UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF PENNSYLVANIA
May 13, 1988
KOPPERS COMPANY, INC., Plaintiff,
AMERICAN EXPRESS COMPANY, a corporation, SHEARSON LEHMAN BROTHERS HOLDINGS, INC., a corporation, SHEARSON LEHMAN HUTTON, INC., a corporation, SL-MERGER, INC., a corporation, BNS PARTNERS, partnership, BNS INC., a corporation, BRIGHT AGGREGATES INC., a corporation, BEAZER PLC, a public limited company, and NATIONAL WESTMINSTER BANK PLC, an English banking company, Defendants
The opinion of the court was delivered by: COHILL, JR.
MAURICE B. COHILL, JR., CHIEF UNITED STATES DISTRICT JUDGE
AND NOW, to-wit, this 13th day of May, 1988, the Court having made certain inquiries of the Securities and Exchange Commission, and the Court having received a response thereto in the form of the letter attached hereto as Appendix A, It Is Hereby ORDERED, ADJUDGED, and DECREED that this response be and hereby is made a part of the public record. It appears that no further evidentiary hearing or discovery will be necessary with respect to preventive measures adopted by Shearson Lehman Brothers Holdings, Inc. and its related entities to avert potential conflicts of interest.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C., 20549
OFFICE of the GENERAL COUNSEL
May 12, 1988
Hon. Maurice B. Cohill, Jr.
United States District Court
Western District of Pennsylvania
Pittsburgh, Pennsylvania 15219
Re: Koppers Co., Inc. v. American Express Co., No. 88-0557 (W.D. Pa.)
Dear Judge Cohill:
The Commission has authorized me to respond on its behalf to your letter of April 22, 1988. In that letter, you asked for the Commission's views on a federal securities law question arising from the BNS, Inc. tender offer for the shares of Koppers Co., Inc. Your letter refers to an opinion and order in the above-captioned matter dated April 15, 1988, in which Your Honor preliminarily enjoined the tender offer, finding a high probability that Koppers will be successful in establishing at a trial on the merits that Shearson Lehman Brothers Holdings, Inc. ("Shearson") is a bidder for purposes of the Williams Act and therefore violated the filing requirements of the Williams Act. As your letter (p. 2) states, that decision was
based on the facts that: (1) Shearson Holdings holds a significant [ i.e., 46 percent] equity interest in the shell corporation, BNS, Inc., through SL-Merger [a wholly-owned Shearson subsidiary]; (2) it will acquire additional significant interests in BNS, Inc. if the tender offer should succeed as a result of its direct contribution to the financing of the purchase; and (3) that Shearson Holdings stands to earn substantial fees as a broker-dealer and underwriter of various financial offerings and transactions associated with the tender offer.
In view of that holding as to Shearson's co-bidder status under the Williams Act, your letter (p. 4) asks:
Whether Shearson Holdings' multi-faceted role in the takeover attempt and its simultaneous equity position in BNS, Inc. (as these roles are explained in the tender offer) violate any federal securities laws because of the apparent, inherent conflicts of interest which these roles present. In other words, can the Chinese Wall concept, approved by the SEC in other contexts, be extended to the situation presented here?
In responding to that question, we will not address the correctness of the Court's ruling that Shearson is a co-bidder.
As this Court recognized (Opinion 45-46), a multi-service firm like Shearson that provides investment banking services to a tender offeror is subject to certain potential conflicts of interest. For example, there is a potential conflict between the firm's duty to the tender offeror to maintain the confidentiality of information concerning the tender offer and its duty, as a broker-dealer, to retail customers not to act contrary to available material information when making recommendations to them or managing their securities accounts.
There also are potential conflicts of interest created by the firm's duty not to take advantage of information obtained in confidence from its investment banking client, either for its customers' or its own benefit in securities transactions.
