Unlocking 144A Securities: Private Placements Explained

A 144A a security offering is also called an onshore offering as this implies the offering is available to American investors. This is in contradistinction to Rule Regulation S where only non-US investors may be asked for capital. For many issuers, the ability to raise from both US and non-US investors is an important strategy as this opens up the pool of investors. Thus, many conduct a 144A and Reg S (144A/Reg S) offering under both Rules simultaneously. Reg S allows for the exemption of securities if the securities were sold outside of one’s country while 144A allows the selling to US investors. The Private Placement Memorandums will outline the terms of the 144A securities offering. For example, if the company is selling notes or bonds, the Private Placement Memorandums will detail the terms of the offering such as the interest rate and maturity date, payment and coupon dates, convertible bond or convertible note dates and terms, and many other factors. Thus, the writing of a Private Placement Memorandums under 144A can assist in expediting the capital raising process. For the securities to be exempted from registration in a 144A offering the Private Placement Memorandums must detail many features.

Here are a few:
• The Private Placement Memorandums must give details of the securities being offered for sale to investors;
• Like in any well prepared and written Private Placement Memorandums the management team of the company must be detailed;
• Additional material regarding the 144A securities being offered must be shown as well (if other than common stock); and
• Finally, financial projections or financial statements must be included in the Private Placement Memorandums. In most cases, they will need to be certified by an independent accountant.
144A is often used in the private placement market to raise capital. The most common form of any document used to raise capital under 144A is the bond Private Placement Memorandums, which will detail the private placement terms. Private placements of 144A are both conducted for equity and debt offerings.

Public Placement of 144A

Often companies that are listed publicly may initiate a private offering under rule 144A to raise capital debt capital by selling securities such as bonds.

Prospectus for Issuers of 144A Bonds

For issuers considering selling 144A bonds, to investors a well-tailored and written Private Placement Memorandums is mandatory, particularly for those seeking US investors. A Private Placement Memorandums offering document can add value to your offering by showing investors you are serious about raising money. In addition, it is essentially a requirement for any issuer that wants to raise debt or equity capital under 144A to hand investors a Private Placement Memorandums. The Private Placement Memorandums will educate the investors and allow them to decide if the offer merits deeper thought or an investment. The document itself should tell the company story, both the product offerings and the securities being offered in detail, including the team behind the company, the terms of the securities, rules such as 144A and more. Attached to any Private Placement Memorandums is the subscription agreement, which is the “contract” between the issuer and the investor. Once signed the investor would then send in his/her money for the securities. The Private Placement Memorandums should be viewed by the issuer as an opportunity not to be wasted. In other words, the Private Placement Memorandums is the story of the company and will be the single most important document used to raise capital from investors. Without such a formal document, it is unlikely a company will raise capital, let alone be taken seriously by those that invest in 144A securities. For startups or established companies or funds seeking to raise capital via a formal 144A offering, securities regulators worldwide, as well as investors in a private offering require the Issuer to submit a professional preliminary red herring Private Placement Memorandums offering document.

Rule 144A is a safe harbor exemption from the registration requirements of Section 5 of the Securities Act for certain offers and sales of qualifying securities by certain persons other than the issuer of the securities. The exemption applies to resale of securities to qualified institutional buyers, who are commonly referred to as “QIBs.” QIBs must be institutions, and cannot be individuals no matter how wealthy or sophisticated. The securities eligible for resale under Rule 144A are securities of U.S. and foreign issuers that are not listed on a U.S. securities exchange or quoted on a U.S. automated inter-dealer quotation system. Rule 144A provides that reoffers and resale in compliance with the rule are not “distributions” and that the reseller is therefore not an “underwriter” within the meaning of Section 2(a)(11) of the Securities Act. A reseller that is not the issuer, an underwriter, or a dealer can rely on the exemption provided by Section 4(1) of the Securities Act. Resellers that are dealers can rely on the exemption provided by Section 4(3) of the Securities Act. Any person other than an issuer may rely on Rule 144A. Issuers must find another exemption for the offer and sale of unregistered securities. Typically they rely on Section 4(2) (often in reliance on Regulation D) or Regulation S under the Securities Act. Affiliates of the issuer may rely on Rule 144A.
What types of transactions are conducted under Rule 144A?
The following types of transactions often are conducted under Rule 144A:
• offerings of debt or preferred securities by public companies;
• offerings by foreign issuers that do not want to become subject to U.S. reporting requirements; and
• offerings of common securities by non-reporting issuers (i.e., “backdoor IPOs”).
Rule 144A modifies the Securities and Exchange Commission (SEC) restrictions on trades of privately placed securities so that these investments can be traded among qualified institutional buyers, and with shorter holding periods six months or a year, rather than the customary two-year period. While the Rule, introduced in 2012, has substantially increased the liquidity of the affected securities, it has also drawn concern that it may help facilitate fraudulent foreign offerings and reduce the range of securities on offer to the general public. Before a security can be offered to the general public, the Securities Act of 1933 stipulates that the issuer must register it with the SEC and provide extensive documentation through a filing with the agency. Rule 144A modifies SEC restrictions so privately placed securities can be traded among qualified institutional buyers with much shorter holding periods and no SEC registration in place. The idea is that sophisticated institutional investors don’t need the same levels of information and protection that individuals require. Critics have noted a lack of transparency and unclear definitions of what constitutes a qualified institutional buyer. Concerns endure that Rule 144A may give unscrupulous overseas companies undue access to the U.S. market without SEC scrutiny. Rule 144A, however, was drawn up in recognition that more sophisticated institutional investors may not require the same levels of information and protection as do individuals when they buy securities. The Rule provides a mechanism for the sale of privately placed securities that do not have and are not required to have an SEC registration in place, creating a more efficient market for the sale of those securities.

