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New Legislation Creates Greater Legal Certainty for Private Resales of Securities, Removes Speedbumps for IPO Filings by Emerging Growth Companies and Facilitates Public Sales of Securities by Small BusinessesMarch 8, 2016
Several recent amendments to the Securities Act of 1933, the Securities Exchange Act of 1934 and the JOBS Act create greater legal certainty for private resales of securities, may encourage earlier IPO filings by emerging growth companies and facilitate the public sale and resale of securities by small businesses. The amendments were included in the Fixing America’s Surface Transportation Act (the “FAST Act”), a bill focused on transportation funding that was signed into law in December 2015. These amendments, among other things:
- create a new Section 4(a)(7) of the Securities Act, an exemption from registration for private resales of securities (similar in some respects to the existing informal “Section 4(a)(1 1/2)” exemption), which may facilitate secondary market activity by creating additional legal certainty as to how and when securities may be privately resold;
- permit emerging growth companies (“EGCs”) to remain in “stealth mode” for longer prior to commencing their IPO, by shortening the period between publicly filing a registration statement and commencing an IPO roadshow;
- allow some emerging growth companies to file IPO registration statements earlier and avoid certain audit costs, by eliminating the requirement to include certain financial statements in initial IPO registration statements filings when those financial statements are not expected to be required at the actual IPO date; and
- allow smaller reporting issuers to forward incorporate information in Forms S 1 and F 1, which may help facilitate resale registrations or private placement securities for PIPE transactions as well as “equity” line transactions by smaller issuers.
Securities Act Section 4(a)(7). Section 76001 of the FAST Act creates a new exemption from Securities Act registration for certain private resales of securities. Securities Act Section 4(a)(7) is similar in several respects to the informal Section 4(a)(1 1/2) exemption, a reasoned set of procedures for resale transactions that embody the traditional characteristics of an issuer private placement pursuant to Securities Act Section 4(a)(2). Pursuant to Section 4(a)(7), resales of securities are exempt from registration if, among other things:
- the seller is not the issuer of the securities or a subsidiary of the issuer (i.e., the exemption is only available for resales of outstanding securities and is not available for primary issues of securities);
- the seller does not engage in general solicitation or advertising (i.e., the exemption is only available for private transactions);
- each purchaser of the securities is an “accredited investor” within the meaning of Rule 501(a) of Regulation D under the Securities Act;
- the class of securities has been outstanding for at least 90 days prior to the transaction;
- the securities are not part of a broker-dealer’s unsold allotment;
- neither the seller nor any intermediary is subject to “bad actor” disqualification pursuant to Rule 506(d)(1) of Regulation D or Section 3(a)(39) of the Exchange Act; and
- the securities were not issued by a dormant, bankrupt, or shell company.
If the issuer is not a reporting company under the Exchange Act, the issuer must also make available upon request certain information. Securities acquired in a transaction exempt from registration pursuant to Section 4(a)(7) are “covered securities” that preempt blue sky law regulation. They are, however, “restricted” securities under Rule 144 under the Securities Act and subject to restrictions on further resales.
Insofar as Section 4(a)(7) is similar in many respects to the Section 4(a)(1 1/2) exemption relied on by market participants for resale transactions that do not expressly fit within SEC resale safe harbors such as Rule 144 and Rule 144A, it is not expected to fundamentally expand the universe of exempt private resale transactions. It does, however, create some much needed clarity to the case by case, multiple factor, fact-specific analysis needed for securities lawyers to get comfortable with specific resales under the Section 4(a)(1 1/2) exemption. This clarity in itself may facilitate more efficient resale transactions through secondary markets and online portals.
