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.

Why Listen to Me? S-4 May Work After All

So.....we have done further research following our initial view that S-4 may not be an appropriate form to register shares to be issued in a reverse merger as a primary registration and method possibly to avoid the 415 concerns on a resale under certain circumstances.

Sometimes, well you just don't need to see the sausage getting made. In any event, we now believe that S-4 may indeed be an appropriate form (along with S-1 as also mentioned). We are waiting for some to give it a shot and see what happens. I expect that will happen pretty soon, as a number of my lawyer friends are talking about it.

Why did we have a different impression? Some had suggested the existence of a telephone interpretation which did not allow the resale of shares registered in an S-4 unless a resale registration was filed; this of course would trigger the 415 issue again. As it turns out, the telephone interpretation in question does not deal with this issue. It merely says you can't use S-4 to register already issued shares for resale. Thus, it does not apply to our hope to use S-4 for a primary registration of shares to be issued in a merger.

This is why I end of these legal discussions with "this is not legal advice"!

So how to do a primary offering and avoid 415?

As we have researched the matter further and consulted with experts, and while none of this constitutes legal advice (consult your lawyer, hopefully me!), here are some additional thoughts on turning secondary offerings into primary offerings so as to lawfully avoid the limitations on the number of shares to be registered under the SEC's new Rule 415 interpretation:

1. S-4 Probably Doesn't Work: It appears that S-4, while registering shares to be issued in a reverse merger and thus making their initial issuance valid, does not make the shares publicly tradeable in a resale. Thus a follow-on resale registration is required, and this is subject to all the 415 problems.

2. S-1 May Work: Two reverse merger scenarios are possible.

(a) In the first, a merger agreement is signed, the private company then completes a PIPE investment into it, then an S-1 is filed to register the shares to be issued in the merger pursuant to the merger agreement, including shares to be issued to the PIPE investor when he converts his shares of the private company in the merger. S-1 is permitted to be used in this way, and any company, even smaller public companies, may utilize this form. Then all shares, including shares held by affiliates and investors, become freely tradeable upon effectiveness of the S-1 and the completion of the merger. Since it's a primary offering document 415 analysis and limitations do not apply. The challenge here is whether the PIPE investor is willing to invest in the private company, even knowing that the S-1 will be filed immediately after the investment (more and more of our clients are willing to make this investment). If not...

(b) In the second approach, money will not be invested until the merger is completed. In this situation, the S-1 is used with a dual purpose. First, you register the shares to be issued in the merger to the holders of private company shares (excluding the investor for this purpose). Second, you register shares to be issued in a public offering of "pubco" securities which will close on the same day as the merger. It appears, subject to the investors possibly having to declare themselves subject to underwriter liability, these shares could then be issued in essentially a "public PIPE" and become immediately tradeable at the market. And the investor takes no risk of the registration not going through as he does not invest until it is effective. Of course here the company must wait until the registration is complete before raising money. A bridge financing prior to filing the S-1 might help tide the company over while it awaits approval of the S-1.

3. Neither of the scenarios has been tried to my knowledge in a reverse merger context, so it is now a question of time before someone files a registration using one of these approaches to see how the SEC reacts. In the end, however, the SEC hopefully can and should offer ways for practitioners to do exactly as they have asked - use a primary registration to allow a registrant to bypass the problems associated with a secondary registration and limits pursuant to Rule 415.

4. Does the suggested S-1 approach work any better than a self-filing? The big extra advantage appears to be the ability to register, without limitation, potentially all shares of the company at once. A self-filing, which is typically a resale or secondary offering, will be subject to 415 limitations. If the self-filing is pursuant to a Form 10-SB, any shareholder without an exemption from registration (such as Rule 144) will have to wait until an exemption is available. And almost certainly the new investor will not have such an exemption available.

Did I mention this does not constitute legal advice? Someone try this and let's see!

Preliminary Musings as to the New Rule 415 Regime - Now What?

Here are some initial thoughts and humble suggestions as we all adjust to the “new normal” under 415 (remember our first reactions when Sarbanes-Oxley was passed?). Bottom line: it ain’t the greatest but the sky is indeed not falling and I believe the SEC is not trying to stop these transactions but rather to rein in some excessive players, and we can all adjust.

