Today we look at some registration issues that may arise when a company issues convertible securities or warrants.
You get a call from Dr. Heywood Floyd, General Counsel of your good client 2001 Corporation. He tells you that 2001 is planning an issuance of common stock purchase warrants, and wants to know if he needs to register the issuance of the underlying common stock. Not to put pressure on you or anything like that, but he also tells you that he has run the question by their latest artificial intelligence creation, the HAL 9000 model computer. HAL had an answer in nanoseconds, and Floyd wants to see if your answer and HAL’s agree.
What do you tell Dr. Floyd?The answer to Dr. Floyd’s question depends in part on when the warrants become exercisable. Section 2(a)(3) of the Securities Act provides that a “right or privilege, when originally issued or transferred with a security, giving the holder of such security the right to convert such security into another security of the same issuer . . . which right cannot be exercised until some future date, shall not be deemed to be an offer or sale of such other security.” The SEC Staff takes the position that if convertible securities or warrants are issued that are convertible or exercisable within one year, an offering of both the convertible security or warrant and the underlying security are deemed to take place. See C&DI 139.01. (The SEC Staff takes a similar view if the conversion or exercise is entirely at the option of the issuer.) In other words, a minimum of one year is required to satisfy the “future date” requirement of Section 2(a)(3).
So, if the warrants are immediately exercisable upon issuance, then the offering of the warrants will be deemed to be an offer to sell the underlying common stock. As a result, 2001 could register the issuance of both 2001’s warrants and its common stock, or it could privately place the issuance of both the warrants and common stock (bearing in mind Rule 144A(d)(3)(i)’s requirements that warrants convertible into stock listed on the NYSE or quoted on Nasdaq cannot be exercised for at least three years and must have an exercise premium greater than 10%). But it could not privately place the warrants and then later register the issuance of the common stock, because the SEC Staff takes the view that a transaction that begins privately must be completed privately. See C&DIs 239.15; 139.29.
On the other hand, if the warrants are not exercisable for more than one year after their issuance, the warrants would not be deemed to be making an ongoing offer to sell the underlying common stock to the warrant holders until the warrants become exercisable. Accordingly, 2001 could either privately place the warrants or register their issuance, without having to worry about the common stock. Remember, though, that the SEC Staff takes the position that the issuance of the underlying common stock must be either exempt or registered prior to the date the warrants become exercisable.
Note that the SEC Staff’s position with respect to employee stock options is more lenient than its position with respect to convertible and exercisable securities more generally. The SEC Staff permits an issuer to register the issuance of common stock underlying an employee stock option on Form S-8 at any time before the option is exercised. The SEC Staff has indicated that this departure from the analysis discussed above is based solely on a policy determination to treat Form S-8 issuances more liberally based on the employment relationship. See C&DI 239.15.
If 2001 did not want to register the underlying common stock, it could consider adding a net share settlement feature to the warrants (i.e., the holder pays the exercise price through surrendering shares of equal value). The idea here is to take advantage of Section 3(a)(9) of the Securities Act, which provides an exemption from registration for certain exchanges of securities among an issuer and its existing security holders where no remuneration is paid in connection with the solicitation of the exchange. If Section 3(a)(9) is available for the issuance of the underlying common stock, it would exempt the offer to sell deemed to be made by the warrant and the warrant could be exercisable immediately upon issuance.