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Who Is An Affiliate And Why Does It Matter – Part 1


The concept of affiliation resonates throughout the federal securities laws, including pertaining to both the Securities Act and Exchange Act rules, regulations and forms and Nasdaq and NYSE compliance.  In this multipart series of blogs, I will unpack what the term “affiliate” means and its implications.  This first blog in the series begins with the Securities Act definition of an “affiliate” and the implications under Rule 144, Section 4(a)(7) and Form S-3 eligibility.  In Part 2 of the series, I will delve into the meaty topic of a primary vs. secondary offering, which itself hinges on whether the offeror is an affiliate.

Securities Act Definition of Affiliate

The Securities Act provides a statutory definition of an “affiliate” to begin what is a facts and circumstances analysis (as is common in the federal securities laws).  Rule 405 of the Securities Act defines an “affiliate” as “[A]n affiliate of, or person affiliated with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the person specified.”  Rule 144, promulgated under the Securities Act mimics the same definition.

What constitutes “control” or “common control” has been the subject of numerous judicial decisions, SEC no-action letters, comment letter responses and practitioner discussions.  The SEC and the judicial decisions have consistently taken the position that the determination of “control” status is dependent in large part on the facts and circumstances involved and, therefore, has declined to state definitively what circumstances will result in a person being deemed to be in “control” of an issuer.

The clearest indication of “control” is where a person or group owns a simple majority of the outstanding voting shares of a corporation.  Share ownership of less than 51% may also be sufficient to establish that a person or group is in control of an issuer.  In United States v. Wolfson, the court found that a corporation’s largest individual stockholder was in “control” where, in conjunction with his family and “right-hand man,” he owned over 40% of the outstanding shares.

Over the years, 10% ownership has become a standard rule of thumb as an indicia of control, at least partially because a 10% or greater shareholder is subject to the reporting and short swing prohibition rules under Exchange Act Section 16.  However, again, the analysis is one of facts and circumstances.  Generally, case law and SEC no-action letters have found that a person was not in control, despite owning in excess of 10%, where they could not exercise control because another group or groups owned more than that amount or when other ownership groups supported management.

Practitioners generally count executive officers and directors as control persons and thus affiliates, but that is not the law.  Several cases have found that being an officer or director may certainly be a factor in determining control but is not dispositive of the issue.  Moreover, in response to a direct inquiry from a company as to whether a person’s status as an officer or director, without more, was enough to establish control for purposes of Rule 144, the SEC stated, “a person’s status as an officer, director, or owner of 10% of the voting securities of a company is not necessarily determinative of whether such person is a control person or member of a controlling group of persons. His status as an officer, director or 10% shareholder is one fact which must be taken into consideration, but, as you recognize, an individual’s status as a control person or as a member of a controlling group is still a factual question which must be determined by considering other relevant facts in accordance with the test set forth in Rule 405 under the Act.” (American Standard SEC No Action Letter).

Control resulting from other less formal relationships is even trickier to determine and can be based on familial, business or even social ties.  Courts and the SEC have been consistent that a person that is part of a group who collectively has the ability directly or indirectly to affect a company’s management or policies are each individually control persons as well.  In In Pennaluna & Co. v. SEC., the court found that it was not necessary to be a shareholder at all to be a control person where relationships with the company or other shareholders result in factual control.  A control group can be completely informal, rather only requiring that they act together and in concert for a common purpose.

Although all facts and circumstances should be reviewed, the following factors should be analyzed in evaluation “control” and thus affiliation:

  • Share ownership, including whether others have greater ownership or access to greater ownership through convertible securities.
  • The effect of any re-sales or planned new issuances.
  • Officer/director or similar positions with the company.
  • Voting control – voting control also includes the ability to influence other shareholder votes, to act as a group, to secure proxies, the effect of abstention on quorum, etc.
  • Substantial business relationships with the company – for example, control has been found where one company was the source of 70% of another company’s revenues.
  • Familial or social relationships with officers, directors or key shareholders.
  • Debtor and credit relationships – such as being a major creditor with the ability to foreclose on assets.
  • Original incorporator or founder.
  • The intent of a shareholder as evidenced by the filing of either a Schedule 13G (passive investor) or 13D and if 13D, reported efforts to exercise control (for more on Schedule 13D and 13G, see HERE).
  • Whether a person has sought to consult on management activities of the company or otherwise makes efforts to assert control and the results of those efforts.

With that as a backdrop, in one comment letter process, the company successfully argued that a 35% owner was not an affiliate for purposes of calculating the company’s public float for determining full shelf S-3 eligibility.  In another case, a company successfully argued that a 30% shareholder was not an affiliate for purposes of being named an underwriter in a re-sale registration statement.


Rule 144

As I’ve repeated many times, the Securities Act requires that every offer and sale of securities either be registered with the SEC or exempt from registration.  Offering exemptions are found in Sections 3 and 4 of the Securities Act.  Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another).  Section 4 contains all transactional exemptions including Section 4(a)(1) which exempts sales by “any person other than an issuer, underwriter, or dealer.”  The vast majority of sales of unregistered securities rely on the Section 4(a)(1) exemption.

Rule 144, promulgated under Section 4(a)(1), is a safe harbor whereby if all of the provisions of the Rule are satisfied, a seller of securities can be confident that they are not an underwriter for purposes of compliance with Section 4(a)(1).  For more on Rule 144, including its requirements, see HERE and for a recent proposed rule change to eliminate a tacking period for variably priced convertible securities, see HERE and HERE.

