Words of Wisdom Blog

The Cheap Stock Survival Guide

L&W Capital Markets Group — Thu, 09 May 2013 12:05:01 -0500

Your good client Frank Bunker Gilbreth is planning the IPO of his consulting company, Therblig, Inc. Frank tells you that Therblig has granted equity awards to dozens of employees during the past 12 months and he wants to know if there will be any issues with Therblig’s planned IPO. While you know enough to know that equity awards are one thing that should not be cheaper by the dozen, you are a bit hazy on the “cheap stock” problem.

Here is what you need to know to avoid the cheap stock trap.

The Cheap Stock Basics

Any equity grants to employees during the 12-month window preceding the filing of an initial public offering registration statement are susceptible to being deemed cheap stock — underpriced pre-IPO equity awards that require an additional earnings charge.

Under accounting and tax rules that apply to equity awards, the value of an equity award on the grant date is considered compensation expense on the company’s income statement for purposes of U.S. GAAP and may constitute taxable income to the employee for U.S. income tax purposes.

When a company makes pre-IPO equity awards at valuations substantially lower than the IPO price, questions arise whether the company has issued cheap stock to its employees. The SEC Staff will scrutinize pre-IPO equity awards to ensure that issuers have correctly accounted for the awards and have included disclosure in the IPO registration statement regarding the process and substance behind the issuer’s valuations of its equity awards.

An issuer that has not correctly recorded compensation expense could face a pre-IPO restatement of its financial statements to correct errors in compensation expense associated with prior equity awards.

How to Avoid the Cheap Stock Trap

The best way to avoid trouble with cheap stock issues is to avoid equity awards entirely during the 12-month period before the filing of your IPO. But, in the real world, complete abstinence may not be realistic for many pre-IPO companies, so the next-best solution is to use protection:

Obtain contemporaneous independent valuations that follow the valuation guidance in the AICPA’s VPES Practice Aid, with respect to all equity awards made during at least the 12-month period before an IPO filing.
Preemptively address the SEC’s focus on cheap stock issues by including disclosure in the IPO registration statement regarding the process and substance behind the company’s valuations of its equity awards, including the factors and events that resulted in changes in the equity value and ultimately the IPO price.
Be ready to provide the SEC Staff with a detailed analysis regarding the process and substance behind your valuation determinations. If you obtained contemporaneous independent valuations on each of the targeted grant dates, you will be well armed to discuss the key drivers in these earlier valuation determinations.

The Cheap Stock Survival Guide contained in our Client Alert (available here) discusses in detail the specific information you will need to provide in your IPO registration statement and in the SEC review process.

A Primer on Section 16 Officers

L&W Capital Markets Group — Thu, 18 Apr 2013 17:42:47 -0500

Your old college buddy Sam Baker has just been appointed CFO of Dixie Candles, Inc. While telling Sam about her promotion, Dixie’s CEO mentioned in passing that of course Sam was now a “Section 16 officer” given that the CFO serves as both principal financial officer and principal accounting officer for the company. In her excitement, Sam forgot to ask exactly what was a Section 16 officer, so she calls you for a quick primer.

Here is what you need to know about Section 16 officers:

Obligations of Section 16 Officers

Under Section 16(a) of the Exchange Act, each person deemed to be an “officer” in accordance with Rule 16a-1(f) is required to file with the SEC various forms indicating their ownership of or transactions in the company’s securities, including common stock and derivative securities, such as stock options and restricted stock units. Each newly minted Section 16 officer must file an “Initial Statement of Beneficial Ownership of Securities” on Form 3 listing the amount of the company’s securities that the officer beneficially owns within 10 days of his or her designation. Changes in the beneficial ownership of the company’s securities, with certain exceptions, must be reported on Form 4 generally within two business days of the date on which the change occurs. In addition, each Section 16 officer is required to file a Form 5 within 45 days after the company’s fiscal year-end unless the officer has previously reported on Form 4 all changes in beneficial ownership.

In addition to these reporting requirements, Section 16 officers are subject to civil liability for certain short-term transactions under Section 16(b) of the Exchange Act. In particular, to prevent the unfair use of information which may have been obtained by an officer, Section 16 authorizes the company to recover any profits realized by the officer from any purchase and sale of securities (or sale followed by a purchase) during a six-month period. Liability is absolute even if the purchase or sale took place after full disclosure and without the use of any inside information. The officer would be liable even if compelled to sell for personal reasons.

Who Is a Section 16 Officer?

