Private placingsSpecific regulation
Are there specific rules for the private placing of securities? What procedures must be implemented to effect a valid private placing?
Under the Securities Act, all offers and sales of securities must be registered or exempt – reflecting a premise that investors should, with limited exceptions, be entitled to make their investment decisions based on a prospectus contained in an effective registration statement filed with the Securities and Exchange Commission (SEC).
To understand the development of US practice concerning private placements against this backdrop, it’s helpful to begin by understanding three key statutory exemptions permitting unregistered issuer private placements and subsequent unregistered resales. These are: section 4(a)(1), which exempts transactions by ‘any person other than an issuer, underwriter or dealer’; section 4(a)(2), which exempts transactions by ‘an issuer not involving any public offering’; and section 4(a)(3), which exempts transactions by ‘a dealer not acting as an underwriter’. The term ‘underwriter,’ as used in section 4(a)(1) and 4(a)(3), is defined broadly to include any person that purchased securities from the issuer ‘with a view to . . . distribution,’ with the term ‘distribution’ in this context understood to have essentially the same meaning as the term ‘public offering’ in section 4(a)(2). As such, the ability of key transaction participants to access the private placement or resale exemptions that are potentially available to them (namely, the ability of issuers seeking to sell their securities in primary issuances to rely on section 4(a)(2), of investors seeking to resell securities to rely on section 4(a)(1), and of banks and other agents helping arrange such sales or resales to rely on section 4(a)(3)) – and in so doing avoid the registration requirements of the Securities Act – hinges on the relevant transactions not being characterised as a public offering. The term ‘public offering’ is not defined in the Securities Act but has been construed by the SEC and the courts over time as a facts and circumstances driven analysis that focuses on factors such as the number of investors, the size of the offering, and the existence of any pre-existing relationship with the offerees, as well as their sophistication. In addition, the SEC has adopted certain rules – in particular, under Regulation D, adopted in 1982, and (although technically a resale safe harbour) Rule 144A, adopted in 1990 – that have helped shed meaningful light on how to effect a good private placement and as such have greatly facilitated the growth of such transactions.
Rule 506 of Regulation D provides issuers with a non-exclusive safe harbour (without monetary limits or caps) that deems offers and sales of securities by issuers that meet its conditions to be transactions not involving any public offering within the meaning of Section 4(a)(2). Traditionally, one of the key conditions to rely on Rule 506 was the absence of general solicitation and advertising – which for the most part required the issuer (or its agents) to have a pre-existing substantive relationship with relevant investors being solicited, and precluded options to widely publicise the offering (for example, through interviews, press releases, digital or other advertising, email blasts and cold calls). As a result of amendments to Regulation D in 2013 driven by the JOBS Act, however, Rule 506 now contains, in addition to the traditional safe harbour (now re-designated as Rule 506(b)), an additional safe harbour (designated as Rule 506(c)) which expressly permits general solicitation or advertising, subject to the requirement that all purchasers in the offering are accredited investors (which, broadly, captures most institutional investors as well as individual investors that are presumed, based on asset or income tests or other specified criteria, to be sophisticated enough to participate in private markets) and that the issuer takes reasonable steps to verify such status. Rule 506(b), while retaining the prohibition of general solicitation and advertising, permits the offering to be extended, in addition to accredited investors, to up to 35 non-accredited investors who have a requisite level of sophistication to evaluate the merits and the risks of the investments (either alone or through a representative). Both Rule 506(b) and (c) include certain other requirements, including requiring the issuer to take reasonable care to ensure that the purchasers are not statutory underwriters (that is to say, not purchasing with a view to distribution), which can be demonstrated in part by appropriate disclosure.
