ATMs and Equity Lines: Overview

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1 Anthony J. Marsico, Greenberg Traurig, LLP, with PLC Corporate & Securities This Article provides an overview of at-the-market equity distribution programs (ATMs) and equity line facilities. It discusses the advantages that ATMs and equity lines offer over other methods of equity financing and explains the structure, terms and mechanics of these facilities and how to implement and maintain them. The Article covers topics including how to register the offered securities with the SEC and how to comply with securities exchange rules, Regulation M and FINRA filing requirements. This is just one example of the many online resources Practical Law Company offers. To access this resource and others, visit practicallaw.com. During the recent economic crisis, turbulent markets and limited access to traditional and certain alternative financing sources lead many public companies to search for new and creative avenues for raising capital. In particular, mid- and small-cap issuers are increasingly turning to two types of alternative equity financing options to meet their liquidity needs: At-the-market equity distribution programs (ATMs). Equity lines. Both of these provide public companies with quick, flexible and cost-efficient means of raising equity capital: In amounts and at times of the company s choosing. At prices the company deems most attractive. Without sacrificing share price stability. Without the need for extensive pre-deal marketing or special selling efforts. OVERVIEW OF ATMS AND EQUITY LINES ATMs and equity lines are designed to allow companies to quickly and opportunistically access equity capital markets, especially during periods of high volatility when traditional equity or debt financing may not be economically attractive or practical. An ATM facility enables a public company listed on a US securities exchange to sell, periodically during the term of the facility, newly issued registered equity securities directly to the public through a registered broker-dealer in amounts and at times and prices determined by the company in its sole discretion. Shares are sold either: Through the designated broker-dealer, acting as sales agent, at prevailing market prices in response to existing demand in an existing secondary market ( at-the-market sales). If the ATM facility permits, directly to the broker-dealer as principal. The company is under no obligation to sell any shares under the ATM. The timing, frequency and terms of any sales orders: Are entirely at the discretion of the company. Can be altered (or sales orders revoked before they are executed) by the company at any time, even intraday. An equity line enables a public company to sell, from time to time at the company s election, a certain dollar amount or number of shares of its common stock directly to a private investor by exercising draw downs (or puts) under an equity line facility. The purchase price for the shares in a particular draw down is determined by a formula tied to the market price of the shares over a specified pricing period, as set out in a written equity line agreement executed at the commencement of the transaction. The equity line agreement sets out, among other terms: The aggregate dollar amount of the investor s total commitment. The specific amounts the company may draw down at any particular time. The number of draw downs the company may make over the term of the facility. The pricing mechanics and discount ranges applicable to a given draw down. The company is under no obligation to sell any shares under the equity line. However, the investor must purchase the shares subject to: A properly delivered draw down (or put) notice from the company. The satisfaction of specified conditions outside the investor s control. ADVANTAGES OF ATM FACILITIES AND EQUITY LINES ATM facilities and equity lines offer many advantages over other equity financing options, including traditional follow-on Learn more about Practical Law Company practicallaw.com

2 underwritten offerings, registered direct offerings and private investments in public equities (PIPEs). ATM facilities and equity lines: Have significantly lower all-in transaction costs. Have less impact on the company s stock price. Provide the company with faster implementation and greater flexibility. Lower Cost of Capital For offerings completed in 2011, the all-in cost of capital, taking into account underwriter or placement agent fees, market discounts and warrant coverage (that is, warrants issued to entice underwriters or investors to participate), was approximately: 20% for PIPEs and registered direct offerings. 15% for follow-on underwritten offerings. In addition, a company s cost of capital increases substantially if it engages in multiple capital raises using these methods. For most equity line products currently in the market, the all-in cost of capital ranges from 8% to 15%, including commitment fees and market discounts (though some could potentially result in higher discounts, depending on the specific pricing formula (see Structure, Terms and Mechanics of Equity Lines)). Typically there are no warrants or non-usage or termination fees associated with equity lines. ATMs offer an even more cost-effective financing option, with broker-dealer commissions in an ATM typically ranging from 2% to 5% of the gross sales price of the securities sold under the facility. There are no market discounts, warrants or structuring, commitment, non-usage or termination fees associated with ATMs. However, companies may incur ongoing maintenance and due diligence costs for an equity line or ATM and may be required to reimburse a portion of the legal fees of the investor (in an equity line) or broker-dealer (in an ATM). Less Impact on Company Stock Price The initial public announcement of an ATM program or equity line generally does not have a significant impact on the company s stock price. There are substantially fewer market overhang (potential dilution) issues with ATMs and equity lines because: Equity line draw downs and ATM stock issuances occur on a delayed basis. Equity line and ATM facilities provide the company with an option, not an obligation, to issue shares over an extended period of time. The impact on stock price is also lower because the precise timing of issuances under an ATM or equity line is not disclosed at the commencement of the program, unlike traditional follow-on underwritten