VIII. Finance, Mergers, and Acquisitions

Transcription

1 VIII. Finance, Mergers, and Acquisitions E.N. Ellis IV and Amy M. Modzelesky A. Introduction B. Regulatory Developments Disclosure Regarding Certain Loss Contingencies SEC Proposes New Disclosure Requirements for Short-Term Borrowings and MD&A SEC Increases Disclosure Requirements for Municipal Securities Repeal of Rule 436(g): SEC Staff Provides Guidance and No-Action Relief Regarding Inclusion of Credit Ratings in Offering Materials C. Announced Transactions Duke Energy Corp. and Progress Energy Inc. Announce Merger Agreement Northeast Utilities and NSTAR Announce Merger Agreement PPL Corp. Acquires Central Networks UK AES Corp. and DPL Inc. Announce Merger Agreement Exelon Corp. and Constellation Energy Announce Merger Agreement A. INTRODUCTION During the past year, regulatory developments have centered on increasing disclosure requirements in the wake of the credit crisis and recession. The Financial Accounting Standards Board (FASB) published an exposure draft of proposed amendments to disclosure requirements applicable to certain loss contingencies. The Securities and Exchange Commission (SEC) proposed new disclosure requirements for short-term borrowings and adopted increased disclosure requirements for municipal securities. The Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted in response to the call for reform of financial regulation. In addition, the pace of consolidation in the electric utility industry has increased, as evidenced by the announcement of several definitive merger agreements. These mergers include those between Duke Energy Corp. and Progress E.N. Ellis IV is a partner in the New York office of Dewey & LeBoeuf, LLP and chair of the Finance, Mergers, and Acquisitions Committee. Amy Modzelesky is an associate in the New York office of Dewey & LeBoeuf, LLP. 219

2 220 RECENT DEVELOPMENTS 2011 Energy Inc., Northeast Utilities and NSTAR, PPL Corp. and Central Networks UK, AES Corp. and DPL Inc., and Exelon Corp. and Constellation Energy. B. REGULATORY DEVELOPMENTS 1. Disclosure Regarding Certain Loss Contingencies In July 2010, the FASB published a new exposure draft with proposed amendments to the disclosure requirements applicable to certain loss contingencies contained in FASB s Accounting Standards Codification Subtopic The proposal was undertaken to address concerns of constituents relating to disclosures about certain loss contingencies under existing guidance, specifically that the disclosures do not provide sufficient information in a timely manner to assist users in assessing the likelihood, timing, and amounts of cash flows associated with loss contingencies. However, the new proposal was significantly scaled back from the FASB s initial proposal in 2008, which had been strongly criticized by public companies, auditors, and the legal community. The new proposal again generated a flurry of negative comments. In October 2010, the FASB decided that more time was needed to analyze the responses. It also determined that the proposed amendments, if eventually adopted, would not be effective for the 2010 calendar year-end reporting period. The FASB has stated that it will undertake re-deliberations, likely in late In a related development, the SEC staff emphasized that they will continue to focus on loss contingency disclosure and companies compliance with the existing disclosure requirements. In particular, the SEC staff indicated their focus will be on the requirement to disclose, if significant, the amount or range of reasonably possible losses in excess of any stated accrual. The SEC s comment letters appear to focus initially on financial services companies. 2. SEC Proposes New Disclosure Requirements for Short-Term Borrowings and MD&A On September 17, 2010, the SEC unanimously voted to propose amendments to existing disclosure rules to require enhanced disclosure of short-term borrowings. 3 In a companion release (interpretive release), the SEC also approved interpretive guidance for current disclosure requirements pertaining to a registrant s management s discussion and analysis of financial condition and results of oper- 1. Formerly included in Accounting for Contingencies, Statement of Financial Accounting Standards No. 5 (FASB 1975). 2. See minutes of the Oct. 27, 2010, FASB board meeting: Disclosures of Certain Loss Contingencies, available at 3. Short-Term Borrowing Disclosure, Securities Act Release No , Exchange Act Release No , 75 Fed. Reg. 59,866 (proposed Sept. 17, 2010) (to be codified at 17 C.F.R. pts. 229, 249), available at

