May 22, 1997
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: File No. S7-07-97
Dear Mr. Katz:
We welcome the opportunity to respond to the request of the Securities
and Exchange Commission (the "Commission") in Release No. 33-7391 (the
"Release") for comments regarding proposed amendments to Rule 144 ("Rule
144") and Rule 145 ("Rule 145") under the Securities Act of 1933, as amended
(the "Securities Act"), and possible regulatory approaches to hedging transactions.
The Release (together with Release No. 33-7187 (the "1995 Release"))
noted that recent years have evidenced the growth of a variety of strategies in both
the private and public securities markets for "hedging" securities that are restricted
securities (within the meaning of Rule 144), securities to which the "presumptive
underwriter" doctrine of Rule 145(c) and (d) applies ("Rule 145 securities") and
securities held by affiliates (within the meaning of Rule 144) of the issuer of the
securities ("control securities"). These hedging strategies allow holders of such
securities to reduce their economic exposure to those securities while maintaining
their investment. Many of these strategies also allow holders of such securities to
monetize their positions (for example, by using these assets as collateral) or
otherwise protect all or a portion of the appreciation of their investment in a tax-advantaged manner.
The Release requests comment on a number of approaches to regulating
hedging transactions, including (a) making the Rule 144 safe harbor unavailable for
persons who hedge prior to the expiration of the Rule 144 holding period, (b)
promulgating a rule that would define a "sale" for purposes of Section 5 ("Section
5") of the Securities Act to include specified hedging transactions, (c) adopting a
shorter holding period during which hedging could not occur without losing the
safe harbor, (d) reintroducing a "tolling" provision in Rule 144 similar to the
provision that was included in the Rule prior to 1990 or (e) maintaining the status
quo with no specific prohibition against hedging, relying instead upon practitioners
to apply a facts-and-circumstances test to determine when Section 5 is implicated.
We feel strongly that the Commission should not adopt any approach that
would (i) prohibit all hedging of restricted, Rule 145 or control securities, (ii) treat
such hedging transactions as "sales" for purposes of Section 5 (thereby effectively
prohibiting any hedging transactions unless the holder of the securities had fully
complied with the requirements of Rule 144 relating to an outright sale of those
securities) or (iii) have the effect of tolling the applicable holding period during the
term of a hedging transaction. We believe that responsible, non-abusive practices
to ensure Section 5 compliance for hedging transactions can be developed by
applying a facts-and-circumstances analysis. However, we are sensitive to the
benefits to both the investor community and market participants of a bright-line,
non-exclusive safe harbor for certain types of hedging transactions. Attached
hereto as Annex A is a summary outline of a proposal (the "Hedging Proposal")
for a non-exclusive safe harbor that would make clear that parties to certain
hedging transactions are not engaged in a distribution and are therefore not
underwriters for purposes of the Securities Act.
I.Hedging Transactions and the Securities Act
The Securities Act is a transactional statute that seeks to ensure investor
protection by requiring that investors be supplied with information regarding an
issuer of securities at the time the issuer or an affiliate of the issuer offers or sells
securities into the open market. The Securities Act and the rules promulgated
thereunder (the "Rules") strike a balance between the goals of investor protection
and the facilitation of capital formation by allowing certain sales of securities to be
made on a private basis without registration in circumstances in which the nature
of the investors or other factors indicate that the application of the mandatory
disclosure requirements of the Securities Act is unnecessary. The Securities Act
and the Rules prohibit transactions that result in improper unregistered
distributions by ensuring that affiliates of issuers and investors in unregistered
placements of securities do not act as "conduits" for unregistered distributions of
securities into the open market.
Hedging transactions are not inconsistent with the goals of the Securities
Act and the Rules. We agree with the arguments articulated or supported by the
Capital Markets Committee and the Federal Regulation Committee of the
Securities Industry Association in its letter of September 19, 1995, by the
Subcommittee on the 1933 Act--General of the Committee on Federal Regulation
of Securities of the Section of Business Law of the American Bar Association in its
letter of September 6, 1995, by Intel Corporation in its letter of September 12,
1995, by Morgan Stanley & Co. Incorporated in its letter of September 29, 1995
and by J.P. Morgan Securities Inc. in its letter of September 19, 1995, all in
response to the Commission's request for comments on the 1995 Release
(together, the "1995 Comment Letters"). The 1995 Comment Letters pointed out
that hedging transactions are consistent with the goals of the Securities Act and the
Rules because (a) such transactions maintain a strict separation between the
restricted, Rule 145 or control securities and any publicly-traded securities that
may be sold short in the open market in connection with such transactions, so no
"leakage" of the restricted, Rule 145 or control securities into the open market
occurs and (b) none of the participants in such transactions, the issuers of such
securities or the investing public is adversely affected by such transactions. The
1995 Comment Letters also point out that even if the Commission were to adopt
an approach that regulates hedging transactions on the basis of the "economic"
effect of those transactions, hedging transactions are economically distinct from
actual sales. At the termination of a cash-settled hedging transaction, the holder of
the restricted or control securities continues to own those securities and retains all
the risks and benefits of ownership thereof. The holder at that time will consider
available alternatives, including the retention or disposition of the restricted or
control securities.(1) Finally, the 1995 Comment Letters argue effectively that
reinstatement of the concepts of "tolling" or "fungibility" would be misguided and
would have far-reaching, negative implications beyond the context of hedging
transactions. We support the positions stated in the 1995 Comment Letters.
If appropriate practices are followed, we do not believe that hedging
transactions constitute indirect distributions of restricted or control securities to
the public. While hedging transactions do generally involve short sales of
securities by holders of restricted, Rule 145 or control securities or by market
participants acting as counterparties to hedging transactions with such holders,
these short sales are effected through the delivery of freely-tradable securities that
are borrowed from existing holders (the "securities lenders") of those securities in
the market. Neither the particular restricted, Rule 145 or control securities being
hedged, nor any other previously non-public securities, enter the market at the time
of the hedging transaction. The investors that purchase securities in such short
sales are thus purchasing freely-tradable securities in the open market, and are not
purchasing restricted, Rule 145 or control securities. At the time the short sales
are "closed out" by returning securities to the securities lenders, current industry
practice (which is supported by the Hedging Proposal) requires that the securities
that were restricted, Rule 145 or control securities at the time of the hedging
transaction not be delivered to the securities lender, even if those securities could
be freely sold at that time. Thus a strict separation is maintained between the
restricted, Rule 145 or control securities and the securities delivered to investors in
the short sales.(2) As a result, hedging transactions do not result in any "leakage" of
restricted, Rule 145 or control securities into the market.
Hedging transactions are entered into by holders of restricted, Rule 145
and control securities for legitimate economic reasons that do not, in properly
structured transactions, compromise the goals of the Securities Act and the Rules.
