Minority Investments in Japanese Publicly- Traded Companies

The M&A Lawyer May 2014 n Volume 18 n Issue 5

BY STEPHEN D. BOHRER AND DAISUKE MORIMOTO

Stephen D. Bohrer is a Foreign Law Partner at Nishimura & Asahi and a leader of the firm’s Cross-Border Transactions Group. Daisuke Morimoto is a Partner at Nishimura & Asahi. Contact: [email protected] or d_morimoto@ jurists.co.jp.

Acquisitions of minority equity stakes in Japa- nese publicly-traded companies are attracting greater interest from investors, whether as pas- sive investments, strategic acquisitions, or as first- step purchases towards a future business com- bination. This heightened interest in Japanese publicly-traded equities is likely being driven by a number of factors, including (i) the recent decline in value of Japanese equities following the rapid rise in the value of the Nikkei 225 index since the introduction of “Abenomics,” (ii) statements by the Bank of Japan’s Governor Haruhiko Kuroda that monetary easing in Japan may even acceler- ate, (iii) the return to profitability of many Japa- nese companies, especially companies that export products from Japan, and (iv) the depreciation in the value of the Japanese Yen against most major currencies (which is beneficial for investors who convert foreign currency into Japanese Yen to fund their equity investment). In structuring and negotiating the terms of a minority investment in a Japan-domiciled company that has shares publicly trading on a stock exchange in Japan (a “Public Company”), investors must unravel a number of issues that may not emerge in a typical change of control buyout transaction. Such issues may depend upon the long-term investment strategy of the investor, the size of the proposed investment as a percentage of the Public Company’s outstanding float, the regulatory regimes applicable to the Public Company,

and the amount of control that the investor seeks make a publicly available filing if it acquires more over the Public Company. than 5% of the outstanding shares of a Public This article outlines the main methods of ac- Company (as more fully discussed below), open quiring a minority interest, then proceeds to high- market purchases are frequently advantageous light some of the issues that investors may wish to for minority investors who seek to stealthily ac- consider in connection with planning a minority quire a meaningful foothold before publicly an- investment in a Public Company, and concludes nouncing a larger share acquisition. with some thoughts from the perspective of a Off-market Purchases. An investor also can Public Company directors facing the prospect of purchase shares of a Public Company outside the a minority investment. stock market by either acquiring a block of shares from an existing shareholder or subscribing for new shares directly from the Public Company. Methods to Acquire a Minority There are various considerations as to whether a Interest block trade or a share subscription is the best ap- Typically, an acquisition of a minority interest proach, such as: in a Public Company can take one of two forms: • Acquiring a block of shares from an existing (i) the investor may purchase the Public Compa- shareholder normally can be completed more ny’s shares in the open market, or (ii) the inves- quickly and with fewer regulatory hurdles tor may acquire the Public Company’s shares in in comparison to a share subscription, and an off-market private transaction directly from a can be a transaction form more conducive to large shareholder or the target company. supporting an investor’s request for represen- The following are some of the benefits and tations and warranties and indemnification trade-offs when acquiring a minority interest in a from the selling shareholder (assuming the Public Company through open market purchases selling shareholder is not a purely financial and off-market private transactions: investor). However, a block trade is not a Open Market Purchases. Acquiring shares of panacea as it is premised on the existence of a Public Company over the applicable stock ex- a single shareholder owning a sufficient num- change is particularly advantageous in light of ber of shares in the Public Company (which this method’s implementation ease and execution may not be the case) and the Public Com- speed. Open market purchases normally can be pany will receive none of the proceeds from arranged and completed within a few days, and the investor’s share purchase (which could be most likely even shorter if the investor already has viewed as an unattractive direction of funds a relationship with a domestic stock broker and from the investor’s point of view if the Public there is sufficient liquidity in the Public Compa- Company has financial issues). ny’s shares. The foregoing can be significant ad- vantages if the minority investor does not expect • Because a new share allotment requires the the Public Company to welcome the investor’s approval of a Public Company’s board of share accumulation. On the other hand, there are directors, acquiring shares directly from an significant disadvantages to open market purchas- issuer can occur only on a consensual basis es, including the lack in certainty of the purchase (regardless of the number of shares to be al- price (as the price will depend on prevailing mar- lotted). A hostile investor will be left at the ket conditions), the inability to rapidly accumu- altar if it seeks to subscribe for shares directly late a sizeable block if there isn’t sufficient trading from the issuer. A large new share allotment liquidity in the securities of the Public Company can be more cumbersome to implement in and the risk that the intentions of the minority comparison to a block trade if the Public shareholder will become publicly known (which Company will allot 25% or more of its out- could cause a spike in the Public Company’s share standing voting shares in a single transaction trading price). Although an investor is required to or series of related transactions to the same

