INTRODUCTION

The Securities Exchange Commission (SEC) has, under the authority of the Securities Exchange Act of 1934 (Exchange Act)(1) and the congressional enactment of the Williams Act amendments,(2) promulgated Schedule 13D, a disclosure form used to regulate the concerns found in section 13(d) of the Exchange Act.(3) Any person who acquires, directly or indirectly, more than five percent beneficial ownership of any registered(4) class of voting equities securities (acquiror) must file a Schedule 13D within ten days of reaching such threshold ownership.(5)

The filing of Schedule 13D seeks to provide stockholders of an issuer and the marketplace with material information about the actual and potential changes in voting control of that issuer as a result of the stock acquisition.(6) Schedule 13D requires the acquiror to disclose extensive information as to its identity and background, including its officers, directors, and principal business, its mode of financing the stock purchases, and its future intentions, plans, agreements, and understandings regarding the issuer.(7) As one might expect, Schedule 13D is one of the most frequently filed Williams Act forms(8) and can be quite controversial.(9) While most would agree that such disclosure requirements do provide issuers’ shareholders with new, pertinent information about a new potential acquiror,(10) this early warning mechanism(11) has its defects(12) and creates confusion as to what exact information acquirors must disclose.

In particular, Item 4 of Schedule 13D,(13) which requires stock acquirors to disclose their purpose in acquiring the shares and any plans or proposals they have with respect to the target issuer, has been considered the most important disclosure item in Schedule 13D(14) and has created disclosure uncertainties(15) resulting in plentiful litigation. A central issue in this arena focuses on whether an insurgent’s preliminary ideas and desires have ripened into a disclosable Schedule 13D purpose or plans or proposal,(16) and how to interpret these plans or proposals. This Article explores the policy and legal interpretations of the requirements of Item 4 of Schedule 13D, and also how courts practically have applied the standard in such disputes. This Article also presents a practical new framework for disclosures under Item 4 of Schedule 13D, taking all of these considerations into account.

THE REGULATORY FRAMEWORK

Section 13(d) of the Exchange Act requires that a person(17) who acquires more than five percent beneficial ownership(18) interest in a class of registered equity securities must prepare a statement containing information that the SEC prescribes as necessary or appropriate in the public interest or for the protection of the investors.(19) This information is specified in Schedule 13D and must be filed within ten days of when the threshold requirement is reached.(20) The acquiror must file six copies of the schedule with the SEC, send one copy to the issuer at its principal executive office by registered or certified mail, and send one copy to each exchange on which the shares are traded.(21) As noted, there is no limit as to how much stock an acquiror can purchase once passing the five percent threshold so long as he files a Schedule 13D within ten days.(22)

Schedule 13D includes seven Items, each requiring disclosure of material aspects of the acquiror and the acquiror’s acquisition.(23) In particular, Item 4, Purpose of Transaction, has created a great deal of disclosure problems.(24) This may be due to the fact that it is often difficult, in the ever-changing, complex business situation of bidders seeking to alter corporate control, to describe their subjective intentions and plans of action with any real certainty.(25) Specifically, Item 4 of Schedule 13D requires disclosure of the following:

Item 4. Purposes of Transaction. State the purpose or purposes of the

acquisition of securities of the issuer. Describe any plans or proposals

which the reporting persons may have which relate to or would result in:

(a) The acquisition by any person of additional securities of the issuer, or

the disposition of securities of the issuer;

(b) An extraordinary corporate transaction, such as a merger, reorganization

or liquidation, involving the issuer or any of its subsidiaries;

(c) A sale or transfer of a material amount of assets of the issuer or of

any of its subsidiaries;

(d) Any change in the present board of directors of management of the

issuer, including any plans or proposals to change the number or term of

directors or to fill any existing vacancies on the board;

(f) Any other material change in the issuer’s business or corporate

structure, including but not limited to, if the issuer is a registered

thereto or other actions which may impede the acquisition of control of the

issuer by any person;

(h) Causing a class of securities of the issuer to be delisted from a

national securities exchange or to cease to be authorized to be quoted

in an inter-dealer quotation system of a registered national securities

association;

(i) A class of equity securities of the issuer becoming eligible for

termination of registration pursuant to section 12(g)(4) of the Act; or

(j) Any action similar to any of those enumerated above.(26)

In addition to filing an initial Schedule 13D to describe these activities, Acquirors must promptly(27) file amendments to the original Schedule 13D Item 4 if any material(28) change occurs in the facts set forth in the [prior filings, including, but not limited to any material change in the percentage of the class beneficially owned.(29) Thus, any person who acquires greater than five percent beneficial interest in a company (bidder or acquiror) must not only make significant disclosures as to the reason for the purchase, but must also continually update the management of the target issuer or company (target) and its shareholders of any material changes in his or her intentions.