I apologize in advance for the somewhat lengthy post, but we have been waiting for this for eight months, so I wish to cover a number of implications and a new idea worth considering that can eliminate the issue.

PIPEs Market in General

My partners and others, I am sure, will have much to say about the overall implications of the new 415 interpretations on the PIPE market as a whole, so I will not say much other than that deals for the smallest public companies are probably going to be more difficult to do and more expensive for the issuers. This does not seem likely to quell the strong growing market for PIPE investments in any meaningful way. In fact, through all this tumult over the last eight months the PIPE business in our law firm has only grown busier and stronger, and there is no sign of letting up.

My hope is that the SEC staff concentrates on punishing true bad guys in the market and removes as many restrictions as possible on the legitimate players. While we finally have a new standard, which is good, with deference to those I do respect at the SEC, I believe it went a bit too far and is unnecessarily restrictive as a guard against a few bad apples.

I am also disappointed in their approach to a second registration, and hopefully that will be revisited. To suggest that you can never register more shares until the LATER of six months and the time that substantially all the shares in the first registration are sold seems counter to what the SEC is trying to achieve here (ie effectively saying you can never register more until all the shares are sold from the first registration). It makes much more sense for it to be the EARLIER of these two things.

Reverse Mergers- Virgins Win?

As to reverse mergers, I suppose there is both good and bad news, leading to a conclusion that deals should and will go forward, but with different assumptions and expectations.

The bad news is I had hoped there might be a different clear standard for first registrations following reverse mergers than the standard applied to PIPE investments into already public companies. Since there is essentially no “float” in a post-reverse merged company, limiting registration to any percentage of float is almost meaningless. This will require the first few deals to go through a trial and error process to see what will work. Hopefully within a short time we will have a sense of their attitude and approach.

The good news is, the SEC has acknowledged and recognizes this problem, and on Friday SEC top lawyer David Lynn mentioned the “no float” issue and suggested that they would be more receptive to registering a reasonable number of shares after a reverse merger even where there is no float, following the six-factor test outlined in their old telephone interpretation. I was slightly disappointed that it took a question from the audience for him to address this rather than being part of his prepared remarks.

So what does this mean for shell mergers? Let’s remember the concern that the 415 issue addresses: that individuals with tradeable shares might get substantially diluted by a large resale registration with virtually no notice or disclosure. I have argued to the SEC staff, and they confirmed the logic of the argument, that in a merger with a virgin shell, there are literally no tradeable shares prior to the merger, so this concern simply does not apply at all. Every shareholder, before having tradeable shares, understands what percent of the company will become tradeable. In a trading shell there is more of a concern about diluting the public shareholders of the shell with the registration following the merger.

Thus, I believe that the staff will be more receptive to registering more shares in a registration following a merger with a virgin (ie fully reporting but non-trading) shell than with an already trading shell. Now, there are other perceived advantages to a merger with a trading shell, such as a larger shareholder base and the momentum that an immediate trading market after a merger can provide. But I will leave the rest of the trading vs. non-trading argument for another post.

Some say to me, well you support virgins because you get money from many clients doing it and you have a few yourself. It’s the other way around. I encourage my clients to do it, and also put my own interests into them, because I believe in the value of the vehicle. It is not for every deal but has tremendous benefit and simplicity in many situations. It is, frankly, almost an accident that this new Rule 415 analysis ends up helping the virgin shells, but here we are.

Self-Filings and SPACs Also Win

It appears that a PIPE placed into a private company just before it proceeds with a self-filing of an SB-2 or 10-SB will be more favorably received under 415 than a similar PIPE invested into a shell merger or already public company. This is because the staff is more comfortable that the PIPE has been “completed,” reducing the concern that the investor is an underwriter. This should increase the value of self-filings, so long as PIPE investors are willing to make that large investment in a private company initially (some are prohibited by their fund documents). It appears that the staff will be more willing to register a larger percentage of the stock for resale in this situation.

