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by Laura Anthony, Esq.

What is A CUSIP and Legal Entity Identifier (LEI) Number?

CUSIP stands for Committee on Uniform Securities Identification Procedures.  A CUSIP number identifies securities, specifically U.S. and Canadian registered stocks, and U.S. government and municipal bonds.  The CUSIP system—owned by the American Bankers Association and operated by Standard & Poor’s—facilitates the clearing and settlement process of securities by giving each such security a unique identifying number.

The CUSIP number consists of a combination of nine characters, both letters and numbers, which act as individual coding for the security—uniquely identifying the company or issuer and the type of security. The first six characters identify the issuer and are alphabetical; the seventh and eighth characters, which can be alphabetical or numerical, identify the type of issue; and the last digit is used as a check digit.  A CUSIP number changes with each change in the security, including splits and name changes.

Whereas CUSIP identifies securities, a Legal Entity Identifier (LEI) identifies issuers.  An LEI is a new global standard identifier for legal entities involved in financial transactions and. once assigned. is that entity’s LEI number in perpetuity.  The LEI standard was mandated by Dodd-Frank to help identify issuers engaging in financial transactions, including in different markets domestically and abroad.  The CUSIP Service Bureau has teamed up with the Depository Trust Company (DTC) to assist in assigning LEI numbers to all issuers that apply for a CUSIP.  The fee for the LEI is $200 and as noted, a single number is assigned to an issuer for the entire life span of that issuer.  The Commodity Futures Trading Commission and National Association of Insurance Commissioners are also requiring and utilizing the LEI number.

The LEI number system is still in its incipient stages and will face challenges in its development.  Many groups have raised concerns regarding repetitive use of numbers—not that the same LEI number will inadvertently be repeated, but rather that an issued LEI number will be the same as some other number issued by some other regulatory body and thus cause confusion.  Moreover, the software and implementation costs associated with making LEI numbers useful to governmental and other organizations will be significant.

The Impact of a CUSIP Change – DTC and Potential Unintended Consequences

Many issuers that were eligible for DTC at the time of their DTC application are no longer eligible due to changes in their operating or reporting status.  As I’ve explained in several past blogs, a basic premise of DTC eligibility and ongoing eligibility is the free tradability of the issuer’s securities.  The issuance of a new CUSIP number triggers a DTC review and will bring to light a change in eligibility status.  If the issuer’s securities are no longer DTC eligible, such ineligibility will require an exit from DTC of the issuer’s securities.  DTC will actually return physical certificates to the broker dealer that deposited such securities and close out the issuer’s DTC account.  The issuer can reapply upon meeting eligibility requirements.

An issuer is required to obtain a new CUSIP for each change in its security, such as a name change, reverse split or reorganization.  That issuer then submits the new CUSIP number to FINRA as part of its corporate action notification documents.  Both FINRA and CUSIP notify the DTC of the new CUSIP number, which triggers a review of the security and a requirement by DTC that the issuer submit an opinion letter supporting the ongoing eligibility of the securities.  Like with a DTC chill notice, the issuer is required to submit an opinion letter, prepared by independent counsel, confirming that the issuer’s securities deposited at the DTC satisfy the DTC’s eligibility requirements, including that they are freely tradable.  In particular, the opinion letter must specify that the securities (i) are not restricted securities under SEC Rule 144(a)(3), or (ii) are exempt from any restrictions on transferability under the Securities Act.  The DTC provides a template for the legal opinion to the issuer.

Accordingly, if the free tradability of the issuer’s securities relies on Rule 144 and the issuer is not qualified for the use of Rule 144, that issuer will no longer be DTC eligible.  After a period of time, almost all issuers rely on Rule 144 for ongoing DTC eligibility.  Even shareholders of issuers that have completed a self-underwritten direct public offering (DPO) or initial public offering (IPO) eventually rely on Rule 144 for securities that were not included in such registration.

Rule 144 is not available to shell companies.  A shell company is an issuer with no or nominal operations or no or nominal non-cash assets. The rule is unavailable for the sale of securities initially issued by a shell company or any issuer that has, at any time, previously been a shell company unless all the requirements of Rule 144(i)(2) are met.  These requirements include that the issuer no longer be a shell company, is subject to the reporting requirements of the Exchange Act for 12 months following the time that it filed Form 10 information indicating it was no longer a shell company, and is current with all Exchange Act reporting requirements.

To be abundantly clear, if the issuer’s securities are not eligible for the use of Rule 144, that issuer is no longer DTC eligible.  Since the DTC cannot monitor millions of securities, it relies on the issuance of a new CUSIP number to trigger a review.  If the issuer is not Rule 144 eligible, that review will prompt an exit from the DTC of that issuer’s securities.

Many issuers that were eligible for the DTC at the time of their DTC application are no longer eligible due to changes in their operating or reporting status. In particular, the issuer may have once been a shell company and is either not subject to the ’34 Act Reporting Requirements or is delinquent in such requirements, or the issuer may currently be a shell company.

An unintended consequence can result where that issuer is party to a merger, acquisition, reverse merger or other agreement that requires the issuer to complete a name change, split or other corporate action as a precondition to closing and also requires that the issuer be DTC eligible as a precondition to such closing.  The issuer who currently has shares trading in DTC without a problem may believe that they are DTC eligible and proceed unaware with the corporate action, resulting in their shares being exited from DTC and their entire transaction being derailed.  Experienced competent counsel will foresee such a problem and fashion a transaction that is not set up for default from the outset.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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