David Feldman's book, Reverse Mergers: Taking a Company
Public Without an IPO, now in its third printing, was published in 2006
by Bloomberg Press (available on http://www.amazon.com).
View David Feldman's reverse merger blog at www.reversemergerblog.com.
Joseph Smith and David Feldman are coauthors of PIPES:
Revised and Updated Edition - A Guide to Private Investments in Public Equity
(Bloomberg Press, 2005) available on http://www.amazon.com.
In the News
Joseph
Smith mentioned in PIPES Report article
about guidance from SEC regarding Rule
415 on December 15, 2006.
Push
for Rule 415 Guidance Bearing Fruit
by
Joe Gose
Behind-the-scenes
efforts to wring clarity out of the
Securities and Exchange Commission's
interpretation of Rule 415 of the Securities
Act of 1933 suggest that a substantial
slice of the micro cap PIPE market is
on the verge of fundamental change.
From a potential boom in the number
of investment syndications to capping
issuances to meet an unofficial threshold,
private placement issuers and investors
are slowly adopting new strategies to
deal with the SEC's shifting view of
Rule 415, which allows issuers to sell
shares on a delayed or continuous basis
in the future if they meet certain requirements.
Eventually, the changes could result
in greater discounts and fewer PIPEs.
Over the last several years, PIPE players
have utilized Rule 415 to register and
sell PIPE offering shares with few if
any major complications. But earlier
this year, the commission began questioning
whether proposed selling shareholders
in PIPE deals listed in registration
filings were affiliates, and whether
the registration statements at that
point were really primary offerings.
In particular, the SEC applied its newfound
interpretation to the smallest of issuers
who wanted to raise an amount that was
generally half or more of their market
float.
The new view stymied deal making by
throwing closed PIPE transactions into
flux as issuers struggled to register
shares. Among the risks presented to
investors who are considered underwriters:
They would have to sell their shares
at a fixed price, they would not be
able to avail themselves of Rule 144,
and they would face potential Section
11 liability, which would allow purchasers
of those shares to return the stock
to investors in cases of material misstatements
or omissions in the registration statement,
says Jack Hogoboom, a partner with law
firm Lowenstein Sandler.
Attorneys representing PIPE issuers
and investors who have met with SEC
staffers and executives over the last
several weeks are coming away with a
better grasp of the commission's philosophy
influencing Rule 415 interpretation
changes. Not only is the commission
exhibiting a distaste for toxic convertibles
and deals with large discounts, but
it is also revealing a broad distrust
of PIPE funds, which are seen as profiteering
stock flippers lacking fundamental investment
intent. Ultimately the SEC is focusing
on protecting end purchasers who buy
PIPE shares in the market and who may
not be aware of potential dilution risks.
Along those lines, the SEC is looking
for more disclosure in registration
statements, says Greg Sichenzia, a partner
with Sichenzia Ross Friedman Ference,
who recently met with commission officials
in Washington to discuss Rule 415. The
commission wants disclosures to focus
on a financing's overall cost to the
issuer, the control persons of the investors
and any affiliation between the investors,
and the impact of potential dilution
that could result from the PIPE, which
may include details of how previous
PIPEs affected dilution and stock price.
Plus, issuers have a better shot at
filing an effective registration statement
if deals feature few "moving parts"--warrants,
price adjustments, ratchets and penalties,
for instance.
But to a large degree, the counselors
remain somewhat perplexed over the SEC's
practical enforcement of the interpretation,
the applicability of which in some cases
solely depends on the subjective whims
of various reviewers and branches. As
to future guidance, PIPE experts largely
anticipate that the SEC will issue an
internal policy, forcing issuers and
investors to continue to adapt to the
environment by studying registration
statement comments. Previous hopes that
the agency would provide guidelines
to the market sometime around the new
year have all buy vanished.
"People have been beating the drums
pretty loud, and it's making a difference,"
says Greg Sichenzia, referring to the
PIPE market's drive to obtain an uncluttered
view of the regulatory landscape. "I
hope we're finally bringing some clarity,
but it's still a wildcard."