None of the 415 issue affects SPACs, since their money is raised through a primary offering not subject to Rule 415 analysis. SPACs, which have grown dramatically, face other challenges from the SEC, including long delays in getting proxies approved for deals awaiting shareholder approval. But it appears they will continue apace undaunted, and this is a good thing. Also, smaller SPACs, again with no 415 problem, may develop as an interesting alternative to virgins and trading shells, which will continue to face the problem at some level.

How about a Form S-4 in Reverse Mergers? Might just work..

Another approach worth considering that some have begun talking about is to register shares to be issued in a reverse merger under an S-4 registration statement. There would be no limit on the number of shares registered because S-4 involves a primary offering, not a secondary. The problems are (1) that the SEC has to review and approve your S-4, and a merger registration is notoriously annoying and (2) you have to wait to close your reverse merger while they do, which could be several months. However, an S-4 approach should be quicker than a self-filing, which still may undergo 415 review. With the S-4 route you do need a shell to merge into that would be the subject of the registration, whereas in a self-filing no third party is necessary. So weigh your own pros and cons.

Ideally, if a PIPE investor is willing to invest prior to the S-4, you will have raised your money just the same as in a merger with a virgin shell and subsequent resale registration. In both cases there is no trading until a registration is approved, so where that investment is available there may not be much difference, except that the S-4 has the benefit of allowing you to register without limitation.

This approach would be exactly what the SEC is hoping everyone will do – turn secondaries that seem large into primaries. Might be another nice application for the virgins, and would eliminate the 415 issue in a reverse merger with a trading shell.

Conclusion

In sum, I’m happy that the uncertainty is mostly over in this area. We all wish the standard would have been higher, but at least we now have one. It’s workable for most players, and reverse mergers will continue.

In truth, any investor in a PIPE into a reverse merger who was betting on the importance of having tradeable shares within a few months and then in fact trading those shares, made the wrong bet. Most of our clients who invest in reverse mergers understand that it is “public venture capital” and they need to have a longer-term outlook with respect to liquidity. Thus, in reverse mergers, this is simply less of a major concern in most cases. Since the average market capitalization in reverse mergers has hit about $60 million, it also won’t be long before most become eligible for short-form registration and are exempt from the 415 analysis.

So I guess I don’t have to recall all the copies of my book after all…

Summary of David Lynn's Comments Today on Rule 415

Below is a memo just distributed by my partner Joe Smith, who attended the PIPE conference this morning:

To: Clients and Friends of Feldman Weinstein & Smith LLP

January 26, 2007

I just got back from listening to David Lynn, Chief Counsel of the SEC’s Corporation Finance Department, discuss the Staff’s new interpretation of Rule 415 for non-shelf eligible issuers (below $75 million float).

What you need to know:

• The issuer can register up to one-third of its pre-deal public float at one time.
  
  
• There may be certain situations, however, where companies seeking to register more than 10% of the float on behalf of a particular investor may be restricted from doing so, or other limitations below the 1/3 threshold may be imposed if the staff has other reasons to think an investor is an affiliate (certain covenants in debt deals may create this impression, as will deals where the investor is only registering 1/3 of the float but has purchased substantially more than 1/3).
  
  
• The SEC will consider, on a case-by-case basis, allowing more than 1/3 of the float to be registered. This goes back to the six Telephone Interpretation D.29 factors. They will be MORE inclined to let a larger number of shares be registered if the deal is common stock or a non-resettable fixed price convertible, and if there are a larger number of smaller investors; and LESS inclined with a toxic or resettable deal or a deal with fewer, larger investors.
  
  
• Contrary to some press reports from an SEC conference in San Diego, once the first registration statement is effective, the company can file a follow-on for an additional 1/3 of the pre-deal float the LATER OF 6 months after the effective date of the first registration statement, or 60 days after “substantially all” of the registered securities have been sold. This means that investors may be forced to sell out their position sooner than they would wish to in order for the balance of the deal to get registered. Mr. Lynn acknowledged after questioning from the crowd that this was not their intent, and that they may have to “reconsider” this element.
  
  
• If the company does another deal for another purpose (acquisition rather than working capital) while the first registration is out there and yet not used up, they will not block the second registration. They will be looking for overlapping investors, and the issuer will need to show that the deals are unrelated. Mr. Lynn said that they had nothing against an investor who understands the company re-investing but they are looking for “structured” deals which attempt to hide that the investor is an affiliate. Query how this may impact rights of participation.
  