investor (or group of related investors) or the of a Public Company would not be able to subse- Public Company’s controlling shareholder quently acquire more than an additional 20% of will change as a result of the proposed share the outstanding voting shares of such company allotment, because under such circumstances directly from shareholders in an off-market trans- the Public Company must obtain either (i) an action (e.g., by entering into a stock purchase opinion from a person independent from the agreement with a major shareholder) without Public Company’s management confirming launching a tender offer open to all shareholders the necessity and reasonableness of the pro- of the Public Company. In addition, Japanese ten- posed share allotment, or (ii) the vote of a der offer rules apply if an investor acquires more majority of the Public Company’s sharehold- than 5% of the outstanding voting shares of a ers approving the proposed share allotment. Public Company through transactions conducted On the other hand, while a new share allot- “outside the market” with more than 10 persons ment may take longer to complete than a during a rolling 60-day period. block trade, it can offer a number of benefits The purpose of requiring the mandatory ap- to an investor, including providing the inves- plication of Japanese tender offer rules in certain tor with due diligence access and the ability circumstances is that if an investor (i) obtains to negotiate ongoing board nomination and substantial control over a Public Company, which information access rights. equates under Japanese securities laws to own- In light of the consensual nature of the trans- ing one-third or more of the outstanding voting action, the expected duration of the investment shares in a Public Company (since this threshold relationship and the potential for board nomina- would allow the investor to veto material matters, tion and information access rights, the new share such as the approval of a merger involving the allotment method is ordinarily the preferred ap- Public Company), or (ii) accumulates shares of a proach when a strategic investor desires to make Public Company through transactions negotiated a minority investment in a Public Company. directly with a seller that do not clear through the applicable stock exchange (i.e., shares acquired “outside the market”), then not only the major Japanese Legal Considerations shareholder that sells the shares to the investor An investor may wish to consider the follow- but the Public Company’s minority shareholders ing Japanese legal issues when making a minority also should have the opportunity to participate investment in a Public Company, regardless of the in the sale. acquisition method: Complying with Japanese tender offer rules will Tender Offer Rules. An investor should be ex- increase the time it will take to complete an invest- tremely careful to structure the timing, manner ment (since a Japanese tender offer must remain and number of shares that it acquires in a Public open to all of the Public Company’s shareholders Company in order to avoid triggering the applica- for at least 20 business days), and add to the in- tion of Japanese tender offer rules to its contem- vestor’s overall transaction costs and completion plated purchase. Very generally speaking, under risks. As a result, it is difficult to imagine a sce- Japanese tender offer rules an investor is required nario where devising an acquisition structure that to launch a mandatory general offer open to all requires compliance with Japanese tender offer shareholders of a Public Company if the inves- rules would promote the interests of an investor tor’s ownership interest in the outstanding voting that seeks to acquire only a minority interest in a shares and certain derivative securities (as defined Public Company. under Japanese securities laws) of a Public Com- Antitrust. Even when a minority interest is ac- pany will exceed one-third as a result of its acqui- quired, compliance with Japanese antitrust laws sition of such company’s shares in an off-market and regulations is not automatically obviated. If transaction. For example, an investor already an investor will acquire more than 20% of the out- owning 13.3% of the outstanding voting shares standing voting shares in a Japanese company (ei-