3 FINANCE, MERGERS, AND ACQUISITIONS 221 ations (MD&A). 4 The interpretive guidance became effective on September 28, Under the proposed amendments, registrants would be required to provide additional disclosure regarding their short-term borrowings, similar to that currently required for bank holding companies under Industry Guide 3. 5 The proposed amendments would apply to annual and quarterly reports, proxy, and information statements that include financial statements, registration statements under the Securities Exchange Act of 1934 (Exchange Act), and registration statements under the Securities Act of 1933 (Securities Act). Form 8-K under the Exchange Act would also be amended to conform to the terminology in the proposed short-term borrowings disclosure requirement. a. Proposed New Short-Term Borrowings Disclosure in MD&A The proposed amendments, if adopted, would require registrants to include in their MD&A a new, separately captioned section that would provide tabular information about their short-term borrowings as well as discussion and analysis. As proposed, Item 303 of Regulation S-K would require registrants to provide tabular disclosure of: the amount in each specified category of short-term borrowings at the end of the reporting period and the weighted average interest rate on those borrowings; the average amount in each specified category of short-term borrowings for the reporting period and the weighted average interest rate on those borrowings; and for registrants meeting the proposed definition of financial company, the maximum daily amount of each specified category of short-term borrowings during the reporting period, and for all other registrants, the maximum month-end amount of each specified category of short-term borrowings during the reporting period. Short-term borrowings categories would include (1) federal funds purchased and securities sold under repurchase agreements, (2) commercial paper, (3) borrowings from banks, (4) borrowings from factors or other financial institutions, and (5) any other short-term borrowings reflected on the registrant s balance sheet. Each category applicable to the types of short-term financing activities a registrant uses must be included, regardless of whether the category is otherwise required to be reported as a separate line item on the registrant s balance sheet, with no minimum quantitative threshold for 4. Commission Guidance on Presentation of Liquidity and Capital Resources Disclosure in Management s Discussion and Analysis, Securities Act Release No , Exchange Act Release No , 75 Fed. Reg. 59,894 (Sept. 17, 2010) (to be codified at 17 C.F.R. pts. 211, 231, 241), available at 5. SEC Industry Guides, available at

4 222 RECENT DEVELOPMENTS 2011 inclusion. Further disaggregation of data by currency, interest rate, or both would be required to the extent necessary to prevent aggregate amounts from being misleading. As noted above, a financial company would have more extensive reporting requirements than a registrant that does not fall within this definition. 6 A registrant that is engaged in both financial and nonfinancial businesses, such as a manufacturing company with a subsidiary that provides financing to its customers, may provide separate short-term borrowings disclosure for its financial and nonfinancial business operations. The proposed amendments, if adopted, would require that each registrant include a narrative discussion of its short-term borrowings arrangements in a manner providing a clear comprehensive description of its liquidity profile, in order to provide context for its short-term borrowings data. This narrative discussion would be required to include: a general description of short-term borrowing arrangements in each category, including any key metrics or other factors that could reduce or impair the registrant s ability to borrow under the arrangements; collateral posting arrangements, if any; and the business purpose of those arrangements; the importance to the registrant of its short-term borrowing arrangements to its liquidity, capital resources, market-risk support, credit-risk support, or other benefits; the reasons for the maximum amount of short-term borrowings for the reporting period, including any nonrecurring transactions or events, use of proceeds, or other contextual information; and the reasons for any material differences between the average short-term borrowings for the reporting period and the period end. This new disclosure is intended to complement, not duplicate, the other MD&A disclosures relating to liquidity and capital resources. These include disclosures in the contractual obligations table, disclosures of off-balance sheet arrangements, and other liquidity and capital resource disclosures. b. Proposed New Reporting Requirements These new requirements would be applicable to annual and quarterly reports as well as registration statements and proxy and information statements that include financial statements. Information in annual reports would be presented for the three most recent fiscal years and for the fourth quarter of the most recent fiscal 6. The proposed amendments broadly define financial company to mean a registrant that is engaged to a significant extent in the business of lending, deposit taking, insurance underwriting, or providing investment advice, or is a broker or dealer as defined in Section 3 of the Exchange Act, and includes without limitation an entity that is itself or the holding company of a bank, savings association, insurance company, broker, dealer, business advisor, futures commission merchant, commodity trading advisor, commodity pool operator, or mortgage real estate investment trust. Short-Term Borrowing Disclosure, 75 Fed. Reg. at 59,871.

5 FINANCE, MERGERS, AND ACQUISITIONS 223 year. Information in quarterly reports would be presented for the relevant quarter in the same level of detail as required for annual periods, but without comparative period data. Registrants would be required to discuss material changes from previously reported disclosures. Registration statements with audited full-year financial statements would be required to include short-term borrowings disclosure for the three most recent fiscal year periods and interim information for any subsequent interim periods. Because foreign private issuers do not file quarterly reports, they would be subject to the proposed disclosure requirements only for their annual report on Form 20-F. Smaller reporting companies would be subject to the proposed requirements with certain exceptions. Specifically, quarterly disclosures would not be required unless material changes occurred during the interim period, and information for the fourth fiscal quarter would not be required in annual reports. In addition, smaller reporting companies would be required to provide only two years, rather than three, of short-term borrowing information in their annual reports. For reporting companies other than bank holding companies, the comparative data requirements for annual reports would be phased in over three years, with disclosure for only the most recent fiscal year required in the first year and for the two most recent fiscal years required in the second. However, registrants would be allowed to include voluntarily the full three years of comparative data in their annual report during the phase-in period. Because comparative data from prior years is not required for quarterly reports, there is no phase-in for this requirement. i. Proposed Leverage Ratio Requirement The SEC is also considering the imposition of a leverage ratio disclosure requirement on companies that are not bank holding companies. Although it contains no specific proposal, the SEC release solicits comments regarding the types of ratios to require and how such a requirement would account for the differences among metrics and industries while still providing comparability. ii. Proposed Form 8-K Amendments Form 8-K would be amended in order to make consistent the current definition of direct financial obligation under Items 2.03 and 2.04 of Form 8-K with the new proposed definition of short-term borrowings. 7 However, the existing carveout in the definition of direct financial obligation for obligations that arise in the ordinary course of business would be retained to maintain the form s focus on disclosure of nonroutine transactions only. c. SEC Interpretive Guidance In conjunction with the proposed amendments, the SEC also issued interpretive guidance on the presentation of the liquidity, leverage ratios, and contractual obligations disclosures in MD&A. This guidance sets forth the SEC s position under its rules as they currently exist and became effective immediately 7. Form 8-K, available at

