purchase. Shearson Holdings has committed itself to provide a financial contribution of $ 570 million to BNS, Inc. and in return will take either (1) unsecured subordinated notes from BNS Inc.; or (2) Series B Preferred Stock in BNS, Inc. The Series A Preferred Stock carries a 15% cumulative divided and limited voting rights. If Shearson Holdings takes Notes, rather than the Series B Preferred Stock, then the tender offer anticipates that "the Notes will be refinanced, in part by the sale of Refunding Securities and the remainder from the [Citibank loan]." Tender Offer, at 28. If this occurs, Shearson Holdings will receive 3.5% of any principal amount of the Refunding Securities. Schedule 14D-1, Amendment No. 12, Exhibit 39, at 3.
There is more to the Shearson's interests than mere equity holdings, however. Shearson also stands to earn significant brokerage fees by: (1) underwriting the purchase of Koppers stock pursuant to the tender offer (some of which Shearson has already realized, since approximately 1,636,000 shares of Koppers have already been purchased through Shearson); (2) underwriting up to $ 570 million in Refunding Securities, if Shearson elects to take Notes rather than equity, in which case Shearson would be entitled to a fee payable of $ 2.5 million. Shearson will also earn a 25% compounded annual return on its equity investment in BNS Inc.'s common stock.
Thus, the Shearson entities play multiple roles in this complex transaction. They have acted, are acting, and will continue to act, as advisor, underwriter, equity partner, and financier to BNS Inc. In addition to their equity interests, they expect to earn significant fees as broker-dealer and underwriter of various financial offerings and transactions associated with this tender offer and its ensuing restructuring.
Although the tender offer contains no indication that the financial arrangement between Shearson and Beazer is anything but ordinary, in fact the arrangement is quite novel. There seems to be no dispute that this is the first time that a broker-dealer has become so intimately involved in a tender offer, see Wall St. J., Mar. 4, 1988, at 4. Shearson's role far surpasses that of a typical investment banker. Not only has Shearson assisted Mr. Beazer in developing a financial structure intended to enable him to acquire Koppers, Shearson has agreed to be a major equity participant in the takeover vehicles.
B. The Williams Act Vis-a-Vis Shearson
The disclosure requirements of the Williams Act were designed to provide information to the market and to prevent market manipulation. They insure that shareholders have an opportunity to make an informed investment decision and additionally provide federal agencies such as the SEC and the Federal Reserve Board the opportunity to monitor tender offer filings for possible violation of federal securities laws.
In light of this intention, we find a high probability that Koppers would be successful in establishing at a trial on the merits that Shearson Holdings is a bidder for Williams Act purposes. We believe that Shearson Holdings is playing a central participatory role in this tender offer. Shearson Holdings has unquestionably been a motivating force fueling the formation and capitalization of BNS, Inc., as it now stands, and as it is intended to stand after the purchase.
We would find it difficult to conclude that as a matter of law, one of the principal planners and players in this transaction is exempt from the disclosure requirements of the Williams Act solely because it would hold slightly less than a 50% interest in the tender offeror after the purchase. Shearson's role here is easily distinguishable from those cases which have found that a particular individual or entity was not a bidder for Williams Act purposes. Shearson's argument that it does not have "control" is not persuasive. Although Shearson argues that its right to vote the stock is overshadowed by the larger number of votes held by Beazer, the limited voting does not change the result that Shearson is one of the entities on whose behalf the tender offer is made.
1. Shearson and Schedule 14D-1 - Item 10(b)
Since we have concluded that, as proffered, the tender offer most likely will be found to violate the Williams Act due to, inter alia, the lack of any information regarding Shearson Holdings, we will address issues which we believe requires special attention in Shearson Holdings Schedule 14D-1. We want to emphasize that by discussing these particular issues, we do not in any way intend to limit the disclosure required by Shearson. In particular, we call Shearson's attention to Item 3 of Schedule 14D-1 regarding "Past contacts, transactions or negotiations with the subject company."
