Rule 155 Creates Safe Harbors for Two Common Integration Situations

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1 NUMBER 143 FROM THE LATHAM & WATKINS CORPORATE DEPARTMENT BULLETIN NO. 143 MARCH 30, 2001 Rule 155 Creates Safe Harbors for Two Common Integration Situations The SEC adopted Rule 155 (Release No ) to provide issuers with more flexibility to react to volatile capital market conditions. Effective March 7, the Securities and Exchange Commission s (SEC) rules regarding integration of offerings were supplemented by Rule 155. The Rule creates safe harbors to allow (i) a public offering immediately following an abandoned private offering and (ii) a private offering 30 days after an abandoned public offering, without integrating the public and private offerings in either situation. These safe harbors provide issuers with more flexibility to react to volatile capital market conditions. The Rule (Release No ) enhances an issuer s ability to quickly abandon a public offering in favor of a private offering, or vice-versa, in response to changing capital market conditions without the SEC viewing the abandoned offering as part of the new offering or raising general solicitation or gun-jumping concerns. Before the adoption of Rule 155, an issuer that was unable to satisfy the conditions under the traditional all facts and circumstances integration test could have had to wait for months after the abandonment of a registered offering before commencing a private offering to be certain that the SEC would not view the two separate offerings as a single integrated offering. Amendments to several other rules became effective simultaneously with the adoption of Rule 155 to allow for the wider utilization and enhancement of the public-to-private-offer safe harbor. Rule 477 was amended to allow automatic effectiveness for any application to withdraw a registration statement before it becomes effective provided that the SEC does not object within 15 days of such application. Rules 429 and 457 will be amended to allow any filing fees paid to the SEC in connection with a withdrawn registration statement to be applied to any future registration statement filed over the next five years. 1 This Client Alert outlines the basic requirements of the two new safe harbors. It also discusses the implications that Rule 155 will have on the SEC s prohibitions against general solicitation in private offerings and gun jumping in registered offerings. Background: The Traditional Integration Doctrine is Still Effective The SEC adopted the integration doctrine to prevent issuers from artificially dividing offerings in order to avoid the registration requirements of Section 5 of the Securities Act. Under this doctrine, the integration of

2 an offering for which a private exemption is claimed with another offering (or offerings) results in the loss of an exemption for each of the purportedly separate offerings unless an exemption is available for the integrated offering taken as a whole. Regulation D, which regulates private placements, provides that the determination as to whether separate sales of securities are part of the same offering (i.e., are considered integrated ) depends on the particular facts and circumstances. Through two interpretative releases and numerous no-action letters, the SEC has created a five-factor test to help issuers identify when the SEC will view separate offerings to be an integrated offering. The five-factor test is as follows: Are the offerings part of a single plan of financing? Do the offerings have the same general purpose? Are the offerings of the same class of security? Are the offerings made at or about the same time? Are the securities sold for the same type of consideration? Practitioners also consider a sixth factor: Are the offerees in each offering of the same class or character? In the past, issuers that were not certain whether the SEC would view their separate offerings as a single integrated offering based on the traditional all facts and circumstances test were forced to wait up to six months 2 after the abandonment of a registered offering before commencing a private offering in order to be sure they qualified for Regulation D s safe harbor. Rule 155 is not intended to nor does it affect this traditional all facts and circumstances integration analysis. Nor does it affect the Black Box no-action letter or its progeny. The Rule 155 safe harbors are intended to provide clarity and certainty for two common situations that in the past have been a source of confusion and uncertainty for practitioners. An issuer may still look to the all facts and circumstances test to determine if two offerings that do not qualify for the Rule 155 safe harbors should be integrated. Registered Offering Following an Abandoned Private Offering In the past, if a private placement was integrated with a subsequent public offering under the traditional test, the SEC would view the offers to sell the securities in the private offering as a violation of Section 5(c) of the Securities Act. Rule 155(b) insures that in such a situation the two offerings will not be integrated. As adopted, Rule 155(b) provides that an issuer that complies with the following conditions will qualify for the first safe harbor: No securities were actually sold in the private offering 3, The issuer and any person(s) acting on its behalf terminate all offering activity in the private offering before the issuer files the registration statement, Any prospectus filed as part of the registration statement discloses information about the abandoned private offering, including: the size and nature of the private offering, the date on which the issuer terminated all offering activity in the private offering, that any offers to buy or indications of interest in the private offering were rejected or otherwise not accepted, and that the prospectus delivered in the registered offering supersedes any selling material used in the private offering, and The issuer does not file the registration statement until at least 30 calendar days after termination of all offering activity in the private offering, unless the issuer and any person acting on its behalf offered securities in the private offering only to persons who were (or who the issuer reasonably believes were) accredited or sophisticated investors. 4 BULLETIN NO MARCH 30, 2001

