares presented would satisfy the several courts have held that share purchases by the requirement of Item 1004(a)(1)(i) of Regulation M-A to acquiror made in advance of a tender offer are not disclose the “total number and class of securities.” improper, because the tender offer rules are only In providing its response that no Enforcement action applicable upon announcement or commencement of would be recommended if the offer was conducted as the tender offer.28 Some courts, however, have taken described in the letter, the Staff particularly noted that: a broader view in interpreting whether transactions occurring before or after the precise technical • The total number and dollar value of securities commencement and termination or withdrawal of the being sought in the offer is disclosed in the offer tender offer were considered part of the tender offer.29 materials as required by Item 1004(a)(1)(i) of Regulation M-A; Issuers must carefully structure any ongoing market purchases or negotiated acquisitions of securities so as • The maximum number of shares that may be to comply with the prohibitions on purchases outside of purchased in the offer is stated on the cover page the tender offer in Rules 13e-4 and 14e-5. In this regard, of the offer to purchase; it is often important to analyze whether the targeted • The offer to purchase discloses the range of securities in the outside purchases are of a separate shares that will be purchased if the offer is fully class from the class of securities that are the subject of a subscribed; and tender offer. The term “class” is not defined specifically • The exact number of shares to be purchased for the purposes of Rule 13e-4 and Regulation 14E, in the offer will be based on the purchase price however the term has been defined for other purposes established by the shareholders determined in accordance with the terms of the offer as disclosed in the offer to purchase. 28 See, e.g., Lerro v. Quaker Oats Co., 84 F.3d 239, 257 (7th Cir. 1996); Kahn v. Virginia Retirement Sys.,13 F.3d 110, 113 (4th Cir. 1993); Heine v. The Signal Companies, Inc., 1977 US Dist. LEXIS 17071(S.D.NY 1977).

26 See SEC No-Action Letter, Tektronix, Inc. (June 19, 1987); SEC 29 See, e.g., Millionerrors Investment Club v. General Electric Co. PLC, No-Action Letter, Janet S. Thiele (Dec. 21, 1987). 2000 Dist. Lexis 4803 (W.D. Pa. Mar. 21, 2000); Perera v. Chiron Corporation, 1996 US Dist. Lexis 22503 (ND. Cal. May 8, 1996); 27 SEC No-Action Letter, Alliance Semiconductor Corp. (Sept. 22, Field v. Trump, 850 F.2d 938 (2d Cir. 1988), cert. denied, 109 S. Ct. 2006). 1122 (1989).

Morrison & Foerster LLP Capital Markets 82 under the Exchange Act. In Section 12(g)(5) of the issuer should be concerned. First, The Market Abuse Exchange Act, the term “class” is defined to include “all Directive (“MAD”). As its name suggests, MAD is securities of an issuer which are of substantially similar intended to prevent abuses relating to insider trading. character and the holders of which enjoy substantially Similar to Regulation FD, MAD requires that an similar rights and privileges.” Further, the SEC has issuer announce without delay information directly provided guidance regarding the determination of concerning it. MAD applies to financial instruments whether different series of preferred stock are the same admitted to trading on a regulated market or for “class” for the purposes of Rule 144A, stating that the which a request for admission to trading has been test under Rule 144A to determine whether securities made. The statute is intended to address insider would be of the same class would be the same test as dealing, market manipulation and the dissemination under Section 12(g)(5) of the Exchange Act and would of false or misleading information. Under MAD, an be interpreted in the same manner.30 issuer should perform an analysis similar to that under Regulation FD – is the insider in possession of material Regulation M nonpublic information. In the case of a debt tender, the terms of the transaction likely was announced, so an While Regulation M does not apply to investment issuer need only consider whether it possesses other grade non-convertible debt securities, it does apply information that may be considered material. to equity securities, non-investment grade debt and convertible debt. An issuer that engages in a tender In the EU, an issuer need also be mindful of anti takeover offer must ensure that it complies with Regulation M. restrictions contained in Directive 2004/25/EC. This Rule 102 under Regulation M makes it unlawful for an directive pertains to takeover bids for the securities of issuer or its affiliates “to bid for, purchase, or attempt issuers governed by the laws of a member state, where to induce any person to bid for or purchase, a covered all or some of the securities are admitted to trading on security during the applicable restricted period.” This a regulated market. A takeover bid means a public prohibition is intended to prevent an issuer from offer (other than by the offeree issuer itself) is made to manipulating the price of its securities when the issuer the holders of securities to acquire all or some of the is about to commence or is engaged in a distribution. securities with the objective of acquiring control. Though If debt being exchanged in an exchange offer is not directly applicable, the directive provides guidance convertible into the issuer’s equity securities, under that an issuer should follow in conducting a tender for its certain circumstances, repurchases of convertible debt own securities. In particular, all holders must be treated securities could be deemed a forced conversion and, equally and must have sufficient time and information to therefore, a “distribution” of the underlying equity enable them to reach an informed decision. security for Regulation M purposes.