Such holders often have supported the growth of small, entrepreneurial companies
by showing the confidence to invest in those companies before they have received
public attention. A significant portion of the investment portfolio of such holders
may consist of such restricted, Rule 145 and control securities, which are likely to
have a low tax basis in the hands of such holders. Even if such holders are
confident about the future prospects of these companies, they may fear that the
market will disagree, or they may simply believe that it is imprudent not to engage
in protective transactions or other strategies to diversify their investment portfolio.
Once a public market develops for the stock of these companies, hedging
transactions allow such holders temporarily to protect such gains, often in a tax-advantaged manner. Because hedging transactions that are cash-settled (as
required in most cases by the Hedging Proposal) do not involve the delivery of any
of the restricted, Rule 145 or control securities at any point in the transaction, such
transactions are often entirely consistent with a holder's desire to remain invested
in a company.
Thus holders that enter into properly structured hedging transactions are
not selling restricted, Rule 145 or control securities into the market, acting as a
"conduit" for a distribution in violation of the Securities Act or, in some cases,
even expressing a negative view about the securities they are hedging. Many
holders are merely protecting their entrepreneurial efforts by tailoring the overall
risk/return profile of their investment portfolios. Permitting investors to engage in
legitimate hedging transactions facilitates efficient capital formation by allowing
investors and market participants temporarily to reduce the risks of their
investments in restricted, Rule 145 and control stock on the basis of their
risk/return objectives. We are not aware of harm to public investors caused by
these transactions.
We believe that significant market disruption would occur if the
Commission were to adopt any approach that prohibited or significantly limited
hedging transactions beyond the limitations set forth in the Hedging Proposal.
Because investors in the private securities markets rely on their ability to hedge
certain of the risks of their investments, we are concerned that a significant
cutback in investors' flexibility to enter into legitimate hedging transactions would
impair the ability of issuers to raise capital in the private markets or effectively
pursue business combinations. This impairment would have a severe effect on a
broad spectrum of issuers, particularly small, entrepreneurial companies that rely
on the private securities markets for capital raising activities. This concern is
starkly illuminated by the 1995 Comment Letter submitted by Intel Corporation.
II.Proposed Non-Exclusive Safe Harbor for Certain Hedging Transactions
While we feel that the facts-and-circumstances approach to Section 5
compliance in hedging transactions can be applied to develop responsible, non-abusive industry practices, we believe that the non-exclusive safe harbor contained
in the Hedging Proposal would provide certainty to parties who want to ensure
that their hedging transactions do not contravene Section 5. We urge the
Commission to retain the facts-and-circumstances approach for sales that do not
fall within the safe harbor by making explicit in any adopting release that a failure
of a particular sale to fall within the safe harbor will not create a presumption that
such sale involves a distribution or that the holder or the counterparty to a hedging
transaction is an underwriter for purposes of the Securities Act.
The Hedging Proposal does not address the hedging of Rule 145 securities
or the holding periods under Rule 145 because we support the Commission's
proposal in the Release to eliminate the presumptive underwriter doctrine in Rule
145(c) and (d). We do not believe that there is sufficient justification for
presuming that holders of securities received in a registered transaction covered by
Rule 145 (a "Rule 145 transaction") that are not affiliates of the issuer of those
securities are underwriters for purposes of the Securities Act. If Rule 145(c) and
(d) are eliminated, holders of securities received in a Rule 145 transaction that are
not affiliates of the issuer of those securities would be free to sell those securities
in the open market, and therefore presumably to hedge those securities. We note
that it is important that the Commission make clear in the release adopting the
proposals regarding Rule 145(c) and (d) that such securities could be freely sold by
such holders without such holders being deemed underwriters for purposes of the
Securities Act. If the Commission were not to make this clear, significant
uncertainty would remain as to the status of a holder that was an affiliate of the
target company in a Rule 145 Transaction but is not an affiliate of the surviving
company. If the Commission does not adopt the proposal in the Release regarding
Rule 145(c) and (d), we believe that the hedging of Rule 145 securities held by
persons who are not affiliates of the issuers of those securities should be treated in
the same manner as the hedging of restricted securities, as set forth in the Hedging
Proposal.
The specific provisions of the Hedging Proposal are discussed below.
Capitalized terms used in the following discussion and not otherwise defined have
the meanings ascribed to them in the Hedging Proposal.
Holding Periods
We believe that the recently-adopted one-year and two-year holding
periods under Rule 144 strike an appropriate balance between facilitating capital
formation through private offerings of securities and ensuring that purchasers of
securities in unregistered placements do not act as "conduits" for unregistered
distributions of those securities into the open market. These holding periods
provide adequate separation between the unregistered placement of the securities
and any subsequent movement of such securities into the open market. We
suggest that the Commission obtain experience with the recent changes to the
holding periods prior to considering whether future reductions are appropriate.
We note that, as discussed in the 1995 Comment Letters, the need to permit
responsible, non-abusive hedging transactions will continue even if the holding
periods are further shortened.
Hedging Restricted Securities of Non-Affiliates
The Hedging Proposal provides a non-exclusive safe harbor for Hedge-Related Sales of Subject Securities with respect to Hedging Transactions where (a)
the Held Security is a restricted security, (b) the Principal is not an affiliate of the
issuer of the Held Security, (c) the holding period of the Held Security is more
than three months, (d) the Hedging Transaction (other than a short sale by a
Principal) is cash-settled and (e) the Held Security is not used by any party to the
Hedging Transaction or any affiliate thereof to close out such Hedge-Related
Sales.
The three-month holding period in clause (c) is intended to establish that a
purchaser of restricted securities in an unregistered placement is taking those
securities without a view to a distribution and to allay any concern that the non-affiliate Principal or the Counterparty is acting as a conduit for an unregistered
distribution.(3) While, for the reasons set forth above, we believe that Hedge-Related Sales do not facilitate unregistered distributions of restricted securities, we
are sensitive to the concern that a Hedging Transaction effected immediately upon
receipt of restricted securities in a private placement could be deemed to be
inconsistent with the purpose of the private placement provisions of the Securities
Act and the Rules. Therefore we believe that it is reasonable for the safe harbor
rule to require that restricted securities be held "unhedged" for a period of time
subsequent to the initial unregistered placement. While a facts-and-circumstances
analysis might result in a shorter "unhedged" holding period in certain
circumstances, we have chosen in the Hedging Proposal a three-month period,
which we believe establishes an appropriate bright-line test. As set forth above,
we believe that Hedging Transactions are consistent with a Principal's intent to
hold the Held Securities for the length of the Rule 144 holding period. The three-month "unhedged" holding period, together with the other requirements of the
Hedging Proposal, will provide appropriate assurance that any Hedge-Related
Sales of Subject Securities with respect to a Hedging Transaction will not have
been made indirectly on behalf of the issuer of the Held Security (or an affiliate of
such issuer) and are consistent with the private placement in which the Principal
received the Held Securities.
