July 19, 2007
FELDMAN WEINSTEIN AND SMITH LLP
420 Lexington Avenue
New York, NY 10170
July 16, 2007
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549-1090
Attention: Nancy M. Morris, Secretary
Re: File No. S7-10-07, Securities and Exchange Commission Release No. 33-8812, RIN 3235-AJ89, Revisions to the Eligibility Requirements for Primary Securities Offerings on Forms S-3 and F-3
Ladies and Gentlemen:
Feldman Weinstein and Smith LLP has the following comments on the Staff's proposed Revisions to the Eligibility Requirements for Primary Securities Offerings on Forms S-3 and F-3.
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 believe that the following points, presented in the Staff's request for comments, could result in further improvements:
The 20% of Float Limitation
The key concern we have with the proposed 20%-of-float limitation in the proposed rule is that it permits a smaller public company to raise funds at the lowest available cost of capital only as a residual artifact of its current share price and current ownership structure, not as a function of the needs of the business itself. Businesses, large and small, run on business plans, whether that is to increase a sales force, pay for research and development, or build a new assembly line. The cost of these growth plans is not a function of whether the founding shareholders still have a controlling stake in the business, or whether on one day in the last 60 days the stock price happened to spike above $75,000,000 in market float.
We believe that shelf-registered securities are the lowest cost form of equity available to any given public company, due to the speed of execution and the fact that the securities are immediately tradable in the hands of the purchasers. The Staff has traditionally taken the view that the simple filing of an S-3 shelf registration provides adequate notice to the marketplace of the scale of an issuer's financing plans or ambitions (and prospective dilution), and the market has been presumed to react appropriately. This will be just as true for the sub-$75,000,000 issuer as for a WKSI.
We believe that rather than imposing an arbitrary 20% of float limitation, it would be more useful to both issuers and to investors if the issuer was instead required to provide a more detailed use of proceeds than is currently required by Regulation S-K, such that if an issuer with a $20,000,000 market capitalization proposed to shelf-register $40,000,000 of securities, current and prospective investors in that company would have some idea whether that was intended to fund plant construction, clinical trial expenses, acquisitions (even if unidentified) or simply to increase executive compensation and perks. We believe this would solve the key challenge created by the 20% of float limit, which would make the new Form S-3 rule of the least benefit precisely to those issuers who have the greatest need for outside equity capital.
We do understand the Staff's stated concern that smaller companies have relatively less liquidity (Release at page 14) and that there may be an adverse result to existing shareholders from a flood of new shares onto the existing market. Although we believe that all of an issuer's shareholders would in fact benefit from owning shares in a strongly-capitalized business rather than one where the executive officers spend too much of their time scrounging for funds from one small private placement after the next, we understand that there can be a reasoned difference of opinion on this subject.
If the Staff prefers to retain a mathematical limit, we find great merit in the Staff's idea (Release at page 31, second bullet point) to use a percentage of dollar trading volume as an alternative test for the amount of securities that could be shelf-registered. We do not think this should be in place of the market float test, but rather it should be a greater-of alternative test, where an issuer could raise in any 12 months the greater of 20% of its float OR 25% of its annualized trading volume.
This would positively address the needs of the more-liquid issuers for capital while assuaging the Staff's concerns about large issuances by illiquid companies. We think that the most appropriate look-back period for determining annualized trading volume would be the same 60 calendar day period used in the public float calculation, as both price and volume are equally potent indicators of market acceptance for a particular issuer's securities at a recent point in time.
A further alternative would be to harmonize the Staff's recent reinterpretation of Rule 415 (addressed further below) with the current initiative. In reassessing Rule 415's application to resale registrations by selling securityholders, the Staff determined that allowing any issuer to register up to one-third of its public float for resale is reasonable. We believe the proposed limit on use of Form S-3 to 20% of an issuer's public float each year is not related to any other standard applied in other aspects of securities regulation. While any percentage cutoff is by its very nature arbitrary, we believe it makes more sense to increase the amount permitted to be registered in a primary offering to at least be equivalent to what the Staff permits in resale registrations.
Therefore, we propose that the Commission permit a smaller reporting company to be able to register up to one-third of its public float each year, rather than 20%, or such higher amount as the Commission or its Staff may determine is permitted in general under Rule 415.