Special rules for European Tenders It may be the case that the holders of an issuer’s debt securities are located in foreign jurisdictions. For instance, if an issuer sold its securities pursuant to Rule 144A in the United States and pursuant to Regulation S outside the United States. Many frequent debt issuers issue and sell their debt securities pursuant to Euro medium-term note programs or market and sell U.S. registered securities into the European Union (“EU”) or other foreign jurisdictions. For these tenders, an issuer must not only focus on the various considerations described above, but also must be cautious that its tender does not violate any rules in the home country of its security holders. In the EU, there are two directives about which an

30 Release No. 33-6862 (Apr. 23, 1990).

83 Morrison & Foerster LLP Capital Markets Morrison & Foerster LLP Capital Markets 84 Recent Tax Developments

85 Morrison & Foerster LLP Capital Markets Recent Tax Developments

the tax attributes of the taxpayer (e.g., its net operating Introduction losses, tax credits or adjusted tax basis in property) are correspondingly reduced. Tax issues can be an important consideration in any On February 17, 2009, the American Recovery and liability management transaction. A corporation that Reinvestment Act (the “Act”) added a new Section restructures its debt may recognize cancellation of 108(i) to the Code. At the election of the taxpayer, indebtedness (“COD”) or other income, may (after Section 108(i) defers the recognition of COD income legislative changes this year) end up deferring in connection with certain repurchases, modifications future original issue discount (“OID”) deductions or and exchanges, referred to as “reacquisition,” of may suffer other negative tax consequences. Even “applicable debt instruments” after December 31, 2008 with sound tax advice certain tax consequences are and before January 1, 2011. For reacquisitions in 2009, inescapable and must be carefully considered before the deferral is five years; for reacquisitions in 2010, the entering into a liability management transaction. The deferral is four years. At the end of the deferral period, following sections discuss various issues that arise the taxpayer must include the COD income ratably when reshuffling a corporation’s liability structure over the next five years. and include the most recent changes to the Internal Revenue Code dealing with liability management. Irrevocable Election The irrevocable election is made on the tax return for any applicable debt instrument on the tax return in the Cancellation-of-Indebtedness Income taxable year for which the reacquisition occurs.

Corporations with outstanding debt may be subject Applicable Debt Instruments to tax on COD income when all or a portion of such debt has been economically cancelled. COD income An applicable debt instrument includes any “debt can arise in a number of circumstances, including instrument” issued by a C corporation. For these forgiveness of debt by the debtholder, the repurchase purposes, a debt instrument generally includes all of debt by the issuer at a discount, the exchange of forms of indebtedness within the meaning of the Code. one debt instrument of the issuer for another, the However, certain annuity contracts are not included. modification of debt and the exchange of debt for equity of the issuer. Additionally, repurchases or Reacquisition exchanges by persons related to the issuer can create A reacquisition includes: COD income. • an acquisition of a debt instrument for cash, Section 108(a) of the Internal Revenue Code (the • an exchange of a debt instrument for another debt “Code”) provides a number of exceptions to the instrument (including a deemed exchange resulting inclusion of COD income, including exceptions related from a modification of the debt instrument), to insolvency and bankruptcy. In each case, the COD income is permanently excluded from taxation. As a • an exchange of a debt instrument for corporate price for the bankruptcy and insolvency exclusions, stock or a partnership interest,

