The SEC recently issued a Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on Potential Exchange Act Section 10(b) and Section 14(a) Liability ("Report of Investigation") that may impact disclosure practices followed by parties engaging in mergers and acquisition transactions.1 The Report of Investigation highlights that material contract terms disclosed or incorporated by reference in a proxy statement or other SEC filing may provide the basis for an SEC enforcement action.
The Report of Investigation concerned a representation regarding compliance with the Foreign Corrupt Practices Act ("FCPA") in a merger agreement filed by Titan Corporation as an appendix to its proxy statement. Titan was seeking stockholder approval of its acquisition by Lockheed Martin. After the proposed merger was announced, Titan disclosed investigations by the Department of Justice ("DOJ") and the SEC for alleged violations of the FCPA. Lockheed amended its offer to, among other things, reduce the acquisition price, and the transaction was approved by Titan stockholders. Subsequently, Lockheed terminated the transaction after Titan missed a deadline for settling the investigations. On the same date that the Report of Investigation was issued, it was announced that Titan agreed to pay more than $28 million to settle criminal and civil claims arising from the alleged violations.
Although Titan amended both the merger agreement and its proxy statement to disclose the DOJ and SEC investigations and the new terms from Lockheed, the FCPA representation remained unchanged. In that regard, Titan's proxy statement contained disclosure that, "'the merger agreement contains representations and warranties by Titan that expire upon completion of the merger as to, among other things, Titan's compliance with the [FCPA].'" The Report of Investigation does not allege that Titan violated either Section 10(b) or Section 14(a) of the Exchange Act or Rules 10b-5 and 14a-9 thereunder.
In the Report of Investigation, the SEC takes the position that the inclusion of a material contractual provision, whether via incorporation by reference or otherwise, in a document filed with the SEC constitutes a disclosure and imposes an obligation on the company to ensure that such disclosure is not false or misleading. The FCPA representation was viewed by the SEC as such a material contractual provision, even while acknowledging that the Titan shareholders were not the intended beneficiaries of the representation.2 Any additional material information regarding the representation that may contradict or qualify the representation may trigger a company's disclosure obligation if omission of that material information would render the disclosure regarding the representation misleading.
The SEC states that the analysis of whether a contractual provision has been rendered misleading turns on whether "a reasonable investor could conclude that the statements made in the representation describe the actual state of affairs and the information could be material" given the context of the disclosure, including the significance of the representation or other contractual provision and the total mix of information available to the investor, citing Basic v. Levinson, 485 U.S. 224, 240 (1988). The SEC also states that this analysis would apply in cases where the company knows of new information before it files the original proxy statement and subsequent amendments.
Although the SEC states that the Report of Investigation is not intended to change disclosure practices followed by companies when engaging in merger or other contractual negotiations, that may be the practical result. At recent securities law conferences, senior SEC staff members have briefly described the Report of Investigation and then reminded companies of the availability of Item 601(b)(2) of Regulation S-K, which permits the omission of schedules or similar attachments to material plans of acquisition, disposition or other similar arrangements filed with the SEC, provided that:
Noting that disclosure schedules need not be filed unless they contain information material to an investment decision, a senior SEC staff member stated at a recent securities law conference that companies have a responsibility to determine whether a disclosure schedule or similar attachment contains material information that should be addressed in the proxy statement. The senior SEC staff member also stated that even though the staff may request disclosure schedules and similar attachments for review on a supplemental basis, the staff has been taking steps to ensure that the Report of Investigation does not result in increased comment on this area or increased requests for disclosure schedules, including instructing staff members of this position.
As always, companies engaging in mergers and other agreements subject to SEC filing should bear in mind the impact of any new developments, whether raised through due diligence or brought to light through the passage of time, on the representations and warranties and other material contractual provisions described or incorporated by reference in the SEC filing. The Report does not specify what disclosure the SEC believes would be appropriate under the circumstances. However, in light of the Report of Investigation and remarks by senior SEC staff members, we believe that companies should review their disclosure controls and procedures to ensure that, among other things, the following steps are taken:
Companies may also consider providing disclaimers or other notices to shareholders in the disclosure document stating that contractual provisions should not be relied on as disclosure of material facts. While this may be helpful to assist investors in understanding the nature and purpose of contractual provisions, we do not believe that such disclaimers will address the SEC's concerns regarding a company's obligation to provide additional material information that contradicts or qualifies the disclosure of a representation. In this regard, the SEC stated in the Report of Investigation that "general disclaimers regarding the material accuracy and completeness of disclosure may not be sufficient disclosure" where the company has material information contradictory to the representations made.
Theresa Hyatte is an Associate in the Corporate Department of the Washington, DC office of Weil, Gotshal & Manges LLP.