An SEC comment letter exchange recently made public serves as a helpful reminder to consider Section 5 of the Securities Act when structuring a PIPE (private investments in public equity) transaction.  In a PIPE, a public company issues securities to one or more accredited investors in a private placement exempt from registration pursuant to Section 4(a)(2) of the Securities Act of 1933, or the safe harbor thereunder provided by Regulation D.  Since the securities in a PIPE offering are initially “restricted securities” within the meaning of the Securities Act, investors cannot freely resell their securities until a holding period under Rule 144 has lapsed or a registration statement has been filed.

PIPE transactions often include registration rights whereby the issuer agrees to file a resale registration statement with the SEC within an agreed-upon period.  The crux of the Section 5 issue in PIPEs often hinges on the timing of the investment decision in the private offering, including whether commitments are in place from all investors, subject only to conditions outside their control so that there is no further investment decision after the filing of the registration statement, and the investors have market risk at the time that the resale registration statement is filed.   In other words, the “sale” in the private offering is completed prior to filing the registration statement. As discussed in the comment letter exchange below, other related factors include whether the private offering closes prior to, or after, the filing of the registration statement and when the shares to be resold were actually issued to the purchaser.

When a PIPE resale registration statement is not viewed as a valid secondary offering, you have a “burst PIPE,” and the entire transaction would be treated as an indirect primary offering by the issuer, with the investor being identified in the registration statement as an “underwriter” and Form S-3 only being available if the company is eligible to use that Form for a primary offering. (See C&DI 139.11)  Being named an underwriter increases the liability exposure for the PIPE investor because underwriters are liable for material misstatements and omissions in the registration statement under Section 11 of the Securities Act, subject to a due diligence defense.  Also, while it is quite common for companies that are not S-3 eligible to conduct a PIPE transaction, the benefit of Form S-3, aside from speed given it is a short-form registration statement, is that the resale may occur at market prices, whereas a primary offering on Form S-1 requires a fixed price to be set.  The distinction between a primary offering and a resale transaction is extremely important in the SEC’s administration of Rule 415, as a resale transaction (often also referred to as a “secondary” transaction) may be made on a shelf basis regardless of the form on which it is registered (Rule 415(a)(1)(i)), while a primary offering may be made on a delayed, episodic, or “at-the-market” basis only if it is eligible to be registered as a primary offering on Form S-3 (Rule 415(a)(1)(x)).  Note in the comment letter exchange below, the SEC staff does not allege a burst PIPE or advise the issuer that the entire transaction should be treated as an indirect primary offering; instead, the Staff asks the issuer to withdraw and refile once the private offering is completed.

For background reading with respect to the SEC interpretive guidance in this area, see Securities Act Section C&DI’s 134.01, 139.06, 139.10 and 139.11, which are repeated at the end of this blog for ease of reference.

SEC Comment Letter — PIPE Transactions with Auto-Adjustment Provisions

The comment letter exchange relates to a Form S-1 filed by Genprex, Inc. to register the resale by selling stockholders of shares that were issued in a private placement. According to the prospectus cover page, the Form S-1 was registering the resale of:

1. Up to 2,352,940 shares of common stock, of which (a) 828,500 shares were issued to the selling stockholders in the private placement and (b) up to 1,524,440 additional shares may be issued to the selling stockholders pursuant to the terms of the private placement.
2. Up to 2,283,740 shares of common stock issuable upon exercise of warrants to purchase common stock that were issued to the selling stockholders in the private placement, of which (a) 621,376 shares are issuable upon the exercise of warrants issued in the private placement and (b) up to 1,662,364 additional shares may be issuable upon the exercise of such warrants pursuant to the terms of the private placement.

Of particular interest to the SEC Staff was an auto-adjustment provision in the PIPE transaction documents, which provided that the per share purchase price of the shares and warrants would be automatically adjusted based on the volume weighted average daily prices on the three trading days after the date (1) the registration statement is declared effective, and (2) the stockholders approve the private placement.  Following any such adjustment to the shares or warrants, the issuer was obligated to issue new shares in proportion to the adjustment.