6 224 RECENT DEVELOPMENTS 2011 upon publication in the Federal Register. The guidance supplements the SEC s prior MD&A interpretive guidance, which remains in effect and is applicable to Form 10-K and Form 10-Q reports, as well as to registration statements that contain MD&A disclosure. Item 303(a) of Regulation S-K requires disclosures of known trends, demands, commitments, events, or uncertainties that will, or are reasonably likely to, result in the registrant s liquidity increasing or decreasing in any material way. The interpretive release identifies difficulties accessing the debt markets, reliance on commercial paper or other short-term financing arrangements, maturity mismatches between borrowing sources and the assets funded by those sources, changes in terms requested by counterparties, changes in the valuation of collateral, and counterparty risk as examples of important trends or uncertainties impacting liquidity that could require disclosure in MD&A. The interpretive release states that additional narrative disclosure could be required in MD&A if financial statements do not adequately convey financing arrangements during the period covered or the effect of financing arrangements on liquidity. For example, if borrowings during the reporting period are materially different than the period-end amounts recorded in the financial statements, disclosure about the intra-period variations is required under current rules to facilitate investor understanding of the registrant s liquidity position. 8 The existing MD&A disclosure requirements contain no specific references into off-balance sheet arrangements, or contractual obligations to repurchase transactions that are accounted for as sales, or to any other transfers of financial assets that are accounted for as sales. The interpretive release states that these arrangements are nevertheless subject to MD&A disclosure requirements. The relevant inquiry is whether the transaction is reasonably likely to result in the use of a material amount of cash or other liquid assets. 9 These transactions may need to be disclosed in the discussion of liquidity and capital resources, especially if the information is not contained in the registrant s off-balance sheet discussion or contractual obligations table. The SEC permits the registrant to determine what section of MD&A is most appropriate for such disclosure. The interpretive release notes that cash management and risk management policies that are relevant to an assessment of financial condition may need to be described in MD&A to provide context for identified exposures. If cash and other investments provide a material source of liquidity for a company, the issuer should consider providing information about the nature and composition of that portfolio, including a description of the assets held and any related market risk, settlement risk or other risk exposure, including limits or restrictions and their effect on the company s ability to use or to access those assets to fund its business operations Commission Guidance, 75 Fed. Reg. at 59, Id. 10. Id.

7 FINANCE, MERGERS, AND ACQUISITIONS 225 i. Leverage Ratios The interpretive release reminds registrants disclosing capital or leverage ratios for which there is no method of calculation prescribed by regulation, or for which a modified methodology is being used, that they need to determine whether any such ratio is a financial measure. If the ratio is a financial measure, the company must determine if it is a non-gaap financial measure. If the ratio is not a financial measure, the registrant must apply the SEC s 2003 guidance for disclosures relating to nonfinancial measures. 11 If a ratio is being presented in connection with debt instruments, guarantees, and related covenants, the registrant must follow the SEC s past guidance on that topic. The interpretive release specifies that when a ratio or measure is included in a filing, MD&A must contain a clear explanation of the calculation methodology. Unusual, infrequent, nonrecurring, or adjusted inputs must be described. If the financial measure differs from industry practice, it may be necessary for the registrant to discuss the differences so that the presentation is not misleading. The registrant should also clearly state why such financial measure is useful to understanding its financial condition. ii. Contractual Obligations Table The interpretive release provides that the contractual obligations table required by Item 303(a)(5) of Regulation S-K should be presented in a way that reflects categories of obligations that are meaningful in light of a company s capital structure and business. The SEC has not issued general guidance regarding treatment of specific items. Rather, the SEC allows each registrant to assess how best to present the contractual obligation information that is relevant to its business. The interpretive release recommends footnotes to provide information necessary for an understanding of the timing and amount of specified contractual obligations, as well as additional narrative disclosure to promote understanding of the data contained in the contractual obligations table. 3. SEC Increases Disclosure Requirements for Municipal Securities On May 27, 2010, the SEC adopted amendments to Rule 15c2-12 under the Exchange Act. In SEC Release No A (adopting release), the SEC also provided additional interpretive guidance with respect to underwriters responsibilities to holders of municipal securities. Issuers of municipal securities and other obligated persons 12 are required to comply with the new rules as of December 1, 11. Conditions for Use of Non-GAAP Financial Measures, Securities Act Release No , Exchange Act Release No , 68 Fed. Reg. 4,820 (Jan. 30, 2003), available at access.gpo.gov/2003/pdf/ pdf. 12. Obligated person means any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund, or account of such person committed by contract or other arrangement to support payment of all or part of the obligations on the municipal securities to be sold in the offering (other than providers of municipal bond insurance, letters of credit, or other liquidity facilities). 17 C.F.R c2-12(f)(10).

