Takeover regulations amended again

Author: | Published: 1 Jan 2007
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The increasing number of acquisitions in Japan in recent years, together with the use of more tender offers under the Securities and Exchange Law of Japan (the SE Law) in these acquisitions, have led to substantial amendments to Japan's tender offer regulations (the TOB Regulations). Unlike the good old days, when a hostile acquisition in the Japanese market was an unfathomable possibility, the risk of being subject to a hostile acquisition is now a common concern, shared by all in management of Japanese listed companies.

Several issues arising under the language of the TOB Regulations were recognized. One such issue, highlighted by Livedoor's use of an off-hour trading system to buy shares in Nippon Broadcasting System, resulted in an amendment to the SE Law in 2005 that required acquisitions through off-hour trading systems to be subject to the TOB Regulations. Also in response to the growing number of acquisitions, a working group was set up in July 2005 under the Financial Services Agency of Japan to discuss other amendments to the TOB Regulations. A bill to revise the SE Law, based on the recommendations made by the working group in December 2005 in its final report, was proposed to the Diet in March 2006 and adopted in June 2006.

The revisions to the TOB Regulations encompass five main changes: (i) broadening the scope of the transactions subject to the TOB Regulations; (ii) requiring more extensive disclosure by the bidder and the target company and extending the tender offer period; (iii) increasing the flexibility to withdraw and change conditions of tender offers; (iv) introducing an obligation to acquire all tendered shares in certain circumstances; and (v) imposing tender offer obligations in the case of contested acquisitions.

The one-third rule

An off-market acquisition of listed shares is required to comply with the TOB Regulations regardless of the number of sellers, as long as the post-acquisition holding ratio of the acquirer (including its special related parties) exceeds one-third of the total voting rights in the target company (known as the one-third rule). An off-market acquisition in this regard means an acquisition of shares other than: (a) an acquisition of shares through a market-based transaction; or (b) an acquisition of shares newly issued by the target company. With respect to (a), based on an amendment to the SE Law in 2005, a share acquisition made through an off-hour trading system run by a stock exchange (for example, Tokyo Stock Exchange Trading Network System (ToSTNet-1)) is not regarded as a market-based transaction.

Under a literal interpretation of the relevant provisions, the one-third rule allows a combination of an off-market acquisition where the post-acquisition holding ratio does not exceed one-third followed by an acquisition that is otherwise exempt from a tender offer under the SE Law (for example, an acquisition of newly issued shares or through an exchange transaction). This combination falls outside the scope of the TOB Regulations despite resulting in a post-acquisition holding ratio exceeding one-third. The appropriateness of this outcome has been the subject of much debate and became a hot topic when Don Quijote tried to acquire Origin Toshu in 2006. Don Quijote: (i) on January 13 2006 acquired 30.92% of Origin Toshu through off-market acquisitions; (ii) commenced a hostile tender offer against Origin Toshu on January 16, which ultimately failed on February 9; and (iii) acquired an additional 15.28% of Origin Toshu through market-based transactions between February 10 and 15, acquiring a total of 46.21% of the voting rights in Origin Toshu. The issue was whether step (i) should have been subject to the TOB Regulations because, if Don Quijote had commenced steps (i) and (iii) in reverse order, it would have been. From this viewpoint, it was argued that the combination of transactions conducted by Don Quijote could be construed as a circumvention of the TOB Regulations.

Series-of-transactions rule

To address this possible circumvention, the new TOB Regulations provide that a combination of an off-market acquisition where the post-acquisition holding ratio does not exceed one-third followed by an acquisition that is exempted from a tender offer, resulting in a post-acquisition holding ratio exceeding one-third, will be subject to the TOB Regulations in certain circumstances. If the acquirer gains more than 10% of the voting rights in the target during any three-month period, irrespective of the method of acquisition (including market-based acquisitions or acquisitions of newly issued shares), the acquirer gains more than 5% of the voting rights in the target during the same period through an off-hour trading system acquisition or an off-market acquisition (excluding an acquisition through a tender offer), and the post-acquisition holding ratio of the acquirer after the transactions exceeds one-third, then all acquisitions during this time (other than acquisitions of newly issued shares) are subject to the TOB Regulations.

