Securities Act of 1933
|Re:||Arclight Systems, LLC|
Incoming letter dated October 17, 2001 and November 27, 2001
You have requested a response as to whether Arclight's "A Units", "B Units", and "C Units" can be considered one class of securities for the purposes of Rule 701(d)(2)(iii). The Division is of the view that you may consider the "A Units", "B Units", and "C Units" as a single class of securities for purposes of calculating under paragraph (d)(2)(iii) of Rule 701 the total amount of securities that may be offered and sold in reliance on the Rule.
Please be advised that this view is based on the representations made to the Division in your letters and that any different facts or conditions might require a different result.
Kevin M. O'Neill
Office of Small Business Policy
BAKER & HOSTETLER LLP
COUNSELLORS AT LAW
3200 NATIONAL CITY CENTER
1900 EAST 9TH STREET
CLEVELAND, OHIO 44114-3485
FAX (216) 696-0740
WRITER'S DIRECT DIAL NUMBER (216)
October 16, 2001
Office of Chief Counsel
Division of Corporation Finance
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549
RE: Rule 701(d)(2)(iii) under the Securities Act of 1933, as amended
Ladies and Gentlemen:
On behalf of Arclight Systems, LLC, a Delaware limited liability company ("Arclight"), we request that the staff of the Division of Corporation Finance (the "Staff") concur with our view concerning the scope of the exemption from registration provided by Rule 701 ("Rule 701") under the Securities Act of 1933, as amended (the "Securities Act"). This request is being made with respect to offers and sales of membership units of Arclight. These offers and sales will take the form of options to purchase membership units granted to employees, managers and certain key consultants of Arclight in connection with a proposed Incentive Compensation Plan (the "Plan").
We ask that the Staff concur with our view that the three classes of membership units authorized by Arclight's Limited Liability Company Agreement be considered one "class" of securities for the purpose of calculating the total amount of securities that may be offered and sold in reliance on Rule 701(d)(2)(iii). In support of our request, we offer the following information about Arclight, the Plan and our analysis of the meaning of Rule 701(d)(2)(iii).
I. Background Information
Arclight was founded to facilitate the sharing of information obtained in the course of processing and filling prescriptions for customers of its pharmaceutical distributor members. Arclight uses the prescription data to develop and commercialize information products for the pharmaceutical industry and other interested parties. Arclight is not subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Arclight's authorized capital consists of 2,500,000 Class A membership units ("A Units," the holders of which will be referred to as "A Members"), all of which are currently issued and outstanding, 5,000,000 Class B membership units ("B Units," the holders of which will be referred to as "B Members"), 3,627,600 of which are currently issued and outstanding, and 2,500,000 Class C membership units ("C Units," the holders of which will be referred to as "C Members"), none of which are currently issued. The A Units are held by the founders of the company. The B Units are held by participating pharmacy retail members. The C Units are reserved for issuance to employees under the Plan and to other potential equity holders. The B Members each hold a fixed number of B Units and a variable number of B Units that is adjusted annually to reflect the amount of data contributed by each B Member during such annual period. In connection with the proposed Plan, options to purchase up to 760,000, or 30%, of the C Units may be granted to certain employees, managers and key consultants. The remaining 1,740,000, or 70%, of the C Units will be reserved for subsequent general equity holders. The 760,000 units reserved for issuance under the Plan represent 7.6% of the total number of authorized capital of Arclight and approximately 12% of the total number of units currently outstanding.
The A, B and C Units are virtually identical in all respects and have equal rights and privileges, with a few minor differences. The principal difference is that the C Units are non-voting. Other differences include: (i) A Members have the right to receive an in-kind distribution of any assets previously contributed to Arclight by such A Members in the event of dissolution and wind-up, (ii) at any time upon thirty days advance written notice to Arclight, an A or B Member may convert any of its membership units, on a one-for-one basis, into authorized but unissued C Units, a provision included in the operating agreement merely to assuage concerns with participation levels during the initial start-up period, (iii) A Members gain 12% additional equity if Arclight should experience a "Valuation Event," defined as an initial public offering, a sale or transfer of all or substantially all of Arclight's assets, any merger, consolidation, reorganization or similar transaction or any sales of shares or units of Arclight's equity interests which results in any purchaser owning more than 50% of Arclight's equity interests and (iv) there are slight technical differences in the manner that A and B Members' votes in the election of directors are calculated. All classes have equal rights to distributions and allocations of loss in proportion to equity ownership and all classes have restrictions on resale and transfer of membership units. In addition, should Arclight effect an initial public offering, the new entity will be a corporation. All membership units will convert into one or more classes of equity with similar economic rights as the units held currently.
Arclight is managed by a seven person Board of Managers. Three managers are elected by A Members. Four managers are elected by B Members, using cumulative voting. This system will remain in place until December 31, 2004. After such date, all seven managers will be elected by all of the members voting together as a single class on a cumulative basis.
As noted, Arclight seeks to offer up to 760,000, or approximately 7.6% of the total number of units currently outstanding, C Units in connection with the Plan. Should the Staff concur with our analysis, the amount of C Units issued in reliance on Rule 701 will not exceed 15% of the aggregate number of securities of that "class" issued and outstanding.
