Recapitalizations And Reorganizations - Securities Regulation

Recapitalizations and Reorganizations

1. Recapitalizations

   1. The "For Value" Requirement

      1. § 2(a)(3) defines "sale" and "offer to sell" as involving "every attempt . . . to dispose of . . . a security . . . for value." (emphasis added)

         • The issue is whether there is a "sale" under § 2(a)(3).

      2. "[F]or value" depends "not only on whether the recipient of the security gives something of value . . . but also on whether value is received from any other source." In re Capital General Corp. (pg. 394)

      3. Free Stock

         • In In re Capital General Corp, after the promoters purchased all the shares of 69 companies and made gifts of the stock to 275 to 900 persons throughout the United States and retained a controlling block of stock for each company, which they later sold for a handsome profit. The Commission concluded that the promoters received value in the form of the public markets that their gifts of stock had fostered. (pg. 394)

         • When many internet start-up companies awarded free stock to individuals who visited the company website, the SEC reasoned that the companies were violating § 5; the staff reasoned that the issuance of stock in consideration of a person's registration on or visit to the company's website fell within the meaning of § 2(a)(3). See, e.g., Vanderkam & Sanders (pg. 394)

      4. Stock Dividends

         • Because there is no consideration for those who receive stock dividends, the typical stock dividend does not involve the sale of a security.

         • Where there is a choice between receiving a cash dividend and a stock dividend, the SEC has taken the position that this is not a sale of a security:

           • "[I]f a corporation . . . declares a dividend payable at the election of the stockholders in cash or in securities, neither the declaration of the dividend, nor the distribution of securities to stockholders who elect to take the dividend in that form, would . . . constitute a sale within the meaning of the Securities Act . . . ." Securities Act Release No. 929 (pp. 394-95)

           • BUT "[I]f . . . there is declared a cash dividend payable to all stockholders, and if the board thereafter determines to grant stockholders the opportunity to waive their preexisting and vested rights to payment of the dividend in cash, and to receive the dividend in the form of securities, the stockholder electing to take securities would . . . be regarded as giving value for the securities so received." Securities Act Release No. 929 (pg. 395)

         • On the other dividend reinvestment programs, in which the stockholders may by prior agreement have their dividend applied toward the purchase of additional shares from the corporation at current market rates, are subject to registration under the Securities Act.

           • An exception to this arises when the dividend reinvestment program is structured so that an entity separate from the issuer purchases on behalf of participating stockholders the issuer's shares on the market, with the cash being the amount that the issuer would otherwise have distributed to those stockholders as a dividend. Under this structure, the SEC has taken the position that this is not the sale. Securities Act Release No. 5515 (pg. 395)

      5. Warrants and Convertible Securities

         • Bonds, warrants, and options are each specifically identified as securities in § 2(a)(1) and must be registered unless an exemption applies.

           • ASIDE: Options are generally not tradable while Warrants are tradable.

         • Whether the underlying security must be registered depends on when, by the instrument's terms, the holder can acquire the underlying security through conversion or exercise of the warrant or option.

           • If the conversion features or the warrant's or the option's terms provide that it can be exercised immediately, two district securities are being offered so that each has to be registered or qualify for an exemption.

           • If by the terms the holder cannot convert or exercise warrants or option until some future date, the underlying security is not "offered for sale" until the future date, and the underlying security's registration is not required at the time the convertible security, warrant, or option is being offered.

             • BUT of course the conversion right itself must be registered.

      6. Amendments to the Articles or Bond Indentures

         • This is re an amendment that changes the terms of securities

         • ISSUES:

           • (1) Whether the amendment is a "sale" of a security under § 2(a)(3)

             • The SEC has been fairly consistent in viewing all material changes in a security's economic or voting rights as entailing the sale of a new security

               • BUT a sale is not involved if the change involves no economic consequences to the holders, such as altering par value. See INDRESCO, Inc., SEC No-Action Letter (pg. 397)

             • Courts are SPLIT

               • Some courts: Changing the terms is functionally equivalent to surrendering the old security for a new one.

