Expanded Coverage of the Tender Offer Rules under the Amended Securities and Exchange Law of Japan
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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 leagl advice based on particular situations.
Under the Securities and Exchange Law of Japan (the "SEL"), certain purchases of shares or other equity securities1 of a company whose shares are listed for trading on a Japanese securities exchange or is otherwise required to file an annual securities report in connection with its shares must be carried out as a tender offer in accordance with specified rules. There have recently been discussions on how to improve the fairness and transparency of Japan's tender offer rules, particularly because some acquirers have been criticized for using controversial techniques to take advantage of perceived loopholes in the existing rules when acquiring listed companies. As a result, the SEL was amended in June of this year and the amendments are scheduled to come into effect later this month.
This newsletter is the first in a series of legal updates addressing key aspects of Japan's tender offer rules under the amended SEL and will focus on the expanded coverage of the tender offers to certain off-market and market transactions involving the shares of a target company and other transactions that are not subject to the tender offer rules under certain circumstances.
Please note that our analysis is based on drafts of the amended tender offer rules that were published in September 2006. We may have updates to our analysis based on the final form of the amended rules after their finalization pursuant to the Enforcement Order and Ordinance of the Cabinet Office.
1. Outline of Share Acquisitions that Trigger Tender Offer Compliance under the Amended SEL
The following is an outline of the circumstances enumerated in Article 27-2(1) of the amended SEL that require an acquisition of equity securities of a public company to be carried out through a tender offer.2
|Circumstances in Which Tender Offer is Required3||Provision in the Amended Law||Corresponding Provision in the Law prior to the Amendment|
|5% Threshold||If the shareholding ratio4 of a bidder is greater than 5% after a series of off-market share purchases from 11 or more shareholders during any 60-day period||Item (i)||Item (iii)|
|One-third Rule||If the shareholding ratio of a bidder is greater than one-third after off-market share purchase(s) from 10 or fewer shareholders during any 60-day period||Item (ii)||Item (v)|
|If the shareholding ratio of a bidder is greater than one-third after market share purchase(s) by certain methods other than an auction ("Specified Purchase") 5||Item (iii)||Item (iv)|
|If the shareholding ratio of a bidder is greater than one-third after a "rapid accumulation" through a combination of off-market and market transactions||Item (iv)||New|
|Increase in Ownership Interest of a Major Shareholder during Another Party's Tender Offer Period||If a major shareholder "rapidly increases its ownership interest" while another party makes a tender offer||Item (v)||New|
|Other Circumstances||Any other situation stipulated by an enforcement order (any purchase by a party with a special relationship with the bidder that can be regarded as "rapid accumulation" by the bidder||Item (vi)||Item (vi)|
The following is a summary of the main tender offer rules.
|Legal Procedures/Disclosure||Information must be disclosed under laws and ordinances by following legal procedures, such as submitting tender offer registration statements, inquiry response reports and tender offer reports, and giving public notice.|
|Tender Offer Period||A certain tender offer period must be provided so that shareholders have time to review the bid.|
|Consistent Purchase Price/Exclusivity||The purchase price must be equal for all purchases, and the bidder cannot, in principle, make any purchase outside of the tender offer process during the tender offer period.|
|Restrictions on Changing Purchase Terms and Withdrawing Tender Offers||After launch, the bidder, in general, cannot make the terms disadvantageous for the selling shareholders or withdraw its tender offer.|
|Equality of the Purchase||When a bidder purchases any shares that have been tendered by shareholders in the tender offer, it must purchase all such tendered shares. If a cap is set on the number of shares that can be purchased and the number of tendered shares exceeds the cap, the bidder must purchase shares from each tendering shareholder on a pro rata basis.|
If a tender offer is compulsory, restrictions such as those listed above will apply to matters such as the method of acquisition, the parties selling target shares, and the terms of the acquisition when a bidder acquires shares issued by a public company.
