SEC Issues Interpretive Guidance Clarifying Up-C Rule 144 Holding Period

November 21, 2016

On November 1, 2016, the Securities and Exchange Commission’s Division of Corporation Finance issued an interpretive letter to clarify and expand the Staff’s recent interpretive guidance to Bank of America, N.A. and Merrill Lynch, Pierce, Fenner & Smith Incorporated (the “BAML Letter”) concerning the application of Rule 144 to the resale of REIT common stock received upon the exchange of privately placed units in an UPREIT umbrella operating partnership. The Staff’s recent follow-up guidance (the “Up-C Letter”) confirms that the analysis presented in the BAML Letter may be extended to Up-C corporate structures that present substantially similar facts. The guidance, available here, clarifies that the Rule 144(d) holding period for corporation shares acquired upon an exchange of partnership units in Up-C structures also commences upon the unit holder’s acquisition of the partnership units.

The Staff’s Up-C Letter provides substantial benefits to holders of publicly traded Up-C common stock received upon exchange of operating partnership units by confirming that such holders may also tack their holding period of the units to their holding period of the common stock. As previously discussed in our analysis of the BAML Letter, available here, these benefits provide significant practical advantages to holders of seasoned partnership units, even prior to conversion. Such practical advantages include enhancing the value and liquidity of the partnership units as pledged collateral to potential lenders and hedging transaction dealers, and addressing Securities Act Section 5 concerns that had deterred pre-conversion hedging transactions that referenced the common stock. The Staff issued the Up-C Letter in response to a request submitted jointly by three law firms.

Background and Impact

The Up-C Letter extends the BAML Letter beyond the UPREIT structure described in that letter, and confirms that the principles underlying the interpretive position support the same result in a variety of Up-C structures involving an exchange of economically equivalent securities. Indeed, although both letters include disclaimers that the interpretive guidance is limited to the specific facts presented therein (i.e., the specific UPREIT and Up-C structures described in the incoming letters), the letters taken together could be viewed as reasonable support for a broader position that holders of securities exchangeable for other securities representing the same proportional right to an underlying pool of assets may look to the date they acquired the exchangeable security when calculating the Rule 144(d) holding period. The Up-C Letter does explicitly clarify that the underlying analysis applies in a variety of different Up-C structures; for example, the Up-C Letter explicitly refers to Up-C structures that:

  • Permit the public holding corporation to limit exchanges in limited circumstances, such as where the exchange would violate applicable law or the company’s trading policies.
  • Only permit exchanges to occur during certain periods or on a limited basis (such as on quarterly exchange dates).
  • Include a tax-receivable or similar arrangement whereby the corporation may share a percentage of tax benefits received by the unit holder upon exchange.
  • Permit the unit holder to hold non-economic voting securities.
  • Permit exchanges only for common stock, and not for cash.
  • Permit either the unit holder or the issuer to elect to receive common stock or cash in exchange for the partnership units.1

Commercial Application

Like the BAML Letter, the Up-C Letter may also facilitate the following specific transactions involving Up-C partnership Units:

  • Elimination of Registration Rights. REITs and Up-Cs often provide unit holders with the right to require the REIT or Up-C to register the issuance or resale of common stock upon the conversion of partnership units. Because such liquidity may now be obtained through public resales in reliance on Rule 144, registration rights may no longer be necessary. 
  • Block Trades. We expect the Up-C Letter to result in an increase in the number of block trades related to Up-C common stock, because block trades now may be accomplished at the time the unit holder converts the partnership units into common stock, regardless of whether there is an effective resale registration statement on file with the SEC.
  • Pledges of OP Units. Prior to the BAML Letter and the Up-C Letter, a pledge of partnership units as collateral for a derivative or other transaction was generally viewed to result in a new holding period for the pledgee upon a redemption request by the pledgee after a default by the pledgor. Bona fide, recourse pledgees may now structure pledges in a manner that would allow the pledgee to receive shares of REIT or Up-C common stock with a Rule 144 holding period that commenced as of the start of the pledgor’s holding period.
  • Margin Loans. Before the interpretive guidance, most lenders were unwilling to lend against partnership units because a default by the borrower/pledgor would have required the lender to request a redemption from the REIT or Up-C and then wait at least six months before selling the common stock. Lenders should now be comfortable that partnership units that have been held for the full Rule 144 holding period (six months if the issuer is a reporting company and current in its periodic reporting, and one year for all other issuers, including the period during which the collateral is pledged) by the borrower/pledgor may be immediately resold by the lender upon default, as long as the lender is itself able to rely on the pledge tacking provision in Rule 144(d)(3)(iv).
  • Hedging in Connection with Derivative Transactions. Similarly, potential counterparties to derivatives transactions involving partnership units often were unable to effectively hedge such transactions because of the concern that the related hedging sales (e.g., short positions) of common stock could be deemed public sales of such stock by the unit holder accomplished without an effective registration statement or valid exemption from registration. The guidance substantially facilitates short positions in hedging activities related to such derivative transactions by eliminating these Securities Act Section 5 concerns, as long as the unit holder has held the partnership units for a sufficient time period depending on the structure of the hedging transaction.2

Understanding the scope and specific application of the BAML Letter and the Up-C Letter is therefore an important step when evaluating the formation of UPREITs, Up-Cs, and other similar corporate structures, as well as potential derivative and lending transactions in connection with securities issued in those structures. However, the Securities Act implications for any such transactions are to some extent unique and therefore require a careful examination and complete understanding of the transaction’s particular facts and circumstances.

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If you have any questions regarding the BAML Letter, the Up-C Letter, or any other letters or issues discussed in this alert or how to structure transactions consistent with relevant precedent, please contact the authors of this alert or your OMM advisor. 

1 Curiously, neither the incoming requests nor the Staff response letters include a discussion of whether the exchange structures described in each letter result in a new investment decision on the part of the unit holder (a common element of traditional Rule 144 tacking analysis—see, e.g., Securities Act Release No. 6099 and Securities Act Rules Compliance and Disclosure Interpretation 132.18); indeed, both letters focus exclusively on the economic equivalence between the two securities. The interplay between investment decisions and economic equivalence therefore remains unclear in this particular context.

2 Parties to derivatives transactions that involve related hedging sales should consider Section 16(c) short-sale implications if any of the parties to the transaction are subject to Section 16 of the Exchange Act, and should note the related interpretive letter from the Commission’s Division of Corporation Finance to Credit Suisse addressing Section 16(c) treatment of common stock underlying vested, in-the-money options. See Credit Suisse First Boston, SEC No-Action Letter (March 18, 2004).

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. Robert T. Plesnarski, an O’Melveny partner licensed to practice law in Washington, DC and Pennsylvania, Shelly Heyduk, an O’Melveny partner licensed to practice law in California, Jaroslaw Hawrylewicz, an O'Melveny partner licensed to practice law in New York, and James M. Harrigan, an O'Melveny associate licensed to practice law in Washington, DC 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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