3 These requirements are intended to insure that investors in the public offering fully understand that any offers to sell securities in the abandoned private offering are withdrawn and are distinct from the offer to sell securities in the registered offering. Because the typical private placement does not result in the sale of a security until the closing date and offers to sell the securities are usually restricted to accredited or sophisticated investors, this new safe harbor will allow most issuers to commence a registered offering immediately after abandoning a private offering, provided that the prospectus contains the proper disclosure and the issuer and its agents cease all marketing activity under the private offering. Private Offering Following an Abandoned Public Offering As stated above, issuers were required to wait for up to six months before the initiation of a private offering after an abandoned public offering if they wished to avail themselves of the Regulation D safe harbor. A determination that an abandoned public offering and a subsequent private offering should be integrated would make the private placement exemption unavailable because the abandoned registration statement would be viewed as a general solicitation for the securities offered in the private placement. 5 Rule 155(c) provides a safe harbor for qualifying private placements following a withdrawn public offering. As adopted, Rule 155(c) provides that an issuer that complies with the following conditions will qualify for the second safe harbor: No securities were actually sold in the registered offering; The issuer withdraws the registration statement under Rule 477; Neither the issuer nor any person acting on its behalf commences the private offering earlier than 30 calendar days after the effective date of withdrawal of the registration statement; The issuer notifies each offeree in the private offering that: the offering is not registered under the Securities Act, the securities will be restricted securities as defined in Rule 144(a)(3) and cannot be resold without registration unless an exemption is available, purchasers do not have the protection of Section 11 of the Securities Act, and a registration statement for the abandoned offering was filed and withdrawn, specifying the effective date of the withdrawal, and Any disclosure document used in the private offering discloses any changes in the issuer s business or financial condition that occurred after the issuer filed the registration statement that are material to the investment decision in the private offering. As with Rule 155(b), Rule 155(c) is intended to insure that investors in the private offering fully understand that the abandoned public offering was separate and distinct from the private offering and that the protections of Section 11 of the Securities Act that would have been available to them in the abandoned public offering will not be available in the private offering. Unlike Rule 155(b), Rule 155(c) does not contain any exceptions to the 30-day waiting requirement between the commencement of the private offering and the official withdrawal of the registration statement for the abandoned public offering. One reason for this distinction is that the securities offered in a registered offering are in theory offered to the general public and are not restricted to accredited or sophisticated investors. Rule 155(c) is available even if the public offering is withdrawn after a full-blown road show. Another reason is that a private-to-public offering safe harbor provides investors with the benefits and protections of Section 11 of the Securities Act, whereas a public-to-private offering denies investors these protections. BULLETIN NO MARCH 30, 2001

