-------------------------------------------------- | | | NOTE: This bulletin has been superseded | | by a revision as of October 1999. | | Please see | | | | http:/www.sec.gov/offices/corpfin/cfslb3r.htm | | | | - webmaster | | | -------------------------------------------------- DIVISION OF CORPORATION FINANCE SECURITIES AND EXCHANGE COMMISSION Staff Legal Bulletin No. 3 (CF) ACTION: Publication of CF Staff Legal Bulletin DATE: July 25, 1997 SUMMARY: This staff legal bulletin provides the Division of Corporation Finance's views regarding the Section 3(a)(10) exemption from the Securities Act of 1933 registration requirements. Further, this legal bulletin expresses the Division's views regarding the Securities Act resale status of securities that are received in transactions exempt from registration pursuant to Section 3(a)(10). SUPPLEMENTARY INFORMATION: The statements in this legal bulletin represent the views of the staff of the Division. This bulletin is not a rule, regulation, or statement of the Securities and Exchange Commission. Further, the Commission has neither approved nor disapproved its content. CONTACT PERSON: For further information please contact Cecilia D. Blye, Special Counsel, at (202) 942-2900. 1. Overview Section 3(a)(10) 1/ of the Securities Act 2/ is an exemption from Securities Act registration for offers and sales of securities in specified exchange transactions. 3/ Before the issuer can rely on the exemption, the following conditions must be met. 4/ The securities must be issued in exchange for securities, claims, or property interests; they can not be offered for cash. 5/ A court or authorized governmental entity 6/ must approve the fairness of the terms and conditions of the exchange. The reviewing court or authorized governmental entity must: find, before approving the transaction, that the terms and conditions of the exchange are fair to those who will be issued securities; 7/ and be advised before the hearing that the issuer will rely on the Section 3(a)(10) exemption based on the court's or authorized governmental entity's approval of the transaction. Before approval, the court or authorized governmental entity must hold a hearing to approve the fairness of the terms and conditions of the transaction. A governmental entity must be expressly authorized by law to hold the hearing, although it is not necessary that the law require the hearing. The fairness hearing must be open to everyone who is proposed to be issued securities in the exchange. Adequate notice must be given to all those persons. There cannot be any improper impediments to the appearance by those persons at the hearing. The National Securities Markets Improvements Act 8/ includes new Section 18 of the Securities Act. 9/ When a state fairness hearing relates to the registration, or exemption from registration, of securities that are "covered securities" before the hearing, Section 18 preempts the state law authorizing that hearing. An issuer, therefore, cannot use that hearing as a basis for relying on the Section 3(a)(10) exemption for securities that are "covered securities" before the hearing. The Division's views on this matter are discussed more completely on page 7. The Section 3(a)(10) exemption is available without any action by the Division or the Commission. Issuers that are unsure of whether the exemption is available for a specific contemplated transaction may, however, seek the Division's views by requesting a "no-action" position from the Division. This bulletin discusses the issues that commonly arise in those "no-action" requests. The Division believes that, by making its views on these issues more widely known, issuers will better understand when the exemption is available. Also, by making the Division's views more widely known, this bulletin should decrease those situations in which an issuer is uncertain whether the exemption is available for a contemplated transaction. 2. Timing of No-Action Requests The Division will not issue a no-action response concerning a transaction after the fairness hearing has been held. An issuer must, therefore, submit its no-action request before the fairness hearing. If an issuer submits a no-action request very close to the fairness hearing date, the Division may not have adequate time to consider the issues presented and respond before the fairness hearing. 10/ 3. Timing of Security Holders' Votes When an issuer solicits security holders' votes on the transaction before the fairness hearing, it is offering the securities to be issued in the transaction. This solicitation ordinarily requires either registration or an exemption. A practical issue arises because many statutes governing fairness hearings require security holders to vote before the hearing, at a time when the issuer cannot be certain that it will be able to rely on the Section 3(a)(10) exemption. In these situations, the Division has not objected to a vote before the fairness hearing, even though this means an investment decision is made before the fairness hearing. The Division takes this view because the timing is required by the governing statute and, under that statute, the transaction is not effected unless the court or authorized governmental entity approves it. In the Division's view, the issuer should submit to the court or authorized governmental entity the disclosure materials offering the securities before it mails them to the offerees. 4. Division Analysis of the Requirements Underlying the Exemption A. The securities must be issued in exchange for securities, claims, or property interests 11/ This requirement generally does not raise interpretive issues. 