The cash-settlement requirement in clause (d) and the requirement in clause
(e) that, in the case of a short sale by a Principal (which could not be cash-settled),
the Held Security not be used to close out the Hedge-Related Sales are intended to
maintain strict separation between the restricted Held Securities and the securities
that are sold in the market in connection with the Hedge-Related Sales. As a result
of these requirements, the restricted securities held by the Principal will not be
delivered by the Principal (into the market or otherwise) at any time pursuant to
the Hedging Transaction. Because the Hedging Transaction may only be settled
by the Principal by delivering cash to the Counterparty, rather than by delivering
the Held Securities, we believe that it would be inappropriate to conclude that the
Principal entered into the Hedging Transaction as an indirect means of selling the
Held Security into the market. The Principal is simply reducing its economic
exposure to the Held Security for the term of the Hedging Transaction.
Hedging Securities of Affiliates
The Hedging Proposal provides a non-exclusive safe harbor for Hedge-Related Sales of Subject Securities with respect to Risk-Retention Hedging
Transactions where (a) the Principal is an affiliate of the issuer of the Held
Security, (b) if the Held Security is a restricted security, the holding period thereof
is more than three months, (c) the Risk-Retention Hedging Transaction is cash-settled and (d) the Held Security is not used by any party to the Risk-Retention
Hedging Transaction or any affiliate thereof to close out such Hedge-Related
Sales.
While, for the reasons set forth above, we believe that Hedge-Related Sales
do not facilitate unregistered distributions of control securities, we are sensitive to
the special status of affiliates under the Securities Act (including Section 2(11)
thereof, which treats affiliates as "issuers" for purposes of the definition of
"underwriter") and the Rules due to, among other things, the close relationship
between affiliates and issuers. Therefore the Hedging Proposal sets forth a more
limited safe harbor where the Principal is an affiliate of the issuer of the Held
Security. We note that, as the Commission observed in the Release, many affiliates
are individuals who have a significant portion of their net worth invested in control
stock. Because an affiliate may hold a substantial percentage of the stock of a
company (particularly in the case of a smaller, entrepreneurial company), an
appropriate approach to regulating hedging transactions by affiliates should permit
affiliates to enter into certain Hedging Transactions without regard to the volume
limitations of Rule 144.
Risk-Retention Hedging Transactions are transactions in which the
Principal retains significant economic exposure to decreases in the value of the
Held Security. By requiring a Principal that is an affiliate of the issuer of the Held
Security to retain significant exposure to the Held Security, the Hedging Proposal
ensures additional economic separation between the Hedge-Related Sales and the
Held Securities. The Hedging Proposal adopts a bright-line test that requires that
the Principal retain exposure to decreases in the price of the Held Security of at
least 10% (taking into account the terms of the Hedging Transaction and any net
payments made by or to the Principal at the time of entering into the Hedging
Transaction).(4) As a result, the Principal will face significant market exposure to
the Held Security. The proposed bright-line test will be simple to implement in
practice.
The requirements of clauses (b), (c) and (d) serve the same purposes in the
context of Risk-Retention Hedging Transactions by affiliates as in the context of
Hedging Transactions for non-affiliates, as discussed above.
While not specifically addressed in the Hedging Proposal, we generally
support the Commission's proposal in the Release to adopt a non-exclusive safe
harbor from the definition of "affiliate" for certain persons who are not in a
position to control an issuer. Such a safe harbor would provide certainty to the
market (which is especially important in light of the Commission's expressed
unwillingness to provide interpretive or no-action relief on the issue of affiliate
status on a case-by-case basis). However, we believe that the 10% threshold
suggested by the Commission in the Release is too low. It is not realistic in
today's market to believe that a 10% stockholder of an issuer, who is not an
executive officer or a director of the issuer and who has no other affiliation with
the issuer, will be in a position to control the issuer or to cause the issuer to
undertake the expense and management commitment required by a registered
secondary sale of securities (i.e. the registration process, the due diligence process,
the underwriting process, etc.).(5)
As an alternative approach, we support a non-exclusive safe harbor based
on the definition of "affiliate" put forth by the Advisory Committee on the Capital
Formation and Regulatory Processes, which would exclude persons other than the
chief executive officer, inside directors, 20% stockholders and 10% stockholders
that also had a representative on the board of directors (the "Advisory Committee
Definition").(6) We believe that this definition comes closer to taking into account
the reality of corporate control dynamics. If the Commission is unwilling to adopt
the Advisory Committee Definition, we believe that the Commission should retain
a facts-and-circumstances approach rather than adopting the 10% threshold
proposed in the Release. While the Release makes clear that the 10% threshold
would be stated as a non-exclusive safe harbor (and we assume that the release
adopting such proposal would make clear that a failure to meet the requirements of
the safe harbor would not raise a presumption of affiliate status), we are concerned
that adoption of the proposed safe harbor would chill legitimate sales and hedging
transactions by persons who, as a practical matter, are not in a position to control
the issuer.
We note that, because Rule 144 provides a safe harbor for certain sales by
affiliates, a narrower definition of "affiliate" in Rule 144, without corresponding
clarification in other areas of the Securities Act, could have the perverse effect of
denying certain persons the safe harbor of the Rule. For example, a 9.9%
stockholder of an issuer that does not hold restricted securities could be concerned
that it might be considered to be in a controlling position with respect to the issuer
(and therefore an "issuer" for purposes of the definition of "underwriter" in
Section 2(11) of the Securities Act) under the traditional facts-and-circumstances
analysis, but could find itself unable to take advantage of the safe harbor provided
by Rule 144 because it does not own restricted securities and does not fit the
Rule's definition of "affiliate". We suggest that if the Commission adopts a
"bright-line" safe harbor test for establishing non-affiliate status, the Commission
make clear that compliance with the requirements imposed on affiliates by Rule
144 will enable any holder to take advantage of the Rule.
Hedging Transactions Within Volume, Holding Period and Information
Requirements of Rule 144
The Hedging Proposal would make clear that, at the election of the
Principal, Hedge-Related Sales may be conducted in compliance with the volume,
holding period and current public information requirements of Rule 144. This part
of the Hedging Proposal would apply to Hedging Transactions by affiliates or non-affiliates after the expiration of the applicable holding period that do not fall within
the safe harbors described above.(7) In addition, if the Commission does not adopt
the proposals in the release relating to Rule 145(c) and (d), this part of the
Hedging Proposal would apply to Hedging Transactions in which the Principal
holds Rule 145 securities with respect to which a three-month holding period has
not run.
