Clients frequently ask us whether they, as underwriters, can take structured notes that are being offered by them and hold them in inventory, or in the “freezer,” and resell the securities at a later time. This question raises a number of interesting issues.
From a disclosure perspective, investors would want to know the portion of the offered securities that will be purchased or held by the underwriter in the offering. Often, this information provides some indication as to whether the offering was successful. An indication of the principal amount of the notes that was purchased by investors may in some cases provide some degree of information as to the potential liquidity of the secondary market for the issuance. The issuer and the underwriter will want to be certain that the prospectus discloses that certain securities will be purchased by the underwriter and held for future resale, and some indication of the price or prices at which such securities will be resold (i.e., will the securities be resold at a fixed price, or at variable prices in the future). Also, the prospectus should disclose whether the underwriters will use the same offering document to re-offer the securities that were purchased by them for future resale.
From the perspective of both the issuer and the underwriter, it will be important, as we discuss further below, that the prospectus discloses that it may be used or delivered by the underwriter when it is making further resales.
From a securities law perspective and a FINRA perspective, it is important to note how much of the offered securities will be purchased by the underwriter for future resales. We noted above the disclosure concern. Apart from that, the securities being purchased by the underwriter may be viewed as an unsold allotment. The underwriter will need to deliver a prospectus in connection with any shares that constitute or that are viewed as an unsold allotment. The underwriter will want to take the securities into an investment account so that the initial offering of the securities can be deemed completed. This is important for several reasons. For Regulation M purposes, the issuer will want to deem the offering completed. The issuer will not want to be deemed to be engaged in a continuous offering. If the offering were deemed a continuous offering, then would it be deemed a variable price deal?
The issuer and the underwriter also will want the lead underwriter to give an “all sold notice” for the transaction so that a secondary trading market can develop for the securities. For TRACE purposes, the issuer and the underwriter and other dealers or distributors will want to know how to mark the securities for FINRA TRACE reporting purposes, and whether it is a primary or a secondary offering (for the indicator, P1 or S1).
Similarly, from a FINRA perspective, FINRA will be interested in whether there was a good “distribution” of the securities in the initial offering. If too large (over 15% is a frequently cited number—although there is no “bright line” test) a percentage of the offered securities is purchased by the issuer or an affiliate of the issuer or the underwriter, then the offering may not be deemed a broad distribution for FINRA purposes.
Holding securities in inventory also potentially involves a variety of U.S. federal tax issues.