SEC posts final rules revising the eligibility requirements for Form S-3

By Cydney Posner

The SEC has posted the final rules revising the eligibility requirements for Forms S-3 and F-3.

The amendments allow certain domestic and foreign private issuers to conduct primary offerings on these forms without regard to the size of their public floats or the ratings of debt they are offering, so long as they satisfy the other eligibility conditions of the forms, have a class of common equity securities listed and registered on a national securities exchange and do not sell more than the equivalent of one-third of their public floats in primary offerings under the rule over any period of 12 calendar months. Shell companies need not apply. Violations of the one-third restriction will also violate the requirements as to proper registration form, even though the registration statement has been declared effective.

The new amendments will become effective 30 days after publication in the Federal Register.

Prior to these amendments, Form S-3 has been available for primary offerings only if the issuer's public float (non-affiliate equity market capitalization) was $75 million or more. (Primary offerings of non-convertible investment grade securities, certain rights offerings, dividend reinvestment plans and conversions and secondary offerings of securities registered on a national securities exchange do not require the company to have a minimum public float.) The changes are the outgrowth of recommendations by the SEC's Advisory Committee on Smaller Public Companies, which recommended that the eligibility requirements be expanded to allow smaller companies to take advantage of the flexibility and other benefits offered by Form S-3. Although, in light of the unique set of investment risks posed by smaller public companies, the SEC was not prepared to allow unlimited use of the Form, it was willing to allow a limited expansion that retains public float as a factor in determining the extent of short-form eligibility.

New General Instruction I.B.6.

General

New General Instruction I.B.6. to Form S-3 will allow companies with less than $75 million in public float to register primary offerings of their securities on Form S-3, provided they:

• meet the other registrant eligibility conditions for the use of Form S-3 (class of securities registered under Section 12 or required to file reports under Section 15(d) and timely filing of reports for preceding 12 months);
• have a class of common equity securities that is listed and registered on a national securities exchange;
• do not sell more than the equivalent of one-third of their public float in primary offerings under General Instruction I.B.6. of Form S-3 over the previous period of 12 calendar months; and
• are not shell companies and have not been shell companies for at least 12 calendar months before filing the registration statement.

An issuer’s eligibility to use Form S-3 under these new form instructions does not mean that the issuer meets the requirements of Form S-3 for purposes of any other SEC rule or regulation, other than Rule 415(a)(1)(x), which pertains to shelf registration.

The most significant change from the original proposal involves the increase of the limitation on the amount of securities that can be offered by companies under the new rules from 20% to 1/3 of public float, together with the compensating condition that securities be listed and registered on a national securities exchange. To make clear that offerings above the one-third cap would violate the form requirements of Form S-3, the SEC is adopting a corresponding amendment to Rule 401(g) to provide that offerings above the cap also violate the requirements as to proper form

under Rule 401 even though the registration statement has previously been declared effective. The condition relating to exchange listing is intended to provide additional investor protection by helping to assure that the issuer maintains depth and liquidity in compliance with exchange maintenance listing standards and satisfies specified corporate governance listing criteria.

Comparable changes are being made to Form F-3.

Calculation of Amount of Securities That May Be Sold

The calculation of the amount of securities that may be sold under the new instruction involves a two-step process:

• First, an issuer must determine its public float by reference to the price at which its common equity was last sold, or the average of the bid and asked prices of its common equity, in the principal market for the common equity as of a date within 60 days prior to the date of sale; and
• Second, the issuer must aggregate the gross sales prices of its securities (equity and debt) sold in primary offerings under new General Instruction I.B.6. in the previous 12 calendar months (including the intended sale) to determine whether the one-third cap would be exceeded.

Based on that calculation, a registrant will be permitted to sell securities with a value up to, but not greater than, the difference between one-third of its public float and the value of securities sold in primary offerings on Form S-3 under new General Instruction I.B.6. in the prior period of 12 calendar months. A "calendar month" is a month beginning on the first day of the month and ending on the last day of that month. That is, for purposes of new instruction, if a registrant relies on this instruction to conduct a shelf takedown equivalent to one-third of its public float on September 15, 2007, it will next be eligible to do another takedown (assuming no change in its float) on October 1, 2008. Of course, although only one-third of the public float may be sold in any year, a company may register a larger amount on the S-3.