The definition of “officer” under Section 16 can be found in Rule 16a-1(f). Certain officers are specifically deemed to be an “officer” under Section 16, including the company’s president, principal financial officer, principal accounting officer (or, if there is no principal accounting officer, the controller), and any vice president in charge of a principal business unit, division or function (such as sales, administrative or finance). In addition, any other officer who performs a policy-making function or any other person who performs similar policy-making functions for the company is considered an “officer” under Rule 16a-1(f). Any officers of subsidiaries who also perform policy-making functions for the company are deemed to be officers under the definition.

Determining whether a person performs a policy-making function often involves careful consideration and varies significantly depending on the nature and structure of the company’s business. A note to Rule 16a-1(f) provides two guideposts: First, the term “policy-making function” does not include insignificant policy-making functions. Second, persons designated as “executive officers” under Item 401(b) of Regulation S-K are presumed to be “officers” under Section 16.

The definition of Section 16 officer is designed to apply narrowly to the small subset of executives in the company who have significant policy-making functions. In addition to a factual analysis of a person’s duties and responsibilities, a company’s corporate organization and reporting lines often will help inform the analysis.

What Is the Difference Between a Company’s Section 16 Officers and “Executive Officers”?

The following table breaks down the differences between the definition of “officer” in Rule 16a-1(f) and “executive officer” under Item 401(b) of Regulation S-K, which definition can be found in Rule 3b-7 of the Exchange Act. As discussed below, the definitions are in practice nearly identical except for two differences, one that is substantive and one that is not.

As noted in the table, the positions of “principal financial officer” and “principal accounting officer (or controller)” are not specifically mentioned in the definition of “executive officer” under Rule 3b-7. However, virtually every company considers its principal financial officer to be an “executive officer” (either as a vice president in charge of a principal function, finance, or as a significant policy-maker) and Item 402(a)(3)(ii) of Regulation S-K automatically defines the principal financial officer as one of the named executive officers (NEOs), so Rule 3b-7's omission of this position is in practice inconsequential. Often, the principal financial officer also serves as the principal accounting officer. However, if the principal accounting officer is a different person from the principal financial officer, many companies do not consider the principal accounting officer or controller to be an executive officer. As a result, the principal accounting officer is the one position where a company’s lists of executive officers and Section 16 officers may potentially diverge.

Who Should Determine Section 16 Officer Status?

Decisions regarding who is a Section 16 officer are generally made each year by the company’s Board of Directors, usually with input from management and company counsel. The SEC Staff has stated that it will not advise registrants regarding the determination of executive officers and will neither object to nor concur in those determinations. Instead, the Staff has explained that the “determination depends on the facts and circumstances and must be analyzed and determined by the issuer and its counsel.” As a result, executive officer status will vary from time to time, depending on the nature and structure of a company's business and the category of persons who serve in a policy-making function. In general, executive officer status will not be challenged after the determination by a Board of Directors acting in good faith and with a reasonable basis.

How Many Section 16 Officers Should a Company Have?

Of course, each company should examine its own facts and circumstances and apply the criteria in Rule 16a-1(f) to determine who within the company should be deemed to be a Section 16 officer. Companies may typically have between six and twelve Section 16 officers. Some companies tend to broaden the category beyond what is necessary, increasing their administrative burden without any corresponding benefit. Companies with an over-inclusive designation of Section 16 officers may face challenges administering timely Section 16 reporting and may unnecessarily subject some employees to the scrutiny and burdens of Section 16.

Where a company has fewer than five executive officers, its executive compensation disclosure will include fewer than five NEOs, which may prompt a comment from the SEC Staff seeking confirmation that the disclosure includes all of the company's NEOs. The Staff typically will not object where a company has fewer than five NEOs if the company can confirm that the number of NEOs is the same as the number of executive officers and that its executive compensation disclosure includes all of the NEOs.

IPO On-Ramp - Smoothing the Road to an IPO

L&W Capital Markets Group — Thu, 04 Apr 2013 11:05:08 -0500

Highway on-ramps: you’ve probably driven on them thousands of times and never given them another thought. But it turns out that they are marvels of engineering.

In this installment we are summarizing a legislative marvel: the IPO on-ramp provisions of the JOBS Act, which was signed into law nearly one year ago, on April 5, 2012. The law – which grew out of the recommendations of the IPO Task Force on which Latham’s Joel Trotter served as one of two securities lawyers – passed with overwhelming bipartisan support and in record time. Now that’s something you don’t see every day

Where Can I Find Information About the JOBS Act?

