Excerpt from Current Issues and Rulemaking Projects Outline Quarterly Update (March 31, 2001)
Equity Line Financings
Note: The following discussion of our views replaces Interpretation No. 4S in the March 1999 Supplement to the Division's Manual of Publicly Available Telephone Interpretations.
Description of "Equity Line" Financing Arrangements
In a typical "equity line" financing arrangement, an investor and the company enter into a written agreement under which the company has the right to "put" its securities to the investor. Under this "put," the company has the right to tell the investor when to buy securities from the company over a set period of time and the investor has no right to decline to purchase the securities. The dollar value of the equity line is set in the written arrangement, but the number of shares that the company will actually issue is determined by a formula tied to the market price of the securities at the time the company exercises its "put."
Private Equity Lines with Registered Resales
In many equity line financings, the company will rely on the private placement exemption from registration to sell the securities under the equity line and will then register the "resale" of the securities sold in the equity line financing. In these types of equity line financings, the delayed nature of the "puts" and the lack of market risk resulting from the formula price differentiate private equity line financings from financing PIPEs (private investment, public equity). We, therefore, analyze private equity line financings as indirect primary offerings.
While we analyze private equity line financings as indirect primary offerings, we recognize that the "resale" form of registration is sought in these financings. As such, we will permit the company to register the "resale" of the securities prior to its exercise of the "put" if the transactions meet the following conditions:
- The company must have "completed" the private transaction of all of the securities it is registering for "resale" prior to the filing of the registration statement.
- The "resale" registration statement must be on the form that the company is eligible to use for a primary offering.
- In the prospectus, the investor(s) must be identified as underwriter(s), as well as selling shareholder(s).
We have been asked a number of interpretive questions regarding private equity line financings.
| Q. |
For the private transaction to be "complete," the investor must be irrevocably bound to purchase all the securities. How does this apply to the "put"?
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| A. |
Only the company may have the right to exercise the "put" and, except for conditions outside the investor's control, the investor must be irrevocably bound to purchase the securities once the company exercises the "put." |
| Q. |
If the investor is permitted to transfer its obligations under the equity line, will the transaction be "completed"? |
| A. |
No. |
| Q. |
If the investor has the ability to make investment decisions under the equity line agreement after the filing of the "resale" registration statement, the investor will not be considered irrevocably bound. What are some structures that we consider to continue to provide the investor with an investment decision? |
| A. |
Examples that we have observed include:
- agreements that give investors the right to acquire additional securities (including the right to acquire additional securities through the exercise of warrants) at the same time or after the issuer exercises its "put";
- agreements that permit the investor to decide when or at what price to purchase the securities underlying the "put"; and
- agreements with termination provisions that have the effect of causing the investor to no longer be irrevocably bound to purchase the securities underlying the "put."
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| Q. |
Is a "due diligence out" a condition to closing within the investor's control that would prevent us from considering the transaction completed? |
| A. |
Yes. |
| Q. |
Are conditions such as (a)"bring downs" of customary representations or warranties and (b) customary clauses regarding no material adverse changes affecting the company conditions to closing within the investor's control that would prevent the private transaction from being completed? |
| A. |
No. |
| Q. |
If the company may "put" securities other than the shares of common stock being registered for "resale," such as a derivative security convertible into common stock (e.g., a convertible note or a convertible preferred security), would the private transaction be considered completed? |
| A. |
No. This is because the investor may have further investment decisions to make regarding the purchase of securities underlying the derivative security and will, therefore, not be irrevocably bound to purchase the securities that are being registered for "resale." |
| Q. |
If the above conditions are not met, can the company register the "resale" of the securities? |
| A. |
As a general matter, no. However, if the following conditions are met, the company may register the "resale" transaction, as these conditions address our concerns regarding inappropriate use of shelf registration and liability for potential violations of Securities Act Section 5.
- The company is eligible to use Form S-3 or Form F-3 for a primary offering of securities.
- The company complies with Rule 415(a)(4).
- The company addresses, in the prospectus, issues relating to the potential violation of Section 5 in connection with the private transaction.
If the preceding three conditions are not met, the company must withdraw the registration statement and complete the private transaction. After the private transaction is completed, the ability to register the "resale" of the securities underlying the "put" would be analyzed in accordance with the views discussed in this section.
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Takedown Off an Issuer's Shelf Registration Statement for Equity Line Financings
Some companies desire to register, as a primary offering, the issuance of the "put" securities under an equity line. We believe that an equity line financing done as a primary offering in which the "put" price is based on or at a discount to the underlying stock's market price at the time of the "put" exercise is an "at the market" offering under Rule 415(a)(4) and must comply with the requirements of that rule. In this regard, we have been asked the following questions regarding the application of Rule 415(a)(4):
| Q. |
May the company and the investor enter into the equity line agreement before effectiveness of the Form S-3 or Form F-3? |
| A. |
As a general matter, no. However, the company and the investor may enter into the equity line agreement before effectiveness of the registration statement if the investor is a registered broker-dealer acting as an underwriter. |
| Q. |
Rule 415(a)(4)(iv) states "[t]he underwriter or underwriters must be named in the prospectus which is part of the registration statement." This leads to two questions:
- Is it appropriate to name the underwriter or underwriters in a prospectus supplement?
No. The registration statement must identify a registered broker-dealer as an underwriter, either in the base prospectus or a post-effective amendment – it is not appropriate to rely on Rule 424 and use a prospectus supplement for this purpose.
- Who must be named as an underwriter?
The prospectus which is part of the registration statement must identify the investor, in addition to the registered broker dealer, as an underwriter.
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| Q |
How do you calculate the 10% test in Rule 415(a)(4)(ii)? |
| A. |
The entire amount of securities available under the equity line may not exceed 10% of the aggregate market value of the company's outstanding voting stock held by non-affiliates. |
| Q. |
When do you calculate the 10% test in Rule 415(a)(4)(ii)? |
| A. |
This calculation is made at the later of the time the issuer enters into the equity line agreement or files the registration statement for the "at the market" offering. |
| Q. |
May the company and the investors amend the equity line financing arrangement later to permit the entire number of securities available under the equity line to exceed the 10% test? |
| A. |
No. The parties may not amend the agreement in order to exceed the 10% test; the company may not exceed the 10% test unless it enters into an entirely new agreement relating to a separate financing arrangement. In this regard, the company and the investors cannot have agreements to enter into new agreements – we believe that all currently anticipated agreements should be combined in determining the 10% threshold. |
Division of Market Regulation Issues
There may be other issues relating to the underlying or "resale" transaction, including broker dealer registration, compliance with Regulation M or compliance with pre-filing requirements of the National Association of Securities Dealers. We encourage companies and investors to contact the Division of Market Regulation or the NASDR, as appropriate, regarding these issues.
http://www.sec.gov/divisions/corpfin/guidance/ci033101ex_sas.htm
