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U.S. Securities and Exchange Commission

Current Issues and Rulemaking Projects
Quarterly Update

Division of Corporation Finance
March 31, 2001

This quarterly update to our Current Issues and Rulemaking Projects outline reflects a new approach by the Division of Corporation Finance. Previously, the Division revised the entire outline periodically by adding new material and deleting dated sections. The users of the outline expressed concern regarding the increasing size of the outline, difficulties in focusing on new material and the loss of deleted sections that continued to include useful, if no longer new, material. In response to these concerns, the Division will leave the most recent version of the complete outline (November 14, 2000) on the Commission's web site and will publish quarterly updates throughout the year. Those quarterly updates will then be combined with updates from the fourth quarter to comprise an annual update to the outline.

The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any of its employees. This outline was prepared by members of the staff of the Division of Corporation Finance and does not necessarily reflect the views of the Commission, the Commissioners or other members of the staff.

Table of Contents

I. Division Organization and Employment Opportunities
  Updated to reflect organization as of March 31, 2001
II. Mergers & Acquisitions
  Option Exchange Offers
III. Electronic Filing and Technology
  No updates
IV. Small Business Issues
  No updates
V. Internationalization of the Securities Markets
  Confidential Processing of Foreign Issuer Filings
VI. Other Pending Rulemaking and Recent Rule Adoptions
  Pending Rulemaking
    Proposed Equity Plan Compensation Plan Disclosure
  Recent Rule Adoptions
    Integration Safe Harbors for Abandoned Offerings
VII. Division of Corporation Finance Staff Legal Bulletins
  No updates
VIII. Current Disclosure, Legal and Processing Issues
  Disclosure, Legal and Processing Issues
    Cover Page Gatefold for Registered Public Offerings
    Section 12 Registration Relief Involving Employee Stock Option Plans
    Equity Line Financings
  Industry-Specific Issues
    Update to "Clarification of Oil and Gas Reserve Definitions and Requirements"
    Sample Letter Sent to Coal Mine Operators Regarding Compliance with Industry Guide 7
    Accounting and Disclosure by Companies Engaged in Research and Development Activities
IX. Accounting Issues
  Auditor Association with Interim Financial Statements
  Please also see "Current Accounting and Disclosure Issues in the Division of Corporation Finance," available on our web site at www.sec.gov/divisions/corpfin.shtml.
X. Significant No-Action and Interpretive Letters -November 15, 2000 Through March 31, 2001
  Sections 2(a)(3) and 5 of the Securities Act
    Liberty Media Corporation – February 7, 2001

I. Division Organization and Employment Opportunities

The Division's organizational structure follows:

Division Director   –   David B. H. Martin (202) 942-2800

Deputy Director   –   Michael McAlevey (202) 942-2810

Senior Counsel to the Director   –   Anita Klein (202) 942-2980


Principal Associate Director (Disclosure Operations)
  –   Shelley Parratt (202) 942-2830

Associate Director (Disclosure Operations)
  –   James Daly (202) 942-2881

Associate Director (Disclosure Operations)
  –   William L. Tolbert, Jr. (202) 942-2891

Senior Special Counsel (Regulatory Policy)
  –   James Budge (202) 942-2800

Office of EDGAR and Information Analysis
  –   Herbert Scholl, Chief (202) 942-2930

Disclosure Support

Associate Director (Legal)
  –   Martin P. Dunn (202) 942-2890

Office of Chief Counsel
  –   Paula Dubberly, Chief (202) 942-2900

Office of Rulemaking
  –   Elizabeth Murphy, Chief (202) 942-2910

Associate Director (Regulatory Policy)
  –   Mauri Osheroff (202) 942-2840

Senior Special Counsel (Regulatory Policy)
  –   Mark W. Green (202) 942-2840

Office of Mergers and Acquisitions
  –   Dennis O. Garris, Chief (202) 942-2920

Office of International Corporate Finance
  –   Paul Dudek, Chief (202) 942-2990

Office of Small Business Policy
  –   Richard Wulff, Chief (202) 942-2950

Associate Director (Chief Accountant)
  –   Robert Bayless (202) 942-2850

Assistant Directors

Health Care and Insurance
  –   Jeffrey P. Riedler (202) 942-1840

Consumer Products
  –   Christopher Owings (202) 942-1900

Computers and Office Equipment
  –   Barbara Jacobs (202) 942-1800

Natural Resources
  –   Roger Schwall (202) 942-1870

Transportation and Leisure
  –   Max Webb (202) 942-1850

Manufacturing and Construction
  –   Steven Duvall (202) 942-1950

Financial Services
  –   Todd Schiffman (202) 942-1760

Real Estate and Business Services
  –   Karen Garnett (202) 942-1960

Small Business
  –   John Reynolds (202) 942-2950

Electronics and Machinery
  –   Peggy Fisher (202) 942-1880

  –   Barry Summer (202) 942-1990

Division Employment Opportunities for Accountants and Attorneys


The Division has about 110 staff accountants with specialized expertise in the various industry offices. The Division provides a fast-paced, challenging work environment for accounting professionals. Our staff works on hot IPOs and current and emerging accounting issues. We influence accounting standards and practices and interact with the top professionals in the securities industry.