2. Expanded Application of Tender Offer Rules (1) -- "Rapid Accumulation" Combining Off-Market and Market Transactions
(1) Purpose of the Revision
If a bidder's shareholding ratio is greater than one-third after purchasing shares through off-market transactions (Article 27-2(1)(ii) in the amended SEL) or through Specified Purchases on the market (Article 27-2(1)(iii) in the amended SEL), the purchase must be made through a tender offer, even if the shares are acquired from only one shareholder (the "One-third Rule"). With respect to the One-third Rule, the SEL prior to the amendments did not specifically state that market share acquisitions and acquisitions of newly issued shares of a target by way of a third-party allotment were subject to the tender offer rules. Therefore, prior to these revisions it was possible to circumvent the tender offer rules by purchasing slightly less than one-third (for example, 32%) of the shares of a target in an off-market transaction and then purchasing additional shares on the market during market hours or acquiring newly issued shares by way of a third-party allotment.6
In order to increase the One-third Rule's effectiveness, the amended SEL expressly provides that the tender offer rules will apply if a bidder's shareholding ratio is greater than one-third of the shares of a target after the bidder conducts a "rapid accumulation"7 of shares of the target by combining off-market and market transactions (Article 27-2(1)(iv) of the amended SEL).
(2) Rapid Accumulation
A "rapid accumulation" is accumulation through the following type of transaction:
While the provisions of the amended SEL use the language "shall be carried out through a tender offer," the definition of "rapid accumulation" encompasses transactions other than tender offers, so in practice it is impossible to retroactively carry out such transactions through a tender offer. The above provision can therefore be viewed as providing that, if a series of transactions during a three-month period is considered a "rapid accumulation" and the shareholding ratio of the acquirer is greater than one-third when the "rapid accumulation" is complete, all of the transactions during that three-month period will be considered unlawful.
If these transactions are viewed across a timeline, it is possible to conclude that if a bidder purchases over 5% of the shares of a target through off-market transactions8 or Specified Purchases on the market (such as through ToSTNeT), it will have a legal obligation to ensure that any purchase of outstanding shares or acquisition of newly issued shares over the subsequent three-month period will not cause the total number of shares acquired by the bidder during any three-month period to exceed 10% and the bidder's shareholding ratio to be greater than one-third. If, for example, a company that holds no shares of a target company acquires 30% of the target's shares through off-market transactions, it will not be permitted, during the subsequent three-month period, to acquire additional target shares (for instance, 4%) such that its total shareholding ratio would exceed one-third when combined with the initial 30% acquisition, through off-market transactions or Specified Purchases on the market (such as through ToSTNeT)9 , trading on the market during market hours, acquiring newly issued shares by way of a third-party allotment, or disposal of treasury stock10 . It will not even be permitted to increase its shareholding ratio over one-third by acquiring additional shares through a tender offer11 .
Therefore, it is necessary under the amended SEL for any company that plans to acquire shares of a target through off-market transactions or off-hour transactions using ToSTNeT or a similar system to think carefully about acquiring shares of that target through a tender offer once it has estimated the extent to which it expects to increase its shareholding ratio over the following three months.
(3) Does Concept of "Rapid Accumulations" Work as a Safe Harbor?
The scope of application of "rapid accumulations" is determined using objective criteria, such as time and quantity, without requiring any subjective judgment of whether the aim of a certain transaction is to effectively circumvent the tender offer rules in view of the previously discussed One-third Rule. Taking this into account, "rapid accumulations" are expected to cover a significant portion of the problematic transactions that have been used to circumvent the law and that have caused concern in the past. With the revisions to the SEL, it will be easier to conclude that, as an interpretation based on arguments against this provision, any transaction in a form that is not formally considered a "rapid accumulation" will not, even in practical terms, be viewed as a circumvention of the tender offer rules.12
3. Expanded Application of Tender Offer Rules (2) -- "Rapid Increase in Ownership Interest" by a Major Shareholder during Another Party's Tender Offer Period
When a purchaser aiming to gain control of a target acquires shares through a tender offer during an acquisition such as a hostile takeover, it is possible for another major shareholder or others to purchase shares of the target in an attempt to thwart the takeover. Under the law prior to the amendments, however, there was an uneven playing field, because the purchaser conducting a tender offer was unable to purchase shares outside of the tender offer and was subject to other restrictions, while its competitor could purchase shares on the market without going through the tender offer process.13
Furthermore, because information about any major shareholder that owns more than a certain number of shares and purchases additional shares to resist a tender offer by a potential acquirer is important for investors, it is desirable that such information be disclosed.
