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OSC Clarifies Timing for Press Release of Pending Merger Transactions - or Does It?

Published: 03/14/2008

By Robert B. Cohen

In January 2008, the Ontario Securities Commission (OSC) released a decision pertaining to the timing of public disclosure in a pending merger transaction. In the case involving Advanced Information Technologies Corp (AiT), the OSC was asked to decide whether Deborah Weinstein, a director and legal counsel to the public company, had breached the Securities Act (Ontario) by permitting or acquiescing in AiT’s purported failure to disclose a potential merger between AiT and 3M Company between April 25, 2002 and May 9, 2002. The events of 2002 were these:

On January 25, AiT’s President, CEO, and one of its directors discussed the idea of hiring a mergers and acquisitions (M&A) advisor. The idea was unanimously approved by the AiT board on February 19. On February 28, AiT’s President met with 3M’s manager and discussed a possible merger. Discussions were quite preliminary and were clearly subject to approval by the superiors and consultants of 3M, as well as the board of directors of each of AiT and 3M.
In March, 3M conducted its initial due diligence and was serious about proceeding with a merger. In April, AiT created a Valuation Committee, which prepared for upcoming pricing discussions and negotiations with 3M. The negotiations took place in the middle of April and on a number of days thereafter..
At AiT’s board meeting on April 25, the board unanimously approved the recommendation to AiT’s shareholders of the acquisition by 3M of all of the outstanding shares and options in AiT at a specified cash purchase price per share, subject to confirmation of the fairness of the price by AiT’s financial advisor and subject to the board being satisfied with the final terms of the transaction (including tax consequences). The board also authorized one of AiT’s directors to execute additional documents to consummate a transaction with 3M, including a non-binding Letter of Intent (“LOI”).
On April 26, one of the directors of AiT signed the LOI with 3M, which was vetted before Deborah Weinstein and her legal associates. The LOI contained customary due diligence, stand-still, and confidentiality provisions. A standard warning letter was then sent to all persons working on due diligence to remind these persons of applicable confidentiality provisions and the prohibition against insider trading and tipping.
On April 29, a draft pre-acquisition agreement was sent to 3M from AiT. The draft agreement structured the transaction as a take-over bid, consistent with the LOI. Phone conversations ensued in early May, and on May 7, 3M advised AiT that it was unlikely they would have an agreement in place by May 14.
In early May, a second and more extensive due diligence visit was conducted by a team from 3M. Rumours began to circulate, and Market Regulation Services Inc. (“RS”) called AiT on May 9 to inquire about an unusual increase in both the trading volume and price of AiT shares. AiT informed RS it did not have any news to report. AiT’s decision about releasing news changed later that day, and AiT issued a press release on May 9 entitled “AiT Comments on Recent Stock Activity,” in which AiT stated it was “exploring strategic alternatives that would ultimately enhance value for [its] shareholders.” No other information was disclosed and no material change report was filed with the press release.
From May 14 forward, 3M provided a draft merger agreement to AiT (which was different from the initial take-over bid agreement provided by AiT in early May). A condition of the draft agreement was the execution of a support agreement by major shareholders of AiT. Over the ensuing week, 3M completed its due diligence and 3M later gave its final approval. On May 22, the AiT board likewise approved the transaction and received a fairness opinion from its M&A advisor. The following day, AiT and 3M executed a definitive merger agreement. AiT issued a press release and subsequently filed a material change report announcing that AiT had entered into a definitive merger agreement.
On July 15, the AiT shareholders approved the transaction with 3M, which closed four days later. A further press release and material change report were then filed.

Faced with these circumstances, the OSC had to determine whether there was a breach of the Securities Act as a consequence of AiT’s failure to file a material change report before May 9, 2002. In reviewing applicable legal principles, the OSC noted:

1. While the standard of proof applicable in Commission proceedings is the civil standard of the balance of probabilities, the burden could only be discharged by “clear and cogent evidence.”

2. The issue of “materiality” is dependent on the facts of each case. The test is the impact the information would have on the market. In some cases, the existence of negotiations of a material transaction may be material in and of itself.

3. In the facts of this case, the negotiations between AiT and 3M were material in relation to AiT as a reporting issuer. However, there is a distinction between a “material fact” (which is broader) and a “material change” (which requires a “change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price, which includes a decision to implement such a change”). The Securities Act only requires disclosure of “material changes” (not “material facts”), a distinction recently endorsed by the Supreme Court of Canada in Kerr v. Danier. (See “The Supreme Court of Canada Walks a Fine Line on IPO Disclosure and Forecast Obligations” for a discussion of this distinction.

4. There is no “bright-line” test as to when a “material change” occurs in the context of the negotiation of a definitive or binding agreement with a reporting issuer. The determination of a material change is a question of mixed fact and law, and the fact that legal and financial advisors are retained is not determinative of the existence of a “material change.”

5. In the context of a proposed M&A transaction, where the proposed transaction is speculative, contingent, and surrounded by uncertainties, a commitment from one party to proceed will not be sufficient to constitute a “material change.” Put another way, there must be sufficient commitment from both parties of the transaction to determine whether a “decision to implement” the transaction has taken place, mandating the filing of a material change report.

6. Consistent with the Supreme Court of Canada decision in Kerr v. Danier, the OSC is not permitted to defer to the “business judgment” of the AiT board in this regard, nor to assess the weight to be given to the circumstances in question based on hindsight.

Ultimately, while the OSC indicated that a “material change” may occur with respect to an issuer in advance of the execution of a definitive agreement, the facts in this case did not clearly establish that a “material change” had occurred before May 9, 2002. More specifically, the OSC found that the LOI was subject to too many significant contingencies beyond the control of AiT—further due diligence was contemplated to support a preliminary price, the support agreement still had to be negotiated with major AiT shareholders, and the break fee had still not been set—such that the LOI, in and of itself, did not reflect a “decision to implement” the transaction with 3M or reflect sufficient commitment from both AiT and 3M to go forward. The OSC also found there were no significant developments in the status of the negotiations after the execution of the LOI through to May 9, 2002 that would have led AiT to conclude that 3M was then more committed to proceed or that there was at that time substantial likelihood that the transaction would be completed (such that a “material change” did not occur before May 9, 2002). Accordingly, the OSC dismissed the charges against Weinstein.

While one might be led to conclude that the OSC has clearly indicated that the mere signing of an LOI would not amount to a “material change,” the OSC expressly indicated that such a conclusion would be erroneous. More specifically, the OSC expressly stated that “in some cases, the signing of an LOI may trigger disclosure, and this will depend on the content of the provisions of the LOI and the degree of commitment reached by the parties.” In this regard, the OSC indicated that the signing of an LOI with a smaller, less process-driven acquirer where the negotiations were being led by the acquirer’s CEO (within his level of authority) might amount to a “material change” and therefore trigger the requirement to disclose the execution of an LOI in such circumstances.

So what do we learn from an analysis of this case? While legal counsel and directors of public companies may be feeling somewhat relieved, such comfort must be tempered by the fact that, given a different day and only slightly different circumstances in the context of a pending merger transaction, the duty to file a material change report may be triggered. Without the law providing a “bright-line” test in circumstances such as these, the duty to file will continue to be shrouded in a large veil of uncertainty.

By Robert B. Cohen

Cassels Brock & Blackwell LLP

Securities Litigation