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Frequently Asked Questions About Regulation M

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Frequently Asked Questions About Regulation M FREQUENTLY ASKED QUESTIONS ABOUT REGULATION M understanding Regulation M Rule 101 What is Regulation M? What is Rule 101 of Regulation M? Regulation M is intended to protect the trading markets Rule 101 prohibits distribution participants and their by prohibiting activities by distribution participants affiliated purchasers from bidding for, purchasing, or that could manipulate the market for a security that attempting to induce any person to bid for or purchase is the subject of an offering. Regulation M impacts the a covered security of a distribution during a restricted activities that may be conducted by issuers, broker- period. We will explain these provisions, and their dealers and other distribution participants around the exceptions, in more detail below. time of a securities offering. Regulation M consists of the following six rules: What constitutes a “distribution”? • Rule 100 – Definitions; Rule 100 defines a “distribution” as a securities offering that is distinguished from ordinary trading • Rule 101 – Activities of Distribution Participants; transactions by the magnitude of the offering and • Rule 102 – Activities of Issuers and Selling Security the presence of special selling efforts and methods. Holders; The number of shares to be sold and the percentage • Rule 103 – nasdaq Passive Market Making; of outstanding shares of the proposed distribution compared to the public float and the security’s • Rule 104 – Stabilizing and Other Activities; and normal trading volume are factors to consider when • Rule 105 – Short Selling. determining the magnitude of an offering.2 Greater than “normal” compensation arrangements, delivery of Does conduct need to be fraudulent or manipulative sales documents such as a prospectus, and conducting to violate Regulation M? road shows are generally indicative of special selling efforts and selling methods.3 In the context of a shelf no. Regulation M is a “prophylactic rule,” and registration that contemplates various selling methods, prohibits certain conduct whether or not it violates each takedown needs to be individually assessed.4 See the anti-fraud provisions of the federal securities laws. “How does Regulation M apply to shelf takedowns?” below. In addition (and conversely), Regulation M is not a “safe harbor” from the anti-fraud rules; conduct can A “distribution” need not be a registered public be unlawful, even if it does not violate Regulation M.1 offering; a private placement can also be a distribution 2 Id at 522. 1 SeC Release nos. 33-7375 and 34-38067, 63 SeC Docket 3 exchange Act Release no. 34-33924, 56 S.e.C. Docket 1302 1141 (1996-1997) (Apr. 1, 1997) (hereinafter referred to as (Apr. 26, 1994), at 6. the “Regulation M Adopting Release”), at 521. 4 See Regulation M Adopting Release, supra, note 1 at 526. 1 Morrison & Foerster LLP Capital Markets under Regulation M.5 A wide variety of private investment discretion with respect to the purchase or placement transactions can be “distributions,” sale of securities. For example, an investment advisory depending on the circumstances, including: subsidiary of an underwriter’s parent company would • Regulation D offerings; and be considered an “affiliated purchaser.” An affiliate of a direct participant that is a separate entity from the • Rule 144A offerings. direct participant and purchases securities for its own account will not be considered an affiliated purchaser What are “covered securities”? if all of the following conditions apply: Covered securities are securities that are the subject • The direct participant: of a distribution or a “reference security.” A reference maintains and enforces policies and procedures security is a security into which the covered security that prevent the flow of information to and from may be converted, exchanged or exercised, or the affiliate; and which may impact the value of the covered security. Derivative securities are not subject to Rule 101 and obtains annual, independent assessment of the therefore, bids or purchases of options, warrants, operation of those policies and procedures. rights, convertible securities or equity-linked securities • The affiliate hasno officers or employees (other than 6 are not restricted by Rule 101. However, during a certain administrative personnel) in common with distribution of derivative securities, Rule 101 does the distribution participant. apply to the underlying security, the value of which affects the return of the derivative security. 