For this reason, under the amended SEL, no major shareholder of a target (owning over one-third of the target's shares) will be allowed to purchase more than 5% of the shares of the target company during the tender offer period of a competing bidder, unless the major shareholder makes its purchases through its own tender offer.
4. Expanded Application of Tender Offer Rules (3) -- Acquiring Additional Shares of a Subsidiary
Under the former SEL, if a parent company that holds more than 50% of the voting rights of a subsidiary purchases additional shares of that subsidiary through off-market transactions from ten or fewer shareholders within 60 days, the parent's purchases were exempt from the tender offer regulations (Article 27(1)(vi) of the former SEL and Article 7(5)(i) of the former SEL Enforcement Order).14
However, if the parent company holds a significant ratio of the subsidiary's shares after purchasing additional shares, the remaining shareholders (with very few shares of the subsidiary) may be placed in an unstable position with respect to their investment, facing, for example, an increased risk of the subsidiary being delisted.
For this reason, under the amended SEL, a parent company will not be exempt from the tender offer rules when it purchases additional shares of a majority-owned subsidiary if the parent's shareholding ratio after the purchase will be two-thirds or greater (proviso of Article 27-2(1) of the amended SEL and Article 6-2(1)(iv) of the amended SEL Enforcement Order). In other words, since the amended SEL will require any purchaser (even parent companies of target subsidiaries) to purchase all of the offered shares or other securities15 if its shareholding ratio following the purchase will be two-thirds or greater (i.e., placing a cap on the shares to be purchased will not be permitted), minority shareholders of such subsidiaries will have the opportunity to dispose of all of their shares through the tender offer process.
Therefore, if, for example, a parent company owns a subsidiary that is required to submit an annual securities report (and the parent company has a shareholding ratio of more than 50%) and intends to make such subsidiary wholly owned through a share-for-share exchange or other method in accordance with the capitalization policy of the group, and if, prior to the share-for-share exchange, it purchases two-thirds or more of the shares of the subsidiary through an off-market transaction, it will be legally required to follow the tender offer procedures, which was not the case under the previous law.
- In this newsletter, unless the context otherwise requires, we use the term "shares" as any equity securities of the issuer subject to which the SEL's tender offer rules apply.
- Before the amendments, the SEL's tender offer rules generally required any purchase in a non-market transaction of shares of a public company to be carried out through a tender offer, with certain enumerated exceptions. In contrast, the amended SEL rules explicitly set forth the particular circumstances under which a purchase by tender offer is required. All other purchases of shares are excluded by default.
- Previously, a parent entity's purchase of shares of its majority-owned subsidiary from ten or fewer other shareholders of the subsidiary within any 60-day period was generally exempt from the tender offer rules. Under the amended SEL, however, such exemption will not apply to an increase in a parent company's stake in a subsidiary, in some cases (See Section 4. Expanded Application of Tender Offer Rules (3) -- Acquiring Additional Shares of a Subsidiary).
- The shareholding ratio of any party with a special relationship with the bidder is included in the bidder's shareholding ratio (Article 27-2(1)(i) and Article 27-2(8) of the amended SEL).
- A "Specified Purchase" through a market transaction specifically means transactions through ToSTNeT on the Tokyo Stock Exchange, J-NET on the Osaka Stock Exchange, or a similar system (FSA Publication No. 53 of July 8, 2005). The circumstance corresponding to Article 27-2(1)(iii) of the amended SEL was added in 2005, when the SEL was previously revised, in response to criticism that the ToSTNeT transaction conducted by Livedoor to acquire Nippon Broadcasting rendered the One-third Rule ineffective (the court ruled that this transaction was valid under the provisions of the SEL in force at the time on the grounds that it constituted a market transaction)
- When acquiring Origin Toshu, Don Quijote attempted, but failed, to acquire over one-third of the shares of Origin Toshu through a tender offer, after acquiring 31% of the target shares in non-market transactions before the tender offer. It then generated controversy by increasing its stake in Origin Toshu to 46% through market transactions, which some argued was a violation of the purpose of the tender offer rules.