In the case of convertible securities, such as convertible debt or warrants, the amount will be calculated by reference to the aggregate market value of the underlying equity shares in lieu of the market value of the convertible securities. The aggregate market value of the underlying equity will be based on the maximum number of shares into which the securities sold in the prior period of 12 calendar months are convertible as of a date within 60 days prior to the date of sale, multiplied by the same per share market price of the registrant’s equity used for purposes of calculating its public float pursuant to the new instruction. The one-third cap on sales does not limit a holder’s ability to convert or exercise derivative securities; that is, it will apply to the amount of convertible securities that a company can sell under Form S-3, while the number of shares into which the convertible securities may be converted will be used to determine the company’s compliance with the one-third cap at the time the warrants were sold, but the number will not impede the purchaser’s later exercise of the warrants.

Because the cap is calculated by reference to public float immediately prior to a contemplated sale, as opposed to the time of the initial filing of the registration statement, the amount of securities that an issuer is permitted to sell can continue to grow over time as the issuer’s public float increases. Alternatively, the level may decrease, although a decrease below the level of float at the time the registration statement was initially filed would not necessarily run afoul of the cap because the relevant point in time for determining compliance with the cap is the time of sale. Therefore, as long as the sale, together with all prior sales under the rule within the period, does not exceed the one-third cap calculated within 60 days of the sale, the transaction would not violate the rule, even if the public float later drops to a level that would make the prior sale exceed the new threshold. Registrants will need to disclose their updated calculations in each prospectus. In the event that the registrant’s float increases to $75 million or more subsequent to the effective date of the registration statement, the one-third cap on additional sales will be lifted. However, if the public float as of the date of the filing of the annual report on Form 10-K is less than $75 million, the one-third cap will be reimposed for subsequent sales under the instruction. The SEC has included in the final release a number of examples of calculations, which I have pasted (albeit without footnotes) at the end of this email.

Shell Companies

Shell companies (including "blank check" companies) may not rely on the instruction. A former shell company that cannot meet the $75 million float criterion but otherwise satisfies the registrant requirements of Form S-3 will become eligible to use Form S-3 to register primary offerings of its securities, provided that:

• it has not been a shell company for at least 12 calendar months;
• it has filed information that would be required in a registration statement on Form 10 or Form 20-F, as applicable, to register a class of securities under Section 12 of the Exchange Act (typically in a Form 8-K); and
• it has been timely reporting for 12 calendar months.

Example A

On January 1, 2009, a registrant with a public float of $25 million files a shelf
registration statement on Form S-3 pursuant to new General Instruction I.B.6. intending
to register the offer and sale of up to $50 million of debt and equity securities over the
next three years from time to time as market opportunities arise. The registration
statement is subsequently declared effective. In March 2009, the registrant decides to sell
common stock off the registration statement. To determine the amount of securities that
it may sell in connection with the intended takedown, the registrant calculates its public
float as of a date within 60 days prior to the anticipated date of sale, pursuant to
Instruction 1 to new General Instruction I.B.6. Calculating that its public float has risen
to $30 million, the registrant determines that the total market value of all sales effected
pursuant to new General Instruction I.B.6. over the past year, including the intended sale,
may not exceed $10 million, or one-third of the registrant’s float. Since the registrant has
conducted no prior securities offerings on Form S-3 pursuant to new General Instruction
I.B.6., it is able to sell the entire $10 million off the Form S-3.

Assuming that it sold the entire $10 million of securities in March 2009, the
registrant in September 2009 once again contemplates a takedown off the shelf. It
determines that its public float (as calculated pursuant to Instruction 1 to new General
Instruction I.B.6.) has again risen, this time to $54 million. Because one-third of $54
million is $18 million, the registrant is now able to sell additional securities in accordance
with new General Instruction I.B.6(a), even though in March 2009 it took down the
equivalent of what was then the entire one-third of its float. However, because the
registrant has already sold $10 million worth of its securities within the 12 calendar
months prior to the contemplated sale, the registrant may sell no more than $8 million of
additional securities at this time ($18 million minus $10 million of securities previously
sold).