A staff accountant's responsibilities include examining financial statements in public filings and finding solutions to the most difficult and controversial accounting issues. A minimum of three years' experience in a public accounting firm or public company dealing with SEC reporting is required. If you want to experience a unique learning opportunity and explore the depth and breadth of accounting theory, principles, and practices, call (202) 942-2960 for information on employment opportunities in the Division.


The Division has about 130 attorneys who process filings and draft and interpret regulations. Every year, we recruit top law school graduates, and from time to time have positions for lateral applicants with solid legal skills and experience. Applicants should demonstrate an ability to accept major responsibilities. We prefer applicants who have had experience in securities transactions involving public companies. It is also helpful, but not necessary, if applicants have accounting and/or business training.

Responsibilities include analyzing and commenting on disclosure documents in public offerings, including those relating to mergers and acquisitions. The positions involve working directly with companies, their executives, underwriters and investment banking firms, outside counsel and outside accountants. The work involves innovative financing and business structures. Interested persons should send resumes to – Division of Corporation Finance, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

II. Mergers and Acquisitions

Option Exchange Offers


On March 21, 2001, the Division of Corporation Finance, pursuant to delegated authority from the Commission, issued an exemptive order under the Securities Exchange Act of 1934 (Exchange Act) for issuer exchange offers that are conducted for compensatory purposes. The order exempts these exchange offers from Rules 13e-4(f)(8)(i) and (ii), the all holders and best price rules, so long as the following conditions are met:

  • the issuer is eligible to use Form S-8, the options subject to the exchange offer were issued under an employee benefit plan as defined in Rule 405 under the Securities Act, and the securities offered in the exchange offer will be issued under such an employee benefit plan;
  • the exchange offer is conducted for compensatory purposes;
  • the issuer discloses in the offer to purchase the essential features and significance of the exchange offer, including risks that option holders should consider in deciding whether to accept the offer; and
  • except as exempted in this order, the issuer complies with Rule13e-4.


The Division of Corporation Finance has become aware of issuers conducting exchange offers to reprice their employees' stock options. The structure of these exchange offers varies from issuer to issuer and is based upon their compensation policies and practices. Frequently these exchange offers will require option holders to agree to revised vesting or exercisability terms or to accept a reduced number of securities in exchange for receiving a lower exercise price. The new options or other securities offered in exchange for existing options may be registered under the Securities Act of 1933 (Securities Act), but generally are offered in reliance on an exemption from registration, typically Section 3(a)(9) of the Securities Act.

These offers commonly involve securities issued through broad-based plans, are open to a large number of employees, are not limited to executive or senior officers of the issuers, are not privately negotiated compensation arrangements, have fixed terms, and are open for a limited period of time. Unlike the situation where an issuer unilaterally reprices its options, the option holders have individual decisions to make. Further, the decision whether to accept the offer is an investment decision and not merely a compensation decision. These exchange offers are subject to the issuer tender offer rule, Rule 13e-4 under the Exchange Act, if the issuer has a class of equity securities registered under Section 12 or is required to file reports under Section 15(d) of the Exchange Act.

The exemptive order eliminates the limitations that the all holders and best price rules place on issuers' ability to structure exchange offers consistent with their compensation policies and practices. This will reduce the burdens and costs to issuers that otherwise must seek individual exemptions from the Division. We believe that these exchange offers do not present the same concerns caused by discriminatory treatment among security holders that these rules were intended to address.

Disclosure and Processing

Issuers that are subject to Rule13e-4 are reminded that the remaining provisions of Rule 13e-4, as well as Regulation14E, apply to these exchange offers. A Schedule TO-I must be filed at the time the exchange offer commences, and the disclosure required by the schedule must be disseminated to option holders in accordance with Rule 13e-4. The disclosure items of the Schedule TO-I must be complied with in the offer to purchase only to the extent applicable. The items do not require a response in the offer to purchase if they are not applicable to the offer. The disclosure should set forth clearly the essential features and significance of the exchange offer, including risks that option holders should consider in deciding whether to accept the offer. The disclosure also should include financial information about the issuer, which generally is material to the option holders' investment decisions. See Item 10 of Schedule TO. The financial information in the disclosure may be in summary form if the issuer incorporates its financial statements by reference into the schedule and offer to purchase. See Instruction 6 to Item10 of Schedule TO.

