You are working on the IPO of Genco, a diversified agribusiness with exciting new technology set to revolutionize the production of olives. Members of the Board of Directors like the stock (and the olive oil), and want to know if they can buy in the IPO.
The short answer is “generally yes” – in other words, this can likely be done but there are some issues to think through first.
The general purpose of Reg M is to prohibit certain behavior that could result in manipulation of a security’s price during its distribution by persons who have an interest in the distribution (for our full explanation of Reg M, including answers to FAQs, see here). To achieve this, Reg M prohibits certain persons, including “affiliated purchasers,” from buying the securities being distributed (as well as certain “reference securities”) during a specified restricted period. Since the directors would be considered affiliated purchasers of the issuer for these purposes, Reg M applies.
Fear not, however! Footnote 95 of the Reg M Adopting Release clarifies that Reg M does not “preclude affiliates of an issuer (e.g., officers or directors) from purchasing securities in the offering” (as opposed to outside the offering). The SEC Staff FAQs on Reg M add a number of additional glosses, including that the securities must be acquired for “investment purposes” and appropriate disclosure may be needed depending on the nature of the offering or the extent of purchases.
How do you meet these requirements? The directors can purchase directly from the underwriters or the issuer as part of the offering itself, but in any event not in the secondary market during the Reg M restricted period. Sometimes the directors will make purchases from the company in a concurrent private offering. The directors will pay the public offering price but may negotiate that the underwriters will not receive any underwriting discount on the shares the directors purchase, so the company will receive 100% of the proceeds of these sales. In addition, the directors would typically sign a lock-up and the shares they acquire would have an appropriate legend (e.g., noting that the shares they hold are restricted or control securities under Rule 144, depending on the type of transaction in which they are acquired).
The working group may decide that disclosure of the director purchases is appropriate in a number of different places in the IPO prospectus, such as:
On the front cover, especially if the amount is substantial in relation to the overall offering. In some cases, this could lead to a comment from the SEC Staff if there is a concern about undue prominence being given to the fact that affiliates are purchasing shares in the offering.
In the Summary box, for example, in an item entitled “Insider Purchases” or something similar.
In the Underwriting Section/Plan of Distribution, where the mechanics of the sales to director can be described. For example, if the directors are purchasing from the underwriters, Genco could include something along the lines of the following:
“The underwriters have agreed to sell an aggregate of [?],000,000 shares of our common stock to Curley, Moe and Larry, who are members of our Board of Directors, at the public offering price set forth on the cover page of this prospectus. [IF APPLICABLE TO YOUR TRANSACTION: The underwriters will not receive any underwriting discount on the sale of such shares].”
Or, if the directors will purchase in a concurrent private transaction, Genco might include:
“Concurrently with our offering to the public, we are offering shares of our common stock to Curley, Moe and Larry, who are members of our Board of Directors and who have each indicated an interest in purchasing shares of our common stock at the public offering price with an aggregate price of $[?] million, which represents an aggregate of [?],000,000 shares of our common stock. We are offering these shares directly to Curley, Moe and Larry and not through underwriters or any brokers or dealers. The shares offered to Curley, Moe and Larry will not be subject to any underwriting discounts or commissions. The shares will not be purchased unless the offering to the public is consummated.”
In the Principal Shareholder/Beneficial Ownership Tables – include a footnote in these tables briefly describing the nature of the director purchases.
Other things to consider
FINRA issues. Depending on your facts, there could be some FINRA issues to navigate (for example, if the director could be considered an “associated person” of a broker-dealer, if the director is also a director of a public company or a certain type of non-public company, or if the director will be buying at less than the full public offering price, inclusive of the underwriting discount).
Subscription Agreement/Escrow. If the directors are buying directly from the company, you should consider having them sign a subscription agreement. In addition, you may want to implement an escrow mechanic whereby, on the date the subscription agreement is signed, the directors are required to wire sufficient funds to purchase the shares into a third-party bank escrow account. Doing this will help ensure that the purchases by the directors, if they are buying directly from the company, actually proceed in the manner described in the prospectus.
Director accounts. If the directors are buying from the underwriters, they may need to set up brokerage accounts to receive the shares (which will require a retail broker to be involved). Account-opening formalities can take some time to complete.