Once a company is public and has a trading symbol, its shares can be traded publicly through a broker if the appropriate U.S. Securities and Exchange Commission regulations are followed. The basic rule is that the shares to be sold must be registered with the SEC unless an exemption from registration applies.
Form SB-2
Source: TKTK
Registration of Shares
Companies and shareholders with stock to sell publicly can register their shares with the SEC. A company’s fi rst public stock issuance is called an initial public offering (IPO). Subsequent registrations are called “follow- ons” or, sometimes, “secondary” offerings.
Shareholders whose shares were not registered when they acquired them can complete a registration—known as a “resale registration.” They undertake to register the shares when they need liquidity and the ability to sell the shares publicly and cannot wait long enough for an exemption to apply (for example, one exemption, under Rule 144, allows public sale without registration after shares have been held for either one year or two years, depending on certain circumstances, and another exemption per- mits public resale without registration if shares were issued pursuant to a bankruptcy reorganization).
In most PIPE transactions, investors acquire unregistered shares (which bear a legend prohibiting transfer except upon registration or an available exemption from registration), with the understanding that the issuing company will effect a resale registration on the investor’s behalf, gener- ally within ninety days. This is usually preferable to a secondary offering because it can happen more quickly with fewer regulatory hurdles. The resale registration generally is not reviewed by the National Association of Securities Dealers (NASD) and has much less stringent state securities, or blue sky, review than an IPO. Of course, in exchange the company gener- ally raises money in the PIPE at a discount to the stock’s trading price, since the investor takes a short-term liquidity risk.
Registration takes time. Someone must write the public offering pro- spectus or offering document, which is included as part of the registration statement fi led with the SEC, making sure to include the information the SEC requires. The prospectus includes at least two years of audited fi nan- cial statements, a year-to-year comparison of results, executive compensa- tion, business description, review of litigation, risk factors, a full capitaliza- tion chart, a detailed discussion of dilution, related party transactions, and a whole host of exhibits including material contracts, corporate charter, and bylaws. Other elements of the registration statement include a sum- mary of prior securities offerings and certain undertakings the company must make to the SEC to complete the registration.
This registration statement (including the prospectus) is fi led and then reviewed by the SEC’s staff of examiners in their Division of Corporation Finance. The SEC must respond to the fi ling of an original or amended registration statement within thirty days. The SEC examiners may request more time (like everyone else they occasionally get backed up with work).
One should always accede to this request. It is not unusual to go through
Source: TKTK
three or four iterations of the fi ling before it is approved, upon which the SEC declares it “effective” and then it can be used to sell shares publicly.
In an IPO registration, a prospectus must go to the buyer the fi rst time each newly registered share is sold; however, SEC rules stipulate that shares sold in resale registrations do not have to be accompanied by a prospectus as long as one is publicly available. The registration must be kept “current”
until all shares registered under that registration statement are sold by the selling shareholders. This may require quarterly and other updating but is usually easy to do.
The SEC review process can vary greatly from deal to deal. Much depends on the particular examiner or group within the SEC’s Division of Corporation Finance. What one group identifi es as a major problem can pass through another group with no comment.
Exemptions from Registration: Rule 144
As mentioned above, stock must be registered with the SEC before it can be sold publicly, unless an exemption applies. A number of exemptions are available, depending on the circumstances and facts of a particular situation.
For example, certain issuances in connection with a bankruptcy reor- ganization are exempt from registration, and shares issued can be immedi- ately resold if there is an existing trading market for them.
In fact, some reverse merger practitioners are creating shells through these issuances in bankruptcy. The small but ardent group doing this, led by Tim Halter of Halter Financial Group, has honed a series of valid techniques to create clean shells by taking usually dormant businesses through bankruptcy and issuing shares to creditors, creating hundreds of shareholders and a very clean shell with shares that can trade immediately following a reverse merger. The main challenge, it seems, is fi nding the dormant companies that are right for this bankruptcy option. In addition, although these shells have the benefi t of a large group of shareholders and free-trading shares, they are not reporting companies. Therefore, a com- pany merging in must complete a registration on Form 10-SB or similar form after a merger before the shell can become a full reporting company.
This delays a listing on the OTC Bulletin Board or higher exchange until the public entity is a full reporting company.
The most popular exemption from registration is Rule 144. As dis- cussed in Chapter 4, Introduction to Rule 419, shares can become freely tradable without registration as long as they are held for a certain period of time. In general, a shareholder must hold unregistered shares for one year. After that, the holder, if not an affi liate, can sell up to 1 percent of the company’s outstanding stock (or average weekly trading volume, which-
Source: TKTK
ever is higher) during each ninety-day period during the second year of holding. After shares have been held for two years, they are freely tradable without these volume restrictions.
If the holder is an affi liate of the company, meaning an offi cer, direc- tor, or other control person (this is generally presumed if one owns over 20 percent or has the ability to effect policy change in the company), no shares become freely tradable for one year. After the one-year period, the volume restrictions described above (1 percent every ninety days) apply not just for an additional year, but for as long as the holder remains an affi liate, and for ninety days thereafter. If shares are purchased from an affi liate, a new holding period begins as if the affi liate never started his own holding period. Thus, an affi liate cannot allow a purchaser to “tack”
his holding period.
Another Rule 144 wrinkle relates to derivative securities such as war- rants or options. If one receives an option on a certain date and holds it for a year, then exercises the option for the cash purchase price, a new holding period begins after that cash purchase. But an exception in the rule allows what’s known as “tacking” of the holding period from the day the option or warrant was issued if the option or warrant is simply traded for com- mon stock. In other words, in so-called cashless exercise transactions, the holding period relates back to when the original derivative was received.
Cashless transactions work as follows. Say a warrant to purchase 100 shares of stock has a $3 per share exercise price and is issued on January 2, 2006, when the stock is trading at $2. This warrant is known as being
“out of the money” because the warrant exercise price is above the current market price. A year later, on January 2, 2007, the stock moves up to $6 a share, making the warrant “in the money,” since the holder can exercise the warrant for $3 when the stock is at $6.
A holder can exercise the warrant for cash at $3 per share, upon which a new holding period begins, and he must wait at least another year under Rule 144 to sell the shares. Alternatively, if permitted by the terms of the security, the holder can exercise a warrant for fi fty shares by turning in the warrants for the other fi fty, in other words, by returning fi fty warrants which now have a net value of $3 per share after the purchase price, which becomes the purchase price for the other fi fty.
The negative side of the cashless event is that the holder must give up a portion of his holdings. The positive side, besides avoiding the use of cash, is tacking the holding period and the immediate ability to sell the underlying shares under Rule 144. In general, PIPE investors receive cash- less exercise warrants as part of their investment. They prefer this cashless exercise feature to protect themselves from the risk that the company will not succeed in completing the registration of their primary stock holdings
Source: TKTK
purchased from the company (after a registration Rule 144 would not be needed), and at least they know that one year after closing the PIPE trans- action they will be able to sell some of their warrants as long as they are in the money and there is a liquid market.
This same analysis applies to preferred stock or convertible debt. In both cases, the security usually can be exchanged for common stock on some basis, without payment of additional cash. Under Rule 144, because one security is exchanged for another, the holding period relates back to the date of acquisition of the preferred stock or convertible debt. Again, in PIPE transactions involving these securities, an investor utilizing this cash- less feature has some protection if the resale registration is not completed.