#13159 - Secondary Distributions - Securities Regulations (Duke Cox)

Overview/ Underwriter concept/ purchases from issuer

1. Issuer sales are known as primary offerings, and sales by others are referred to as either trading transactions or secondary distributions

   1. Trading transactions are exempt from §5, and secondary distributions are not

2. §5 literally requires that every sale be either registered or exempt. 4(a)(1), which exempts all transactions except those by an issuer, underwriter, or dealer. 2(a)(11) defines underwriters as any person who purchases from an issuer with a view to the distribution of a security

   1. Purchase

      1. The underwriter must purchase “for value”

         1. A donee is not an underwriter unless one can find as a condition of the gift an undertaking by the donee that would constitute the giving of “value”

   2. View to investment intent? If yes, not underwriter.

      1. Look at circumstantial evidence to determine intent to hold the security indefinitely

      2. Holding the shares for two years may create a presumption of investment intent

      3. What kind of changed circumstances will indicate original investment intent?

         1. Change in circumstances of the holder of the security

         2. Change in issuer circumstances doesn’t count

         3. Examples:

            1. Sell the securities to prevent a bankruptcy

   3. Distribution

      1. A distribution is resale that is inconsistent with the issuer’s exemption

         1. If the issuer could have sold securities to A, then you can sell it to the same person.

         2. This is similar to a 3(a)(11) intrastate offering: a Texan can resell to another texan

      2. Opposite of a private transaction

         1. Distribution to a market

         2. No assurance that individuals can fend for themselves

   4. Problem 6-1: no, he didn’t purchase the shares, with a view to distribute it.

   5. Problem 6-2 16 months ago, Beatrice purchased 1000 unregistered chromium mines inc common shares through a private placement. much to her surprise, beatrice has just been admitted to the prestigious and expensive Padooka University graduate school. If beatrice now sells her chromium shares to pay the tuition deposit demanded by pdooka univ, will she violate section 5?

      1. no view to: you’re selling it to pay for school, change of circumstances

   6. 6-4: A year ago, burt acquired 1000 shares of SunTech in a private placement. SunTech’s annual report, which has just been released, reflects that earnings have quadrupled in the past year. Burt is ecstatic and also in need of cash for a new addition to his house and has approached his neighbor Carol, a broker dealer, about possibly reselling the shares. Carol offers to contact several of her clients about their purchase of Burt’s shares. Burt agrees. Before Carol actually begins soliciting her clients, she asks your advice. What would you tell Carol?

      1. question of whether Burt had investment intent -- only been a year, but possibly changed circumstances: he needs cash for a new addition to his house

      2. was there an exemption relied upon in the private exemption? if yes, Burt can only sell shares to persons that SunTech could have sold to in the private placement

   7. 6-5: assume in problem 6-4 that, when Burt acquired his SunTech shares, there already existed trading in SunTech shares in the OTC market. Nevertheless, SunTech had issued shares to selected purchasers in a private placement to raise funds quickly and cheaply. One year after purchasing his shares, Burt approaches Carol about selling the shares into the OTC market. How would you advise Carol?

      1. This is a distribution (OTC market)

   8. 6-6: What results if the shares had been sold to Burt as part of a registered offering and shortly after Burt purchased those shares he resold them through Carol in the OTC market?

      1. so long as Burt is not a control person this is fine: once you registered the distribution, the distribution contemplates a resell. So it’s okay to resell.

Private investment in public equity

1. In a typical PIPE, the company relies on an exemption from SEC registration requirements to issue investors common stock or securities convertible into common stock for cash. The company then registers the resale of the common stock issued in the private placement, or issued upon conversion of the convertible securities issued in the private placement, with the SEC. Generally, investors must hold securities issued in a private placement for at least one year. However, because the company registers the resale of the PIPE shares, investors are free to sell them into the market as soon as the SEC declares the resale registration effective