Item 10(b) of Schedule 14D-1 provides: that the bidder must disclose, "To the extent known by the bidder after reasonable investigation, the applicable regulatory requirements which must be complied with or approvals that must be obtained in connection with the tender offer" if such information is "material to a decision by a security holder whether to sell, tender or hold securities being sought in the tender offer."
In light of this disclosure requirement, we believe that Shearson Holdings must fully disclose to Koppers' shareholders what effect Shearson's projected equity position in Koppers would have on its status as a broker/dealer. The relationship between broker/dealers and their clients is not that of an ordinary merchant to his customer; strict standards of a fiduciary must be adhered to by the dealer. S. Jaffe, Broker-Dealers and Securities Markets § 7.01 (1978). By engaging in business, the broker-dealer makes a broad representation to the public at large that he will deal fairly with his customers and handle transactions in the usual manner and in accordance with trade custom. Charles Hughes & Co. v. SEC, 139 F.2d 434, 437 (2d Cir. 1943).
Because of Shearson's identity as a major broker-dealer, and because its role in this tender offer is entirely unprecedented, we believe that knowledge of the ramifications of Shearson's equity involvement in a registered security on its future broker-dealer activities is material to a decision by each Koppers' stockholder. Shearson's multiple roles present it with delicate ethical issues that must be forthrightly addressed; the resolution of these may impact on Shearson's continued role in BNS Inc. While we do not, as a court, profess to be an expert in securities regulation, we do recognize potential conflicts of interest when we see them. Not only would the complexities of such issues be material to the decisions by the shareholders of Koppers, but important to the securities market as a whole. The Senate Report on the Williams Act explained the very broad public policy underlying such disclosure:
The competence and integrity of a company's management . . . are of vital importance to stockholders. Secrecy in this area is inconsistent with the expectations of the people who invest in the securities of publicly held corporations and impairs public confidence in securities as a medium of investment.
S.Rep. No. 550, 90th Cong. 1st Sess. 2 (1967) (emphasis added).
A brief review of current SEC Rules reveals that the SEC, acting with the interests of security holders in mind, is quite concerned with potential "double-dealing" by broker-dealers. See SEC v. Roussel, 485 F. Supp. 295, 296-97 (D. Kan. 1980) (SEC filed, and was successful in, an action against broker-dealer alleging that broker-dealer defrauded stockholders of a target company by engaging in unlawful scheme to obtain control of the target).
SEC Rule 10b-6 makes it unlawful for a broker-dealer participating in a distribution of securities to bid for or purchase the security being distributed for any account in which he has a beneficial interest until after the broker-dealer has completed its participation in the distribution. 17 C.F.R. § 240.10b-6.
C. Analogous Rules and Regulations
While the issue with which we are wrestling is not directly addressed by SEC rules, there are indications in analogous rules and regulations which provide guidance for the direction we should take. For instance:
a) The Exchange Act provides that no broker or dealer shall use any instrumentality of interstate commerce to induce the purchase or sale of over-the-counter stock by means of any "manipulative, deceptive, or other fraudulent device or contrivance." 15 U.S.C. § 78o(c)(1). The SEC has provided that this same prohibition applies to stock which is exempted from registration. 17 C.F.R. § 240.10b-3.
Pursuant to congressional authority, 15 U.S.C. § 78o(c)(1), the SEC has defined the devices and contrivances that are deemed to be manipulative, deceptive and otherwise fraudulent. SEC Rule 15d1-5 provides:
The term "manipulative, deceptive, or other fraudulent device or contrivance" as used in section 15(c)(1) of the Act, is hereby defined to include any act of any broker, dealer . . . controlled by, controlling, or under common control with, the issuer of any security, designed to effect with or for the account of a customer any transaction in, or to induce the purchase or sale by such customer of, such security unless such broker, dealer . . ., before entering into any contract with or for such customer for the purchase or sale of such security, discloses to such customer the existence of such control, and unless such disclosure, if not made in writing, is supplemented by the giving or sending of written disclosure at or before the completion of the transaction.
