June 2007 SEC FORMALIZES ITS POSITION ON PIPE TRANSACTIONS By Jeffrey T. Hartlin, Elizabeth A. Brower and Michael L. Zuppone Private investment in public equity offerings, labeled primary offering made on behalf of the issuer, in which “PIPEs” by market participants, have become a case the PIPE investors would be viewed as effectively permanent alternative for raising equity capital by public acting as statutory underwriters with respect to the companies in need of financing. Pursuant to informal resale of their shares to the public. guidance issued by the Staff of the Securities and BACKGROUND Exchange Commission (“SEC”) in the mid 1990s, PIPEs have been treated as completed private placements not PIPE transactions have two components. The first subject to integration with subsequent registered component involves the original issuance of the secondary offerings by selling securityholders. Under securities – i.e., the private placement of securities by a this guidance, PIPE investors have been able to have the public company to one or more accredited investors in shares issued in (or the shares underlying convertible reliance on the statutory private placement exemption securities issued in) the PIPE transaction registered for provided by Section 4(2) of the Securities Act and/or public resale into the trading market concurrently with private offering exemption provided by Regulation D or soon after the closing of the PIPE transaction. under the Securities Act. The securities sold in PIPEs Recently, as described below, the treatment of PIPEs may include common stock, straight or convertible investors in registered offerings as just selling preferred stock, convertible debt or a combination of securityholders, as opposed to statutory underwriters, these securities, as well as warrants that are issued to has been called into question in certain circumstances. investors as a “sweetener.” Since they are privately placed to the PIPE investors, such securities are In a series of recent public statements, the Staff of the considered “restricted securities” within the meaning of SEC’s Division of Corporation Finance has provided the rules under the Securities Act. informal guidance as to the circumstances, under which it would view a registered offering of securities on behalf Because the PIPE investors require resale liquidity, the of PIPE investors as a primary offering on behalf of the second component involves the filing of a registration issuer. In these circumstances the offerings would no statement by the issuer to register with the SEC the longer be viewed as permissible delayed or continuous reoffer and resale of the shares issued in the PIPE by the secondary offerings on behalf of selling securityholders investors as named selling securityholders on a delayed under Rule 415(a)(1)(i) of the Securities Act of 1933 (the or continuous basis in one or more transactions at “Securities Act”), which permits delayed or continuous varying prices (i.e., variable priced). Although the PIPE offerings on behalf of unaffiliated selling securityholders. can be structured so that an effective registration In particular, the Staff indicated that, if the number of statement is a condition to the closing of the PIPE, most shares proposed to be registered on behalf of PIPE PIPEs today provide for the filing of a registration investors constitutes more than one‐third of the issuer’s statement with the SEC within some number of days non‐affiliate public float (i.e., one‐third of the after the PIPE is closed. Once the SEC declares the outstanding shares held by non‐affiliates) immediately registration statement effective, the PIPE investors are prior to the PIPE transaction, the Staff will then generally able to freely resell their shares in the presumptively view the proposed registered offering of trading market. shares for resale by the PIPE investors as an indirect 18 Offices Worldwide | Paul, Hastings, Janofsky & Walker LLP | www.paulhastings.com StayCurrent PIPEs offer a number of advantages over other financing to the PIPE, the registration will be presumed to be a primary alternatives. In particular, PIPEs allow issuers to raise offering on behalf of the issuer, and the PIPE investors whose capital much more quickly than an SEC registered shares are being registered will be deemed underwriters of the primary public offering by the issuer. Moreover, PIPEs offering. That is, the SEC will presume that the investors may be completed on a confidential basis. With are effectively acting as a conduit for issuers to sell registered public offerings, issuers are often forced to shares directly to the investing public. publicly announce their intent to sell shares by filing a The Staff appears to be particularly concerned that registration statement with the SEC in advance of pricing issuers may be attempting to disguise offerings made on and confirming purchase orders from investors. In many their behalf as offerings made on behalf