Morrison & Foerster LLP Capital Markets 86 • a contribution of a debt instrument to capital, and In the case of a liquidation or sale of substantially • a complete forgiveness of the indebtedness by the all the assets of the taxpayer (including in a Title 11 holder of the debt instrument. or similar case), the cessation of business or similar circumstances, any item of income or deduction that Section 108(i) applies when either the issuer or a person had been deferred is required to be included in the related to the issuer (within the meaning of Section taxable year in which such event occurs. A Title 11 case 108(e)(4) of the Code) reacquires the debt instrument. is deemed to occur the day before the petition is filed, such that the accelerated Section 108(i) COD income Deferral of OID Deductions cannot be discharged in the subsequent bankruptcy case If a debt instrument having OID is issued in exchange and excluded under Section 108(a)(1)(A) of the Code. for an applicable debt instrument, deductions for the Congress has authorized the Treasury Department OID on the new instrument are disallowed during the to prescribe regulations extending application of deferral period to the extent such OID does not exceed these acceleration rules to other circumstances where the COD income realized but deferred in the exchange. appropriate. After the expiration of the deferral period, the deferred OID deductions may be claimed ratably over the CoordinatioN With other Section 108 five-year period during which the COD income must Exclusions be included. For these purposes, if the proceeds of a new debt instrument are used directly or indirectly by If a taxpayer elects the deferral regime of Section the issuer to reacquire any of its existing applicable 108(i), none of the Section 108(a) exclusions (i.e., the debt instruments (e.g., in a refinancing), the new debt exclusions for insolvency, bankruptcy and farm or instrument will be treated as though it were exchanged business real property debts) can apply with respect to for the reacquired debt instrument.1 If only a portion the applicable debt instrument. of the proceeds from a new debt instrument are used to reacquire an applicable debt instrument, these rules Considerations apply to the portion of any OID on the newly issued Section 108(i) is not an unfettered boon to taxpayers debt instrument equal to the portion of the proceeds realizing COD income. Because of its complexity and from that instrument used to reacquire the outstanding qualifications, taxpayers will have to carefully consider instrument. its benefits and burdens prior to making an election. Example: Issuer issues a new debt instrument Among other things: with OID for $1000 of cash and uses the cash to repurchase existing debt with an adjusted issue • An election under Section 108(i) can be attractive price of $1100, generating $100 of COD income. to a solvent issuer. However, the election Assume Issuer makes an election under Section precludes the application of the bankruptcy or 108(i) and $200 of OID will accrue on the new insolvency exclusions of Section 108(a). Under debt instrument during the COD deferral period. both of those rules, COD income is permanently Under these provisions, $100 of OID deductions excluded from gross income and not merely will be deferred but may be deducted ratably deferred. Those options may be more attractive to over the five-year period during which the COD a taxpayer, especially a taxpayer with little or no net operating losses or other tax attributes to be income must be included. reduced. On the other hand, Section 108(i) does not require the reduction of tax attributes, which Acceleration of Deferred Items may be attractive to taxpayers with net operating losses or other attributes they intend to use. 1 The Act does not define “directly or indirectly” for these purposes, Further, reliance on the insolvency exclusion can although any Treasury regulations issued under new Section 108(i) prove difficult—COD income is only excluded to could provide guidance. Other Code provisions, and the regulations the extent of insolvency, which taxpayers have the thereunder, have addressed similar language. Under one possible burden of demonstrating. standard, the relevant inquiry could be whether the new debt would not have been issued but for the reacquisition of the old debt. • Although the election is irrevocable, it appears Regardless, issuers of new debt with OID within close proximity of the reacquisition of old debt must bear in mind any such issuance should to apply to each applicable debt instrument be scrutinized in light of this provision. separately, meaning taxpayers may, to some

