July 19, 2007
FELDMAN WEINSTEIN AND SMITH LLP
420 Lexington Avenue
New York, NY 10170
July 19, 2007
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549-1090
Attention: Nancy M. Morris, Secretary
Re: File No. S7-11-07, Securities and Exchange Commission Release No. 33-8813, RIN 3235-AH13, Revisions to Rule 144 and Rule 145 to Shorten Holding Period for Affiliates and Non-Affiliates
Ladies and Gentlemen:
Feldman Weinstein and Smith LLP has the following comments on the Staff's proposed Revisions to Rules 144 and 145.
Our law firm represents issuers, investment banks and institutional investors primarily in business combination and financing transactions, including reverse merger and PIPE transactions, giving our attorneys a front-row seat in observing the challenges which the current rules impose on smaller public issuers. Overall, the proposals represent a dramatic and positive set of steps to help smaller public companies raise necessary capital on a timely basis and at a lower cost of capital than the current regulations permit.
We wish to strongly commend the Commission for proposing the following:
1. The reduction in the holding period under Rule 144 for unregistered securities in most cases to six months.
2. The changes to and codification of the so-called Worm/Wulff letters relating to shares of shell companies to allow the availability of public sale under Rule 144 no later than six months following a reverse merger and availability of so-called Form 10 information. Requiring successor control persons of former shell companies to register shares of the former shell has always been a concern of shell founders, and the proposal would eliminate this fear.
3. Clarification and codification of interpretations permitting tacking of holding periods for conversions and exchanges of securities and cashless exercise of options and warrants.
We believe that the following points, presented in the Staff's request for comments, could result in further improvements:
Tolling Provision for Hedged Positions (Proposed Rule 144(d)(3)(xi)).
1. The proposed provision would increase the cost of capital for issuers. We believe the proposed provision requiring a tolling of the holding period for so long as a holder is engaged in certain hedging transactions (but no longer than one year from date of acquiring the securities) is ill-advised and unnecessary. We believe some members of the Staff may be of the view that hedging a stock position is both without cost and without risk to the investor. Nothing could be further from the truth. Hedging is both costly (the investor has to pay a counterparty to assume risks initially assumed by the investor) and not foolproof. In selling borrowed shares, the investor is subject to the constant risk of a costly buy-in.
Essentially, a hedged investor and non-hedged investor are investing in two different deals entirely, with a different cost basis and different potential return profile. The fact the two investors make parallel but different investment decisions out of the same underlying transaction (the issuer is indifferent), based upon a free market, does not ipso facto turn the hedged investor into an underwriter, nor does it suggest he had no investment intent at the time of purchase. At times the Commission has acknowledged the market benefits of short-selling and other risk-hedging techniques, but some of its regulatory policies, such as the instant proposal, seem to directly counteract these benefits.
Hedging transactions by investors are of direct benefit to the issuers: a reduced-risk investment will provide a lower cost of capital to the issuer, which the Commission states is the primary objective of the proposed rule change (Release at pages 71 and 72). Given the continuous disclosure available to the capital markets today (particularly Form 8-K Item 3.02), and the overwhelming prevalence of program and institutional trading in the equity markets, we respectfully disagree with the notion that only people who hold a security for six months (or a year) are not underwriters. We believe there is very little practical basis remaining for distinguishing between primary offerings by issuers and after-market trading. We are hopeful that you will determine that the proposed six-month holding period for non-affiliates of reporting companies be applied to all such investors.
2. The provision, if adopted, should be limited only to the offsetting long securities. Even if the Commission determines to retain proposed Rule 144(d)(3)(xi) as initially proposed, we believe it should be revised to make clear that the one-year holding period will only apply to the hedged portion of the position. Many investors acquire significant stakes in a particular issuer, and are able to hedge only a very small portion of that holding, whether because few shares are available to borrow, the absence of an options market, or other reason. These investors should not be penalized as to their entire position due to a small hedged position. A practical alternative would be to specify that the offsetting long position to any put equivalent position would have to be held for one year in order to be eligible to be sold under Rule 144.
3. If the proposed Rule 144(d)(3)(xi) is adopted, we request further guidance in order to ensure compliance. If the Commission determines to adopt the proposed rule, it is not clear from the proposing release (page 21) what information a subsequent purchaser or a selling broker-dealer must obtain from the original purchaser in order to have a reasonable basis to believe that the correct holding period has been completed. If a seller represents and warrants in writing that it has not held a put equivalent position for at least the previous six months, is that sufficient, or will some further investigation or submission of trading records be required?
We recommend a four-month holding period for all securities of reporting companies.
The Commission does not need to look far for a good example of an effective market that appears to be working well with a universal four-month holding period for unregistered securities held by non-affiliates of reporting companies. The Canadian markets adopted a four month holding period for all securities of reporting companies approximately two years ago (NI 45-102), following a two-year experiment in which only larger companies (roughly equivalent to S-3 eligible issuers) were subject to a four month hold.
The Commission has accepted its Canadian counterpart's judgment on registered offerings (the MJDS system and automatic effectiveness of Form F-10 filings) for more than a decade, and we are hopeful it also can be comfortable following their findings and actual experience with respect to resales of unregistered equity securities by non-affiliates after a universal four-month holding period for reporting companies.
It is clear to us that holding for 120 days should in all circumstances remove any doubt that the holder is not an underwriter and had investment intent at the time of purchase. Yet simultaneously it could mean the elimination of literally hundreds of registration statements by PIPE investors willing to wait that long for the ability to resell without registration. Most PIPE investors are not willing to wait six months, and will still insist on a registration of some shares even before they are able to sell under the Commission's six-month proposal. As evidence of this, the typical PIPE agreement requires registration to be completed within 120 days before penalties begin to be paid.
We request clarification of the Worm/Wulff Codification.
We request clarification of the much-appreciated proposal with respect to Worm/Wulff. It appears the Commission is proposing the ability to sell control securities which are not restricted securities of a former shell company as soon as 90 days following the availability of Form 10 information. Any restricted securities, whether or not control securities, it would appear, will start their holding period on the date of availability of Form 10 information and thus the holder would wait, in most cases, six months following the availability of that information.
Unfortunately, in virtually all shell companies, control securities are restricted and not registered, as SEC Rule 419 places significant restrictions on any attempt to register. Thus, we are aware of no real-world circumstances where the 90 day period would actually apply.
We assume the authors of the proposal intended for the 90-day period to be applicable in some circumstances and believed that this represents sufficient time for the Form 10 information to be disseminated and absorbed. Therefore, we propose that non-affiliates of shell corporations be permitted to sell shares starting 90 days after release of Form 10 information, so long as on the day of sale they have held the shares for at least six months (in other words the holding period would commence upon the earlier of acquisition of shares and release of Form 10 information). We would further propose that affiliates and promoters of shells (and transferees from affiliates and promoters) commence their holding period upon release of the Form 10 information and wait for six months thereafter.
Coordination with Other Recent Commission Initiatives
We are extremely pleased to see the Commission turn its attention to adopting a number of the recommendations made by the Advisory Committee on Smaller Public Companies.
In general, the proposal (as well as its five companion proposals which relate primarily to implementation of the Committees recommendations) will provide an extremely significant advance in striking a more appropriate balance between careful regulation and removing unnecessary impediments to capital formation. From the proposed increased availability of Forms S-3 and F-3, to the suggested improvements in Regulation D and expansion of the availability of scaled disclosure for smaller public issuers, these are truly the changes that all participants in the small and microcap markets have been awaiting at least since the establishment of the Committee.
Thank you for your consideration of our comments in this matter.
Feldman Weinstein and Smith LLP