Hedge-Related Sales by a Principal should not give rise to concern in
situations in which outright sales by the Principal would be covered by the safe
harbor of existing Rule 144. In addition, while we feel strongly that Hedge-Related Sales by a Counterparty should not be generally attributed to the Principal,
Hedge-Related Sales by a Counterparty should be treated no worse under Rule
144 than Hedge-Related Sales or outright sales by the Principal.
The Hedging Proposal is derived in part from the premise that securities
transactions by a Counterparty to a Hedging Transaction (or any "derivative"
transaction) should not be presumed to be attributable to the holder of the
securities being hedged. We are concerned that a contrary view would have broad
ramifications in other areas. Accordingly, we urge the Commission to make clear
in any release adopting a safe harbor such as that set forth in the Hedging Proposal
that the adoption of the safe harbor does not raise any contrary implication.
The aggregation provisions set forth in the Hedging Proposal are consistent
with the aggregation concepts contained in Rule 144(e)(3).
As discussed in more detail in Part III of this letter, Hedging Transactions
entered into with a Counterparty may involve continuous Hedge-Related Sales by
the Counterparty during the term of the Hedging Transaction in connection with
the Counterparty's "dynamic hedging" activities. As a result, it is important that,
for purposes of determining compliance with the volume limitations of Rule 144,
the number of securities deemed to have been sold by the Principal in connection
with such a Hedging Transaction will be the notional amount of Held Securities
underlying such Hedging Transaction, and all such securities will be deemed to
have been sold at the time of entering into such Hedging Transaction. (This
approach is consistent with the staff's current requirement that a registration
statement covering short sales effected in connection with a hedging transaction
include (for purposes of calculating the registration fee) a number of securities
equal to the number of securities underlying the hedging transaction, even if the
actual number of short sales executed in connection with dynamic hedging over the
term of the hedging transaction exceeds this number.)
An integral part of our proposal relating to Hedge-Related Sales effected in
compliance with the volume, holding period and current public information
requirements of Rule 144 is that the Principal should be able to deliver the Held
Securities to the Counterparty to settle the Hedging Transaction, and the
Counterparty should be able to deliver such Held Securities to securities lenders to
close out the borrowings associated with Hedge-Related Sales. If the Hedge-Related Sales are conducted in compliance with the volume, holding period and
current public information requirements of Rule 144, then the Held Securities
should be deemed to have been sold to the public in the Hedge-Related Sales for
purposes of closing out the related borrowings. This position is consistent with
the position taken by the Commission in the case of so-called "short-sales against
the box", in which the Commission has permitted the restricted or control
securities held in the "box" to be used to close out a short position that was
created in compliance with Rule 144.(8)
The Hedging Proposal does not address the manner-of-sale requirement of
Rule 144 because we support the Commission's proposal in the Release to
eliminate that requirement.(9) We concur in the Commission's observation that the
current requirement imposes obstacles to transactions that are not distributive in
nature. When a sale is made in accordance with the current public information,
holding period, volume and notice requirements of Rule 144, the manner in which
the sale is effected should not be determinative of a distribution. The requirement
in the Hedging Proposal that Hedging Transactions be cash-settled (or, in the case
of a short sale by a Principal that is not an affiliate of the issuer, settled with a
security other than the Held Security) will continue to maintain strict separation
between the restricted or control Held Securities and the securities that are sold in
the market in connection with Hedge-Related Sales.
Hedging Transactions That Do Not Involve Subject Securities
The Hedging Proposal would make clear that Hedge-Related Sales of
securities that are not Subject Securities do not raise registration issues under
Section 5. The definition of Subject Securities borrows from Rule 144A(d)(3) in
that it excludes securities underlying Held Securities where the Held Securities are
convertible into or exchangeable for such underlying securities if the conversion or
exchange option is at least 10% out-of-the-money at the time of issuance. Just as
in Rule 144A(d)(3), such Held Securities are not sufficiently fungible with the
underlying securities to treat sales of such underlying securities as the equivalent of
sales of such Held Securities. Because the conversion or exchange option was
significantly out-of-the-money at the time of issuance, there was at such time a real
possibility that such option would expire unexercised and that therefore the
convertible or exchangeable Held Securities would never be converted into or
exchanged for such underlying securities. As a result, sales of such underlying
securities should not be deemed to involve a distribution of the Held Securities.
If the Commission were to adopt a different approach, it would cause
significant market disruption in the market for convertible or exchangeable
securities traded pursuant to Rule 144A ("Rule 144A Convertible Securities").
Consistent with risk management strategies utilized in the market for registered
convertible securities, many investors in the market for Rule 144A Convertible
Securities rely on their ability to hedge some of the risks of ownership of Rule
144A Convertible Securities in Hedging Transactions that involve Hedge-Related
Sales of the securities underlying those Rule 144A Convertible Securities. Market
makers in that market would generally be unwilling to act as such if they were not
able to enter into such Hedging Transactions to hedge their market making
positions. Thus the placement and trading markets for Rule 144A Convertible
Securities, like the placement and trading markets for registered convertible
securities, are facilitated today by such Hedging Transactions. If the Commission
were to adopt an approach that did not allow Hedge-Related Sales of securities
underlying Rule 144A Convertible Securities to be freely made without
registration, we are concerned that the ability of issuers to raise capital in the Rule
144A Convertible Securities market would be severely impaired and that there
would be a decrease in the liquidity of Rule 144 Convertible Securities. The Rule
144A Convertible Securities Market is extremely important to capital-raising
efforts, especially by smaller companies.
General - Integration
The Hedging Proposal would make clear that, in the absence of a plan or
scheme to evade the registration requirements of the Securities Act, Hedge-Related Sales that fall within the safe harbors of the Hedging Proposal would not
be integrated with any other offers or sales of Subject Securities by the Principal, a
Counterparty or the issuer of the Held Security.(10)
Because the Hedge-Related
Sales that fall within the safe harbors involve open-market sales of freely-tradable
securities, they should not raise integration concerns. If Principals and
Counterparties were concerned that other offers or sales of Subject Securities
could be integrated with such Hedge-Related Sales, the utility of the safe harbors
of the Hedging Proposal would be significantly impaired.