offerings, PIPEs and registered direct offerings. In addition, specific equity line draw downs and ATM stock issuances generally are not publicly announced at the time of sale. Instead, companies typically disclose the results of sales made through these facilities at the end of each fiscal quarter, greatly limiting arbitrage or speculation relating to the size or pricing of specific sales. Accordingly, with an ATM facility or equity line, a company can raise capital in periodic increments that do not cause as much downward pressure on the market price of its stock as a single, large, marketed follow-on equity offering might. Faster Implementation and Greater Flexibility Typically an ATM or equity line facility takes two to three weeks to negotiate and implement. Relative to other financing options, this short timeline saves valuable management time and resources. Once an ATM facility or equity line is in place, management can: Access cash quickly, as and when needed, in an orderly, flexible manner. Precisely match the sources and uses of funds. Raise a substantial amount of capital in a relatively short period of time, if there is sufficient liquidity in its stock. ATMs and most equity line facilities do not require lock-up agreements from the company or its directors, officers or significant stockholders, which are common in traditional followon underwritten offerings, registered direct offerings and PIPEs. ATMs and equity lines also do not restrict companies from pursuing other equity or debt financing, permitting the company maximum flexibility to raise capital through other channels. ATM FACILITIES ATMs are not intended to replace traditional equity financings, since the capacity of an ATM program generally is limited by the company s market liquidity. They are instead intended to provide an attractive supplemental means to access equity capital, particularly in turbulent markets. Since 2001, ATM programs with an aggregate total commitment of approximately $60 billion have been implemented for companies in a wide variety of industries, including: Airlines. Banking and financial services. Biotech and life sciences. Energy and utilities. Natural resources. REITs. Technology. Transportation. More than 110 ATM facilities, exceeding $16 billion in aggregate total commitment, were implemented in 2011 alone. 2

3 Structure, Terms and Mechanics of ATM Facilities ATM facilities enable public companies listed on a US securities exchange to sell, periodically during the term of the facility, newly issued registered equity securities directly to the public, including: Common stock. Preferred stock. American depositary shares (ADSs) and American depositary receipts (ADRs). The securities are sold through a designated broker-dealer, acting as sales agent, at prevailing market prices in response to existing demand in an existing secondary market. Some ATM facilities provide a mechanism under which the broker-dealer may purchase shares from the company as principal on terms to be negotiated between the parties from time to time in a separate agreement. The company is under no obligation to sell any shares and the timing, frequency and terms of sales orders: Are entirely at the discretion of the company. Can be altered (or sales orders revoked before they are executed) by the company at any time, even intraday. The broker-dealer generally executes orders through an electronic communications network (ECN) to preserve anonymity (which helps prevent a negative impact on stock price), but many ATMs also permit the broker-dealer to sell in block trades and to execute private sales. Eligible Companies ATM facilities may be employed by: Public companies that: have equity securities listed on a US securities exchange (for example, the NYSE, NYSE MKT or NASDAQ); and are eligible to register a primary offering of securities on Form S-3. Foreign private issuers (FPIs) that: have equity securities (including ADSs and ADRs) listed on a US securities exchange; and are eligible to register a primary offering of securities on Form F-3. Canadian FPIs that: have a dual listing of equity securities on the Toronto Stock Exchange (TSX) and a US securities exchange; and are eligible to register securities on Form F-10 (under the US/Canadian Multi-Jurisdictional Disclosure System (MJDS)). Closed-end investment companies registered under the Investment Company Act of 1940 (Investment Company Act) that: have equity securities listed on a US securities exchange; and meet the reporting requirements of Form S-3 (and whose securities are qualified to be registered on Form S-3), but are required to use Form N-2 to register their securities. ATM facilities are increasingly being used by non-us companies. A growing number of dual-listed companies in Canada, Hong Kong, Australia and Israel have implemented ATM facilities in the US. Many jurisdictions do not have regulatory systems that permit equity distribution programs equivalent to ATM facilities, so many dual-listed companies take advantage of their US listing to set up an ATM facility in the US. Implementing and Maintaining ATM Facilities To implement an ATM facility, a company must have an effective shelf registration statement on Form S-3 that complies with Rule 415(a)(4) under the Securities Act of 1933 (Securities Act), which applies to at-the-market offerings. The requirement to use Form S-3 applies only to a US company that is not a closed-end investment company. For the registration statement form and other requirements applicable to FPIs and closed-end investment companies, see Eligible Companies. A company may either: File a new shelf registration statement. Use an existing effective shelf registration statement, as long as there is a sufficient amount of shares available to be issued under that shelf registration statement to cover at least the total number of shares (or the full dollar amount) of the company s common stock subject to the ATM facility. If the company is a well-known seasoned issuer (WKSI), it can file an automatic shelf registration statement on Form S-3ASR immediately before signing an ATM sales agreement. The automatic shelf registration statement becomes effective at the time of filing, though the company can delay paying the applicable registration fee until it files with the SEC the prospectus supplement relating to the ATM (which sets out the maximum amount of shares to be sold under the ATM) (see Practice Note, SEC Filing Fees and How to Calculate Them ( us.practicallaw.com/ )). A company using a registration statement on Form S-3 or Form F-3 that has a public float of less than $75 million is subject to certain limitations on the volume of sales permitted under that form. For more information, see Box, Sales Volume Limitations for Certain Smaller Issuers under Form S-3 and Form F-3. Because a broker-dealer is considered an underwriter under the Securities Act with respect to sales deemed to be atthe-market under an ATM facility, it typically conducts preoffering due diligence substantially similar to that performed by underwriters in a firm commitment public offering (see Practice Note, Due Diligence: Securities Offerings ( us.practicallaw.com/ )). After completing due diligence, the company and the brokerdealer enter into a sales (or equity distribution) agreement that gives the company the right to instruct the broker-dealer to sell shares on its behalf during the term of the program. The sales 3