First SEC Staff Comment and Genprex Response

The comment below (a link to the response letter is here) was issued by the Staff in its first letter to the issuer, followed with the issuer’s response:

1. Please note that the selling stockholders must be irrevocably bound to purchase a set number of securities for a set purchase price at the time of filing the resale registration statement subject only to the effectiveness of the registration statement or other conditions outside their control. In addition, the selling stockholders must be at market risk at the time that the resale registration statement is filed. The purchase price cannot be contingent on the market price at the time of effectiveness of the resale registration statement or at any subsequent date. In this regard, we note:
   • The per share purchase price of the shares and the per share exercise price of the warrants will automatically be adjusted based on the market price after the date that (i) a registration statement covering the resale of the securities issued in the private placement is declared effective by the SEC and (ii) your stockholders approve the private placement.
   • Following any adjustment of the per share purchase price of the shares, you will issue additional shares in proportion to such adjustment, and following any adjustment to the per share warrant exercise price, the number of warrant shares that may be issued pursuant to each warrant will be proportionately increased.
   • Another adjustment to the per share purchase price of the shares and the per share exercise price of the warrants will occur on the date that shares may be sold pursuant to Rule 144 if all of the shares issuable pursuant to the purchase agreement are not included in this resale registration statement.

For these reasons, it appears that the private placement of the shares and warrants was not complete at the time this resale registration statement was filed. Please withdraw and refile once the private placement has been completed. For guidance, please refer to Securities Act Sections Compliance and Disclosure Interpretations Question 134.01.

Response:

We respectfully submit that the requirements of CD&I Question 134.01 were met at the time of the closing of the offering because all consideration was paid, and the investors’ final investment decision was made, on May 9, 2018. The subsequent adjustment to the number of shares does not require any new consideration to be paid, or investment decision on the part of the investors. The investment amount for the securities is fixed and was fully paid at the time of the closing on May 9, 2018 and not subject to change or adjustment at a later date. Accordingly, the investors’ full subscription amount was at market risk at the time of the filing of the registration statement. The issuance of the additional shares, if any, is akin to dilution protection and is addressed under CD&I Question 132.06 which provides that, for purposes of Rule 144, shares acquired pursuant to anti-dilution rights tack back to the original placement of the securities. The justification for the CD&I is that, at the time of the dilution adjustment, the holder is not paying any additional consideration or making any new investment decision. Similarly, in this transaction, the issuance of the shares does not require the payment of any additional consideration or new investment decision and accordingly the investor is fully at market risk at the time of the closing, which was prior to the filing of the registration statement.

Moreover, C&DI question 134.01 addresses the circumstances in which the resale registration statement is filed, or even declared effective, before securities have been sold to the investors. In contrast, the Registration Statement was filed after the May 9, 2018 closing of the private placement.

For the reasons set forth above, we respectfully request that the Staff reconsider its position with respect to Comment No. 1.

Second SEC Staff Comment and Genprex Response

The Staff wasn’t convinced after this first round of comments and as shown in the below exchange re-issued its comment in a second letter to the issuer (a link to the second response letter is here)  The issuer’s response follows.

1. We note your response to our prior comment 1 and reissue. In order for the private placement of the shares to be complete and the selling stockholders to be at market risk, (i) the per share purchase price must be fixed and cannot be subject to adjustment based on the current market price of the common stock and (ii) the selling stockholders must be irrevocably bound to purchase a set number of securities at the time of the filing of the resale registration statement. The fact that the total investment amount is fixed does not therefore fit within the requirements of the accommodation set forth in CDI 139.11 of Securities Act Sections, which requires that the number of securities to be received be set. Further, the investors are not at market risk if the amount of their investment is preserved by receiving additional securities based on the market price on certain future dates. Please withdraw this registration statement and refile once the private placement has been completed.

Response:

Having carefully reviewed the Staff’s comment letters and the applicable Commission rules and Compliance and Disclosure Interpretations (“C&DIs”) referenced therein, we respectfully submit that we do not believe that the requirements articulated in C&DI 134.01 and 139.11 are applicable to the Genprex transaction, for the reasons described below.