  
• Shell mergers: they don’t have a special rule, but acknowledged that there is no float, so they will let issuer make its case for a useful number of registrable shares on a case-by-case basis. [Feldman comment: this is a positive thing for reverse mergers.]
  
  
• Equity Lines: no new guidance, assume an equity line can be registered for no more than 1/3 of the float.
  
  
• New disclosure rules, which have been circulated in at least one comment letter, will require that each investor disclose, among other things, how many shares it shorted pre-effectiveness and when.

Rule 415 - You Heard it Here First..well after Dow Jones..

At the San Diego PLI conference, SEC Corporation Finance Deputy Director Shelley Parratt was the first to announce the new internal registration guidelines this evening. The standard will be one-third of the non-affiliate stock, below which you're probably OK, and above which they are very willing to entertain arguments that those seeking to register do not meet the test of being an underwriter. The next registration for the same investors, it appears, must wait for 6 months after the PIPE or, if earlier, 60 days after substantially all the shares are sold in the first registration. I'm sure we'll be hearing lots more in the next few days. Bloomberg News, I know, is covering this extensively. More to come when I have it...

Rule 415 Guidelines - Stick a fork in it...

It's done. As I understand it, the SEC staff has now completed their internal guidelines under Rule 415. I believe Marty Dunn will talk about it today in Chicago, and I understand there will be a meaningful media presence, so hopefully we'll hear something even by tomorrow. Also, David Lynn, as previously indicated, is appearing at the PIPE conference here in New York on Friday morning (my partner Joe Smith is speaking at that conference tomorrow). I am confident he will go into detail at that appearance.

My prediction: some percentage of float (ie nonaffiliate stock), similar to other predictions maybe 30-33%, in most PIPE transactions, but with a facts and circumstances test that can go higher, in particular in reverse merger situations. I do not believe there will be a separate reverse merger rule per se, but rather we will do trial and error on a few deals and get a sense. We already know of one company that finally got approved in recent weeks with almost 50% of the outstanding stock following a reverse merger. I also believe Marty and David will talk about how quickly a second registration can get completed. Stay tuned!

Today's Rule 415 Update

As of midday today, the internal guidance at the SEC has not yet been issued, but it is still anticipated imminently. As mentioned below, the hope is that David Lynn's appearance on January 25 at a PIPE conference in NY will provide information. Also, Deputy Director of Corporation Finance Marty Dunn is speaking at Northwestern University Law School's conference on securities law, which runs Jan 24-26. I expect to get reports from that appearance as well. I'll hold off on further blogging on this topic untiil there's some news.

Very soon I hope this will cease to be the "415 blog" and move back to its original purpose!

Top SEC Lawyer to Speak on Rule 415; Other Stuff

David Lynn to Speak: At the PIPE conference in New York scheduled for January 25 and 26, the SEC's Chief Counsel of Corporation Finance, David Lynn, has been confirmed to speak on the issues surrounding Rule 415. My partner Joe Smith is one of the speakers at this conference. Here is a link if you are interested: http://www.frallc.com/conference.aspx?ccode=b407

Miami PIPE Conference: I spoke at the PIPE conference held in Miami this week, along with a very impressive cadre of other speakers. I gave a four-hour workshop on reverse mergers (fun but tiring!), then joined a panel on the topic, as well as a panel put together at the last minute on Rule 415. The views of the 415 panel essentially mirrored my summary on this blog below. All agree we are beginning to come out of the period of confusion and uncertainty that ruled the last few months, and that more clear guidance is expected in a few weeks.

The RM Blog is Growing! I just learned that our average daily page views on this blog are in the mid-hundreds, which is amazing! Thanks to all for your support and don't hesitate to post responses or other thoughts below my posts. I look forward to your input and reactions. I will work to continue to earn your interest and regular visits.

My Meeting with the SEC on January 3 - More Good News on 415

Happy New Year to all!

