A so-called “safe harbor” rule pertaining to private placements and initial public offerings was adopted by the Securities & Exchange Commission late last month. While the new ruling appears unlikely to trigger significant controversy, the fact that it addresses a dilemma in the making for several years caused some to concede that its adoption comes a day late and a dollar short in today’s stymied market.
The Integration of Abandoned Offerings, or Rule 155, was adopted unanimously by the SEC in mid-January. It was originally proposed as part of an overhaul of U.S. securities laws dubbed the SEC’s “aircraft carrier” proposal some two years ago.
Rule 155 is set to become effective March 7, said John Heine, an SEC spokesperson. Although President Bush is seeking a 60-day freeze on regulations adopted at the end of President Clinton’s term, Heine stated the SEC decided to follow through with this one. Rule 155 is considered non-partisan, said Heine, and as an independent regulatory agency, the SEC was not bound by law to follow the Bush directive.
Under Rule 155, companies must now only wait 30 days before a private placement round can take place. This new regulation essentially makes the lengthy exception-to-the-rule maneuvering unnecessary and saves a lot time, money and sanity for attorneys and their clients.
Paul Blumenstein, a partner with law firm Grey Cary, said the only piece that may be more significant than it appears on the surface is the added level of disclosure now required in the new S-1 registration, should the company attempt a public offering again. “You need to disclose any material changes in your business since the filing of the last S-1,” he said, adding that he was advising his clients to record these changes in the “Schedule of Exceptions” document commonly contained in an S-1.
A Perpetual Cycle Of Collapse
“If a company failed to follow through with a public offering, and they found they were in a position of needing cash, they were caught in a bind,” Blumenstein said. “And this gray area was something you as a lawyer or a banker would worry about.”
The SEC had set forth regulations that set up hurdles for companies with failed public offerings. In short, if the IPO failed and was pulled, it became difficult for a company to seek alternative capital to stay afloat purely because an S-1 had been on file. The waiting period between the pulled S-1 and when a company could seek a private placement round was at least six months. However, the established criteria were ambiguous and the process was extremely time consuming – and if not approved by the SEC, such private placement rounds jeopardized the chances of any future public offering from the company.
“How do you raise money to survive? That was the question that had always been there,” said Laird Simons, head of the securities group for Fenwick & West. “And we all saw a huge exacerbation of this problem when the market collapsed [last April].”
Because a company had an S-1 on file, the SEC felt the organization had made a general solicitation. Succeeding in legally receiving a private placement round, and not endangering a future public offering, requires a melee of legal maneuvers that must be performed and then approved by the SEC. In its most basic terms, companies have one of two routes to take.
In Plan A, the private placement round could take place, but the SEC severely restricts the type of investor allowed to ante up the capital.
“Up to three, large, accredited investors,” said Blumenstein. “And if you don’t do it right, in a technical sense you’ve made a private offering without registering it.”
Such moves would severely handicap a future IPO. When the company filed a new S-1, the SEC would ask for an analysis from the corporate lawyers of why the private placement round was not registered properly. If the SEC was not satisfied with the answer, it would contend the company had violated registration, and the new filing would now have a recision obligation. That raised the potential that those who bought stock in the ultimate initial public offering had the right to get their money back, because the placement round from the period of first attempt to go public was not disclosed.
In Plan B, a company would petition the SEC that the second attempt at an initial public offering was, in fact, a completely different type of security offering than the previous attempt. However, there are about five criteria that have to be met in order to get such a designation, but the SEC guidelines are not crystal clear on those factors.
“You run the risk of getting into a “yes-it-is, no-it’s-not” argument with the SEC,” Blumenstein explained. And with the SEC ultimately holding the discretionary power, a company is unlikely to come out of such a debate unscathed.
Better Late Than Never
While running afoul of the existing SEC regulations was not necessarily commonplace in the past, recent developments triggered a flood of outcry from the legal community to address the situation. The evolution of the New Economy led to the advent of young start-ups flooding the IPO market over the last two years. Suddenly, IPO capital was being sought after by companies that did fit the traditional profile.
“This is why it suddenly became important. Lots of people were suddenly in this situation,” said Simons
Most believe the SEC finally approved Rule 155 because it didn’t want its regulations to become the catalyst for the collapse of hundreds of companies and thousands losing their jobs. However, in looking over the halted IPO market of this year, its adoption in 2001 now seems to be behind the times.
“It some ways you could say it’s eight months too late,” noted Simons. “It’s solving a problem a little after the barn door has closed.”
Nonetheless, Blumenstein said that at least the rule is in place to deal with markets of the future. “While it may be late, it has made people like me a lot happier than with other rule changes,” he said.