- The amended SEL only sets forth circumstances that lead to a transaction being subject to the tender offer rules, but does not use the term "rapid accumulation."
- As any acquisition through a tender offer is not included in the calculation of the 5% shareholding threshold (as stipulated by the language "excluding any acquisition by a tender offer" in Article 27-2(1)(iv) of the amended SEL), it is permissible to increase one's stake in a target after first completing a tender offer for the target's shares, as long as such increase is not part of a separate acquisition of over 5% of the shares of the target through an off-market transaction or Specified Purchases on the market.
- As acquisitions through off-market transactions after which the purchaser's shareholding ratio is greater than one-third are prohibited under Items (i) and (ii) of Article 27-2(1), and acquisitions through Specified Purchases on the market after which the purchaser's shareholding ratio is greater than one-third are prohibited under Item (iii) of Article 27-2(1), these acquisitions are excluded from the scope of application of Item (iv) of Article 27-2(1) (Article 27-2(1)(iv) of the amended SEL).
- Acquisition of shares through disposition of treasury stock is considered to be a purchase of shares, rather than an acquisition of newly issued shares, because it is an acquisition of outstanding shares (see Kinyū Shōhin Torihikihōsei no Kaisetsu (4) Kōkai Kaitsuke Seido - Tairyō Hoyū Hōkoku Seido (Explanation of the Legal System under the Financial Instruments and Exchange Law (4) Tender Offer System - Major Shareholding Reporting System), Shiro Okita, Assistant Director of Corporate Accounting and Disclosure Division, Planning and Coordination Bureau, Financial Services Agency, (Shoji Homu No. 1774)).
- A great deal of care must be exercised here, as no additional acquisition can be made, even through a tender offer. As described in this newsletter, Article 27-2(1)(iv) of the amended SEL stipulates that it is not only acquisitions that cause a purchaser's shareholding ratio to exceed one-third (in this case, an acquisition of 4% of the target shares) that must be carried out through a tender offer (i.e., prohibited transactions), but rather, all transactions carried out during a three-month period (see Okita).
- Prior to the amendment of the SEL, there was a legal argument aimed at preventing the circumvention of the tender offer rules. Under this theory, even if individual purchases of shares, when viewed in isolation, did not fall into the category of transactions that were specifically covered under the former SEL (for example, neither the acquisition of a 32% interest through off-market transactions from ten or fewer shareholders within a 60-day period nor subsequent market purchases of additional shares to increase the ratio over one-third were directly covered by the tender offer rules under the former SEL), such purchases, together with other purchases made under the same intention to acquire more than one-third of the shares, were regarded as one transaction, which as a whole was subject to the tender offer rules. Under the former SEL, in practice, this theory had a great influence on the structure of acquisitions of the shares of other companies. As noted in the main text of this newsletter, under the amended SEL, the importance of such an argument will be mitigated by the introduction of the transactional category "rapid accumulations". However, it is still possible that there remain certain types of transactions that would not constitute rapid accumulations but, under equitable considerations, should be subject to the tender offer rules. In such case, the traditional argument used to prevent circumvention of the tender offer rules under the former SEL would continue to have importance in evaluating the legality of such transactions.
- Although ensuring equality among the purchasers was not the original purpose of the tender offer rules, the revisions to the SEL have established new provisions to protect the interests of parties other than investors, such as the target company and purchaser. Some have pointed out that the purpose of the tender offer rules is shifting from protecting investors to establishing fair corporate acquisition rules (see Kinyū Shōhin Torihikihō Nyūmon (Introduction to Financial Instruments and Exchange Law)," Etsuro Kuronuma, Nikkei Bunko).
- This exemption from the tender offer procedures was provided in these cases because it was not considered a transfer of control.
- See the main text of Article 27-13(4) of the amended SEL and Article 14-2-20 of the proposed SEL Enforcement Order. The obligation of purchasers to purchase all shares in a tender offer will be explained in an upcoming newsletter.