It bears noting that Regulation D, being a non-exclusive safe harbour, is not always followed strictly; indeed, offerings that are limited to institutional investors are more often than not still undertaken in reliance on section 4(a)(2) directly. Yet its influence as a guide to what constitutes a good private placement under section 4(a)(2) has been considerable, with a relatively standard set of procedures having developed since its adoption that permits issuer private placements in reliance on section 4(a)(2) to be conducted with much greater confidence. Key aspects of such procedures typically include:
- restrictions on general solicitation and advertising;
- investor letters signed by each investor (containing various acknowledgements, certifications and agreements in relation to resale);
- large purchase consideration (or minimum denominations);
- few, if any, offerees that are not institutional accredited investors;
- restrictive legends;
- certificated securities;
- requirements on resale for legal opinions and subsequent purchaser letters (typically containing acknowledgements, certifications and agreements comparable to those executed by initial investors); and
- other mechanisms such as stop-transfer instructions to help police resales and ensure that applicable restrictions cascade to any subsequent purchasers in the aftermarket.
In conducting a private placement, care should also be taken to consider the blue sky laws of the individual US states.
- In contrast to Regulation D, Rule 144A is technically a resale safe harbour, and yet its influence on private placement procedures has been no less significant. In general, Rule 144A provides a non-exclusive safe harbour for resales of securities by investors and dealers to persons that are reasonably believed to be qualified institutional buyers (QIBs) – which, in general, are institutions that in the aggregate own and invest in at least US$100 million in securities of unaffiliated issuers on a discretionary basis. In addition, to access the rule, certain conditions must be met, including that:
- the securities in question, when issued, must not be of the same class as, or fungible with, securities listed on a US national securities exchange;
- the sellers (and persons acting on their behalf) must take steps to ensure that purchasers are aware that sellers may be relying on the rule; and
- investors must also have (unless the underlying issuer is subject to Exchange Act reporting requirements, or exempt from those requirements under Rule 12g3-2(b) or a foreign government) the right to receive certain financial and other information from the underlying issuer.
If the conditions are met, the relevant resales will be deemed to not be distributions and the relevant sellers will therefore not be deemed underwriters for purposes of section 4(a)(1) or 4(a)(3), respectively. What is particularly notable about Rule 144A requirements is that resales pursuant to the rule are generally permitted to proceed without the investment letters and the various mechanisms discussed above in the context of section 4(a)(2) private placements to help ensure that the applicable restrictions cascade – the general expectation being that QIBs will be familiar with, and abide by, relevant resale restrictions (including deemed restrictions that are communicated to them). Note, moreover, that although Rule 144A is a safe harbour for resales, rather than issuer private placements, by pairing an initial sale of securities to banks or agents (in reliance on section 4(a)(2)) with an onward resale by those banks or agents in reliance on Rule 144A, a widely-used mechanism has developed which allows issuers to effectively conduct private placements to QIBs but with far fewer restrictions than traditionally characterised conventional private placement procedures. Indeed, the adoption of Rule 144A has also influenced practices in section 4(a)(2) private placements where Rule 144A might not, for various reasons, be available – for example, rights offerings, exchange offers and similar transactions that are not easily structured as resales – but where issuers are willing to limit their offerings to QIBs. In these instances, 4(a)(2) to QIBs procedures that largely replicate the Rule 144A procedures have become common.
It is worth emphasising though that certain anti-fraud provisions under the US securities laws (and related liability considerations) are still applicable to these exempt transactions, in particular section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which typically results in certain due diligence and other practices being undertaken in connection with such offerings.Investor information
What information must be made available to potential investors in connection with a private placing of securities?
There are generally few formal requirements for disclosure in the context of private placements in the United States. In the context of a Rule 506 private placement that includes non-accredited investors (which is relatively rare, although up to 35 such non-accredited investors are permitted if the issuer has reasonable belief in their sophistication), such investors must be provided with information prior to sale that is broadly comparable to the information that would be provided in an SEC-registered offering. In addition, in the context of a Rule 144A offering, investors must have (unless the underlying issuer is subject to Exchange Act reporting requirements or exempt from those requirements by Rule 12g3-2(b) or a foreign government) the right to receive certain financial and other information from the underlying issuer – namely, a brief description of its business and its products and services and certain financial statements.
