Is the Rule 415 Issue Still Relevant? (hint: yes)
Some are wondering if the new Rule 144 proposals, in particular shortening the holding period before being able to sell without registration in most cases to six months, essentially moot the entire Rule 415 brouhaha. The short answer: well yes and no.
There is no question that shortening the Rule 144 holding period will meaningfully ameliorate the risk undertaken by PIPE investors under the SEC's new interpretation of Rule 415. As we recall, the SEC has sought to limit the percentage of a company's public float that can be registered for resale at one time if a company has less than a $75 million market capitalization and is not eligible for short-form S-3 registration for resale. PIPE investors, who initially purchase restricted securities, depend on this resale registration to get their shares to be tradable. Under the new interpretation, if they purchase greater than 30% of the company's public float, they have to wait 6 months from the time they sell substantially all the shares under the first registration before being allowed to do another. Assuming this may be a significant time period, in order to sell any shares that have not been registered, an exemption from registration, such as Rule 144, has to apply. The SEC staff believes that if one is seeking to register a large number of shares in a resale registration, it is probably a "hidden" primary offering that should have been done on a form, and under restrictions, that apply to a primary (such as a public offering undertaken by a company).
In its application, we have seen the SEC be firm on the 30% rule in many cases, but much more flexible in others. In particular, we are seeing them permit companies to go well beyond the 30% in many post-reverse merger situations. The SEC staff indicated, when announcing their new 30% standard back in January, that they acknowledge that there is typically very limited float following a reverse merger, and thus they would try to allow a reasonable number of shares to trade. True to their word, we have seen situations where as much as 50% of the company's outstanding stock, not just float, has been allowed to be registered for resale following a reverse merger.
So assume you can register some shares in a PIPE following a reverse merger (or any PIPE for that matter), and that takes about 3-4 months. If you know that the balance of the shares will be freely tradable without restriction (assuming the investor is not an affiliate and the company remains current in its SEC filings for up to a year) just 2-3 months later, wouldn't that eliminate the issue? To a large extent yes.
But there are other issues. Here are some:
1. In the past the ability to register all the shares issued in an investment within 3-4 months (sometimes less) has been an attractive feature of PIPEs. Even an additional 2-3 months is a long time for some investors, and it likely still will have an impact on PIPE pricing and the amount of discount to the public trading price (or expected trading price in a reverse merger scenario) that an investor will request. It may even continue to cause some deals not to happen because the investor simply does not want to wait six months to become unrestricted.
2. If the investor has more than 20% of the stock he might be presumed to be an affiliate. In that case, even under the new Rule 144 proposal, that investor would be limited in his ability to sell in many cases to 1% of the outstanding stock each 90 days for as long as he remains an affiliate.
3. Then there is the problem of warrants, a popular feature of PIPE investments. If one has a 3-year warrant issued at the time of a PIPE investment, the Rule 144 holding period (even if reduced to six months) does not begin until the warrant is exercised for cash. Thus, if a year or so has passed since the issuance of the warrant, when the investor desires to exercise, he must wait an additional six months (under the proposal) before being able to sell. Prior to the Rule 415 problem, the shares underlying the warrants typically were registered so they could be sold immediately upon exercise. Some warrants have a "cashless" exercise feature that allows an investor essentially to trade "in the money" warrants as the exercise price for other warrants.
As an example, if an investor has 100 warrants to purchase shares at $2.00, and the stock is trading at $4.00, the investor can simply swap 50 of the warrants as the exercise price for the other 50. Cashless exercise warrants have a benefit of "tacking" the holding period of the warrants and stock, so that as long as under the proposal one holds a warrant for six months, then exercises with a cashless feature, the shares could be sold. And thankfully the SEC has included in its Rule 144 proposal clearer guidance that this tacking indeed does apply. However, some investors do not like to have to give up part of their warrants for a cashless exercise. In other cases companies really want the money from the exercise, not the cashless. So cashless exercise may not solve the problem.
As I stated in a recent conference, I believe that while well-intentioned, the staff killed a flea with a sledgehammer in its approach to Rule 415. I also have real questions as to both the legal and policy underpinnings of the interpretation, as I have had to really scratch my head to understand 1) why investors are more protected when a company does a primary offering than when it does a secondary offering and 2) why the mere fact that an investor purchases a larger percentage of a company's stock somehow creates a presumption that they are an underwriter.
I understand Congress may be questioning the SEC commissioners about this in the near future, if they have not already. Indeed, it seems counter to the whole policy shift favoring careful reduction in the regulatory burdens of smaller public companies so magnificently proffered in the SEC's fabulous new rule proposals (see entries below). Maybe, hopefully, now is the time, as the Commission works to help small companies to reduce their costs in complying with regulation and enhance their ability to raise capital, to take another look at 415.
Happy July to all, I hope you are all working on constructive yet thoughtful comments to the SEC proposals.
There is no question that shortening the Rule 144 holding period will meaningfully ameliorate the risk undertaken by PIPE investors under the SEC's new interpretation of Rule 415. As we recall, the SEC has sought to limit the percentage of a company's public float that can be registered for resale at one time if a company has less than a $75 million market capitalization and is not eligible for short-form S-3 registration for resale. PIPE investors, who initially purchase restricted securities, depend on this resale registration to get their shares to be tradable. Under the new interpretation, if they purchase greater than 30% of the company's public float, they have to wait 6 months from the time they sell substantially all the shares under the first registration before being allowed to do another. Assuming this may be a significant time period, in order to sell any shares that have not been registered, an exemption from registration, such as Rule 144, has to apply. The SEC staff believes that if one is seeking to register a large number of shares in a resale registration, it is probably a "hidden" primary offering that should have been done on a form, and under restrictions, that apply to a primary (such as a public offering undertaken by a company).