4 SALES VOLUME LIMITATIONS FOR CERTAIN SMALLER ISSUERS UNDER FORM S-3 AND FORM F-3 Under the General Instructions to Form S-3 and Form F-3, a company with common stock listed on a US national securities exchange and a public float of less than $75 million may not sell more than one-third of the aggregate market value of its public float under a Form S-3 or Form F-3 over a period of 12 months, including ATM or equity line sales and any other shelf takedowns. SEC interpretive guidance indicates that if a company is subject to the one-third public float limitation at the time an ATM or equity line agreement is executed, the total amount of securities issuable under the ATM or equity line facility may represent no more than one-third of the company's public float at the time the agreement is executed (Question , Compliance and Disclosure Interpretations: Securities Act Forms). If the company's public float exceeded $75 million at the time the agreement was executed, but later dropped below $75 million, the one-third public float volume restriction: Comes into effect as soon as the Form S-3 registration statement is amended in accordance with Section 10(a) (3) of the Securities Act, which typically occurs when the company files its annual report on Form 10-K. Continues in effect for as long as the company's public float remains below $75 million. (Revisions to the Eligibility Requirements for Primary Securities Offerings on Forms S-3 and F-3, SEC Release No (December 19, 2007)) agreement is very similar to an underwriting agreement for a traditional follow-on public equity offering, with standard: Representations and warranties of the company. Covenants of the company. Conditions to the obligations of the broker-dealer, including the delivery of legal opinions and comfort letters. Indemnification provisions. For more information on equity distribution agreements, see Practice Note, Equity Distribution Agreements: Fundamental Elements ( Once executed, the sales agreement (together with any related company press release) is filed by the company with the SEC under cover of a current report on Form 8-K (Form 6-K for an FPI), which is incorporated by reference into the earlier-filed registration statement covering the ATM. The company also files with the SEC a prospectus supplement to the base prospectus included in the registration statement. The prospectus supplement describes the general terms of the ATM program, including: The plan of distribution. The maximum amount of shares to be sold. The name of the designated broker-dealer sales agent. After all the required documents have been executed, delivered and filed, whenever the company wants to access the equity market, it delivers a notice to the broker-dealer instructing it to sell shares under the parameters set out in that notice, including: The number of shares to be sold or the amount of gross proceeds to be raised. The period during which sales are to be made. The minimum price per share. Any volume restrictions the company wishes to impose. After receiving the notice, the broker-dealer begins selling the shares, often through ECNs or on the stock exchange on which the stock is listed, utilizing the company s existing market liquidity. The brokerdealer sells shares throughout the day, usually in volumes averaging less than 25% of the average daily trading volume for the shares. Limiting the volume of sales in this manner is meant to avoid putting downward pressure on the share price. Sales are often made in ordinary brokered transactions, with no special selling efforts. Generally, an ATM sales agreement or equity distribution agreement does not permit a company to execute sales under the program during blackout periods imposed by the company s insider trading policies, which can vary widely from company to company. Even outside a designated blackout period, a company may possess material non-public information, which would preclude it from selling its securities through an ATM program. For more information about insider trading, see Standard Documents, Summary Memorandum on Insider Trading ( com/ ) and Sample Corporate Policy on Insider Trading ( The company must disclose aggregate sales and commission amounts paid under the ATM facility on at least a quarterly basis either: In a prospectus supplement filed under Rule 424(b) under the Securities Act. If permitted by the ATM sales agreement, in the company s quarterly report on Form 10-Q or annual report on Form 10-K (as applicable). These public disclosure requirements, which are based on informal SEC guidance, are set out in the ATM sales agreement. In some cases, such as with a block trade, the volume or terms of particular sales may be individually material and therefore would require prompt ad hoc disclosure in a prospectus supplement filed under Rule 424(b) (in other words, outside the otherwise fixed quarterly disclosure schedule). While the ATM program is in effect, the broker-dealer will require periodic bring downs of its business and legal due diligence, including bring-down legal opinions, negative assurance letters and comfort letters. The sales agreement usually requires the delivery of these documents on a quarterly (but at least on an annual) basis or upon the occurrence of any material change in the company s business or financial condition. 4