In practice, however, diligence and disclosure standards in the context of private placements are heavily influenced by diligence and disclosure norms in the context of registered offerings – albeit with certain exceptions, such as early-stage equity investments and true debt private placements, which typically involve a limited number of investors that conduct extensive due diligence. This is largely driven by liability concerns under certain anti-fraud provisions; principally section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Most Rule 144A offerings in the United States (including most US high yield bond issuances and most equity offerings by foreign private issuers (FPIs) that accompany an initial listing abroad), for example, are marketed off offering memoranda whose structure and content largely replicates the disclosure standards that would be applicable in US registered deals.Transfer of placed securities
Do restrictions apply to the transferability of securities acquired in a private placing? And are any mechanisms used to enhance the liquidity of securities sold in a private placing?
Resale restrictions are a critically important feature of US private placement transactions. If a purchaser in an issuer’s private placement (or indeed, under longstanding SEC positions, any subsequent purchaser in a chain of sales and purchases from that issuer) resells its purchased securities in a manner that amounts to a distribution, the purchaser not only risks being characterised as a statutory underwriter – thus jeopardising its own ability to rely on the exemption in section 4(a)(1) (for transactions by any person other than an issuer, underwriter or dealer) or, as applicable, section 4(a)(3) (for transactions by a dealer not acting as an underwriter) – but also potentially jeopardises the issuer’s original reliance on the exemption in section 4(a)(2) (for transactions by an issuer not involving any public offering).
Accordingly, although the specific policing mechanisms used to ensure compliance can vary across transaction types (with offerings to QIBs tending to have few, if any, policing procedures beyond deemed representations and deemed requirements to inform subsequent purchasers, while offerings to accredited investors typically tend to have considerably more intrusive procedures), in general, US private placements will almost invariably seek in some manner to limit resales in the aftermarket to transactions that clearly fit (often through safe harbours) into an exemption from registration. Typical such exemptions for resale include:
- the Rule 144A safe harbour, which permits private resales to persons reasonably believed to be QIBs if certain conditions are met;
- the so-called section 4(a)(1-½) exemption, which is not technically a safe harbour or exemption in its own right, but rather a set of procedures developed by the securities bar to permit limited private resales to persons that, in general terms, could have purchased in the original placement and who agree, upon purchase, to become subject to comparable restrictions;
- section 4(a)(7), which is a relatively new non-exclusive safe harbour for resales that came into effect in 2015 through the FAST Act, and which in many respects codifies practices developed in relation to the section 4(a)(1-½) exemption. Although it entails certain more burdensome requirements than typical practices under section 4(a)(1-½) (for example, delivery by the seller to the purchaser of certain specified information), it also offers certain potential advantages, in particular where sales to non-institutional accredited investors are contemplated;
- the Rule 144 safe harbour, which permits the public resale of restricted securities (a term which, among others, includes securities purchased in Rule 144A, section 4(a)(2) and section 4(a)(1-½) transactions), subject to a holding period requirement of one year (or six months in the case of securities of Exchange Act reporting companies that are current in their reporting) and certain additional limitations and requirements for sellers that are issuer affiliates; and
- Regulation S, which provides a safe harbour for resales of securities outside the United States under Rule 904 if certain conditions are met. In the case of resales by non-affiliates, the relevant conditions will, with certain exceptions, be limited to requirements that the offer and sale are made in offshore transactions and the absence of directed selling efforts.
The liquidity provided by these options may well be sufficient for investors in various contexts. Offshore resales, for example, may well be the natural (and in practice only necessary) resale option for equity securities of FPIs for which there is a large and liquid trading market abroad. In instances where the basic suite of resale options discussed above is not perceived as sufficient, however, investors routinely seek registration rights that require issuers to take certain steps to help ensure that privately placed securities can be freely resold (which is typically achieved by issuers filing resale registration statements after the offering, or by undertaking A/B exchange offers that result in privately placed securities being swapped for essentially identical securities through a registered exchange).