We understand that issuers contemplating option exchange offers are concerned that staff review may cause issuers to incur additional costs to disseminate revised materials in response to staff comments and also may cause offers to be extended. The Division always balances the necessity of staff review with the best use of staff resources. These types of exchange offers are conducted for compensatory purposes and are less likely to raise the concerns that often are present in non-compensatory tender offers. In this regard, the Division staff's decision to review these exchange offers will take into account the presence of the disclosure discussed above. Issuers should note that they are responsible for full compliance with Rule 13e-4 whether or not the staff reviews the filings. Issuers also are reminded of their disclosure obligations under Item 402 of Regulations S-K and S-B and under generally accepted accounting principles.

Issuers or their counsel should contact the Office of Mergers & Acquisitions at (202) 942-2920 if they have questions about the exemptive order or compensatory option exchange offers generally.

III. Electronic Filing and Technology

No updates.

IV. Small Business Issues

No updates.

V. Internationalization of the Securities Markets

Confidential Processing of Foreign Issuer Filings

Filings by public companies are generally available to the public, including filings of amendments to remedy disclosure deficiencies identified by staff reviewers. The Division of Corporation Finance staff recognizes that foreign private issuers and foreign governments often face unique circumstances when accessing the US markets. This is particularly true when a foreign registrant's securities trade publicly in its home market, and the company will be making new and different disclosure as a result of its registration with the SEC.

To address these concerns, the staff often reviews and screens draft submissions of foreign registrants on a non-public basis. The staff, however, is revising its practice in this area. The staff generally will continue to accept on a draft basis registration statements in connection with an issuer's initial registration with the SEC. Except in unusual circumstances, however, once a foreign issuer has registered a transaction under the Securities Act or a class of securities under the Exchange Act, the staff will no longer accept from that issuer additional registration statements on a draft basis and will not review or screen a registration statement until it is publicly filed.

The timing and scope of staff review of draft registration statements is generally the same as for publicly filed registration statements. Foreign issuers are reminded that, when draft registration statements are submitted to the staff, the documents should be complete, as described in "International Financial Reporting and Disclosure Issues," available on the SEC's website. The Division's Office of International Corporate Finance should be contacted in advance of any draft submission.

VI. Other Pending Rulemaking and Recent Rule Adoptions

Pending Rulemaking

Proposed Equity Compensation Plan Disclosure

As the use of equity compensation, particularly stock options, has increased in recent years, so too have concerns about the impact of these programs. These concerns involve (a) the absence of full disclosure to security holders about equity compensation plans, (b) the potential dilutive effect of these plans and (c) the adoption of many plans without the approval of security holders.

On January 26, 2001, the Commission proposed amendments to its rules and forms that would require registrants to disclose, at least annually, information about the total number of securities that have been authorized for issuance under their equity compensation plans in effect as of the end of the last completed fiscal year, whether or not the plans have been approved by security holders (Securities Act Release No. 7944). Specifically, the proposed amendments would require disclosure in a registrant's proxy statement or annual report on Form 10-K or 10-KSB of the following:

  • the number of securities authorized for issuance under each equity compensation plan of the registrant in effect as of the end of the most recently completed fiscal year;
  • the number of securities issued pursuant to equity awards made during the last completed fiscal year, plus the number of securities to be issued upon the exercise of options, warrants or rights granted during the last completed fiscal year, under each plan;
  • the number of securities to be issued upon the exercise of outstanding options, warrants or rights under each plan; and
  • other than securities to be issued upon the exercise of outstanding options, warrants or rights, the number of securities remaining available for future issuance under each plan.

This disclosure would be set forth in a tabular format in the registrant's proxy or information statement whenever the registrant is seeking security holder action regarding a compensation plan or in the registrant's annual report on Form 10-K or 10-KSB in years when the registrant is not seeking security holder action regarding a compensation plan. The time period for submitting comments on these proposals ended on

April 2, 2001.

Recent Rule Adoptions

Integration Safe Harbors for Abandoned Offerings

On January 26, 2001, the Commission adopted new Securities Act Rule 155 (Securities Act Release No. 7943). This rule provides safe harbors from integration for a registered offering following an abandoned private offering, or a private offering following an abandoned registered offering. For purposes of these safe harbors, Rule 155(a) defines a "private offering" as an unregistered offering of securities that is exempt from registration under Section 4(2) or 4(6) of the Securities Act or Rule 506 of Regulation D under the Securities Act.