7 • The affiliate doesnot, during the applicable restricted period (as described below), act as a market maker (unless acting as a specialist in compliance with Who is considered a “distribution participant”? the rules of a national securities exchange) or as a A “distribution participant” includes any person broker-dealer for a covered security. who has agreed to participate or is participating in This exception accommodates the needs of a distribution, such as underwriters, prospective underwriters and other entities that are part of complex underwriters, brokers and dealers. However, a broker- financial services companies. dealer that performs only ministerial duties and receives a fixed fee for its limited role is not considered a distribution participant.8 What is the Rule 101 “restricted period”? Rule 101 applies only during a restricted period. The What constitutes a “prospective underwriter”? length of the restricted period will differ depending on the type of covered security. For securities with A prospective underwriter is a person who has either: an ADTV (as defined below) of $100,000 or more of • submitted a bid to the issuer or selling shareholder an issuer whose common equity securities have a and who knows or is reasonably certain such bid public float value of $25 million or more, the restricted will be accepted; or period begins on the later of one business day prior to • has reached, or is reasonably certain to reach, an the pricing date or such time that a person becomes understanding that such person will become an a distribution participant and ends on the completion underwriter regardless of whether the underwriting of its participation in the distribution. For all other terms and conditions have been agreed upon. securities, the restricted period begins on the later of five business days prior to the pricing date or such Who is considered an “affiliated purchaser”? time that a person becomes a distribution participant, and ends on the completion of its participation in the An “affiliated purchaser” includes a person acting in distribution. In the case of convertible securities, the concert with or who is controlled by or under common ADTV used to determine the restricted period is that control with a distribution participant. The definition of the convertible security itself and not the reference also includes any separate department or division that security.9 regularly purchases securities for its own account or the account of others or that recommends or exercises 5 SeC Staff Legal Bulletin no. 9, (Oct. 27, 1999, Revised September 10, 2010) (hereinafter referred to as the “SeC Reg M FAQ”). 6 See Regulation M Adopting Release, supra, note 1 at 524. 7 Id at 524. 8 See SeC Regulation M FAQ, supra, note 5. 9 Id. Morrison & Foerster LLP Capital Markets 2 Morrison & Foerster LLP Capital Markets What is the Rule 101 “restricted period” for mergers, When does the distribution period end for an offering acquisitions and exchange offers? with a “green shoe” option? In mergers, acquisitions and exchange offers, the In transactions where an overallotment option is restricted period begins on the day proxy solicitation exercised, the exercise of the option does not affect or offering materials are first distributed to security the completion date, unless the underwriters exercise holders, and ends upon the completion of the their overallotment option for more shares than the net distribution. If the offering is in connection with an syndicate short position at the time that the option is acquisition of a privately held company, the restricted exercised. In such cases, the completion date would period would commence one or five days (depending be extended to the time at which all the excess shares on the type of covered security as described above) have been sold. Furthermore, if there are any excess prior to the day on which the target security holders shares, any bids or purchases by the underwriters are first asked to commit to the transaction.10 made before the exercise of the option could violate Rule 101 of Regulation M.12 If an underwriter joins the underwriting syndicate on the pricing date, will its prior bids or purchases for How can an underwriter protect against violations the covered securities violate Rule 101? of Rule 101 for market-making activities during a no. For such an underwriter, the restricted period distribution period of debt securities subject to a begins when it joins the syndicate. Broker-dealers who green shoe option? become “prospective underwriters” often maintain Some offerings of listed non-convertible debt securities restricted lists or watch lists in order to monitor bids have a green shoe option. As discussed above, if for or purchases of covered securities, in order to avoid an underwriter were to exceed the syndicate short a violation of Regulation M. position at the time that the green shoe is exercised, any previous market-making bids or purchases of How is “business day” defined for purposes of the such debt securities would have been deemed to restricted period? occur during the distribution period and in violation of Rule 101 of Regulation M. There are two options A “business day” is the 24-hour period based on the for underwriters to prevent this type of violation: (1) principal market for the covered security, and includes obtain an investment grade rating from a nationally a complete trading day for that market. recognized statistical rating organization; or (2) police For example, if pricing occurs at the close of trading all sales to ensure that the syndicate short position will in the principal market on Tuesday, and a one business not be exceeded at the time of the green shoe exercise.
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