5 Typically, an ATM sales agreement allows the company to terminate the ATM facility at any time, without any termination fees or penalties. Compliance with Securities Exchange Rules The company and its counsel must ensure that the ATM facility is in compliance with the rules and regulations of: The US securities exchange on which the company s securities are listed. For a dual-listed company, the foreign exchange on which its securities are listed. While the specific requirements of foreign exchanges are beyond the scope of this article, foreign exchanges generally have notification requirements, share amount limitations and, in certain cases, pricing restrictions, all of which must be considered when implementing a US ATM program for a dual-listed company. The company must also file any required notification or additional listing application to list the shares to be issued in connection with the ATM facility on the exchange. For example: NASDAQ requires 15-day advance notice for transactions that may result in the issuance of more than 10% of a company s outstanding common stock or voting power (Rule 5250(e)(2) (D), NASDAQ Listing Rules). The NYSE requires the filing of a supplemental listing application for certain transactions that may result in the issuance of common stock (Section 703, NYSE Listed Company Manual). Stockholder Approval Requirements for ATMs under the Exchanges 20% Rules Each of NASDAQ, the NYSE and the NYSE MKT generally requires stockholder approval for a private placement completed at a discount to the greater of book value or market price of an issuer s common stock if the offering may result in the issuance of 20% or more of the issuer s outstanding capital stock or voting power prior to issuance. In general, NASDAQ and the NYSE MKT provide that stockholder approval is not required for a public offering. The NYSE has an exception for any public offering for cash. However, just because the securities are registered on a registration statement filed with the SEC, that does not necessarily make the offering public for purposes of these stock exchange requirements. Registration is just one factor to consider. Even if the offering is registered, it does not assure that the offered securities will be broadly marketed or widely distributed. Generally, ATM programs are considered public offerings under NASDAQ rules if the bulk of the sales are conducted on an agented basis and at-the-market (that is, through a designated broker-dealer, acting as sales agent, at prevailing market prices in response to existing demand in an existing secondary market). Accordingly, a NASDAQ-listed company can sell more than 20% of its outstanding capital stock or voting power in an ATM offering without stockholder approval. It is also possible for a NYSE-listed or NYSE MKT-listed company to sell more than 20% of its outstanding shares in an ATM offering without stockholder approval under NYSE or NYSE MKT rules, though guidance from the NYSE and the NYSE MKT on this topic is limited. For more information on the NASDAQ and NYSE 20% rules, see Practice Notes, NYSE 20% Rule: Stockholder Approval Requirements for Securities Offerings ( com/ ) and NASDAQ 20% Rule: Stockholder Approval Requirements for Securities Offerings ( com/ ). Compliance with Regulation M Each ATM transaction must be analyzed carefully at the outset to determine whether it constitutes a distribution for purposes of Regulation M, which governs the activities of underwriters, issuers, selling security holders, and others in connection with offerings of securities. Regulation M defines a distribution as an offering of securities that is distinguished from ordinary trading transactions both by: The magnitude of the offering. The presence of special selling efforts and selling methods. If an ATM transaction constitutes a distribution, the ATM brokerdealer s ability to publish research reports and engage in market-making activities during the term of the ATM facility may be significantly limited and other restrictions under Regulation M would apply. Regardless of whether an ATM transaction constitutes a distribution, Regulation M also prohibits a brokerdealer from engaging in any stabilization activity in the company s common stock during the full term of the ATM program. Many ATM agreements expressly prohibit the broker-dealer from engaging in any market making, bidding, stabilization or other trading activity with regard to the company s stock (including short sales) if that activity would be prohibited under Regulation M or other anti-manipulation rules under the Securities Exchange Act of 1934 (Exchange Act). ATMs and FINRA Rule 5110 The Financial Industry Regulatory Authority (FINRA) must review and approve the underwriting compensation and other arrangements in certain registered offerings, including offerings under an ATM facility. Sales of securities in an offering that requires a filing with FINRA under FINRA Rule 5110 may proceed only after FINRA has issued a no objections letter relating to the underwriting terms and other arrangements. For a description of the exemptions available under FINRA Rule 5110, see Box, FINRA Rule 5110 Filing Exemptions. In an ATM transaction, FINRA s same-day clearance option can be used to obtain a FINRA no objections letter within 24 hours of the FINRA filing, so that sales under the ATM may occur promptly after the program is established. Even if a FINRA filing is not required in an ATM transaction, the substantive requirements of FINRA Rule 5110 still apply. 5

6 FINRA RULE 5110 FILING EXEMPTIONS A FINRA Rule 5110 filing exemption is available if both: The company: has been subject to the reporting requirements of Section 12 or Section 15(d) of the Exchange Act for at least 36 calendar months; is current in its Exchange Act reporting obligations; and has registered the offering with the SEC on Form S-3 (or Form F-3 for an FPI). The company's public float is either: at least $150 million for a company using Form S-3 (or $300 million for a company using Form F-3); or between $100 million and $150 million and the company's common stock has had an annual trading volume of at least 3 million shares. A FINRA filing exemption is also available for offerings of securities by FPIs organized under the laws of Canada or any Canadian province or territory: Registered on Form F-10 (under the standards of that form approved in the MJDS adopting release dated June 21, 1991). Offered under Canadian shelf prospectus offering procedures. There is no similar FINRA filing exemption for Form N-2 filings by closed-end investment companies. While guidance from FINRA on the appropriate determination date for determining whether the filing exemption