   1. Contract with issuer is that issuer will register shares in the future (new round of shares)

      1. You can then exchange shares you receive for the registered shares

   2. The opposite of shelf registration raise capital, then register security

      1. 1) issuer issues private shares to hedge fund

      2. 2) Issuer registers shares

      3. 3) Hedge fund gives up restricted shares and gets registered shares

      4. 4) Hedge fund gets rid of shares cover short position or sell into market

2. The large majority of PIPE deals are undertaken by small public companies. These companies generally pursue PIPEs not because they offer advantages over other financing alternatives, but because the companies have no other financing alternatives

   1. Desperation financing

3. How do hedge funds make money? See problem 6-7 on page 355.

4. Problem 6-7: Quick Buck has earned significant profits by repeatedly carrying out following investment strategy: acquires from public companies via private placements preferred shares from the issuing company that at some later date are convertible into the issuer’s common shares (usually on a 1 to 1 basis). Because the preferred shares are restricted, QB is able to purchase at a discount. Following announcement of private placement, the issuer’s common shares invariably decline in value (because dilutive effect of the discount). In advance of this announcement, QB secretly engages in substantial short selling of the issuer’s common shares. Upon registration of the issuer’s common shares, QB covers its short position by converting restricted preferred shares into registered common shares (= pocketing substantial profits)

   1. SEC has tried to argue that this is not okay but lost case because the PIPE shares used to cover the short positions cannot be considered sold or offered for sale pursuant to section 5

5. 6-8: Assume in 6-7 that issuer is Logicon Devices and that it does not meet issuer criteria for Form S-3. Why doesn’t QB’s resale to the public of the registered security nullify Logicon’s exemption? What if it’s treated as a shelf takedown?

   1. The exemption is not nullified because of Rule 152: a subsequent public offering does not nullify the exemption of a previous private placement.

   2. Then it will be treated as a shelf takedown. 415(a)(1)(x) only available for S-3 issuers. This will be problematic.

Control Person Distributions and Brokers’ Exemption

1. One who purchases from a control person with the view to distribution is an underwriter go back to 2(a)(11): purchase, view to, distribution

2. Who is a control person?

   1. Managerial position able to influence company policy: CEO, CFO, directors participating in the process of making company policy

3. 2(a)(11) provides that a control person is an issuer, but only for the purpose of determining whether the person who purchases from or sells for the control person is an underwriter. A control person is not an issuer for other purposes of the Act because the control person is not included within 2(a)(4)’s definition of an issuer

   1. The control person therefore is not able to use the issuer-based exemptions established in 4(a)(2) or 4(a)(5) and (6), Regulation D, or Rule 147

4. If the issuer’s distribution has not come to rest, the resale is evaluated in terms of its impact on the exemption the issuer relied on in offering the security. The person reselling the security, whether or not a control person, is simply an intermediary in the issuer’s transactions

   1. But if the distribution has come to rest, then the control person has the ability to begin a new distribution

      1. Then we conduct the underwriter analysis

5. Three significant control relationships are implicated in 2(a)(11)’s broad sweep:

   1. Any person controlling the issuer

   2. Any person controlled by the issuer

   3. Any person under common control with the issuer

144: regulates the resale of two categories of securities: restricted securities and control securities

1. Restricted securities are securities acquired pursuant to one of the transactions listed in 144(a)(3)

   1. 144(a)(3)(i): only 4(a)(2) and 4(a)(5) private offering is restricted

   2. 144(a)(3)(ii): Reg. D. shares subject to resale restriction are restricted

      1. You don’t need to see if Reg. D. offerings satisfy the Reg. D. requirement.

2. 144(b)(2) “Control securities” is used to refer to securities held by an affiliate of the issuer, regardless of how the affiliate acquired the securities

3. Must satisfy the following conditions:

   1. 144(c)(1) Must be adequate current public information available about the issuer

      1. 144(b)(i) for restricted shares, if the shares are issued more than a year, there is no information requirement.

   2. 144(d) If the securities being sold are restricted securities, the security holder must have held the security for a specified holding period

      1. 6 months for reporting companies; one year for non-reporting companies

      2. T or F: Automatic tacking: period of time begins when the shares are issued. Need 6 months from the time of issue to time of transfer

   3. For control person: the...