This decision will likely come as a relief to most corporations, directors and their legal counsel, as it largely confirms the existing commonsense approach to material change reporting. The OSC's investigative branch, which brought the regulatory action against AiT, had argued for reporting at a considerably earlier stage - a possibility that had caused concern in the business and legal communities.
A noteworthy aspect of the ruling is its recognition that the target board's duty to report may depend in some cases on the nature of the acquiror. In particular, where the acquiror is a large company, the rigours of its due diligence requirements and the multiple internal hurdles that may have to be surmounted before it can give final sign-off on a deal may mean that a transaction is not "substantially likely" until very late in the negotiation process. In the case at hand, the OSC panel agreed that, in light of the size and internal review procedures of the buyer (and other factors pointing to the contingent nature of the transaction), disclosure was not required until the final documentation was actually signed.
Highlights of the ruling
OSC Staff noted that the statutory definition of "material change" includes a "decision to implement" a "change in the business, operations or capital of the issuer" as well as such a change itself. From this they concluded that a material change need not actually have occurred in order to require disclosure. That this is so is widely accepted, but the issue (predictably) became what sort of decision by a board counts as a "decision to implement".
OSC Staff argued that AiT, a TSX-listed technology company, had been obliged to disclose a potential acquisition by Minnesota-based 3M Co. as soon as the board had given the go-ahead (through a resolution) to proceed with negotiating on the basis of a $2.88 per share offer by 3M. This approval, obtained on April 25, 2002, was followed the next day by a Letter of Intent (LOI) that was expressly stated to be non-binding, contained a no-shop provision, a right to respond to unsolicited superior offers and a stipulation that any agreement was subject to a favourable due diligence review to be completed over the following three weeks.
The OSC panel hearing the case rejected Staff's argument that the April 25 board resolution and/or the LOI constituted a "decision to implement" triggering a material change disclosure requirement. The panel stated the applicable principle as follows:
[A]n issuer's disclosure obligations arise not when a potential transaction is identified and discussed with the board, but instead, when the decision by the board to implement the potential transaction is based on its understanding of a sufficient commitment from the parties to proceed and the substantial likelihood that the transaction will be completed.
Even though the minutes of the April 25 meeting described the transaction as though it were virtually a done deal, the OSC panel noted that the minutes had actually been drawn up several months later, after the deal was done, and discounted their definitive tone. While AiT dodged a bullet on this point, it is a good reminder of the importance of keeping accurate and sufficiently detailed minutes that fully record any doubts that may be expressed about the viability of transactions currently under negotiation. It is also advisable to avoid formal resolutions at an early stage, as a matter of best practices.
Based on the evidence of board members, the OSC panel concluded that the board had not considered the transaction substantially likely on April 25. It also found that the April 26 LOI reflected this uncertainty. While a LOI can trig¬ger disclosure obligations, it will do so only where its terms are sufficiently firm and there is an adequate commitment to the trans¬action as described. In this case neither of these conditions were satisfied: the LOI was non-binding, due diligence had to be completed, the $2.88 price was subject to downward renegotiation and key elements of the deal (e.g. the break fees and support agreements) remained to be negotiated.
A material change might still have occurred, quite apart from the LOI, as negotiations proceeded and the deal firmed up. However, the panel found that while AiT was clearly committed to the transaction in the weeks following April 26, 3M was not. In particular, the panel cited 3M's commitment to its complex "Six Sigma" approvals process and the fact that the driver of the deal at 3M was a middle manager. The panel observed:
With an organization as large and complex as 3M it is important to distinguish between the business team's enthusiasm for doing a transaction which will enhance their operating unit's size and contribution to the 3M organization's success, and the corporate level approvals which had to be in place before 3M was committed to proceed with the acquisition of the AiT shares.
Even the May 14 approval by the 3M board was conditional upon CEO approval of the due diligence report and integration plan, which were fundamental to 3M's process. That approval was not obtained until May 21.
The panel did not accept Staff's position that these uncertainties were outweighed by the fact that some senior members of 3M were following the negotiations, that the proposed acquisition fit into the company's corporate strategy, that the LOI was signed by an executive VP of 3M who reported directly to the company's CEO, that the value of the transaction was only marginally over the level below which 3M board approval was not required or that 3M appeared to be acting in good faith. One significant take-away from this decision is that the board of a relatively small target may often be entitled to suspect the degree of "commitment" of a larger and more bureaucratic acquiror until the last of the acquiror's significant internal hurdles have been surmounted.
The panel noted in passing that a LOI might constitute a material change where an acquiror is "smaller [and] less process-driven" or where negotiations are led by the acquiror's CEO. In this case, however, the success of the transaction was insufficiently certain to require reporting as a material change at any point prior to the date that the merger agreement was actually approved by the 3M CEO and executed by the parties.
The OSC panel accordingly found that the corporation had not breached s. 75 of the Securities Act and that the company's outside counsel - who was also a director and who (as such) was alleged to have acquiesced in the alleged failure to disclose - was absolved.
The lesson of the case is that the common sense approach prevails, although it is important to note that the standard applied by the OSC panel is highly fact specific. In light of this, it is still essential for boards to consider possible disclosure obligations very carefully at each step in the process toward a proposed transaction and to ensure that their reasons for concluding that the transaction has not yet crossed the threshold of "commitment" and "substantial likelihood", where that is their conclusion, are both cogent and clearly recorded.