applies is scant, most broker-dealers are of the view that for the exemption to apply, the company must satisfy the relevant requirements both at the time of: The filing of the shelf registration statement for the ATM or public equity line. The execution of the ATM sales agreement or public equity line agreement and the filing of the related prospectus supplement. Accordingly, a FINRA member would be prohibited from participating in an ATM if the compensation arrangements do not comply with the substantive requirements of the rule, whether or not a FINRA filing is required. For more information on the FINRA review process, including sameday clearance, see Practice Note, FINRA and Securities Offerings: The Road to No Objections ( A private placement of shares by the company to the investor, with a subsequent registered public resale of the shares by the investor (a private equity line). In either case, the equity line is structured so that all shares purchased by the investor through the equity line may be publicly resold into the market without restriction. Like ATM facilities, equity lines provide issuers with a relatively fast and flexible means of raising equity capital. The all-in cost of capital tends to be slightly higher for most equity lines than for ATM facilities, but equity lines can offer some advantages compared to ATM facilities and other equity financing options, including: An equity line is a firm commitment by the investor to purchase the company s common stock, unlike an ATM offering, which is usually conducted only on a commercially reasonable efforts agency basis. (In a typical ATM facility, the selling brokerdealer agent is not obligated to purchase any stock for its own account as principal and there are no assurances that any shares will be sold in the market in accordance with the pricing terms set by the company.) Generally the market outs in an equity line agreement are substantially narrower than those in other types of equity financings, including: follow-on underwritten offerings; registered direct offerings; and ATM facilities. With equity lines there are no automatic quarterly and annual management certification requirements or requirements for bring-down legal opinions or comfort letters (which can increase ongoing maintenance costs) like those required under ATM facilities. More than 1,100 equity lines with an aggregate total commitment in excess of $20 billion have been implemented since 2001, with over 125 equity lines exceeding $1.9 billion in aggregate total commitment implemented in Equity lines have been established for companies with market capitalizations ranging from less than $25 million to more than $1 billion in a wide variety of industries, including: Biotech and life sciences. Energy and utilities. Natural resources. REITs. Technology. EQUITY LINES An equity line can be structured either as: A registered public offering by the company, in which the company sells shares to an investor through takedowns off a shelf registration statement (a public equity line). 6

7 Structure, Terms and Mechanics of Equity Lines At the commencement of an equity line transaction, the company and the investor negotiate the terms of the equity line as set out in the written equity line agreement to be executed by the parties. Key terms include: The aggregate dollar amount of the investor s total commitment. The specific amounts the company may draw down at any particular time. The term of the facility, which typically ranges between 18 and 36 months. The number of draw downs the company may make over the term of the facility. The specific pricing mechanics and, if applicable, discount ranges. The conditions that must be satisfied at the time of any draw down. The termination provisions. Equity line terms vary widely among different equity line products. The specific terms of a given equity line depend in large part on the company s market capitalization, the liquidity of its shares and its relative bargaining power. Once the agreement is executed and the equity line facility is in place, the company has the right, but not the obligation, to cause the investor to purchase common stock by submitting to the investor a standard draw down or put notice. Each draw down notice specifies the dollar amount or number of shares the company desires to sell and other pricing-related information. Most equity line products use a forward-looking pricing period to determine the actual purchase price the investor will pay for the shares. The forward-looking pricing period consists of a certain number of trading days following the company s delivery of the draw down notice, typically ranging from five to ten trading days, but sometimes as long as 12 or 15 trading days. Some equity lines use a backward-looking or historical pricing period, consisting of a certain number of trading days preceding delivery of the draw down notice. A backward-looking pricing period enables the company to fix the price of the shares at the time it delivers the draw down notice to the investor. For a discussion of typical forward-looking and backward-looking pricing formulas, see Box, Equity Line Pricing Formulas. In addition, certain equity line products provide for an up-front commitment fee. The fee, usually payable in shares of common stock, typically ranges between 1% and 5% of the investor s total commitment under the equity line. Maintenance of Equity Lines Similar to the SEC s position regarding sales agents for ATM facilities, the SEC takes the position that a private investor in an equity line is a statutory underwriter for purposes of the Securities Act. Accordingly, the investor is subject to underwriter liability in connection with its resale of equity line shares (see Practice Note, Liability Provisions: Securities Offerings ( com/ )). As a result, in an equity line transaction, before each draw down the investor and its counsel typically conduct preoffering due diligence substantially similar to that performed by an underwriter in a firm commitment public offering (or a registered broker-dealer acting as a sales agent in an ATM offering). Compliance with Securities Exchange Rules As in the case of an ATM facility, the company and its counsel must ensure that the terms of the equity line comply with the rules and regulations of: The US securities exchange on which the company s securities are listed. For a dual-listed company, the foreign exchange on which its securities are listed. The company must comply