SEC proposal to reduce eligibility requirements for Form S-3

By Cydney Posner

The SEC has posted its release proposing changes to the eligibility requirements for Form S-3 (and Form F-3). The proposed changes would allow domestic and foreign private issuers to conduct primary securities offerings on these forms without regard to the size of their public float or the rating of debt they are offering, so long as they satisfy the other eligibility conditions and do not sell more than the equivalent of 20% of their public float in primary offerings on these forms over any period of 12 calendar months. Shell companies would be prohibited from using these forms for primary offerings until 12 calendar months after they cease being shell companies.

Currently, to use Form S-3, a company must satisfy the form’s registrant requirements and at least one of the transaction requirements. The registrant requirements generally relate to reporting history under the Exchange Act. The transaction requirements provide that companies may register primary offerings only if their public float is at least $75 million. Primary offerings of non-convertible investment grade securities, certain rights offerings, dividend reinvestment plans and conversions, and offerings by selling shareholders of securities registered on a national securities exchange do not require that the company has a minimum public float. Note that individual takedowns are not subject to prior selective SEC staff review.

The proposal is an outgrowth of the report of the SEC's Advisory Committee on Smaller Public Companies, which recommended that the SEC allow all reporting companies listed on a national securities exchange, NASDAQ or trading on the OTCBB to be eligible to use Form S-3 if they have been reporting under the Exchange Act for at least one year and are current in their reporting at the time of filing.

Proposed Revisions to Form S-3

The proposed amendments would add new General Instruction I.B.6. to Form S-3 to 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;
• they are not shell companies and have not been shell companies for at least 12 calendar months before filing the registration statement; and
• they do not sell more than the equivalent of 20% of their public float in primary offerings under General Instruction I.B.6. of Form S-3 over any period of 12 calendar months.

Comparable changes are proposed to Form F-3.

Consistent with its use for purposes of the registrant eligibility requirements in Form S-3, a "calendar month" is a month beginning on the first day of the month and ending on the last day of that month. For example, for purposes of Form S-3 registrant eligibility, if a registrant were not timely on a Form 10-Q due on September 15, 2006, but was timely thereafter, it would first be eligible to use Form S-3 on October 1, 2007. Similarly, for purposes of proposed General Instruction I.B.6. of Form S-3, if a registrant relies on this Instruction to conduct a shelf takedown equivalent to 20% 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.

As proposed, companies traded on the OTCBB and Pink Sheets could be eligible to use form S-3 under the new instruction; however, it does not have broader implications. That is, an issuer’s eligibility to use Form S-3 under the proposed additional form instructions does not mean that the issuer meets the requirements of Form S-3 for purposes of any other SEC rule other than Rule 415(a)(1)(x), which pertains to shelf registration.

Registrants with a public float below $75 million would determine the amount of securities that may be sold pursuant to Form S-3 under a two-step process:

• determination of the public float immediately prior to the intended sale; and
• aggregation of all sales of the registrant’s securities pursuant to primary offerings under General Instruction I.B.6. of Form S-3 in the previous 12-month period (including the intended sale) to determine whether the 20% limitation would be exceeded.

Public float would be measured by reference to the price at which common equity was last sold, or the average of the bid and asked prices, in the principal market for the common equity as of a date within 60 days prior to the date of sale. (Note that an entity that does not have equity securities trading in any public trading market would not be entitled to rely on the instruction.). For purposes of calculating the aggregate market value of securities sold during the preceding 12 calendar months, companies would add the gross sales prices for all primary offerings pursuant to proposed Instruction I.B.6. during the preceding period of 12 calendar months. Companies could then sell securities with a maximum value equal to the difference between 20% of their public float and the value of securities already sold in primary offerings on Form S-3 under proposed Instruction I.B.6. in the prior period of 12 calendar months. The method of calculating the 20% limit on sales is the same whether the company is selling equity or debt securities, or a combination of both.

This aggregate gross sales price includes the sales of equity and debt offerings. Companies could now use S-3 for non-investment grade debt. With respect to convertible securities, such as convertible debt or warrants, the amount of securities that may be sold in any period of 12 calendar months would be calculated by reference to the aggregate market value of the underlying equity shares, not the convertible securities themselves. The calculation would be based on the maximum number of shares into which the securities sold in the prior period of 12 calendar months were convertible as of a date within 60 days prior to the date of sale, multiplied by the same per share market price of the equity used for purposes of calculating public float pursuant to Instruction 1 to proposed General Instruction I.B.6. of Form S-3. The actual conversion price would be used for securities that already converted.

The proposed 20% limit on sales is not intended to impact a holder’s ability to convert or exercise derivative securities purchased from the company. For example, the 20% limit would apply to the amount of common stock warrants that a company could sell under Form S-3, and the number of common shares into which the warrants are exercisable would be relevant for determining the company’s compliance with the 20% rule at the time the warrants were sold, but would not impede the purchaser’s later exercise of the warrants.

Because the 20% restriction is calculated by reference to the 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. However, a decrease in public float subsequent to filing of the registration statement would not necessarily run afoul of the 20% limitation because the relevant point in time for determining whether a registrant has exceeded the threshold would be the time of sale.

The 20% restriction on additional sales would be lifted in the event that public float increased to $75 million or more subsequent to the effective date of the registration statement, but of course would need to be reexamined at each 10(a)(3) amendment. If, at that time, the public float is less than $75 million, the 20% restriction would be reimposed for subsequent sales made pursuant to General Instruction I.B.6.

The release contains several useful examples that illustrate how the calculations are made.