We have collected a wide variety of JOBS Act-related materials on the JOBS Act section of our website, including our comprehensive report, “The JOBS Act After One Year: A Review of the IPO Playbook.” We also recommend keeping an eye on the SEC Division of Corporation Finance JOBS Act website, where you can find Corp Fin JOBS Act FAQs and other resources from the SEC Staff.

What Is the IPO On-Ramp?

The IPO on-ramp refers to Title I of the JOBS Act. Title I of the JOBS Act creates a new category of issuer, called an emerging growth company, or EGC. To qualify as an EGC, a company must have annual revenue for its most recently completed fiscal year of less than $1.0 billion. A company will remain an EGC until the earliest of:

the last day of any fiscal year in which it earns $1.0 billion in revenue;
the date when it qualifies as a “large accelerated filer,” with at least $700 million in public float;
the last day of the fiscal year ending after the fifth anniversary of its IPO pricing date; or
its issuance, in any three-year period, of more than $1.0 billion in non-convertible debt securities.

EGC status is generally unavailable to any public company that priced its IPO on or before December 8, 2011.

What Are Some of the Key Changes to the IPO Process for EGCs?

Testing the Waters. Before or after filing a registration statement, EGCs may meet with qualified institutional buyers and other institutional accredited investors to gauge their interest in a contemplated offering.
Confidential SEC Review. EGCs may initiate the IPO registration process confidentially. However, an EGC must publicly file its initial submission and all amendments at least 21 days prior to conducting its traditional IPO road show marketing process.
Scaled Financial Disclosure. EGCs may go public using two years, rather than three years, of audited financial statements and as few as two years, rather than five years, of selected financial data.
Increased Availability of Research. The JOBS Act permits research analysts to cover EGCs sooner than under prior law and eased some of the ministerial restrictions on analyst communications during the IPO process. Practices in this area continue to develop. Although pre-deal research on EGC IPOs has not emerged, analysts now routinely publish research reports on newly public EGCs as much as 15 days earlier than under prior law for IPOs and during some previously blacked-out periods immediately following EGC secondary offerings.

What are the Elements of the IPO On-Ramp?

As long as an issuer continues to qualify as an EGC, it will benefit from the IPO on-ramp, during which its regulatory requirements as a public company phase in gradually. This phased approach eases the cost of public company compliance.

The on-ramp exemptions for EGCs cover four broad areas:

Internal Controls Audit. EGCs are exempt from the internal controls audit required by Section 404(b) of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley).
Executive Compensation. EGCs may use streamlined executive compensation disclosure and are exempt from the shareholder advisory votes on executive compensation required by Dodd-Frank.
Extended Phase-In for New GAAP. EGCs may use private-company phase-in periods for new accounting standards.
PCAOB Rules. EGCs are exempt from any Public Company Accounting Oversight Board rules that, if adopted, would mandate auditor rotation or auditor discussion and analysis.

"A Night in Tunisia" Part 2 - Non-Public Submissions from Foreign Private Issuers

L&W Capital Markets Group — Wed, 27 Mar 2013 15:33:27 -0500

In a past installment, we discussed some of the basics of foreign private issuers (FPIs). This week, your good client Dizzy has called to tell you that he wants to take his FPI musical instrument manufacturing company (whose signature product is a trumpet with a distinctive bent horn) public in the United States. He wants to know if he can begin the SEC review process before publicly filing a registration statement for the initial public offering. Will Dizzy be singing the blues?

Confidential SEC review of FPI IPO registration statements

Under the SEC Staff’s current policy, an FPI may submit its IPO registration statement on a confidential basis if it:

qualifies as an emerging growth company (EGC) under the JOBS Act;
is listed or is concurrently listing its securities on a non-US securities exchange;
is being privatized by a foreign government; or
can “demonstrate that the public filing of an initial registration statement would conflict with the law of an applicable foreign jurisdiction.”

So, an FPI that is not an EGC and is solely listing its securities in the United States generally may not submit a registration statement for confidential review. By contrast, an FPI that is an EGC or will dual list in the United States may begin the SEC review process by confidentially submitting its F-1 registration statement for review. A dual-listed FPI that is also an EGC should indicate at the outset whether it is confidentially submitting as an eligible FPI or as an EGC (among other things, an EGC is required to make all of its previous confidential submissions publicly available on EDGAR at least 21-days prior to the start of its traditional road show).

How does Dizzy confidentially submit the registration statement for its IPO?

