The views expressed in this article are those of the authors and do not necessarily represent the views of Jones Day or its clients.

In a recent article in the NYU Journal of Law & Business, we discuss some of the legal and regulatory concerns that have arisen in structuring tender offers for debt securities.  The paper’s title refers to a divergence that has developed between accepted market practices and the legal framework that is supposed to govern them.  This divergence is grounded in the SEC’s reliance on no-action letters as a regulatory mechanism to address developing market practices, an approach that buys the SEC regulatory flexibility at the expense of a misalignment between legal mandates and practical realities.

Navigating Tender Offer Structuring

Our paper first focuses on market and regulatory responses to two provisions of rules adopted under the Williams Act: (1) the required twenty-day period for holding tender offers open and (2) the price stability requirement for the final ten days of the tender offer.  When the SEC rules were first adopted, debt securities were exempted from these provisions.  The SEC amended the rules in 1986, however, to remove exemptions for debt tender offers.  Investment banks acting as dealer managers for tender offers immediately responded by requesting that the SEC exempt debt securities from the twenty- and ten-day requirements.  The SEC staff responded within two weeks of the new rules’ effective date by issuing a no-action letter “sanctioning”[1] tender offers for investment-grade debt securities that were affected by the changes.[2]

The 1986 no-action relief has been expanded by a series of no-action letters addressing different debt tender offer structures that violate (or at times arguably violate) either the ten- or twenty-day rules.  Many of these structures—common in today’s capital markets—are discussed in detail in our paper.  We briefly address some of these structures below:

• Short-Period Tender Offers.  Rule 14e-1(a) requires all tender offers be held open for at least twenty business days.  Given pricing fluctuations based on benchmark U.S. Treasury securities, market practice had been to hold debt tender offers open for less than twenty or even ten days before the 1986 rule change.  And as noted above, the SEC staff issued no-action letters allowing these short-period tender offers to continue under certain conditions.  In practice, these structures are widely accepted, although this practice violates a bright-line timing standard that does not appear open to SEC staff interpretation through no-action letters.

• Fixed-Spread Tender Offers.  Rule 14e-1(b) requires all tender offers be held open for at least ten business days after a change in the consideration offered.  In a fixed-spread tender offer, the price offered isn’t a fixed dollar amount, but is instead a fixed percentage over a benchmark security.  This structure results in a price that fluctuates daily (or even within the day) as the price of the benchmark security fluctuates.  Arguably, this fixed-spread pricing violates the ten-day price stability requirement due to its inherent price instability—another problem the SEC “fixed”[3] through no-action relief where certain conditions are met.  Among the conditions is that the tender offer be for “any and all” of the class or series of debt.

• Waterfall Tender Offers.  In a waterfall tender offer, the issuer makes an offer for a maximum aggregate dollar value of multiple classes or series of debt securities.  The issuer typically establishes a priority ranking of bonds that will be accepted.[4]  The tender “spills down” from a preferred series to subordinate series only if all or the stated maximum amount of a preferred series is tendered.  An issue with waterfall structures arises when fixed-spread pricing is used.  Given the priority structure in waterfall tenders, the “any and all” condition discussed in the previous bullet cannot be met in any offer where the maximum consideration offered is less than the aggregate value of all series included in the tender offer.

• Consent Solicitations.  Tender offers are commonly combined with a consent solicitation, which asks bondholders to approve changes to the terms of the bonds.  Most often, the changes involve amending or removing restrictive covenants included in the indenture governing the bonds.  When these consent solicitations are combined with the structures discussed above, it is often unclear whether the accompanying tender offer complies with the SEC staff position in no-action letters.   For example, the SEC staff has not formally addressed whether a consent solicitation can be combined with a short-period tender offer or a tender offer using fixed-spread pricing.

The use of no-action letters to address these structures has instilled a dependence on no-action and other informal guidance for regulator and regulated alike by providing a type of sanction for transaction structures that, despite their beneficial qualities, may violate—or in some cases clearly violate—the securities laws.  As a consequence, while no-action letters do not carry the force of law, they set today’s de facto standards for structuring debt tender offers.

Implications for Legal Practitioners

Attorneys play a significant role in policing the debt tender offer market by providing “no violation” opinion letters.  These opinions are customary in tender offers, with recipients expecting legal counsel to approve the transaction’s structure.  The standards governing legal practice require lawyers to consider only “law” in providing legal opinions—a standard that includes securities statutes and SEC rules, but does not include no-action letters.  Thus, at least by the standards set out for legal opinion practice, an attorney cannot give an unqualified “no violation” opinion for a transaction structure that violates a bright-line SEC rule—such as the twenty-day requirement in Rule 14e-1(a)—even if the structure complies with standards set by SEC staff no-action letters and current market practices.  Establishing clear foundational rules for those markets is an important function of the SEC, and its reliance on no-action letters in the market for debt securities has hampered this objective.  In the example discussed earlier in this post, market participants continue to rely on the same nonbinding no-action relief nearly 30 years after the SEC first issued the letter.