ther a publicly or privately-held company), then a be shortened depending on certain facts associat- notification 30 days prior to the target acquisition ed with the proposed investment (often down to date will need to be filed by the investor with the 14 days). Failure to comply with the notification Japan Fair Trade Commission if during the most requirements under Japan’s Foreign Exchange recently completed fiscal year revenues from sales and Foreign Trade Act can lead to members of made in Japan by the (i) investor and its “corpo- the investor’s management team being subject to rate group” (as defined under Japanese antitrust imprisonment for up to three years and/or the in- laws) exceeded 20 billion Japanese Yen and (ii) vestor being required to pay a monetary penalty target company and its subsidiaries exceeded five of up to one million Japanese Yen (however, if the billion Japanese Yen. The 30-day standstill period amount of the investment for the violative trans- can be shortened at the discretion of the Japan action exceeds one million Japanese Yen, then Fair Trade Commission. Failure to comply with the monetary fine can be increased to up to three the notification requirements under Japanese an- times the amount of the investment). titrust laws can lead to a monetary penalty pay- To date, only one proposed foreign invest- able by the investor of up to two million Japanese ment has been blocked pursuant to the rubric Yen and the imposition of criminal sanctions on of Japan’s Foreign Exchange and Foreign Trade members of the investor’s management team. Act—the proposed acquisition in 2008 by the Foreign Ownership Restrictions. Pursuant Children’s Investment Fund (a British hedge fund) to Japan’s Foreign Exchange and Foreign Trade to increase its holdings in J-Power, a Japanese Act, if a foreign investor acquires (either directly electric wholesale company, from 9.9% to more or along with its affiliates) 10% or more of the than 20%. Japan’s Ministry of Economy, Trade outstanding shares of a Japanese company (ei- and Industry objected to the ownership increase ther a publicly or privately-held company), then based on the argument that the purpose of the the investor must file a notification with Japan’s Children’s Investment Fund was to maximize Ministry of Finance and the Japanese economic profits, which was incompatible with J-Power’s ministry overseeing the industry in which the function as an energy provider to Japan. target company operates by the 15th day of the In addition to restrictions under Japan’s For- month after the month in which the acquisition eign Exchange and Foreign Trade Act, a foreign closes. The notification is a short-form document investor also should bear in mind whether there and typically takes only a few days to prepare, are any industry-specific regulations that could and is not publicly available. A filing before an impact its ability to acquire an ownership interest acquisition followed by a 30-day waiting period in a target Japanese company. For example, there is required pursuant to Japan’s Foreign Exchange are specific regulations restricting foreign owner- and Foreign Trade Act depending on the country ship in Japanese companies engaged in broadcast- of origin of the investor or if the target company ing, air transportation, and telecommunications. or any of its subsidiaries engage in a business that Share Ownership Reporting Requirements. is either deemed to be critical to Japan’s nation- Under Japan’s Financial Instruments and Ex- al security (e.g., weapons, aircraft, and nuclear change Act, if an investor (domestic or foreign), power) or engage in certain protected industries together with its affiliates (which is defined by (e.g., agriculture, petroleum, and leather). In the statute to include other persons with whom the pre-acquisition filing context, the filing should investor has formed a group), acquires more than be made no later than six months and no sooner 5% of the outstanding shares of a Public Com- than 30 days before the anticipated share acqui- pany, then the investor must file with the Local sition date. The investor can proceed with the Finance Bureau a “Large Shareholding Report” acquisition if it is not notified by the applicable within five business days from the date on which Japanese ministry within a 30-day waiting period it acquired its 5% interest. The Large Share- that its investment is blocked or subject to further holding Report requires the investor to disclose review. The foregoing 30-day waiting period can various kinds of information about itself and the

