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Who Is An Affiliate And Why Does It Matter – Primary VS Secondary Offering

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 began with an analysis of the Securities Act definition of “affiliate” and the implications under Rule 144, Section 4(a)(7) and Form S-3 eligibility (see HERE).  In this Part 2 of the series, I am delving into the meaty topic of a primary vs. secondary offering, which itself hinges on whether the offeror is an affiliate.

Secondary/Resale Offerings vs. Primary Offerings

A secondary offering is an offering made by or on behalf of bona fide selling shareholders and not by or on behalf of the registrant company.  A secondary offering can only occur after a company is public.  That is, even if a company goes public using a direct listing whereby the initial registration statement is a “resale registration statement,” such registration statement will be deemed a primary offering and subject to the rules and limitations of a primary offering.  For more on direct listings, see HERE.

As set forth in Securities Act Rule 415, the determination of whether an offering is a primary or secondary offering, hinges on the question of whether the offering is being made by the registrant or on behalf of the registrant or truly by third-party selling shareholders.   Whether an offering is a primary offering vs. a secondary resale offering is not as simple as looking at the face of the registration statement to see if the offering is being conducted by the registrant/issuer or by selling security holders, or both. For instance, it is clear that a resale registration statement that is used in a direct listing process resulting in the initial sale of company securities to the public and the company being public and trading on a securities exchange, is by or on behalf of the company.

The distinction between a primary and secondary (resale) offering has many implications to the registration process, including: (i) only a primary offering on Form S-3 or F-3 qualifies to be priced at-the-market (i.e., at any price other than a fixed priced) – all other primary offerings (including indirect primary offerings) must be at a fixed price; (ii) secondary offerings on all forms qualify to be priced at-the-market; (iii) a parent company or majority owned subsidiary does not qualify to be considered a bona fide unaffiliated selling shareholder and thus may not engage in a secondary offering; (iv) if an offering is couched as a secondary offering but is determined to in fact be a primary offering on or behalf of the registrant, it will be treated as a primary offering (indirect primary); (v) sellers in a primary offering or indirect primary offering must be named as “underwriters” in the registration statement and are subject to the liability imposed by Section 11 of the Securities Act; (vi) secondary offerings may be made on a continuous or delayed basis; and (vii) primary offerings that are made on a continuous or delayed basis must be at a fixed price unless they are registered on Forms S-3 or F-3.

Securities Act Rule 415 specifically provides that an offer by “the registrant, a subsidiary of the registrant or a person of which the registrant is a subsidiary” is a primary offering not eligible for at the market pricing unless registered on Forms S-3 or F-3 and for which the sellers must be named underwriters.   Although Rule 415 does not specifically include the word “affiliates,” where the selling shareholder is an affiliate (control person) as defined in Rule 405, the SEC will deem that person to be an alter ego of the company and ineligible to engage in a secondary offering.

That is, unless the facts support a conclusion that a seeming affiliate such as an officer, director or 10% or greater shareholder, is not in fact an affiliate as defined in Rule 405, that person would not be able to utilize a registration other than Form S-3 or F-3 to sell securities at a market price.  Moreover, regardless of the registration statement used, that person would need to be named an underwriter and be subject to the associated Section 11 liability.  The analysis as to whether the selling shareholder is an “affiliate” as defined in Rule 405 is the same as described in Part 1 of this blog series and repeated below for ease of reference.

Indirect Primary Offering

I used the term “indirect primary offering” above, which begs the question, what is that?  An indirect primary offering is a term of art used to describe an offering where the seller is not the company/registrant on the face of the registration statement, but that is nonetheless made “by or on behalf” of the company registrant such that the offering is treated as a primary offering.

An offering may be an indirect primary offering where the sellers are affiliates as defined by Securities Act 405, where the offering is the initial offering of the company securities to the public (such as in a direct listing process) or where the amount of securities being offered is substantial as compared to the existing outstanding securities of the company.