8 226 RECENT DEVELOPMENTS (compliance date). The amendments affect only primary offerings 13 of municipal securities on or after the compliance date. The amendments are intended to improve continuing disclosure requirements for municipal securities to enable investors to make more informed decisions. a. Disclosure Requirements Rule 15c2-12 requires underwriters participating in primary offerings of municipal securities of $1,000,000 or more to furnish investors, upon request, with copies of an official statement prepared in connection with the offering. Further, an underwriter in a primary offering must reasonably determine before purchasing or selling municipal securities that issuers and other obligated persons have contractually undertaken in writing to provide continuing disclosure information to the Municipal Securities Rulemaking Board (MSRB), subject to certain exemptions. This continuing disclosure requirement includes annual financial statements, certain operating data with respect to an issuer or obligated person, notices of material events, and notices of failure to comply with the written undertaking discussed above. b. Amendments to the Rule i. Variable Rate Demand Obligations Subject to Continuing Disclosure Requirements Prior to the amendments, Rule 15c2-12 afforded limited exemption to certain types of municipal securities, including certain variable rate demand obligations (VRDNs), which are long-term securities that bear interest at short-term interest rates because they may be tendered for redemption or purchase. 14 As a result of this exemption, issuers and other obligated persons were not required to furnish annual financial information or file notices of the listed events with the MSRB. The amendments eliminate this exemption and require participating underwriters to reasonably determine that issuers of VRDNs, or other obligated persons, have agreed in a written contract to provide continuing disclosure documents and event notices to the MSRB. The amendments apply to all primary offerings of VRDNs, as well as any remarketing of such securities that constitutes a primary offering within the meaning of Rule 15c2-12. The SEC emphasized that the changes are justified given the substantial growth and other developments in the market for 13. Primary offering means an offering of municipal securities directly or indirectly by or on behalf of an issuer of such securities, including any remarketing of municipal securities (1) that is accompanied by a change in the authorized denomination of such securities from $100,000 or more to less than $100,000 or (2) that is accompanied by a change in the period during which such securities may be tendered to an issuer of such securities or its designated agent for redemption or purchase from a period of nine months or less to a period of more than nine months. 17 C.F.R c2-12(f)(7). 14. Specifically, Rule 15c2-12 provided that a primary offering of municipal securities in authorized denominations of $100,000 or more were exempted from the notice requirements of the Rule if such securities, at the option of the holder thereof, may be tendered to the issuer of such securities or its designated agent for redemption or purchase at par value or more at least as frequently as every nine months until maturity, earlier redemption, or purchase by such issuer or its designated agent. 17 C.F.R c2-12(d) (2010).

9 FINANCE, MERGERS, AND ACQUISITIONS 227 VRDNs since Rule 15c2-12 was first promulated in The elimination of this exemption requires issuers of VRDNs or other obligated persons to prepare annual financial information and operating data disclosure for their offerings. The exemption, however, will continue to apply to remarketings of VRDNs that are outstanding on the day preceding the compliance date as long as such securities (1) continue to remain in authorized denominations of $100,000 or more and (2) may, at the option of the holder, be tendered to the issuer of such securities or its designated agent for redemption or purchase at par value or more at least as frequently as every nine months until maturity, earlier redemption, or purchase by the issuer or its designated agent. 15 ii. Additional Events Subject to Disclosure The amendments to the Rule expand the list of events relating to a municipal security that issuers or other obligated persons must have agreed to disclose pursuant to a written agreement. The amendments require four additional events to be reported, two of which require disclosure only if material: (1) tender offers; (2) bankruptcy, insolvency, receivership, or similar proceeding regarding an issuer or an obligated person; (3) consummation of a merger, consolidation, or acquisition involving an obligated person or the sale of all, or substantially all, of the assets of the obligated person other than in the ordinary course of business; the entry into a definitive agreement to undertake such an action or the termination of a definitive agreement relating to any such actions, other than pursuant to its terms, if material; and (4) appointment of a successor or additional trustee, or the change of the name of a trustee, if material. iii. Elimination of the Materiality Condition for Certain Events Prior to the amendments, Rule 15c2-12 required, among other things, that issuers of municipal securities or other obligated persons file with the MSRB in a timely manner notices of certain material events. Prior to the amendment, the Rule listed eleven events that needed disclosure, if material. 16 The amendments clarify that six of the eleven are of such great importance to investors that 15. Amendment to Municipal Securities Disclosure, Exchange Act Release No A, 75 Fed. Reg. 33,100, 33,156 (proposed May 27, 2010) (to be codified at 17 C.F.R. pts. 240, 241), available at Prior to the amendments, Rule 15c2-12 required notices to be filed in a timely manner with the MSRB with respect to the following eleven events, if material: (1) principal and interest payment delinquencies; (2) nonpayment related defaults; (3) unscheduled draws on debt service reserves reflecting financial difficulties; (4) unscheduled draws on credit enhancements reflecting financial difficulties; (5) substitution of credit or liquidity providers or their failure to perform; (6) adverse tax opinion or events affecting the tax-exempt status of the security; (7) modifications to the rights of security holders; (8) bond calls; (9) defeasances; (10) release, substitution, or sale of property securing repayment of the securities; and (11) rating changes. 17 C.F.R c2-12(b)(5)(i)(C) (2010).

