What Is A 144A Security?
Rule 144A is a safe harbor exemption from the registration requirements of Section 5 of the Securities Act for certain offers and sales of qualifying securities by certain persons other than the issuer of the securities. The exemption applies to resales of securities to qualified institutional buyers, who are commonly referred to as “QIBs.” QIBs must be institutions, and cannot be individuals—no matter how wealthy or sophisticated. The securities eligible for resale under Rule 144A are securities of U.S. and foreign issuers that are not listed on a U.S. securities exchange or quoted on a U.S. automated inter-dealer quotation system. Rule 144A provides that reoffers and resales in compliance with the rule are not “distributions” and that the reseller is therefore not an “underwriter” within the meaning of Section 2(a)(11) of the Securities Act. A reseller that is not the issuer, an underwriter, or a dealer can rely on the exemption provided by Section 4(1) of the Securities Act. Resellers that are dealers can rely on the exemption provided by Section 4(3) of the Securities Act. Rule 144A modifies the Securities and Exchange Commission (SEC) restrictions on trades of privately placed securities so that these investments can be traded among qualified institutional buyers, and with shorter holding periods—six months or a year, rather than the customary two-year period.
While the Rule, introduced in 2012, has substantially increased the liquidity of the affected securities, it has also drawn concern that it may help facilitate fraudulent foreign offerings and reduce the range of securities on offer to the general public. Rule 144A is designed to provide an exemption to the general rule that all securities must be registered with the SEC before being sold. The rule specifically addresses the resale of securities among what the rule calls qualified institutional buyers, which includes most categories of institutions that qualify as accredited investors under the securities laws. Individual investors cannot be qualified institutional buyers; only institutions qualify under Rule 144A. The general intent of the rule is to allow institutions to engage in transactions the SEC would deem too risky for the general public. Institutions can make trades even though the underlying issuer hasn’t provided the full information required for SEC registration. The assumption is that large institutions are savvy enough to do their own due diligence without the SEC backing them up, in contrast to individual investors, who typically lack the resources to verify claims from issuers without the agency’s help. In addition, Rule 144A has made the markets for privately placed restricted securities more liquid than they would otherwise be. Ordinarily, a two-year holding period applies under SEC Rule 144 to institutions that buy restricted securities from issuers. By allowing trades among qualified institutions, Rule 144A allows shorter-term investment in these securities.
Who may rely on Rule 144A?
Any person other than an issuer may rely on Rule 144A. Issuers must find another exemption for the offer and sale of unregistered securities. Typically, they rely on Section 4(2) (often in reliance on Regulation D) or Regulation S under the Securities Act. Affiliates of the issuer may rely on Rule 144A.
What types of transactions are conducted under Rule 144A?
The following types of transactions often are conducted under Rule 144A:
• offerings of debt or preferred securities by public companies; offerings by foreign issuers that do not want to become subject to U.S. reporting requirements;
• and offerings of common securities by non-reporting issuers (i.e., “backdoor IPOs”).
Rule 144A program
An issuer that intends to engage in multiple offerings may have a Rule 144A program. Rule 144A programs are programs established for offering securities (usually debt securities) on an ongoing or continuous basis to potential offerees. They are similar to “medium-term note programs,” but they are unregistered, and the securities are offered only to QIBs. These programs often are used by financial institution and insurance company issuers to offer securities, through one or more broker-dealers, to institutional investors in continuous offerings.
Among the advantages of using Rule 144A programs are
• no public disclosure of innovative structures or sensitive information;
• limited FINRA filing requirements; and
• reduced potential for liability under the Securities Act.
The Impetus for Rule 144A
Before a security can be offered to the general public, the Securities Act of 1933 stipulates that the issuer must register it with the SEC and provide extensive documentation through a filing with the agency. Rule 144A, however, was drawn up in recognition that more sophisticated institutional investors may not require the same levels of information and protection as do individuals when they buy securities. The Rule provides a mechanism for the sale of privately placed securities that do not have—and are not required to have—an SEC registration in place, creating a more efficient market for the sale of those securities.
Rule 144A Holding Requirements
In addition to not requiring that securities receive SEC registration, Rule 144A relaxed the regulations over how long a security must be held before it can be traded. Rather than the customary two-year holding period, a minimum of a six-month period applies to a reporting company, and a minimum one-year period applies to issuers not required to meet reporting requirements. These periods begin on the day the securities in question were bought and considered paid in full.
Public Information Requirement
A minimum level of public-accessible information is required of the selling party. For reporting companies, this issue is addressed as long as they are in compliance with their regular reporting minimums. For non-reporting companies (also called non-issuers), basic information regarding the company, such as company name and the nature of its business, must be publicly available.
Trading Volume Formula
For affiliates, there is a limit on the number of transactions, referred to as the volume, that cannot be exceeded. This must amount to no more than 1% of the outstanding shares in a class over three months or the average weekly reported volume during the four-week period preceding the notice of sale on Form 144.