The conditions of the Rule 155(b) private-to-registered safe harbor are as follows:

  • No securities were sold in the private offering;
  • The issuer and any person(s) acting on its behalf terminate all offering activity in the private offering before the issuer files the registration statement;
  • Any prospectus filed as part of the registration statement discloses information about the abandoned private offering, including
  • the size and nature of the private offering,
  • the date on which the issuer terminated all offering activity in the private offering,
  • that any offers to buy or indications of interest in the private offering were rejected or otherwise not accepted, and
  • that the prospectus delivered in the registered offering supersedes any selling material used in the private offering; and
  • The issuer does not file the registration statement until at least 30 calendar days after termination of all offering activity in the private offering unless the issuer and any person acting on its behalf offered securities in the private offering only to persons who were (or who the issuer reasonably believes were) accredited investors or sophisticated.
The conditions of the Rule 155(c) registered-to-private safe harbor are as follows:

  • No securities were sold in the registered offering;
  • The issuer withdraws the registration statement;
  • The issuer and any person acting on its behalf do not commence the private offering earlier than 30 calendar days after the effective date of withdrawal of the registration statement;
  • The issuer notifies each offeree in the private offering that
  • the offering is not registered under the Securities Act,
  • the securities will be "restricted securities" as defined in Rule 144 and cannot be resold without registration unless as an exemption is available,
  • purchasers do not have the protection of Section 11 of the Securities Act, and
  • a registration statement for the abandoned offering was filed and withdrawn, specifying the effective date of the withdrawal; and
  • Any disclosure document used in the private offering discloses any changes in the issuer's business or financial condition that occurred after the issuer filed the registration statement that are material to the investment decision in the private offering.

To facilitate reliance on the registered-to-private safe harbor, Rule 477 was amended to provide automatic effectiveness for an application to withdraw an entire registration statement that has not yet become effective, unless the Commission objects within 15 days after the issuer files the application.

Rules 429 and 457 were amended to move the provisions addressing the offset of filing fees from Rule 429 to Rule 457. Amended Rule 429 continues to address combined prospectuses.

Amended Rule 457 provides that where all or a portion of the securities offered remain unsold after a completion or termination of a registered offering, or withdrawal of the registration statement, the aggregate total dollar amount of the filing fee associated with those unsold securities may be offset against the total filing fee due for one or more subsequent registration statements. The subsequent registration statement(s) must be filed within five years of the initial filing date of the earlier registration statement, and must be filed by the same registrant (including a successor within the meaning of Rule 405), a majority-owned subsidiary of that registrant, or a parent that owns more than 50 percent of the registrant's outstanding voting securities.

Amended Rule 457 also provides as follows:

  • If a filing fee is paid for the registration of an offering and the same registration statement also covers the resale of the securities, no additional filing fee is required to be paid for the resale;
  • Payment of a filing fee is not required for the registration of an indeterminate amount of securities to be offered solely for market-making purposes by an affiliate of the issuer; and
  • A registration fee may be calculated on the basis of the maximum aggregate offering price of the securities, without regard to whether the securities are offered by the issuer or selling shareholders.

The effective date for the new rule and the amendments is March 7, 2001.

VII. Staff Legal Bulletins for Division of Corporation Finance

No updates.

VIII. Current Disclosure, Legal and Processing Issues

Disclosure, Legal and Processing Issues

Cover Page Gatefold for Registered Public Offerings

In many registered public offerings, issuers choose to include text and/or artwork inside the front and back cover pages. Graphics depicting a registrant's products or services, or explaining how they are used, can be very helpful to investors – particularly when the products or services relate to a complex process or technical industry. In order to avoid significant re-printing costs, we will review proposed gatefold and other graphic presentations as soon as they are available. Most of our comments are based on the following staff concerns:

  • The graphics don't accurately represent current business – for example, the depiction of products that do not exist yet or are not the registrant's products, the selective one-sided presentation of only the most favorable aspects of a registrant's business, excessive hyping, the inclusion of testimonials or statistical data that are taken out of context, or the identification of customers or other third parties upon which the registrant is not substantially dependant;
  • The text in the graphics does not adhere to plain English principles – for example, the use of technical industry jargon and terms that are unfamiliar to the average investor or the inclusion of extensive narrative text which repeats information already contained in the summary or business sections; and
  • The graphics detract from other prospectus disclosure because it is too confusing or obscure.

The gatefold for each registrant is unique, and we take into account all the information we have learned about the registrant and its industry when we review it. Sometimes the gatefolds for two different registrants seem similar at first glance, but they may raise significant staff concerns in one instance and not in the other, based on the unique facts of each registrant.

