The integration doctrine prevents issuers from circumventing the registration requirements of the Securities Act of 1934 by determining whether two or more securities offerings are really one offering that does not qualify as an exempt offering, or an exempt offering is really part of a registered public offering.

Securities Act Release No. 33-4552 (November 6, 1962) sets forth a five factor test that is used as a guideline in determining whether the separate offerings of an issuer that occur within a short time of one another will be integrated. These same factors are set forth in the Note to Rule 502(a) of Regulation D, which factors address whether the offerings:

1. are part of a single plan of financing;
2. involve the issuance of the same class of securities (convertible securities, warrants, and other
3. derivative instruments generally are deemed to be the same class as the underlying security unless the terms of the primary security prohibit exercises until at least the one year anniversary date);
4. are made at or about the same time;
5. involve the same type of consideration is to be received; and
6. are made for the same general purpose.

Rule 502(a) provides for a six-month (soon to be 90 days) safe harbor wherein multiple private offerings that are conducted at least six (6) months apart will not be integrated. In addition, a private offering that is conducted at least six (6) months before or after a registered or exempt public offering will not be integrated with the public offering. Fortunately, effective February 4, 2008, the SEC changed the length of integration safe harbor from six (6) months to ninety (90) days.

In addition, Rule 155 sets forth a safe harbor for abandoned private and public offerings (Release No. 33-7943, effective March 7, 2001). Generally, the rule creates safe harbors to allow: (i) a public offering immediately following an abandoned private offering and (ii) a private offering thirty (30) days after an abandoned public offering, without integrating the public and private offerings in either situation. These safe harbors provide issuers with more flexibility to react to volatile capital market conditions.

Rule 155 does not replace, but rather supplements, the five factor test that will be used whenever the safe harbor is inapplicable. For example, the five-factor test, rather than Rule 155, would apply when evaluating whether two or more private offerings should be integrated with each other. Moreover, Rule 155 recognizes only Sections 4(2) and 4(6) and Rule 506 offerings as exempt offerings. Finally, Rule 155 is not available for shelf registration statements.

Concurrent Private and Registered Offerings in PIPE Transactions

The primary legal consideration in any PIPE (private investment in public entity) investment is ensuring that the issuer takes all steps necessary to make the investment a valid private placement. The issuer must conduct the PIPE offering in a manner that does not involve any general solicitation or advertisement. In this context, an issuer that had considered a public offering and filed a registration statement with the SEC may be deemed to have engaged in a general solicitation for the offering, and the issuer would have to completely abandon that offering by withdrawing the registration statement for a period of time before engaging in the PIPE transaction.

SEC Rule 155

Rule 155 does not alter the position taken by the SEC staff in its no-action letters to Black Box Inc. and Squadron, Ellenoff, Pleasant & Lehrer. In these letters, the staff indicated that it would not integrate a registered offering and a concurrent unregistered offering made only to Qualified Institutional Buyers (as defined by Rule 144A under the 1933 Act) and no more than two or three large accredited institutional investors.

Given that a PIPE transaction inherently involves a private placement of securities and a subsequent public offering, the PIPE transaction has higher integration risks. To ensure that the PIPE transaction is respected as two separate transactions, the initial private placement must be “complete” prior to filing of any registration statement for the underlying securities. In the standard PIPE transaction, meeting this requirement normally does not pose a problem since the registration statement is filed following the closing of the PIPE transaction.

Private Placement Completion

The SEC will consider a private placement complete if: (a) all of the purchasers have fully paid the purchase price for the securities in the private offering, or (b ) each purchaser is irrevocably obligated to purchase a set number of securities, the purchase price is fixed and the transaction cannot be renegotiated.