III.Proposal Regarding Registered Short Sales
In the Release, the Commission requests comment on whether the initial
hedge in connection with a hedging transaction should be treated differently than
subsequent "maintenance" hedging. As discussed below, we believe there is a
fundamental difference between the initial hedge entered into by a counterparty to
a hedging transaction and subsequent dynamic hedging transactions, if any. While
the Release does not specifically address short sales effected pursuant to an
effective registration statement, we would like to take this opportunity to propose
an approach to registering the short sales of a Counterparty to a hedging
transaction. Attached as Annex B is a summary outline of a proposal (the
"Registered Short Sale Proposal") for a non-exclusive safe harbor that would
permit certain short sales in connection with dynamic hedging activities to be
effected without registration under the Securities Act. The transactions
contemplated by the Registered Short Sale Proposal involve situations in which the
initial Hedge-Related Sales by a Counterparty to a Hedging Transaction do not fall
within the safe harbor of the Hedging Proposal (and are not otherwise exempt
from registration as a result of a facts-and-circumstances analysis) and therefore
are effected pursuant to an effective registration statement. Capitalized terms used
in the following discussion and not otherwise defined have the meanings ascribed
to them in the Registered Short Sale Proposal.
The Registered Short Sale Proposal draws a distinction between (1) "Initial
Related Sales", which are defined as Related Sales made by a Counterparty to a
Subject Transaction (a) prior to and in anticipation of entering into such Subject
Transaction and (b) during the period beginning when the Counterparty enters into
such Subject Transaction and ending at the close of business on the fifth Trading
Day thereafter (provided that the number of Initial Related Sales shall not exceed
the total notional amount of Underlying Securities underlying the Subject
Transaction) and (2) all subsequent Related Sales. We believe that while it may be
appropriate to require registration for the Initial Related Sales, subsequent Related
Sales should be permitted without registration.
To illustrate this, it is important to understand how a Counterparty is likely
to enter into Related Sales in connection with a Subject Transaction. Subject
Transactions (or any hedging transactions) can generally be broken down into one
or more component option positions. With respect to each option position that
makes up a Subject Transaction, it is possible to determine at any time the value of
the option on the basis of the exercise or "strike" price of the option, the then-current market price of the Underlying Security (which together determine
whether and to what extent the option is "in-the-money" or "out-of-the-money" at
that time), the remaining term of the option, the predicted volatility of the
Underlying Security and other factors. It is also possible, on the basis of the same
factors, to determine the mathematical relationship between changes in the value of
the option and changes in the value of the Underlying Security. This relationship is
referred to as the "delta" of the option. For every one unit increase or decrease in
value of the Underlying Security, the value of the option will increase or decrease
by delta times such unit. This is a fluid process -- the delta of an option changes
(i) as the value of the Underlying Security changes and (ii) as the time remaining to
maturity of the option decreases.
The Counterparty to a Subject Transaction uses the deltas of the options
comprising such Subject Transaction to help determine the amount of any Related
Sales made by that Counterparty. Consider the example of a Subject Transaction
consisting of the purchase of a one-year call option on 100,000 shares by a
Counterparty. If the Counterparty were to determine that the initial delta of the
call option were .4, the Counterparty would itself be temporarily hedged against
small movements in the value of the Underlying Security if it sold short 40,000
shares of the Underlying Security (because the expected loss to the Counterparty
on the call option in the event of a decrease in the price of the Underlying Security
would be approximately equal to the expected gain to the Counterparty on the
short position in the Underlying Security, and the expected gain to the
Counterparty on the call option in the event of an increase in the price of the
Underlying Security would be approximately equal to the expected loss to the
Counterparty on the short position in the Underlying Security). For example, if the
price of the Underlying Security dropped by $1 per share, the value of the option
would decrease by $40,000 (delta of .4 times $100,000, the aggregate amount of
the decrease in the value of the Underlying Security), but the value of the
Counterparty's short position would increase by an equal amount (40,000 shares
times $1 per share), and the total value of the Counterparty's portfolio would not
change.
The $1 drop in the price of the Underlying Security would, however, result
in a change in the delta of the option, which in turn would lead the Counterparty to
adjust its hedging position as follows. Because the price of the Underlying
Security dropped, the new delta of the call option will be less than .4. If the
Counterparty were to determine that the new delta were .38, the Counterparty
would buy 2,000 shares of the Underlying Security to reduce its short position to
38,000, as indicated by the new delta. At any time, a Counterparty that is engaged
in "delta hedging" with respect to a Subject Transaction can be expected to
maintain a short position with respect to a number of shares of the Underlying
Security equal to the product of (a) the number of shares of the Underlying
Security underlying the Subject Transaction and (b) the combined delta, or "hedge
ratio", of the options comprising the Subject Transaction. Therefore, if the
Counterparty is engaged in delta hedging, any changes in the combined delta of a
Subject Transaction after the Subject Transaction is entered into are likely to result
in the Counterparty effecting additional Related Sales to increase its short position
or purchases to decrease its short position. Such an ongoing process of hedging
on the basis of a changing combined delta is an example of "dynamic hedging".
A Counterparty to a Subject Transaction may engage in delta hedging as
described above, may have an existing proprietary position in the Underlying
Security that may serve as part of the Counterparty's hedging strategy, may remain
unhedged or "naked" in its exposure to the Subject Transaction, or may hedge its
exposure in other ways. At the time of pricing of a Subject Transaction, all of the
economic terms of the Subject Transaction as between the Principal and the
Counterparty (including, with respect to each option making up the Hedging
Transaction, the strike price, maturity and number of securities covered) will have
been "locked in", and the initial hedge by the Counterparty will have been
established. After the initial hedge, the Principal to a Subject Transaction is
unlikely to be informed of particular hedging transactions by the Counterparty.
The Principal will be not be affected by (and will therefore be indifferent to) any
subsequent hedging transactions effected by the Counterparty in furtherance of the
Counterparty's own hedging strategy. Such hedging transactions are entirely
unrelated to the Principal's investment strategy.
The Registered Short Sale Proposal imposes registration and prospectus
delivery requirements with respect to the maximum number of Related Sales that a
Principal could reasonably anticipate that a Counterparty to a Subject Transaction
might effect in connection with a delta hedging strategy. Because the combined
delta of a Subject Transaction can be determined at the time the Subject
Transaction is entered into, the Principal to a Subject Transaction is in a position
to anticipate with some degree of certainty the amount of the initial Related Sales
that a Counterparty is likely to effect. However, as discussed above, the combined
delta of the Subject Transaction will change as a result of changes in the market
price or the volatility of the Underlying Security, as a result of other factors and
simply as a result of the passage of time. At the time of entering into the Subject
Transaction, there is no way to predict the direction or the magnitude of any future
net changes in the combined delta, and any Related Sales made by the
Counterparty in the process of dynamic hedging will in no way affect the terms of
the Subject Transaction between the Principal and the Counterparty. Thus any
such Related Sales could not be anticipated by, and in no way should be
attributable to, the Principal. These sales will be ordinary market transactions by
the Counterparty to maintain its own internally hedged position. In a Subject
Transaction in which the initial Related Sales are effected pursuant to an effective
registration statement, subsequent Related Sales in connection with dynamic
hedging transactions should not be viewed as having been made by or on behalf of
the Principal pursuant to the registration statement in connection with the Hedging
Transaction, but should be viewed as ordinary open market transactions in freely-tradable securities by the Counterparty.