10 228 RECENT DEVELOPMENTS 2011 information about them should be disclosed automatically in all circumstances. Accordingly, the amendments repeal the materiality qualification for the six events, specifically: (1) principal and interest payment delinquencies with respect to the municipal securities being offered; (2) unscheduled draws on debt service reserves reflecting financial difficulties; (3) unscheduled draws on credit enhancements reflecting financial difficulties; (4) substitution of credit or liquidity providers, or their failure to perform; (5) defeasances; and (6) rating changes. The materiality condition, however, will remain applicable to the following events: (1) nonpayment-related defaults; (2) modifications to rights of security holders; (3) bond calls; and (4) the release, substitution, or sale of property securing repayment of the securities. iv. Disclosure of Certain Tax Events Affecting the Tax Status of Municipal Securities Prior to the amendments, the Rule required issuers and other obligated persons to file a notice in the event of adverse tax opinions or events affecting the taxexempt status of the security, if material. The amendments clarify that certain tax events are of such significance to investors that issuers or other obligated persons should submit notices regarding such events without a materiality determination. The amendments require that participating underwriters reasonably determine that issuers or other obligated persons have undertaken in a written agreement to disclose any adverse tax opinions, the issuance by the Internal Revenue Service of proposed or final determinations of taxability, Notices of Proposed Issue (IRS Form 5701-TEB) or other material notices or determinations with respect to the tax status of the security, or other material events affecting the tax status of the security. v. Establishment of a Filing Deadline for Notices Prior to the amendments, Rule 15c2-12 required notices of the listed events be filed simply in a timely manner, without designating a specific filing deadline. The amendments provide clarity by requiring that event notices be filed not more than ten business days after the occurrence of the event. c. Additional Interpretative Guidance on Obligations of Underwriters The SEC has previously provided interpretative guidance relating to underwriters obligations under the antifraud provisions of the federal securities laws, particularly when making a determination as to whether there is a reasonable basis to recommend municipal securities to investors in an offering. In the adopting release, the SEC reaffirmed its previous interpretations and provided additional

11 FINANCE, MERGERS, AND ACQUISITIONS 229 guidance on underwriters obligations and duties to investors. The SEC emphasized that an underwriter in a municipal offering should carefully evaluate the likelihood that an issuer or other obligated person will comply with continuing disclosure obligations. At a minimum, underwriters should review the issuer s or obligated person s disclosure documents in a professional manner for possible inaccuracies and omissions and should use independent judgment in assessing the accuracy or completeness of the issuer s or obligated person s continuing disclosure representations. 17 In particular, the SEC staff emphasized that an underwriter should request the filing history of the issuer or other obligated person and consider any evidence suggesting that it has a history of persistent and material breaches of its disclosure obligations or has not remedied past failures prior to commencement of the offering. 4. Repeal of Rule 436(g): SEC Staff Provides Guidance and No-Action Relief Regarding Inclusion of Credit Ratings in Offering Materials On June 21, 2010, the president signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. A handful of provisions of the Act became effective June 22, 2010, including the Act s repeal of Rule 436(g) under the Securities Act. 18 Rule 436(g) exempted nationally recognized statistical rating organizations (NRSROs), such as Moody s Investors Service, Standard & Poor s Ratings Services, and Fitch Ratings, from being considered experts in the event their ratings were included in a Securities Act registration statement or prospectus. Under the Securities Act, the written consent of an expert (which includes any person who is named in the registration statement or prospectus as having prepared or certified a portion of the registration statement or prospectus) must be filed with the SEC. 19 The consenting expert is subject to enhanced liability for the prepared or certified portion of the registration statement or prospectus. 20 Moody s, S&P, and Fitch have announced that, given the potential for additional liability, they are currently unwilling to consent to the use of their ratings 17. When evaluating the reasonableness of an underwriter s basis for assessing the accuracy and truthfulness of representations in final official statements, the Commission reiterated that the following nonexclusive list of factors should be considered: (1) the extent to which the underwriter relied upon municipal officials, employees, experts, and other persons whose duties have given them knowledge of particular facts; (2) the role of the underwriter (manager, syndicate member, or selected dealer); (3) the type of bonds being offered (general obligation, revenue, or private activity); (4) the past familiarity of the underwriter with the issuer; (5) the length of time to maturity of the bonds; and (6) whether the bonds are competitively bid or are distributed in a negotiated offering. Amendment to Municipal Securities Disclosure, 75 Fed. Reg. at 33, Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No , 939(G), 124 Stat (2010) U.S.C. 77g(a) U.S.C. 77k.

