When and how are legends removed from restricted global notes?
Part I of “When the Legends Die” dealt with removal of legends from restricted equity securities under Rule 144 other than in connection with a resale. The guiding principles are the same for debt securities, although the mechanics differ. Under the current version of Rule 144 (as revised in February 2008), restricted debt securities, such as those resold in transactions under Rule 144A, now become freely tradable by non-affiliates at roughly the same time as traditional registration rights would have become available. As a result, both issuers and investors have begun to rethink the traditional approach to registration rights.

Under the traditional approach, both reporting and non-reporting issuers wishing to privately place debt securities issue notes use one or more global notes bearing a restricted CUSIP number. To provide unrestricted notes in a straight debt transaction, the issuer agrees pursuant to a registration rights agreement to conduct a registered exchange offer (an “A/B exchange offer”). In the A/B exchange offer, the issuer registers an exchange offering of new registered notes with the same terms as the restricted notes in exchange for the restricted notes. Noteholders affiliated with the issuer and broker-dealers holding notes for their own account are ineligible to participate in these exchange offers under the Exxon Capital line of no-action letters, and they continue to hold interests in the restricted notes. Moreover, the Exxon Capital exchange offer mechanism is unavailable for convertible notes. To provide unrestricted notes in a convertible debt transaction, for which the A/B exchange offer process is not available, traditional registration rights agreements require the issuer to agree to file a resale shelf registration statement to register resales of the notes and underlying common stock and to maintain the shelf’s effectiveness until the time those securities become freely tradable by non-affiliates under Rule 144. Similarly, these shelf provisions were also present, though very rarely invoked, in most straight debt transactions to provide for resales of notes by affiliates and broker-dealers. As of 2016, the traditional approach still sees some life in straight debt land, particularly where it is important to market the debt as having registration rights; the convert market gravitated quickly to the procedures described below and registration rights are only seen in cases where there are issues with satisfying the requirements of the new approach.¹

In response to the February 2008 amendments to Rule 144 and in collaboration with the Securities Industry and Financial Markets Association (SIFMA), in April 2009 DTC instituted a platform to facilitate the “exchange”² of restricted Rule 144A notes, including convertible notes, for unrestricted securities. See SIFMA Guidance: Procedures, Covenants, and Remedies in Light of the Revised Rule 144 (October 2008). DTC substantially followed the guidelines proposed by SIFMA in designing its exchange platform. See DTC’s Notice Regarding its Exchange Platform (April 2009) for a general discussion of this process. The two processes, the SIFMA guidelines, which provide a template for how the indenture will work,³ and the DTC mechanic, which allows for the delegending of the global note and the migration of the CUSIP, work together. In short, when restricted notes become freely tradable by non-affiliates under Rule 144 (i.e., one year after issuance, assuming no affiliates have entered the chain of title), DTC will process an exchange of the notes issued under the restricted CUSIP number for notes with an unrestricted CUSIP number. This exchange can be established as a mandatory exchange, where all notes eligible for exchange are simultaneously moved to an unrestricted CUSIP number without any need for action on the part of any noteholder, or as an optional exchange, where individual noteholders have the option to exchange eligible notes on a one-off basis. The mandatory exchange procedures are our focus here because they offer a meaningful alternative to traditional registration rights.⁴

Although restricted securities of a reporting issuer may be resold by non-affiliates six months after initial issuance as long as the issuer is current in its Exchange Act reporting, the SIFMA Guidance looks to the one-year anniversary of issuance to avoid the added complexity of sorting out whether the issuer is current in its periodic filings, which is now a prerequisite for free tradability between six months and one year under Rule 144.