In December 2009, the registrant determines that its public float has risen to $78
million. To this point, assuming it has only sold an aggregate of $18 million of its
securities pursuant to the subject Form S-3 as described above, it has $32 million of
securities remaining on the registration statement and potentially available for takedown
(the total amount registered of $50 million, less the $18 million previously sold).
Because one-third of $78 million is $26 million, and the registrant has already sold $18
million within the previous year, new General Instruction I.B.6(a) will, in most
circumstances, prohibit the registrant from selling more than an additional $8 million of
securities in the latest offering. However, under Instruction 3 to new General Instruction
I.B.6., the registrant is no longer subject to the one-third cap on annual sales because its
float has exceeded $75 million. If it chooses, the registrant may sell the entire $32
million of securities remaining on the registration statement all at once or in separate
tranches at any time until the company next updates the registration statement pursuant to
Section 10(a)(3) by filing its Form 10-K. This will be the case even if the registrant’s
float subsequently falls below $75 million before it files that Form 10-K, at which time
the registrant is required to recompute its public float in accordance with Rule 401. In
the event that the registrant’s public float as of the date of that Form 10-K filing is less
than $75 million, the one-third cap will be reimposed for all subsequent sales made
pursuant to new General Instruction I.B.6. and will remain in place until the registrant’s
float equals or exceeds $75 million.

Example B

A registrant has 12 million shares of voting common equity outstanding held by
nonaffiliates. The market price of this stock is $5 per share, so the registrant has a public
float of $60 million. The registrant has an effective Form S-3 shelf registration statement
filed in reliance on new General Instruction I.B.6. of Form S-3, pursuant to which the
registrant wants to issue $10 million of convertible debt securities which will be
convertible into common stock at a 10% discount to the market price of the common
stock. Pursuant to Instruction 2 to new General Instruction I.B.6., the amount of
securities issued is measured by reference to the value of the underlying common stock
rather than the amount for which the debt securities will be sold. At the 10% discount,
the conversion price is $4.50 and, as a result, 2,222,222 shares currently underlie the $10
million of convertible debt. Because the current market price of those underlying shares
is $5 per share, for purposes of General Instruction I.B.6. the value of the securities being
offered is $11,111,110 (2,222,222 shares at $5 per share), which is less than the $20
million allowed by the one-third cap (one-third of $60 million).

After the convertible debt securities are sold and are outstanding, the registrant
contemplates an additional takedown. To determine the amount of securities that the
registrant may sell under General Instruction I.B.6. in the anticipated offering, the
registrant must know its current public float and must calculate the aggregate market
value of all securities sold in the last year on Form S-3 pursuant to General Instruction
I.B.6. Instruction 2 to new General Instruction I.B.6. requires that the registrant compute
the market value of convertible debt securities sold under I.B.6. by reference to the value
of the underlying common stock rather than the amount for which the debt securities
were sold. With respect to the notes that were sold and have been converted, the
aggregate market value of the underlying common stock is calculated by multiplying the
number of common shares into which the outstanding convertible securities were
converted times the market price on the day of conversion. With respect to the notes that
were sold but have not yet been converted, the aggregate market value of the underlying
common stock is calculated by multiplying the maximum number of common shares into
which the notes are convertible as of a date within 60 days prior to the anticipated sale by
the per share market price of the registrant’s equity used for purposes of determining its
current float. The date chosen by the registrant for determination of the maximum number
of shares underlying the convertible security must be the same date as the registrant
uses for determining its market price in connection with the calculation of public float
pursuant to new instruction.

In this example, assume that the registrant has a current per share stock price of
$5.55. If half of the notes converted into common stock while the per share market price
was $5.00 ($4.50 discount), then, for purposes of Instruction 2 to new General Instruction
I.B.6., the value of that prior issuance is $5,555,555 (half of the notes divided by the
discounted conversion price of $4.50 and then multiplied by $5, the market price on the
day of conversion).

As for the notes that have not yet been converted, the aggregate market value of
the underlying common stock is determined by calculating the number of shares that may
be received upon conversion and multiplying that by the current market value of $5.55.
Therefore, the outstanding note amount ($5 million) is divided by the discount
conversion price ($5), resulting in 1,000,000 shares and this amount is then multiplied by
the current market value of $5.55. Thus, for purposes of Instruction 2 to new General
Instruction I.B.6., $5,550,000 is the value of the outstanding notes that have not yet been
converted. Adding this to the value of the notes that have already been converted results
in a total value of $11,105,555 having been issued under this Form S-3.

To determine the amount of additional securities that the registrant may sell under
General Instruction I.B.6., the registrant should add the value of the notes issued
($11,105,555) plus the value of all other securities sold by the registrant pursuant to
Instruction I.B.6. during the preceding 12 calendar months. If this amount is less than
one-third of the registrant’s current public float, it may sell additional securities with a
value up to, but not greater than, the difference between one-third of its current public
float and the value of all securities sold by it pursuant to Instruction I.B.6. during the
preceding 12 calendar months.

