Without fanfare, the issuance of guidance, or any other formal notice, the SEC quietly changed its policy related to the filing of an at-the-market resale registration statement for an equity line financing by OTC Pink listed companies. To be clear, an OTC Pink listed company may now utilize a re-sale registration statement on Form S-1 for an equity line financing transaction, pursuant to which the securities may be sold by the investor, into the market, at market price. This results in a dramatic shift, for the better, for OTC Pink companies in the world of capital markets.
Background
Rule 415 sets forth the requirements for engaging in a delayed offering or offering on a continuous basis. Under Rule 415 a re-sale offering may be made on a delayed or continuous basis other than at a fixed price (i.e., it may be priced at the market). It is axiomatic that for a security to be sold at market price, there must be a market. Generally, and historically, a company that trades on the OTC Pink market may not rely on Rule 415 to file a re-sale registration statement whereby the selling shareholders can sell securities into the market at market price. That is, until recently all registration statements, whether re-sale, primary or indirect primary, must be at a fixed price unless the issuer is trading on the OTCQB or higher.
As there is no actual rule that identifies what is a market for purposes of Rule 415, the SEC has looked to Item 501(b)(3) of Regulation S-K. Item 501 provides the requirements for disclosing the offering price of securities on the forepart of a registration statement and outside front cover page of a prospectus. Item 501 requires that either a fixed price be disclosed or a formula or other method to determine the offering price based on market price. The SEC uses this rule to require a fixed price where a company trades on the OTC Pink since there is no identifiable “market” to tie a price to.
There was a time when the SEC refused to recognize any of the tiers of OTC Markets, as a “market” for purposes of at-the-market offerings. On May 16, 2013, the SEC issued a C&DI recognizing the OTCQB and OTCQX as markets for purposes of filing and pricing a re-sale registration statement. See HERE ). That C&DI specifically referred to the filing of a resale registration statement for an equity line financing, but the SEC and practitioners relied on the C&DI to allow the filing of an at the market resale registration statement by an OTC Markets traded company, in all circumstances, as long as the company traded on the OTCQB or OTCQX.
Of course, the re-sale registration statement would need to be a true re-sale and not an indirect primary offering. The SEC generally views the registration of more than one-third (33.33%) of the company’s pre-transaction total shares outstanding, held by non-affiliates, as an indirect primary offering. An indirect primary offering is treated the same as a primary offering and could not rely on Rule 415 to sell securities at other than a fixed price.
Equity Line Transactions:An equity line financing is a transaction whereby a company enters an investment contract to put shares to an investor (the equity line provider) at a price, generally determined by a formula based on a discount to market price. The company generally has the right to require the investor to buy securities over a set period of time, subject to specific terms in the contract. Assuming the contract terms are satisfied, the investor has no right to decline to purchase the securities (or a limited right to decline). The dollar value of the equity line is set in the written agreement, but the number of securities varies based on a formula tied to the market price of the securities at the time of each “put.”
Most equity line financing arrangements are similar to a PIPE (private investment into public entity) transaction such that the company relies on the private placement exemption from registration to sell the securities under the equity line and then files a registration statement for the resale of such securities by the investor. However, whereas in a PIPE transaction the investor bears the risk, in an equity line transaction the investor often bears little risk due to the delayed nature of the puts coupled with the price of the securities being a formula tied to market price. Accordingly, the SEC views equity line financing registrations as indirect primary offerings.
Over the years the SEC issued various guidance on equity line financings and the ability to file a re-sale registration statement for the financing, despite the fact that the securities would not have been issued at the time of filing the registration statement. In May 2013, the SEC issued a new C&DI which was, until November 2020, the operative guida for equity line transactions.
In particular:
“Question: When may a company file a registration statement for the resale by the investors of securities sold in a private equity line financing?
Answer: In many equity line financings, the company will rely on the private placement exemption from registration to sell the securities under the equity line and will then register the ‘resale’ of the securities sold in the equity line financing. In these types of equity line financings, the delayed nature of the puts and the lack of market risk resulting from the formula price differentiate private equity line financings from financing PIPEs (private investment, public equity). We, therefore, analyze private equity line financings as indirect primary offerings.
While we analyze private equity line financings as indirect primary offerings, we recognize that the ‘resale’ form of registration is sought in these financings. As such, we will permit the company to register the ‘resale’ of the securities prior to its exercise of the put if the transactions meet the following conditions:
- the company must have ‘completed’ the private transaction of all of the securities it is registering for ‘resale’ prior to the filing of the registration statement;
- the ‘resale’ registration statement must be on the form that the company is eligible to use for a primary offering; and
- in the prospectus, the investor(s) must be identified as underwriter(s), as well as selling shareholder(s).