We believe that the definition of the "Initial Related Sales" represents an
appropriate bright-line test to delineate Related Sales that could be anticipated by
the Principal from Related Sales in connection with dynamic hedging by the
Counterparty. In our experience, it would be extremely unusual for a
Counterparty not to have established its "initial hedge" within five Trading Days of
pricing the Subject Transaction. In fact, a Counterparty that is delta hedging will
generally have established its initial hedge by the time of pricing a Subject
Transaction because the economic terms of the Subject Transaction are "locked
in" at the time of pricing, so Counterparty would not be fully hedged if the initial
Related Sales had not been effected at such time.
We understand that in the past the staff has expressed a contrary view with
respect to dynamic hedging activities. The staff's current requirement that all
Related Sales in connection with dynamic hedging activities be registered has
effectively precluded Counterparties from hedging on a registered basis. If each
subsequent Related Sale must be made pursuant to a registration statement and,
presumably, accompanied by a current prospectus, the Counterparty will be unable
to effect such Related Sales during any "blackout" period under the registration
statement. It is essential for issuers to be able to impose blackout periods during
which sales under the registration statement may not be made because of corporate
developments (such as major transactions or the impending release of quarterly
results) that may make the prospectus incomplete or misleading but that are not
yet ripe for public disclosure. Because the delta of a transaction can change on a
daily, hourly or even minute-to-minute basis, a Counterparty engaging in dynamic
hedging must be free to effect subsequent Related Sales at any time. If a
Counterparty faces potential blackout periods, it will be unwilling to enter into the
Subject Transaction. In addition, a requirement that all Related Sales be registered
imposes an ongoing burden on the issuer of the Underlying Security because such
issuer will be continuously "in registration", and therefore will need to ensure that
its prospectus is fully current at all times, during the term of the Subject
Transaction. Further, Counterparties have been unwilling to assume the continuous
potential liability under Section 11 of the Securities Act associated with hedging
activity that may occur months or even years after entering into the Subject
Transaction. Thus, the staff's current position on dynamic hedging has made it
impossible to effect Related Sales on a registered basis. We believe that this is an
unfortunate result because the registration of the Initial Related Sales would
preserve the policies underlying the registration provisions of the Securities Act
while at the same time permitting market participants to enter into legitimate
hedging transactions.
If the Commission adopts our approach to registered hedging transactions,
it is important that, in the absence of a plan or scheme to evade the registration
requirements of the Securities Act, unregistered Related Sales (as permitted by our
approach) by the Counterparty not be integrated with other offers or sales by the
Principal, the Counterparty or the issuer. As discussed above in the context of the
Hedging Proposal, we do not believe that Related Sales in connection with
properly structured Subject Transactions raise integration issues.
In addition, it is essential that the Counterparty be able to deliver securities
received from the Principal at the termination of the Subject Transaction to
securities lenders to close out the Related Sales without delivering a prospectus to
the lender, to the extent that a prospectus has been delivered to the open market
purchaser in connection with the Related Sale. Restricted or control Underlying
Securities could not be delivered to securities lenders to close out Related Sales in
excess of the number of Initial Related Sales. This will maintain a strict separation
between the securities held or issued by the Principal and the securities sold in the
market on an unregistered basis.
When a Counterparty effects Initial Related Sales pursuant to a registration
statement, a prospectus will be delivered to the public investor that is making an
investment decision regarding the securities sold. When those Initial Related Sales
are closed out by returning securities to the securities lender, no purpose is served
by delivering a prospectus to the securities lender, which has acted only as a lender
and has not made any investment decision with respect to the securities at the time
securities are returned to it.(11) In fact, a securities lender lending through an agency
arrangement with a custodian may be entirely unaware that its securities have been
borrowed. It would be anomalous to deliver a prospectus to the securities lender
and thereby raise a question as to whether the securities lender, which did not
purchase the securities on the basis of the prospectus, may have a cause of action
against the issuer or the Counterparty based on the prospectus. Moreover, a
requirement that a prospectus be delivered to the lender would make the
transactions contemplated by the Registered Short Sale Proposal impossible for the
following reason. Loans of securities in connection with short sales are demand
loans -- the lender can "call in" the loan at any time. If a Counterparty's borrow of
securities is called in by a securities lender, the Counterparty must either find
another lender of fungible securities or "buy in" its short position in order to repay
the borrow. The Counterparty has no control over whether or when a securities
loan may be called in. Thus, if the Counterparty were required to deliver a
prospectus to the lender upon repayment of a securities loan in connection with a
registered Initial Related Sale and the loan were called in during an issuer-imposed
"blackout" period under the registration statement, the Counterparty would be
placed in an impossible position. In contrast to the non-existent benefits achieved
by requiring prospectus delivery to securities lenders, such a requirement imposes
real monetary and liability obligations on issuers, Principals and Counterparties. If
prospectus delivery is required, issuers would need to maintain an effective
registration statement and the Counterparty would be subject to the risk of
unpredictable "blackout" periods. As a result, we do not believe that issuers,
Counterparties and Principals would be willing to enter into these transactions if
such a requirement were imposed.
IV.Conclusion
Properly structured hedging transactions allow holders of restricted, Rule
145 and control securities to achieve legitimate economic goals without
compromising the goals of the Securities Act and the Rules. We believe that it is
possible to develop responsible, non-abusive practices to ensure Section 5
compliance in these transactions by applying a facts-and-circumstances approach.
We urge the Commission to retain a flexible facts-and-circumstances approach in
this area. We have proposed non-exclusive safe harbors for unregistered hedging
transactions and for short sales in connection with registered hedging transactions
in order to provide certainty to the marketplace in connection with certain hedging
activities. We are not aware of harm or abuse caused by current hedging
techniques, and do not believe that the market disruption that would be caused by
a cutback in investors' ability to hedge restricted, Rule 145 or control securities
can be justified.
We appreciate the opportunity to comment on the Commission's proposals
and suggestions, and hope that the Commission finds these comments helpful.
Please feel free to contact any of the undersigned to discuss our proposals further.
| Respectfully submitted,
Goldman, Sachs & Co.
/s/ Patricia Maher
(212) 902-0940
J.P. Morgan Securities Inc.
