SEC Proposes Relaxation of Rule 144 Restrictions, Together with Rules Package to Facilitate Capital Raising by Smaller Companies

At its open meeting on May 23, 2007, the Securities and Exchange Commission voted to propose a number of rule changes intended to facilitate public and private capital-raising activities and ease disclosure requirements, in both cases particularly for smaller companies. The principal implication for larger companies involves relaxation of the safe harbor provisions of Rule 144 under the Securities Act of 1933 for sales of restricted securities.

In many respects the proposals seek to implement the recommendations of the Commission’s Advisory Committee on Smaller Public Companies, which was formed in March 2005 and delivered its final report in April 2006. The proposals, while salutary, do not extend to broad reform of the process by which issuers raise capital through private offerings not required to be registered under the Securities Act of 1933.

The proposed changes include the following:

• revising Securities Act Rule 144, principally to permit sales of restricted securities by non-affiliates without limitation after six months (or up to one year for securities held by owners that have hedged their positions) in the case of issuers that are reporting companies with current information, and after one year in the case of other issuers;
  
  
• providing exemptions from registration under the Securities Exchange Act of 1934 in the case of certain compensatory stock options;
  
  
• providing an additional exemption from Securities Act registration under Regulation D that would permit limited advertising, in the case of offerings limited to a class of investors with higher thresholds than the current “accredited investor” definition but with far lower thresholds than the current “qualified institutional buyer” definition;
  
  
• increasing, generally to $75 million unaffiliated public float, the eligibility threshold for the more limited disclosure requirements applicable to small business issuers; and
  
  
• providing for the use of Form S-3 and F-3, and therefore expanding shelf registration for primary offerings, to include smaller issuers that are timely in their reporting and offer limited amounts of securities.
  

The proposals also would conform Securities Act Rule 145’s resale provisions to those in the Rule 144 proposals for non-affiliates and eliminate the presumptive underwriter doctrine of Rule 145 in most cases, and would simplify Form D and require that it be filed electronically.

The texts of the various rule proposals and the accompanying releases are not yet available.

The most significant impact for larger issuers, those with unaffiliated public float of more than $75 million, relates to the proposed changes to Rule 144. The proposals would shorten the holding period to six months in the case of sales by non-affiliates of securities of reporting companies with current information and would provide for sales thereafter without any limitations. However, this liberalization would be accompanied by a limited reintroduction of a “tolling” provision that would extend the holding period to as much as one year in the case of non-affiliates who have hedged their restricted securities position. It was emphasized at the SEC’s open meeting that because the extended holding period could only last up to one year, it was not more restrictive than the provisions of existing Rule 144. One issue that may arise as a result of the proposed special hedging provision involves how purchasers of restricted securities would be able to ascertain whether prior owners had engaged in hedging transactions that could affect the subsequent owner’s holding period. This issue could arise particularly in the case of securities offered and sold pursuant to Rule 144A under the Securities Act, which are often held at DTC or otherwise in book entry form, where tracing of prior ownership may not be feasible. There was no indication at the meeting or in the statements currently available whether the proposed rules and accompanying releases will address the issue of tacking holding periods where prior owners’ hedging activities are not known or will otherwise address the question of hedging transactions.

The Commission will issue six separate proposing releases covering related topics:

• Securities Act Rules 144 and 145. As noted above, this proposal would shorten the holding period in the case of sales of restricted securities by non-affiliates to six months (or up to one year in the case of securities as to which the owner had engaged in hedging activities by entering into certain short positions or put-equivalent positions) for securities of reporting issuers with current information and to one year for other issuers, and would permit sales without any limitations after these holding periods. Volume and manner of sale limitations and Form 144 filing requirements would thus appear to be effectively eliminated for Rule 144 sales by non-affiliates.
  
  The proposal would provide for the elimination of manner of sale limitations in the case of sales of debt securities by affiliates, raise the thresholds at which Form 144 would be required to be filed by affiliates and codify certain staff positions under Rule 144.
  