We will not object that a private transaction is not ‘completed’ based on the lack of a fixed price if the agreement provides for pricing based on a formula tied to market price and there is an existing market for the securities as evidenced by trading on a national securities exchange or through the facilities of the OTC Bulletin Board or the OTCQX or OTCQB marketplaces of OTC Link ATS. [May 16, 2013]”
In November 2008, the SEC issued a series of C&DI providing guidance as to when the private offering part of an equity line transaction could be considered “completed.” This guidance was not changed by the March 2013 new C&DI (which only added the OTCQB and OTCQX as recognized markets). In accordance with the November 2008 guidance, the SEC would allow the filing of resale type registrations if the following conditions are met:
- The Issuer must have completed the private transaction prior to filing the registration statement (i.e., both parties must be fully contractually bound, with all material points agreed upon);
- The “resale” registration statement must be on the form that the Issuer is eligible to use for a primary offering; and
- In the prospectus, the investors must be identified as both underwriter(s) and selling shareholder(s).
For the first condition to be met, the investor must be irrevocably bound to purchase all the securities. That is, only the issuer can have the right to exercise the put and, except for conditions outside the investor’s control, the investor must be irrevocably bound to purchase the securities once the Issuer exercises the put. In addition, the obligations of the investor must be non-assignable to meet the “irrevocably bound” condition.
Moreover, if the investor has the ability to make investment-related decisions under the terms of the contract, they will not be deemed to be irrevocably bound allowing for the filing of a resale registration statement. Examples of investment decisions that would be viewed by the SEC as creating a continuing transaction (and not a completed transaction allowing for the filing of a registration statement) include:
- Agreements that give the investor the right to acquire additional securities (including through warrants) at the same time or after the Issuer exercises a put;
- Agreements that permit the investor to decide when or at what price to purchase the securities underlying the put;
- Agreements with termination provisions that have the effect of causing the investor to no longer be irrevocably bound to purchase the securities; and
- Agreements that allow the Investor to exercise a “due diligence out.”
However, the agreements may allow for customary “bring-downs” as conditions to closing such as customary representations and warranties and customary clauses regarding no material adverse changes affecting the issuer that would be within the investor’s control.
On November 13, 2020, the SEC amended the C&DI it had issued in March 2013 and withdrew the five from November 2008 as moot. The November 2020 C&DI provides:
“C&DI 139.13 Question: In many equity line financings, the company will rely on the private placement exemption from registration to sell the securities under the equity line and will then seek to register the “resale” of the securities sold in the equity line financing. When may a company file a registration statement for the resale by the investors of securities sold in a private equity line financing?
Answer: In these types of equity line financings, the company’s right to put shares to the investor in the future and the lack of market risk resulting from the formula price differentiate private equity line financings from financing PIPEs (private investment, public equity). We, therefore, analyze private equity line financings as indirect primary offerings, even though the “resale” form of registration is sought in these financings.
The at-the-market limitations contained in Rule 415(a)(4) would otherwise prohibit market-based formula pricing for issuers that are not eligible to conduct primary offerings on Form S-3 or Form F-3. Nevertheless, we will not object to such companies registering the “resale” of the securities prior to the exercise of the equity line put if the transactions meet the following conditions:
- the company and the investor have entered into a binding agreement with respect to the private equity line financing at the time the registration statement is filed;
- the “resale” registration statement is on a form that the company is eligible to use for a primary offering;
- there is an existing market for the securities, as evidenced by trading on a national securities exchange or alternative trading system, which is a registered broker-dealer and has an active Form ATS on file with the Commission; and
- the equity line investor is identified in the prospectus as an underwriter, as well as a selling shareholder.
We will not object to the filing of a registration statement for a private equity line financing prior to the issuance of securities by the company under the equity line even when there are contingencies attached to the investor’s obligation to accept a put of shares from the company, as long as the above conditions are satisfied and the following terms of the investment have been agreed upon by both parties and disclosed by the company at the time that the resale registration statement is filed:
- the number of shares registered for resale;
- the maximum principal amount available under the equity line agreement;
- the term of the agreement; and
- the full discounted price (or formula for determining it) at which the investor will receive the shares.”
The new C&DI succinctly combined the previous ones. I thought it was interesting that the SEC had eliminated a reference to the OTCQB and OTCQX; however, equity line registrations filed shortly after the new C&DI for an OTC Pink entity were still required to be at a fixed price.
Recently, however, the SEC has confirmed that it will allow an equity line re-sale registration statement to be filed by an OTC Pink company and priced at the market if all the requirements of C&DI 139.13 have been satisfied. In that regard, our firm has cleared at least one re-sale S-1 for an OTC Pink company in the past month.
Interestingly, the SEC is now clearly taking the position that the OTC Pink is an “existing market for the securities, as evidenced by trading on a national securities exchange or alternative trading system, which is a registered broker-dealer and has an active Form ATS on file with the Commission” for purposes of equity line financings, but has not yet expanded that view for purposes of straight re-sale registration statements.
I am hopeful that with the new 15c2-11 rules together with OTC Markets incredible job at regulating the marketplace, the OTC Pink will soon be recognized as an “existing market” for securities across the board.