This article continues my series on obligations (and rights and responsibilities) of the board of directors during a merger and acquisition transaction. This blog focuses on the director’s duty of disclosure. A director’s duty of disclosure is part and parcel with their duty of loyalty. That is, the duty of disclosure primarily focuses on a director’s duty to disclose conflicts of interest he may have with respect to any corporate action. However, the duty also extends to a director’s duty to inform shareholders fully on matters involving a shareholder vote and in making any public disclosures.

Duty to Disclose

The duty to disclose (like other duties) only extends to material facts and circumstances. “Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.” TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438 (1976). In the case of a merger or acquisition requiring shareholder vote for instance, directors must provide shareholders with material information necessary to make an informed decision. In the case of press releases or other public disclosures, information provided must meet the disclosure obligations as well as the meet the standards for the duties of care and good faith.

Transparency and Shareholders

In In Re Pure Res., 808 A.2d 448, the court held that the directors had a duty to disclose to shareholders the substantive work performed and total involvement of investment bankers in pending merger transaction. The court reasoned that this information would assist an investor in determining whether the value being paid was fair. Other courts have concurred with this opinion and specified that shareholders are entitled to see valuation reports and financial projections prepared by investment bankers in a merger transaction, and it is the board of director’s duty to supply this information. Moreover, other courts have held that shareholders are entitled to be informed of financial advisors roles and compensation in a merger or acquisition transaction.

A director’s duty of disclosure is based in state law and is separate and distinct from a company’s duty to disclose under both the Securities Act of 1933 and Securities Exchange Act of 1934. Whereas the state law duty to disclose supports private causes of action, including possible class action lawsuits, the federal duty supports both private causes of action (including class actions) and regulatory enforcement proceedings.

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (”Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (”Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Section 5 of the Securities Act of 1933, as amended, contains the basic registration requirements for all offerings and rules of securities. Section 5(a) provides that “unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly:

(1) …to sell such security through the use or medium of any prospectus or otherwise; or
(2) …to transmit through the mails or in interstate commerce any such security for the purpose of sale or for delivery after sale”

Section 5(b) provides that “it shall be unlawful for any person directly or indirectly:

(1) …to transmit through the mails or in interstate commerce, any prospectus relating to a security with respect to which a registration has been filed…., unless such prospectus meets the requirements of Section 10; or
(2) …to transmit through the mails or in interstate commerce any such security for the purpose of sale or for delivery after sale, unless accompanied or preceded by a prospectus that meets the requirements of subsection (a) of Section 10”

Section 5(c) provides that “it shall be unlawful for any person, directly or indirectly, … to offer to sell or to offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed as to such security…”
In order to understand just what Section 5 covers, one must look to the definitions contained in

Section 2. Section 2 defines a “sale” to include “every contract of sale or disposition of a security, or an interest in a security, for value.” An “offer to sell” and “offer for sale” are defined to include “every attempt to offer or dispose of, or solicitation of an offer to buy, a security or an interest in a security, for value.” Finally, a “security” is defined to include, among other items, any “note, stock, bond, debenture or evidence of indebtedness; any investment contract (including real estate for investment); any security future, put, call, straddle or option on a security; any fractional undivided interest in oil, gas or other mineral rights; any certificate of deposit; and any group or index of securities.”

Literally read, Section 5 of the Securities Act applies to every sale of every security by every person, with a security including almost anything. Literally read, Section 5 requires a registration statement to be filed before any offer to sell a security could be made. Obviously, the business world could not function within such strict confines and accordingly congress enacted Sections 3 and 4 of the Securities Act to provide exemptions to the strict and all encompassing confines of Section 5.

However, the business world does have to operate within and understand that Section 5 is all encompassing and that only if a transaction falls within a specifically enumerated exemption in Sections 3 or 4 or the rules and regulations of the SEC, can the requirements of Section 5 be avoided.

Accordingly, prior to entering into business discussions which could be interpreted as falling under Section 5 of the Securities Act, it is important to consult with and retain the services of experienced securities counsel.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

Section 3(a)(9) of the Securities Act of 1933, provides an exemption from the registration requirements for “[E]xcept with respect to a security exchanged in a case under title 11 of the United States Code, any security exchanged by the issuer with its existing security holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange.” Generally, in an exchange offer, the issuer offers to exchange new debt or equity securities for its outstanding debt or equity securities.

Since Section 3(a)(9) is a transactional exemption, the new securities issued are subject to the same restrictions on transferability, if any, of the old securities, and any subsequent transfer of the newly issued securities will require registration or another exemption from registration. However, since the new securities take on the character of the old securities, tacking of a holding period is generally permitted allowing for subsequent resales under Rule 144 (assuming all other conditions have been satisfied for use of such rule).

Section 3(a)(9) Exchanges Surge in Popularity

Section 3(a)(9) exchanges have recently gained in popularity as public companies attempt to manage liabilities and clean up their balance sheets in the face of a down economy. Section 3(a)(9) exchanges can be used to reduce interest payments or accruals (by exchanging high rate debt for lower rate or by exchanging accrued interest or preferred payments for equity); reduce or eliminate outstanding debt (by exchanging debt for equity) and to modify the terms of existing securities (for example, modifying conversion ratios and redemption provisions).

The advantages of a Section 3(a)(9) exchange include: (i) can be completed quickly as there is no registration required; (ii) are flexible (an issuer can retire partial or entire liabilities); (iii) minimal costs; and (iv) often can be accomplished largely tax free for debt holders. The disadvantages include: (i) the new securities may be restricted depending on the status of the old securities offered in exchange or the availability of Rule 144 tacking of a holding period; and (ii) no commissions or other compensation can be paid, such as to a broker or investment banker.

Four Criteria of Section 3(a)(9)

The four main requirements of Section 3(a)(9) are as follows: (i) same Issuer – the issuer of the old securities being surrendered must be the same as the issuer of the new securities; (ii) no additional consideration from the security holder; (iii) offer must be made exclusively with existing security holders; and (iv) no commission or compensation may be paid for soliciting the exchange.

Section 3(a)(9) exempts any securities exchange by the issuer with its security holders. This means that the new securities being issued and the securities that are being surrendered must be from the same issuer. The “same issuer” can at times be a successor issuer. The SEC has taken the position that where an Issuer has fully and unconditionally assumed the obligations of the debt securities of another issuer, the subsequent exchange of that debt by the successor issuer qualifies as a Section 3(a)(9) exchange. Presumably the successor issuer has become the “issuer” by fully and unconditionally assuming the obligation.

Parent Company and Subsidiary Considered Two Separate Issuers

A parent and subsidiary are generally considered two separate issuers. Accordingly, if a subsidiary proposes to exchange debt that is guaranteed by the parent, for debt that is not guaranteed by the parent , the exchange would not qualify under Section 3(a)(9). However, the SEC has granted no-action relief for parent/subsidiary exchange transactions in particular fact circumstances.

The prohibition against paying commission or other compensation for the solicitation of an exchange, does not include the payment of administrative or ministerial fees solely for document preparation, mailing or legal opinions.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!