17 C.F.R. § 240.15c1-5.
b) Rule 10b-5 prohibits any person from employing a fraudulent device or engaging in a fraudulent practice in the connection with the sale or purchase of any security. Thus, we find there is a serious question over whether the antifraud prohibitions of Rule 10b-5, which would apply to sales of Koppers' stock, could be construed to cover the actions of the broker-dealer which are expressly prohibited in Rule 15c1-5. It certainly appears possible that an analogy could be drawn.
We note that a class action lawsuit has already been filed in this court on behalf of customers of Shearson alleging that Shearson violated its fiduciary duties to them and manipulated the market by failing to disclose its role in the Koppers' tender offer while at the same time providing advice with respect to Koppers stock. See Complaint in Hartings v. Shearson Lehman Brothers Holdings, Inc., et. al., Civil Action No. 88-744 (W.D. Pa. 1988).
Lastly, we note that despite the fact that the securities industry is a highly regulated industry, that although it is clear that the principle of clean hands, arms-length dealing and full disclosure permeates, Shearson has yet to voluntarily seek SEC or Federal Reserve Board review of the validity of its role in this transaction.
Certainly, the market deserves an explanation of the measures (if any) taken by the Shearson interests to protect their many customers from the obvious conflicts of interest which the Shearson position here will engender. On balance, we believe that both the shareholders of Koppers and the securities markets deserve an explanation from Shearson as to how it intends to address the conflict of interest dilemma that its role in the Koppers takeover presents. In light of the unique position which Shearson has in the securities markets and the sheer novelty of this transaction, we construe Item 10(b) of Schedule 14D-1 to require Shearson to undertake an investigation of these issues and fully disclose its findings.
D. Shearson Must Disclose Financial Information
There is one final point to address regarding the required disclosure by Shearson. Shearson has argued that even if it is a bidder it does not have to disclose financial information. We disagree.
Item 9 of Schedule 14D-1 provides that where a bidder is other than a natural person and the bidder's financial condition is material to a decision by a security holder of the subject company on whether to sell, tender or hold securities being sought in the tender offer, adequate financial information concerning the bidder must be disclosed. We believe that a shareholder would find particularly important and material information regarding the financial condition of one of the prime financial contributors to this transaction.
While it may be true that those shareholders who have firmly decided to tender their shares will have little interest in the financial position of Shearson Holdings other than its ability to pay, other Koppers' shareholders still face a difficult problem in determining their most advantageous course of action, a problem enhanced by their ignorance of the course other shareholders are adopting. "If the bidder is in a flourishing financial condition, the stockholder might decide to hold his shares in the hope that, if the offer was only partially successful, the bidder might raise its bid after termination of the offer or infuse new capital into the enterprise. Per contra, a poor financial condition of the bidder might cause the shareholder to accept for fear that control of the company would pass into irresponsible hands." Prudent Real Estate Trust v. Johncamp Realty, Inc., 599 F.2d 1140, 1147 (2d Cir. 1979).
Thus, Shearson must fully comply with Item 9 in its Schedule 14D-1.
V. DISCLOSURE OF PLANS TO REPAY FINANCIAL OBLIGATIONS AND CONTRIBUTIONS
A. The Plans Described in the Tender Offer
SEC regulations recognize that the nature and terms of financing arrangements are highly material to the decisions of investors. Schedule 14D-1 requires that the bidder "state the source and the total amount of funds or other consideration for the purchase of the maximum number of securities for which the tender offer is made." 17 C.F.R. § 240.14d-100, Item 4(a). For borrowed funds, it also requires the bidder to provide a summary of "each loan agreement or arrangement containing the identity of the parties, the term, the collateral, the stated and effective interest rates, and other material terms or conditions relative to such loan agreement." Item 4(b)(1).
