Surprise! Yesterday, the SEC announced that it had voted, without an open meeting, to propose amendments to Rule 144 to revise the method for determining the holding period—essentially eliminating tacking—for securities “acquired upon the conversion or exchange of certain ‘market-adjustable securities.’ The proposed amendment is intended to reduce the risk of unregistered distributions in connection with sales of those securities.” It is worth emphasizing that the proposed amendment “would not affect the use of Rule 144 for most convertible or variable-rate securities transactions.” Essentially, the amendment is intended to apply to “floating priced” or “floating rate” convertibles, often referred to as “death-spiral” converts, issued by companies that do not have securities listed, or approved for listing, on a national securities exchange. The proposed amendments would also:
- mandate the electronic filing of all Form 144 notices related to the resale of securities of Exchange Act reporting companies;
- eliminate the Form 144 filing requirement for non-reporting companies;
- change the filing deadline for Form 144 to coincide with the filing deadline for Form 4;
- amend Forms 4 and 5 to add a check box to permit filers to indicate that a sale or purchase reported on the form was made pursuant to a transaction that satisfied Rule 10b5-1(c); and
- make minor changes to Form 144, including eliminating certain personally identifiable information.
The SEC also indicated that it intends to create an “online fillable” document for entering the information required by Form 144 and, where applicable, Form 4. According to SEC Chair Jay Clayton, the “proposed amendments modernize, clarify and strengthen Rule 144, including to ensure that holders of market-adjustable securities are assuming the economic risks of their investment rather than acting as a conduit for an unregistered sale of securities to the public on behalf of an issuer….In addition, the proposed shift to electronic filing of Form 144 provides a necessary update to reflect today’s markets, particularly given the benefits—and the feasibility—of electronic filing our experience over the past nine months has demonstrated.”
Proposed limited revision of “tacking” rule for certain converts. Rule 144 provides a non-exclusive safe harbor from the statutory definition of “underwriter” to help sellers assess whether the Securities Act Section 4(a)(1) exemption—the exemption for “transactions by any person other than an issuer, underwriter, or dealer”—is available for their resales of restricted or control securities. The safe harbor is designed to establish that the seller of securities did not purchase the securities with a view to distribution and, therefore, is not an underwriter under Section 4(a)(1). The SEC explains that the Rule’s holding period requirement, which requires that the seller assume “the full economic risks of investment” for an appropriate period of time prior to resale, can help to show “that the seller did not purchase the securities with a view to distribution,” i.e., “is not acting as a conduit, directly or indirectly, on behalf of the issuer for the sale of unregistered securities to the public.” The SEC contends that application of the “tacking” provisions of Rule 144 to market-adjustable securities undermines this key premise.
Currently, Rule 144(d)(3)(ii) allows holding periods to be “tacked”: “If the securities sold were acquired from the issuer solely in exchange for other securities of the same issuer, the newly acquired securities shall be deemed to have been acquired at the same time as the securities surrendered for conversion or exchange, even if the securities surrendered were not convertible or exchangeable by their terms.” Some form of this provision has existed since 1972, according to the SEC. The proposed amendments would revise Rule 144(d)(3)(ii) to change the approach to determining the holding period for securities acquired upon the conversion or exchange of certain “market-adjustable securities” issued by companies that do not have securities listed, or approved for listing, on a national securities exchange. As of the end of 2019, according to the SEC’s economic analysis, there were approximately 2,760 unlisted reporting issuers.
Under the proposed amendment, the holding period for “market-adjustable securities” would not begin until the underlying securities are acquired upon conversion or exchange. Note, however, that the proposed amendment “would not affect the use of Rule 144 for most convertible or variable-rate securities transactions.” Rather, it would apply only to “market-adjustable securities,” which are defined as convertible or exchangeable securities that contain “terms, such as conversion rate or price adjustments, that offset, in whole or in part, declines in the market value of the underlying securities occurring prior to conversion or exchange, other than terms that adjust for stock splits, dividends or other issuer-initiated changes in its capitalization.” This is not the typical convertible preferred where the conversion price or rate is generally fixed at the time of sale, even though the security may provide for mechanical adjustments to the number of underlying shares and the conversion price as a result of stock splits or otherwise under anti-dilution provisions “designed to protect the holder’s economic interest if the issuer subsequently issues shares of the underlying securities at a price below their current market value or below the holder’s original purchase price.” Rather, market-adjustable securities have conversion rates that are not fixed and “adjust for, and protect the holder against, general decreases in market value of the underlying securities.” Because their floating conversion rates can result in substantial dilution, these securities are often referred to as “death-spiral” converts. The example provided by the SEC is a convertible security with a conversion rate that “may be discounted from a weighted average price of the publicly traded class of securities, typically, common stock, calculated for a period leading up to the date of conversion or exchange. Therefore, the conversion price provides a discount from the recent market price that can be realized at the time sales of the underlying equity securities begin.” As the SEC explains,
“While the holder of a typical convertible security is at substantial economic risk upon conversion with respect to the underlying security if the underlying security fails to appreciate or declines in value, this is not the case in market-adjustable securities transactions where the conversion or exchange price and/or the amount of securities received on conversion are not fixed at the time of the initial transaction. In these transactions, holders have the right to convert the securities into the underlying securities (often shares of common stock) at a conversion price that yields a substantial discount to the market price of the underlying securities at the time of conversion or exchange. If the securities are converted or exchanged after the Rule 144 holding period is satisfied, the underlying securities may be sold quickly into the public market at prices above the price at which they were acquired. Accordingly, initial purchasers or subsequent holders have an incentive to purchase the market-adjustable securities with a view to distribution of the underlying securities following conversion to capture the difference between the built-in discount and the market value of the underlying securities.”
