By Anna T. Pinedo and James R. Tanenbaum, Morrison & Foerster
In a world dominated by Twitter tweets, Facebook status updates and a proliferation of reality television shows, a commentator may naturally wonder whether the traditional bounds between private and public have fallen away. As we are securities lawyers, we tend to be more focused on the blurring of lines between private placements and public offerings, than on whether the Kardashians are sharing too much information.
It was not that long ago that a company's financing life cycle was rather predictable. An emerging company financed its growth by raising capital from friends and family, willing angel investors, and, if it were lucky, venture or private equity investors. These offerings were structured as private offerings, exempt from the registration requirements of Section 5 of the Securities Act. After a number of successful financing rounds, the company might be ready to take the next step and pursue an initial public offering, or IPO. Once public, the company might subsequently turn to the capital markets again through a follow-on offering, if it needed to raise additional funds.
Over time, regulatory reforms brought greater certainty to private placements and exempt offerings, through the adoption of Regulation D and the promulgation of the Rule 144A resale safe harbor. The holding period for securities not sold in public offerings, or restricted securities, has been shortened several times. In addition, market structure changes contributed to greater liquidity for restricted securities, and also resulted in significant changes to the IPO market. Over the last two decades, more and more companies (both private and public reporting companies) have come to rely on exempt offerings, and securities offering methodologies have morphed as new forms of hybrid offerings have become more popular. A recent study by the SEC's Division of Risk, Strategy, and Financial Innovation noted that there has been a shift from public to private capital raising, with more capital having been raised over the last three years through private offerings. It is easy to trace the rise of Regulation D offerings, and the development of private investment in public equity (PIPE) transactions, as well as that of public offerings that bear many of the characteristics typically associated with private offerings, such as registered direct offerings and wall-crossed or confidentially marketed public offerings. The recently enacted Jumpstart Our Business Startups (JOBS) Act likely will contribute to an even greater reliance on private offerings and to more blurring of the lines between private and public.
JOBS Act Eases General Solicitation Prohibition
Even prior to the JOBS Act, the SEC had been considering whether this prohibition against general solicitation made sense given the prevalence of internet communications and the use of social media. Many market participants had suggested that the SEC consider “deregulating” offers, and focus instead on the actual purchasers in exempt offerings. The JOBS Act requires that the SEC undertake rulemaking to revise the prohibition against general solicitation. Within 90 days of enactment of the JOBS Act, the SEC must revise Rule 506 to make the prohibition against general solicitation or general advertising contained in Rule 502 inapplicable in the context of Rule 506 offerings, provided that the issuer takes reasonable steps to verify that all purchasers in the offering are accredited investors. Also within the same time period, the SEC must revise Rule 144A(d)(1) to permit the use of general solicitation or general advertising in connection with Rule 144A offerings.
While it is clear that during this interim period, prior to SEC rulemaking, market participants should continue to refrain from the use of general solicitation and general advertising, there are a number of questions left unanswered by the JOBS Act. For example, the Act remains silent on the Section 4(2) private offering exemption. Generally, a statutory private placement involves an offering to a limited number of financially sophisticated offerees who: are given access to information relevant to their potential investment, have some relationship to each other and to the issuer, and are offered securities in a manner not involving any general advertising or general solicitation. As we noted above, an issuer often structures its private offering as a Regulation D/Section 4(2) offering, such that if the issuer fails to satisfy a condition of Regulation D, it may still rely on the broader Section 4(2) exemption. Will the Section 4(2) exemption be available if general solicitation has been used? Over the years, courts have considered closely whether investors contacted in connection with an offering had a pre-existing relationship with the issuer. Of course, relaxing the ban on general solicitation would seem to diminish the significance, at least in the context of Rule 506 offerings, of a pre-existing relationship. SEC staff has indicated that the SEC will not address Section 4(2).
There are a few other ambiguities which may be addressed by the staff in connection with its rulemaking in the area. The JOBS Act does not address the prohibition against “directed selling efforts” contained in Regulation S. For cross-border offerings structured as Rule 144A/Regulation S offerings, in the absence of further guidance, a general solicitation may be regarded as a directed selling effort.