/s/ Stephen E. Gray
(212) 648-4986
Morgan Stanley & Co. Incorporated
/s/ Robin Roger
(212) 761-4765
Salomon Brothers Inc
/s/ Marcy Engel
(212) 783-5957
|
cc: Alan L. Beller
(Cleary, Gottlieb, Steen & Hamilton)
John M. Brandow
Richard J. Sandler
(Davis Polk & Wardwell)
Robert W. Reeder
(Sullivan & Cromwell)
Annex A
Outline of Proposal for Hedging
Restricted and Control Securities
1. Summary of Proposal:
- Retain the recently-adopted Rule 144 holding periods of one year prior
to "dribble out sales" and two years prior to unrestricted sales by non-affiliates.
- Provide a safe harbor for holders of restricted securities (within the
meaning of Rule 144) and their counterparties after a three-month holding period
for hedging transactions and resulting market sales of fungible securities.
- Provide a safe harbor for affiliates and their counterparties for hedging
transactions and resulting market sales of fungible securities where significant
exposure to the securities in question is retained by the affiliate and where, in the
case of restricted securities, a three-month holding period has elapsed.
2. Definitions:
Hedging Transaction means a transaction (or series of transactions)
entered into by a holder (the "Principal") of a long position in a security (the "Held
Security") the which is to reduce the Principal's exposure to changes in price of
the Held Security. Hedging Transactions can include short sales or options,
collars, swaps or other derivative transactions with respect to the Held Security.
Risk-Retention Hedging Transaction means a Hedging Transaction (other
than a short sale) following which the Principal retains exposure to decreases in the
price of the Held Security of at least 10% (taking into account the terms of the
Hedging Transaction and any net payments made by or to the Principal at the time
of entering into the Hedging Transaction).
Hedge-Related Sale means an offer or sale of a Subject Security (as
defined below) in the open market that is undertaken by a Principal as part of a
Hedging Transaction (e.g., a short sale against the box) or that is undertaken by a
person or entity, or any affiliate thereof (together, a "Counterparty"), that is a
party to a Hedging Transaction entered into with a Principal (e.g., a dealer that is a
party to a collar with a Principal holding restricted securities) to hedge its exposure
resulting from such Hedging Transaction.
Subject Security means a security of the same class and series as the Held
Security, or another security with substantially similar terms or into which the Held
Security can be converted, exchanged or exercised; provided that where the Held
Security is a convertible or exchangeable security or right or warrant that meets
the standards of Rule 144A(d)(3) at the time of issuance, the underlying security
will be deemed not to be a Subject Security.
3. Holding Periods:
Retain the recently-adopted one-year holding period after which "dribble
out" sales would be permitted and two-year holding period after which unlimited
sales under Rule 144(k) (or a successor provision) would be permitted for non-affiliates.
4. Hedging Restricted Securities of Non-Affiliates:
Provide a non-exclusive safe harbor for Hedge-Related Sales of Subject
Securities with respect to any Hedging Transaction, where (a) the Held Security is
a restricted security, (b) the Principal is a non-affiliate, (c) the holding period of the
Held Security (calculated as under the current Rule) is more than three months, (d)
the Hedging Transaction (other than a short sale by a Principal) is cash-settled and
(e) the Held Security is not used by any party to the Hedging Transaction or any
affiliate thereof to close out such Hedge-Related Sales.
5. Hedging Securities of Affiliates:
Provide a non-exclusive safe harbor for Hedge-Related Sales of Subject
Securities with respect to a Risk-Retention Hedging Transaction, where (a) the
Principal is an affiliate of the issuer of the Held Security, (b) if the Held Security is
a restricted security, the holding period thereof is more than three months, (c) the
Risk-Retention Hedging Transaction is cash-settled and (d) the Held Security is
not used by any party to the Risk-Retention Hedging Transaction or any affiliate
thereof to close out such Hedge-Related Sales.
6. Hedging Transactions Within Volume, Holding Period and
Information Requirements of Rule 144:
Amend or clarify Rule 144, as necessary, to assure that Hedge-Related
Sales conducted in compliance with the volume limitations and the holding period
and current public information requirements of Rule 144 will fall within the Rule's
safe harbor.
For purposes of paragraphs (e)(1) and (e)(2) of Rule 144, all Hedge-Related Sales by Counterparties in respect of Hedging Transactions of a Principal
and all other sales executed or established by the Principal will be aggregated with
all other sales of Subject Securities by the Principal within the preceding three
months, except that such Hedge-Related Sales need not be aggregated with sales
of securities other than restricted securities by persons other than affiliates.
Except in the case of a short sale by a Principal, for purposes of
determining compliance with the volume limitations of Rule 144, the number of
securities deemed to have been sold by the Principal in connection with a Hedging
Transaction will be the notional amount of Held Securities underlying such
Hedging Transaction, and all such securities will be deemed to have been sold at
the time of entering into such Hedging Transaction.
If the Hedge-Related Sales in connection with a Hedging Transaction are
effected pursuant to this paragraph 6, the Principal may deliver the Held Securities
to the Counterparty to settle the Hedging Transaction, and the Counterparty may
deliver such Held Securities to securities lenders to close out the borrowings
associated with Hedge-Related Sales.
7. Hedging Transactions That Do Not Involve Subject Securities:
The proposal assumes that Hedge-Related Sales of securities that are not
Subject Securities do not raise registration issues under §5 of the Securities Act
and therefore do not require a safe harbor. This should be clarified in any
proposing release.
8. General:
- Anti-abuse -- The safe harbors provided above shall not be available in
the case of Hedge-Related Sales that are part of a plan or scheme to evade the
registration requirements of the Securities Act.
- Integration -- In the absence of such a plan or scheme, Hedge-Related
Sales that fall within the safe harbors described in Paragraphs 4, 5 and 6 above
shall not be integrated with any other offers or sales of Subject Securities made by
the Principal, a Counterparty or the issuer of the Held Security, except that Hedge-Related Sales shall be aggregated for purposes of the volume limitations of Rule
144 as described in Paragraph 6.
Annex B
Outline of Proposal for Registration of
Short Sales Made in Connection with
Certain Hedging Transactions
1. Summary of Proposal:
Provide a safe harbor such that if there is registration of the initial short
position created by a counterparty that is hedging its exposure to a derivative
transaction:
- the counterparty may make subsequent short sales without registration;
- in the absence of abuse, such subsequent short sales will not be
integrated with other sales of underlying securities by the counterparty, its
principal or the issuer of the underlying securities; and
- the counterparty may use certain underlying securities purchased from
or delivered by the principal to settle short sales, without having to register the
delivery of such underlying securities to the stock lenders.
2. Definitions:
Call Equivalent Position means an interest in a security (the "Underlying
Security") that increases in value as the value of the Underlying Security increases,
including, but not limited to, a long convertible security, a long call option and a
short put option.
Principal means (i) the issuer of an Underlying Security, (ii) an affiliate of
such an issuer or (iii) a non-affiliate of such an issuer holding restricted securities
(within the meaning of Rule 144) that are either (a) Underlying Securities or (b) a
Call Equivalent Position on Underlying Securities.
