It is often said that a 144-A offering is the alternative to an IPO, particularly if one is seeking to raise a ‘large’ amount of capital in the shortest amount of time.
A good idea at the time. To overcome the clumsiness implicit in private placement of restricted (i.e., unregistered) securities, and to offer foreign issuers limited access to US capital markets without undertaking the full panoply of SEC reporting and accounting requirements, the SEC adopted Rule 144A in 1990. This rule permits substantially unrestricted sales of unregistered securities to income- and asset-tested qualified institutional buyers (QIBs), which may trade such securities only among themselves. Rule 144A requires that the securities not be equivalent to any other class of the issuer’s securities traded in public markets. As law professor William Sjostrom notes, this restriction had, until recently, limited the domestic securities eligible under the rule to debt instruments. Other conditions imposed by the rule include a notice to the buyer that the securities are subject to Rule 144A and a modest disclosure obligation—much less stringent than for 1933 Act public offerings—for any issuer that is not itself a public company or exempt foreign issuer. These conditions, plus the inherent discount factors applicable to any private placement in relatively illiquid and opaque markets, served to keep Rule 144A transactions at modest levels of activity.
Modified big bang. Over the years, observes the author, various impediments to active marketing of Rule 144A securities have fallen. For example, several investment banks, brokers, and finally NASDAQ itself (in a market it calls PORTAL) have established markets that enable QIBs to trade and obtain current pricing information on Rule 144A securities. As a consequence, offerings under the rule have come to resemble public offerings more than traditional private placements. “Underwriter” syndicates (which Rule 144A excludes from the 1933 Act’s definition of an underwriter) buy from the issuer and resell to QIBs, who may then trade among themselves in the new secondary markets. Although the markets’ impact remained specialized while growing in size, the author cites a 2007 example of a significant ($880 million) new equity issue as a groundbreaking event that signaled the possibility of using a Rule 144A offering as a substitute for an IPO.
Balancing act of pros and cons. If issuers can now raise substantial sums under Rule 144A without undertaking the burdens of registering themselves and the securities with the SEC, they need to weigh the pros and cons of doing so. The traditional benefits of public markets, besides access to larger sums, include the development of active secondary trading; this in turn establishes the liquidity and visibility needed for creating employee equity compensation plans and for pricing subsequent offerings (thereby allowing venture capitalists to exit, which encourages them to invest in the first place). The Rule 144A offering market still cannot match the liquidity benefits of the public markets, however, but the author concedes it is moving in that direction. The costs of going public lie chiefly in the costs of regulation itself, the loss of confidentiality and flexibility in dealing with many anonymous holders instead of a few institutions which may accept nondisclosure to preserve competitive advantages, plus the multiplied liability factors that SEC exposure entails. While all issuers remain subject to Rule 10b-5, the threshold of liability is higher for the private issuer than it would be under the more specific 1933 and 1934 Act provisions for registered securities and issuers. A private issuer also has many fewer occasions on which to incur liability, since it makes fewer disclosures with which holders can argue. One countervailing factor is that as QIBs grow in number, it becomes harder for an issuer to avoid crossing the 500-shareholder threshold that would subject it willy-nilly to the 1934 Act registration and disclosure regime. The largest countervailing factor, in the author’s view, remains the continuing premium that QIBs must charge, by discounting their purchase price, for the lack of liquidity and transparency in the market for unregistered securities.
Regulatory anomalies see the light. The development of Rule 144A markets brings to light several regulatory paradoxes. For example, while the qualifications for being a QIB are more stringent than those applicable to individual and institutional accredited investors under Regulation D and other private placement exemptions, nothing prevents an issuer from selling in parallel in Rule 144A and other exempt placements. Moreover, although a QIB may resell to another QIB only during the Rule 144 holding period, this is typically just one year. Thus it is possible for unregistered securities of a disclosure-exempt issuer to leak out to the Pink Sheets and other unregulated but public markets. What holds wholesale abuse in check is the 500-shareholder threshold, but this applies only to shareholders of record, not to beneficial holders of street-name securities. The author favors allowing greater access by accredited investors generally to the Rule 144A market, but he cautions that the SEC should reconsider how to apply the 500-shareholder limit if restricted securities leak into the hands of unsophisticated investors.
Abstracted from UCLA Law Review
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