By E. Steve Bolden II, Esq.[1] and Eric C. Blue, Esq.[2]

Restricted Securities and Alternative Purchaser Exit Strategies

The United States securities laws require that an issuer who offers its securities in the public market comply with the registration requirements set out in Section 5 of the Act. Under Section 5 of the Act, if an issuer cannot avail himself or his securities of an exemption from registration, the issuer must file a registration statement in order to offer or sell the securities.1 There are a number of exemptions that issuers rely on to avoid registration of their securities. One such exemption is Section 4(2) of the Act, which provides that the registration requirements of Section 5 shall not apply to any transactions by an issuer not involving a public offering.2 Regulation D is another exemption. It consists of Rules 501 through 506 of the Act, with Rules 504 through 506 providing exemptions to issuers based, in part, on the purported dollar amount of the offering.

From a liquidity perspective, a purchaser who purchases a security from an issuer who relies on a registration exemption must consider what exit strategies are available to the purchaser when the purchaser ultimately decides to sell the restricted security. To emphasize the point, Rule 502(d) of Regulation D provides that any security purchased in a Regulation D private offering that exceeded in the aggregate $1,000,000 shall have the status of securities sold pursuant to Section 4(2) of the Act. That means that such securities cannot be resold without registration of the security or an available exemption from the registration requirements.

Historically, issuers who conducted private placements of securities would grant purchasers registration rights, which consisted of: (a) “demand registration rights,” permitting the holders of a finite amount of a security to demand the issuer to register the securities; and (b) “shelf registration rights,” requiring that an issuer register the securities under a shelf registration statement pursuant to Rule 415 of the Act. These registration rights came with certain negative consequences such as exposing the holders of these restricted securities who exercised their registration rights to (1) underwriter liability under Section 11 of the Act in connection with the resale of their securities and (2) liability under Section 12(a)(1) of the Act for offers and sales of securities in violation of Section 5 of the Act, including the prospectus delivery requirements.

Another liquidity concern associated with the grant and subsequent exercise of these registration rights is the liquidity discount that is often applied to restricted securities to determine the security’s actual value in light of certain statutory resale restrictions (such as Rule 502(d) of Regulation D). As a corollary to this liquidity discount, it is customary for registration rights agreements to have “black out” periods during which the holders of restricted securities are not permitted to demand registration or, if a registration statement is already effective, to deliver a prospectus in connection with the resale of their restricted securities.

Rule 144A was adopted to deal primarily with the private placement of restricted securities and their subsequent resale. Although a Regulation D issuer must adopt appropriate restrictions to ensure that the securities are not resold in violation of the registration provisions, Rule 144A was adopted on the assumption that purchasers in a Regulation D offering may acquire the securities with a view towards reselling them later pursuant to Rule 144A. Rule 144A was designed to provide an efficient, liquid market among large institutional investors – investors with securities portfolios in excess of $100 million – for securities issued in exempt offerings or in reliance on Regulation S of the Act. In order to qualify for the Rule 144A exemption, four (4) conditions must be satisfied:

The result of Rule144A has been to provide a practical framework for the resale of securities while they are within the applicable Rule 144 holding period.

The Portal: Providing a Liquidity Premium for Rule 144A Securities

In its press release, NASDAQ indicated the following as the rationales underpinning the need for the Portal: The Portal would serve the interests of both issuers and investors by developing a standardized trading platform that would include major market participants and attract and centralize the capital formation process for Rule 144A issuers and investors; The Portal would provide liquidity for Rule 144A equity securities; and The Portal would create transparency and enhanced shareholder value by providing a standardized trading platform for Rule 144A securities, consistent shareholder tracking, and a means of clearing and settling trades in Rule 144A securities under an established regime.

Prior to the industry-wide alliance to develop the Portal, a number of banks had established firm-specific Rule 144A trading platforms to provide enhanced liquidity for these securities, including Goldman Sachs’ GSTrUE system, a multiple-broker trading platform for Rule 144A equity securities that was launched in May of 2007, and Bear Stearns’ Best Markets. There are definite advantages to a system such as the Portal, which include the ability of an issuer to access the capital markets without registration and the ability of the purchaser of these Rule 144A issues to resell them in an objective value-driven manner on an organized trading platform. Indeed, prior to the Portal and other recently created trading platforms, the 144A trading market was primarily a telephone- based market without independent access to pricing information.

Furthermore, the proponents of the Portal argue that utilizing NASDAQ’s trading platform will allow 144A investors to congregate at the same time, which could result in a more liquid-market. The access to the capital markets on a standardized trading platform such as the Portal presents tremendous growth opportunities for small and mid-cap private companies as well as alternative investment vehicles, such as hedge funds, venture capital funds and private equity funds. Another major advantage touted by advocates of the Portal is the ability to track the number of shareholders. This is important because once the number of a company’s shareholders goes beyond 499 for a U.S. company and 299 for a foreign company, the company must register the shares.

The future of the Portal is, in part, dependent upon the ability of the founding partners – which include NASDAQ, Bank of America, Bear Sterns, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, J.P. Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, UBS and Wachovia Securities – to provide a trading platform focused on objective pricing mechanisms and overall market valuation given the universe of participants that are likely to avail themselves of the platform. Given the increased number of issuers utilizing Rule 144A offerings – according to NASDAQ, the total capital raised through such deals was greater than the amount raised on the exchanges combined – if the Portal achieves its intent, the Portal could make a serious impact on the Rule 144A securities market.

References

[1] E. Steve Bolden II is counsel at Akin Gump Strauss Hauer & Feld LLP where he focuses on corporate and securities matters, including mergers and acquisitions, public and private securities offerings and private equity transactions. Mr. Bolden’s peers have voted him four times (2005-2008) a Texas Super Lawyer “Rising Star” of the Texas Bar published in Texas Monthly. He currently serves on the Board of Directors for the State Bar of Texas as a section representative, the Dallas Bar Association Board of Directors, and is the 2008 President of the J.L. Turner Legal Association, the African-American Bar Association of Dallas.

[2] Eric C. Blue is an associate at Akin Gump Strauss Hauer & Feld LLP where he focuses on corporate and securities law, with a concentration in the formation and operation of U.S. domestic and offshore private investment funds. Mr. Blue also represents non-investment fund clients in connection with mergers and acquisitions and other general corporate law matters. He currently is the 2008 Treasurer of the J.L. Turner Legal Association, the African-American Bar Association of Dallas.

[1] See 15 U.S.C. § 77e(c)(1988).
[2] See 15 U.S.C. § 77d(2)(1988)(codifying Section 4(2) of the Act).