1. C&DI 134.01 and 139.11 Do Not Apply to the Genprex Transaction

The requirement articulated in C&DI 134.01 and 139.11 and Securities Act Rule 152 is that the private placement must be completed before the resale registration statement is filed. However, by their terms, C&DI 139.11 and 134.01 apply only to PIPE transactions where the securities to be offered pursuant to the registration statement (or securities convertible into such securities) have not yet been sold or issued to the selling stockholders at the time the registration statement is filed. In contrast, in the Genprex transaction, all of the shares and warrants were sold to the selling stockholders prior to the filing of the resale registration statement. Therefore, C&DI 139.11 and 134.01 do not apply to the Genprex transaction.

C&DI 134.01 and 139.11 address the specific problem caused by a PIPE transaction in which the closing of the private placement does not take place until after the filing of the resale registration statement and is contingent upon the effectiveness of the registration statement. Recognizing that in such a transaction the actual closing takes place after, rather than before, the filing and effectiveness of the resale registration statement, in C&DI 134.01 and 139.11, the Staff has formulated a set of requirements that allow parties to deem such a transaction to have been completed for purposes of Rule 152 at the time the registration statement is filed and before the transaction has actually closed.

In the close-after-effectiveness structure addressed by C&DI 134.01 and 139.11, although a purchase agreement to buy and sell securities is signed before the resale registration statement is filed, no securities have been sold or issued pursuant to the purchase agreement at the time the registration statement is filed. The investors’ obligation to close the transaction is contingent upon the effectiveness of the registration statement. If the registration statement is not declared effective, the closing condition is not satisfied and the investors can decline to close and walk away, with the result that no securities may ever be sold or issued pursuant to the purchase agreement.

In light of this contingency, for a private placement to be deemed “constructively” completed prior to the sale or issuance of securities, C&DI 134.01 and 139.11 require that the investor must be at market risk at the time the resale registration statement is filed. In the context of a transaction where the actual sale or issuance of securities has not yet occurred at the time the resale registration is filed, this requirement means that the investor must be irrevocably bound to purchase the securities, subject only to the effectiveness of the registration statement or other conditions outside the investor’s control, and that the number of securities and the purchase price must be set in the purchase agreement and may not be contingent on the market price at the time of effectiveness of the registration statement or thereafter.

In contrast to the transactions contemplated by C&DI 134.01 and 139.11, the Genprex private placement was actually, rather than constructively, completed before the filing of the resale registration statement. Under the purchase agreement, the investors’ obligation to close was not contingent on the effectiveness of the resale registration statement. Rather, the closing of the transaction took place on May 9, 2018, while the resale registration statement was filed with the Commission on May 22, 2018. At the closing, a specific number of securities were sold and purchased at a specific price set forth in the purchase agreement, the purchase price was paid in full, and the shares and warrants were issued to the investors. The additional securities that may be issued to the investors after the closing as a result of the adjustments set forth in the purchase agreement would not constitute additional sales of securities taking place after the effectiveness of the registration statement. Much like securities issued as a result of conversion rate adjustments applicable to convertible securities, any such additional securities would be issued to the investors for no additional consideration and would not require any additional investment decisions by the investors.

The key difference between the Genprex transaction and the transactions contemplated by C&DI 134.01 and 139.11 is that the Genprex transaction actually closed before the registration statement was filed. If the Genprex registration statement is not declared effective, the investors cannot choose to terminate the purchase agreement and walk away. Nor are the investors entitled to receive a refund of any portion of the purchase price paid by them at the closing. Thus, from and after the closing, the investors are exposed to economic and other risks associated with the Company’s business, including the risk of insolvency or bankruptcy, to the same extent as any other stockholders of the Company. Moreover, the adjustments set forth in the Genprex purchase agreement will not protect the investors in the event the market price of the Company’s common stock declines below $4.25 per share following the closing. In other words, although the investors’ exposure to a potential market price decline is mitigated by the adjustments, it is not completely eliminated.

As a result, the investors were at substantial market risk in respect of their investment as of the closing of the transaction on May 9, 2018. Accordingly, the Genprex private placement was completed prior to the filing of the resale registration statement on May 22, 2018.

2. C&DI 139.10 Applies to the Genprex Transaction

We believe that C&DI 139.10 applies to the Genprex transaction. Unlike C&DI 134.01 and 139.11, C&DI 139.10 contemplates a transaction where all of the securities convertible into the common stock to be sold to the public in the secondary offering are sold to the selling stockholders in a private placement before the filing of the resale registration statement. C&DI 139.10 states that, in such a transaction, the company may file, prior to the conversion, a registration statement for the resale of the common stock issuable upon conversion of the outstanding convertible securities, even if the securities are convertible into common stock using a conversion ratio based on the company’s common stock trading price at the time of conversion.

