New Plumbing for PIPEs

John Hempill, Morrison & Foerster

Anyone with kids knows that the strangest things can end up in your drains - I once had my plumbing backed up by a Spauldeen (which, for those of you not residing in one of the four outer boroughs of New York City, is a handball). Around August 2006, the Securities and Exchange Commission, or SEC, decided to plug up microcap PIPEs (the acronym for "Private Investment in Public Equity"). Specifically, comments began appearing in comment letters for resale registration statements filed by issuers who could not use the short-form registration statement on Form S-3 for primary offerings to the following effect:

".given the nature and size of the transaction, we are unable to agree with your analysis that the transaction being registered is appropriately characterized as a transaction that is eligible to be made on a continuous or delayed basis under Rule 415(a)(1)(i) may register the transaction on the form on which you are eligible to register the transaction as a primary offering; identify the investors as selling shareholders and underwriters in the registration statement and include the price at which the underwriters will sell the securities."

In other words, the SEC was refusing to permit the registration of securities of large participants in a PIPE offering, at least for "at the market" offerings from time to time. Even more frustrating, the SEC refused to issue any official guidance on what their issue was here for about six months thereafter. Where things stand currently is that these microcap issuers cannot do a PIPE for more than a third of their float without the risk of getting a comment like this from the SEC.

The SEC has recently issued proposed regulations that, while not providing these microcap issuers with relief for the problem described above, open up new financing opportunities for them. Specifically, the proposed regulations would revise the eligibility requirements for use of Form S-3 in a primary offering to include all issuers who meet the current eligibility requirements for this form other than the $75 million float requirement. This would include companies currently trading only on the OTC Bulletin Board and Pink Sheets. Such issuers however, would be limited to registering 20% of their float on this form during any rolling 12 month period, with certain aggregation provisions. In addition, "shell" companies would not be able to use this new provision. Consequently, while not providing much of a solution for currently "clogged" PIPEs, these proposed regulations will enable microcaps to more quickly and economically access the capital markets than they have in the past, at least to a limited extent.

The SEC is also considering amending Rule 144. Some of the proposed changes include shortening the holding period to 6 months and making Rule 144(k) available immediately thereafter to non-affiliates. If indeed proposals like these are adopted (and provided a new definition of "affiliate" that is unduly restrictive is not adopted), they will provide the real relief to microcap PIPEs by allowing purchasers of securities eventual access to the public markets even if the related registration statement is held up in SEC review.

John Hempill,, of Morrison & Foerster acts as general outside counsel for a number of privately and publicly held companies in a variety of industries. He has extensive experience in private and public finance, ranging from representing private emerging growth companies, venture capital funds and strategic investors in seed rounds and later stage private financings, to representing public companies and investment banks in public offerings, as well as 144A and PIPEs financings.