Rule 144 sets forth different conditions for sellers that are “affiliates” or a person that has been an affiliate in the past 90 days then for those that are non-affiliates.  Sales by affiliates always require that a company have current public information, are subject to volume limitations (the drip rules), are subject to manner of sale requirements (sales must be made through a broker-dealer) and require the filing of a Form 144.  Sales by non-affiliates only require current public information when effectuated after six months but prior to a one year holding period and are never subject to the volume limitations, manner of sale requirements, or the filing of a Form 144.  Accordingly, determination of affiliate status, including when such status begins and ends, has a significant impact on the proper use of Rule 144.

Under Rule 144, a “person” includes: (i) any relative or spouse of such person, or any relative of such spouse, any one of whom has the same home as such person; (ii) any trust or estate in which such person or any of the persons specified in (i) collectively own 10 percent or more of the total beneficial interest or of which any of such persons serve as trustee, executor or in any similar capacity; and (iii) any corporation or other organization (other than the issuer) in which such person or any of the persons specified in (i) are the beneficial owners collectively of 10 percent or more of any class of equity securities or 10 percent or more of the equity interest.  Accordingly, if a person is deemed an affiliate, each of these persons and entities would also be an affiliate.

Moreover, Rule 144 is not available to a company that is or ever was a shell company until the following conditions are satisfied: (i) the company has ceased to be a shell company; (ii) is subject to the Exchange Act reporting requirements (voluntary filers are not subject to the Exchange Act reporting requirements – for more on determining voluntary reporting status, see HERE); (iii) has filed all reports and other materials required to filed under the Exchange Act (other than Form 8-Ks) for the preceding 12 months; and (iv) has filed Form 10 information with the SEC reflecting its non-shell business operations.

Rule 144 is a non-exclusive safe harbor such that if it is not available, a seller may try to rely on Section 4(a)(1) directly.  However, case law and the SEC have unilaterally concluded that an affiliate of the company may not rely on Section 4(a)(1) for the resale of securities.  In particular, an affiliate is presumptively deemed an underwriter unless such affiliate meets the requirements for use of Rule 144.

Although other exemptions may be available for an affiliate to sell securities, Section 4(a)(1) and Rule 144 are the only exemptions that will result in a recipient of securities receiving freely tradeable shares and accordingly are the only exemptions that an affiliate can rely on to sell securities into the public marketplace.  For more on Section 4(a)(1) and the judicial 4(a)(1 ½), see HERE

Section 4(a)(7)

In addition to the judicial Section 4(a)(1 ½), in December 2015, the Fixing American’s Surface Transportation Act (the “FAST Act”) created a new statutory exemption – Section 4(a)(7).  For a complete explanation of Section 4(a)(7), see HERE.  Where an affiliate seller is relying on the Section 4(a)(7) exemption, that affiliate must provide the buyer with a statement regarding the nature of the affiliation accompanied by a certification that it has no reasonable grounds to believe that the issuer is in violation of the securities laws or regulations.


Form S-3 Eligibility

The ability to use an S-3 registration statement is significant for exchange traded companies.  An S-3 allows forward incorporation by reference and can be used for a shelf registration among other benefits. S-3 eligibility is comprised of both company requirements and transaction requirements (see here for a full discussion of S-3 eligibility – HERE).

Assuming a company meets the basic eligibility requirements, it must determine if it meets the transactional requirements.  Form S-3 can be used for primary offerings of a company whose market value of voting and non-voting common equity held by non-affiliates is $75 million or more, including for the sale and issuance of new securities or for the resale of already issued and outstanding securities held by third parties (indirect primary or resale), including offerings by subsidiaries and standby underwriters in connection with the call or redemption of warrants or a class of convertible securities (Instruction I.B.1.).

As such, primary shelf eligibility depends on a company’s non-affiliate float making the question of affiliation center in the computation.  If a company is not primary shelf eligible, it must rely on the baby-shelf rule under Instruction I.B.6.  Under the baby-shelf rule, a company can offer up to one-third of the market value of its non-affiliate float in any trailing 12-month period.

To calculate the non-affiliate float for purposes of S-3 eligibility, a company may use the last sale price or the average of the bid and asked prices on any date within the last 60 days.  The registration capacity for a baby shelf is measured immediately prior to the offering and re-measured on a rolling basis in connection with subsequent takedowns. The availability for a particular takedown is measured as the current allowable offering amount less any amounts actually sold relying on the baby shelf rule in prior takedowns.  Accordingly, the available offering amount will increase as a company’s stock price increases and decrease as a stock price decreases and as affiliate status changes over time through the addition of new affiliates or the change in status of an existing affiliate.

Moreover, if the aggregate market value of voting and non-voting common stock held by non-affiliates equals or exceeds $75 million after the effective date of the S-3, the one-third limit will not apply to additional sales and instead the registration statement will be considered filed under the full shelf registration provisions.

The Author

Laura Anthony, Esq.

Founding Partner

Anthony L.G., PLLC

A Corporate Law Firm


Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC 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, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with 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; 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 American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA 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 small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including the American Red Cross for Palm Beach and Martin Counties, Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others.

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

Contact Anthony L.G., PLLC. Inquiries of a technical nature are always encouraged.

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Anthony L.G., PLLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.

© Anthony L.G., PLLC


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