In Part I, appearing in MCC's November 2005 issue, we discussed transactions such as spin-offs structured to avoid Securities Act registration of the stock of the subsidiary. In this Part II, we examine the steps required for registration of the stock of the subsidiary and the related restrictions on issuer communications and increased obligations as a public company.
If the conditions of Staff Legal Bulletin No. 42, are not satisfied, the Securities Act registration of the spin-off or subsidiary IPO would be required. Such registration would typically be effected on a registration statement on Form S-1. The preparation of a Form S-1 involves significant time and effort on the part of a large working group. The Form S-1 must include, among other information, detailed information regarding the subsidiary's business, the risks involved in investing in its stock, management's analysis of the subsidiary's financial condition and results of operations, use of proceeds, dilution, executive officers and directors, executive compensation and certain relationships and related party transactions (especially with the parent company). In addition, it must include audited balance sheets for the last two fiscal years, audited income statements and statements of cash flows for the last three fiscal years and unaudited financial statements for any subsequent interim period. If the subsidiary has recently acquired another business, the registration statement also may be required to include financial statements for such business as well as pro forma combined financial information.
Communications During Phases Of The Registration Process
The SEC has adopted new offering rules, effective December 1, 2005, which relax current restrictions on issuer communications prior to and during a public offering. Unfortunately for entities engaging in an IPO, most of the new rules' benefits are available only to seasoned issuers with a history of SEC filings.3
As before, the securities offering process is divided into three phases, each of which has its own set of restrictions.
Pre-Filing. During the first phase, which occurs before the registration statement is filed, an issuer (i.e., the subsidiary to be spun-off) may not offer or sell any of the offered securities or otherwise engage in any communications deemed to "condition the market". The new SEC rules will exempt communications that are made by or on behalf of the issuer (which includes the parent of the subsidiary to be spun-off) more than 30 days prior to the filing of the registration statement, so long as they do not refer to a registered securities offering and the issuer takes reasonable steps within its control to prevent further distribution or publication during the 30-day period. In addition, the new rules will exempt communications that constitute "factual business information" (as defined in the new rules) made during the 30-day period. Communications that constitute "forward-looking information" (as defined in the new rules) are generally not permitted.
Post-Filing, Pre-Effectiveness. After filing the Form S-1, the registration statement will go through the SEC review process, which may include several rounds of comments. Generally, a subsidiary will need to file several amendments to the registration statement before satisfying the SEC that it has responded to all of the SEC's comments. In the case of an underwritten subsidiary IPO, NASD Regulatory Services and Operations also may review the deal's terms with a view to reasonableness of the underwriter's compensation. The parties generally should expect that the registered spin-off or subsidiary IPO will take about four to six months from start to finish.
During the review phase, an issuer may make oral offers regarding the securities as well as written offers in the form of a statutory prospectus. Effective December 1, 2005, issuers will also be able to deliver a "free writing prospectus," which includes any written communication that constitutes an offer to sell or a solicitation of an offer to buy a security that does not satisfy the requirements for a statutory prospectus and does not fall within an exception to the Securities Act's definition of prospectus. Issuers will, however, need to deliver a copy of the most recent statutory prospectus filed with the SEC to any recipient of a free writing prospectus, but the delivery requirement will not apply if the free writing prospectus is provided to the recipient by someone other than the issuer who receives no compensation from the issuer for its distribution or if the issuer has already provided the most recent statutory prospectus. The free writing prospectus will need to contain a required legend and will need to be filed with the SEC.4 Issuers and other offering participants will need to retain all free writing prospectuses that they have used for three years after the relevant offering.
Under the new rules, written communications will include "graphic communications" (such as e-mails) and communications by website, CD-ROM, widely distributed telephone messages, facsimile, videotape or audiotape. The new rules also contain special provisions for information contained in an electronic road show or available online. Delivery obligations of an issuer and other offering participants will be independent of each other.