Employee and Private Company Liquidity Programs. The new exemption also addresses some uncertainty as to how long a security needed to be held prior to being resold pursuant to the Section 4(a)(1 1/2) exemption. While not an express condition for resales pursuant to the Section 4(a)(1-1/2) exemption, the length of time a seller held the securities was, under certain circumstances, one consideration among others analyzed by securities attorneys in determining whether the exemption could be relied on. For example, employees of private companies seeking to realize pre-IPO liquidity by selling to outside investors often face the question of whether they need to wait for some minimum holding period between exercising options for cash and selling their shares to support their investment intent. Section 4(a)(7) resolves that uncertainty by requiring no holding period by the seller, only that at least 90 days must have passed since the class of securities was originally issued by the issuer.
Hedging Transactions. The new exemption may also impact the market for affiliate or restricted security hedging transactions because Section 4(a)(7) does not impose any minimum holding period before a private resale, and therefore counterparties will have theoretically greater (albeit limited) liquidity as a result of the increased regulatory certainty with respect to the disposition or rehypothecation of securities that have not been held for the full Rule 144 holding period.
JOBS Act Amendments. Section 71001 of the FAST Act amends certain provisions of the JOBS Act relating to public offerings by emerging growth companies and smaller public companies:
Emerging Growth Company Roadshows. The FAST Act amends Section 6(e)(1) of the Securities Act by reducing the period before which an EGC may commence its IPO road show after publicly filing the IPO registration statement from 21 to 15 days. This allows potential IPO companies to better monitor market conditions before they make public their filing of a registration statement and plans for an IPO.
Lesser financial statement registrants at filing. The SEC’s interim rules in response to the FAST Act mandate amend the instructions to Forms S 1 and F 1 to provide that EGCs may omit certain historical period financial information, if the issuer reasonably believes that the omitted information will not be required to be included in the filing at the time of the contemplated offering, so long as the issuer amends the registration statement prior to distributing a preliminary prospectus to include all financial information required at the time of the amendment.
Emerging Growth Company Status Grace Period. The FAST Act further amends Section 6(e)(1) to provide a grace period for issuers that qualified for EGC status at the time of the first confidential registration statement filing but that subsequently ceased to be an EGC during the offering process, allowing issuers to avail themselves of EGC status until the earlier of: (i) the consummation of the IPO reflected in the confidential registration statement, or (ii) one year from the date the issuer ceased to be an EGC.
Impact of Forward Incorporation by Reference on PIPEs and Equity Line Transactions. The interim rules also revise Forms S 1 and F 1 to allow smaller reporting companies to incorporate by reference filings that are made after the Form S 1 or F 1 becomes effective (i.e., to forward-incorporate future filings). Previously, these companies had to file post effective amendments (e.g. to incorporate new financial information from a 10-Q or a 10-K) and have those amendments declared effective by the SEC. The changes eliminate that additional administrative burden on companies and the resulting blackout on the use of registration statements by these issuers. One effect of these changes will be to make it easier for those companies to access capital through “equity lines”, which are irrevocable commitments by purchasers to buy securities under certain parameters when and if the issuer draws down on the commitment. Equity lines are often structured as resale registrations. It will also help newly public companies who are not yet eligible for use of Forms S 3/F 3 because of a limited reporting history of less than 12 months maintain resale liquidity for existing security holders, particularly affiliates.
Disclosure Modernization Initiative. Sections 72001-72003 of the FAST Act also mandate that the SEC: (i) amend Form 10 K to allow issuers to submit a summary page on Form 10 K, as long as each item identified in the summary includes a cross-reference to the information, (ii) revise Regulation S K to reduce the burden of public reporting requirements on smaller issuers, and (iii) undertake a study of Regulation S K and issue a report to Congress concerning its findings and proposed recommendations for simplification and modernization of Regulation S K.
The complete text of the FAST Act is available here. Interim SEC rules implementing the FAST Act mandate with respect to Forms S 1 and F 1 have also been adopted by the SEC and are available here.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Rob Plesnarski, an O'Melveny partner licensed to practice law in the District of Columbia and Pennsylvania, Eric Sibbitt, an O’Melveny partner licensed to practice law in California and New York, and James Harrigan, an O'Melveny associate licensed to practice law in the District of Columbia and Maryland, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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