Pursuant to DTC’s mandatory exchange platform and based on the SIFMA Guidance, the following procedures will apply:

• CUSIP Numbers – When the notes are initially issued, and regardless of whether the issuer is a reporting issuer, the notes are typically assigned a restricted and an unrestricted CUSIP number so that the securities can assume the unrestricted CUSIP in lieu of the original restricted CUSIP when they become freely tradable. When the CUSIP number exchange takes place, the notes are automatically moved from the restricted CUSIP number to the unrestricted CUSIP number.
• Executed Trustee Free Transferability Certificate and DTC Instruction Letter – One year after issuance, the issuer delivers a free transferability certificate to the trustee instructing the trustee to remove the legend because the securities have become freely tradable by non-affiliates. Concurrently, the issuer delivers an Instruction letter to DTC instructing DTC to effect the CUSIP number exchange. DTC requires this Instruction letter at least 15 days before the exchange date. The form of issuer free transferability certificate to the trustee is sometimes attached as an exhibit to the indenture. The form of the DTC Instruction letter is attached to DTC’s publication regarding mandatory exchange.⁵

Under the SIFMA procedures, upon the trustee’s receipt of the free transferability certificate, the legend on the global certificate is deemed removed. On the exchange date specified in the DTC Instruction letter, the unrestricted CUSIP is automatically substituted for the restricted CUSIP. No new global certificate is required because the global certificate legend expressly contemplates that the resale restrictions will terminate upon instruction from the issuer if at least one year has elapsed from the original issue date. No action is required on the part of the trustee to make this happen so there is no need for a legal opinion. (Since free transferability is a matter of fact rather than law, industry consensus is that free transferability is not an appropriate opinion request and, accordingly, issuers are advised to draft their indentures to avoid the need for an opinion of counsel for this process.)

Finally, note that affiliates cannot participate in the exchange process. DTC’s form of Instruction letter requires the issuer to represent expressly that no affiliate is a holder of the notes to be exchanged as of the date of the letter. However, neither the DTC Instruction letter nor the trustee’s free transferability certificate require the issuer to represent that no affiliate has ever owned any of the notes, even though an affiliate in the chain of title creates complications under Rule 144. In order to avoid the complications associated with an affiliate in the chain of title, an issuer should implement procedures to ensure that notes acquired by affiliates are not moved to the unrestricted CUSIP number. The SIFMA Guidance suggests one approach: The indenture or registration rights agreement could carve out affiliates from the issuer’s obligation to exchange restricted notes for unrestricted notes. See SIFMA Guidance at note 16. Another approach is as follows: In order to facilitate the automatic substitution of the unrestricted CUSIP number for the restricted CUSIP number upon exchange, notes issued to affiliates could be issued under separate restricted certificates (and a restricted CUSIP number) from those issued to non-affiliates. That way, in the Instruction letter to DTC at the time of exchange, the issuer can request that DTC exchange only the notes issued under the non-affiliate global certificates. Notes held by affiliates will continue to be represented by restricted certificates. See SIFMA Guidance at note 16. A third approach would involve prohibiting affiliates from taking an interest in the global notes under any circumstances.
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¹   One example is with exchangeable notes issued by REITs where the typical REIT offering structure (notes issued by the partnership, exchangeable into shares of common stock issued by the parent corporation) prevents the Rule 144 holding period for the notes to be tacked to the underlying shares.
²   Even though DTC uses “exchange” terminology, this is not an exchange offer on the level of the A/B exchange offer – rather this is just the deemed exchange of global notes – really just the change of the CUSIP. As a result, the tender offer rules do not apply.
³   The SIFMA guidance is used by many indentures, but there are other mechanical options to achieve the same result, so it is important to review the specific terms of the applicable indenture.  The DTC mandatory exchange process is, however, the only game in town.

⁴   Notwithstanding DTC’s exchange platform, the current state of play with respect to the construction of registration rights is in flux. Intuitively it would make sense that registration rights would kick in only if the issuer were unable to move the restricted notes to an unrestricted CUSIP number via DTC’s exchange platform after the expiration of Rule 144’s one-year holding period or, in the alternative, to implement a monetary penalty if the issuer fails to do so. The convertible note market has generally followed our prediction. However, we have seen continuing demand for traditional registration rights (including an A/B exchange offer) in the high yield market both for marketing reasons and because of market uncertainty with DTC’s exchange process. It remains to be seen how the high yield market will ultimately settle out on the need for traditional registration rights in light of the February 2008 amendments to Rule 144.

⁵   Bear in mind that DTC does not permit deviation from these forms, so issuers should follow the model forms and related instructions closely in order to facilitate a timely exchange. See the Form 144A and Regulation S Instruction letters at 3-6 of DTC’s Procedures for Mandatory Exchange.