FPIs should submit IPO registration statements for non-public review through EDGAR, in the same manner as EGCs. That means using the updated procedures for confidential EGC submissions on new Form DRS or DRS/A outlined here and here.

When submitting an F-1 confidentiality, bear in mind that the F-1 must be substantially complete. However, the SEC Staff has confirmed that the non-public submission of a registration statement does not constitute the “filing” of a registration statement under the Securities Act. This is relevant to the SEC’s rules that key off of a filing with the SEC, such as Rule 163A’s 30-day safe harbor from the definition of offer. It also means that the registration statement does not need to be signed and does not need to include the consent of the FPI’s auditors or other experts. In addition, because a confidential submission is not a filing, FPIs are not required to pay SEC filing fees until the first public filing. However, confidential submissions do trigger FINRA filing requirements and require the submission of a FINRA application and payment of FINRA’s applicable filing fee (unless no FINRA member broker-dealer is yet involved in the offering). See FINRA Rule 5110(b)(4).

Taking Sides with the Family - Directed Share Programs

L&W Capital Markets Group — Wed, 13 Mar 2013 13:22:36 -0500

Jack Woltz is looking to take his studio, Woltz International Pictures, public. As part of the IPO, Woltz wants to have a directed share program to reward his family, associates and stars for their loyalty and hard work during the developmental years of the studio.

What issues do you need to consider?

Gun-jumping issues. At some point, Woltz will need to formally invite his family and associates to participate in the DSP. Because this communication will likely be an offer subject to Section 5 of the Securities Act, it is important to find an appropriate safe harbor such as Rule 134. For a discussion of how Rule 134 works in the DSP context, see pp. 16-17 of our Client Alert on offers. (And don’t forget to leave the gun and take the cannoli.)
Maximum DSP Size. In 2003, a FINRA (formerly NYSE/NASD) advisory committee recommended imposing a 5% maximum size for an issuer’s DSP – the rationale being that a larger DSP could compromise the IPO process. That recommendation has not yet been adopted as part of rulemaking and while some DSPs have adhered to the 5% recommended limit, market practice varies.
Lock-ups. FINRA no longer requires that DSP shares be locked up for three months (a concept you may find in some older precedents). However, under FINRA Rule 5131(d), to the extent any lock-up agreement applies to shares owned by officers and directors, that agreement must include the shares purchased by the officers and directors in the DSP.
Broker-Dealers Under FINRA Rule 5130(d)(1), broker-dealers are not allowed to participate as a purchaser in the DSP (with an exception for immediate family members of broker-dealer personnel that are employees of the issuer). The 2007 proposing release for the rule stated that “[FINRA] does not see any…basis to justify new issue allocations from the issuer to a broker-dealer.” Therefore, unfortunately, if Jack makes the underwriters an offer to participate in the DSP, it will be an offer they will just have to refuse (even though, as Jack likes to say, “I ain’t no bandleader”).
Underwriting/Disclosure. The underwriting arrangements will address the DSP, and typical DSP disclosure would include a short paragraph in the Underwriting section of the prospectus covering topics such as the number or percentage of shares being reserved for the DSP, categories of DSP purchasers, and the reallocation process if the DSP is not fully purchased or if designees renege on their commitments.

Securing Unsecured Notes (Part II)

L&W Capital Markets Group — Wed, 27 Feb 2013 11:43:37 -0500

Previously, we described the plight of Mr. Wonka and his company, WWCC, a global candy maker and high yield issuer that has fallen on hard times. Mr. Wonka is absolutely thrilled with your proposal to have WWCC grant an “equal and ratable” lien over the factory in favor of WWCC’s outstanding notes. This will allow WWCC to obtain new secured bank financing without breaching the terms of its outstanding notes. Mr. Wonka even offers to take you for a ride in his Great Glass Elevator—if you can just get the deal closed before WWCC runs out of cash! You’re almost there, but keep in mind a few traps for the unwary that will arise when WWCC proceeds to grant liens in favor of the outstanding notes.

Regulation S-X Rule 3-16

If the existing notes are registered (or are due to become registered), and as the result of equally and ratably securing the notes, stock in the issuer’s subsidiaries will be pledged, the issuer must exercise caution to avoid becoming subject to the requirements of Regulation S-X Rule 3-16. S-X Rule 3-16 requires that if the stock of an affiliate of an issuer (often a subsidiary) constitutes a “substantial” portion of the collateral for notes that are registered, the issuer must file the financial statements of the subsidiary that would be required if the subsidiary were itself the issuer (generally three years of audited financial statements). Substantial in this context means 20 percent or more of the principal amount of the notes being secured. For more discussion of S-X Rule 3-16 and how it works, see p.16 of our publication on financial statements.