Registrants and underwriters can expedite staff review and reduce the number of staff comments if they keep in mind our concerns when they are preparing their gatefold and other graphic presentations.

Section 12 Registration Relief Involving Employee Stock Option Plans

Companies have granted stock options to broad based groups of employees under stock option plans in anticipation of going public within a short time after the stock option grants. These stock options are granted under stock option plans established for compensatory purposes. Many companies are now finding that they have granted stock options to 500 or more employees and their plans to go public have been delayed.

Under Section 12(g) of the Exchange Act, an issuer with 500 holders of record of a class of equity security and assets in excess of $10 million at the end of its most recently ended fiscal year must register the class of equity security, unless it has an exemption from registration. Stock options are a separate equity security under the Exchange Act. Accordingly, an issuer with 500 or more option holders and more than $10 million in assets is required to register that class under the Exchange Act, absent an exemption. The exemption from registration under Section 12(g) contained in Rule

12h-1(a) for "[a]ny interest or participation in an employee stock bonus, stock purchase, profit sharing, pension, retirement, incentive, thrift, savings or similar plan which is not transferable by the holder except in the event of death or mental incompetency, or any security issued solely to fund such plans" does not apply to stock options.

Beginning in 1991, the Commission by order, and subsequently the staff by no action letter, exempted or relieved issuers with 500 or more stock option holders from having to register their stock options under the Exchange Act when specified conditions were present. For the conditions necessary to receive relief under these letters and orders see, for example, the no action letter to Mitchell International Holdings, Inc. (available December 27, 2000).

Due to current market conditions, which are delaying the plans of many companies to go public, we are revising the conditions necessary to receive relief from registering their employee stock options under Section 12(g). As in the past, any relief granted by the staff would apply only to the stock options. Once a company has 500 holders of record of any other class of equity securities (e.g., common stock outstanding as a result of stock issuances, including option exercises), it would be required to register that class. The modified conditions would need to be present only when the company is relying on the relief.

We will consider granting relief in situations where the conditions of our prior no action letters noted above are met with the following modifications:

  • The options may be immediately exercisable.
  • Former employees may retain their vested options.
  • As with the current conditions, the options must remain non-transferable in most cases. However, we will permit the options to transfer on death or disability of the option holder. The stock received on exercise of the options may not be transferable, except back to the company or in the event of death or disability.
  • Consultants may participate in the option plan if they would be able to participate under Rule 701. We encourage you to review the adopting releases effecting the recent changes to Rule 701 and Form S-8 to understand the categories of consulting services that fall within this group. Releases 33-7645 and 33-7646.

We will premise any changes in our current position on option holders receiving essentially the same Exchange Act registration statement, annual report and quarterly report information they would have received had the company registered the class of securities under Section 12, including audited annual financial statements and unaudited quarterly financial information, each prepared in accordance with GAAP.

April 30, 2001 is the filing date for registration statements of issuers that met the Section 12(g) registration requirement as of December 31, 2000. We will consider extending that filing date to July 30, 2001 for any issuer that has submitted a no-action request to us by April 30, 2001. Any questions may be directed to Amy Starr in the Office of the Chief Counsel, (202) 942-2900.

Equity Line Financings

Note: The following discussion of our views replaces Interpretation No. 4S in the March 1999 Supplement to the Division's Manual of Publicly Available Telephone Interpretations.

Description of "Equity Line" Financing Arrangements

In a typical "equity line" financing arrangement, an investor and the company enter into a written agreement under which the company has the right to "put" its securities to the investor. Under this "put," the company has the right to tell the investor when to buy securities from the company over a set period of time and the investor has no right to decline to purchase the securities. The dollar value of the equity line is set in the written arrangement, but the number of shares that the company will actually issue is determined by a formula tied to the market price of the securities at the time the company exercises its "put."

Private Equity Lines with Registered Resales

In many equity line financings, the company will rely on the private placement exemption from registration to sell the securities under the equity line and will then register the "resale" of the securities sold in the equity line financing. In these types of equity line financings, the delayed nature of the "puts" and the lack of market risk resulting from the formula price differentiate private equity line financings from financing PIPEs (private investment, public equity). We, therefore, analyze private equity line financings as indirect primary offerings.

While we analyze private equity line financings as indirect primary offerings, we recognize that the "resale" form of registration is sought in these financings. As such, we will permit the company to register the "resale" of the securities prior to its exercise of the "put" if the transactions meet the following conditions:

  • The company must have "completed" the private transaction of all of the securities it is registering for "resale" prior to the filing of the registration statement.
  • The "resale" registration statement must be on the form that the company is eligible to use for a primary offering.
  • In the prospectus, the investor(s) must be identified as underwriter(s), as well as selling shareholder(s).