12/ However, it is important to note that when options, warrants, or other convertible securities are issued in the Section 3(a)(10) transaction, Section 3(a)(10) does not exempt the later exercise or conversion. This is different than transactions that are exempt under Section 1145 of the U.S. Bankruptcy Code. 13/ Section 1145 specifically exempts the later exercise or conversion from Securities Act registration. 14/ B. A court or authorized governmental entity must approve the exchange's terms and conditions 1. Appropriate authorization for governmental entity approval If a governmental entity is approving the exchange, that entity must be authorized by statute: to hold a hearing on the transaction, although it is not necessary that the statute require the hearing; and to approve the fairness of the exchange's terms and conditions. 15/ In this analysis, the statute must require the entity to conclude affirmatively that the exchange is fair to the security holders participating in the exchange. 16/ For example, the statute must require the governmental entity to conclude that the terms and conditions of the exchange are "in the best interest of shareholders" or "fair" to shareholders, not that the exchange is "not unfair," "not unreasonable," "not prejudicial," or "not counter to the best interest of shareholders." 17/ If there is a question as to whether the statute authorizes the governmental entity to hold a hearing on the transaction and to approve the fairness of the exchange's terms and conditions, it may be clear from the actual practice of the authorized governmental entity. For example, in State Mutual Life Assurance Company (March 23, 1995), the Division relied on an opinion from counsel to the Division of Insurance of the Commonwealth of Massachusetts that the relevant statute authorized the Massachusetts Insurance Commissioner to make the requisite fairness determination. If an issuer intends to rely on the Section 3(a)(10) exemption, it may want to look at prior Division no-action responses and see if the particular statute has ever been the basis for a Division no-action position. If the statute has been the basis for a favorable Division position, the issuer should consider whether the language of the statute has changed since the Division took that favorable position. 2. The effect the National Securities Markets Improvements Act has on exchanges approved by governmental entities Issuers have raised questions on how the recently enacted National Securities Markets Improvements Act affects the scope of the Section 3(a)(10) exemption for transactions approved by governmental entities. New Section 18 of the Securities Act preempts any state from registering "covered securities." When a state fairness hearing relates to the registration, or exemption from registration, of securities that are "covered securities" before the hearing, Section 18 preempts the state law authorizing that hearing. An issuer, therefore, cannot use that hearing as a basis for relying on the Section 3(a)(10) exemption. This preemption does not apply to a fairness hearing procedure relating to securities that are not "covered securities" prior to the hearing, such as securities traded on the Nasdaq SmallCap Market. In this instance, the state law authorizing the fairness hearing would not be preempted, even if it was promulgated under state securities law. Issuers of these SmallCap Market securities could use this fairness hearing as a basis for relying on the Section 3(a)(10) exemption. This preemption also does not apply to fairness hearing procedures that are outside the scope of the state securities laws. For example, it is the Division's view that Section 18 would not preempt a state's corporation, banking, or insurance law that authorizes a fairness hearing procedure if that state law does not relate to registration, or an exemption from registration, of securities. Depending on the circumstances, an issuer may be able to use such a fairness hearing as a basis for relying on the Section 3(a)(10) exemption. 3. Information that must be available to the court or authorized governmental entity when it makes its fairness determination The issuer must advise the court or authorized governmental entity before the hearing that the issuer will rely on the Section 3(a)(10) exemption based on the court's or authorized governmental entity's approval of the exchange. It is the Division's view that the reviewing court or authorized governmental entity making the fairness determination "must have sufficient information before it to determine the value of both the securities, claims or interests to be surrendered and the securities to be issued in the proposed transaction." 18/ 4. Foreign courts It is the Division's view that the term "any court" in Section 3(a)(10) may include a foreign court. 19/ In connection with no-action requests in these situations: all requirements that apply to exchanges approved by U.S. courts must be met; and the issuer must provide the Division with an opinion from counsel licensed to practice in the foreign jurisdiction that says that before the foreign court can give its approval, it must consider the fairness to persons receiving securities in the exchange. 20/ C. Before approval, the court or authorized governmental entity must hold a hearing on the fairness of the exchange; this hearing must be open to everyone who is proposed to be issued securities in the exchange The court or authorized governmental entity must: hold a hearing to determine whether the exchange's terms and conditions are fair to all those who will receive securities in the exchange; and approve the fairness of the terms and conditions of the exchange. 