In its application, we have seen the SEC be firm on the 30% rule in many cases, but much more flexible in others. In particular, we are seeing them permit companies to go well beyond the 30% in many post-reverse merger situations. The SEC staff indicated, when announcing their new 30% standard back in January, that they acknowledge that there is typically very limited float following a reverse merger, and thus they would try to allow a reasonable number of shares to trade. True to their word, we have seen situations where as much as 50% of the company's outstanding stock, not just float, has been allowed to be registered for resale following a reverse merger.
So assume you can register some shares in a PIPE following a reverse merger (or any PIPE for that matter), and that takes about 3-4 months. If you know that the balance of the shares will be freely tradable without restriction (assuming the investor is not an affiliate and the company remains current in its SEC filings for up to a year) just 2-3 months later, wouldn't that eliminate the issue? To a large extent yes.
But there are other issues. Here are some:
1. In the past the ability to register all the shares issued in an investment within 3-4 months (sometimes less) has been an attractive feature of PIPEs. Even an additional 2-3 months is a long time for some investors, and it likely still will have an impact on PIPE pricing and the amount of discount to the public trading price (or expected trading price in a reverse merger scenario) that an investor will request. It may even continue to cause some deals not to happen because the investor simply does not want to wait six months to become unrestricted.
2. If the investor has more than 20% of the stock he might be presumed to be an affiliate. In that case, even under the new Rule 144 proposal, that investor would be limited in his ability to sell in many cases to 1% of the outstanding stock each 90 days for as long as he remains an affiliate.
3. Then there is the problem of warrants, a popular feature of PIPE investments. If one has a 3-year warrant issued at the time of a PIPE investment, the Rule 144 holding period (even if reduced to six months) does not begin until the warrant is exercised for cash. Thus, if a year or so has passed since the issuance of the warrant, when the investor desires to exercise, he must wait an additional six months (under the proposal) before being able to sell. Prior to the Rule 415 problem, the shares underlying the warrants typically were registered so they could be sold immediately upon exercise. Some warrants have a "cashless" exercise feature that allows an investor essentially to trade "in the money" warrants as the exercise price for other warrants.
As an example, if an investor has 100 warrants to purchase shares at $2.00, and the stock is trading at $4.00, the investor can simply swap 50 of the warrants as the exercise price for the other 50. Cashless exercise warrants have a benefit of "tacking" the holding period of the warrants and stock, so that as long as under the proposal one holds a warrant for six months, then exercises with a cashless feature, the shares could be sold. And thankfully the SEC has included in its Rule 144 proposal clearer guidance that this tacking indeed does apply. However, some investors do not like to have to give up part of their warrants for a cashless exercise. In other cases companies really want the money from the exercise, not the cashless. So cashless exercise may not solve the problem.
As I stated in a recent conference, I believe that while well-intentioned, the staff killed a flea with a sledgehammer in its approach to Rule 415. I also have real questions as to both the legal and policy underpinnings of the interpretation, as I have had to really scratch my head to understand 1) why investors are more protected when a company does a primary offering than when it does a secondary offering and 2) why the mere fact that an investor purchases a larger percentage of a company's stock somehow creates a presumption that they are an underwriter.
I understand Congress may be questioning the SEC commissioners about this in the near future, if they have not already. Indeed, it seems counter to the whole policy shift favoring careful reduction in the regulatory burdens of smaller public companies so magnificently proffered in the SEC's fabulous new rule proposals (see entries below). Maybe, hopefully, now is the time, as the Commission works to help small companies to reduce their costs in complying with regulation and enhance their ability to raise capital, to take another look at 415.
Happy July to all, I hope you are all working on constructive yet thoughtful comments to the SEC proposals.
posted by David N. Feldman at
7/01/2007 09:21:00 AM
5 Comments:
Any word on 144k being reduced to six months for non-affiliates? Or do you think it will be halved to a year? Thanks again for your informative blog.
Well, technically the proposal makes 144(k) one year. However, it's even better than that. It proposes that nonaffiliates can sell, without volume limitations of any kind, starting in six months, so long as the company stays current in its filings until one year. After one year, you can sell without limits even if the company is not current. These periods are longer for non-reporting companies by the way.
But would OTCBB Pinksheets give a ticker symbol to a company that filed a Form 10 six months after a private placement? That is, say you had the requisite number of sharholders and public float (400,000-500,000), but the non-affiliates had only held for six months. Would those non-affiliate, six month-old shares be considered "freely trading" for the purposes of submitting a 15c-211, or would OTCBB/Pinksheets want those shares to be truly free, i.e. available for resale under 144k? Either way the new rules are an improvement as you used to have to wait two years under the old interpretation of 144K to have shares be considered "free."
Technically the shares would still be restricted from six months to one year as the company must remain current in its filings for 144 to be available until you hit one year. But as long as the company is current you'd be able to sell following six months with no volume restrictions.
There are reportedly a couple of new troubling comment letters from the SEC relating to Rule 415 that have the potential of adversely affecting reverse merger/PIPE transactions again. Could you briefly explain what they are and their expected impact?
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