The sale must also be handled by the brokerage in a manner deemed routine for affiliate sales. This requires no more than a normal commission be issued, and neither the broker nor the seller can be involved in the solicitation of the sale of those securities.
To meet filing requirements, any affiliate sale of over 5,000 shares or over $50,000 during the course of a three-month span must be reported to the SEC on Form 144. Affiliate sales under both of these levels are not required to be filed with the SEC.
Concerns Over Rule 144A and Responses
As the Rule succeeded, as intended, in increasing non-SEC trading activity, concern rose at the number of trades that were all but invisible to individual investors, and even murky to some institutional ones, as well. One problem with the Rule 144A regulatory setup is that even though the trades sanctioned by it became an important segment of trading in some issuers’ securities, the reporting requirements made activity in the 144A market harder for ordinary investors to see. In the corporate bond market, the Financial Industry Regulatory Authority estimated last year that the total volume of 144A transactions was about 20% of the overall average daily volume for the entire bond market. In the high-yield debt area, that proportion was even higher at nearly 30%. To give more information to all market participants, FINRA started reporting transaction data for Rule 144A trades in the corporate debt market in mid-2014. With its Trade Reporting and Compliance Engine, FINRA leveled the playing field for Rule 144A and non-Rule 144A trades, imposing many of the same informational requirements on both. FINRA heralded the move as “bringing transparency to a market that had previously operated in the dark.” An executive at FINRA added that “the information will help professional investors and contribute to more efficient pricing of these securities, as well as inform valuation for mark-to-market purposes.”
Nevertheless, even though Rule 144A is designed to allow financial institutions greater latitude in making trades, some concerns persist. Many Rule 144A transactions involve securities of foreign companies that don’t want to subject themselves to SEC scrutiny, and that exposes U.S. institutions to the potential for fraudulent representations from those foreign issuers. One counterargument is that by allowing institutions to spread the risk from foreign-issued securities in private placements, Rule 144A actually reduces the overall systemic danger to the industry as a whole. Still, Rule 144A does make it easier for companies to issue private placements by essentially facilitating a secondary market among institutions for those securities. To some extent, that makes regular initial public offerings and other public issuance less attractive, leaving average investors with fewer investment options. You won’t see references to Rule 144A every day, but the SEC rule plays a key role in how large institutions trade. Thanks to efforts from FINRA and others, you can get more information on this previously hidden market and gain valuable insight from the behavior of issuers and institutions alike. If you’re an individual investor, you might like the Fool’s broker tool, which helps you compare the features of various online investment accounts.
What securities are eligible for exemption under Rule 144A?
Securities offered under Rule 144A must not be “fungible” with, or substantially identical to, a class of securities listed on a national securities exchange (which includes the NASDAQ Market System) or quoted in an automated inter-dealer quotation system (“listed securities”). Common stock is deemed to be of the “same class” if it is of substantially similar character and the holders enjoy substantially similar rights and privileges. American Depositary Receipts (“ADRs”) are considered to be of the same class as the underlying equity security. Preferred stock is deemed to be of the same class if its terms relating to dividend rate, liquidation preference, voting rights, convertibility, call, redemption, and other similar material matters are substantially identical. Debt securities are deemed to be of the same class if the terms relating to interest rate, maturity, subordination, convertibility, call, redemption, and other material terms are substantially the same. A convertible or exchangeable security with an effective conversion premium on issuance (which means at pricing) of less than 10%, and a warrant with a term less than three years or an effective exercise premium on issuance (at pricing) of less than 10%, will be treated as the “same class” as the underlying security.
What is a 144A Bond Offering?
144A bonds fall under “Rule 144A”. The 144A is an SEC rule issued in 1990 that modified a two-year holding period requirement on privately placed securities by permitting QIBs to trade these positions among themselves. Prior to this the holding period for such private stock was different. A 144A bond offering is a U.S. based offering, and typically is considered an alternative to the timely and costly initial public offering.
Bonds and Notes
There are two common terms used to describe debt securities issuance, a “bond”, and a “note”. A bond is traditionally having a maturity date – an expiration or ending date that the bond terminates on – after 10 years. For notes, the common length is up to ten years. Thus, if a company issues a 144A bond, by the traditional definition the 144A bond will last for more than 10 years. If a company issues a 144A note than traditionally the notes will mature within 10 years of the issue. While the semantics of the bonds and notes do not matter that much in the business world, they do matter for those that know and it is important to be precise when outlining your debt offering. A 144A bond offering is a private placement offered in the United States for U.S. investors and clears through DTCC, usually (but not always). Additionally, 144A offerings and its Reg S component clear and settle via Euroclear or Clearstream in Europe. A 144A is, in the vast majority of cases, a debt issuance. While very few issuers percentage wise issue a 144A equity security, most companies and governments opt to issue 144A debt, and indeed the majority of such 144A offerings are almost all notes or bonds.
Securities Lawyers In Utah
When you need legal help with Securities Law in Utah, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.
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