87 Morrison & Foerster LLP Capital Markets extent, tailor their Section 108 approach to is deductible only when paid. COD income. The Act provides that the AHYDO rules will not apply • Application of Section 108(i) to real estate to exchanges of existing debt for new debt of the same investment trusts and regulated investment issuer if (i) the new debt is issued between August 31, companies (“REITs & RICs”) is not entirely clear. 2008 and January 1, 2010; (ii) the existing debt is not REITs & RICs should be considered C corporations an AHYDO; and (iii) the new debt is not issued to a for purposes of the section. However, Section 108(i) related party. The Act also grants the Treasury the does not define the term “pass-through entity,” a authority to extend the suspension. In practice, what term that includes REITs & RICs elsewhere in the this means is that a corporation may roll over its debt Code. Although the special rules, including the with new debt, with interest deductions on the new acceleration rules, applicable to partnerships, S debt not subject to otherwise applicable limitations corporations, and “other pass-through entities” do under the AHYDO rules. not appear suited for REITs & RICs, the absence of a clear definition creates some uncertainty. If and when the Treasury Department issues regulations Contingent Convertible Debt under Section 108(i), such regulations could Instruments address this issue. • Application of Section 108(i) to issuers with debt U.S. corporations have raised billions of dollars of providing contingent payments may also prove funding by issuing so-called contingent convertible debt complicated. Relief under Section 108(i) may instruments (“CoCos”). CoCos are debt instruments be available for reacquisitions of indebtedness convertible into stock of the issuer that provide for subject to the “noncontingent method” the payment of “contingent interest.” For example, a under the contingent payment debt regulations. typical CoCo may provide that the amount of interest If available, the extent of any relief will depend on payable equals the amount of the dividends paid on the nature of the reacquisition. the underlying stock or if the CoCo’s price exceeds a percentage (e.g., 120%) of its adjusted issue price. As a result of the contingent interest feature, CoCos are AHYDO Relief treated as “contingent payment debt instruments” for U.S. federal income tax purposes, and the issuer, An applicable high yield discount obligation as well as the holder, is subject to the “noncontingent (“AHYDO”) is a debt instrument with a maturity bond method” rules provided for in the Treasury in excess of 5 years, which has a yield that equals or regulations. Under this method, the holder is required exceeds the sum of the “applicable federal rate”2 plus 5 to include interest or OID in income over the term of the percentage points, and which has “significant original CoCo based upon the comparable yield of the issuer. issue discount.”3 The issuer of an AHYDO is denied a The issuer takes a corresponding interest deduction. deduction for a portion (the “disqualified portion”) of The “adjusted issue price” of the CoCo increases by the OID.4 In addition, the non-disqualified portion of OID amount of interest that is deemed to accrue, and any differences between taxable income included and cash 2 The “applicable federal rates” are interest rates published monthly received are reconciled when a contingent payment by the U.S. Treasury for purposes of applying various provisions of the is made (which, often, is not until maturity or upon Internal Revenue Code. conversion of the CoCo into stock of the issuer). 3 Under Section 165(i)(2), OID is significant if, immediately before Upon a restructuring or repurchase of a CoCo prior to the close of any accrual period ending more than five years after issue, the aggregate amount that has been included in gross income with maturity, the issuer’s COD income is not determined respect to such instrument exceeds the sum of actual interest payments by reference to the CoCo’s face amount but rather plus an amount equal to the product of the debt instrument’s issue by reference to its accreted adjusted issue price. For price and yield to maturity. example, a CoCo issued ten years ago with a face 4 Under Section 165(e)(5), the disqualified portion of OID is the amount of $1000x by an issuer with a comparable yield lesser of (i) all OID or (ii) the product of (a) the sum of OID and at the time equal to 5%, currently has an adjusted issue stated interest on the instrument and (b) the ratio of (X) an amount by which the yield to maturity exceeds 6% plus the AFR to (Y) the price equal to approximately $1,600x. As a result, a yield to maturity. repurchase of the CoCo by the issuer prior to maturity