Because S-X Rule 3-16 is burdensome, many issuers negotiate to cut back the collateral to exclude the portion of stock in subsidiaries that would otherwise trigger the rule. The security agreement will contain a cut-back provision that works automatically so the excluded securities are never part of the collateral, and S-X Rule 3-16 isn’t implicated.

How about the TIA?

A few Words of Wisdom back we discussed some issues under the Trust Indenture Act in connection with Section 3(a)(9) exchanges. Luckily, you do not need to worry about the TIA in connection with many typical unregistered debt offerings. As we previously explained, TIA 304(b) exempts Section 4(2) and Rule 144A offerings, while TIA 304(a) exempts a grab-bag of exempt offerings (including Section 3(a)(2) offerings for banks and Section 3(a)(3) commercial paper).

However, if you find yourself without an exemption from the TIA, you'll need to be mindful, since Section 314(d)(1) of the TIA generally requires the delivery of certain certificates and opinions of fair value in connection with obtaining the release of collateral subject to the lien of an indenture. The SEC Staff has historically granted no-action relief from the requirements of Section 314(d)(1) in cases where the notes trustee does not control decisions regarding whether the collateral is maintained or released.¹ Accordingly, where existing notes are equally and ratably secured as the result of the subsequent incurrence of new secured debt, and a party other than the existing notes trustee (such as the collateral agent under new credit facilities) controls the release of collateral, the issuer need not comply with Section 314(d).

Once the existing notes become secured, the TIA imposes an additional compliance obligation. Under Section 314(b) of the TIA, on an annual basis an issuer must deliver to the existing notes trustee an opinion of counsel stating that, in the opinion of counsel, such action has been taken with respect to the recording, filing, re-recording, and refilling of the indenture as necessary to maintain the lien of such indenture. The opinion must recite the details of the actions taken, or state that, in the opinion of counsel, no action is necessary.

_______________________

¹ See, e.g., Pregis Corp., SEC No-Action Letter, 2007 WL 4328651 (Dec. 7, 2007).

Securing Unsecured Notes (Part I)

L&W Capital Markets Group — Wed, 13 Feb 2013 15:04:35 -0500

Willy Wonka, a local candy maker and CEO of Willy Wonka Candy Company, calls you in a state of high excitement. The global recession is taking its toll on WWCC, and Mr. Wonka needs to raise money quickly. But Mr. Wonka is discovering that no one is willing to lend funds to WWCC on an unsecured basis. Nor are his bankers interested in Mr. Wonka’s offer to sign over the Wonka name—they just want a lien over WWCC’s factory.

Mr. Wonka has urgent concerns that must be addressed before he will consider granting a lien over the factory. For example, in the event of foreclosure, what will happen to Mr. Wonka’s hard-working (but vertically challenged) staff?

By contrast, you have some issues to consider under WWCC’s outstanding unsecured high yield bonds. In particular, the typical limitation on liens covenant – sometimes called a negative pledge – can present a significant constraint on an issuer’s ability to participate in business combinations and other transactions financed with new secured debt, such as leveraged acquisitions or, in WWCC’s case, rescue financing.

Here is some guidance in thinking through this sticky problem.

Background on the limitation on liens covenant

The limitation on liens covenant in a bond indenture typically restricts an issuer’s ability to secure future debt with liens on the assets of the issuer and its subsidiaries, other than specified “Permitted Liens.” For high yield issuers, the limitation on liens will generally apply to all of the assets of the issuer and the guarantors, but it will include significant carveouts. The high yield carveouts typically permit the issuer to incur only a limited amount of senior secured credit facilities, secured purchase money debt and capital leases and secured debt of foreign subsidiaries, as well as other miscellaneous secured debt.

Investment grade indentures with limitations on secured indebtedness may have a narrower scope -- rather than covering all of the assets, the limitation may apply to only certain assets, usually defined as “Principal Properties” (such as WWCC’s factory) and stock and intercompany debt of subsidiaries. In that event, the covenant typically provides narrower carveouts as well, for example that the issuer is unable to incur material secured debt for borrowed money above a general basket.