Valuation of Securities Being Issued
One issue that we believe should be clarified in either the final amendment to Form S-3 or in the final issuing release is the valuation of the securities that may be issued under the 20% limit (assuming the Commission elects to maintain that requirement as proposed). At the bottom of page 15 of the Release, the Staff notes "the 20% limit would apply to the amount of common stock warrants that a company could sell. . ."
It is not clear what the Staff means by that. Is it the cash (or equivalent) purchase price of the warrant itself, the aggregate exercise price of the warrants, or the difference, if any, between the exercise price and the market price of the underlying common stock at the time the warrants are first issued? In a world where most deals for micro-cap stocks include a warrant component, this is an important point. It is especially important to have clear guidance on this subject as transactions are often sold as units of common stock and warrants, without any expressed allocation of the unit purchase price between the various components of the unit.
Blue Sky Concerns
The Staff makes an excellent point in the Release at page 35, second bullet point, concerning the lack of a Blue Sky exemption for OTC Bulletin Board issuers. This factor has made the existing shelf registration regime nearly useless for those OTCBB issuers who currently have a float in excess of $75,000,000, who have been eligible to use Form S-3 for primary offerings all along. In our representation of investment banks, this problem has regularly killed transactions.
The whole point of the shelf registration is to allow virtually instantaneous reaction to market conditions. The lack of any equivalent process at the state level has essentially limited their use to transactions where all of the investors are either located offshore or resident in a state such as New York where only a non-substantive notice filing is required. Otherwise, the speed which is the hallmark of shelf offerings is entirely lost.
We suggest that the solution would be for the Commission to assert its authority to make all S-3 (or F-3) registered securities covered securities for purposes of Section 18(b). Given the continuous disclosure requirements that now apply to all OTCBB companies, this would not in any way subvert the congressional intent behind Section 18(b).
Respectfully, we do not see the rationale for excluding resale registrations from this proposal. The Staff seems to indicate that they are concerned about indirect primary offerings taking place. We believe that any concerns about this have already been fully addressed by the Staff's reinterpretation of Rule 415 (which is briefly addressed at the end of these comments). Given the continuous disclosures now being made by all reporting issuers, there does not seem to be any additional need to require issuers that have completed a private placement to go through a cumbersome S-1 registration. Therefore, we propose that a further S-3 resale registration be permitted for up to one-third of an issuer's public float each year, or such higher amount as the Commission or its Staff may determine is permitted in general under Rule 415.
Shell Company Exclusion
We do not understand why former shell companies need to wait a full year before being able to avail themselves of short-form registration. Since the Commission is proposing to permit former holders of shell company shares to be able to sell them in as little as 90 days under the proposed amendments to Rule 144, one presumes the Commission now feels comfortable that sufficient information about the merged company has been disseminated within that time frame, particularly due to the revised so-called "super" Form 8-K reporting requirements adopted two years ago. We strongly urge you to reconsider this time frame and limit it to 90 days.
Coordination with Other Recent Commission Initiatives
Rule 415 Reassessment. While not published for requested comments in the proposal, we believe that the instant proposal to revise the eligibility requirement to use Forms S-3 and F-3, together with the companion proposal to amend Rule 144 (Release 33-8813), are an appropriate opportunity to take another look at the Division of Corporation Finance staff's recent re-interpretation of Securities Act Rule 415.
Contrary to the spirit embedded in the proposed amendments to Form S-3 and Rule 144, which are both intended to make capital formation easier and cheaper for issuers, the Division of Corporation Finance, in its informal reinterpretation of Securities Act Rule 415 over the last 12 months, has gone in the opposite direction, making capital formation materially more costly to issuers, by denying legitimate investors the ability to timely exit from an investment. Unfortunately, this re-interpretation has already resulted in many potential nonabusive PIPE transactions being abandoned.
The new proposals will help ameliorate the problem created by this re-interpretation, but other problems, such as the inability to tack the holding periods on cash exercise of warrants, and therefore sell warrant shares without registration, will not go away. The entire thrust of the Rule 415 interpretation, from a policy perspective, seems counter to the spirit of the well-thought out new proposals.
Therefore, we propose that the Commission, as part of the new proposals, codify and modify its interpretation of Rule 415 to permit at least 50% of an issuer's actual outstanding shares to be registered for resale at one time, and more if other considerations exist.
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 shortened holding periods for Rule 144, 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
420 Lexington Avenue, Suite 2620
New York, NY 10170