The Commission believes that violations of the federal securities laws stemming from these conflicts can be avoided through the use of well-established preventive policies and procedures, such as Chinese Walls, restricted lists and watch lists. In other words, the Commission believes that neither Shearson's significant involvement in the tender offer, including its equity interest in the offeror, nor even a status as a co-bidder" under the Williams Act, as the Court found here, makes this case different from the traditional situation in which the investment firm acts as dealer-manager without taking an equity position. Even without an equity position, the firm is subject to substantial potential conflicts of interest that are not different in principle from the conflicts that exist where it has an equity position. In both situations the firm must adopt and effectively implement appropriate preventive procedures.
The Commission has rejected the view that the conflicts of interest discussed above require the prohibition of multiple roles by securities firms. The Commission has stated that, if multiple roles were prohibited, "the capital-raising capability of the industry and its ability to serve the public would be significantly weakened."
As stated in the 1963 Report of the Special Study of the Securities Markets, the total elimination of potential conflicts in the securities industry "is obviously quite out of the question."
The Commission believes that there is no need to impose a requirement as drastic as prohibition of multiple roles in these situations if preventive procedures are established and implemented.
Among the preventive procedures commonly used are Chinese Walls, restricted lists and watch lists.
A Chinese Wall isolates the trading side of the firm from the investment banking side. A restricted list prohibits recommendations to customers relating to, or solicitation of customer orders to purchase or sell, a particular security, and prohibits trading for the firm's own account in the security. Another type of restricted list enables the firm to prevent such activities as the issuance of a research recommendation concerning a security. Firms frequently use a watch list to monitor trading activity to determine whether any leaks in the Chinese Wall have occurred. The Commission has not designated the specific policies and procedures that should be adopted in particular circumstances.
The Commission formalized the propriety of these procedures as a device to avoid liability in the context of tender offers when it adopted Rule 14e-3 in 1980. That rule establishes a "disclose or abstain from trading" requirement for persons in possession of material information regarding a tender offer, when that person "knows or has reason to know" that the information is nonpublic and has been acquired from certain specified sources. Securities Exchange Act Rule 14e-3(a), 17 C.F.R. 240.14e-3(a). However, recognizing that a blanket proscription would prevent multi-service financial institutions from engaging in their various roles, the Commission built into the rule an exception. Under that exception, no violation of Rule 14e-3(a) occurs if an institution engaged in the securities business can show, first, that the individuals making investment decisions for a transaction about which the institution possesses confidential information did not know the information and, second, that the institution has implemented reasonable procedures to ensure that such individuals would not violate Rule 14e-3(a). These procedures may include, but are not limited to:
(i) those which restrict any purchase, sale and causing any purchase and sale of any such security or (ii) those which prevent such individual(s) from knowing such information.
17 C.F.R. 240.14e-3(b)(2).
Although the Commission has not codified the use of preventive procedures as a means to avoid securities law liability except in Rule 14e-3, the principles also extend to actions under Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. The Commission has made clear that position in recent testimony before Congress on proposed insider trading legislation and did so previously in connection with the Insider Trading Sanctions Act of 1984. See Statement of David S. Ruder, Chairman, Securities and Exchange Commission, Before the Subcommittee on Securities of the Senate Banking, Housing and Urban Affairs Committee, Concerning the Commission's Revised Proposal to Define Insider Trading (Dec. 15, 1987); Letter from Chairman John S.R. Shad to Honorable Timothy E. Wirth (June 29, 1983), reprinted in H.R. Rep. No. 355, 98th Cong., 2nd Sess. 28 (1983).
The fact that Shearson has a significant involvement in this tender offer, including a substantial equity position, does not affect the availability of the Chinese Wall and other procedures as means to avoid certain securities law liability. Thus, the Commission believes that Shearson's role in the tender offer does not create any conflicts of interest that cannot be remedied through the effective implementation of the types of policies and procedures described above.
Daniel L. Goelzer
cc: All parties of record (through Judge Cohill)