with the same requirements of US and foreign exchanges applicable to ATM facilities, including: Prior notification and additional listing application requirements for US exchanges. Share amount limitations and pricing restrictions, if applicable, for foreign exchanges. Stockholder Approval Requirements for Equity Lines under the Exchanges 20% Rules US national securities exchanges, including NASDAQ, treat both public equity lines and private equity lines as private offerings subject to stockholder approval requirements. Accordingly, unless the equity line is at market under the listing maintenance rules of the applicable securities exchange, a company may not issue more than 20% of its outstanding common stock or voting power through an equity line without prior stockholder approval. (To be considered at market under applicable NASDAQ listing maintenance rules, the average purchase price (taking into account any market discount) for all shares issued under the equity line must exceed the greater of book or market value of the common stock measured at the time the equity line agreement is executed (not at the time of any particular draw down). (Market value for NASDAQ purposes is the last consolidated closing bid price for the company s common stock immediately prior to execution of the equity line agreement; it is unclear whether the NYSE or the NYSE MKT would apply the same analysis as NASDAQ in determining whether an equity line is at market.)) Because equity line pricing formulas are based on share prices to be measured during future pricing periods (see Box, Equity Line Pricing Formulas), the precise number of securities issuable under an equity line cannot be calculated at signing. Accordingly, to ensure compliance with the exchanges 20% stockholder approval rules, most equity line purchase agreements provide that the investor s total equity line commitment is subject to the limitation that no more than 19.99% of the company s outstanding common stock or voting power (measured at the time the equity line agreement is executed) may be issued through the equity line without stockholder approval. 7

8 EQUITY LINE PRICING FORMULAS Forward-looking Pricing Formulas Many equity lines with forward-looking pricing formulas provide that the purchase price for a given draw down is based on a simple discount to the forward-looking daily volume weighted average price (VWAP) of the company's common stock for each trading day during the forward-looking pricing period on which the VWAP exceeds a designated threshold (floor) price. If the daily VWAP of the company's common stock falls below the threshold price on any trading day during the pricing period, the investor is not required to purchase the pro rata portion of the aggregate requested draw down amount allocable to that particular day. Market discounts typically range from 3% to 15%, though they vary widely among equity line products. Certain equity line products may provide that the purchase price is based on a discount to the average of the lowest VWAPs or closing prices of the company's stock over only a portion of the forward-looking pricing period. For example, the formula may look to either: The three lowest VWAPs or closing prices over a ten-, 12- or 15-trading day forward-looking pricing period. The lowest VWAP or closing price on any trading day during the pricing period. Backward-looking Pricing Formulas Some equity lines with backward-looking pricing formulas provide that the actual price at which the investor purchases the shares in a given draw down is based on the lower of: The average of the lowest closing prices of the company's stock over a certain number of trading days (for example, three trading days) during the ten-, 12- or 15-days preceding the date of delivery of the draw down notice. The lowest trade price on the date of delivery of the draw down notice. Avoiding Section 16 Insider Status and Beneficial Ownership Reporting Requirements Because the private investor in an equity line is purchasing shares as principal, equity line agreements also typically include a beneficial ownership limitation designed to prevent the issuer from becoming a Section 16 insider. The limitation provides that the investor is not required to make any purchase under the equity line that would cause the investor s beneficial ownership of the company s outstanding common stock to exceed 9.9% at any time. Becoming a Section 16 insider would significantly restrict the investor s ability to trade the shares it purchases under the equity line because the investor would be: Required to file reports under Section 16(a) of the Exchange Act (see Practice Note, Section 16 Reporting: Why, How and When to Do It ( Subject to the short swing profit disgorgement rules under Section 16(b) of the Exchange Act (see Practice Note, Section 16(b) Short-swing Profit Liability: The Perils of Turning a Quick Profit ( Some investors may also impose a beneficial ownership limitation of 4.9% to avoid the potential obligation to file beneficial ownership reports under Section 13(d) or 13(g) of the Exchange Act (see Practice Note, Section 13(d) Beneficial Ownership Reporting ( Compliance with Regulation M As with an ATM program, the parties to an equity line must comply with Regulation M to the extent applicable. Accordingly, most equity line agreements prohibit the investor from engaging in short sales during the term of the facility. Many equity line agreements also prohibit the investor from engaging in hedging and price stabilizing activities during the term of the facility. Public Equity Lines A public equity line is a registered public offering by the company in which draw downs are executed through takedowns off a shelf registration statement. In many ways, a public equity line is structured as a hybrid of an ATM and a registered direct offering (see Article, Registered Direct Offerings: Overview ( us.practicallaw.com/ )). The SEC treats public equity lines as at-the-market equity offerings subject to Rule 415(a)(4) under the Securities Act. Similar to an ATM facility, a public equity line may be employed by: US public companies that: have equity securities listed on a US securities exchange; and are eligible to use a Form S-3 shelf registration statement. FPIs that: have common equity listed on a US securities exchange; and are eligible to use Form F-3. Canadian FPIs that: have a dual-listing on the Toronto Stock Exchange (TSX) and a US securities exchange; and are eligible to use Form F-10 under the MJDS. Certain closed-end investment companies registered under the Investment Company Act that: have equity securities listed on a US securities exchange; and meet the reporting requirements of Form S-3 (and whose securities are qualified to be registered on Form S-3), but are required to use Form N-2 to register their securities. As with ATMs, a company with a public float of less than $75 million is subject to certain limitations on the volume of sales permitted under that form (see Box, Sales Volume Limitations for Certain Smaller Issuers under Form S-3 and Form F-3). 8

