Section 3(a)(9) of the Securities Act of 1933, provides an exemption from the registration requirements for “[E]xcept with respect to a security exchanged in a case under title 11 of the United States Code, any security exchanged by the issuer with its existing security holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange.” Generally, in an exchange offer, the issuer offers to exchange new debt or equity securities for its outstanding debt or equity securities.

Since Section 3(a)(9) is a transactional exemption, the new securities issued are subject to the same restrictions on transferability, if any, of the old securities, and any subsequent transfer of the newly issued securities will require registration or another exemption from registration. However, since the new securities take on the character of the old securities, tacking of a holding period is generally permitted allowing for subsequent resales under Rule 144 (assuming all other conditions have been satisfied for use of such rule).

Section 3(a)(9) Exchanges Surge in Popularity

Section 3(a)(9) exchanges have recently gained in popularity as public companies attempt to manage liabilities and clean up their balance sheets in the face of a down economy. Section 3(a)(9) exchanges can be used to reduce interest payments or accruals (by exchanging high rate debt for lower rate or by exchanging accrued interest or preferred payments for equity); reduce or eliminate outstanding debt (by exchanging debt for equity) and to modify the terms of existing securities (for example, modifying conversion ratios and redemption provisions).

The advantages of a Section 3(a)(9) exchange include: (i) can be completed quickly as there is no registration required; (ii) are flexible (an issuer can retire partial or entire liabilities); (iii) minimal costs; and (iv) often can be accomplished largely tax free for debt holders. The disadvantages include: (i) the new securities may be restricted depending on the status of the old securities offered in exchange or the availability of Rule 144 tacking of a holding period; and (ii) no commissions or other compensation can be paid, such as to a broker or investment banker.

Four Criteria of Section 3(a)(9)

The four main requirements of Section 3(a)(9) are as follows: (i) same Issuer – the issuer of the old securities being surrendered must be the same as the issuer of the new securities; (ii) no additional consideration from the security holder; (iii) offer must be made exclusively with existing security holders; and (iv) no commission or compensation may be paid for soliciting the exchange.

Section 3(a)(9) exempts any securities exchange by the issuer with its security holders. This means that the new securities being issued and the securities that are being surrendered must be from the same issuer. The “same issuer” can at times be a successor issuer. The SEC has taken the position that where an Issuer has fully and unconditionally assumed the obligations of the debt securities of another issuer, the subsequent exchange of that debt by the successor issuer qualifies as a Section 3(a)(9) exchange. Presumably the successor issuer has become the “issuer” by fully and unconditionally assuming the obligation.

Parent Company and Subsidiary Considered Two Separate Issuers

A parent and subsidiary are generally considered two separate issuers. Accordingly, if a subsidiary proposes to exchange debt that is guaranteed by the parent, for debt that is not guaranteed by the parent , the exchange would not qualify under Section 3(a)(9). However, the SEC has granted no-action relief for parent/subsidiary exchange transactions in particular fact circumstances.

The prohibition against paying commission or other compensation for the solicitation of an exchange, does not include the payment of administrative or ministerial fees solely for document preparation, mailing or legal opinions.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

The disclosure requirements at the heart of the federal securities laws involve a delicate and complex balancing act. Too little information provides an inadequate basis for investment decisions; too much can muddle and diffuse disclosure and thereby lessen its usefulness. The legal concept of materiality provides the dividing line between what information companies must disclose, and must disclose correctly, and everything else. Materiality, however, is a highly judgmental standard, often colored by a variety of factual presumptions.

Transparency in Financial Markets

The guiding purpose of the many and complex disclosure provisions of the federal securities laws is to promote “transparency” in the financial markets. However, the task of winnowing out the irrelevant, redundant and trivial from the potentially meaningful material falls on corporate executives and their professional advisors in the creation of corporate disclosure, and on investment advisors, stock analysts and individual investors in its interpretation. The concept of materiality represents the dividing line between information reasonably likely to influence investment decisions and everything else. However, materiality is a notoriously elusive, ever changing and unpredictable concept.

Only those misstatements and omissions that are material violate many provisions of the securities laws, including the bedrock provisions requiring accurate financial reporting. In 1976, the U.S. Supreme Court set the standard for a materiality evaluation, which standard remains today. In TSC Industries, Inc. v. Northway, Inc., the Supreme Court held that information should be deemed material if there exists a substantial likelihood that it would have been viewed by the reasonable investor as having significantly altered the total mix of information available to the public.