In effect, market-adjustable securities have a discounted conversion or exchange feature that typically provides holders with “protection against investment losses that would occur due to declines in the market value of the underlying securities prior to conversion or exchange. As a result, these holders are not exposed to the market risk associated with holding the underlying security prior to conversion or exchange; they are only exposed to that market risk during the time that they hold the underlying security after the conversion or exchange.” The SEC maintains that if the holder converts and promptly resells the underlying security, the holder has not really assumed the economic risks of investment of the underlying security.
The proposed amendment to Rule 144(d)(3)(ii) would not apply to securities issued by listed companies, the theory being that exchange listing standards requiring shareholder approval for substantial issuances would largely prevent these dilutive issuances. In addition, the SEC has observed that listed companies generally do not issue these types of securities. According to the SEC’s economic analysis, “their use has been concentrated in the subpopulation of issuers who are unable to issue additional equity or fixed-rate convertibles, such as financially distressed firms, other low- or no-revenue firms, and those approaching bankruptcy.”
Proposed Amendment to the Form 144 Filing Requirements. Rule 144(h) requires an affiliate who intends to resell securities of the issuer during any three-month period in a transaction that exceeds either 5,000 shares or has an aggregate sales price of more than $50,000 to file a Form 144 concurrently with either the placing of an order with a broker to execute the sale or the execution of a sale directly with a market maker. Form 144 may be filed on paper or, for resales of securities of reporting companies (99% of filings), electronically, but of the 31,000 Form 144 filings made in 2019, only 221 were filed electronically, with the vast majority filed on paper.
The SEC is proposing to amend Rules 101(a) and 101(b) of Reg S-T to mandate the electronic filing of all Form 144 filings relating to securities of Exchange Act reporting companies and to eliminate Form 144 reporting altogether for securities of non-reporting companies. The SEC maintains that mandatory electronic filing “would facilitate more efficient storage and retrieval of the transaction information and facilitate analysis of this information.” The SEC is also proposing a six-month transition period. The proposal would also eliminate the requirement that the affiliate send a copy of the Form 144 to the principal exchange. In addition, the SEC is proposing minor changes to Form 144 to update the form and eliminate certain personally identifiable information and unnecessary information fields.
In addition, the SEC plans to develop an online fillable document that would make electronic filing easier and would also allow filing of both a Form 144 and a Form 4 to report the same sale of equity securities if desired. Some of the disclosures required by Form 144 are the same as those required by Form 4 and many affiliates required to file Form 144 are also Section 16 filers. If the amendments are adopted, the SEC plans to provide for an option on EDGAR to file a Form 144 and a Form 4 through a single user interface, using the information entered into the fields to create separate Form 4 and Form 144 filings.
To facilitate coordination of this combined filing, the SEC is proposing to amend the Form 144 filing deadline (applicable to all Forms 144) to coincide with the Form 4 filing deadline. Under the proposed amendments to Rule 144(h)(2), the Form 144 filing deadline would be the end of the second business day following the day on which the sale of securities has been executed, or the deemed date of execution, rather than, as is currently the case, concurrently with either the placing of an order with a broker to execute the sale or the execution of a sale directly with a market maker.
Rule 10b5-1(c) Transaction Indication in Forms 4 and 5. Form 144 requires the seller to represent, as of the date that the Form is signed, that he or she does not know of any material adverse information regarding the current and prospective operations of the issuer that has not been publicly disclosed. Filers who have adopted Rule 10b5-1(c) written trading plans or instructions are permitted to make that representation as of the date they adopted the plan or gave instructions, rather than the date they signed the Form 144. With regard to Section 16 forms, for transactions executed under Rule 10b5-1(c) plans, where the reporting person does not select the date of execution, the date on which the executing broker, dealer, or plan administrator notifies the reporting person of execution of the transaction is deemed the date of execution, so long as the notification date is not later than the third business day following the trade date. The SEC is proposing to permit filers of Form 4 and 5, at the filer’s option, to indicate through a check box on the Form that the reported sale or purchase was made pursuant to Rule 10b5- 1(c). Filers could still provide additional information, such as the date of a Rule 10b5-1 plan, in the “Explanation of Responses.”
Happy holidays! Happy new year!