12 230 RECENT DEVELOPMENTS 2011 in registration statements. 21 Despite this position, the fixed income markets rely heavily on NRSRO credit ratings, as evidenced by the following: Issuers of debt securities typically include NRSRO s credit ratings in term sheets and press releases relating to securities offerings; Corporate debt issuers commonly discuss NRSRO credit ratings in periodic reports, which are incorporated by reference into their Securities Act registration statements and prospectuses; Underwriters of debt securities use so-called Bloomberg screens containing NRSRO credit ratings to convey final pricing terms to purchasers; and Purchasers of debt securities typically base their investment guidelines on NRSRO credit ratings. The asset-backed securities markets rely on NRSRO credit ratings to an even greater extent. These transactions are typically structured to create multiple tranches of asset-backed securities, each having a specified credit rating from one or more NRSROs. In addition, pursuant to Items 1103(a)(9) and 1120 of Regulation AB, if an NRSRO credit rating is a condition of the offering of any class of the asset-backed securities, the identity of the NRSRO and the credit rating must be disclosed in the registration statement and prospectus. 22 The repeal of Rule 436(g) and refusal of major NRSROs to consent to the inclusion of their ratings in registration statements and prospectuses threatened to significantly disrupt the fixed income markets. In response, the staff of the SEC Division of Corporation Finance on July 22, 2010, issued five compliance and disclosure interpretations 23 regarding issuers that are not subject to Regulation AB disclosure requirements (i.e., corporate debt issuers). a. Corporate Debt Issuers In its compliance and disclosure interpretations, the SEC staff confirmed that corporate debt issuers would generally need to obtain and file the written consent of a credit rating agency if information about the agency s credit ratings is included in, or incorporated by reference into, any such issuer s registration statement, prospectus, or prospectus supplement that is first filed with the SEC on or after July 22, b. Free Writing Prospectuses and Press Releases The SEC staff also confirmed that consents are required only with respect to credit rating information contained in Securities Act registration statements and Section 10(a) prospectuses. Credit rating information in free writing prospectuses 21. See Anusha Shrivastava, Bond Sale? Don t Quote Us, Request Credit Firms, WALL ST. J., July 21, 2010, available at See 17 C.F.R (a)(9), SEC Staff Compliance and Disclosure Interpretations, available at corpfin/guidance/securitiesactrules-interps.htm. 24. Id.

13 FINANCE, MERGERS, AND ACQUISITIONS 231 filed pursuant to Rule 433 and in term sheets or press releases that comply with Rule 134 do not trigger the consent requirements described above. 25 c. Issuer Disclosure-Related Ratings Information The staff stated that an issuer would not need the consent of a credit rating agency for disclosure of credit ratings in a filing with the SEC that is related only to: changes in a credit rating, for example, in a risk factor disclosure regarding the issuer s creditworthiness; the liquidity of the registrant, such as in the issuer s management s discussion and analysis of financial condition and results of operations; the cost of funds for a registrant; or the terms of agreements that refer to credit ratings, for example, in descriptions of debt covenants, interest, or dividends that are tied to credit ratings and potential support to variable interest entities (issuer disclosure-related ratings information). 26 d. Grandfathered Information To the extent an issuer has included or incorporated by reference credit ratings information in a registration statement on Form S-3 or Form F-3 that was declared effective prior to July 22, 2010, the staff will not object to reliance on Rule 401(a) to allow continued use of the registration statement without filing a consent of the credit rating agency, provided that: 27 issuers rely on Rule 401(a) for this purpose only until the filing of the next post-effective amendment to such registration statement. This includes the filing of the issuer s next annual report on Form 10-K, 20-F, or 40-F, which is deemed to be a post-effective amendment for the purposes of Section 10(a)(3); and no subsequently incorporated periodic or current report contains ratings information that is not limited to issuer disclosure-related ratings information. C. ANNOUNCED TRANSACTIONS The pace of consolidation in the electric utility industry increased in the past year, as evidenced by a number of announced mergers of large electric utilities. These mergers are described below. 25. Id. 26. Id. 27. Rule 401(a) under the Securities Act states: The form and contents of a registration statement and prospectus shall conform to the applicable rules and forms as in effect on the initial filing date of such registration statement and prospectus. 17 C.F.R (a).