All Facts Must be Considered

Despite this standard, the concept remains fact driven and difficult to apply. There are no numeric thresholds to establish materiality, and market reaction is inconsistent and not always available. Ultimately professionals and company management must consider all facts and circumstances available to them on any given day to determine the materiality of a given disclosure in light of the standard established by the Supreme Court in TSC Industries.

Generally, professionals and company management must look in the first instance at specific disclosure guidelines set out in the federal securities rules and regulations (such as Regulations S-X and S-K and Forms 10-Q, 10-K and 8-K). Secondly, professionals and company management must consider all facts presently affecting the Company. For instance, a specific disclosure may be highly relevant in light of current economic conditions and of little importance in a different economic climate. Ethical issues are generally not considered material, unless specifically required by statute (such as the Foreign Corrupt Practices Act).

Selective Disclosure Prohibited

The SEC has issued further guidance on materiality in Staff Accounting Bulletin No. 99 (SAB 99). Although SAB 99 is meant to clarify some materiality issues, many practitioners find that it confuses rather than clarifies. For the most part SAB 99 simply reiterates that materiality cannot be defined by law or standards but must be determined anew for each fact and disclosure issue.

In determining materiality practitioners should keep in mind Regulation FD which prohibits the selective disclosure of material information. That is, Regulation FD requires that if material information is to be disclosed, it must be disclosed to the entire market, either through a press release or Form 8-K or both, and not selectively, such as to certain analysts or market professionals.

Professionals and company management should also consider that the SEC has consistently pushed for greater and more complete disclosures. Accordingly, it is better to err on the side of disclosure than against it.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

Serving as an independent director carries serious obligations and responsibilities.

Following the passage of the Sarbanes Oxley Act of 2002 (SOX), the role of independent directors has become that of securities monitor. They must be informed of developments within the company, ensure good processes for accurate disclosures and make reasonable efforts to assure that disclosures are adequate. Independent directors, like inside directors, should be fully aware of the company’s press releases, public statements and communications with security holders and sufficiently engaged and active to questions and correct inadequate disclosures.

Disclosure and Transparency

The basic premise of federal securities laws is disclosure and transparency. The theory behind this regulatory structure is that if a Company is forced to disclose information about particular transactions, plans or programs, the company and its officers and directors will take greater care in making business decisions. If a director knows or should know that his or her company’s statements concerning particular issues are inadequate or incomplete, he or she has an obligation to correct that failure.

It is the Securities and Exchange Commission’s (SEC) viewpoint that independent directors should play a significant role in the direction of a company’s affairs, particularly when they have relevant expertise, experience and sophistication. According to the SEC, independent directors must not only be familiar with their company’s communications to the public, but must also compare these communications with what they know to be the facts. Additionally, they are then responsible to follow up and practice vigilance in ensuring that communications are complete and accurate.

Internal Systems Protect Company Operations

All independent directors have an obligation to question employees or legal counsel as to the background of issues or the need for disclosure of specific information. If they are aware of specific non-disclosures, they must inquire into the situation. All independent directors should insist on internal systems so that they have regular and sufficient information about the company’s affairs. Moreover, directors who review, approve, or sign their company’s proxy statements and periodic reports must take steps to ensure the accuracy and completeness of the statements, or face personal regulatory liability for the failure to do so.

The SEC has the power to bring actions against independent directors for misstatements or omissions in offering documents under the Securities Act of 1933, as amended, for fraud under Section 10 of the Securities Exchange Act of 1934, as amended or for aiding and abetting Company securities laws violations. SOX specifically authorizes the SEC to seek “any equitable relief that may be appropriate or necessary for the benefit of investors.” The SEC often utilizes this power to pursue injunctive relief such as a prohibition to act as a public company director in the future, which reputational damage potential can act as a motivator.

Although all directors have direct personal liability for statements made in a registration statement or other filing signed by such directors, Rule 176 promulgated under the Securities Act of 1933, as amended, provides a due diligence defense to such actions. To invoke the due diligence defense the defending director needs to be diligent and verify facts and statements.

Better Compliance Limits Exposure

Even though independent directors are not responsible for every single company statement or even all of the company’s securities compliance, certain directors may be well situated to achieve better compliance, such as members of the audit committee or directors who sign company filings. The SEC has indicated that it intends to utilize its powers to require directors to take their role as securities monitors seriously. To date, however, the SEC has pursued very few cases against independent directors, and most of such cases have been settled without fanfare and generally involve injunctive relief. Moreover, successful private litigation against independent directors is rare.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!