Exception for securing existing notes “equally and ratably”

Generally, the limitation on liens covenant in both investment grade and senior high yield indentures includes one major exception: the issuer may grant additional liens over its assets above and beyond Permitted Liens so long as it “equally and ratably” secures the existing notes. This exception, which is known as the “equal and ratable clause,” is consistent with the purpose of the negative pledge provision. Its mission is not to prohibit the issuer from encumbering its assets, but merely to assure noteholders that if the issuer grants a lien to secure other people’s debt, the issuer will equally and ratably secure the existing notes.

If the negative pledge under the existing notes applies to certain assets only (e.g., “Principal Properties held by domestic subsidiaries”) then only those assets need to be subjected to the new lien securing the existing notes. By contrast, assets that are not subject to the negative pledge may be independently pledged in favor of other financing sources without providing a ratable lien in favor of the existing noteholders. For example, lenders under an asset-based senior secured credit facility could obtain an independent lien over accounts receivable and inventory that does not need to be shared with the existing noteholders if such assets are not covered by the negative pledge covenant in the existing notes indenture. Further, WWCC could seek separate financing secured by a pledge of the Wonka logo or other intellectual property assets.

What constitutes securing existing notes equally and ratably?

In the context of acquisition financing, the new triggering lien is typically created to secure borrowings under a new senior secured credit facility. Bank lenders do not like to share their liens with anyone. If they do agree to be equally and ratably secured with other creditors, they will likely insist that the other creditors take a silent role in all decision-making concerning remedies, etc.

Industry practice is to take the view that a plain obligation to secure existing notes equally and ratably, without more, requires only equal and ratable treatment in the application of proceeds of collateral and does not require that the existing notes trustee have any ability to control the collateral or the enforcement of remedies. Accordingly, unless an indenture provides otherwise, it is not necessary to give the noteholders any control over the release of collateral from the derivative lien granted to them by operation of the obligation to equally and ratably secure the notes. Shared collateral agreements can provide bank lenders with exclusive control over the release of shared collateral, without the consent of the existing noteholders.

Senior secured credit facilities generally require the borrower to apply certain proceeds from asset sales to repay the loans. If the disposed assets are subject to an equal and ratable lien in favor of existing notes, such proceeds could arguably constitute “proceeds of the collateral” and an argument could be made that the noteholders are entitled to their ratable share of such proceeds. The security documents that grant the new equal and ratable lien to secure existing notes often provide for a collateral trust account that will hold the noteholders’ ratable share of the proceeds of collateral following an enforcement event. However, outside of the enforcement context and absent an explicit provision to the contrary, market practice is that proceeds of asset sales (in the ordinary course or otherwise) need not be applied to ratably repay or redeem existing notes and, in fact, there may be no mechanism under the existing notes indenture to prepay, redeem or make an “asset sale offer” with respect to the existing notes.

Some practical concerns

The requirement to equally and ratably secure the notes can be effected by a collateral trust agreement in favor of the collateral agent under the new senior secured credit facilities, who will hold the lien for the ratable benefit of each of the lenders under the senior secured credit facilities and the existing noteholders.
Intercreditor provisions regarding the application of proceeds of the collateral among the various secured parties and control of the enforcement of remedies can be included in the security agreement regarding the shared collateral.
Assuming that no consent or other action is needed from the existing notes trustee in connection with the transactions (and that the existing notes trustee is not otherwise involved in the transactions, e.g., as trustee with respect to new notes to be issued), the question arises whether the existing notes trustee need even be involved in or aware of the process of equally and ratably securing the existing notes.
Legal counsel to the issuer will need to have enough certainty, even without explicit sign-off from the existing notes trustee, that the arrangement complies with the existing notes indenture in order to be able to render its legal opinion with regard to the absence of conflicts with the existing notes indenture. As a result, it is good practice to provide drafts of the new shared collateral agreements to the existing notes trustee’s counsel for review and (typically, limited) comment, although, as discussed above, trustee sign-off is generally not required.

Late for a Very Important Date - Late SEC Filings and the Use of a Shelf Registration Statement

L&W Capital Markets Group — Wed, 30 Jan 2013 17:38:02 -0500

In a past installment, we addressed what Alice Wonderland, the General Counsel of our good public company client, March Hare, Inc., should be aware of in connection with a late SEC filing. This time, Alice called us after March Hare missed the filing deadline for a Form 8-K…..silly rabbit! Alice wants to know whether this affects March Hare’s ability to do a take-down from its currently effective shelf registration statement.

Has March Hare headed down a rabbit hole this time?