Furthermore, Item 5 of Schedule 14D-1 requires "bidders" to disclose "any plans or proposals which relate to or would result in . . . a sale or transfer of a material amount of assets of the subject company or any of its subsidiaries." Such plans are considered highly material and their inadequate disclosure has frequently led to the issuance of preliminary injunctions. See Marshall Field & Co. v. Icahn, 537 F. Supp. 413, 416 (S.D.N.Y. 1982); Pargas, Inc. v. Empire Gas Corp., 423 F. Supp. 199, 209 (D. Md. 1976), aff'd, 546 F.2d 25 (1976). Defendants argue, however, that Item 5 only requires disclosure of those plans or proposals that rise to the level of firm intentions. Elec. Specialty v. Int'l Controls Corp., 409 F.2d 937, 948 (2d Cir. 1969).
The tender offer contemplates that $ 543 million of the money borrowed from the syndicate of banks led by Citibank at the time of the merger (Part A of the Merger Facility) is to be repaid within 18 months. The remaining $ 644 million of the Merger Facility is an eight-year term revolving loan (Part B). There are apparently no specific plans for repayment of Part B of the Merger Facility.
However, it is the apparent desire of both the Beazer interests and the Shearson interests that Shearson's interests in BNS Inc. should be transferred to Beazer with relative despatch. Of course, BNS Inc. and/or the Beazer interests will require a tremendous amount of capital to both repay the 18-month term portion of the bank loan ($ 543 million of the $ 1,187 million Merger Facility), and also repay the contributions of the various Shearson interests ($ 570 million if Shearson Holdings takes Notes, or $ 540 million in Series A Preferred Stock along with a $ 30 million loan, plus $ 23.05 million contributed by SL-Merger to BNS Partners), not to mention Speedward's relatively minuscule contribution to BNS Partners of $ 2.45 million. This is in addition to interest owed on the bank loans, dividends due on the preferred stock (20% to Bright Aggregates' Series a Preferred Stock, and 15% to Shearson Holdings' Series B Preferred Stock), and the money borrowed by BNS Partners to purchase Koppers' stock on margin. Furthermore, none of this accounts for Mr. Beazer's borrowings from NatWest (up to $ 300 million), which will apparently be serviced and repaid from his other holdings. Tender Offer, at 28.
The tender offer indicates that part of BNS Inc.'s borrowings are to be repaid with funds generated by the sale of certain Koppers' assets, notably including the Chemical and Allied Products Division (Mr. Beazer has indicated that his interest is primarily in the Construction Materials and Services Division). The tender offer contains the following statements:
The [bank loan agreement] will provide that, until Part A is repaid in full, the Borrower [the survivor of the merger of BNS Inc. and Koppers] will have an obligation to sell certain assets ("Designated Assets") for cash at fair market value and to use the proceeds to repay Part A. Designated Assets will include the Company's Chemicals and Allied Products business (which is to be sold for net cash proceeds of not less than $ 400 million before payment of associated taxes, unless the fair market value is determined to be lower) and certain other assets to be specified. In addition, the Borrower will be required to make prepayments of Part B based on a percentage of "consolidated excess cash" (which will be defined), and to apply the proceeds of any sale of assets other than Designated Assets (except to the extent of certain permitted reinvestments in capital assets) and amounts received on account of overfunded pension plans to the prepayment of Part B.
Tender Offer, at 27.
It is anticipated that borrowings by Beazer PLC under the NatWest Loan Facility will be repaid from funds generated internally by Beazer PLC. It is anticipated that borrowings by the Purchaser under the Bank Facilities will be repaid from funds generated internally by the Purchaser (including, after the Merger, funds generated by the Company), the sale of the Company's Chemical and Allied Products business and other, as yet unidentified, assets or other sources, which may include the proceeds of the sale of debt or equity securities. It is anticipated that the [Shearson] Notes will be refinanced, in part by the sale of Refunding Securities.