Post-Effectiveness. The final and most permissive phase begins once the SEC has declared the registration statement effective. During this phase, the issuer or other offering participant may offer and sell the registered securities, as long as delivery of the security occurs simultaneous with or after delivery of a final prospectus. Under a new "access equals delivery" approach effective December 1, 2005, the final prospectus delivery requirement will be satisfied if the issuer has filed a registration statement that has been declared effective, has filed a final prospectus, neither the registration statement nor the prospectus is the subject of any pending proceeding or examination under Securities Act Sections 8(d) or (e), and none of the issuer, an underwriter or participating dealer is the subject of any pending proceeding under Securities Act Section 8A. In lieu of delivery of a final prospectus, an underwriter, broker or dealer participating in an offering will be able to satisfy its delivery obligation by delivering, within two days after completion of the sale, a notice that the sale was made pursuant to an effective registration statement in which a final prospectus would have been required to have been delivered, but for the exemption provided by Rule 172 permitting a notice of sale instead of delivery of a final prospectus. A purchaser who receives the notice instead of a final prospectus may request a copy of the final prospectus from the person responsible for sending the notice.5
Issuers engaged in a public offering are subject to liability for material misstatements or omissions contained in the prospectus and registration statement. Commencing December 1, 2005, a free writing prospectus will fall within the definition of a "prospectus" under the Securities Act and, therefore, issuers will be subject to liability for material misstatements or omissions therein under Securities Act Section 12(a)(2). Since it will not be deemed part of the registration statement, however, they will not be subject to liability under Securities Act Section 11. Section 12(a)(2) provides for a due diligence defense to liability, with the burden of proof placed on the defendants. Under Securities Act Section 11, which applies only to material misstatements and omissions contained in a registration statement, this defense is not available to the issuer. Additionally, communications related to an offering that are neither a prospectus nor an offer to sell or solicitation of an offer to buy are subject to Regulation FD. Regulation FD prohibits selective disclosure of material non-public information by or on behalf of an issuer to analysts, institutional investors and others unless the issuer disseminates the same information to the public by filing a Form 8-K, issuing a press release or using another disclosure method reasonably designed to provide broad, non-exclusionary distribution. If a disclosure is intentional (involving knowledge or recklessness in not knowing), the issuer must publicly disclose the information simultaneously with the disclosure. If the disclosure is unintentional, the issuer must publicly disclose promptly (but in no event later than 24 hours or commencement of next day trading on the NYSE).
Obligations Of Public Companies
In most spin-offs, the subsidiary's stock will also be required to be registered under Exchange Act Section 12, subjecting it to the Exchange Act's periodic reporting, proxy, insider reporting and short-swing profit liability provisions. If the issuer wishes to list its stock on an exchange (as most will), it will be required to prepare an applicable listing application and to comply with the relevant exchange or association's quantitative and qualitative criteria for listing and continued listing (including substantive corporate governance requirements).
Upon filing a Securities Act registration statement (even if the spin-off is never completed) or otherwise becoming an Exchange Act reporting company, the subsidiary will become subject to the full panoply of the provisions of the Sarbanes-Oxley Act of 2002. The subsidiary must comply with all of Sarbanes' requirements, especially those relating to personal loans to insiders and director independence, prior to launching the transaction. Going forward, the subsidiary also will be subject to all of the regulations applicable to public companies generally, including, among other things, the requirement to file annual, quarterly and current reports and Regulation FD's prohibition on selective disclosure. In addition, all financial statements will need to conform to standards of the SEC and the Public Company Accounting Oversight Board. Overall, once a registration statement is filed or the subsidiary becomes an Exchange Act reporting company, the subsidiary will need to deal with the transparency now being demanded of all public companies.
2 Staff Legal Bulletin No. 4 provides that no "sale" requiring registration under the Securities Act occurs in a stock dividend in which the recipient neither makes an investment decision regarding nor pays consideration for the stock, the subsidiary stock is distributed pro rata among the parent's stockholders, the parent furnishes adequate information to the stockholders, the spin-off is undertaken for a valid business purpose and, if the parent acquired the stock in an unregistered transaction, the parent must have held the securities for at least two years.
3 This article assumes that the subsidiary to be spun-off is not a public company prior to the spin-off.
4 With respect to issuer information contained in a free writing prospectus prepared by someone other than the issuer, only the issuer's information must be filed. Persons other than the issuer participating in the offer and sale of the securities are also subject to the filing requirements for any free writing prospectus that they widely distribute, unless such information has already been filed under the rules. A new free writing prospectus need not be filed if it does not contain substantial changes or additions from a previously filed free writing prospectus. Additionally, an issuer may file a free writing prospectus published by unpaid media within one business day after its publication (rather than simultaneously with its publication.)
5 During this phase, an issuer also may engage in certain communications with customers and certain communications regarding research reports without triggering the prospectus delivery obligation .
M. Ridgway Barker is Chair of the Corporate Finance & Securities Practice Group of Kelley Drye & Warren LLP. Randi-Jean G. Hedin is a Partner in the Corporate Finance & Securities Practice Group. Acknowledgement is given to Jeffrey A. Letalien, an Associate in the Corporate Finance & Securities Group, for his efforts in the preparation of this article.