14 232 RECENT DEVELOPMENTS Duke Energy Corp. and Progress Energy Inc. Announce Merger Agreement 28 On January 10, 2011, Duke Energy Corp. and Progress Energy, Inc. announced that the boards of directors of both companies unanimously approved a definitive merger agreement to combine the two companies in a stock-for-stock transaction. The merger will create the largest U.S. utility with a total enterprise value of approximately $65 billion. The combined company, which will be called Duke Energy, will be headquartered in Charlotte but maintain substantial operations in Raleigh. Under the terms of the agreement, Progress Energy s shareholders will receive shares of common stock from Duke Energy in exchange for each share of Progress Energy common stock. Based on Duke Energy s closing share price on January 7, 2011, Progress Energy shareholders would receive a value of $46.48 per share, or $13.7 billion in total equity value. Duke Energy will also assume approximately $12.2 billion in Progress Energy debt. Following the completion of the merger, officials anticipate Duke Energy shareholders will own approximately 63 percent of the combined company, and Progress Energy shareholders will own approximately 37 percent on a diluted basis. Based on Duke Energy s quarterly cash dividend of 24.5 cents per common share as of the date of announcement, Progress Energy shareholders would receive a dividend increase of approximately 3 percent. Duke Energy expects to affect a reverse stock split immediately prior to closing; the exchange ratio will be appropriately adjusted at that time to reflect the reverse split. According to the press release announcing the merger, the combined company will have the country s largest regulated customer base, providing service to approximately 7.1 million electric customers in six regulated service territories in North Carolina, South Carolina, Florida, Indiana, Kentucky, and Ohio. The combined company will have approximately 57 gigawatts of domestic generating capacity from a diversified mix of coal, nuclear, natural gas, oil, and renewable resources. When the merger is completed, Duke Energy s chief executive James F. Rogers will become executive chairman of the new organization. In this role, Rogers will advise the CEO on strategic matters, play an active role in government relations, and serve as the company s lead spokesman on energy policy. William D. Johnson, the current chief executive of Progress Energy, Inc., will become president CEO. Both Rogers and Johnson will serve on the board of directors of the new company, which will be composed of eighteen members, with eleven designated by Duke Energy s board of directors and seven by Progress Energy s board of directors. The companies are targeting a closing by the end of Completion of the merger is conditioned upon, among other things, the approval of shareholders 28. Press Release, Duke Energy Corp. (Jan. 10, 2011), available at news/releases/ asp.

15 FINANCE, MERGERS, AND ACQUISITIONS 233 of both companies. The waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 has expired. Other necessary regulatory approvals must be obtained from the Federal Energy Regulatory Commission (FERC), Nuclear Regulatory Commission, Kentucky Public Service Commission, North Carolina Utilities Commission, and South Carolina Public Service Commission. The companies will also provide information regarding the merger to their other state regulators, which include the Florida Public Service Commission, Indiana Utility Regulatory Commission, and Ohio Public Utilities Commission. 2. Northeast Utilities and NSTAR Announce Merger Agreement 29 On October 18, 2010, Northeast Utilities (NU) and NSTAR announced that the boards of trustees of both companies unanimously approved a definitive merger agreement that will create a utility with a total enterprise value of approximately $17.5 million. The combined company will be known as Northeast Utilities. Under the terms of the agreement, NSTAR shareholders would receive shares of Northeast Utilities common stock for each NSTAR share with a total equity value of approximately $9.5 billion. The exchange ratio reflects a no premium merger based on the average closing share price of each company for the twenty trading days preceding the announcement. Following completion of the merger, it is anticipated that Northeast Utilities shareholders would own approximately 56 percent, and NSTAR shareholders would own approximately 44 percent of the combined company. The agreement provides that Northeast Utilities dividend per share would be increased to a rate that is equivalent to NSTAR s dividend per share on an exchange ratio-adjusted basis. According to the press release announcing the merger, the newly combined company will operate six regulated electric and gas utilities spanning three states with almost 3.5 million electric and gas customers. The combined Northeast Utilities will have almost 4,500 miles of electric transmission lines, 72,000 miles of electric distribution lines, and 6,000 miles of gas distribution lines. The companies assured customers that the merger will allow them to combine their resources to improve service quality and that customers will not experience any merger-related rate changes. The two companies currently plan to invest $9 billion in New England s energy infrastructure during the next five years. Northeast Utilities will have dual headquarters in Hartford, Connecticut, and Boston, Massachusetts. Charles W. Shivery will become the non-executive chairman of Northeast Utilities for eighteen months. Thomas J. May, current chairman, president, and CEO of NSTAR will become president and CEO of Northeast Utilities. After eighteen months, May will assume the additional role of chairman. The new board will be made up of fourteen trustees from the two original companies, with seven members nominated by the NU board and seven by the NSTAR board. The NU board will nominate the lead trustee. 29. Press Release, Northeast Utilities (Oct. 18, 2010), available at news_netscape.asp.

