SEC staff issues SLB 3A regarding Section 3(a)(10)

By Cydney Posner

Better late than never, they say. Scheduled to be available when the amendment to Rules 144 and 145 became effective on February 15, Staff Legal Bulletin 3A, Section 3(a)(10) exemption from the Securities Act's registration requirements and the resale status of securities received in transactions exempt from registration pursuant to Section 3(a)(10), was posted today to the SEC's website.

Section 3(a)(10) of the Securities Act provides an exemption from registration for offers and sales of securities issued in exchange for securities, claims or property interests, where a court or authorized governmental entity, authorized by law to hold a hearing, has approved the fairness of the terms and conditions of the exchange following a hearing on the matter. The exemption is available without any action by Corp Fin or the SEC.

Resale of 3(a)(10) Securities

The key issue addressed in this amended SLB is the impact of revisions to the Rule 144/145 resale provisions to securities issued in 3(a)(10) transactions. The amendments to Rule 145, among other things, eliminated the presumptive underwriter provision in Rule 145(c) except for transactions involving a shell company (other than a business-combination-related shell company). The SLB states that, because securities received in a Rule 145(a) transaction (not involving a shell company) that was exempt under Section 3(a)(10) would not constitute "restricted securities" within the meaning of Rule 144(a)(3), those securities may generally be resold without regard to Rule 144 if the sellers are not affiliates of the issuer and have not been affiliates within 90 days of the date of the transaction. In the event that the securities are held by affiliates of the issuer, those holders may be able to resell the securities in accordance with Rule 144.

When one of the parties to the 3(a)(10) transaction is a shell company, other than a business-combination-related shell company, then the Rule 145(c) and (d) resale limitations apply to any party to that transaction (other than the issuer of the 3(a)(10) securities) and to any person who is an affiliate of the party at the time the transaction is submitted for vote or consent. In those situations, holders who are deemed to be underwriters under Rule 145(c) may resell their securities without registration in the manner permitted by Rule 145(d) (subject to the exceptions for plans or schemes to evade the securities laws). Note that, in computing the holding period for purposes of Rule 145(d)(2)(ii) or (d)(2)(iii), these persons may not "tack" the holding period of the securities exchanged for the 3(a)(10) securities.

Other issues addressed in the newly amended SLB include:

Timing of No-Action Requests

Issuers sometimes seek a no-action letter from the SEC with regard to 3(a)(10) transactions. The staff advises in the SLB that the issuer must submit its no-action request before the fairness hearing. Generally, the Division tries to respond to no-action requests within 30 days of receipt. If an issuer submits a no-action request very close to the fairness hearing date, the Division may not have adequate time to consider the issues presented and respond before the fairness hearing. The request will not be answered if submitted after the hearing.

Timing of Security Holders’ Votes

Ordinarily, because solicitation of a stockholder vote by the issuer would be an offer, any required stockholder vote must be taken after the fairness hearing. However, if the state statute requires the vote prior to the hearing, the staff generally has not objected, even though the result is that an investment decision was made before the fairness hearing. The basis for the staff's view is that, under the governing state statute, the transaction is not effected unless the court or authorized governmental entity approves it. The staff believes that the issuer should submit to the court or authorized governmental entity the disclosure materials offering the securities before it mails them to the offerees.

Analysis of the Requirements Underlying the Exemption

Securities Must Be Issued in Exchange for Securities, Claims or Property Interests

While 3(a)(10) also exempts sales of securities that are "partly in such exchange and partly for cash...., " the staff's position is that 3(a)(10) exempts transactions that are "predominantly exchanges" and that the "partly for cash" language is "intended merely to permit flexibility in structuring those exchanges." Because these analyses are fact-specific, an issuer may wish to request a no-action letter when this issue is presented.

In limited circumstances, the staff has not objected to the issuance of securities as attorneys’ fees under the 3(a)(10) exemption, such as when those securities amount to no more than one-third of the securities issued in the settlement.

When options, warrants, or other convertible securities are issued in a 3(a)(10) transaction, 3(a)(10) does not exempt the later exercise or conversion.

(Compare Section 1145 of the U.S. Bankruptcy Code, which specifically exempts the later exercise or conversion.)