share purchase, most importantly (i) the percent- effort to foil a hostile takeover. There is no one- age of the outstanding shares of the Public Com- size-fits-all “poison pill” in Japan; however, a pany beneficially owned by the investor, (ii) the popular variant is the “advance warning” pill. In purchase price for the shares acquired by the in- this defense, generally speaking the subject com- vestor and the source of funds used to finance the pany discloses in advance the type of information acquisition(s), (iii) the purpose of the investment, that it seeks from any would-be acquiror of a and (iv) a summary of any agreements relating large block of the company’s shares. The subject to the share acquisition (including, any put op- company also typically sets a waiting period, such tion, call option, or right of first refusal). In ad- as 60 days, that it seeks an acquiror to observe be- dition to an initial filing, an investor is required fore purchasing the subject company’s shares. If to file an amendment to its Large Shareholding the acquiror does not follow these rules, or if the Report within five business days upon a decrease target company’s board (or a special committee) or increase in its ownership by more than 1% of concludes that the offer is likely to damage share- the outstanding shares of the Public Company or holder value, then the board may thwart the ac- upon any other material change in the contents quiror’s share purchase plan by issuing warrants of its Large Shareholding Report. Certain finan- exercisable by all other company shareholders. cial institutional investors that do not intend to Whether a Public Company has adopted a control the Public Company are eligible to report “poison pill” and the details of the plan are both initial acquisitions and subsequent changes on a matters of public record. Accordingly, before ac- relatively more delayed basis. quiring a large amount of a Public Company’s In light of the disclosure obligations necessitat- shares in the open market, it is imperative for an ed by the requirement to file a Large Sharehold- investor to research whether the Public Company ing Report, a minority investor would not be able has adopted a “poison pill” and, if so, to under- to clandestinely acquire a large block of a Public stand the contours of the plan. As “poison pills” Company’s shares unless it rapidly accumulates adopted by Japanese companies typically permit shares prior to the filing date of its Large Share- its board of directors to waive the application of holding Report (which, depending on the Public the “poison pill,” the potential negative economic Company’s historical trading volume, may not be consequences to an investor associated with the a cost-effective option as sudden large purchases triggering of a “poison pill” should not exist if the could cause the trading price of the Public Com- investor acquires shares directly from the Public pany’s shares to spike and rumors to circulate). Company. However, the initial waiver of the ap- Failing to timely file a Large Shareholding Report plication of a “poison pill” ordinarily is not an or including a material misstatement (or an omis- evergreen pass for future share acquisitions, so sion) exposes a first-time delinquent investor to an investor owning shares in a company with a a monetary penalty equal to 0.001% of the to- “poison pill” should balance the likelihood of tal market value of the Public Company as of the the investor seeking to acquire additional shares date when the Large Shareholding Report should in the Public Company against the likelihood of have been filed (in a failure-to-file case), or the the Public Company triggering its “poison pill” filing date of the defective Large Shareholding Re- against subsequent share accumulations by the port (in a material misstatement/omission case). investor. This formula applies regardless of the number or Public Disclosure Requirements. The Public percentage of shares held by the delinquent inves- Company and the investor ordinarily desire to tor, and the penalty amount increases by 150% if keep a contemplated minority investment confi- the investor was subject within the past five years dential until the transaction is completed. From to a monetary penalty arising from a violation of the viewpoint of the Public Company, confidenti- Japanese securities laws. ality is important because a minority investment Poison Pills. Many Japanese blue chip compa- that will be accomplished through a new share is- nies have adopted so-called “poison pills” in an suance could have a negative impact on the trad-

