The Securities and Exchange Commission is increasing its scrutiny of Private Investment in Public Equity (PIPE) transactions. It is well known that the Division of Enforcement has undertaken investigations into insider trading and improper short selling by PIPEs investors. Less known, but equally important, is that the Division of Corporation Finance likewise is enhancing its examination of whether issuers are registering PIPEs offerings appropriately.
Historically, the Division of Corporation Finance focuses on four questions when reviewing a PIPEs transaction for compliance with the Securities Act of 1933:
- Is the private investment complete?
- Is the public offering properly characterized as a secondary resale?
- Is the issuer registering the public offering on the proper form?
- Is there adequate disclosure about the terms and effect of the transaction?
In a series of key speeches recently by its Deputy Directors and Chief Counsel, however, the Division of Corporation Finance expressed concern about the increase in structured PIPE transactions, particularly convertible notes, in which an issuer seeks to register for resale a substantial number of shares in comparison to the issuer’s capitalization. One example cited was an issuer who sought to register for resale more than 10 times the number of its outstanding shares. When coupled with market-price formulas and price reset features, these so-called “extreme convertible” transactions potentially have a significant dilutive effect on an issuer’s common stock price and financial condition.
Accordingly, the Division announced that if an issuer seeks to register more than onethird of the outstanding common stock held by non-affiliates prior to the transaction, the staff will issue a comment requesting the issuer to analyze whether the purported secondary offering actually is a primary offering, given its nature and size. Issuers will need to assess all facts and circumstances in preparing their analysis, including the standards in Part D.29 of the Division’s Manual of Publicly Available Telephone Interpretations.
Ultimately, an issuer who is unable to persuade the staff that an offering is appropriately characterized as a secondary offering would have to identify the selling shareholders as underwriters. Further, if it is ineligible to conduct a primary offering using a Form S-3, an issuer must utilize a more comprehensive Form S-1 or Form SB-2 which limits the issuer’s ability to conduct “at the market” offerings.
Aside from providing the analysis above, issuers of structured PIPE transaction also may receive a series of questions from the Division staff in the form of comments with a view towards disclosure:
- How did the issuer determine the number of shares to sell?
- What payments, regardless of whether labeled a “fee”, did or will the issuer make to the selling shareholders and placement agent?
- What are the net proceeds to the issuer from conversion after taking into account all payments?
- Does the issuer have a current intention and ability to repay the note?
- What are the possible proceeds to the selling shareholders?
- What is the relationship between the issuer and selling shareholders?
- Who are the natural persons that control an institutional selling shareholder?
- If known to the issuer, what if any short positions do the selling shareholders hold?
- If the issuer has a history of undertaking similar transactions, what has been the resulting impact upon the stock?
To prevent circumvention of its one-third standard, the Division also announced that the staff will not object to an issuer registering an additional one-third tranche of shares the later of (a) 60 days after the sale of “substantially all” of the prior tranche, or (b) six months after the effectiveness of the prior tranche registration statement. The part (a) measurement is made on a per-shareholder basis. Significantly, a separate offering of securities would not necessarily be governed by this 60 days and six months formula. Rather, the issuer must perform a traditional integration analysis to ensure each offering is distinct.
The Division does not intend to issue written guidance in this area other than through the comment letter process. Therefore, understanding the analysis and approach reflected in the Division senior staff speeches is essential. Even when an issuer seeks to register less than one-third of outstanding common stock, it remains possible the staff may scrutinize the PIPEs offering in the manner described above. To avoid an adverse result, an issuer must exercise care in soliciting, negotiating, and drafting PIPE transactions.