The adoption of Rule 144A: an alternative for companies entering U.S. capital markets. (Securities and Exchange Commission rules) (SEC Practice)by Lucchesi, William J.
Rule Provides Safe Harbor
The principal objective of Rule 144A is to increase the efficiency and liquidity of the U.S. market for equity and debt securities issued in private placements by allowing large institutional investors to trade restricted securities more freely with each other without subjecting the companies issuing such securities to the SEC registration and disclosure process. The rule provides a safe-harbor relief from the registration requirements of the Securities Act of 1933 for resale of certain unregistered securities to any institution that the seller reasonably believes is a qualified institutional buyer" (QIB). A QIB, defined broadly, is an institution that owns and manages $100 million ($10 million in the case of a registered broker-dealer) or more in qualifying securities. For a banking institution to qualify as a QIB, a $25 million minimum net worth test must also be satisfied.
Desire to Attract Non-U.S. Companies
Historically, many non-U.S. companies have been reluctant to sell securities in the U.S. capital markets because of the rather stringent disclosure requirements of the federal securities laws, as well as the time and effort associated with the SEC registration and periodic reporting process. By providing an exemption from registration, Rule 144A is expected to result in attracting more foreign companies to the U.S. capital markets. Moreover, by making the U.S. markets more attractive to companies outside the U.S., the rule is also expected to significantly increase the opportunities of U.S. institutional investors to acquire the securities of foreign companies.
What Securities Qualify
In general terms, securities eligible for trading under the new rule include both debt and equity issues of foreign as well as domestic issuers. However, privately placed securities that, at the time of their issuance, are "comparable" with other securities of that company currently trading on a U.S. exchange or quoted in the NASDAQ system are not eligible for resale under Rule 144A. The rule indicates that comparable in this context means securities of substantially the same class or character.
In addition to the eligibility requirements, once unregistered securities are placed with eligible investors the general rule is that they cannot be sold in the U.S. public markets for at least two years unless, of course, the securities are registered with the SEC. Rule 144A modifies the two-year holding period to run continuously from the time the restricted securities are initially sold by the issuer until they are resold. Prior to this change, the holding period of the former owner of the securities could not be combined with that of the seller for purposes of determining when the two-year restriction period expired.
The rule sets forth certain informational requirements for the issuer regarding the initial sale or resale of restricted securities. if the issuer of securities under Rule 144A is a U.S. company already registered with the SEC or a foreign company that furnishes home-country information to the SEC, information concerning the business of the issuer and the issuer's financial statements need not be provided to the buyer.
If the issuer is a U.S. company not registered under the securities law enacted in 1934 or a foreign company not required to furnish home- country information to the SEC, Rule 144A requires the issuer to provide the buyer, upon request, with a brief statement of the nature of the issuer's business and of its products and services as well as certain financial information.
The required financial information includes the most recent balance sheet and profit and loss and retained earnings statements for three years. These financial statements, which would generally be prepared in accordance with statutory (home-country) accounting principles, are required to be audited to the extent audited financial statements are "reasonably available."
Implications of Rule 144A
Some general observations concerning the implications of Rule 144A are:
* It would appear that the principal benefits of the rule, such as the ability to trade restricted securities without the issuer being subject to the SEC registration and disclosure process, will be experienced by foreign companies that are not already registered with the SEC. Large institutional investors and international investment bankers are also likely to be major beneficiaries of the rule.
* Relatively small U.S. companies that are not sufficiently seasoned to enter the public markets might also find Rule 144A attractive in that it is likely to provide a more liquid private placement market.
* Privately held companies that meet the eligibility requirements for the use of Rule 144A need to be cognizant of the asset and shareholder criteria that may trigger the need for SEC registration under Sec. 12(g) of the 1934 act. This section requires a U.S. company to register with the SEC when its total assets exceed $5 million and it has a class of equity securities held by 500 or more persons' These size tests would override the registration exclusion otherwise provided by the rule.
* Non-U.S. companies interested in availing themselves of Rule 144A should also be aware that investors or potential investors may in some cases, request that they furnish financial statements prepared in accordance with U.S. GAAP (or reconciled to U.S. GAAP) irrespective of the fact that SEC registration is not required.
* Companies that are considering a placement of securities under Rule 144A need to be aware that the application of the rule requires the direct involvement of a lawyer with the necessary expertise in this area to ensure that any securities sold on this basis meet the complex eligibility requirements and other provisions of the new rule.
SEC Considers 144A to be a Big Step
Whether or not Rule 144A proves to be a popular alternative to a public offering and listing of securities remains to be seen. It is clearly viewed by the SEC, however, as an important development in its efforts to ease the disclosure burden for foreign companies that desire to enter the U.S. capital markets.
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