The SEC has permitted concurrent registered and private offerings to be made under the conditions set forth in its Black Box and other related “no action” letters (described above). A “Black Box PIPE” would be undertaken, for example, during a period when the company has on file an effective resale or shelf registration statement. In such situations, the SEC requires that the private offering be made only to: (a) persons who are qualified institutional buyers (QIBs) as defined in Rule 144A(a) under the Securities Act, and/or (b) no more than two or three large institutional accredited investors.

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!

Without fanfare, publications, or other notice, in mid 2006, PIPE investors and the Issuers that utilized them noticed a big difference in the way that the Securities and Exchange Commission’s (SEC) division of corporate finance reviewed and commented upon, resale registration statements. Although the SEC staff contended that its position on Rule 415 had not changed, there was, incontrovertibly, a dramatic impact felt by Issuers and PIPE investors.

For years, Issuers had relied upon Rule 415 in order to register the resale of shares issued in PIPE transactions (a “secondary offering”). Rule 415 governs the registration requirements for the sale of securities to be offered on a delayed or continuous basis, such as in the case of the take down or conversion of convertible debt and warrants. In the years prior to 2006, Issuers would register shares they sold in a PIPE transaction, which could represent in excess of 50% of their outstanding public float.

Convertible Debt and Subsequent Resale

In a typical convertible debt and/or warrant PIPE transaction, the exercise price to convert the debt or warrant was based on a discount to current market price. Accordingly, the PIPE investor would convert a small percentage of the debt or warrant into common shares and immediately sell those shares on the open market, thus forcing down the price of the stock. The PIPE investor would then convert another small percentage of the debt or warrant at a discount to the new lower market price and again immediately re-sell the shares, further depressing the market price. This process could continue infinitum until all of the debt or warrants had been converted leaving the Company’s stock price considerably lower than where it started. Thus the term “death spiral”.

The SEC recognized this pattern and the negative effect it had on the marketplace. Beginning in mid 2006, the SEC staff began tightening the availability of Rule 415 for secondary offerings, particularly where the number of shares being registered exceeded 30% of the Issuers public float. The SEC was able to do this without rule amendments or such by simply taking the position that the registration of in excess of 30% of the public float should be closely reviewed and possibly considered a primary offering and not a secondary offering at all. A primary offering is one where the securities are being sold by the Issuer (or in this case on behalf of the Issuer) as opposed to a third party, such as a PIPE investor.

Primary versus Secondary Offerings

The consequences of deeming an offering a primary offering as opposed to a secondary offering are two-fold. First, Rule 415, the rule that allows securities to be registered for sale on a delayed or continuous basis, is generally unavailable for primary offerings by small business issuers. Second, a primary offering requires that each of the investors named as a selling security holder be identified as an underwriter. Underwriter status exposes the named underwriter to full liability for any misstatements or omissions in that registration statement (subject to a due diligence defense). Most PIPE investors want to be just that, investors, not guarantors of the statements, or misstatements, of an Issuer.

Toxic Offerings

The SEC staff made it clear that its interpretation of Rule 415 was meant to curtail death spirals and other “toxic offerings” which tended to flood the market with penny stocks whose value continued to decline. The SEC’s efforts worked. Since mid 2006 the number of Rule 415 registered PIPE offerings declined dramatically. Prominent PIPE investors such as Cornell Capital and the Laurus Fund significantly decreased their investments in small business issuers.

Small business issuers found it considerably harder to attract PIPE and other speculative investors. In fact, it is the pressure from these small business issuers that has since prompted other changes in federal securities laws, such as the decreased holding period under Rule 144, and the use of registration exemptions to lure investors, such as Section 3(a)(9) and (10) of the Securities Act.

Reverse Merger Exceptions

It should be noted as well, that in the past year, the SEC staff is again routinely allowing the registration of securities in excess of 30% of the public float in cases where the registrant was a shell company and has just completed a reverse merger or other transaction that causes it to cease being a shell company. Presumably this has been to assist small business issuers attract investors following the depressive effects of the prohibition of the use of Rule 144 for companies that are or become shell companies.

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!