On Tuesday, January 3, 2007, I met with Martin Dunn, Deputy Director of the SEC’s Division of Corporation Finance (Corp Fin) and David Lynn, Chief Counsel of Corp Fin. Subject to signoff from their boss John White, the Director of Corp Fin, these two, with the assistance of other staffers, have been formulating the Staff’s response in the Rule 415 matter. They are aware that I am blogging on this meeting, and have asked only that I clarify that we had "discussions not pronouncements" and that nothing has been finalized yet.

I apologize for some of the technical language for the non-lawyers, but here are the headlines:

Rule 415 Status: In the internal guidance to be issued, the staff intends to focus on two areas, disclosure and the primary vs. secondary offering analysis. In the latter case, a percentage is going to be set as a threshold. If you seek to register an amount below that percentage, it will be a very good sign that you have a valid secondary offering and the registration can proceed. Otherwise you need to provide ameliorating factors, most important of which appears to be keeping the ownership of any one investor as low as possible. The percentage threshold has not yet been decided upon, nor has it been decided whether the percentage will be based on “float” or outstanding shares.

Second Registration: Assuming the percentage to be registered will be limited, a big question has been, how quickly can a second registration for additional shares be filed? The staff understands the need for the market to have clear guidance on this point, and intends to provide it. The hope is that a second registration can take place relatively quickly, such as within 60-90 days after the first.

PIPE Structure is Irrelevant: To correct certain statements circulating in the marketplace (and possibly representing an evolution of their thinking), they indicated that PIPE structure is not at all relevant, and they have no problem whether the deal is a common, debt or preferred instrument. What does matter is the ultimate percentage of the company the investors will receive on a fully diluted basis.

Rule 144 Period to Shorten? It appears the staff is ready to seek a rulemaking to reduce the Rule 144 holding period from one year to six months. This would be a major development and reduce the negative impact of limiting registration, but is expected to take up to a year to complete. They may, however, seek to bring back a tolling of the holding period in connection with shorting activities.

Form S-3 for OTCBB Companies? The staff is moving toward seeking a rulemaking to allow short form registration on Form S-3 for all reporting companies for up to 20% of their stock per year in a primary offering sold at the market. Mr. Dunn initially floated this idea in a speech this fall.

Post-Reverse Merger Registrations Different? The staff appeared receptive to treating registrations immediately following reverse mergers differently than other registrations currently in their sights. The hope is, if they must limit, they will focus on limiting registration to a percentage of the outstanding stock rather than the stock held by non-affiliates.

Worm/Wulff Relief for Non-Affiliates? The staff appeared receptive to considering some relief under the so-called Worm/Wulff letters for certain non-affiliate holders of shares. Stay tuned on this one. If so, this could further enhance the utility of so-called “virgin” shells.

Self-Filings More Attractive: It appears the staff will look more favorably on registrations done as self-filings following a PIPE completed into a previously private company. This is because the PIPE transaction, in their mind, has been "completed," and this might create the opportunity to register a larger percentage of the stock.

Timing: I know I have predicted relief deadlines before without success, but it really does appear that the internal guidance will be released this month. At that time the staff intends to appear at conferences and get the word out since, as we all know, Wall Street abhors uncertainty.

It appears, at long last, we are on the verge of much greater certainty in these transactions.

For more info, do not hesitate to get in touch with me.

Rule 415 Update - Positive News

In recent days, there have been several positive pieces of news on the Rule 415 front (see posting below for more info on this issue).

First, a law firm which represents many issuers has circulated a memo resulting from their meeting with several senior SEC staffers. The memo suggests that it does appear that the "33-1/3% of the float (ie nonaffiliate stock)" standard setting the ceiling as to what portion of the company's stock can be registered at one time will remain.

However, the staff seems to be much more willing than in recent months to forego that limitation if ameliorating factors exist. These factors could include if (i) affiliates have held their stock for a longer rather than shorter period, (ii) no one investor seeking to register holds more than 10% of the company's stock, (iii) PIPE investments are structured with more common stock rather than derivative securities such as convertible preferred stock or convertible debt and (iv) the PIPE does not include so-called "death-spiral" features. The staff basically admitted they probably went a little too far in their reinterpretation.

In addition, in the past the staff seemed to suggest that anyone whose stock is registered in the 33% has to wait six months to do a subsequent registration of any additional stock. The staff apparently backed off on this in their meeting with the law firm, acknowledging the benefit of an additional registration prior to the one year Rule 144 period. Thus, a second registration now apparently can happen in less than six months, also a positive development.