                 • In SEC v. Associated Gas & Electric Co., the extension of the maturity date on a bond's indenture was a sale as the lengthening of the maturity date is functionally equivalent to surrendering the old security for a new one. (pp. 397-98)

               • Other courts: Not creating a new security if following the terms.

                 • In Browning Debenture Holders' Committee v. DASA Corp., the court held that no substantial alteration of the bonds had occurred because the original bond indenture authorized alteration of the bondholders' rights. (pg. 397)

             • Where the issue is reincorporation in a different jurisdiction, the SEC staff maintains in No-Action Letters that registration is not required because a reincorporation involves only a change in form, not substance. See, e.g., Adolf Coors Co., No-Action Letter; see also Western Air Lines, Inc. (finding that a Delaware Corporation's amendment of the articles to abolish cumulative voting was a "sale" of a security)

           • (2) Whether the sale involves the type of exchange of securities exempted under § 3(a)(9) - SEE BELOW

      7. Spin-Offs

         • A classic spin off begins with the corporation transferring the assets to be shed to a newly created company, all of whose stock is owned by the transferring corporation. At this point, the new corp. is a wholly owned subsidiary.

           • Next the company distributes stock to the parent's stockholders pro rata.

             • If the parent does not retain a controlling interest, it is now independent.

         • SEC v. Datronics Engineers, Inc. (pg. 400)

           • In this case, Datronics spun off several corporations that each did not have any business purpose of its own.

           • The court found that this was a § 5 violation because the transfer of the stock to new assignees created a new market and created enhanced value for the shares that Diatronics retained; therefore, this was for value.

         • In SEC v. Harwyn Indust. Corp., the court held that the company violated § 5 by spinning off four of its subsidiaries through a series of stock dividends.

           • The court concluded that registration was required because each spin off lacked a business purpose; thus, each was viewed as a scheme to create a public market for unregistered securities.

             • Registration is less likely if the spin-offs have a proper business purpose.

           • BUT subsequent decisions have held that spin-offs that are accompanied by misleading disclosures do not involve the purchase or sale of a security. See Isquith v. Caremark International, Inc. (pg. 402)

         • Notwithstanding the proper business purpose discussion, the SEC staff, although still concerned with whether there is a proper business purpose, has placed far greater emphasis on whether the spin-off was accompanied by adequate information available about the spin-off. See, e.g., Genge Industries, Inc., SEC No-Action Letter (pg. 402)

           • The current staff position focuses on whether the distributee-shareholders are provided an "information statement" (a document that contains information similar to that found in a registration statement, proxy statement, or annual report)

           • When the spun-off company is not a reporting company and will not soon become one, the staff has conditioned its no-action letters on the shares being subject to transfer restrictions such that no public market is created.

         • Currently, the SEC staff requires that all sales of spun-off shares by an affiliate to comply with Rule 144 and sales by non-affiliates must be pursuant to Rule 144 if the spun-off company is not a reporting company.

           • If the spun-off shares are those of a reporting company, non-affiliates may dispose of their shares without concern over Rule 144.

         • A reverse merger is another way to do a spin-off.

         • The SEC adopted Rule 15c2-11 to address spin-offs and the concern over public trading in securities about which there is little public information.

           • Subject to certain exemptions, the Rule prohibits a broker or dealer from submitting a quotation for a security in a quotation medium unless it has in its records specified information concerning the security and the issuer, in certain circumstances, furnishes the information to the interdealer quotation system two days before the publication of such quotation.

2. Reorganizations

   1. Mergers, Acquisitions, and Recapitalization

      1. Business combinations and recapitalizations trigger § 5 concerns whenever they involve the issuance of securities.

      2. Three ways to do an acquisition:

         • (1) Merger

         • (2) Share Exchange (stock for stock)

(3) Asset Transaction (stock for assets)

3. Rule 145(a): In any corporate reorganization, if a shareholder vote is required, then subject to the '33 Act.

   • Rule 145(c) expands the scope of underwriter to include a holder who was a control person of the acquired or recapitalized ...