We have been asked a number of interpretive questions regarding private equity line financings.

Q. For the private transaction to be "complete," the investor must be irrevocably bound to purchase all the securities. How does this apply to the "put"?
A. Only the company may have the right to exercise the "put" and, except for conditions outside the investor's control, the investor must be irrevocably bound to purchase the securities once the company exercises the "put."
Q. If the investor is permitted to transfer its obligations under the equity line, will the transaction be "completed"?
A. No.
Q. If the investor has the ability to make investment decisions under the equity line agreement after the filing of the "resale" registration statement, the investor will not be considered irrevocably bound. What are some structures that we consider to continue to provide the investor with an investment decision?
A. Examples that we have observed include:

  • agreements that give investors the right to acquire additional securities (including the right to acquire additional securities through the exercise of warrants) at the same time or after the issuer exercises its "put";
  • agreements that permit the investor to decide when or at what price to purchase the securities underlying the "put"; and
  • agreements with termination provisions that have the effect of causing the investor to no longer be irrevocably bound to purchase the securities underlying the "put."

Q. Is a "due diligence out" a condition to closing within the investor's control that would prevent us from considering the transaction completed?
A. Yes.
Q. Are conditions such as (a)"bring downs" of customary representations or warranties and (b) customary clauses regarding no material adverse changes affecting the company conditions to closing within the investor's control that would prevent the private transaction from being completed?
A. No.
Q. If the company may "put" securities other than the shares of common stock being registered for "resale," such as a derivative security convertible into common stock (e.g., a convertible note or a convertible preferred security), would the private transaction be considered completed?
A. No. This is because the investor may have further investment decisions to make regarding the purchase of securities underlying the derivative security and will, therefore, not be irrevocably bound to purchase the securities that are being registered for "resale."
Q. If the above conditions are not met, can the company register the "resale" of the securities?
A. As a general matter, no. However, if the following conditions are met, the company may register the "resale" transaction, as these conditions address our concerns regarding inappropriate use of shelf registration and liability for potential violations of Securities Act Section 5.

  • The company is eligible to use Form S-3 or Form F-3 for a primary offering of securities.
  • The company complies with Rule 415(a)(4).
  • The company addresses, in the prospectus, issues relating to the potential violation of Section 5 in connection with the private transaction.

If the preceding three conditions are not met, the company must withdraw the registration statement and complete the private transaction. After the private transaction is completed, the ability to register the "resale" of the securities underlying the "put" would be analyzed in accordance with the views discussed in this section.

Takedown Off an Issuer's Shelf Registration Statement for Equity Line Financings

Some companies desire to register, as a primary offering, the issuance of the "put" securities under an equity line. We believe that an equity line financing done as a primary offering in which the "put" price is based on or at a discount to the underlying stock's market price at the time of the "put" exercise is an "at the market" offering under Rule 415(a)(4) and must comply with the requirements of that rule. In this regard, we have been asked the following questions regarding the application of Rule 415(a)(4):

Q. May the company and the investor enter into the equity line agreement before effectiveness of the Form S-3 or Form F-3?
A. As a general matter, no. However, the company and the investor may enter into the equity line agreement before effectiveness of the registration statement if the investor is a registered broker-dealer acting as an underwriter.
Q. Rule 415(a)(4)(iv) states "[t]he underwriter or underwriters must be named in the prospectus which is part of the registration statement." This leads to two questions:

  • Is it appropriate to name the underwriter or underwriters in a prospectus supplement?

    No. The registration statement must identify a registered broker-dealer as an underwriter, either in the base prospectus or a post-effective amendment – it is not appropriate to rely on Rule 424 and use a prospectus supplement for this purpose.

  • Who must be named as an underwriter?

    The prospectus which is part of the registration statement must identify the investor, in addition to the registered broker dealer, as an underwriter.

Q How do you calculate the 10% test in Rule 415(a)(4)(ii)?
A. The entire amount of securities available under the equity line may not exceed 10% of the aggregate market value of the company's outstanding voting stock held by non-affiliates.
Q. When do you calculate the 10% test in Rule 415(a)(4)(ii)?
A. This calculation is made at the later of the time the issuer enters into the equity line agreement or files the registration statement for the "at the market" offering.
Q. May the company and the investors amend the equity line financing arrangement later to permit the entire number of securities available under the equity line to exceed the 10% test?
A. No. The parties may not amend the agreement in order to exceed the 10% test; the company may not exceed the 10% test unless it enters into an entirely new agreement relating to a separate financing arrangement. In this regard, the company and the investors cannot have agreements to enter into new agreements – we believe that all currently anticipated agreements should be combined in determining the 10% threshold.

