• NASD Corporate Financing Rule 2710 Can Be Disastrous For PIPE Offerings
  • October 14, 2004 | Author: Ralph V. De Martino
  • Law Firm: Cozen O'Connor, [incorporation phrase format]A Professional Corporation - Washington Office
  • In a PIPE offering, an investment banker (acting as a selling agent for a public company) privately places equity securities of the issuer with accredited investors (often institutional investors) at a negotiated discount to the public price at which the securities trade. The issuer agrees to register the re-offer and resale of the privately placed securities with the Securities and Exchange Commission (SEC) within some discrete time (for instance 90 or 120 days) following the closing of the private placement ¿ thus enabling the investors to resell the securities into the public market. Failure to have the registration statement declared effective prior to the agreed-upon date usually results in the imposition of substantial cash penalties, the reduction of the conversion or exercise price of derivative securities issued in the private placement and/or the issuance of additional securities to the private investors. Anything that threatens the effectiveness of the registration statement raises the specter of investor dissatisfaction, increased financing costs for the issuer and reduced credibility of the issuer and the placement agent. In macro terms, it also threatens the overall utility of PIPES as a means of facilitating capital formation. The National Association of Securities Dealers, Inc. (NASD) addresses the fairness of financing terms imposed by NASD member firms engaged in public offerings with Corporate Financing Rule, 2710. This rule sets forth filing requirements that must be met by any NASD member proposing to participate in an offering and it also requires that the NASD issue an affirmative determination regarding the proposed terms of a public financing prior to the commencement of the offering. Generally, the lead syndicate member files all relevant information relating to the compensation of members of the selling syndicate, as well as copies of all proposed operative underwriting and selling agreements. That filing satisfies the obligation of every NASD member that may ultimately participate in the offering. The NASD reviews the terms of the proposed financing, engages in dialogue with the filing member and ultimately issues a determination with respect to whether the proposed compensation and terms of the financing are fair. In the absence of an affirmative determination by the NASD, no member may participate in the offering. Moreover, the staff of the SEC has generally taken the position that it will not take action to cause a registration statement to be declared effective, absent the conclusion of the NASD review process with an affirmative determination by the NASD. But Rule 2710 does not apply to private placements, at least not directly. That fact has led to substantial misunderstanding, violations of the Rule and delays in processing resale registration statements. Rule 2710 is implicated whenever a member of the NASD "participates" in a public offering. Oddly enough, the mere participation by a member of the NASD as a selling shareholder of securities purchased in a private offering, or of securities issued to it, or to people associated with it, in connection with acting as placement agent in a private offering (such as placement agent warrants) may trigger the applicability of Rule 2710. The NASD also takes the position that in the absence of a Rule 2710 approval, members may be foreclosed from facilitating the resale of securities for customers seeking to offer and sell their securities pursuant to an effective resale prospectus. This is based upon the argument that the member firm's facilitation of the re-offer or resale constitutes "participation" in the public offering. As members of the NASD and their counsel become more aware of their obligations under Rule 2710 in the PIPE context, selling security holders may find themselves frustrated by their inability to resell their securities because the broker through which they seek to sell may not have the benefit of a 2710 determination. At the present time Rule 2710 is honored more in breach than in compliance in the PIPE context, but the NASD is aggressively pursuing non-compliance. Rule 2710 has been the subject of a panoply of recent amendments. Therefore, anyone engaged in PIPES needs to consult with counsel expert in this area. It is also possible that the SEC staff may refuse to process a request to accelerate the effective date of a registration statement because it has not received notice from the NASD that it has issued a determination as to the fairness of the financing terms. Therefore, it is extremely important that the filing required by 2710 be done promptly, and that the issuer and its counsel work with counsel for the placement agent to assure that the filing is timely made. Also, the issuer is allowed to make the filing directly. If its counsel is expert in the area, this may be the preferable course of action, as it allows the issuer's counsel to control the entire process.