9 The due diligence, document preparation and SEC registration process involved in implementing a public equity line are substantially similar to those involved in establishing an ATM program. Also similar to an ATM program, the company must disclose the purchase price, the amount of securities sold and the net proceeds to the company on at least a quarterly basis either: In a prospectus supplement filed under Rule 424(b) under the Securities Act. If permitted by the equity line agreement, in the company s quarterly report on Form 10-Q or annual report on Form 10-K (as applicable). As with an ATM, in some cases the volume or terms of particular sales may be individually material and therefore require prompt ad hoc disclosure in a prospectus supplement filed under Rule 424(b) (in other words, outside the otherwise fixed quarterly disclosure schedule). Unlike private equity lines, with a public equity line there are no prohibitions on: Renegotiation of the terms. Amendments. Waivers. The ability of the investor to make investment decisions from time to time. Accordingly, public equity line products can be structured to be extremely flexible and may permit the parties, on mutual agreement, to modify the pricing terms in the equity line agreement or in a particular draw down notice, including by: Shortening the pricing periods. Changing the threshold prices. Modifying the size of permissible draw downs. These modifications may be made from time to time as desired, even during a draw down pricing period. A public equity line product may also provide that in addition to the mandatory draw down amount the company desires to sell to the investor at a given time, the company may designate an additional dollar amount of shares that the investor may purchase at its option. Public Equity Lines and FINRA Rule 5110 Though public equity line investors typically are not FINRA members or registered broker-dealers subject to FINRA s rules, the filing requirements under FINRA Rule 5110 apply to a public equity line if a FINRA member is participating in the transaction (for example, as a placement agent or a finder). For a discussion of the FINRA Rule 5110 filing requirement and available exemptions in the context of ATM offerings, see ATMs and FINRA Rule 5110 and Box, FINRA Rule 5110 Filing Exemptions. If no FINRA filing exemption is available, FINRA members are prohibited from participating in the public equity line unless the appropriate filing is made and FINRA has delivered a no objections letter relating to the compensation. As with an ATM, FINRA s same-day clearance option can now be used in a public equity line transaction to obtain a no objections letter within 24 hours of the FINRA filing. Even if a FINRA filing is not required, the substantive requirements of FINRA Rule 5110 still apply to any FINRA member participating in the transaction. Accordingly, a FINRA member is prohibited from participating in a public equity line to the extent its compensation does not comply with the substantive requirements of Rule 5110, regardless of whether a FINRA filing is required. Private Equity Lines A private equity line is a private placement of shares by the company to the investor, with a subsequent registered public resale of the shares by the investor. It is structured very much like a PIPE, except with delayed draw downs instead of a one-time sale. After the transaction documents for the private equity line have been executed, the company files a resale registration statement with the SEC covering the investor s future resales of the shares the company may issue to it under the equity line facility. Once the resale registration statement is declared effective by the SEC, the company can start exercising draw downs under the equity line. Guidance issued by the SEC s Division of Corporation Finance states that private equity lines are differentiated from PIPEs by: The delayed nature of the private equity line draw downs. The lack of market risk resulting from equity line pricing formulas. Accordingly, the SEC analyzes a private equity line as a so-called indirect primary offering. Even though it is analyzed as a kind of primary offering, the SEC permits a company to register the investor s public resales of the equity line shares before the company actually exercises any draw downs, as long as the transaction meets all of the following conditions: The company must have completed the private placement of all of the securities it is registering for resale before it can file the resale registration statement. The resale registration statement must be on a form that the company is eligible to use for a primary offering. The investor must be named as an underwriter and a selling stockholder in the prospectus. For the private placement to be considered complete, the investor must be irrevocably bound to purchase all of the equity line shares. This means that: Only the company can have the right to exercise a draw down. Except for conditions outside the investor s control, the investor must be irrevocably bound to purchase the securities once the company exercises a draw down. (Question , Compliance and Disclosure Interpretations: Securities Act Sections.) 9

