SEC Staff Legal Bulletin Clarifies Registration Exemption for Securities Issued in Reorganizations

In the first staff legal bulletin in almost three years, the SEC staff has clarified the registration exemption for securities issued in reorganizations. The exemption, found in Section 3(a)(10) of the Securities Act, is available when the securities are issued in exchange for other securities, not for cash, and the fairness of the exchange is approved by a court of governmental entity. The fairness hearing must be open to everyone to whom securities would be issued in the proposed exchange.

The Section 3(a)(10) exemption is available without any action by the staff or the Commission. But issuers unsure of whether the exemption is available for a specific transaction they are contemplating may request a no-action position. The bulletin discusses issues that commonly arise in those no-action requests.

The SEC staff said that it will not issue a no-action response concerning a transaction after the fairness hearing has been held. Thus, an issuer must submit its no-action request before the fairness hearing. Also, the staff cautioned issuers not to submit a no-action request very close to the fairness hearing date since that may not give the staff adequate time to consider the issues presented and respond before the hearing.

Statutes governing fairness hearings often require a shareholder vote before the hearing, which could be at a time when the issuer is not certain it will be able to rely on the Section 3(a)(10) exemption. In these situations, the SEC staff has not objected to a vote before the fairness hearing, even though this means an investment decision is made before the fairness hearing, since the transaction is not effected unless the court or other authority approves it. In the staff’s view, the issuer should submit to the court or approving authority the disclosure materials offering the securities before it mails them to the offerees.

In addition, the staff believes that the court or authority making the fairness determination must have sufficient information before it to determine the value of both the securities, any claims or interests to be surrendered, and the securities to be issued in the proposed transaction. The staff will allow a foreign court to approve the transaction if all requirements that apply to exchanges approved by U.S. courts are satisfied and the issuer provides an opinion from counsel in the foreign jurisdiction stating that, before the foreign court can give its approval, it must approve the fairness of the proposed exchange to persons receiving securities in the exchange.

While the issuer must provide appropriate and timely notice of the fairness hearing, the statute does not specify the information that must be included in the required notice. And the SEC staff does not address the adequacy or appropriateness of the information provided to persons who have a right to appear at the hearing, except to broadly require that the notice adequately advise those who are to be issued securities in the exchange of their right to attend the hearing and give them the information necessary to exercise that right. The staff also cautions issuers rely on the Section 3(a)(10) exemption to consider whether, as a practical matter, imposing prerequisites to appearance will prevent those persons from having a meaningful opportunity to appear at that hearing.

The staff also clarified the status of fairness hearings conducted under state securities laws. The National Securities Markets Improvements Act of 1996 amended Section 18 of the Securities Act to preclude any state from requiring registration or qualification of covered securities, which are nationally listed securities. One effect of this was that an issuer could not use a state fairness hearing as a basis for relying on the Section 3(a)(10) exemption.

The SEC staff said that Congress’ prohibiting reliance on state fairness hearings was inadvertent. The staff noted that Congress corrected this situation in the Securities Litigation Uniform Standards Act of 1998, which amended Section 18 to add securities issued under Section 3(a)(10) as a category exempt from the definition of covered securities. Thus, the staff believes that an issuer may rely upon a fairness hearing conducted under state securities law to perfect an exemption under Section 3(a)(10) for securities that otherwise would be covered securities.