ing price of the company’s shares in light of the until the “material information” has been made dilutive nature of the new share issuance and the public. Japanese securities laws do not rely solely potential “shorting” activities that arbitrageurs on a catch-all description to define “material in- may undertake (and a lower trading price for the formation,” such as any information that a rea- Public Company’s shares could allow the minority sonable investor would consider important when investor to demand a lower purchase price). Simi- making an investment decision. Rather, Japanese larly, an investor would want to keep confidential securities laws also provide specific examples of a proposed subscription for newly-issued shares events that are automatically considered “material if there is a reasonable likelihood that the trad- information,” such as the issuance or repurchase ing price of the Public Company’s shares could of shares, cancellation of a business collaboration, increase in light of the stature of the investor or suspension of business, and material changes in the proposed strategic relationship that would published financial forecasts. Insiders (and as a be forged between the Public Company and the result of recent amendments, tippers as well) who investor. A sudden spike in the trading price of violate the insider trading prohibition are sub- the Public Company would be problematic not ject to imprisonment for up to five years and/or a only to the investor given the potentially higher maximum fine of five million Japanese Yen, plus a acquisition price for its minority investment, but hefty administrative fine. If an officer of a corpo- to the directors of the Public Company because ration violates the insider trading prohibition for they could be held personally liable if the Public the benefit of his employer, then the employer-cor- Company’s board approves a stock issuance at poration also can be subject to a maximum fine of a “substantially favorable” price without share- five hundred million Japanese Yen. holder approval (as more fully discussed at the As the use of “Big Boy” letters is not an effec- end of this article). tive shield in Japan, counsel should be consulted The rules and regulations of the Tokyo Stock at the outset of a block investment to devise meth- Exchange (and not Japanese corporate or securi- ods to help cleanse an investor from possessing ties laws) govern the disclosure obligations of a “material information.” Public Company. Insider Trading Concerns. An investor owning a block of shares in a Public Company will need Conclusion to consider whether Japan’s insider trading rules As owning an interest in Public Companies be- will impact the investor’s ability to management comes more attractive to investors, the directors its investment. An investor with information ac- of Public Companies may actively seek minority cess rights, board appointment rights, or who has investors for potentially very different business entered into a strategic alliance with the Public reasons—placing a large block of shares with a Company is particularly susceptible to receiving “friendly” stable investor could be a useful defen- insider information. Should an investor be subject sive measure to help insulate the company from a to Japan’s insider trading rules, then its invest- hostile acquiror. At the same time, placing newly ment in the Public Company could be frozen at issued shares with a desirable minority investor suboptimal times (with potentially lucrative op- will require the directors of a Public Company to portunities lost). consider a host of business and legal issues. The Article 166 of Japan’s Financial Instruments methodology used to determine the share allot- and Exchange Law provides that “insiders” ment price is typically the board’s most critical (which term includes directors, officers, employ- legal decision. ees, agents, and shareholders owning more than Under Japan’s Companies Act, the board of di- 3% of a Public Company and its parent company rectors may not authorize the issuance of shares and subsidiaries) who receive “material informa- at a “substantially favorable” price without ob- tion” are prohibited from trading or otherwise taining the approval of a supermajority of the transferring securities of the Public Company company’s shareholders. A subscription price is

not considered to be “substantially favorable” if the price is “fair.” As a matter of black-letter Jap- anese corporate law, the question of what consti- tutes a “fair” or a “substantially favorable” price is open-ended. The answer depends on all of the facts and circumstances of the particular share issuance, as determined by the court. However, a well-established principle is that if the price for the new shares is based on the trading price for the shares as of the date the board makes its decision to issue the shares in the allotment, then the purchase price ordinarily will not be considered “favorable” if the subscription takes place within a reasonably short period after the board’s approval for such share allotment to the investor. Japanese courts also have generally considered a discount of 10% from the market price as not constituting an issuance at a “substantially favorable” price. An investor should be sensitive to the legal issues faced by the directors of a Public Company when structuring its investment proposal. If the board does not support the investor’s acquisition proposal, then the investor most likely will face an uphill battle. Of even greater consequence, an investment opportunity could be forever lost or trust irreparably broken if an investor proposes an investment plan that could expose the Public Company’s directors to personal liability or could lead the Public Company to excessive scrutiny. Accordingly, careful planning and expert advice is needed to negotiate an investment that is favorable to the investor and at the same time can be embraced by the Public Company.