Determining whether an offering is an indirect primary offering involves a review of facts and circumstances just as determining affiliation.  The SEC has issued guidance in the form of C&DI, including:

612.09 It is important to identify whether a purported secondary offering is really a primary offering, i.e., the selling shareholders are actually underwriters selling on behalf of an issuer. Underwriter status may involve additional disclosure, including an acknowledgment of the seller’s prospectus delivery requirements. In an offering involving Rule 415 or Form S-3, if the offering is deemed to be on behalf of the issuer, the Rule and Form in some cases will be unavailable (e.g., because of the Form S-3 “public float” test for a primary offering, or because Rule 415(a)(1)(i) is available for secondary offerings, but primary offerings must meet the requirements of one of the other subsections of Rule 415). The question of whether an offering styled a secondary one is really on behalf of the issuer is a difficult factual one, not merely a question of who receives the proceeds. Consideration should be given to how long the selling shareholders have held the shares, the circumstances under which they received them, their relationship to the issuer, the amount of shares involved, whether the sellers are in the business of underwriting securities, and finally, whether under all the circumstances it appears that the seller is acting as a conduit for the issuer. [Jan. 26, 2009]

The SEC has also issued guidance related to determining whether an offering is an indirect primary involving PIPE and equity line transactions.  In general, a secondary offering is not a valid secondary if the securities being offered for sale have not yet been issued, with two exceptions.

Related to a PIPE, the SEC has said:

In a PIPE transaction, a company will be permitted to register the resale of securities prior to their issuance if the company has completed a Section 4(a)(2)-exempt sale of the securities (or in the case of convertible securities, of the convertible security itself) to the investor, and the investor is at market risk at the time of filing of the resale registration statement. The investor must be irrevocably bound to purchase a set number of securities for a set purchase price that is not based on market price or a fluctuating ratio, either at the time of effectiveness of the resale registration statement or at any subsequent date. When a company attempts to register for resale shares of common stock underlying unissued, convertible securities, the PIPE analysis applies to the convertible security, not to the underlying common stock. There can be no conditions to closing that are within an investor’s control or that an investor can cause not to be satisfied. For example, closing conditions in capital formation transactions relating to the market price of the company’s securities or the investor’s satisfactory completion of its due diligence on the company are unacceptable conditions. The closing of the private placement of the unissued securities must occur within a short time after the effectiveness of the resale registration statement.

Related to an equity line, the SEC provides:

Question: In many equity line financings, the company will rely on the private placement exemption from registration to sell the securities under the equity line and will then seek to register the “resale” of the securities sold in the equity line financing. When may a company file a registration statement for the resale by the investors of securities sold in a private equity line financing?

Answer: In these types of equity line financings, the company’s right to put shares to the investor in the future and the lack of market risk resulting from the formula price differentiate private equity line financings from financing PIPEs (private investment, public equity). We, therefore, analyze private equity line financings as indirect primary offerings, even though the “resale” form of registration is sought in these financings.

The at-the-market limitations contained in Rule 415(a)(4) would otherwise prohibit market-based formula pricing for issuers that are not eligible to conduct primary offerings on Form S-3 or Form F-3. Nevertheless, we will not object to such companies registering the “resale” of the securities prior to the exercise of the equity line put if the transactions meet the following conditions:

  • the company and the investor have entered into a binding agreement with respect to the private equity line financing at the time the registration statement is filed;
  • the “resale” registration statement is on a form that the company is eligible to use for a primary offering;
  • there is an existing market for the securities, as evidenced by trading on a national securities exchange or alternative trading system, which is a registered broker-dealer and has an active Form ATS on file with the Commission; and
  • the equity line investor is identified in the prospectus as an underwriter, as well as a selling shareholder.

We will not object to the filing of a registration statement for a private equity line financing prior to the issuance of securities by the company under the equity line even when there are contingencies attached to the investor’s obligation to accept a put of shares from the company, as long as the above conditions are satisfied and the following terms of the investment have been agreed upon by both parties and disclosed by the company at the time that the resale registration statement is filed:

  • the number of shares registered for resale;
  • the maximum principal amount available under the equity line agreement;
  • the term of the agreement; and
  • the full discounted price (or formula for determining it) at which the investor will receive the shares.

Regardless, over the years, the “amount of securities” being registered has become a central focus.  The SEC has taken an unwritten, but consistent approach, that if greater than 1/3 of the outstanding public float is being registered at one time, it is an indirect primary and not eligible for secondary offering treatment.

Refresher on 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 trading 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, 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 evaluating “control” and thus affiliation:

  • Share ownership, including whether others have greater ownership or access to greater ownership through convertible securities.
  • The effect of any resales 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 creditor 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 resale registration statement.

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.

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