of PIPE investors cases, issuers are not shelf registration eligible, or if shelf in order to obtain the benefits of shelf registration, registration eligible, other factors are present that would including the ability to effect an “at the market” offering prevent a shelf takedown either as an overnight bought to the public on a delayed or continuous basis using a deal or a confidentially marketed direct public offering. Form S‐3 shelf registration statement that the issuer The filing of a registration statement or a Red Herring might not otherwise be eligible to use. Although the Staff prospectus filed under a shelf registration statement for a announced that it does not intend to release formal marketed offering has a tendency to create “overhang,” guidance on this issue, it has informally articulated where the market perceives the pending issue as several points that issuers must address in PIPE potentially dilutive, which can exert downward pressure registration statements. Issuers must address on an issuer’s stock price and ultimately reduce the price at which shares may be sold by the issuer in the offering. • how long the investors have held the shares, the On the other hand, most PIPEs do not require any public circumstances under which the investors received disclosure by issuers until their purchase agreement with the shares, the investors’ relationships to the issuer, investors has been executed and the price at which the the amount of shares involved in the registration, securities are sold has been determined. whether the investors are in the business of underwriting securities and whether, under all the Historically, the Staff has permitted issuers to register a circumstances, it appears that the investors are significant number of shares issued in PIPE transactions acting as a conduit for the issuer.1 for reoffer and resale by PIPE investors under a “resale shelf” registration statement as permitted by Rule • the number of investors included in the registration 415(a)(1)(i) under the Securities Act. Rule 415(a)(1)(i) and the percentage of the offering being sold by each allows issuers to register the reoffer and resale of the investor; shares issued in the PIPE on behalf of investors, who are • the identities of the natural persons with voting or able resell them over time on a delayed or continuous investment power over the securities registered on basis in one or more transactions at varying prices, rather behalf of the investors; than at a fixed price. In many cases, the Staff has accepted for filing resale shelf registration statements • the relationships among the investors; that have included shares representing more than 75% • any payments the issuer has made, or will make, to (and in some cases, more than 100%) of the issuer’s non‐ the investors, their affiliates and/or the placement affiliate public float. agent for the PIPE; THE STAFF’S “NEW” POSITION • the net proceeds received by the issuer from the The New One-Third Test PIPE after taking into account all payments and expenses (i.e., how much the issuer will actually Beginning in 2006, the Staff began cracking down on receive from the sale of the securities); issuers attempting to use Rule 415(a)(1)(i) to register the shares issued in large PIPE transactions for immediate • how the issuer determined the number of securities resale by investors. Specifically, through a series of to sell to investors in the PIPE; public presentations and interviews, members of the Staff announced the following position: if an issuer seeks 1 These factors are set forth in Question D. 29 of the Staff’s to register shares issued in a PIPE that constitutes one‐third or Manual of Publicly Available Telephone Interpretations. more of its shares held by non‐affiliates as of immediately prior 2 StayCurrent • if the issuer sold convertible securities, the issuer’s INITIAL RESPONSE BY ISSUERS AND good faith estimate of the actual number of shares INVESTORS that will be issued to the investors upon conversion The Staff’s new guidance began taking shape through a of those securities (i.e., the maximum dilutive effect series of comment letters delivered to issuers attempting of these securities); to register shares constituting a substantial portion of • if the issuer sold convertible debt, the issuer’s ability their public float for resale by PIPE investors. Issuers or intention to repay the debt; have attempted to respond to the Staff’s comment letters in a variety of ways including the following: • if known to the issuer, the current short positions held by any of the investors; and • by referring the Staff to the issuer’s prior resale registration statements that included an equally • whether the issuer had recently completed one or large percentage of the issuer’s stock and noting they more financings with the same group of investors were declared effective with little, if any, reaction (i.e., whether the issuer is disguising one large PIPE from the SEC.