II. Analysis of Rule 701(d)(2)(iii)
Rule 701(d)(2)(iii) provides that the aggregate amount of securities sold in reliance on Rule 701 in any twelve-month period may not exceed 15% of the outstanding securities of that class being offered and sold in reliance on the rule. Rule 701 does not contain a definition of "class" of securities for the purpose of determining whether the A, B and C Units should be considered a single "class" of securities in calculating the amount of offers and sales Arclight may make under Rule 701.
Section 12(g)(5) of the Exchange Act defines the term "class." Although this definition is for purposes of Section 12(g)(5) only, it offers a useful guide in defining "class" of securities in the context of Rule 701. The definition provides that a "class" of securities includes all securities of an issuer that are of a substantially similar character, the holders of which enjoy substantially similar rights and privileges. As noted above, A, B and C Units are nearly identical in character, except for differences with respect to voting rights and other minor technical features that facilitate the business operations of the company. In fact, if Arclight were to effect an initial public offering, the units would likely convert to a single class of equity, given that the economic rights of all the membership units are substantially similar with respect to allocations of income and loss. In addition, after an initial three-year start-up period, all units have rights with respect to the election of directors. Because of this, we believe that the three classes of membership units are substantially similar in character and that the holders of the respective membership units enjoy substantially similar rights and privileges. As such, the three classes should be considered one "class" for the purposes of Rule 701.
With its proposed Plan, Arclight wishes to encourage and enable participants to acquire a passive equity ownership and personal financial interest in the company. This will provide additional incentive for the promotion of the welfare of the company and for the continued service of the participants in the Plan with or to the company. If the A, B and C Units are not considered one "class" for purposes of Rule 701, both the Company's business purpose and the purpose of Rule 701 will be frustrated. As discussed in Release No. 33-6768 (dated April 14, 1988 and effective May 20, 1988), one purpose of Rule 701 is to enable a non-public entity to issue equity interests to its employees as part of an incentive plan such as that which Arclight has proposed. This purpose was reiterated in Release No. 33-7645 (dated February 25, 1999), in which the Staff amended Rule 701 to be even less restrictive, recognizing the increased usage of equity ownership as an incentive and retention device for employees.
Arclight's request is similar to the requests in both Osler Health, Inc. (publicly available February 11, 1998), and Deluxe Corporation (publicly available August 6, 1998). In Osler Health, Inc., the Staff permitted the company to treat two separate classes of common stock as one "class" of securities for purposes of Rule 701. Although the Staff made its determination under the prior version of Rule 701(d)(2)(iii) (formerly Rule 701(b)(5)(ii)), the substance of the provision has not changed. In Osler Health, Inc., the company represented to the Staff that its Class A Common Stock, issued to founders and investors, and Class B Common Stock, issued to certain physicians, would have equal rights and privileges, except that the Class B Common Stock (the class issued pursuant to Rule 701) was non-voting. Also, if the company was to effect an initial public offering, the Class B Common Stock would convert automatically into Class A Common Stock.
In Deluxe Corporation, the Staff concluded that the company's three classes of shares, HCL Shares, Deluxe Shares and Third Party Shares, were a single "class" of securities under Rule 701. Once again, the Staff based its conclusions on an analysis of former Rule 701(b)(5)(ii), identical in substance to current Rule 701(d)(2)(iii). In Deluxe Corporation, the three classes of shares carried similar rights and privileges, except with respect to the number of directors each class was permitted to elect and certain transfer restrictions placed on the HCL and Deluxe Shares. In addition, it was anticipated that the Third Party Shares received after exercise of options prior to an initial public offering would become subject to repurchase rights in favor of HCL-Deluxe N.V., the issuer, and other restrictions on transfer.
Each of these requests is similar to Arclight's request. As discussed, Arclight's three classes of membership units are of substantially similar character and the holders of each enjoy similar rights and privileges, except that the C Units are non-voting and do not enjoy identical technical features. Like the company in Osler Health, Inc., all classes of membership units will likely convert into one class of equity interest should Arclight effect an initial public offering, and the primary difference between Arclight's classes of membership units are that the C Units are non-voting. Furthermore, the differences between Arclight's membership units are not as significant as the differences between the three classes of stock in Deluxe Corporation, as the Third Party Shares were treated much differently from the HCL and Deluxe Shares upon an initial public offering. Therefore, concluding that Arclight's three classes of membership units may be treated as one "class" of security for the purpose of the Rule 701(d)(2)(iii) calculation is entirely consistent with past Staff statements on the issue.
Treating the A, B and C Units as one class of securities will also further the purpose of Rule 701 by allowing Arclight greater flexibility in compensating its deserving employees, managers and key consultants. We believe this to be appropriate in light of the Staff's previous interpretations of Rule 701, and in light of the underlying purpose of Rule 701.
The Staff may assume that Arclight will comply with all other requirements of Rule 701 in connection with offers and sales of C Units as part of the Plan. We would greatly appreciate your prompt consideration of this matter. Please contact me at (216) 861-7090 with any questions regarding this matter. If you decide not to accept the foregoing analysis, we would appreciate the opportunity to discuss the reasons for your position prior to the issuance of any formal written response to this request.
Pursuant to Release No. 33-6269, we have enclosed one original and seven copies of this letter. Please acknowledge receipt of this letter by file stamping the extra copy enclosed and returning it to me in the enclosed self-addressed stamped envelope.
Suzanne K. Hanselman
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