Things are turning out so well for your client Green Goo that United Goo, a leader in the sustainable sewage space, is in negotiations with Green Goo to add Green Goo to its portfolio of gooey companies. Green Goo’s General Counsel calls to ask about disclosing the negotiations transaction.
What do you say when Green Goo’s GC calls asking if the company needs to disclose the merger negotiations?

Your short answer is essentially, “No – with caveats.” Let’s take this from the top. (We normally try to minimize footnotes and case citations in these WoWs, but we’ve included them below since you may want to have the cases to hand when dealing with this topic.)

To begin with, there is no general duty under the securities laws to disclose merger or other similar transaction negotiations until there is a material definitive agreement. The US Supreme Court’s decision in Basic v. Levinson¹ is the fundamental source for this proposition, and various recent lower court decisions have applied Basic to reach the same conclusion. See, e.g., Levie v. Sears;² Vladimir v. Bioenvision (which has the helpful statement that “if there is no other duty to disclose, silence on the issue of merger discussions is not misleading”).³

But don’t pop the champagne corks just yet. The general point that there is no obligation to disclose merger negotiations is subject to some hefty caveats. Assuming this is a material transaction,⁴ disclosure may be required in certain situations that trigger a duty to speak.

To begin your analysis, you should ask Green Goo’s General Counsel the following questions:
1. Is Green Goo involved in any securities sales, and is the trading window open?

Selling securities is an event that may give rise to an obligation to disclose a pending material transaction, even if not completed. There may also be concerns about liability under Rule 10b-5 for Green Goo’s executives (for example, in connection with option and warrant exercises). You may want to ask the GC to be on the lookout for unusual trading activity in the company’s securities – if you see that, let’s talk.
2. When is Green Goo’s next periodic report due?

The good news is that there no line item in the Form 10-K or 10-Q that calls for disclosure of pending merger transactions. But you should bear Exchange Act Rule 12b-20 in mind. Rule 12b-20 provides that in addition to the information expressly required to be included in an Exchange Act report, “there shall be added such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made not misleading.” So, you will want to have a look at existing disclosure and ask yourself whether there is anything material in there (a statement affirmatively denying any merger or similar negotiations perhaps) that might lead you to consider disclosure in an upcoming Exchange Act report. This might also be a good time to revisit Green Goo’s risk factor disclosure – a risk factor designed to address the fact that the company may at any time begin negotiations for significant transactions could be appropriate.
3. What has Green Goo already said?

The point of this question is to figure out if there are any past public disclosures that arguably create a duty to update. Here are some possible scenarios and how to think about them:

• Green Goo’s spokesperson told a reporter, prior to the negotiations, that the company was not considering any transaction with United Goo. Courts may find a duty to update prior disclosure if (a) a prior statement is still “alive” in the marketplace⁵ or (b) intervening events have rendered statements such as opinions and projections misleading there was a duty to make that disclosure in the first place.⁶ In our scenario, the spokesperson was not under an explicit disclosure obligation and the statement was not misleading in light of the circumstances under which it was made, so the duty to update is likely not implicated.
• The spokesperson made the comment not knowing that the CEO had already begun discussing a possible transaction with United Goo. In this case, Green Goo may have a duty to correct that statement. Courts have found a duty to correct when a speaker learns later that a prior disclosure was misleading when made.⁷
  The CEO made general statements about the company’s financial performance or marketing strategy that clearly did not contemplate a material transaction, but did not address the topic explicitly. General statements of financial performance and plans or marketing strategy should not give rise to a duty to disclose the potential merger or other material transaction.⁸
• A third party has disseminated rumors about the pending transaction. This can be tricky. Needless to say, the company cannot deny the rumors if doing so would be misleading. But “no comment” may not work from a business perspective – the company may want to communicate more proactively and not let the rumors continue unchecked.⁹ This gets particularly tough if the rumors are inaccurate. There is no short answer to this dilemma, and you should bear in mind that once a company starts down the path of disclosing the pending transaction it is not easy to go back to silence (unless the transaction falls apart, of course)

What else should the GC be thinking about?

You may want to ask about the current status of 13Ds and 13Gs that are on file for Green Goo. While this is not specifically Green Goo’s issue, transaction participants may appreciate having these issues flagged. Recall that Exchange Act Section 13(d) requires beneficial holders of more than 5% of a class of equity securities registered under the Exchange Act to file a Schedule 13D, though these holders may file a Schedule 13G in lieu of a Schedule 13D if they did not acquire the securities with the purpose or effect of changing or influencing control of the issuer.

First, Green Goo’s Schedule 13G filers must consider whether they need to file an annual amendment to report changes in the information they previously disclosed. See CD&I 104.02. If a change occurs in such a way that a holder reporting ownership on Schedule 13G now holds the securities with a purpose or effect of changing or influencing control of the issuer or, importantly, in connection with a transaction having that purpose or effect, these Schedule 13G filers must file a Schedule 13D indicating the change within 10 days of that change. Thus, holders reporting on Schedule 13G that are involved in the merger negotiations in which Green Goo may experience a change in control should generally file a Schedule 13D within ten days of entering into the negotiations.¹⁰

Similarly, a security holder must amend its Schedule 13D “promptly” when there are any material changes in the facts that are in the filed Schedule 13D. See Exchange Act Rule 13d-2(a); CD&I 104.03. This includes any changes in the facts underlying Item 4 of Schedule 13D, which requires disclosure of, among other things, any plans or proposals the reporting person may have that would relate to or result in an extraordinary corporate transaction or significant sale of assets of the company. See also C&DI 110.06 (generic disclosure reserving the right to engage in any of the kinds of transaction enumerated in Item 4 must be amended when the security holder has formulated a specific intention with respect to the disclosable matter).

In a separate WoW, we explore what happens when you have a deal, and in particular, what you need to file on Form 8-K.

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¹   Basic v. Levinson, 485 U.S. 224, 239 n. 17 (1988).
²   Levie v. Sears Roebuck & Co., 676 F.Supp.2d 680, 686 (N.D.Ill. 2009).
³   Vladimir v. Bioenvision Inc., 606 F.Supp.2d 473, 485 (S.D.N.Y. 2009), aff’d Case No. 09-3487–cv (2nd Cir. April 7, 2010).
⁴   The determination as to whether this transaction is material is made under Basic v. Levinson’s probability and magnitude test, or the probability of the merger or transaction occurring and the magnitude of the transaction. In many instances, the farther along the company is in the negotiations, the more likely the transaction is to take place – that is, the probability increases.
⁵   Ross v. A.H. Robins Co., 465 F. Supp. 904, 908 (S.D.N.Y. 1979), rev’d on other grounds, 607 F.2d 545 (2d Cir. 1979).
⁶   See In re Time Warner Inc. Securities Litigation, 9 F.3d 259, 267 (2d Cir. 1993).
⁷   Backman v. Polaroid Corp., 910 F.2d 10, 16‑17 (1st Cir. 1990).
⁸   Vladimir v. Bioenvision Inc., 606 F. Supp.2d at 485.
⁹   There may be implications too under both the NYSE and Nasdaq Rules (under which a company may need to consider disclosure as a result of rumors). See NYSE Listed Company Manual Section 202.05; Nasdaq IM-5250-1.

¹⁰   See Levie v. Sears Roebuck & Co., 676 F.Supp.2d at 688-689.