pdf

SEC Staff Issues Revised Compliance and Disclosure Interpretation Clarifying Rule 144 Provisions Applicable to Sales of Securities by a Pledgee

June 14, 2013

 

Executive Summary 

Following a request for guidance from Bank of America, N.A., Merrill Lynch, Pierce, Fenner & Smith Inc. (together, “Bank of America Merrill Lynch”) and O’Melveny & Myers LLP, the Securities and Exchange Commission’s Division of Corporation Finance, on May 16, 2013, issued revised Securities Act Rules Compliance and Disclosure Interpretation (“C&DI”) 532.01 clarifying the provisions of Rule 144 under the Securities Act of 1933 (the “Securities Act”) applicable to the sale of securities by a non-affiliate pledgee under a bona fide pledge, where the securities were acquired by the affiliate pledgor in the open market (i.e., the securities were not restricted securities in the hands of the affiliate pledgor). Specifically, revised C&DI 532.01 makes clear that:

  • Assuming the non-affiliate pledgee has not been an affiliate of the issuer during the preceding three months, no requirements of Rule 144 will apply to sales of the securities by the non-affiliate pledgee other than the current public information requirement of Rule 144(c)(1); and
  • This guidance applies regardless of whether the securities were pledged with or without recourse.
    Prior to revision, C&DI 532.01 provided that the holding period required by Rule 144(d) does not apply to such resales by non-affiliate pledgees, but was silent with respect to other resale restrictions, as well as whether the holding period guidance was dependent on recourse against the borrower. The absence of such guidance had created inconsistency in the application of Rule 144, notwithstanding the plain language of Rule 144(c)(1).

Background

Rule 144 provides a non-exclusive safe harbor from the definition of “underwriter” in Section 2(a)(11) of the Securities Act. If a person is not an “underwriter” in connection with a sale of securities, that person is eligible to enter into that sale of securities without registration under the Securities Act in reliance on the exemption from registration found in Section 4(a)(1) (as that provision exempts “transactions by any person other than an issuer, underwriter, or dealer”). As such, a person satisfying the applicable conditions of Rule 144 in a sale of securities may be certain (absent a scheme to evade registration) that the Section 4(a)(1) exemption is available for that sale of securities.

Rule 144(b)(1) sets forth the conditions under which a non-affiliate, who is not selling on behalf of an affiliate (e.g., selling bona fide pledged securities following a default), may sell restricted securities. Under Rule 144(b)(1), the conditions of Rule 144 that may apply to sales of restricted securities by such non-affiliates are paragraphs (c)(1) (the “current public information requirement”) and (d) (the “holding period requirement”). Compliance with no other provisions of Rule 144 is required for such a non-affiliate seller to be deemed not to be an underwriter within the meaning of Section 2(a)(11) of the Securities Act.

The Staff originally issued C&DI 532.01 in January 2009 to provide guidance on the application of the Rule 144 holding period requirement to the situation in which an affiliate pledgor defaults on a loan that is secured by securities that were not restricted in the hands of the affiliate pledgor (i.e., the securities were acquired by the affiliate pledgor in the open market rather than directly from the issuer). C&DI 532.01 as originally issued by the Staff, stated:

A pledgor who is an affiliate defaults on a loan that is secured, in a bona fide pledge situation, by stock acquired in the open market. The pledgee may sell the stock without regard to the holding period requirement of Rule 144. A new holding period for the pledgee is not necessary because the securities were acquired solely by operation of the pledge agreement and therefore are not deemed to have been “sold” to the pledgee by the affiliate.

Accordingly, pursuant to original C&DI 532.01, a non-affiliate-pledgee in the presented fact pattern need not comply with the provisions within Rule 144(b)(1) relating to compliance with Rule 144(d).

C&DI 532.01, however, was silent with respect to the application of the current public information requirement of paragraph (c)(1), which Rule 144(b)(1) applies to non-affiliates until the restricted securities have been held for one year. Notwithstanding the plain language of Rule 144(b)(1) regarding the resale restrictions applicable to non-affiliates, C&DI 532.01 created uncertainty with respect to other resale restrictions that may apply in the above fact pattern. We understand that certain practitioners were of the view that paragraph (c)(1) did not apply in the presented fact pattern while other practitioners were advising their clients to comply with all resale restrictions under Rule 144 (including paragraphs (e), (f), and (h)), other than the holding period, until the pledged securities have been held for a combined holding period of one year, or six months if the issuer is, and has been for a period of at least 90 days immediately before the sale, subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) and has filed all required reports under the Exchange Act during the 12 months preceding the sale. We further understand that uncertainty has existed among practitioners as to whether the Staff’s interpretation in C&DI 532.01 is dependent on the loan having been made with recourse against the borrower. Revised C&DI 532.01 addresses the above uncertainties.