While C&DI 139.10 does not expressly state that, presumably, the foregoing guidance is based on the Staff’s conclusion that the private placement described in C&DI 139.10 is completed at the time the registration statement is filed, despite the potential subsequent adjustments to the number of shares that may be issued on conversion based on the common stock trading price at the time of conversion. In other words, the possibility of a post-filing adjustment to the number of shares issuable upon conversion does not mean that the private placement is not completed before the filing.

The Genprex purchase agreement contemplates that additional shares may be issued to the investors after the closing based on the market price of the Company’s common stock after the date the resale registration statement becomes effective. Similar to adjustments to the conversion ratio of convertible securities based on the company’s common stock trading price at the time of conversion, as contemplated by C&DI 139.10, any additional securities that may be issued to the investors under the Genprex purchase agreement would be issued to them for no additional consideration and would not require additional investment decisions by the investors, as noted above. Thus, we believe that the Genprex transaction is similar to the transaction contemplated by C&DI 139.10, and therefore, the Genprex private placement was completed at the time the resale registration statement was filed.

3. Resale Registration Statement Was Recently Declared Effective in a PIPE Transaction with a Similar Structure

We are aware of at least one resale registration statement that was recently declared effective by the Commission in connection with a PIPE transaction with a structure virtually identical to the Genprex transaction. On March 22, 2018, Arcadia Biosciences, Inc. issued shares of its common stock and warrants to purchase shares of its common stock to certain investors in a private placement pursuant to a securities purchase agreement dated as of March 19, 2018. Pursuant to the purchase agreement, the number of shares of common stock issued to the investors and the exercise price of the warrants were subject to adjustment based on the market price of Arcadia’s common stock after a resale registration statement was declared effective by the Commission. Arcadia filed a resale registration statement on March 30, 2018, and it was declared effective by the Commission on April 23, 2018.

In structuring the Genprex transaction and preparing the resale registration statement, the parties to the Genprex transaction were aware of the Arcadia transaction and were guided by the terms and conditions thereof. In particular, the purchase price adjustment provisions contained in the Genprex purchase agreement are virtually identical to those in the Arcadia transaction.

For the reasons set forth above, we respectfully request that the Staff reconsider its position with respect to Comment No. 1.

It appears the SEC staff was comfortable with the issuer’s response after this second round of comments as no follow-up comments were issued, and the S-1 went effective shortly thereafter.

As “bonus content” for those interested in this topic, here is another recent SEC Staff comment letter exchange involving a PIPE transaction (links to the letters are here and here).  In this exchange, the issuer was required to amend its Stock Purchase Agreement in order to, among other things, remove the PIPE investor’s ability to waive certain conditions to the closing and references thereto, which the SEC Staff viewed as giving the purchaser control over the closing conditions and not consistent with C&DI 139.11 (“There can be no conditions to closing that are within an investor’s control or that an investor can cause not to be satisfied.”).

Relevant C&DI’s

Securities Act Section 4(2)
Question 134.01 (same as 139.06).

Question: Can a registration statement for a secondary offering be filed if the securities to be offered pursuant to the registration statement have not yet been sold to the selling security holders?

Answer: No. When the primary sale will be made in reliance upon the Section 4(2) exemption, having a registration statement for resale on file before the private offering takes place would cast doubt upon the validity of the exemption because distribution is clearly contemplated. Also, the registration of a secondary offering under such circumstances may call into question whether the offering is a genuine secondary. The resale registration statement may be filed if securities are privately placed, with the closing of the private placement contingent on filing or effectiveness of a resale registration statement. At the time of filing the registration statement, the purchasers in the private placement must be irrevocably bound to purchase the securities subject only to the filing or effectiveness of the registration statement or other conditions outside their control, and the purchase price must be established at the time of the private placement. The purchase price cannot be contingent on the market price at the time of effectiveness of the registration statement. [Nov. 26, 2008]

Securities Act Section 5
Question 139.10

Question: A company privately placed convertible securities in reliance on the exemption provided by Section 4(2). The company agreed to file a registration statement within two months after the private placement closing to register the resale of the common stock issuable on conversion of the convertible securities. The securities were convertible into common stock using a conversion ratio based on the company’s common stock trading price at the time of conversion. Can the company use Form S-3 to register the resale of the common stock prior to conversion? Can the company use Rule 416 to register for resale an indeterminate number of shares that it may issue due to the operation of the conversion formula?

