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Recent securities law amendments may increase sponsor liquidity16/01/2008. Source: Weil, Gotshal & Manges. Amir Iliescu, Michael Szlamkowicz
 The SEC recently approved amendments to Rules 144 and 145 of the Securities Act of 1933. These amendments are expected to increase the liquidity of privately-placed securities for investors and therefore reduce the cost of this capital, write Amir Iliescu and Michael Szlamkowicz of Weil, Gotshal & Manges.
These amendments may also impact sponsors in a number of different ways, including by providing them with more flexibility to (i) resell securities received by them in connection with the sale of a portfolio company and (ii) resell securities acquired in a PIPE transaction without relying upon a resale registration statement. In light of the reduced holding periods and elimination of other requirements effected by these amendments, sponsors should also take a fresh look at the need for contractual post-IPO transfer restrictions on management and equity co-investors.
Summary of the Amendments Securities that are not registered under the Securities Exchange Act of 1934 or are owned by affiliates of the issuer are generally subject to various resale limitations. Rules 144 and 145 are safe harbors that permit recipients of these “restricted” or “control” securities to resell those securities in compliance with the Securities Act of 1933 provided that certain conditions are met. These conditions can include holding periods, the availability of current public information regarding the issuer, volume limitations and manner of sale requirements.
The key changes to Rules 144 and 145 to be effected by these amendments include the following: Reduced Holding Period – Prior to the amendments, the required holding period for effecting a Rule 144 resale of securities was (i) one year subject to the current public information requirement, volume limitations, manner of sale and the filing of Form 144 and (ii) two years for non-affiliates who have not been an affiliate for the prior 90 days without any additional 144 restrictions.
The amendments have reduced the holding period for the sale of restricted and control securities as follows: (i) for affiliates, six months if the issuer is a “reporting company” (i.e., files periodic reports with the SEC under the Securities Exchange Act of 1934) and one year if the issuer is not a reporting company, in each case subject to the other customary Rule 144 manner of sale requirements, and (ii) for non-affiliates, six months generally without any other Rule 144 manner of sale requirements (note that the current public information requirement applies for a one-year holding period) if the issuer is a reporting company and otherwise one year without any other manner of sale restrictions.
Debt Securities
The amendments to Rule 144 also eliminate the manner of sale restrictions as to debt securities (including non-participating preferred stock) and increase the volume limitation of permitted resales during any three month period from 1% to 10% of any tranche of debt securities (or class of non-participating preferred stock).
Less Restrictions for Resales of Stock Received in a Merger or Similar Transaction
Under Rule 145 prior to the amendment, any person (other than the issuer) or its affiliates who are parties to a reclassification of securities, merger, consolidation or transfer of assets that is subject to shareholder approval is presumed to be an underwriter with respect to any resales of such securities. As a result, securities received by those persons deemed to be underwriters, including affiliates of the target company who received securities in the transaction (regardless of whether through an S-4 registration statement or as a result of a private placement exemption), were prohibited from publicly reselling those securities unless the issuer had a resale registration statement in effect or those securities were resold in compliance with the holding period and certain other manner of sale requirements under Rule 144.
The amendment to Rule 145 eliminates this underwriter presumption (other than in limited circumstances, such as transactions involving a shell company), and therefore permits affiliates of the target that receive acquiror stock in a merger or similar transaction to resell such securities without restriction under Rule 144 or Rule 145 and without the need for an effective registration statement (note though that if the holder also becomes an affiliate of the acquiror, then the Rule 144 resale restrictions applicable to control securities will still apply).
Impact on Private Equity Sponsors
These amendments may impact private equity sponsors in the following ways:
- Stock-for-Stock Deals - Stock consideration issued by public companies may become more attractive to sponsors as a result of these amendments. In a typical transaction where a sponsor was an affiliate of a public company and received stock of another public company as consideration in a merger transaction, they were presumed to be an underwriter of the securities they received under old Rule 145 and could only resell those securities pursuant to an effective resale registration statement filed by the issuer or under Rule 144 or Rule 145. The practical effect of this was that unless the issuer promptly filed a resale registration statement with the SEC, then the sponsor was only able to resell after holding the securities of the issuer for at least one year and selling the shares subject to the volume limitations.
If the sponsor was unable to maintain the effectiveness of a resale registration statement or there was not current public information available about the issuer (e.g., the issuer suspended its periodic reporting due to disclosure or financial reporting issues), then the sponsor may be blocked out of the market for a lengthy period of time until this issue is resolved. As a result of the amendments, the sponsor will be able to freely resell registered securities it receives in a merger or similar transaction from a public company (assuming it is not an affiliate of the acquiror).
- PIPEs- Sponsors will also have more flexibility to resell securities received in a PIPE transaction without relying on an effective resale registration statement being in place. As a result of the amendments, a sponsor who is an affiliate of the issuer will be able to resell securities acquired in a PIPE transaction after a six-month (as opposed to one-year) holding period subject to the current public information requirement and volume limitations. A sponsor who is not an affiliate of the issuer will be able to resell those securities freely after a six-month holding period (subject to the issuer satisfying the current public information requirement).
- Management and Co-Investors - One consequence of the amendments to Rule 144 is that a sponsor’s management team and co-investors will similarly have enhanced liquidity rights (and perhaps even better than the sponsors in that management members who are not on the board of the portfolio company and coinvestors may be less likely to be affiliates of the issuer). Sponsors may want to take a fresh look at contractual post-IPO transfer restrictions they impose upon management and coinvestors to limit the risk that management and co-investors front run them in selling securities of the portfolio company post-IPO once the underwriters lock-up period expires.
Conclusion
The amendments to Rules 144 and 145 are expected to increase the liquidity of privately-placed securities for investors and therefore reduce the cost of this capital. These amendments will also generally benefit private equity sponsors in that they give sponsors more flexibility in terms of reselling restricted securities, particularly if the sponsor is not an affiliate. This may particularly make stock-for-stock deals and PIPEs more attractive to sponsors. Sponsors should also take a fresh look at the contractual post-IPO restrictions on transfer that they request from their management and coinvestors in view of the enhanced liquidity that they may have under the amendments to Rule 144.
Weil, Gotshal & Manges is a leading legal specialist in private equity services, with dedicated private equity lawyers in major financial centres throughout the world. For more information please visit www.weil.com.
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