Morrison & Foerster LLP Capital Markets 88 for its face amount would result in COD income to notes. Reopening a debt issue can cause significant tax the issuer equal to $600x. As noted above, the impact consequences, particularly where the additional notes on the issuer may be softened by the Act because the are issued with OID. issuer may be permitted in certain situations to elect Taxpayers are required to currently accrue OID on a to defer the recognition of the COD income. Even constant yield basis for any debt instrument that is absent a repurchase or modification of the CoCo, the issued with more than a de minimis amount of OID. OID issuer faces the same situation upon maturity of the generally arises where a note is originally issued at a instrument. If the CoCo is retired, upon maturity, discount and is an attribute of the note itself (i.e., OID for its face amount, the issuer would have to include “travels” with the note and does not vary depending $600x in income. Issuers of CoCos can be expected to on whether an original investor or a secondary market carefully weigh all available options as alternatives investor holds the note). In contrast, “market discount” that have substantially the same economic result may generally arises when a secondary-market investor not necessarily have substantially the same tax result. purchases a debt instrument at a discount after original On the other hand, holders of CoCos would likely issue. Market discount is generally not currently taxable welcome a repurchase or modification as the holders as it accrues, unless the holder so elects. would then be able to reverse prior OID inclusions. Thus, where the original notes are not issued with Where the tax treatment of the holders upon a OID, but where the additional notes are priced at a repurchase is relatively straightforward, a significant discount in excess of the statutory de minimis amount modification of these debt instruments can produce a (e.g., because interest rates have risen after original host of complex and technical tax rules if the modified issue), a holder would generally prefer the original debt instrument is not considered “publicly traded” notes and the additional notes to be fungible from a tax under U.S. federal income tax principles. For example, standpoint, so that the additional notes (like the new stellar hedge fund performance during prior years notes) are not treated as having been issued with OID, have resulted in several financial institutions offering but rather are treated as being acquired by holders at a their clients tailored structured notes, the payout market discount. The reopening rules discussed below on which is linked to the performance of hedge police the boundaries within which the additional funds. Unfortunately, it would seem that many of notes may be treated as fungible with the original these structured notes are currently under water. notes in this manner. Restructurings and workouts of these instruments, and other debt instruments that are not publicly traded, If the additional notes and the new notes do not meet can result in the restructured debt instrument being the requirements described below, the tax law treats the “split” into two components for U.S. federal income additional notes as a fresh issuance issued with OID tax purposes: a non-contingent component and a and, accordingly, the original notes and the additional contingent component under current regulations. The notes would not be fungible from a tax standpoint. application of these rules can be extremely complex If the original notes and the additional notes are, and both issuers and holders that participate in debt nonetheless, issued so that they are indistinguishable restructurings and workouts would be well advised to (i.e., issued with the same terms and CUSIP number), it discuss their particular situations with tax counsel. would be impossible for secondary market purchasers or, for that matter, the IRS, to trace securities through the chain of intermediate ownership and determine Debt Reopenings whether their notes were issued as part of the original issuance (issued without OID) or the additional issuance (issued with OID). There is a risk, then, Debt issues are often “reopened,” meaning that an that the additional notes may taint the original notes, issuer issues an additional tranche of notes (“additional with the IRS treating both the original notes and the notes”) at some point after original issue (“original additional notes as having been issued with OID. notes”). The additional notes bear the same terms and security identification code (e.g., CUSIP number) as the To be fungible from a tax standpoint, the reopening original notes. The issuer’s intent is that the original must satisfy one of three tests: the original notes and notes and the additional notes be indistinguishable the additional notes must be issued within 13 days of and, therefore, completely fungible. One benefit of the original note (the “13 day rule”), or the additional fungibility is that it adds liquidity to the market for the notes must be part of a “qualified reopening” of the

89 Morrison & Foerster LLP Capital Markets original notes under either one of the two alternative under additional tests that are more fact-specific. tests discussed below. Under each of the three tests, As a practical matter, if neither the original notes nor the a precondition is that the additional notes must have additional notes would be viewed as being issued with terms that are in all respects identical to the terms of OID (each tested on a separate basis), the requirement the original notes. that the original notes be publicly traded, even though Under the first rule, a reopening of debt instruments is required by the text of the regulations, may be irrelevant. treated as a qualified reopening if: Thus, even though such a reopening may not qualify as a “qualified reopening” within the meaning of the • the original notes are “publicly traded” (see regulations, the original notes and the new notes may, discussion below), nonetheless, be fungible for tax purposes. In those • the issue date of the new notes (treated as a circumstances, the note issue may be reopened without separate issue) is not more than six months after adverse tax consequences to a holder. the issue date of the original notes, and • on the pricing date of the reopening (or, if earlier, the announcement date), the yield of the original notes (based on their fair market value) is not more than 110% of the yield of the original notes on their issue date (or, as is often the case, if the original securities were issued with no more than a de minimis amount of OID, their coupon rate). Alternatively, a reopening of debt instruments (regardless of whether the reopening occurs within 6 months or not) is treated as a qualified reopening if: • the original notes are publicly traded, and • the additional notes (treated as a separate issue) are issued with no more than a de minimis amount of OID. Applicable regulations provide detailed rules that define when notes are treated as “publicly traded.” The most common scenarios are (a) the notes are listed on a national securities exchange, or (b) the notes appear on a system of general circulation (including a computer listing disseminated to subscribing brokers, dealers or traders) that provides a reasonable basis to determine fair market value by disseminating either recent price quotations (including rates, yields or other pricing information) of one or more identified brokers, dealers or traders, or actual prices (including rates, yields, or other pricing information) of recent sales transactions (a “quotation medium”). A quotation medium does not include a directory or listing of brokers, dealers or traders for specific securities that provide neither price quotations nor actual prices of recent sales transactions. Bloomberg and/or TRACE may qualify as a quotation medium for a particular issuance if there is sufficient trading frequency and volume within the testing period. Even if a particular tranche of notes does not satisfy the requirements of (a) and (b) above, they may, nonetheless, be treated as publicly traded

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