21/ The hearing must be open to everyone who is proposed to receive securities in the exchange. The issuer must provide appropriate notice of the hearing in a timely manner. 22/ Section 3(a)(10) does not specify the information that must be included in the required notice. Although the anti-fraud requirements of the federal securities laws would govern disclosure, the Division does not address the adequacy or appropriateness of the information provided to persons who have a right to appear at the meeting. In connection with no-action requests, the Division will consider the adequacy of the notice only to the extent that it: adequately advises those who are proposed to be issued securities in the exchange of their right to attend the hearing; and gives them the information necessary to effect that right. An issuer that intends to rely on the Section 3(a)(10) exemption should consider whether, as a practical matter, imposing prerequisites to appearance will prevent those persons from having a meaningful opportunity to appear at that hearing. 23/ 5. Resale Status of Securities Received in a Transaction Exempt from Securities Act Registration Pursuant to Section 3(a)(10) In the Division's view, holders must resell securities received in Section 3(a)(10)-exempt exchanges in the manner permitted by Securities Act Rule 145(c) and (d). 24/ These Rule 145(c) and (d) resale limitations apply only to holders that were affiliates of any party to the exchange at the time of the Section 3(a)(10)-exempt sale. Generally, Rule 145(d) provides three appropriate methods for unregistered resales by these holders: resales that meet all of the Rule 144 requirements, except for the holding period and notice filing requirements (Rule 145(d)(1)); resales by persons who are not affiliates of the issuer and have held the securities for at least one year from the date of the Section 3(a)(10)-exempt transaction without regard to Rule 144, except for the current public information requirement (Rule 145(d)(2)); and resales by persons who are not, and for the last three months have not been, affiliates of the issuer and have held the securities for at least two years from the date of the Section 3(a)(10)-exempt transaction without regard to Rule 144 (Rule 145(d)(3)). It is the Division's view that securities received in a Section 3(a)(10)-exempt transaction may be resold in the following manner: 1. Persons may resell their Section 3(a)(10) securities without regard to Rules 144 or 145(c) and (d) if they: a) are not affiliates of any party to the transaction before the transaction; AND b) are not affiliates of the issuer of the Section 3(a)(10) securities after the transaction. 2. Persons may resell their Section 3(a)(10) securities in the manner permitted by Rule 145(d)(1), (d)(2), or (d)(3) if they: a) are affiliates of any party to the transaction before the transaction; BUT b) are not affiliates of the issuer of the Section 3(a)(10) securities after the transaction. 25/ 3. Persons may resell their Section 3(a)(10) securities in the manner permitted by Rule 145(d)(1) if they: a) are affiliates of any party to the transaction; AND b) are affiliates of the issuer of the Section 3(a)(10) securities after the transaction. The resale provisions of Rule 145(d)(2) or (d)(3) would not be available to this third group because Rule 145(d)(2) and Rule 145(d)(3) are not available to affiliates of the issuer of the Section 3(a)(10) securities. _______________________________ 1/ 15 U.S.C. 77c(a)(10). Section 3(a)(10) reads as follows: Except with respect to a security exchanged in a case under title 11 of the United States Code, any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court or by any official or agency of the United States or by any State or Territorial banking or insurance commission or other governmental authority expressly authorized by law to grant such approval. 2/ 15 U.S.C. 77a et seq. 3/ The Trust Indenture Act of 1939 does not include an exemption that is the equivalent of Section 3(a)(10) of the Securities Act. If an issuer is relying on Section 3(a)(10) to offer and sell debt securities without Securities Act registration, it should note that the Trust Indenture Act would still apply to that offering. 4/ The staff derives these conditions from the language of Section 3(a)(10) and positions expressed by the Commission in Securities Act Release No. 312 (March 15, 1935) [11 FR 10953]. 5/ Section 3(a)(10) also exempts sales of securities that are "partly in such exchange and partly for cash...". It is the Division's view that Section 3(a)(10) exempts transactions that are predominantly exchanges and that the "partly for cash" language is intended merely to permit flexibility in structuring those exchanges. The Division has not received no-action requests that raise the issue of whether the exchange is truly an exchange or whether the level of cash involved changes its nature. Because this analysis necessarily would be very fact specific, the Division is not able to give specific guidance on the issue in this staff legal bulletin. To the extent the issue is presented in a transaction, an issuer may wish to request the staff's views on that particular transaction. 6/ Authorized governmental entities may include state insurance commissions, state corporation or securities commissions, state banking agencies, etc. 7/ In the Division's view, the reviewing court or authorized governmental entity must find the terms and conditions of the exchange to be fair both procedurally and substantively. 8/ Pub. L. No. 104-290 (1996). 9/ "Covered securities" are defined in Section 18 of the Securities Act. They include, among others, securities listed or approved for listing on the New York Stock Exchange, the American Stock Exchange, or the Nasdaq National Market System. 