Public companies often issue and sell securities in so-called private investment in public equity (PIPE) transactions, which are private offerings exempt from the registration requirements of the Securities Act of 1933 (the “Securities Act”) in reliance on Section 4(a)(2) of the Securities Act. One condition to the availability of that exemption is that the securities sold (so-called “restricted securities”) not be distributed (i.e., resold publicly) without registration before they have been held for a sufficient period. This period is effectively one year under Rule 144 of the Securities Act, a rule adopted by the Securities and Exchange Commission (the “SEC”) to provide a safe harbor for resales of restricted securities. To prevent the unregistered and non-exempt resale of restricted securities, issuers place legends on the securities prohibiting their resale in transactions that could violate the Securities Act and jeopardize the availability of the Section 4(a)(2) exemption. This article addresses concerns law firms have in authorizing on behalf of their issuer clients the removal of legends on securities issued in PIPE transactions before investors resell the securities under a resale registration statement and before Rule 144 becomes available.
Procedures for removing Securities Act legends from restricted securities generally are well-established. Before they will remove legends from restricted securities, transfer agents require written authorization to do so from the issuer’s counsel on behalf of its client, which may be in the form of an instruction or opinion letter. As a general matter, most law firms will deliver that letter only in connection with either (i) the actual and contemporaneous resale of the securities in a registered or exempt transaction or (ii) in the absence of a resale, after satisfaction of the Rule 144 holdingTo support removal of the legends when the holder sells under a registration statement or pursuant to an exemption from registration, issuers and their counsel typically obtain representations from the holder that it complied with the plan of distribution under the registration statement or the requirements for an exemption from registration.
Investors in PIPE transactions, including in de-SPAC and other business combination transactions and equity lines of credit, typically obtain an agreement from the issuer to register the resale of the acquired securities soon after their investment and before Rule 144 becomes available. Recently, some of these investors have requested removal of Securities Act legends when the registration statement covering the resale of their securities becomes effective even though they have no current intention to resell those securities. These investors argue for legend removal to avoid potential delays in the settlement of future resales or to facilitate hedging strategies.
Informal surveys at recent bar group meetings have indicated that law firms have, for the most part, resisted investor pressure to authorize removal of legends when a resale registration statement becomes effective absent an actual and contemporaneous sale of the securities by the investor. Law firms have been concerned that an effective registration statement does not alter the status of the securities covered by the registration statement – i.e., they continue to be “restricted securities” until sold in a transaction that changes that status. Law firms are mindful that the SEC consistently has taken the positions that (i) placing legends on restricted securities restricting their transfer has proven in many cases to be an effective means of preventing illegaland (ii) assurances from an investor that it will resell the securities in compliance with the Securities Act without more are not necessarily sufficient to protect the Section 4(a)(2) exemption for the original
Many large securities brokers have internal controls and procedures that differentiate between “restricted securities,” “control shares” and securities acquired in Rule 145 transactions. Like law firms, those brokers have expressed concerns about removing Securities Act legends other than in connection with the resale of the securities because of the risk that those securities will enter the general pool of fungible, freely tradable securities and be resold in a potentially illegal distribution. Those brokers also have concerns that they will be unable to properly categorize unlegended securities for purposes of their internal controls. These brokers have emphasized that the sophistication of the investor is not relevant to addressing their
Where does that leave us? On the one hand, law firms representing issuers want to ensure that clients do not jeopardize their Section 4(a)(2) exemption by prematurely removing Securities Act legends and thereby facilitating an illegal distribution. At the same time, issuers want to raise capital as cost-effectively as possible, investors want liquidity and the ability to engage in hedging strategies, and brokers and transfer agents, as intermediaries, want to avoid being involved in an illegal distribution. To accommodate all of these objectives, several large securities brokers have established or are developing internal controls (such as holding securities in separate accounts) that will permit them to hold unlegended, restricted securities while still allowing them to satisfy internal compliance policies and track the restricted status of those securities, thus preventing their illegal resale. To support the removal of Securities Act legends before the securities are resold, some brokers have expressed a willingness to make representations to, and agreements with, the issuer and its counsel that are intended to provide assurances that resales of the securities will comply with the Securities Act.
Whether the internal controls and procedures brokers establish, and the representations and agreements they are willing to make to issuers and their counsel, will be sufficient to enable law firms to authorize the removal of Securities Act legends from restricted securities apart from their actual and contemporaneous resale and before Rule 144 becomes available remains to be seen. For now, some law firms and brokers are developing procedures to address the concerns. However, until satisfactory controls and procedures and representations and agreements that enable the removal of legends are agreed upon, law firms can be expected to continue resisting requests that legends be removed from restricted securities before their actual resale or satisfaction of Rule 144 requirements.
The authors wish to thank Donald W. Glazer, Advisory Counsel to Goodwin Procter LLP, Co-Chair of the TriBar Opinion Committee and co-author of Glazer and FitzGibbon on Legal Opinions; Stanley Keller, a Senior Partner in the Boston office of Locke Lord LLP and a former Chair of the American Bar Association Business Law Section’s Federal Regulation of Securities Committee, Legal Opinions Committee and Audit Responses Committee; and Robert Evans, Chair of Locke Lord LLP’s Capital Markets Group and Chair of the Subcommittee on Securities Law Opinions of the American Bar Association Business Law Section’s Federal Regulation of Securities Committee.