In the remedy context, courts have found that the SEC, the target’s management, and the target’s shareholders all have standing to sue the Schedule 13D acquiror who has misrepresented or fraudulently completed a Schedule 13D at the time of filing.(30) If a court finds a violation of Rule 13d-1, the remedy most often granted is ordering the bidder to cure the defect or to disclose pertinent information by amending its Schedule 13D.(31) If an acquiror, however, fails to file a timely, sufficient Schedule 13D, the acquiror may also be enjoined from further purchases,(32) from casting a shareholder vote until the violation is cured,(33) or from changing representation on a board of directors,(34) or may be ordered to give up profits made on shares improperly acquired.(35) Such prohibitions provide a strong incentive to Schedule 13D acquirors to reveal their intentions in such securities purchases because a time delay in such a context may prove to be expensive and, in some cases, jeopardize a takeover bid.(36)

POLICY AND THE BUSINESS BACKDROP

Within the complex, fluid, and often secretive business context of seizing control of a target company, there are many conflicting interests among the three main parties: the target’s management, the target’s bidder, and the target’s shareholders.(37) Until the passage of the Williams Act in 1968,(38) obtaining control of a corporation by means of a tender offer or other type of stock purchase was not specifically regulated under the federal securities laws, aside from Rule 10b-5 claims.(39) Forming against a backdrop of changing markets for corporate control, proliferation of takeovers, and, in particular, cash tender offers, section 13(d) of the Williams Act became the starting point(40) for the legislation which attempted to give investors pertinent information to evaluate proposed tender offers prudently.(41) Senator Williams sought to form a regulatory scheme which required disclosures by investors who accumulated stock rapidly and in large blocks, thereby insuring that investors would obtain adequate information about significant purchases of their stock, regardless of the takeover method.(42)

With the passage of the Williams Act, the regulatory mechanism for stock acquisition transactions became tied to a trigger threshold in which disclosure would be required.(43) This was somewhat different than requiring advance disclosures (notice sent to the issuer prior to acquisition), which was what Senator Williams had originally intended.(44) The SEC, however, took the position that mandating advance notice of large stock acquisitions by bidding companies would be. a flawed policy because such disclosures would be, in many cases, impossible or misleading.(45) So, as section 13(d) stands today, it embodies an early warning system which puts the target company’s management and shareholders on notice of large acquisitions of stock, albeit after the acquisition already has occurred.

Given that this legislation mandates open disclosure of a bidder’s acquisition intentions, what purposes and whose purposes are truly served? Courts have been inclined to recognize that such disclosures are more critical to the company’s shareholders and the investing public than to the company’s management.(46) Assuming the investing public uses such information to gauge their investment strategies and decisions, courts have found that investors would be irreparably harmed if important information, upon which such decisions were made, was not available to them.(47) Furthermore, because such decisions occur in the context of stock transactions, which are inherently difficult to unscramble, shareholders are also irreparably harmed when basing their decisions on false or misleading information.(48) So, while a Schedule 13D disclosure has great effect on the internal distribution of corporate power among incumbent management and the insurgent bidder, the courts routinely have favored informing investors of potential changes in corporate control and permitting the market to value the shares properly.(49)

Whereas shareholders and public investors have been favored, courts have been reluctant to tip the balance of power between the target management and the takeover bidder.(50) From a practical business perspective, target management is the likely party to be the most active and interested party in Schedule 13D disclosures, given the dispersed and often inactive nature of general shareholders. Subsequently, a target’s management is most frequently at odds with the Schedule 13D filer, using the disclosures in Schedule 13D as a form of defense against losing control. The courts’ even-handedness approach promotes the belief that neither side in the control struggle should be given additional advantages because the investor, if provided accurate and truthful information, should be in a position to make the final informed choice.(51) From a utilitarian perspective, takeover bids should not be discouraged because they provide check[s] on entrenched but inefficient management(52) and give shareholders the opportunity to sell their inefficient investment for a premium over its market price.(53)

