SEC Comment about “Affiliate” Stockholder in Public Float Calculation

by Bass, Berry & Sims PLC
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Bass, Berry & Sims PLC

In monitoring SEC comment letters, we came across this SEC comment letter made public this month. It serves as a reminder to registrants that, when calculating a company’s public float, there is an informal presumption that a 10% or greater stockholder is an affiliate of the company; however, this presumption is rebuttable by the registrant.

The letter stated that “[t]he Staff has consistently taken the position that the determination of ‘control’ status is dependent in large part on the facts and circumstances involved and, therefore, has declined to state definitively what circumstances will result in a person being deemed to be in ‘control’ of an issuer. While the Company recognizes that, as a rule of thumb, more than 10% ownership has become an informal benchmark at which control should be evaluated, such ownership, standing alone, is not dispositive.”

Several Factors Determine Whether or Not a Stockholder is an Affiliate

In the letter, the registrant cited several factors in making its determination that a 35% stockholder was not an affiliate for purposes of calculating its public float, including that the stockholder was not an officer or director, cannot designate a director, does not have the ability to influence company management or policy and there were no other indicia of control over the company. The SEC’s staff did not object to the company’s determination that the passive stockholder was not an affiliate for purposes of calculating its public float.

The relevant comment is below:

Form S-3 Filed August 29, 2017

General

2. Please disclose how you calculated the public float, including how you determined the number of shares held by officers and directors of the company, 10% or greater shareholders, and the selling shareholders.

Response: In response to the Staff’s comment, the Company has included on Exhibit A attached hereto its calculation of the public float. For purposes of this calculation, the Company does not currently consider any of its shareholders who are not directors or executive officers of the Company, including any such shareholders owning 10% or more of the Company’s common stock, to be “affiliates” of the Company.

The term “affiliate” is defined in Rule 405 under the Securities Act of 1933, as amended (the “Securities Act”), as a “person that directly, or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with,” an issuer. The term “control” is defined in Rule 405 under the Act as “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.”

The Staff has consistently taken the position that the determination of “control” status is dependent in large part on the facts and circumstances involved and, therefore, has declined to state definitively what circumstances will result in a person being deemed to be in “control” of an issuer. While the Company recognizes that, as a rule of thumb, more than 10% ownership has become an informal benchmark at which control should be evaluated, such ownership, standing alone, is not dispositive.

Based on the most recent information available to the Company from NASDAQ, the only 10% or greater shareholder of the Company is Nantucket Investments Limited (“Nantucket”), which owns approximately 35.0% of the Company’s outstanding common stock as of July 31, 2017. Nantucket acquired all of its shares in the Company pursuant to a settlement and discounted payoff agreement, dated March 31, 2017 (the “Settlement Agreement”), by among Napo Pharmaceuticals, Inc. (“Napo”), a wholly-owned subsidiary of the Company, Nantucket and lenders who were party to Napo’s existing financing agreement, dated October 10, 2014 (the “Financing Agreement”), pursuant to which Napo agreed, simultaneously with the consummation of the merger with the Company on July 31, 2017 (the “Merger”), (a) to make a cash payment to the Nantucket of no less than $8 million, which reduced the outstanding principal obligations under the Financing Agreement, and (b) in satisfaction as a compromise for the remaining outstanding obligations under the Financing Agreement and the release of any lien or security interest in respect of such outstanding obligations, (x) to transfer to Nantucket 2,666,666 shares of the Company’s voting common stock (the “Initial Tranche C Shares”) owned by Napo and (y) pursuant to the Agreement and Plan of Merger, dated March 31, 2017, by and among the Company, Napo, Napo Acquisition Corporation, a wholly-owned subsidiary of the Company, and Napo’s representative (the “Merger Agreement”), to cause the Company to issue to Nantucket (i) 2,217,579 shares of the Company’s voting common stock (the “Remaining Tranche C Shares” and, together with the Initial Tranche C Shares, the “Tranche C Shares”), (ii) 18,479,826 shares of the Company’s non-voting common stock (the “Tranche A Shares”) and (iii) 19,700,625 shares of the Company’s non-voting common stock (the “Tranche B Shares” and, collectively with the Tranche A Shares and the Tranche C Shares, the “Debt Exchange Shares”).

In connection with the execution of the Merger Agreement and the Settlement Agreement, the Company and Nantucket entered into an Investor Rights Agreement, dated March 31, 2017 (the “Investor Rights Agreement”), pursuant to which, among other things, the Company agreed to pay Nantucket’s up to $250,000 of expenses incurred in connection with the transactions contemplated by the Investor Rights Agreement, Settlement Agreement and Merger Agreement, which, pursuant to the terms of the Investor Rights Agreement, the Company at its option elected to pay such $250,000 of expenses by issuing 270,270 additional shares of the Company’s non-voting common stock (the “Expense Reimbursement Shares”) to Nantucket. The Company also agreed to register on one or more registration statements (1) the resale of the Tranche C Shares and the shares of voting common stock issuable upon conversion of the Expense Reimbursement Shares, (2) the Tranche A Shares and, to the extent certain conditions are met, (3) the Tranche B Shares. The Tranche B Shares are not included in Nantucket’s share ownership percentage because they are currently held escrow and shall be released from escrow under specified conditions only upon joint instruction of both the Company and Nantucket in accordance with the terms of the Investor Rights Agreement.

Nantucket is a passive investor and has reported its beneficial ownership on a Schedule 13G thereby disclaiming any control intent. Other factors evidencing that Nantucket is not an affiliate include:

  • Neither Nantucket nor any representative of Nantucket has ever served as an officer of the Company.
  • Nantucket does not possess the power, directly or indirectly, to elect or designate any member of the Company’s Board of Directors.
  • Nantucket does not have the ability, by relationship, contract or otherwise, to affect the management or policies of the Company. Moreover, the Company’s management has indicated that Nantucket has not sought to consult on management activities of the Company.
  • There are no other control indicia with respect to Nantucket. There are no familial relationships and, except as described above, no other business relationships between the Company and Nantucket.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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