No, March Hare will be able to continue to do takedowns off of its existing Form S-3 until it files the next Form 10-K. See C&DI 198.03. A company tests Form S-3 eligibility at the time it files its Form 10-K, since the 10-K acts as a post-effective update under Securities Act Section 10(a)(3). See C&DI 114.04 and C&DI 144.01. It also needs to test eligibility at the time of any post-effective amendment to the Form S-3 (for example, for purposes of adding new shares in the case of a non-automatic shelf).

March Hare’s 10-K is looming. Is its shelf in danger of fading away like the Cheshire Cat?

First, it depends what kind of 8-K was late for this very important date. Only 8-K’s that are filed count – those that are furnished don’t. Form 8-Ks under Items 2.02 (earnings releases) and 7.01 (Regulation FD disclosure) are considered furnished and not filed, see General Instruction B.2 to Form 8-K and C&DI 115.07.

Second, Form S-3 is more forgiving about some filed 8-Ks than others. General Instruction I.A.3(b) of Form S-3 lets you off the hook for late filings of Form 8-K’s solely under Items:

§ 1.01 and 1.02 (material definitive agreements)
§ 1.04 (mine safety)
§ 2.03 and 2.04 (off-balance sheet arrangements)
§ 2.05 (exits or disposals)
§ 2.06 (impairments)
§ 4.02(a) (non-reliance on previously issued financial statements)
§ 5.02(e) (compensatory plans with certain executives)

Third, even if March Hare failed to file one of the Form 8-Ks that matter, you may be able to pull a rabbit out of the hat if you can convince the SEC Staff to give you a waiver. Keep in mind that the SEC Staff typically won’t entertain a waiver request more than 30 days before a company is due to file its Form 10-K.

March Hare has fallen down the rabbit hole. When will it be able to climb back out and what does it have to do while it is down there?

If March Hare loses shelf eligibility, it will have to file a post-effective amendment at the time of the Form 10-K on whatever form would be available to it – typically, Form S-1. See C&DI 144.01. Note that March Hare will have to wait for the SEC Staff to declare the new post-effective amendment effective before it could do a shelf take-down, and that that using Form S-1 for a shelf offering is more complicated than using Form S-3. See C&DI 113.02 for an explanation of how to add information in subsequent Exchange Act reports to an S-1 shelf.

Once twelve months and any portion of a month immediately before the filing have gone by, March Hare will once again be able to file a registration statement on Form S-3 assuming it meets the other requirements of the form. See C&DI 115.03. So, if March Hare’s Form 8-K was originally due on February 20, 2012, and the company was thereafter timely in its reporting, it would first be eligible to use Form S-3 on March 1, 2013.

Apocalypse 2012? Guess Not...

L&W Capital Markets Group — Tue, 15 Jan 2013 18:06:25 -0500

You are working on a public offering for Mayan Vacation Properties, Inc., an operator of resorts in the Yucatan Peninsula. Mayan is a calendar year filer, and the question has come up when its third quarter interim financial statements will go stale. That has deal timing implications, of course.

Contrary to certain predictions and beliefs the world did not end on December 21, 2012. So you can’t rely on B’ak’tun 13 to short-circuit the need to provide an answer.

Q: When do third quarter financial statements go stale?

A: It depends on the type of filer. The 2012 third quarter financial statements for the different types of filers listed below go stale at the close of business on the following dates in 2013 (assuming a calendar year fiscal year).

Q: What if a large accelerated filer or accelerated filer is also a loss corporation or a delinquent filer?

A: The earlier February 14 staleness date applies to all loss corporations and delinquent filers, regardless of their size.

Q: When must annual audited financial statements for 2012 be included in a 2013 IPO registration statement?

A: In order for an IPO registration statement to be declared effective, annual audited financial statements for 2012 must be included after February 14, 2013.

Q: Let’s assume Mayan is a loss corporation. Can it conduct an offering off of an effective shelf registration statement during the gap period AFTER February 14 (when its third quarter financial statements go stale) and BEFORE it files its Annual Report on Form 10-K?

A: Yes. As a refresher, a “loss corporation” is a company that does not expect to report positive income after taxes but before extraordinary items and the cumulative effect of a change in accounting principle for the most recently ended fiscal year and for at least one of the two prior fiscal years. See S-X Rule 3-01(c). The SEC Staff will not object to a loss corporation taking down securities off an effective shelf during the gap period, as long as the shelf was effective before the gap period commenced. See C&DI 119.02. But a loss corporation couldn’t go effective on a new shelf registration statement after the close of business on February 14, 2013 without audited year-end financials.