Testing the Waters; Integration Issues
First, of course, this is a departure from the traditional offering communications framework. Securities practitioners have long been worried about communications conducted by an issuer or on its behalf prior to the filing of a registration statement. Those communications might have constituted “gun-jumping” or conditioning of the market. Now, the JOBS Act sanctions limit communications by the issuer prior to the filing of a registration statement. These communications presumably may be initiated to persons with whom the issuer has no pre-existing relationship. Again, this seems to diminish the significance of a pre-existing relationship even in the context of a “limited” offering.
The ability to use general solicitation in the context of Rule 506 offerings, and the ability to test the waters, will test existing notions regarding the “integration” of securities offerings.
Often, an issuer that intended to conduct an IPO found that the IPO window had closed and the process had extended itself, and the issuer needed to complete a private placement. One could also foresee a different dynamic now. A private equity investor approached during the test-the-waters process might be interested in making a private investment prior to the IPO. The SEC has the view that under appropriate circumstances an issuer may conduct a private offering at the same time as a registered public offering, without having to limit the private offering to QIBs and a few additional large institutional accredited investors, or to the issuer's key officers or directors. Provided that the investors in the private offering were contacted about, and became interested in, the exempt offering through some means other than the filing of the registration statement for the public offering, and there has been no general solicitation, then the prior filing of a registration statement alone would not impact the potential availability of a private placement exemption. The SEC's analysis typically focuses on whether the investors in the private placement had a pre-existing relationship with the issuer and were contacted directly by the issuer or by an agent on its behalf outside the public offering effort. This analysis will need to be revised in a post-JOBS Act world.
One could see that there might be some confusion during a test-the-waters process, during which an issuer is in fact approaching institutions about a potential investment.
In connection with its adoption of Rule 155(c), the staff noted: “We believe that ordinarily an issuer would not be inclined to incur the costs of preparing and filing a registration statement with the intention to withdraw it later and commence a private offering. Nevertheless, we wish to assure that issuers do not use this integration safe harbor merely as a mechanism to avoid the private offering prohibition on general solicitation and advertising. At the time the private offering is made, in order to establish the availability of a private offering exemption, the issuer or any person acting on its behalf must be able to demonstrate that the private offering does not involve a general solicitation or advertising. Use of the registered offering to generate publicity for the purpose of soliciting purchasers for the private offering would be considered a plan or scheme to evade the registration requirements of the Securities Act.” Of course, post-JOBS Act, there will be no prohibition on general solicitation, and the purpose of permitting test-the-waters communications is precisely to permit an issuer to withdraw from the IPO process if there is insufficient interest. All of this suggests that the JOBS Act may require revisiting some integration safe harbors.
Private companies may find Regulation A+ offerings a compelling capital raising alternative. A Regulation A+ offering may be more useful than a Rule 506 offering. Regulation A does not impose any limitations on offerees. In contrast to Rules 505 and 506 of Regulation D, and Section 4(2) of the Securities Act, Regulation A does not limit the number of offerees or investors that can participate in the offering, nor does it impose any requirement that offerees be accredited investors. Securities offered and sold pursuant to Regulation A are offered publicly and are not “restricted securities.” The securities are freely tradable in the secondary market (assuming that there is a secondary market) after the offering. No holding period applies to the securities purchased in this type of offering. This may be important to certain institutional investors that are subject to limitations on investments in “restricted securities.” A company also may consider conducting a Regulation D offering, or a Regulation S offering, after it has completed a Regulation A-type offering. A company may choose to remain a nonreporting company even after it completes the Regulation A-type offering. Alternatively, a company may choose to list its securities and become a reporting company contemporaneous with undertaking a Regulation A-type offering. In essence, a Regulation A+ offering may be a company's “IPO” but the company will still have available to it the opportunity to submit confidentially its registration statement for its first registration statement for the public offering of its equity securities.
Anna T. Pinedo, a partner at Morrison & Foerster, concentrates her practice on securities and derivatives. She represents issuers, investment banks/financial intermediaries, and investors in financing transactions, and is, with James R. Tanenbaum, the co-author of “Exempt and Hybrid Securities Offerings,” a treatise on securities matters. James R. Tanenbaum chairs Morrison & Foerster's Global Capital Markets practice. He concentrates his practice on corporate finance and the structuring of complex capital markets transactions.
© 2012 Morrison & Foerster LLP
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