This balance between management and bidder has created a hazy but heated battleground for information disclosure in the context of Schedule 13D. It is clear that, if a target’s management was not cognizant of a control threat, the Schedule 13D would alert them that their corporate positions possibly could be in danger, causing the target management to steel their defensive efforts.(54) Likewise, a bidder fears that premature public disclosures of preliminary ideas or proposals discussed with other holders, or even management, would, in the least: (i) increase the market price of the issuer’s shares, (ii) alert management and evoke defensive retaliation, and (iii) announce to other potential bidders the possibility that the company is in play.(55) Thus, Schedule 13D disclosures often increase a bidder’s costs and risks, and subsequently lower the expected return from the acquisition.(56) It has also been suggested that the need for secrecy and the importance of surprise may tempt a bidder to withhold material information from the marketplace and legal counsel.(57)

The dynamics of this power struggle, though glossed over by courts, undoubtedly affects the amount of information shareholders receive in a Schedule 13D. In practice, the reporting person typically seeks to preserve his or her freedom of action while considering a number of different options, which can include: (i) holding the shares for investment (with no control interest or potential control interest in the future); (ii) seeking representation on, or control of, the issuer’s board; (iii) acquiring additional shares by purchase on the open market, privately or by tender offer; (iv) selling its holdings to the issuer or a third party; or (v) seeking a merger or change in the issuer’s business policies.(58) Likewise, a defensive target company’s management seeks to flush out information regarding every possible move by the Schedule 13D filer, including any tentative plans, proposals, agreements, meetings, or other relevant activity which may elucidate that bidder’s intentions and strategies to acquire control in the company. As a result of this tension, Schedule 13D disclosures tend to be broad and lengthy discussions of a spectrum of the alternatives open to the Schedule 13D filer, the possible effects of the acquisition, and actions that have or may be taken.(59) Because of possibility bombarding or a shotgun approach,(60) some have argued that Item 4 of Schedule 13D, to some extent, is exposing shareholders to misleading,(61) redundant, or nonvaluable information, which in the long run only imposes costs on the bidders and the ultimate outcome of the acquisition.(62) Also, the rules do not require these types of shotgun disclosures and, if made, a bidder continually would have to update these matters to prevent them from becoming misleading at a later date.(63) The converse effect, vagueness, also occurs. Persons filing a Schedule 13D have commonly stated under Item 4 that the purpose of the transaction is for investment purposes only,(64) much to the disliking of the SEC.(65)

Nevertheless, there is great importance to what is filed in a bidder’s Schedule 13D. A target’s management can, and often does, use a misfiled Schedule 13D as a defense tactic to delay or enjoin further stock acquisitions by a corporate bidder.(66) A filer’s Schedule 13D disclosures on Item 4 often determine such litigation. Therefore, regardless of exactly what investors are taking away from public Schedule 13D statements, management and bidders alike need to know the parameters of information required by Schedule 13D.

HYPOTHETICAL SCHEDULE 13D DISCLOSURE PROBLEM

The most difficult scenario involves a control acquisition that consists of many plans and actions which clearly would be material to shareholders. Because of the policy arguments behind misleading shareholders, however, there are questions as to whether a Schedule 13D requires disclosure of all of these events. For instance, assume that XYZ Acquiror Corporation (XYZ) has purchased more than five percent stock ownership in ABC Target Corporation (ABC). Within the ten days in which XYZ has to file its Schedule 13D, XYZ has extensive meetings among its board members, drawing up several merger plans involving financing and stock purchase schedules. They label these plans merger options and distribute them to all officers and directors and discuss the possibility of a takeover. They do not decide, however, to pursue any of the plans. They instead meet with ABCs officers a few days later to discuss a possible merger but are rebuffed by ABCs officers. A few days later, after another XYZ board meeting, the vice-president in charge of mergers decides to attempt a merger again; he or she calls ABCs board and decides on Plan C of the merger options.