Numbers Issue
Still, private placement agents and
attorneys continue to build transactions
using bits of knowledge gathered over
the last several weeks. A major guideline
centers on the size of the offering,
and lawyers largely agree that the SEC
generally wants to cap the amount of
shares issued in a deal at around 30%
to 33% of public float. To get there,
PIPE players need to divide the securities
held by the selling shareholders--plus
any underlying warrant or convertible
securities also being register--by the
number of shares outstanding held by
non-affiliates, says Steven Siesser,
a partner with Lowestein Sandler.
But Siesser says the method amounts
to an "apples to oranges" comparison.
"You're looking at selling shareholders
on a fully diluted basis and the universe
or the population of the float on the
narrowest basis," he says. "So you can
get to 30% very quickly, and [that's
when] the staff starts having problems."
Plus, no one is sure whether
the SEC will apply different thresholds
to different securities. The commission
would prefer to see common stock transactions
only, for example. Thus, the agency
could comment on convertible deals that
issue 20% of the float, suggests Joseph
Smith, a partner with Feldman Weinstein
& Smith, or it may quickly clear
registration statements in which investors
are receiving only common stock for
more than 30%. At the same time, equity
lines are apparently acceptable to the
commission as long as they're within
the 30% cap.
Room to Maneuver
At least some good news appears to be
emerging around the 30% issue: The SEC
has acknowledged that its Rule 415 interpretation
has chilled the ability of small companies
to raise capital, Sichenzia reports.
He suggests that the commission has
become more willing to apply a facts
and circumstances test to issuances
that exceed 30% of the float, particularly
when the financing is tied to an acquisition
that's accretive to a company's value,
when the deal involves a reverse merger
or when several investors are taking
part in a placement, along other situations.
Indeed, PIPE attorneys largely agree
that the larger the syndicate of investors
in PIPEs attempting to buck the 30%
threshold, the better. The SEC is acutely
focused on an investor's ability to
control issuers in such deals even though
investors typically want to avoid control.
In fact, the commission has junked its
support of contractual blockers, which
prevent investors from owning more than
5% to 10% of the company at one time,
in the application of the new Rule 415
interpretation to registrations statements.
Why? The commission is worried that
an investor in a large deal could still
dump a huge amount of shares on the
market, they say.
Moreover, the SEC has rejected gating
conversions or resales s a potential
remedy, as well as agreements that investors
won't pursue special selling efforts.
Gating provisions restrict the stock
that a PIPE investor can convert or
sell at any one time--a certain number
of shares a month or a percentage of
trading volume each week, for example--while
special selling efforts would include
road shows or other programs to promote
the stock.
On the other hand, the commission appeared
to favor the strategy of filing more
than one registration statement for
transactions that exceed the 30% threshold,
experts say. Issuers who cut back the
total number of shares listed on the
initial filing to around 30% to achieve
effectiveness would then file subsequent
registration statements to cover the
remaining shares using the same 30%
cap. Plus, Sichenzia adds, the commission
indicated that it might view the practice
even more favorably if issuers were
only obligated to register a portion
of underlying PIPE securities in successive
registration statements over a period
time. Yet the SEC has failed to indicate
what it considers an acceptable time
frame between filings.
Shaping Agreements
Beyond requiring issuers and investors
to take broad steps to assuage the SEC,
Rule 415 has become a negotiating point
in PIPE purchase agreements. Issuers
typically want to add language to postpone
or stay penalties associated with effective
registration statement delays that stem
from Rule 415 comments. While investors
have become more sympathetic to the
situation, they still want penalties
such as liquidated damages to kick in
at some point.
Investors and issuers looking for more
alternatives can always rely on Rule
144 as an exit strategy, in which case
no registration statement filing would
be needed. In fact, attorneys representing
PIPE funds say they're advising their
clients to be prepared to rely solely
on Rule 144, which could drive discounts
higher.
And although it hasn't yet happened
yet, eventually investors could agree
to lengthen the required time periods
between a PIPE closing and a registration
statement filing. That's an element
that the SEC favors because it indicates
investment intent rather than simple
stock flipping behavior. But it also
adds to an investor's risk, which will
likely drive up the price of capital.
"I don't think the SEC was trying to
tell the market how to price deals,"
Sichenzia says. "But the result [of
the interpretation] is that it's telling
the market how to price deals."
