TheCorporateCounsel.net

As John shared, the SEC’s proposal to modernize the regulatory scheme for transfer agents includes a new rule that will have implications for issuers because it would require transfer agents to establish a reasonable basis for removing restrictive legends on a security and provide a related safe harbor. This White & Case alert notes that the proposal would likely standardize requirements around the Rule 144 legend removal process, which have been inconsistent over the years depending on the transfer agent you’re working with, but also potentially complicate things by making the process more document and analysis intensive across the board. 

Under the safe harbor, there are two ways a transfer agent can establish a reasonable basis: (1) an opinion of counsel or (2) reaching its own conclusion, documented in writing. As John noted, the legend removal opinion cannot be given by an affiliate, officer, director, or employee of the issuer or the holder and proposal’s language around “red flags” may invite “skittish transfer agents to see ghosts.” The memo suggests some other ways that the proposal, if adopted, could change the process for issuers. For example:

[F]or every issue it services, a transfer agent would be required to keep a current list of the issuer’s own employees who are authorized to give it instructions on legends, and refuse instructions from anyone off that list. Only issuer employees can be on the list, so counsel, underwriters, and paying agents who have historically given legend instructions on an issuer’s behalf will need another route to the transfer agent.

Many transfer agents today accept shorter opinions where the opinion giver is relying almost entirely on representations given by holders and brokers. However, the safe harbor’s opinion checklist would require considerably more detail in the opinion itself (naming the documents reviewed, walking through a specific exemption, and reaching a transaction-specific conclusion).

[W]hat would [more] significantly increase the diligence burden is the requirement that transfer agents consider what could constitute a “red flag,” as discussed above. The proposed safe harbor cannot be met by simply ruling out the specific red flags enumerated by the SEC, but instead requires an opinion giver to have conducted a thorough investigation into a highly fact-dependent field of subtle distinctions and reached considered conclusions to identify problematic trades, which will dictate whether an opinion can be delivered. 

Because the rule includes a broad definition of “unregistered securities transaction” and would encompass unregistered original issuances or transfers by an affiliate, that same “reasonable-basis analysis” would be required in “private placement closings, PIPE issuances, note conversions, warrant exercises, equity compensation deliveries, and affiliate transfers of every kind, many of which have never before required a transfer agent-facing legal opinion.”

Notably, note conversions and warrant exercises in particular are included in this list. These two actions historically have not been an area of concern for the SEC because any safeguards would have been applied to the initial issuance. By including these types of transactions within the scope of Rule 17ad-31, the SEC may be adding an additional layer of friction to these transactions. Equity compensation deliveries follow a similar pattern: equity compensation is largely regulated at the time of the initial issuance, and including it in the new rule’s coverage could make it somewhat more difficult for companies to align employee compensation with shareholders’ interests by tying compensation to future performance.

Ultimately, the memo concludes that the requirements transfer agents are likely to impose if these rules are adopted as proposed will make legend removal cost more and take longer at a time when settlement timing is very short, and the associated challenges may fall on issuers. Certain issuers, like those with significant affiliate holdings, may want to comment before the November 3rd deadline.

– Meredith Ervine