Q: On January 2, 2013, because the world did not end, Mayan was able to consummate the acquisition of B’ak’tun Inc., a specialty calendar maker. Mayan now wants to do a securities offering. When do B’ak’tun’s third quarter financial statements go stale?

A: Let’s assume separate B’ak’tun financials will be needed in any new Mayan registration statement under Rule 3-05 of Regulation S-X (i.e., the deal closed more than 74 days prior to the effective date of the registration statement or exceeds any of the significance tests in Rule 3-05 at above the 50% level). The general rule is that the permitted age of financial statements of an acquired or soon-to-be acquired business is determined by looking to the staleness rules that apply to its financial statements rather than the staleness rules applicable to the financial statements of the acquiring company. In other words, you usually need to determine whether the acquired company is, for example, a large accelerated filer, an accelerated filer or an initial filer, and then analyze the dates on which its financial statements go stale under the rules summarized above.

Since B’ak’tun is a private company, it would be treated like an IPO filer for staleness purposes. That means its third quarter financial statements would normally go stale on February 14, 2013. However, the SEC Staff will allow you to look to the acquiring company to determine staleness in this circumstance. See Financial Reporting Manual, Section 2045.5. So, if Mayan’s financials do not go stale until, say, March 1, the deal team may have a bit of breathing room.

Q: Same fact pattern, except Mayan is not doing a securities offering. Do B’ak’tun’s third quarter financial statements also go stale on February 14 for Form 8-K purposes?

A: No. If Mayan is not conducting a securities offering and just needs to get a Form 8-K on file to report the acquisition, then B’ak’tun’s third quarter financials are good all the way until March 31. In other words, Mayan will not need to include B’ak’tun annual audited financial statements for 2012 in its Item 9.01 8-K if it is able to get that 8-K on file before April 1.

As a reminder, the Latham desktop staleness calendar has answers to your year-round staleness questions and the Latham financial statement guides have answers to your questions about what is required in financial statements for US securities offerings.

Amended Periodic Reports

L&W Capital Markets Group — Thu, 06 Dec 2012 06:34:08 -0500

Your good client, Ferris Bueller, GC of a company that manufactures reversible car odometers, calls to ask for your advice. He called in sick to the office on the day that his company filed its 10-K, so he realized only when the company received a comment letter from the SEC Staff that the as-filed 10-K mistakenly omitted pages. The company must now amend its 10-K, and Ferris is asking about some of the technical aspects.

Is there a special form for amended reports?

No. Under Exchange Act Rule 12b-15, amendments should be filed on the same form as the original report and marked with an “A” to indicate that the report is an amendment. For example, Bueller should file a Form 10-K/A, and note on the cover page that it is Amendment No. 1.

Let’s say you are only amending one year of the MD&A. Can you re-file only the changed year only or do you have to refile the entire MD&A?

You must file in its entirety each item of the form that is being amended — you can’t amend less than a complete item. Item 7 of Form 10-K requires MD&A covering the three-year period of the financial statements, see Instruction 1 to Regulation S-K Item 303(a), so as a result, you will have to refile the entire MD&A.

Does the filer have to re-file the entire report, or only the items that are being amended?

Some companies choose to re-file the entire report, but you need not file more than the amended items.

What if you are amending more than one filing (e.g., several 10-Ks in a multi-year restatement). Can you file one jumbo amendment?

The SEC Staff takes the position that you cannot amend multiple Exchange Act filings in a single amended filing, and instead must file separate amendments for each report being modified. See C&DI 133.01. In appropriate circumstances, however, some companies will request a waiver from the Staff of the Division of Corporation Finance, Office of Chief Accountant (CF-OCA) to permit the filing of a “super 10-K” similar to the accommodation for “comprehensive” 10-K filings described in Section 1320.4 of the Financial Reporting Manual.

Who needs to sign the amendment?

Any duly authorized representative of the company may sign. It is not necessary, for example, to get a majority of a company’s board to sign a 10-K/A, even though this was required for the original 10-K. See C&DI 133.02.

What about SOX certifications?

We covered the requirements for certifications under the Sarbanes-Oxley Act of 2002 in amended Exchange Act reports here (an oldie but a goodie).

Anything else to keep in mind?

Although not required by rule, it is both customary and advisable to include an explanatory note discussing the reasons for the amendment. Explanatory notes of this sort usually appear immediately after the cover page of an amended filing.