Revised C&DI 532.01

On May 16, 2013, the Staff revised C&DI 532.01 as follows:

A pledgor who is an affiliate defaults on a loan that is secured, either with or without recourse, by a bona fide pledge of company stock acquired in the open market (i.e., these securities are not “restricted securities” in the pledgor’s hands). In the pledgee’s hands, these securities are “restricted securities” because they have been “acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public offering.” If the pledgee is a non-affiliate and has not been an affiliate during the preceding three months, the pledgee may resell such securities pursuant to Rule 144(b)(1) without regard to the holding period requirement in Rule 144(d) but subject to the current public information requirement in Rule 144(c)(1), as applicable. No other requirements in Rule 144 are applicable to the pledgee’s resale.

The revised language makes clear that paragraph (c)(1), through the operation of paragraph (b)(1), continues to apply in the presented fact pattern, while all other resale restrictions, such as those contained in paragraphs (e), (f), and (h) of Rule 144, do not. Revised C&DI 532.01 also provides that the Staff’s guidance in the above fact pattern applies both to loans made with and without recourse against the borrower.

Application of the Revised Guidance

The Staff’s issuance of revised C&DI 532.01 provides clarity on the application of Rule 144(b)(1) to resales by non-affiliate pledgees of securities acquired from an affiliate pursuant to a bona fide pledge following default on the underlying loan, made with or without recourse against the borrower, where the pledged securities originally were purchased by the affiliate in the open market. The application of Rule 144(b)(1) in such circumstances may be summarized as follows:

  • If the issuer of the pledged securities is, and has been for at least 90 days prior to the sale, subject to the reporting requirements of the Exchange Act, and the issuer is current in its reporting under the Exchange Act as provided by paragraph (c)(1), the pledged securities may be immediately resold without restriction by the non-affiliate pledgee without restriction; and
  • If the issuer of the pledged securities is, and has been for at least 90 days prior to the sale subject to the reporting requirements of the Exchange Act but is not current as provided in paragraph (c)(1), the pledged securities may be resold without restriction if they have been held by the non-affiliate pledgee for one year. Consistent with Rule 144(d)(3)(iv) and Securities Act Rules C&DI 130.01, the non-affiliate pledgee may tack the affiliate pledgor’s holding period to establish the one-year holding period, if, and only if, the pledge was made with recourse against the borrower.

Common Misconceptions

Revised C&DI 532.01 will help to ensure consistency of guidance among practitioners with respect to resale restrictions applicable to sales of pledged securities by a non-affiliate pledgee where the affiliate pledgor originally acquired the pledged securities in the open market. In on our experience, a lack of relevant public guidance created both uncertainty and significant misconceptions among practitioners. Some of the more common misconceptions related to sales of pledged securities by a non-affiliate pledgee where the affiliate pledgor originally acquired the pledged securities in the open market are as follows:

  • Conditions of Rule 144 Which Apply to the Non-Affiliate Pledgee. Notwithstanding the language of C&DI 532.01 as originally issued by the Staff, some practitioners were of the view that all of the conditions of Rule 144, including the Rule 144(d) holding period, applied to securities received by a non-affiliate pledgee from an affiliate pledgor under a pledge agreement. Revised C&DI 532.01 clarifies that this is not the case. Rather, the only condition of Rule 144 that applies to the non-affiliate pledgee, regardless of how long the affiliate pledgor held the securities, is the current public information requirement of Rule 144(c)(1).
  • Application of Current Public Information Requirement of Rule 144(c)(1). Some practitioners had an overly broad reading of C&DI 532.01 as originally issued by the Staff and were of the view that none of the conditions of Rule 144 applied to securities acquired under the above circumstances. Revised C&DI 532.01 makes clear that the Staff’s position is that the current public information requirement of Rule 144(c)(1) does in fact apply to securities received by a non-affiliate pledgee from an affiliate pledgor under a pledge agreement.
  • Tacking Under Rule 144(c)(1). Notwithstanding the language of C&DI 130.01, some practitioners were of the view that a non-affiliate pledgee could not rely on the tacking provisions in Rule 144(d)(3) to determine whether the Rule 144(c)(1) current public information condition has been met for a one-year period. Other practitioners were of the view that a non-affiliate pledgee could tack in reliance on Rule 144(d)(3)(iv) regardless of whether the pledge was made with or without recourse. The interplay of C&DI 130.01 and revised C&DI 532.01 clarifies that the tacking provisions in Rule 144(d)(3)(iv) may be applied in determining whether, under Rule 144(b)(1)(i), the Rule 144(c)(1) condition has been met for a one-year period. Accordingly, a non-affiliate pledgee may tack in reliance on Rule 144(d)(3)(iv) when the pledge was made with recourse against the borrower but may not tack when the pledge was not made with such recourse. The application of the Rule 144(d)(3)(iv) tacking provision would be similar if the non-affiliate pledgee foreclosed upon restricted securities from the affiliate pledgor.
  • Recourse vs. Non-Recourse Pledge. Some practitioners were of the view that a non-affiliate pledgee could sell shares received under the pledge agreement without regard to the holding period requirement of Rule 144 only when the loan in question was made with recourse against the borrower. Revised C&DI 532.01 makes it clear that this is not the Staff’s position. Rather, the Staff’s guidance in the above fact pattern applies to loans made both with and without recourse against a borrower.

Additional Considerations

Although revised C&DI 532.01 provides needed clarity on the application of Rule 144 to the sale of securities by a non-affiliate pledgee under a bona fide pledge, we believe that the following considerations not directly addressed by the C&DI merit discussion:

  • Securities Acquired by an Affiliate Pledgor in a Registered Transaction. Although revised C&DI 532.01 only addresses securities acquired by an affiliate pledgor in the open market, we believe that the application of C&DI 532.01 also should extend to securities acquired by the affiliate pledgor pursuant to an effective registration statement. Under both circumstances, the securities in question are not restricted securities in the hands of the affiliate pledgor. Accordingly, the treatment of the securities when they are received by a non-affiliate pledgee under the pledge agreement for Rule 144 purposes should be the same.
  • Shell Companies. Shell companies present unique considerations as addressed in Rule 144(i) and such considerations must be examined before practitioners consider the application of revised C&DI 532.01. 
  • Non-Reporting Issuers. Revised C&DI 532.01 only addresses securities acquired by an affiliate pledgor in the open market. Consequently, securities of a non-reporting issuer appear beyond the scope of the C&DI. We believe, however, that the application of revised C&DI 532.01 also should extend to securities of a non-reporting issuer acquired by the affiliate pledgor under a bone fide pledge. If the issuer of the pledged securities is not subject to the reporting requirements of the Exchange Act, and there is publicly available information concerning the issuer specified in paragraphs (a)(5)(i) to (xiv), inclusive, and paragraph (a)(5)(xvi) of Exchange Act Rule 15c2-11, we believe that the pledged securities may be immediately resold by the non-affiliate pledgee without restriction. However, if the non-reporting issuer has not made such information publicly available, then we believe that the pledged securities may be resold without restriction if they have been held by the non-affiliate pledgee for one year. Consistent with Rule 144(d)(3)(iv) and Securities Act Rules C&DI 130.01, it is our view that the non-affiliate pledgee may tack the affiliate pledgor’s holding period to establish the one-year holding period if, and only if, the pledge was made with recourse against the borrower.

                                                                # # # # #

If you have any questions regarding revised C&DI 532.01 or issues discussed in this alert, or how to structure derivative transactions consistent with relevant precedent, please contact the authors of this alert or your OMM advisor. In addition, the authors of this alert wish to thank Glen A. Rae, Eric P. Hambleton, Robert J. Dilworth, Debra Marvin and Bess Schachner of Bank of America Merrill Lynch, who were instrumental in assessing relevant legal issues and current market practice.

________________________________________________________________________

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 Plesnarski, an O'Melveny partner licensed to practice law in the District of Columbia and Pennsylvania, Scott Lesmes, an O'Melveny senior counsel licensed to practice law in the District of Columbia, and Marty Dunn, an O'Melveny partner licensed to practice law in the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

Portions of this communication may contain attorney advertising. Prior results do not guarantee a similar outcome. Please direct all inquiries regarding New York's Rules of Professional Conduct to O’Melveny & Myers LLP, Times Square Tower, 7 Times Square, New York, NY, 10036, Phone:+1-212-326-2000. © 2013 O'Melveny & Myers LLP. All Rights Reserved.