How to Complete an Unregistered Spin-Off

by Laura Anthony, Esq. on October 22, 2013 in Form 10, Rule 144, Rule 145, Section 5, Securities Attorneys, Spin-Off

A spin-off is when a parent company distributes shares of a subsidiary to the parent company’s shareholders such that the subsidiary separates from the parent and is no longer a subsidiary.  The distribution normally takes the form of a dividend by the parent corporation.   In Staff Legal Bulletin No. 4, the Securities and Exchange Commission (SEC) explains how and under what circumstances a spin-off can be completed without the necessity of filing a registration statement.

In particular, the subsidiary shares (the shares distributed to the parent company shareholders) do not need to be registered if the following five conditions are met: (i) the parent shareholders do not provide consideration for the spun-off shares; (ii) the spin-off is pro-rata to the parent shareholders; (iii) the parent provides adequate information about the spin-off and the subsidiary to its shareholders and to the trading markets; (iv) the parent has a valid business purpose for the spin-off; and (v) if the parent spins-off restricted securities, it has held those securities for at least one year.  Below is a discussion of each of the five conditions.

The first condition is that the parent shareholders do not provide consideration for the spun-off shares.  This is because if value is provided, a “sale” has occurred and a “sale” requires registration under Section 5 of the Securities Act of 1933, as amended, unless an exemption is available.  In a spin-off, an exemption is rarely available due to the wide variety of shareholders receiving the spun-off shares. 

The second condition is that the spin-off must be pro rata.  When the spin-off is pro rata, the parent shareholders have the same proportionate interest in the parent and the subsidiary both before and after the spin-off.  If a spin-off is not pro rata, the shareholders’ relative interests change and some shareholders give up value for the spun-off shares, requiring registration pursuant to the first condition.

The third condition requires that adequate information be provided to the shareholders.  If the subsidiary is a non-reporting company it can satisfy this condition by providing the shareholders with an information statement which satisfies the Section 14 proxy rules of the Securities Exchange Act of 1934 prior to or contemporaneously with providing the spun-off shares.  In addition, the non-reporting subsidiary must file a Form 10 registration statement, which can be accomplished after the spin-off but prior to the start of trading on the spun-off subsidiary. A reporting subsidiary is deemed to have satisfied its information requirements as long as it is current in its reporting obligations and it provides any pertinent information directly related to the spin-off itself.

Where both the parent company and the subsidiary are non-reporting, the adequate information requirement is met if the by the date of the spin-off: (i) the parent provides the shareholders with an information statement which satisfies the Section 14 proxy rules of the Securities Exchange Act of 1934,(ii) the shares are restricted until such time as a Form 10 is filed; and (iii) the transfer restrictions are enforced such as by means of stop transfer instructions to the transfer agent. 

The fourth condition is that there is a valid business purpose for the spin-off.  Although there may be many valid business purposes, the SEC specifically recognizes the following as valid: (i) allowing management of each business to focus solely on that business; (ii) providing employees of each business stock-based incentives linked solely to her or her employer; (iii) enhancing access to financing by allowing investments into each business separately; and (iv) enabling the companies to do business with each others competitors. 

Likewise, although there are numerous purposes that would not be valid, the SEC specifically lists the following as not valid: (i) creating a market in the spun-off securities without providing adequate information and (ii) creating a public market in a shell or development-stage company.

Finally, the last condition is that the parent has held the shares for a minimum of one year.  This is so the receiving shareholder may tack with the parent’s holding period and thereby satisfy the holding period requirements of Rule 144. 

The SEC has also taken the position, that as long as all the above conditions have been satisfied, the spin-off will not require registration under Rule 145 merely because the shareholders have voted on the spin-off and/or assets are transferred into the subsidiary as part of the spin-off.    Furthermore, except where specifically delineated above (non-reporting parent and subsidiary) as long as all the above conditions are satisfied, the shares issued in the spin-off are not restricted securities. 

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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