Court or Authorized Governmental Entity Must Approve the Exchange’s Terms and Conditions

Authorization. Authorized governmental entities may include state insurance commissions, state corporation or securities commissions or state banking agencies. If a governmental entity is approving the exchange, that entity must be authorized by statute both (i) to hold a hearing on the transaction (although the statute need not require the hearing; and (ii ) to approve the fairness of the exchange’s terms and conditions. (Where court approval will be the basis for the exemption, the court also must make this finding; however, the court need not be expressly authorized by statute to do so.) The statute must require the entity to conclude affirmatively that the exchange is fair to the security holders participating in the exchange by concluding, for example, that the terms are "in the best interest of shareholders" or "fair" to shareholders, but not that the exchange is "not unfair," "not unreasonable," "not prejudicial" or "not counter to the best interest of shareholders." The conclusion must be from the point of view of the persons to whom the securities are issued in the exchange, and this authority to pass upon the fairness must be express. Moreover, the governmental entity must find the terms and conditions to be fair both procedurally and substantively.

Questions regarding statutory authority may be clear from the actual practice of the authorized governmental entity. Issuers may want to look at prior no-action responses for past decisions regarding particular statutes, taking into account whether there may have been intervening changes to the statute.

Information That Must Be Available to the Court or Authorized Governmental Entity When It Makes Its Fairness Determination. The issuer must advise the court or authorized governmental entity before the hearing that the issuer will rely 3(a)(10) based on the court’s or other entity’s approval of the exchange. The staff believes that the reviewing court or other entity "must have sufficient information before it to determine the value of both the securities, claims or interests to be surrendered and the securities to be issued in the proposed transaction."

Fairness Hearings Conducted under State Securities Laws. Under Section 18 of the Securities Act (NSMIA), securities that otherwise would be "covered securities," and therefore exempt from the registration or qualification provisions of state securities laws, are removed from the definition of "covered securities" if they are offered and sold in reliance on 3(a)(10). Accordingly, an issuer may rely upon a fairness hearing conducted under state securities law to perfect an exemption under 3(a)(10) for securities that otherwise would be covered securities. However, securities issued under 3(a)(10) are no longer exempt from the registration or qualification provisions of any state securities laws.

Foreign Courts. Section 3(a)(10) hearings may be held by foreign courts. However. in no-action requests in these situations, that staff has required that (i) all requirements that apply to exchanges approved by U.S. courts must be met; and (ii) the issuer must provide the staff with an opinion of counsel licensed to practice in the foreign jurisdiction stating that, before the foreign court can give its approval, it must approve the fairness of the proposed exchange to persons receiving securities in the exchange. The opinion is required because the fairness standard in foreign jurisdictions often is derived from case law that interprets and applies the statute, rather than from the specific language of the statute. The opinion of foreign counsel should state clearly that:

• under applicable law, the court cannot approve the exchange unless it finds the transaction to be fair to the persons who will receive the securities;
• those persons will receive notice of, and have the right to appear at, the fairness hearing; and
• the issuer will advise the court before the hearing that it will rely on the 3(a)(10) exemption and not register the exchange under the Securities Act based upon the court’s approval of the exchange.

Before Approval, the Court or Authorized Governmental Entity Must Hold a Hearing on the Fairness of the Exchange; This Hearing Must Be Open to Everyone to Whom Securities Would Be Issued in the Proposed Exchange

The court or authorized governmental entity must hold a hearing to determine whether the terms and conditions of the proposed exchange are fair to all those who will receive securities and must then approve the fairness of the terms and conditions of the proposed exchange. The hearing must be open to everyone to whom securities would be issued in the proposed exchange (remember optionees).

The issuer must provide appropriate and timely notice of the hearing. For example, if the securities are held in bearer form, there must be appropriate publication of the notice.

The anti-fraud provisions of the federal securities laws would apply to the required notice; however, 3(a)(10) does not specify the information that must be included. Although the staff does not address the adequacy or appropriateness of the information provided, in connection with no-action requests, the staff will consider the adequacy of the information only to the extent that it adequately advises those who are proposed to be issued securities in the exchange of their right to attend the hearing and gives them the information necessary to exercise that right.

The SLB advises that issuers should consider whether, as a practical matter, the imposition of prerequisites to appearance will prevent those persons from having a meaningful opportunity to appear at that hearing; however, the staff has not objected to the mere requirement to file a notice of an intention to appear.

This content is provided for general informational purposes only, and your access or use of the content does not create an attorney-client relationship between you or your organization and Cooley LLP, Cooley (UK) LLP, or any other affiliated practice or entity (collectively referred to as “Cooley”). By accessing this content, you agree that the information provided does not constitute legal or other professional advice. This content is not a substitute for obtaining legal advice from a qualified attorney licensed in your jurisdiction and you should not act or refrain from acting based on this content. This content may be changed without notice. It is not guaranteed to be complete, correct or up to date, and it may not reflect the most current legal developments. Prior results do not guarantee a similar outcome. Do not send any confidential information to Cooley, as we do not have any duty to keep any information you provide to us confidential. This content may be considered Attorney Advertising and is subject to our legal notices.