10/ Generally, the Division responds to requests for no-action within 30 days of receipt. It makes every effort to satisfy the time schedule of the requestor, but may not be able to meet a very short deadline. 11/ For a discussion of exchanges that are "partly for cash," see footnote 5. 12/ Despite the "exchange" requirement of Section 3(a)(10), the Division has not objected to the issuance of shares as attorneys' fees without registration in reliance on the Section 3(a)(10) exemption, so long as those securities amount to no more than one-third of the securities issued in the settlement. See e.g., Sulcus Corp. (June 19, 1996); The Score Board (November 3, 1995); Aura Systems, Inc. (July 8, 1994). 13/ 11 U.S.C. 1145. 14/ See e.g., Allied Leisure Industries, Inc. (October 4, 1979) and Canadian Conquest Exploration, Inc. (April 6, 1989). 15/ Where an issuer will use court approval as a basis for relying on the Section 3(a)(10) exemption, the court also must make this finding. It is not necessary, however, that the court be expressly authorized by statute to do so. See Securities Act Release No. 312 (March 15, 1935). See also the discussion in the Foreign Courts subsection of this bulletin for the requirements for a foreign court to approve the exchange. 16/ In 1938, the staff of the Commission stated its view that: [A] commission or authority must be authorized to grant approval of the fairness of the terms and conditions of the issuance and exchange, from the point of view of the persons to whom the securities are issued in the exchange, and this authority must be express. This seems to be the proper interpretation if the requirement of a hearing upon the fairness of the terms and conditions is not to be rendered meaningless. As a result many commissions, such as public service commissions, whose authorization may be required for the reorganization of certain companies, will be found not to have the requisite authority because [they are] not authorized to pass upon the interest of the security holders. (emphasis added) Milton V. Freeman, A Summary of Administrative Interpretations of the Securities Act of 1933, As Amended at 280-81 (draft of May 1, 1938) (citations omitted). This position was restated in the Report of the Task Force on Disclosure Simplification (March, 1996) (the "Task Force Report"). 17/ Examples of appropriate statutory standards in favorable Division responses to no-action requests include requirements that the entity determine that the transaction: (1) "adequately protects the interests of depositors, other creditors and shareholders" (Minowa Bancshares, Inc., November 26, 1990); (2) be "fair and equitable" to shareholders (Farm Family Mutual Insurance Co., April 2, 1996); (3) promotes the "public convenience and advantage and the interest of [the merging] institutions, their members, stockholders and depositors" (CFX Corp., April 19, 1996); and (4) "is such that an intelligent and honest man, a member of the class concerned and acting in respect of his interest, might reasonably approve" (The Hongkong and Shanghai Banking Corporation Ltd., January 23, 1991). 18/ See Task Force Report at page 60. See also Information Resources, Inc. (February 27, 1995); Applied Magnetics Corp. (May 30, 1995); and Gensia Inc. (June 23, 1995). 19/ See e.g., Lucas Industries plc (August 20, 1996); Symantec Corp. (November 22, 1995); Orbital Sciences Corp. (October 13, 1995); Minera Andes, Inc. (September 21, 1995); Cadillac Fairview, Inc. (May 26, 1995); LAC Minerals Ltd. (June 27, 1991); The Hongkong and Shanghai Banking Corporation Ltd. (January 23, 1991). 20/ The Division requires this additional opinion because the fairness standard in foreign jurisdictions often is derived from case law that interprets and applies the statute(s), rather than from the specific language of the statute(s). The opinion of foreign counsel should state clearly that: under applicable law, the court cannot approve the exchange unless it finds the transaction to be fair to the persons who will receive the securities; those persons will receive notice of, and have the right to appear at, the fairness hearing; and the issuer will advise the court before the hearing that it will rely on the Section 3(a)(10) exemption and not register the exchange under the Securities Act based on the court's approval of the exchange. 21/ As noted in footnote 7, we believe that the reviewing court or authorized governmental entity must find both the terms of and procedures for the exchange to be fair. 22/ For example, if the securities are held in bearer form there must be appropriate publication of the notice. 23/ The Division has not objected to the mere requirement to file a notice of an intention to appear. For examples of favorable staff responses to no-action requests where the filing of a notice of an intention to appear was required, see Digicon Inc. (August 19, 1996); Canadian Pacific Ltd., (June 26, 1996); Cadillac Fairview, Inc., (May 26, 1995). 24/ The Division initially expressed these positions in the no- action response to St. Ives Holding Company, Inc. (July 22, 1987) and continues to follow them in its analysis of these issues. The Commission recently proposed to eliminate the resale limitations of Rule 145(c) and (d). If this proposal is adopted, the staff's position regarding resale conditions will be reassessed. 25/ In computing the holding period of the Section 3(a)(10) securities for purposes of Rule 145(d)(2) or (d)(3), such persons may not "tack" the holding period of the securities exchanged for the Section 3(a)(10) securities in the Section 3(a)(10)-exempt transaction.