10 A private equity line purchase agreement must be drafted carefully to ensure compliance with SEC guidance in this area. The investor cannot have the ability to make any investment decisions after the filing of the resale registration statement for a private equity line. Examples of provisions that may permit the investor to make an investment decision include: A due diligence out. The right to acquire additional securities through conversion or exercise of derivative securities, including warrants or convertible preferred stock. The right to determine when or at what price the securities underlying a draw down may be purchased. Termination provisions that have the effect of causing the investor to no longer be irrevocably bound to purchase the draw down securities. Accordingly, unlike a public equity line, a private equity line cannot permit any amendment or waiver of any terms or conditions of the equity line after the resale registration statement has been filed with the SEC. In addition, if the investor is permitted to transfer its obligations under a private equity line, the investor may not be deemed irrevocably bound under the equity line and, therefore, the transaction may not be considered complete for purposes of the SEC s guidance on this topic. Accordingly, any provision in the equity line documents suggesting that the investor s obligations under the equity line can be assigned to a third party (other than an affiliate of the investor) is problematic. Customary conditions to the settlement of any draw down (for example, bring downs of standard representations and warranties and customary clauses regarding no material adverse changes) will not be deemed to be conditions within the investor s control that would prevent the private transaction from being completed. However, the investor must not be able to delay the company s ability to deliver a draw down notice by requiring the company to comply with any certification requirements or due diligence obligations. Form S-3 and Form F-3 Sales Volume Limitations Because the SEC views private equity lines as indirect primary offerings, a company may use Form S-3 or Form F-3 to register the resale of equity line shares only if the company is eligible to use that form on a primary basis. Accordingly, a company with common stock on a US national securities exchange and a public float of less than $75 million may not register for resale equity line shares in excess of one-third of its public float on a Form S-3 or Form F-3 over a period of 12 months (see Box, Sales Volume Limitations for Certain Smaller Issuers under Form S-3 and Form F-3). The one-third cap is measured as of the execution of the private equity line agreement and applies to both: The investor s maximum dollar commitment under the private equity line facility. The maximum number of securities issuable under the equity line. Because the sale of all the securities to the investor is deemed to occur when the company and the investor execute the private equity line agreement, the company and the investor must determine at that time whether the maximum number of securities issuable under the equity line complies with the one-third cap (Question , Compliance and Disclosure Interpretations: Securities Act Sections). Availability of Form S-1 for Private Equity Lines One advantage of private equity lines over public equity lines and ATMs is that a public company with common stock listed on a US national securities exchange or the OTC Bulletin Board may establish a private equity line under a Form S-1 or Form F-1 registration statement if it is ineligible to use Form S-3 or Form F-3 (or has temporarily lost its Form S-3 or Form F-3 eligibility). (By contrast, companies cannot conduct ATMs or public equity lines on Form S-1 or Form F-1. This is because, under Securities Act Rule 415, companies may not use Form S-1 or Form F-1 to engage in a primary securities offering on a delayed basis or at-the-market.) The option of filing on Form S-1 or Form F-1 means that a private equity line may appeal to a company that is subject to the one-third public float limitation of Form S-3 or Form F-3 but that requires substantially more equity financing. This is because for a private equity line on Form S-1 or Form F-1, the maximum dollar commitment set out in the private equity line agreement need not be limited to one-third of the company s public float. While the number of shares that may be registered under any single Form S-1 resale registration statement is limited to onethird of the company s public float shares as of the Form S-1 filing date, if a private equity line agreement includes a maximum dollar commitment over one-third of the dollar value of the company s public float, the company may use successive Form S-1 resale registration statements to register the private equity line shares. Based on SEC guidance, the SEC will permit a company to register another tranche of shares for resale by the investor on the later of the date that is: 60 days after the investor has resold substantially all of the shares that were previously registered. Six months after the effective date of the prior registration statement. Private Equity Lines and FINRA Rule 5110 Offerings exempt from SEC registration under any of the following provisions are exempted from both the filing and substantive requirements of FINRA Rule 5110: Sections 4(a)(1), 4(a)(2) or 4(a)(6) of the Securities Act. Rule 504 (if the securities are restricted securities under Rule 144(a)(3)), 505 or 506 of Regulation D under the Securities Act. Issuances under most private equity lines are exempt from Securities Act registration requirements under Section 4(a)(2) of, and Rule 506 under, the Securities Act. Accordingly, a FINRA 10

11 Rule 5110 filing typically is not required at the time the private equity line transaction documents are executed, even if a FINRA member has acted as placement agent or finder. However, FINRA members do have certain FINRA notification requirements in connection with private placements that may apply in the context of a private equity line (see Practice Note, Section 4(2) and Regulation D Private Placements: FINRA Rule 5123 Requiring Notice Filings for Certain Private Placements ( In addition, FINRA has advised that under certain circumstances, if a FINRA member firm is participating in the registered resale of privately placed equity line shares, it should assess whether it has a FINRA Rule 5110 filing requirement at the time of its participation. Practical Law Company provides practical legal know-how for law firms, law departments and law schools. Our online resources help lawyers practice efficiently, get up to speed quickly and spend more time on the work that matters most. This resource is just one example of the many resources Practical Law Company offers. Discover for yourself what the world s leading law firms and law departments use to enhance their practices. To request a complimentary trial of Practical Law Company s online services, visit practicallaw.com or call Use of PLC websites and services is subject to the Terms of Use ( and Privacy Policy (

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