For example, suppose an acquirer holding 20% of the target acquires an additional 7% of the target on January 1 through an off-market acquisition (not through a tender offer) and wishes to acquire an additional 8% through the market on February 1. The acquirer would be prohibited from doing so because that 8% acquisition will result in an acquisition of more than 10% of the target within three months, an acquisition of more than 5% of the target within the same period by an off-market acquisition (that was not acquired through a tender offer) and a post-acquisition ratio exceeding one-third. The acquirer will be required to wait until April 1 to acquire the additional 8% of the target because the acquirer acquired the first 7% without using the tender offer process.

This new series-of-transactions rule is unique in the sense that it is applied to transactions retrospectively and requires the acquirer to wait for up to three months before engaging in its next transaction, rather than requiring the acquirer to make a filing with respect to each transaction.

It is also expected to alleviate the risk assumed by an acquirer and arising from the lack of any clear interpretation of the law that any series or combination of transactions could potentially be subject to the TOB Regulations. The rule now provides greater certainty when determining which transactions are subject to the TOB Regulations, allowing transaction combinations that do not otherwise fall within the conditions of the series-of-transactions rule to proceed without needing to consider the TOB Regulations.

Information disclosure and the tender offer period

It has been recognized that it is essential that investors be provided with enough information concerning a tender offer and adequate time to make an informed decision, making the tender offer process as fair as possible. To ensure this fairness, the TOB Regulations were amended as follows.

The target company's opinion

The opinion of the target company with respect to the tender offer in question is highly informative for investors in making their decision regarding the offer. This is especially the case in hostile tender offers, where any opinions and responses given by the tender offeror and the target company, if disclosed to the public, are invaluable to investors. Under the new TOB Regulations, the target company is obliged to give its opinion with respect to the tender offer.

The target company is required to submit an opinion report within 10 business days of the commencement of a tender offer. In the opinion report, the target company must state not only its opinion (that is, in support of, neutral, or opposed to the tender offer) but also the reason for its opinion, its intention to engage in any defensive measures, and the process by which the target company formed its opinion.

The target company's inquiry process

The new TOB Regulations also formally allow the target company to put questions to the tender offeror in its opinion report, which is expected to give more meaningful information to investors of the target company.

When the target company makes its enquiries, the tender offeror must give its response by submitting a response report within five business days of receiving the queries. The tender offeror can choose not to give specific answers to the queries by stating reasons for not doing so in the response report. However, the fact that the tender offeror does not provide specific answers will be informative to investors.

The new TOB Regulations limit this formal inquiry process to giving the target company one chance to ask questions, and imposing an obligation on the tender offeror to respond. In practice, in the context of a hostile tender offer, it is expected that the target company and the tender offeror will voluntarily disclose their respective opinions and responses on an ongoing basis, so that more information will be provided to investors.

Tender offer period

The duration of a tender offer period, especially in the context of a hostile tender offer, is important. If the period set by a tender offeror is short, the management of the target company might not have enough time to adequately examine the offer and propose a counter-strategy to investors for their consideration.

The new TOB Regulations provide that the tender offer period must be set between 20 and 60 business days (before the amendment, the required tender offer period was set in calendar days). Also, if the tender offeror sets an offer period less than 30 business days, the target company will have the right to extend the offer period by up to a total of 30 business days by requesting so in its opinion report.

Withdrawing offers and changing offer conditions

To protect investors, any change in conditions that is unfavourable to investors (such as a reduction in the tender offer price) or withdrawal of the tender offer other than in circumstances specifically listed in the SE Law or the relevant regulations, is generally prohibited.

The inflexibility of this prohibition is evident when a target company responds defensively to a hostile tender offer by completing a stock split during the period of the tender offer. Even in this case, under the TOB Regulations before the amendments, the tender offeror was prohibited from reducing its tender offer price. It was also unclear whether the tender offeror was even allowed to withdraw its offer in these situations, because a stock split was not specifically listed in the SE Law or the relevant regulations as a ground for withdrawal.

