Registering Convertible Securities

by Laura Anthony, Esq. on January 12, 2010 in SEC Guidance

Many clients seek to register convertible securities, such as convertible debentures, warrants, options or convertible preferred stock. The question most often asked is how many share need to be registered, and in particular, does the Company need to register the shares underlying the convertible security.

First, it is essential to review a few basic facts on what a convertible security is and how it works.

Convertible Security Defined

A “convertible security” is a security that can be converted into a different security – typically shares of the company’s common stock. In most cases, the holder of the convertible determines whether and when a conversion occurs. In other cases, the company may retain the right to determine when the conversion occurs.

Companies that may be unable to tap conventional sources of funding sometimes offer convertible securities as a way to raise money more quickly. In a conventional convertible security financing, the conversion formula is generally fixed – meaning that the convertible security converts into common stock based on a fixed price. The convertible security financing arrangements might also include caps or other provisions to limit dilution (the reduction in earnings per share and proportional ownership that occurs when, for example, holders of convertible securities convert those securities into common stock).

Death Spirals

By contrast, in less conventional convertible security financings, the conversion ratio may be based on fluctuating market prices to determine the number of shares of common stock to be issued on conversion. A market price based conversion formula protects the holders of the convertibles against price declines, while subjecting both the company and the holders of its common stock to certain risks. Because a market price based conversion formula can lead to dramatic stock price reductions and corresponding negative effects on both the company and its shareholders, convertible security financings with market price based conversion ratios have colloquially been called “floorless”, “toxic,” “death spiral,” and “ratchet” convertibles.

Registration of Convertible Securities

Where convertible securities are being registered, the underlying securities must be registered where such securities are convertible within one year, or where the securities are convertible at the option of the Company. Where the securities are convertible or exercisable within one year, an offering of both the overlying security and underlying security is deemed to be taking place. If such securities are not convertible or exercisable within one year, the Company may choose not to register the underlying securities at the time of registering the convertible securities. However, the underlying securities must be registered no later than the date they become exercisable or convertible.

Timing of Registration

Where securities are convertible at the option of the issuer, the underlying securities must be registered at the time the convertible securities are registered since the entire investment decision that the investor will be making, is made at the time of purchasing the convertible security. That is, the security holder, by purchasing a convertible security that is convertible at the option of the Company, is in effect also deciding to accept the underlying security.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!


Tags: , , , , , , , , ,