Rule 144A Holding Requirements

In addition to not requiring that securities receive SEC registration, Rule 144A relaxed the regulations over how long a security must be held before it can be traded. Rather than the customary two-year holding period, a minimum of a six-month period applies to a reporting company, and a minimum one-year period applies to issuers not required to meet reporting requirements. These periods begin on the day the securities in question were bought and considered paid in full.

Public Information Requirement

A minimum level of public-accessible information is required of the selling party. For reporting companies, this issue is addressed as long as they are in compliance with their regular reporting minimums. For non-reporting companies (also called non-issuers), basic information regarding the company, such as company name and the nature of its business, must be publicly available.

Trading Volume Formula

For affiliates, there is a limit on the number of transactions, referred to as the volume that cannot be exceeded. This must amount to no more than 1% of the outstanding shares in a class over three months or the average weekly reported volume during the four-week period preceding the notice of sale on Form 144.

Brokerage Transactions

The sale must also be handled by the brokerage in a manner deemed routine for affiliate sales. This requires no more than a normal commission be issued, and neither the broker nor the seller can be involved in the solicitation of the sale of those securities.

Notice Filings

To meet filing requirements, any affiliate sale of over 5,000 shares or over $50,000 during the course of a three-month span must be reported to the SEC on Form 144. Affiliate sales under both of these levels are not required to be filed with the SEC.

Holding Period for 144A Securities

According to the Rule 144A, one must hold the shares for a certain period of time before being able to sell the restricted securities in a marketplace. If the issuing company of the securities is a reporting company the required holding period is minimum six months and for the stocks of non-reporting companies the minimum required holding period is one year. The holding period begins on the day the securities are bought and fully paid. Rule 144 regulates transactions with restricted, unregistered and control securities. These type of securities are typically acquired in unregistered, private sales or constitute a controlling stake in an issuing company. Investors may acquire restricted securities through private placements or other stock benefit plans offered to a company’s employees. The SEC prohibits the resale of restricted, unregistered and control securities, unless they are registered with the SEC prior to their sale, or they are exempt from the registration requirements when five specific conditions are met.

Conditions for Resale of Rule 144 Securities

Five conditions must be met for restricted, unregistered and control securities to be sold or resold. First, the prescribed holding period must be met. For a public company, the holding period is six months, and it begins from the date a holder purchased and fully paid for securities. For a company that does not have to make filings with the SEC, the holding period is one year. The holding period requirements apply primarily to restricted securities, while resale of control securities is subject to the other requirements under Rule 144. Second, there must be adequate current public information available to investors about a company, including historical financial statements, information about officers and directors, and a business description. Third, if a selling party is an affiliate of a company, he cannot resell more than 1% of the total outstanding shares during any three-month period. If a company’s stock is listed on a stock exchange, only the greater of 1% of total outstanding shares, or the average of the previous four-week trading volume can be sold. For over-the-counter stocks, only the 1% rule applies. Fourth, all of the normal trading conditions that apply to any trade must be met. In particular, brokers cannot solicit buy orders, and they are not allowed to receive commissions in excess of their normal rates. Finally, the SEC requires an affiliated seller to file a proposed sale notice, if the sale value exceeds $50,000 during any three-month period, or if there are more than 5,000 shares proposed for sale. If the seller is not associated with the company that issued the shares and has owned the securities for more than one year, the seller does not have to meet any of the five conditions and can sell the securities without restrictions. Also, non-affiliated parties may sell their securities, if they held them for less than a year, but greater than six months, provided the current public information requirement is met.

Why Is Rule 144 Important?

As an employee, small business owner, or investor, you may own some “restricted” or “control” securities. These are usually given in the following situations:
• As a part of an employee benefits package
• As compensation for professional services
• In exchange for “seed-money” or start-up capital
• As a part of a merger and acquisitions (M&A) transaction
Rule 144 is important because it provides an exemption under which you can sell these securities in the public stock market without registering them with the SEC. Investors and shareholders in private offerings have the opportunity to resell their restricted securities, which makes them more valuable than if you held onto them indefinitely.
Rule 144 applies if you are:
• a non-affiliate shareholder who wants to sell their restricted securities
• an affiliate of the issuing company who wants to sell their securities (whether they are restricted or “free trading”) into the public market
Rule 144 does not apply to:
• sales in the public market that involve a brokerage firm
• private transactions, including sales, gifts, estate distributions, and pledges (but will apply when the recipient wants to sell the restricted stock to the public market).