Under the new TOB Regulations, a tender offeror is now allowed to reduce its tender offer price when any of the circumstances specified in the regulations, including a stock split, occur. To do so, however, the original tender offer registration statement must disclose that there is a possibility that the tender offer price may be reduced in certain circumstances, and the reduction must be in proportion to the dilution ratio caused by the particular event. In addition to allowing a price reduction, the list of circumstances under which a tender offeror may withdraw its tender offer has been expanded, and now includes, for example, a stock split and disposal of valuable assets of the target company, so that a tender offeror will not suffer any unexpected financial loss as a result of defensive measures taken by the target company.

Obligation to acquire all tendered shares

Under the TOB Regulations, a tender offeror is able to set an upper limit on the number of shares to be acquired through the tender offer by stating this limit in the tender offer registration statement. If an amount of shares greater than the upper limit number is tendered, the tender offeror is only required to acquire its stated upper limit of shares from tendering shareholders on a pro rata basis. Before the amendments, if the upper limit was set high, but not equal to 100% of the target company's outstanding shares, and the number of tendering shareholders exceeded that limit, it was likely that the tendering shareholders would remain minority shareholders of the target company. In this case, the target company was likely to be delisted due to its highly concentrated shareholder base and, as such, the remaining minority shareholders would find themselves in an unstable situation. To prevent these involuntary minority shareholders being forced to agree unfavourable decisions, the new TOB Regulations provide that the maximum upper limit that can be stipulated by the tender offeror is the amount that would result in a post-acquisition holding ratio of the tender offeror of less than two-thirds. In other words, if the tender offeror sought to acquire two-thirds or more of the voting rights of the target company, it would be prevented from setting the upper limit that it desired.

In addition to this amendment, the new TOB Regulations provide that, where the tender-offeror seeks a post-acquisition holding ratio of two-thirds or more, the tender offeror is required to make an offer to purchase all classes of equities, even those that are not listed. It has been argued that this is an unreasonable requirement, because it is practically impossible to offer a fair price to all classes of unlisted equities (such as stock options that can only be exercised by management of the target) and because, based on a literal interpretation of the regulations, the tender offeror is not legally required to offer a fair price for all classes of shares (such as unlisted equities). So the tender offeror, while required to make an offer for all securities, may do so by offering a low price, and as such, the regulation has no real meaning.

Contested acquisitions

When there are contested acquisitions for the same target company, investors are placed in a difficult position in deciding who to sell their stock to. The acquisition processes of competing acquirers should be transparent to investors so that adequate information is provided for investors to make an informed decision. Many people will recall the rather opaque way in which Don Quijote, having already acquired 30.92% of Origin Toshu, proceeded to acquire an additional 15.28% through market-based transactions during the TOB period set by AEON to acquire the same target. And the way in which Livedoor suddenly increased its holding in Nippon Broadcasting System to 35% through an off-hour trading system during the TOB period set by Fuji Television Network to acquire the same target.

To improve the transparency of contested acquisitions, the new TOB Regulations provide that if a large shareholder, holding more than one-third of the voting rights of the target company, aims to acquire more than 5% of the target company during a TOB period set by another tender offeror, it must use the tender offer process to acquire the additional holding in the target.

Expect more M&A

The TOB Regulations have been amended every year since 2003. Among these amendments, the amendment to the TOB Regulations in 2006 was the most substantial, and is expected to have a large impact in practice. A hostile takeover is no longer an unexpected occurrence and many listed companies are adopting at least some type of defensive measures. If this trend towards acquisitions continues, together with the liberalization of merger consideration under the Company Law effective from May 2007, Japan can expect to a greater quantity, and a greater variety, of M&A transactions over the coming years.

This article is based on information available as of December 12 2006.

The author would like to acknowledge the help of John S Oki and Melissa Rudd, foreign attorneys of Nagashima Ohno & Tsunematsu, in preparing this article.

Author biography

Tomohiko Iwasaki

Nagashima Ohno & Tsunematsu

Tomohiko Iwasaki is a partner of Nagashima Ohno & Tsunematsu. His main area of practice is M&A, corporate restructuring and other corporate transactions. He graduated in 1995 with an LLB from the University of Tokyo, and in 2002 with an LLM from Harvard Law School. He was admitted to practise law in Japan in 1997. He worked at Schulte Roth & Zabel in New York as a foreign attorney from 2002 to 2003, and at the Ministry of Justice of Japan as an attorney from 2003 to 2005.