The law firm briefly discussed reverse mergers with the staff. They indicated that these transactions likely will be treated as a separate category, and the 33% limitation may not apply at all in reverse mergers. We are currently seeking more information on this, but this sounds like good news. In general, the staffers told the law firm that they very much do not wish to quell small companies' interest in and benefit from PIPEs and reverse mergers.

Second, in my own conversations with "those in the know," I am being told that final decisions on these matters are expected before the end of the year. The new guidelines may come only in the form of internal direction, in which case we will learn of them indirectly through the staff's response to registrations filed hereafter.

In the meantime, we are still seeing anecdotal evidence in both directions while the examiners await their internal advice. Some companies are still receiving the "415 comment" even, in one case, with as little as 29% of the float being registered. Other companies' registrations are sailing through without comment on the issue, in one case with over 50% of the outstanding being registered.

Overall, the positive news is outweighing the negative, and hopefully in a matter of weeks we will remember this as an annoying speed bump that ultimately did not impact the long term growth of the reverse merger or "alternative public offering" business.

Your humble blogger is off to warmer climes for a few days, but I'll continue to monitor things and let you know if any newsworthy information is passed to me. Happy holidays and a happy, healthy and safe New Year to all!

The Rule 415 Conundrum- We Await the SEC...

In recent interpretations, staff members of the Securities and Exchange Commission’s Division of Corporation Finance for the first time have been advising small public issuers (the almost 10,000 companies with less than $75 million in public trading stock) that they must limit the percentage of their company that may be registered to increase their float.

These “resale registrations,” typically permitting stock of former private equity investors to become tradable, according to the staff are really indirect public offerings by the company if the percentage is too high. Therefore, they say, the registration must be transformed into a “direct” public offering, which in almost all circumstances for these small companies is unachievable. While I respectfully disagree with the legal interpretation, that analysis can be saved for the legal journals.

I do need, however, to discuss what this will bring about. This interpretation (of Rule 415 under the Securities Act of 1933) likely will have the impact of effectively shutting down all financing opportunities for these small companies, any one of which could be the next Microsoft, Yahoo or Amgen. If private equity or so-called PIPE (private investment in public equity) investors are unable to achieve liquidity soon after their investment, most will simply not invest, or at best will substantially increase their price to do so to account for the additional risk.

There are those within the SEC who contend that these smaller companies should not be public. I could not disagree more strongly. One example: Advanced Cell Therapeutics, which managed to raise funds in a PIPE to support its research on extracting stem cells from fetuses without damaging the fetus. There is no other potential source of financing for a company like this other than a PIPE investor.

In biotechnology in particular, the question should not be whether the company is big enough to be public, but rather whether it can benefit from being publicly held. Easier access to large pools of capital is a major benefit to being public. If a small public company can raise money through PIPEs, the next cancer cure or Alzheimer’s treatment could be the result.

Reverse mergers also will be significantly impacted. After a merger, most shares in the company are “restricted” and cannot be sold unless the holder waits at least a year or registration is possible. And investors in what was the shell must have their shares registered – they cannot even sell after holding a year or two or even more. By limiting the amount to be registered to a very small amount (recently we have heard the desire of the staff to limit registration to 30% of shares held by nonaffiliates, a very small amount following most reverse mergers), the ability of these companies to benefit from going public through this popular and legitimate technique would decrease dramatically.

I implore the SEC’s Commissioners and Division of Corporation Finance, as well as the Congressional committees providing oversight, to show their support of entrepreneurs and small businesses when they seek to access public markets, and provide clear and unequivocal guidance as to how to provide liquidity for investors in these companies in a manner that is realistic, meaningful and balancing all interests, rather than overreacting to those few who abuse the system.

Allowing continued growth in the $25 billion a year PIPE market, the only source of capital for very small companies to support their efforts to achieve their goals, can provide the opportunity for inventors, entrepreneurs and visionaries to achieve their version of the American dream. We hope the SEC will recognize the value of these companies and not cause thousands of companies to stop in their tracks and fail simply because their regulations made capital unavailable.