Answer: If the company satisfies the Form S-3 registrant eligibility requirements and the offering satisfies the Form’s secondary offering requirements, the company may use Form S-3 to register, prior to the conversion, the resale of the common stock issuable upon conversion of the outstanding convertible securities. The company may not use Rule 416 to register for resale an indeterminate number of shares resulting from operation of the conversion formula. Rule 416 does not apply by its terms in these circumstances, because the floating conversion rate is not “similar” to an anti-dilution provision. Instead, the company must make a good-faith estimate of the maximum number of shares that it may issue on conversion to determine the number of shares to register for resale. If the number of registered shares is less than the actual number issued, the company must file a new registration statement to register the additional shares, assuming the selling securityholder desires to sell those additional shares. It may use Rule 462(b), if available, for this purpose.

The selling securityholder information in the registration statement, at the time of effectiveness, must include the total number of shares of common stock that each selling securityholder intends to sell (based on current market price if there is a floating conversion rate tied to market price), regardless of any contractual or other restriction on the number of securities a particular selling securityholder may own at any point in time. As the selling securityholders resell shares of common stock following conversion, the company must file prospectus supplements, as necessary, to update the disclosure of the number of shares that each selling securityholder intends to sell, reflecting prior resales. The plan of distribution in the prospectus filed as part of the registration statement must specify, in compliance with Item 508 of Regulation S-K, how each selling securityholder intends to dispose of the securities it receives on conversion. [Nov. 26, 2008]

Question 139.11

Question: A company privately placed convertible securities in reliance on the exemption provided by Section 4(2), but has not yet issued some or all of the convertible securities. The company agreed to file a registration statement within two months after the private placement closing to register the resale of the common stock issuable on conversion of the convertible securities. The securities were convertible into common stock using a conversion ratio based on the company’s common stock trading price at the time of conversion. Can the company use Form S-3 to register the resale of the common stock prior to conversion?

Answer: Unless the transaction involving the issuance of the convertible security meets the conditions under which a company may file a registration statement for resale of privately placed securities before their actual issuance (commonly known as a “PIPE,” or private-investment, public-equity transaction, as discussed below), the registration for resale of the common stock underlying the unissued convertible security would not be viewed as a valid secondary offering. Instead, the transaction would be treated as an indirect offering by the issuer, and thus a primary offering, with the investor being identified in the registration statement as an “underwriter.” In such circumstances, the registration statement may not use the phrase “may be an underwriter.” Instead, the disclosure in the registration statement must state that the investor “is an underwriter.” As a result, the company may register on Form S-3 the resale of the underlying common stock, or the convertible security itself, only if the company is eligible to use that Form for a primary offering. In addition, if the company continues to sell privately additional convertible securities after it has filed the registration statement for the securities underlying the previously sold convertible securities, the continuation of the same offering may call into question the Section 4(2) exemption generally claimed for the entire convertible securities offering.

In a PIPE transaction, a company will be permitted to register the resale of securities prior to their issuance if the company has completed a Section 4(2)-exempt sale of the securities (or in the case of convertible securities, of the convertible security itself) to the investor, and the investor is at market risk at the time of filing of the resale registration statement. The investor must be irrevocably bound to purchase a set number of securities for a set purchase price that is not based on market price or a fluctuating ratio, either at the time of effectiveness of the resale registration statement or at any subsequent date. When a company attempts to register for resale shares of common stock underlying unissued, convertible securities, the PIPE analysis applies to the convertible security, not to the underlying common stock. There can be no conditions to closing that are within an investor’s control or that an investor can cause not to be satisfied. For example, closing conditions in capital formation transactions relating to the market price of the company’s securities or the investor’s satisfactory completion of its due diligence on the company are unacceptable conditions. The closing of the private placement of the unissued securities must occur within a short time after the effectiveness of the resale registration statement. [Nov. 26, 2008]