  The proposal would also amend Rule 145 to eliminate the presumptive underwriter provisions in most cases and to harmonize the restrictions of Rule 145(d) with those of Rule 144. It will also solicit comment on combining the reporting obligations under Rule 144 with those under Form 4 for certain affiliated persons.
  
  
• Exemption of Compensatory Employee Stock Options from Registration Under Section 12(g) of the Exchange Act. This proposal would create two exemptions from the registration requirements of Section 12(g) of the Exchange Act for compensatory stock options held by more than 500 holders.
  
  The first exemption, applicable to non-reporting companies, would exempt from registration stock options granted to employees, directors, consultants and advisors pursuant to a written compensatory stock option plan, so long as the options and securities issuable upon their exercise were subject to transfer restrictions, and the company provides risk and financial information to option holders similar to the information required by Securities Act Rule 701 if more than $5 million in options are issued in a 12-month period. This information would include financial statements prepared in accordance with (or reconciled to) U.S. GAAP.
  
  The second exemption would exempt from registration as a separate class of securities compensatory stock options granted by reporting companies that have registered under Section 12 of the Exchange Act the class of securities underlying those options.
  
  
• Revisions to Regulation D Limited Offering Exemptions. The proposal would create a new exemption from the registration requirements of the Securities Act for offerings conducted in accordance with new Securities Act Rule 507. The exemption under this new rule would require that all sales be made to a newly defined class of “Rule 507 qualified purchasers.” The new category of investors would be limited to individuals with $2.5 million of investments or annual incomes of $400,000 (or $600,000 with spouse) and institutions that have $10 million in investments or that currently qualify as accredited investors without regard to the amount of their assets. The proposed exemption would permit limited advertising, apparently including tombstone-like advertising, in connection with the offering. It would thus provide a departure from the current rules relating to private offerings, which generally prohibit any publicity or advertising. The statements made at the SEC’s open meeting leave unclear the extent to which the proposals would broadly address the current prohibition in private offerings on general solicitation and advertising.
  
  This proposal would also revise the criteria for natural persons and institutions to be considered “accredited investors” under existing Rule 506 of Regulation D by adding an alternative $750,000 “investments-owned” standard to the current total assets and net worth standards, and by providing for adjustments to those thresholds to account for future inflation, with the first adjustments to occur in five years.
  
  Finally, the proposal would shorten the integration safe harbor (i.e., the minimum period of time required between a private and public offering to prevent those transactions from being “integrated” for purposes of the Securities Act) from six months to 90 days.
  
  
• Smaller Reporting Company Regulatory Relief and Simplification. This proposal would amend rules under the Securities Act and the Exchange Act to increase the number of companies eligible for the “scaled” disclosure and reporting requirements currently applicable to small business issuers. The proposal would create a new category of “smaller reporting companies,” combining the current categories of “small business issuers” and “non-accelerated filers.” The new category would include those issuers with a public float of $75 million or less (up from the current threshold of $25 million for small business issuers). These issuers would be eligible to provide the more limited disclosure currently permitted for small business issuers. The proposal would also eliminate Regulation S-B and “SB” forms by merging them into Regulation S-K and the “S” forms.
  
  
• Revisions to the Eligibility Requirements for Primary Securities Offerings on Forms S-3 and F-3. This proposal would expand the eligibility requirements of Forms S-3 and F-3 to allow companies with a public float of less than $75 million to conduct primary offerings of securities using these forms, including through shelf registration. The use by these smaller companies of Forms S-3 and F-3 would be conditioned on their meeting the other eligibility conditions for those forms and on their limiting securities offered on those forms to no more than 20% of their public float during any one-year period.
  
  
• Electronic Filings and Simplification of Form D. This proposal would mandate the electronic filing of Form D and simplify the form.

The participants at the meeting provided only general descriptions of the various proposals, which are also summarized in the opening statements made at the meeting and the press release issued after the meeting.

The comment period will be 60 days from publication of the proposed rule amendments in the Federal Register.

The SEC’s press release describing the proposals and the opening statements by the Division of Corporation Finance can be viewed at the following links:

http://www.sec.gov/news/press/2007/2007-102.htm

http://www.sec.gov/news/speech/2007/spch052307ko-ab-kh.htm

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