Initial Related Sales means, with respect to a Subject Transaction, the
Related Sales made by the Counterparty (a) prior to and in anticipation of entering
into such Subject Transaction and (b) during the period beginning when the
Counterparty enters into such Subject Transaction and ending at the close of
business on the fifth Trading Day thereafter; provided that the number of Initial
Related Sales shall not exceed the total notional amount of Underlying Securities
underlying the Subject Transaction.
Related Sale means a sale in the open market of an Underlying Security
that a Counterparty makes in connection with a Subject Transaction.
Subject Transaction means, with respect to an Underlying Security, a
transaction between a Counterparty and a Principal as a consequence of which the
Counterparty intends to sell Underlying Securities in the open market in
anticipation of entering into or during the term of the transaction.
Trading Day means, with respect to an Underlying Security, any day on
which trading is generally conducted in the primary United States market for such
Underlying Security.
Terms not defined herein are defined in the accompanying Hedging
Proposal for hedging restricted and control securities without registration.
3. Proposed Rule:
Provide a safe harbor such that if the Principal and the Counterparty to a
Subject Transaction register the Initial Related Sales: (i) no registration shall be
required for any other Related Sales effected in connection with such Subject
Transaction, (ii) in the absence of a plan or scheme to evade the registration
requirements of the Securities Act, the Related Sales described in clause (i) above
shall not be integrated with any other offers or sales of Underlying Securities made
by the Principal, the Counterparty or the issuer of the Underlying Securities and
(iii) if the Principal settles the Subject Transaction by delivering the Underlying
Securities, or if the Principal sells such Underlying Securities to the Counterparty,
the Counterparty may use such Underlying Securities, in an amount not to exceed
the number of Initial Related Sales, to close out any borrowing transactions
entered into in connection with any Related Sales, without having to register the
delivery of such Underlying Securities to the lenders in such borrowing
transactions.
1. Even during the term of a hedging transaction, it is not possible for a holder of
restricted or control securities to eliminate all of the economic risks of holding the hedged
securities. Hedging strategies can only temporarily exchange a degree of market risk for other
risks, including the risks that (i) the counterparty to a hedging transaction will default on its
obligations under the hedging transaction (i.e. credit risk), (ii) the lender of securities in
connection with a hedging transaction that involves short sales will "call in" the borrow,
requiring the hedging party to purchase securities in the open market at current prices in order to
cover its short position, (iii) the hedging party will be required to post additional collateral in
connection with a hedging transaction if the value of the underlying security changes and (iv)
there may be costs associated with closing out the hedging transaction.
2. As discussed under "Hedging Transactions Within Volume, Holding Period and
Information Requirements of Rule 144", it is not necessary to maintain this separation where the
short sales are conducted in compliance with the volume, holding period and current public
information requirement of Rule 144.
3. If the Commission does not adopt the proposal in the Release regarding Rule 145(c)
and (d), Hedge-Related Sales by a Counterparty during such three-month period with respect to
Hedging Transactions in which the Held Security is a Rule 145 security and the Principal is not
an affiliate of the issuer would fall within the safe harbor so long as such Hedge-Related Sales
met the requirements of Rule 144, as described below under the heading "Hedging Transactions
Within Volume, Holding Period and Information Requirements of Rule 144".
4. For example, a Principal holding 100 shares of control stock with a current price of
$100 per share could enter into a "collar" transaction with a Counterparty, in which the Principal
would purchase from the Counterparty a put option on 100 shares with a strike price of $80 per
share (for which option the Principal might pay the Counterparty $5 per share) and the Principal
would sell to the Counterparty a call option on 100 shares with a strike price of $100 per share
(for which the Counterparty might pay the Principal $10 per share). This would result in a net
payment to the Principal of $5 per share at the time of entering into the transaction. If the price
of the stock were to drop below $80 per share at the termination of the transaction, the Principal
would exercise his put option and put the shares to the Counterparty for $80 per share, thereby
limiting his "loss" in the stock to $20 per share ($100 initial price minus $80 received on
exercise of the put option). However, the Principal received a net payment of $5 per share at the
time of entering into the transaction, so the Principal's net loss on the transaction is limited to
$15 per share, or 15% of the initial price of the stock. Therefore, the described collar transaction
would constitute a Risk-Retention Hedging Transaction.
5. The legislative history of the Securities Act suggests that the principal reason for
equating "control persons" with issuers for purposes of Section 2(11) thereof is that such persons
are presumably able to compel the issuer to initiate the registration process. H.R. Rep. No. 85,
73d Cong., 1st Sess. 13-14 (1933).
6. In calculating the 10% and 20% thresholds, traditional "control group" aggregation
principles would continue to apply.
7. For example, this part of the Hedging Proposal would provide a safe harbor for Hedge-Related Sales in connection with a Hedging Transaction in which an affiliate that holds restricted
stock enters into an equity swap after the expiration of the one-year Rule 144 holding period, so
long as the Hedge-Related Sales do not exceed the volume limitations of Rule 144 and comply
with the current public information requirements of Rule 144.
8. See Release No. 33-60999, 1 Fed. Sec. L. Rep. ("CCH") ¶ 2705H, at Question 80
(August 2, 1979).
9. Even if the Commission retains the current manner-of-sale requirement of Rule 144, we
urge the Commission to reconsider the staff's position in Bear Stearns & Co. Inc. (available April
4, 1991). In Bear Stearns, the staff indicated that the delivery of stock upon the exercise of an
over-the-counter option did not comply with the manner-of-sale requirement of Rule 144. We
believe that this position is inconsistent with the Rule 144(f), which expressly permits
"transactions directly with a 'market maker'". So long as the Counterparty to the Hedging
Transaction is a "market maker" and the other requirements of Rule 144 are satisfied at the time
of exercise, we believe that Rule 144 should be available to permit delivery of restricted and
control securities upon the exercise of an over-the-counter option. We perceive no basis upon
which to distinguish between a direct sale to a market maker by a holder of control or restricted
securities and a sale made to a market maker through the exercise of an over-the-counter option.
10. As indicated above, Hedge Related Sales for any particular Principal that are made in
compliance with the volume, holding period and current public information requirements of Rule
144 would still be subject to the aggregation provisions of Rule 144.
11. This is consistent with long-established practice in the context of registered public
offerings in which the underwriters are granted an over-allotment or "Green Shoe" option to
cover short sales effected in connection with the offering. In such offerings, a prospectus is
delivered to the buyers in the short sales but not to the securities lenders when the option is
exercised and the borrow is repaid with newly issued securities (or securities acquired from a
selling securityholder). In a follow-on or secondary public offering, such lenders may not have
received a prospectus at any point in connection with such offering.