Division of Market Regulation Issues

There may be other issues relating to the underlying or "resale" transaction, including broker dealer registration, compliance with Regulation M or compliance with pre-filing requirements of the National Association of Securities Dealers. We encourage companies and investors to contact the Division of Market Regulation or the NASDR, as appropriate, regarding these issues.

Industry-Specific Issues

Clarification of Oil and Gas Reserve Definitions and Requirements

The following are additions to the Division's discussion regarding this matter in the November 14, 2000 Current Issues and Rulemaking Projects outline at section VIII.A.16.

Determination of Reserves Under Production Sharing Agreements

Under Production Sharing Agreements, a host government typically retains the title to the hydrocarbons in place, although the contracting company usually assumes all the costs for exploration and carries all risks. When a discovery is made, the contract provides for the contracting company to recover all its exploration and development expenditures and receive a share of profits, subject to certain limits. The amounts due to the contracting company are typically taken in kind.

In general, two methods of determining oil and gas reserves under production sharing arrangements have been proposed by registrants: (a) the working interest method and (b) the economic interest method. Under the working interest method, the estimate for total proved reserves is multiplied by the respective working interest held by the contracting company, net of any royalty. Under the economic interest method, the company's share of the cost recovery oil revenue and the profit oil revenue is divided by the year-end oil price, which represents the volume entitlement. The lower the oil price, the higher the barrel entitlement, and vice versa.

Reserve volumes determined by various owners should add up to 100% of the total field reserves, but that is not always the case using the working interest method. If the working interest is different from the profit entitlement, the economic interest method is the method acceptable to the staff because it is a closer representation of the actual reserve volume entitlement that can be monetized by a company. Also, use of the economic interest method avoids violating the prohibition in paragraph 10 of SFAS 69 against reporting reserves owned by others.

Sample Letter Sent to Coal Mine Operators Regarding Compliance with Industry Guide 7

(This letter is available at http://www.sec.gov/divisions/corpfin/guidance/coalmineletter.htm)

Accounting and Disclosure by Companies Engaged in Research and Development Activities

Biotechnology companies and others engaged in research and development activities often provide services and transfer rights under complex arrangements that present many accounting and disclosure issues. The arrangements may include payment terms that include receipt of up-front fees and milestone payments. These arrangements may include multiple elements such as product licensing agreements, manufacturing/supply agreements, royalty agreements, research and development agreements, and equity issuances, among others. Different methods of accounting for revenue and expense recognition may be appropriate under each of these arrangements. If these arrangements comprise a significant portion of revenues, clear and balanced disclosure should be provided about the terms of the arrangements, the methods of accounting for them, the specific risks and uncertainties associated with them, and their historical and expected effects on operations and financial position.

Revenue Recognition

Question 5 to SAB 101 advises that up-front fees, such as technology license fees, should be deferred and recorded over the term of the agreement unless it is clear that the earnings process is completed. In evaluating whether the earnings process is complete, the perspective of the licensee must be considered. If the licensee requires from the registrant future products or services to exploit the license, the license fee ordinarily should be deferred because the earnings process is not complete.

Many arrangements provide for milestone payments to be received either based on the passage of time or the occurrence of specific events. The timing of milestone payments may be reflective simply of project financing terms, rather than representative of the culmination of any particular earnings process. Diversity in accounting for milestone payments exists. In some cases, registrants defer milestone payments and recognize contract revenue on a systematic basis corresponding with services, costs, or time. In other cases, registrants recognize milestone payments as earned upon the occurrence of contract-specified events, if those events coincide with the achievement of a substantive element in a multi-element arrangement or measure substantive stages of progress toward completion under a long-term contract.

To make the arrangements transparent to investors, the following disclosures are encouraged:

  • Business Discussion – Describe each type of arrangement entered into by the company, explaining its business purposes and the underlying activities. Examples of agreement types are product/technology licenses, research and development agreements, production/supply agreements, royalty agreements, equity sales agreements, etc. Disclose the significant terms and characteristics of material agreements, including the various elements of products and services to be delivered by each party, the contract period, payment terms and amounts, obligations of the parties, events and circumstances that trigger milestone payments, and termination provisions. If the company has more than one arrangement with the same party, or that party has other types of relationships with the company, such as vendor, customer, or stockholder, discussion of the multiple relationships and arrangements together may be necessary for investor understanding.
  • Management's Discussion and Analysis – Discuss the historical and expected effects of material new contracts and the achievement of revenue recognition milestones on operations and financial position. Disclose the amounts of material up-front and milestone fees scheduled to be received and to be recognized as revenue over each of the next five years. Material uncertainties affecting realization of fees should be highlighted.
  • Financial Statements – Disclose your revenue recognition policies. Describe specifically how you apply your policies for each major revenue stream (i.e., research and development services, license agreements, product sales, consulting) and payment form (i.e., up-front fees, milestone fees, royalty payments). If different revenue recognition policies are followed for a particular major revenue stream or payment form due to varying facts, circumstances or contractual terms, each policy should be separately described. In many cases, especially for recognition of milestone payments, it will be necessary to discuss the facts and circumstances resulting in the culmination of the earnings process. Disclose your accounting policies for multi-element arrangements. Disclose the major terms of material arrangements/agreements.

