LOWENSTEIN SANDLER PC CLIENT ALERT SPECIALTY FINANCE SEC STAFF CLARIFIES VIEWS ON RULE 415 By Jack D. Hogoboom, Michael D. Maline, Steven E. Siesser and Steve M. Skolnick January 2007 In December, 2006, members of public float. If the Staff does not allow an The Staff does not have any our Firm’s Specialty Finance offering to be considered as a secondary definitive guidance on this 415 Issue, Group met with David Lynn, offering, then the offering is a deemed so navigating through it has proven quite Chief Counsel of the Securities primary offering. The consequences of difficult. To their credit, however, the and Exchange Commission’s members of the Staff are concerned being a deemed primary offering are Division of Corporation Finance, about the impact these perceived twofold: (1) the issuer must meet the and Carol McGee, Deputy Chief changes have had, particularly on the higher, primary offering eligibility criteria Counsel, in an attempt to clarify ability of smaller public companies to for using a Form S-3 Registration raise money. The Staff also have been the Staff’s recent application of Statement, meaning that it must have a quite willing to speak directly with Rule 415 under the Securities public float in excess of $75 million; and market participants about their concerns. Act of 1933. (2) each of the investors named as a sell- Given the complexity of this issue and ing shareholder in the registration the absence of any written guidance Although the Staff contends that its posi- statement must be identified as an from the Staff, the information in the tion on Rule 415 has not changed, it is underwriter. If the issuer fails to meet the marketplace is fragmented, frequently incontrovertible that the Staff is using this eligibility criteria for using a Form S-3, the inconsistent and, indeed, sometimes Rule to disallow many types of deals that Staff requires the issuer to withdraw the wrong. Further, people who already have were previously permitted. registration statement and re-file it on met with the Staff on the 415 Issue have either a Form S-1 or SB-2. This can be In its continued scrutiny of the PIPEs mar- apparently taken away from those time consuming and costly, since the ketplace and its efforts to curb market meetings what they wanted to hear or Staff only comments after the issuer has abuses, the Staff has focused its regulato- thought they heard. As a result, informa- already filed its registration statement, ry energy on Rule 415, which is the rule tion is out in the marketplace that is not and the other forms of registration issuers rely upon to subsequently register consistent with the SEC’s position. statement require additional detailed for resale the shares issued in a PIPE At the risk of further muddying the financial and narrative disclosures. transaction. Under existing Staff interpre- waters, we summarize below our “take- Underwriter status, however, is the real tation and practice, issuers have been aways” from our meeting with the Staff. "showstopper" in the sense that it imme- able to register as a valid secondary offer- diately exposes the selling shareholder to ing under Rule 415 shares they sold in a full liability for any misstatements or PIPE representing well upwards of 50% omissions in that registration statement of their outstanding public float (i.e., the (subject to a due diligence defense). number of outstanding shares held by The practical impact of this new Staff non-affiliates). Beginning last Spring, the focus is that issuers can no longer sell Staff began tightening the availability of Rule 415 for secondary offerings, particu- and register as many securities as in the larly where the number of shares being past, thereby making many future PIPE registered exceeded 30% of the issuer's deals smaller than past deals.
LOWENSTEIN SANDLER PC CLIENT ALERT Specialty Finance Focus of SEC Concern We also discussed with the Staff the indicated that its comments will not only “Alternative Public Offering” (APOs) (i.e., focus on the Rule 415 Issue, but also ask The Staff remains concerned about abu- transactions in which a PIPE occurs for additional disclosure relating to the sive transaction structures, and market simultaneously with or shortly after the costs and risks of these private offerings. participants who are more likely to reverse merger), as an example of trans- The additional disclosure will relate to: engage in illegal trading activities in and actions that receive Rule 415 scrutiny. around PIPE transactions. We discussed • The dilutive impact of this offering Many commentators have indicated that with the Staff a number of different sce- and similar past transactions the Staff seems to have a different set of narios under which the Rule 415 Issue criteria in mind when reviewing reverse • The amount actually received by the might arise. Of most interest to PIPE mergers, and that APOs can register issuer from the transaction investors, we asked the Staff about a many more shares than customary PIPEs. “classic” PIPE transaction in which an • The costs of the transaction, includ- We explored some examples of these issuer sells shares of common stock at a ing all fees paid or payable transactions with the Staff during our discount to market with warrants that meeting. The Staff recognized that the • Increased risk disclosure are exercisable at a premium to market typical reverse merger transaction, where and contain customary price-related In our view, these enhanced disclosures there is an exceedingly small public float antidilution adjustments. The Staff reas- should be included now in all resale and a relatively high multiple of that sured us that this “classic” structure was registration statements, regardless of float sold in a concurrent financing not particularly concerning to them and whether the issuer believes that Rule transaction, does not present the same was not the focus of its scrutiny. Instead, 415 may be an issue, rather than waiting abusive concerns as, say, the toxic trans- the Staff referred us to transactions such for a Staff comment. While not conclu- actions. Consistent with some of the as “toxic convertibles” where convertible sive about it, the Staff seemed to commentators’ views, the Staff indicated notes are issued with floating conversion indicate that providing this type of a willingness to view these transactions prices, resulting in a conversion into a disclosure may actually obviate the need differently than other PIPE financing multiple (e.g., 2x, 3x, 4x or higher) of for the issuance of a Rule 415 comment, transactions, and allow greater flexibility the total number of outstanding shares. even where the offering size exceeds in registering the shares in an APO. The Staff noted that in many of these 30% of the public float. transactions, the issuer’s stock price Staff Will Rely on The 30% Test is Only a trades down over time and that public Comment Process Screening Device investors are often unaware of the risk Because the Staff continues to apply a these transactions create. The Staff also The Staff advised us that there is an facts and circumstances test to Rule 415, pointed to transactions with excessive established percentage test (which we the Staff does not believe it is possible or up-front financing fees or hidden trans- believe is 30%, although the Staff would appropriate to provide general interpre- action fees as additional areas of not confirm the number) that will be tive guidance on Rule 415. As a result, concern. In particular, the Staff used as a screening device, and not as a the Staff expects to resolve Rule 415 expressed a strong desire for issuers to “hard-and-fast rule” as to what will issues on a case-by-case basis through include adequate disclosure about the constitute a deemed primary offering by the registration statement comment fees paid in these transactions. The an issuer. As described to us, for admin- process. The Staff does, however, expect Staff’s new use of Rule 415 is designed istrative purposes, the Staff needed to to standardize the comments it issues to curtail these “toxic convertible” implement a simple test for its reviewers with respect to the Rule 415 Issue, so transactions, and not impair the more to determine whether to issue a Rule issuers can better gage how to respond traditional or “classic” type of PIPE 415 comment on a particular registration to and resolve the Staff’s concerns. transactions. However, as the Staff statement. As the Staff reviewer exam- Consistent with its concerns about the acknowledged rather colorfully, “When ines a registration statement, one of the ultimate purchasers of these securities you cast out a net, you catch some items on its “checklist” is to determine (i.e., the investing public), the Staff has dolphins with the tuna.” whether the number of shares being
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