Example C

A registrant has an effective registration statement on Form S-3, filed pursuant to
new General Instruction I.B.6., through which it intends to conduct shelf offerings of its
securities. At the time of its first shelf takedown, the registrant’s public float is equal to
$21 million (which means that the maximum amount available to be sold under the one-third
cap would be $7 million). Based on new General Instruction I.B.6(a), the registrant
sells $3 million of its debt securities. Six months later, the registrant’s public float has
decreased to $9 million. The registrant wishes to conduct an additional takedown of debt
securities off the shelf but, because of the reduction in its float, it is prohibited from doing
so. This is because with a public float of $9 million, General Instruction I.B.6(a) only
allows the registrant to sell a maximum of $3 million worth of securities (one-third of $9
million) pursuant to the registration statement during the prior period of 12 calendar
months that ends on the date of the contemplated sale. However, the registrant has
already sold securities valued (for purposes of new General Instruction I.B.6.) at $3
million in the 6 months prior to the contemplated sale and so must wait until at least one
full year has passed since the $3 million sale of securities to undertake another offering
off the Form S-3 unless its float increases. Note that although the registrant’s float does
not allow additional sales, the $3 million takedown of securities 6 months prior does not
violate the one-third cap because, at the time of that prior sale, the registrant’s float was
$21 million.

Example D

Pursuant to new General Instruction I.B.6., a registrant with a public float of $48
million files a Form S-3, which the registrant intends to use as a universal shelf
registration statement to sell up to $100 million of debt or equity securities, or a
combination of both at any time or from time to time.

After the registration statement is declared effective, the registrant decides to do a
takedown off the shelf comprised of convertible promissory notes and warrants to
purchase to common stock. The notes are convertible into shares of common stock at a
50% discount to the market price of the common stock. The warrants are exercisable for
shares of common stock at an exercise price equal to $5 per share. Because the
registrant’s float is $48 million, it may sell up to $16 million of securities (one-third of
$48 million) pursuant to General Instruction I.B.6. The registrant wants to do a takedown
of $1 million in convertible promissory notes. The registrant intends to issue the notes
along with warrants to purchase an additional 10,000 shares of its common stock.
In order to determine if this sale is permissible under General Instruction I.B.6.,
the registrant must calculate the amount of securities it has sold pursuant to General
Instruction I.B.6. in the previous 12 months and add this to the value of the securities in
the intended sale. If the combined value is $16 million or less, it may proceed with the
sale.

Assume that the registrant has not sold any securities pursuant to the Instruction
I.B.6. in the previous 12 months. To determine the value of the convertible promissory
notes, the registrant is required by Instruction 2 to General Instruction I.B.6. to calculate
the value of the shares underlying the convertible notes. The notes are convertible into
shares of common stock at a 50% discount to the market price of the common stock.
Assuming that the market price of the common stock is $2 per share, the notes are
convertible as follows: $1 million (the price of the notes) divided by 1 (50% of the
market price of the common stock) is equal to 1 million shares of common stock that the
purchasers will receive upon conversion. Since the market price of the stock is $2 per
share, the value of the 1 million shares is $2 million (1 million shares at $2 per share).
Therefore, the value of the accompanying warrants for 10,000 shares must be less than
$14 million for the sale to be within the one-third cap (one-third of $48 million, less the
$2 million of common stock underlying the convertible notes).

To calculate the value of the warrants, which are derivative securities, Instruction
2 to General Instruction I.B.6. requires that the registrant calculate the value of the shares
underlying the warrants in lieu of the market value of the warrants. Under the terms of
the warrants, the warrants are exercisable for 10,000 shares at an exercise price of $5 per
share.

Instruction 2 to General Instruction I.B.6. states that the aggregate market value of
the underlying equity shall be calculated by multiplying the maximum number of
common equity shares into which the derivative securities are convertible or for which
they are exercisable, as of a date within 60 days prior to the date of sale, by the same per
share market price of the registrant’s equity used for purposes of calculating the
registrant’s float. Assuming that the market price of the registrant’s stock is $2 per share,
the value of the shares underlying the warrants is $20,000 (10,000 shares multiplied by
$2 per share). Because the underlying value of the convertible notes is $2 million and the
underlying value of the warrants is $20,000, the intended sale has a value of $2,020,000
and does not exceed the one-third cap (of $16 million).

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