Research and Development Expenses

Many biotechnology registrants incur significant research and development expenses. Although these expenditures may represent the majority of the expenses for many of these registrants, the discussion of R&D expense in Commission filings is generally uninformative. As indicated in FRC 501.01, MD&A is intended to give an investor an opportunity to view a registrant through the eyes of its management. The following disclosures are encouraged to enhance an investor's understanding of the company's use and expected use of resources in R&D activities:

  • Business Discussion – Disclose the nature and status of each major R&D project or group of related projects currently in process.
  • Management's Discussion and Analysis – Disclose for major R&D projects or groups of related projects the costs incurred to date, the current status, and the estimated completion dates, completion costs and capital requirements. If estimated completion dates and costs are not reasonably certain, discuss those uncertainties. Disclose the risks and uncertainties associated with completing development projects on schedule and the consequences if they are not completed timely.
  • Financial Statements – Disclose your accounting policies for internal research and development expenditures, research and development conducted for others, and research and development services for which you have contracted. Disclose the types of costs included in R&D costs, including salaries, contractor fees, building costs, utilities, administrative expenses and allocations of corporate costs. Disclose the amount of research and development expenses incurred in each year.

IX. Accounting Issues

Auditor Association with Interim Financial Statements

Rule 10-01(d) of Regulation S-X and Rule 310(b) of Regulation S-B require the review of interim financial statements by an independent public accountant prior to their filing in Form 10-Q or 10-QSB. The registrant is not required to state in the filing that the interim financial statements have been reviewed. A report of the independent public accountant is required to be included in the filing only if the registrant states that the financial statements have been reviewed. The interim review should be conducted in accordance with SAS 71. The AICPA's Professional Issues Task Force issued Practice Alert No. 2000-4, which provides auditors with important information they will need to consider for quarterly reviews of financial statements of public companies.

If the registrant fails to obtain a review of the interim financial statements prior to their filing in Form 10-Q or 10-QSB, the filing is deficient and the registrant is deemed not to be current or timely in its Exchange Act filings. If a review was not obtained, the staff believes the registrant should disclose in a headnote, under Item 1 of Part I and preceding the quarterly financial statements, that it did not obtain a review of the interim financial statements by an independent accountant using professional review standards and procedures, although such a review is required by the form. Completion of a review after the interim financial statements have been filed with the Commission will make the filing current, although it will not be deemed timely.

Auditors have professional responsibilities to consider when the registrant files interim financial statements in a Form 10-Q or 10-QSB that have not been reviewed. Unless otherwise disclosed in the filing, investors are likely to presume that the review required by the form has been performed by the auditor of record. If financial statements with which the independent accountant would be associated are included in a Form 10-Q or 10-QSB without the accountant's timely review, the auditor should consider Practice Alert 2000-4, AU§504 and Exchange Act Section 10A. Practice Alert 2000-4 advises that the auditor should consider discussing that failure with the company's audit committee and the company's legal counsel. If the deficiency is not immediately addressed through the accountant's completion of a review, the accountant should request that the client promptly amend the filing to disclose that the financial statements have not been reviewed by an independent accountant as required by the form. In addition, the auditor has a responsibility to follow the guidance in Section 10A. Under that section, if the company and its board fail to take appropriate remedial action with respect to an illegal act that is material to the financial statements, and the auditor reasonably expects to modify its report or resign due to the illegal act, then the auditor should report the violation of the law to the SEC.

X. Significant No-Action and Interpretive Letters - November 15, 2000 Through March 31, 2001

Sections 2(a)(3) and 5 of the Securities Act

Liberty Media Corporation – February 7, 2001

The Division was unable to advise that it would not recommend enforcement action if the registrant redeemed its outstanding shares of tracking stock in exchange for shares of a subsidiary corporation holding the assets and liabilities the tracking stock was designed to track without registering the exchange under the Securities Act of 1933. The letter noted that this will be the Division's position going forward in similar situations involving the redemption of tracking stock of a parent company in exchange for shares of a subsidiary.


Modified: 05/25/2000