March 25, 2004

Gun-Jumping – Lessons in Dealing

Below is an interesting March 8th news article from Institutional Dealers’ Digest about the film “Billy Dead” that recently conducted an online IPO that was halted by the SEC (if you ever are faced with gun-jumping, don’t forget to see our sample “Risk Factors Regarding Gun-Jumping” in the “Disclosure Analysis & Samples” Practice Area):

“Less than two weeks after Civilian Capital raised the curtain on its initial public offering of Billy Dead Inc.-the first IPO for an individual movie ever attempted in the U.S.-the Securities and Exchange Commission has called “Cut.” According to SEC filings, Civilian Capital was asked to halt its offering and clarify any risks to investors before it could proceed.

Civilian, a NASD-registered broker/dealer, wants to raise up to $7.8 million to finance the production of its first film-“Billy Dead,” a murder mystery set to star Ethan Hawke that was originally slated to start production this spring. To fund the film, Civilian last Nov. 13 launched an online offering of 900,000 shares of Series A preferred stock in Billy Dead’s holding company, at $8.75 each. But shortly thereafter, Civilian returned investors’ initial funds, a move it credits to extensive news coverage of the offering that made it difficult for investors to adequately assess the offering’s risk.

Billy Dead’s latest prospectus details a number of inaccuracies and overly optimistic statements about the company that were presented by the media. (Full disclosure: IDD was first to report on the potential IPO, as far back as May 14, 2001, following up on news of registration of the shares in an Apr. 28 story and a Nov. 17 article about marketing the shares. But none of the IDD stories was cited among those containing the hype that caused the deal to be yanked.)

Civilian’s pulled IPO shows how risky it can be for companies in the process of raising capital to talk to the media, especially at a time when the SEC has been trying to become a more vigilant watchdog for investors. A spokesman for the SEC says it does not track how often IPOs are pulled, nor would it give any guidance on its reasoning. Industry observers, however, were not surprised to learn that the offering had been tabled. They say that the SEC has become more exacting in its interpretation of securities laws. Calls to Civilian were not returned.

If Civilian has become mum, it could be because its prior efforts to cultivate the media backfired. In a new prospectus filed Feb. 13, 2004, the company states that it stopped the offering on Dec. 8 “in order to reduce the risk of investors’ possible reliance on news reports and articles, or information which appeared on the underwriter’s website in a manner which was insufficiently balanced.” Underwriter Civilian Capital then returned investors’ money.

The prospectus details several of the news stories and Internet reports published in November and December 2003. It appears that after one or two news organizations misreported information about the offering, the errors snowballed when other reporters writing follow-up stories pulled incorrect information from the earlier ones.

First off, the prospectus cites a Nov. 19, 2003, article from the Associated Press that incorrectly reported the Billy Dead offering as a Nasdaq IPO, when the shares were actually slated to trade on the Over the Counter Bulletin Board (OTCBB). “These statements, which were additionally stated in slightly altered forms in other articles and reports, are erroneous,” says the new prospectus.

The prospectus also hints that some news stories carried overly optimistic comments from Civilian’s management when it was supposed to be in the quiet period after filing for the IPO.

“In an article in The Economist dated Dec. 2, 2003, Barry Poltermann, President of Civilian Capital, is quoted as saying that the offering is on track to close.'”

The prospectus goes on to name a Bloomberg wire article first published on Nov. 13, 2003, that was reprinted in various publications, including the Chicago Tribune, that quoted Poltermann’s views about the offering’s success: “My confidence is off the charts,'” he told Bloomberg. “I’ve been working on this for four years. We wouldn’t do it if we weren’t extremely confident.” Civilian’s plans to launch another six film IPOs and raise up to $60 million by the end of 2004 were also reported in the articles.

To clarify the uncertainty of these statements, the latest prospectus goes to great lengths to point out there is no assurance that even the Billy Dead offering will be completed, or that Civilian’s plans for other film IPOs will come to fruition. “When considering the merits of this investment, investors should not rely on any representations of confidence made by the underwriter in their ability to raise sufficient funds to close this offering, or plans of the underwriter to pursue similar film offerings in the future,” it states.

A third problem hinted at in the prospectus was one journalist’s own interpretations of the offering’s risks and how they might be offset. Citing a Dec. 15, 2003, article from Business Week, the prospectus indicates that the journalist went too far by discussing hypothetical returns for the film and contingency plans Civilian might use to pay back investors if “Billy Dead” were to make an unsuccessful box office debut.

“This hypothetical scenario was not based on any information provided to the author by management or Civilian Capital,” states the prospectus. “We believe the author analyzed information that appears in the Management’s Plan of Operation’ section of this prospectus and based the potential returns upon his estimates and assumptions that are inherently subject to significant uncertainties and contingencies, primarily concerning the timing and cost of the Film’s distribution. Billy Dead, Inc. has never made, and does not intend to make, any public financial projections about the performance of the film Billy Dead, Inc. was formed to produce.”

Why the SEC Acts

Bankers say there are a variety of reasons the SEC can halt an offering. “But it’s usually because of the CEO or CFO mistakenly giving a quote when they shouldn’t have,” says the head of equity capital markets for one midsize firm. That’s why most securities firms go out of their way to avoid the media once they have filed an offering, he explains.

“It’s rare the SEC would penalize a company for hype if the company had nothing to do with it,” adds the banker. Once an offering is tabled, however, the costs can be significant. The refiling charges and associated legal fees are one thing; then there’s the risk that slowing up a deal could scare off investors, who have long been leery of Hollywood.

After failed efforts by the Street to fund limited partnerships for groups of films in the 1980s, bankers say investors have since shied away from anything exclusively film-related. Only investments in major entertainment conglomerates-such as The Walt Disney Co. and Time Warner Inc., whose returns are not solely tied to the performance of films-have been able to attract mainstream investors.

Nonetheless, the financial success of a few recent independent films has piqued investors’ interest. But such success stories are still few and far between. Indeed, the profitability of independent films reported in conjunction with Civilian’s offering showed up as another SEC concern, according to Billy Dead’s prospectus.

“Both [a] CBS Marketwatch Internet article and the Associated Press article referred to [Civilian] officials as stating that in certain instances low-budget films have a greater chance at profitability than more costly projects,” it states. “These statements attributed to Mr. Fuhrman [Billy Dead Inc.’s CEO] or to representatives of Billy Dead, Inc. have been repeated, sometimes in slightly altered forms, in several other press articles.”

Another example cited is a quote from Poltermann that aired on NPR’s “On the Media” program on Nov. 21, 2003. “I’m not saying that it’s still not a very risky game,” Poltermann is quoted as saying. “The movie business is hit-driven. But it doesn’t have to be Blair Witch Project’ or My Big, Fat Greek Wedding’ to do very well. In fact, last year Y Tu Mama Tambien’ was actually more profitable [on] a return-on-investment basis than My Big, Fat Greek Wedding.'”

The new prospectus says these statements are “not balanced representations of potential film profitability because they do not represent the fact that numerous films or groups of films released at the same time were less profitable than the cited films or groups of films.”