4 Collateral Effects of Rule 155 Is Gun Jumping Dead? A cursory read of Rule 155(b) would lead a reader to believe that under certain circumstances gun jumping would be permissible in a registered offering (e.g., the dissemination of private offering material and solicitation of offers to buy securities before a registration statement is filed). However, the SEC has instituted several measures to prevent the use of the Rule 155(b) safe harbor to facilitate any intentional gun jumping. First, any issuer that relies on the Rule 155(b) safe harbor must first satisfy the private offering exemption (i.e., the private offering must be bona fide). Rule 155 defines a private offering as an unregistered offering of securities that is exempt from registration under Section 4(2) or 4(6) of the Securities Act or Rule 506 of Regulation D. This requirement is intended to insure that the initial private offering is a serious offering by the issuer, and the issuer initially has the intention to consummate the offering when commenced. Second, the SEC has stated that it intends to closely monitor the use of Rule 155(b) to prevent its misuse and the Staff has the authority to request additional information from the issuer regarding the termination of all offering activity in the private placement. Finally, any issuer that although in technical compliance intends to use either of the Rule 155 safe harbors as a plan or scheme to evade the registration requirements under the Securities Act will be denied the right to use the safe harbor. These measures are designed to insure that any gun jumping that may occur as a result of the utilization of Rule 155(b) is incidental to a bona fide private offering and not a plan to avoid the gun jumping restrictions of the Securities Act. Although Rule 155(b) does not specifically address the practice of testing the waters prior to filing a registration statement for a public offering, it appears to sanction this practice as a policy matter in some cases. Inasmuch as the Rule permits full contact with accredited or sophisticated investors immediately prior to the filing of a registration statement, it would seem that limited contacts with qualified institutional buyers would also be permitted. Are General Solicitations Permitted Under Rule 155(c)? Without a closer study of Rule 155(c), a reader might conclude that a general solicitation would be permissible in a private offering. The second safe harbor does provide issuers with amnesty for general solicitations occurring prior to the commencement of a 30-day cooling-off period. However, the private placement must otherwise be free of general solicitations and must otherwise qualify for an exemption from registration under Section 4(2) or 4(6) of the Securities Act or Rule 506 of Regulation D. In the SEC s view, this requirement will insure that the private offering following the abandoned public offering is a bona fide private offering. So practitioners should not conclude that the ban on general solicitations in private placements has been lifted. However, it would seem that a 30-day cooling-off period could go a long way to curing the impact of impermissible solicitations since 30 days is enough to cool off the heat generated by a full public road show process. Time will tell. We understand that the Staff is continuing to develop proposals that relate to the offering process, both public and private. Rather than the revolutionary change in the Aircraft Carrier proposals (Release Nos (November 3, 1998) and A (November 13, 1998)), the current project is evolutionary in scope. We will be reporting any developments to you as they arise. 1 Since these amendments became effective on March 7, 2001, any filing fees paid with respect to past registration statements that are withdrawn after March 7, 2001, will be available to offset future filing fees. 2 The SEC has viewed offerings occurring more than six months apart as separate offerings based on the six-month non-integration safe harbor of Regulation D, even if the offerings are not relying on the Regulation D exemption. BULLETIN NO MARCH 30, 2001

5 3 It is presumptive evidence that this restriction has been violated if the issuer receives any funds from investors or any funds are placed in escrow as consideration of the securities. 4 Accredited investor is defined under Rule 501(a) of Regulation D of the Securities Act. A sophisticated investor is an investor who, either alone or with his or her representative, has knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment. See Rule 506(b)(2)(ii) of Regulation D of the Securities Act. 5 The adopting release cites the Letter of John J. Huber, Director, Division of Corporate Finance, to Michael Bradfield, General Counsel, Board of Governors of the Federal Reserve Systems, regarding Bankers Trust Company (March 16, 1984), which stands for the proposition that the filing of a registration statement is a general solicitation. BULLETIN NO MARCH 30, 2001

6 Client Alert is published by Latham & Watkins as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the attorneys listed to the right or the attorney whom you normally consult. Copyright 2001 by Latham & Watkins BOSTON! CHICAGO! FRANKFURT HAMBURG! HONG KONG! LONDON LOS ANGELES! MOSCOW! NEW JERSEY NEW YORK! NORTHERN VIRGINIA! ORANGE COUNTY SAN DIEGO! SAN FRANCISCO SILICON VALLEY SINGAPORE! TOKYO! WASHINGTON, D.C. If you have any questions about this Client Alert, please contact Kirk A. Davenport or Daniel Nam in our New York office, John J. Huber in our Washington, D.C. office, or any of the attorneys listed here. BOSTON Ian B. Blumenstein (617) CHICAGO Christopher D. Lueking Marc Bassewitz (312) FRANKFURT John D. Watson, Jr HAMBURG Christoph von Teichman LONDON Mark A. Stegemoeller Gay L. Bronson LOS ANGELES Pamela B. Kelly (213) MOSCOW Anya Goldin NEW YORK/ NEW JERSEY Kirk A. Davenport Daniel Nam (212) NORTHERN VIRGINIA Scott Herlihy (703) ORANGE COUNTY Charles K. Ruck Patrick T. Seaver (714) SAN DIEGO Scott N. Wolfe (619) SAN FRANCISCO/ SILICON VALLEY Robert A. Koenig Scott R. Haber Peter F. Kerman (650) SINGAPORE/ HONG KONG Michael W. Sturrock WASHINGTON, D.C. John J. Huber (202) BULLETIN NO MARCH 30, 2001