16 234 RECENT DEVELOPMENTS 2011 Northeast Utilities and NSTAR stated in their press release that they expect to obtain required regulatory approvals in nine to twelve months. The merger has been approved by the shareholders of each company; the waiting period under Hart-Scott-Rodino has expired; and applications to the Massachusetts Department of Public Utilities, FERC, and the Nuclear Regulatory Commission are pending. Review by the Federal Communications Commission was completed without objection. Review by the Maine Public Utilities Commission is pending. A hearing has been held to determine if the Connecticut Department of Public Utility Control has jurisdiction to review the merger. 3. PPL Corp. Acquires Central Networks UK On March 1, 2011, PPL Corp. announced that it had reached a definitive agreement to acquire the Central Networks electric distribution business from E.ON. UK for approximately $5.6 billion. Central Networks electric distribution business, which is located in central England, is the second largest in the United Kingdom. The companies closed the transaction on April 1, No regulatory or shareholder approvals were necessary for the transaction. 31 PPL paid $5.7 billion in cash to Central Networks and assumed $800 million of debt. PPL initially funded the acquisition with drawings under a committed bridge loan facility. Permanent financing was completed in the second quarter of 2011 in two parts. On April 15, 2011, PPL issued 92 million shares of its common stock at a public offering price of $25.30 per share, including 12 million additional shares purchased by the underwriters to cover overallotments. 32 PPL also issued a total of million equity units each with a stated amount of $50 for an aggregate amount of $977.5 million, including $2.55 million additional equity units purchased by the underwriters to cover overallotments. 33 On May 17, 2011, WPD East Midlands and WPD West Midlands, the acquired companies, together issued 1.4 billion of corporate bonds. 34 The issue comprised 600 million of WPD East Midlands 5.25 percent notes due 2023 and 800 million of WPD West Midlands 5.75 percent notes due The net proceeds of the April 15 and May 17 offerings were used to repay the outstanding indebtedness under the bridge loan facility, which PPL fully repaid on May According to a press release issued by PPL, Central Networks regulated distribution operations serve five million customers in the Midlands area of England and are conducted through Central Networks East plc and Central Networks West plc. PPL also owns Western Power Distribution (WPD), which provides regulated 30. Press Release, PPL Corp. (Apr. 1, 2011), available at index.php?s=12270&item= Press Release, PPL Corp. (Mar. 1, 2011), available at index.php?s=12270&item= Press Release, PPL Corp. (Apr. 15, 2011), available at index.php?s=12270&item= Id. 34. Press Release, PPL Corp. (May 17, 2011), available at index.php?s=12270&item= PPL Corp., Current Report (Form 8-K) (May 20, 2011), available at Archives/edgar/data/922224/ /form8-k.htm.

17 FINANCE, MERGERS, AND ACQUISITIONS 235 distribution services to 2.5 million customers in England and Wales through WPD South West and WPD South Wales. The WPD and Central Networks service territories are contiguous, and PPL expects significant synergies from the combined operations. 36 After completing the acquisition, PPL owns and operates the largest network of electricity delivery companies in the United Kingdom in terms of regulated asset value, at a combined value of $7.8 billion. PPL companies are providing regulated utility services to more than ten million customers in England, Wales, Pennsylvania, Kentucky, Virginia, and Tennessee AES Corp. and DPL Inc. Announce Merger Agreement 38 On April 20, 2011, AES Corp. and DPL Inc. announced that they entered into a definitive merger agreement under which AES will acquire DPL in a transaction with an enterprise value of $4.7 billion, including a total equity value of $3.5 billion. The board of directors of both DPL and AES have unanimously approved the agreement. 39 Under the terms of the agreement, AES will acquire all of DPL s outstanding common shares for approximately $3.5 billion in cash. Upon completion of the transaction, DPL s common stock will no longer be traded publicly, and each outstanding share will be converted into the right to receive cash in the amount of $30 per share without interest. AES will also assume $1.2 billion of debt in the merger. 40 AES will not buy DPL s preferred shares, and DPL will continue to pay preferred share dividends. The companies announced that the merger will not affect DPL s pension plan, and DPL s workforce will remain intact through DPL s corporate contributions and community support will continue at current levels for at least two years. 41 Following this merger, DPL will become a wholly owned subsidiary of AES. However, the transaction documents contain provisions that allow DPL s subsidiary, Dayton Power and Light Co., to maintain its name and remain headquartered in Dayton for at least two years after the merger. 42 The transaction is expected to close in the next six to nine months, subject to approval by DPL s shareholders and the receipt of certain regulatory approvals, including those from FERC and the Public Utilities Commission of Ohio, and antitrust review under Hart-Scott-Rodino Press Release, PPL Corp. (Mar. 1, 2011), available at index.php?s=12270&item= Press Release, PPL Corp. (Apr. 1, 2011), available at index.php?s=12270&item= Press Release, AES Corp. (Apr. 20, 2011), available at Press Release, DPL Inc. (Apr. 20, 2011), available at Press Release, AES Corp., supra note Press Release, DPL Inc., supra note Press Release, AES Corp., supra note Id.