Revlon “Ring-Fencing” Settlement: Greater Risk Of SEC Enforcement Activity In Going Private Transactions?

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On June 13, 2013, the Securities and Exchange Commission announced the settlement of administrative proceedings against Revlon, Inc. In the settlement order, the SEC asserted that the company hid information regarding a 2009 “going private transaction” from its independent board members and minority shareholders in violation of Section 13 of the Securities Exchange Act of 1934 and Rule 13e-3 thereunder. The SEC alleged that Revlon actively worked to remain ignorant of a third-party financial adviser’s opinion that the transaction did not provide adequate consideration to certain of the company’s minority shareholders. The SEC described this tactic as “ring-fencing,” designed to circumvent Revlon’s public disclosure obligations. Without admitting or denying the SEC’s allegations, Revlon agreed to settle the SEC's charges, pay an $850,000 penalty and cease and desist from further violations.

Civil lawsuits challenging going private transactions are common.  In many cases, because of the inherent conflicts in such transactions, the decision must meet a stringent “entire fairness” standard in which both the decision process and the offered consideration must be fair to the minority shareholders.  However, SEC enforcement actions stemming from going private transactions are rare, with only a handful of enforcement actions filed based on alleged violations of Rule 13e-3. The Revlon settlement may signal the SEC’s increased interest in enforcing the rule.

The 2009 Exchange Offer

The SEC’s allegations were based on Revlon’s conduct in connection with a complex 2009 debt restructuring plan. Revlon sought to repay a certain portion of its long-term debt held by its controlling shareholder, MacAndrews & Forbes Holdings Inc. (M&F), by offering to issue new preferred shares to minority shareholders who tendered their common stock in exchange. The exchanged common stock would then be transferred to M&F, thereby reducing Revlon’s debt.

Revlon’s exchange offer constituted a “going private” transaction under Section 13 of the Exchange Act and Rule 13e-3, because it had “either a reasonable likelihood or a purpose” of causing a class of equity securities subject to the reporting requirements of the Exchange Act (a) to be deregistered or to otherwise cease to be subject to such reporting, or (b) to be delisted from a national exchange or inter-dealer quotation system. 

Revlon Allegedly Builds the “Ring-Fence”

Some of Revlon’s minority shareholders were current and former employees who held shares of Revlon common stock in the company’s 401(k) plan. The 401(k) plan trustee allegedly informed Revlon that it could only allow 401(k) plan members to participate in the exchange offer if a third-party financial adviser concluded that the offer provided “adequate consideration,” a requirement of the Employee Retirement Income Security Act of 1974. The results of this adequate consideration analysis would wholly determine whether the trustee could allow 401(k) plan members to tender their shares.

Rule 13e-3 was designed to protect minority shareholders from the conflicts of interest inherent in going private transactions. It requires extensive disclosures regarding the transaction, covering in particular the potential conflicts, the approval processes and any material valuation materials that create an information imbalance between the minority shareholders and the company.  Accordingly, Schedule 13E-3 and Item 1015 of Regulation M-A, which governed Revlon’s exchange offer documents, required Revlon to disclose whether it “received any report, opinion (other than an opinion of counsel) or appraisal from an outside party that is materially related to the . . . transaction.”

According to the SEC’s allegations, Revlon did not wish to disclose the existence or conclusions of the adequate consideration opinion to minority shareholders considering the exchange offer.  In order to avoid this obligation, Revlon allegedly undertook a series of “ring-fencing” actions to keep the company “out of the flow of information” regarding the adequate consideration opinion and therefore to remain willfully ignorant of its existence or conclusions. In particular, the SEC alleged that Revlon:

  • Amended its agreement with the 401(k) plan trustee to make clear that the 401(k) plan trustee had sole authority to determine whether to allow 401(k) plan members to tender their shares;
  • Ensured that it was not a party to any engagement letter between the 401(k) plan trustee and the third-party financial adviser concerning the adequate consideration opinion, even though the company reimbursed the 401(k) plan trustee for the entire cost of engaging the third-party financial adviser;
  • Directed the 401(k) plan trustee to refrain from mentioning the adequate consideration opinion when it informed Revlon whether it would allow the company’s 401(k) plan members to participate in the exchange offer; and
  • Removed references to the third-party financial adviser and the adequate consideration opinion from a notice to be sent by the 401(k) plan trustee to the 401(k) plan members concerning the exchange offer (which was also included as an exhibit to the company’s exchange offer public filings with the SEC).

Revlon subsequently received notice from the 401(k) plan trustee that it would not allow 401(k) plan members to participate in the exchange offer. Although this result indicated that the plan trustee had received an unfavorable consideration opinion, per Revlon’s alleged instructions, the notice did not make reference to such opinion. The SEC alleged that Revlon’s independent directors, who were charged with determining the fairness of the exchange offer to the company’s minority shareholders, were unaware of the existence of the adequate consideration opinion.

Having received the plan trustee’s notice, Revlon moved ahead with the exchange offer, disclosing in the final offer filing that its independent directors had determined the transaction was fair both to shareholders who decided to participate and those who did not participate.  The exchange offer closed in early October 2009. Minority shareholders tendered approximately 9.3 million shares of Revlon common stock, or 46% of the outstanding minority shares.

The SEC Action

The SEC charged that Revlon’s actions to “ring-fence” the adequate consideration opinion and thereby conceal the opinion from its independent directors and its minority shareholders violated Rule 13e-3(b)(1)(iii), which bans engaging in “any act, practice or course of business which operates or would operate as a fraud or deceit upon any person.” The SEC asserted that these actions made Revlon’s public disclosures regarding the exchange offer—specifically the representation that the board had conducted a “full, fair and complete” evaluation of the exchange offer—materially misleading. The SEC claimed that the board’s process was compromised because Revlon concealed from the independent directors that it had engaged in a course of conduct to “ring-fence” the adequate consideration opinion.

In the SEC’s release adopting Rule 13e-3, the SEC recognized that going private transactions present significant potential for “shareholder harm, overreaching by issuers or its affiliates, and potential coercive effects on minority shareholders.” The Revlon settlement indicates that just as a going private transaction is likely to be the subject of civil litigation, the transaction and its related SEC filings may also be subject to increased scrutiny and possible enforcement action by the SEC.

Lessons for Boards and Management

  • While SEC rules require disclosure of certain valuation information materially related to a transaction that the company “receives,” companies that take affirmative steps to remain ignorant of such information expose themselves to potential liability under SEC rules barring fraud or deceitful conduct.
  • As part of the diligence required for approval of a going private transaction, independent board members must insist that they be presented with all information potentially material to the transaction, then hire their own independent advisers to assess the materiality of the information in order to determine whether it is relevant to their decision. 
  • Materials relating to the adequacy of the consideration offered in a going private transaction will almost always be deemed material by the SEC. These materials should be shared with both the company’s independent directors and their advisers in order to be evaluated for possible disclosure in the offering materials.