Rule 144A and Registration Rights

Your good private equity client, Calvin Coolidge of Green Mountain Capital, a private equity firm, wants to acquire Maple Syrup, a privately held corporation. Green Mountain is contemplating financing the acquisition with borrowings by Maple Syrup under a new sale of high yield bonds.

We explained to Cal that, because the bonds will be exchanged for new bonds in a registered A/B exchange offer, Maple Syrup will become an SEC reporting company at the time of the exchange offer. Since Maple Syrup will publicly offer only debt securities (not equity), it will be able to take advantage of some special breaks from the SEC’s reporting and corporate governance requirements for companies that have registered equity. Eventually, Maple Syrup will likely become a voluntary filer and will enjoy certain additional benefits, subject to certain limitations.

Cal seems unconvinced, and thinks that the special breaks that the SEC provides to debt-only filers aren’t very special at all.
“Why register the bonds?” he asks in his usual laconic style.

Legally, Cal has a good point–the bonds become freely tradable after one year. But, for market-related reasons, Maple Syrup may in the end decide to conduct an exchange offer. Here are some reasons why.

“Freely Tradable” Under Rule 144

Let’s start with free tradability. We’ve previously discussed the SEC’s 2008 amendments to Rule 144, under which the non-affiliate holder of a non-reporting company’s security (provided the holder has not been an affiliate for the immediately preceding 90 days) may resell the security free of restrictions if one year has passed since the securities were originally acquired from the issuer or an affiliate of the issuer. (Check out our Client Alert on this topic. We’ve also previously discussed DTC’s procedures for removing restrictive legends from Rule 144A or Regulation S global notes.

Given that the high yield bonds to be sold by Maple Syrup will become freely tradable at the one-year magic date, Cal is right to ask why Maple Syrup should need to conduct an A/B exchange offer in the first place. After all, the bankers on the deal are telling Cal that the exchange offer need not be consummated until 365 days after the bonds are issued, at which time investors in the bonds should be able to sell them free of restriction.

So, what are the arguments in favor of registration?

Major bond index requirements

A primary reason why investment grade bonds issued in a Rule 144A transaction have preserved traditional registration rights has to do with the requirements of certain major bond indices (such as the Barclays Capital US Aggregate Bond Index, a key index for US-dollar denominated, non-convertible investment grade bonds). These indices require index-listed securities to be “registered” rather than simply “unrestricted” or “freely tradable.”

Internal investor policies

In addition, the internal policies or formation documents of some bond investors, such as mutual funds, as well as certain regulatory requirements impose basket limitations on the amount of “unregistered” securities or securities “without registration rights” that such investors can hold. As with the listing requirements of the major bond indices, these limitations distinguish between “registered” and “unregistered” bonds, instead of more properly distinguishing between “restricted” and “unrestricted” or “freely tradable” bonds. Particularly with respect to bad credits or distressed issuers, the initial purchasers may not want to reduce the universe of potential investors to whom the bonds may be marketed by ruling out those investors with basket limitations.

Bond investors may like information (and SEC scrutiny)

Finally, if the issuer is not already an Exchange Act reporting company, like Maple Syrup, having it file an exchange offer registration statement will subject the company to the full panoply of laws and rules applicable to SEC registered companies. That may be attractive to bond investors – for example, they will get an ongoing flow of publicly available information about Maple Syrup in a form with which they are familiar.

Convertible bonds

While we’re at it, we should point out that the convertible bond market has almost uniformly abandoned traditional registration rights in favor of additional interest as the only remedy if the issuer fails to file its Exchange Act reports on time or the bonds are not otherwise freely tradable between six and twelve months after issuance. These provisions are typically found directly in the indenture, obviating a registration rights agreement.

This is largely the case because the 144A market for convertible bonds is deep and primarily comprises hedge funds that are not typically subject to the same basket limitations as mutual funds. Convertible bonds are also ineligible for inclusion in the Barclays Capital US Aggregate Bond Index to begin with.