Number 1053 July 14, 2010 Client Alert Latham & Watkins Corporate Department Capital Markets Group Upsizing and Downsizing Your IPO The reds have been printed; the deal is Getting Started: on the road; and the champagne is on ice. Now, all that is left is for the IPO The Importance of the investors to step up and buy the stock. Earlier Filings It’s a tempting moment to relax — but Let’s start with a review how you got to an experienced deal lawyer knows where you are now. better. This is the time to start preparing for the possibility that the deal will be When you first filed the registration wildly oversubscribed or will struggle statement, you had to complete the mightily. In either case, the question “Calculation of Registration Fee” table that will shortly come your way is on the front cover. The primary purpose “How much can the deal be upsized or of the fee table was to calculate the downsized at pricing?” amount of filing fees required to be paid to the SEC at that time. Several “The purpose of To answer that seemingly simple amendments later, when your deal was this Client Alert question, you will need to break it into ready to go to investors, a preliminary three component parts: prospectus was filed showing the is to provide you • Was your registration statement number of shares expected to be sold with the tools accurate and complete as of the time and a “bona fide” estimate of the you need to react it became effective? price range per share as required by quickly and wisely • Have you provided investors with all Regulation S-K Item 501(b)(3). That the information they need to make an range was very likely a $2 range, in to questions about informed investment decision prior to keeping with the informal SEC Staff pricing outside the confirming orders? policy for deals expected to price below range when the • Do you owe the SEC any additional $20 per share (if the upper limit is above filing fees? $20 per share, the informal policy is moment of truth that a price range of up to 10 percent arrives.” Getting to the bottom of these points is of the upper limit is bona fide). The a surprisingly complex undertaking. The price range prospectus was circulated rules in this area are technical and not to investors at the beginning of the road always intuitive, and you may be asked show. to make some difficult judgment calls under significant time pressure. The Now, the deal is on the road. Investor purpose of this Client Alert is to provide feedback is rolling in. If investor demand you with the tools you need to react is stronger than anticipated, the issuer quickly and wisely to questions about and the selling stockholders may want pricing outside the range when the to sell more shares or increase the price moment of truth arrives. per share being sold, or both. On the other hand, if a crisis in some far-away part of the world happens to come to Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom, France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. Latham & Watkins practices in Saudi Arabia in association with the Law Office of Mohammed Al-Sheikh. Under New York’s Code of Professional Responsibility, portions of this communication contain attorney advertising. Prior results do not guarantee a similar outcome. 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Latham & Watkins | Client Alert roost while your deal is on the road, the same price range prospectus that was underwriters may have to struggle to circulated to investors, how far can complete a smaller deal, involving fewer the deal be upsized or downsized at shares or a lower price per share, or both. pricing and after effectiveness without Let’s review the tools in your toolbox for having to go back to the SEC for upsizing or downsizing your deal. permission?” In order to understand the magic of Options Prior to Effectiveness Rule 430A, you will need to master the interplay between several key provisions Until your registration statement has of the Securities Act and a number of been declared effective by the SEC, rules and Compliance and Disclosure you can revise your deal all you want Interpretations (C&DIs) published by in a pre-effective amendment with a the SEC Staff. Once you have mastered new price range and/or a new number these rules, you will need to answer of securities to be sold. You may need these three questions: to pay additional filing fees if you are upsizing, but it’s no problem to do so. If • Is the “Section 11 file” complete as of demand is through the roof, this may be the effective time of the registration an option to consider. statement? • Is the “Section 12 file” complete as of However, using a pre-effective the time you want to start confirming amendment to upsize or downsize a orders? deal after the price range prospectus • Do you owe the SEC any more filing has been distributed to investors is fees? typically a last resort in our experience. Among other things, there can be unwelcome timing implications (for Section 11 and Section 12 example, you will need to obtain a new Let’s start with a few words about auditor’s consent and updated signature the primary liability provisions of the pages and clear any comments from Securities Act. the SEC Staff on the new disclosure). Section 11(a) of the Securities Act In addition, the new filing containing imposes liability if any part of a the amended price range could send a registration statement, at the time signal to the market about pricing that it became effective, “contained an may be premature. Particularly for deals untrue statement of a material fact or that are in trouble and may need to omitted to state a material fact required be downsized, refiling the registration to be stated therein or necessary statement with a revised price range can to make the statements therein not spell disaster. misleading.” Section 11 liability only covers statements made in a registration Options After Effectiveness statement at effectiveness. We think of the registration statement at the Those who qualify for the special magic moment of effectiveness as the treatment offered by Rule 430A and “Section 11 file.” This is a helpful way the related rules will find it much to remember that Section 11 is a highly more attractive to make the necessary technical provision, in the sense that it changes to the terms of the deal after looks only at: (a) what is or is deemed effectiveness.1 In most cases, therefore, to be in the registration statement (b) at the question for the deal team will the time it became effective.2 be whether the proposed changes to the number of shares to be sold and By contrast, Section 12(a)(2) of the the price per share qualify for Rule Securities Act is not limited to the 430A’s magic? Put another way, the key registration statement and is not linked to question is this: the moment of effectiveness. It imposes liability on any person who offers or “Assuming we go effective on a sells a security in a registered offering registration statement containing the 2 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert by means of a prospectus, or any oral Rule 430A communication, which contains “an Rule 430A is a very special rule. It untrue statement of a material fact or permits a registration statement to be omits to state a material fact necessary in declared effective without containing order to make the statements, in the light final pricing information. Instead, of the circumstances under which they it allows you to insert information were made, not misleading.” Section retroactively into a registration 12(a)(2) is less technical and more holistic statement and have it be treated as if than Section 11. Section 12(a)(2) takes it were there as of its effective date. into account all oral statements, free Rule 430A provides that pricing- writing prospectuses and statements in related information (which includes the price range prospectus, rather than the price per share and the number of focusing exclusively on the registration shares offered) that is contained in a statement. prospectus filed pursuant to Rule 424(b) Under Securities Act Rule 159 (which after effectiveness of the registration we discuss in greater detail below), statement will be deemed to have been Section 12 looks to the sum of what part of the registration statement as of investors have been told at the time the the effective date. In other words, Rule underwriters confirm orders. Section 430A allows you to tinker with your 12’s focus, therefore, is the price range “Section 11 file” after the fact and have prospectus sent to investors and any the changes travel backwards in time. additional information that may have Rule 430A is a particularly useful tool been conveyed to investors (orally or in for complying with Section 11, and we writing) on or before the time of pricing. are going to review all of its glorious We think of this collection of information twists and turns below. Keep in mind, as the “Section 12 file.” however, Rule 430A’s two important In order to deal with all of the issues limitations. First, it only applies to that arise in the context of changing pricing information.3 And second, the size and price of an IPO after the Rule 430A does not help you make registration statement has been declared corrections to your “Section 12 file,” as effective, you will need to keep in mind it does not allow you to retroactively both your “Section 11 file” and your add to the information actually given to “Section 12 file.” investors at the time of pricing. Here is a summary of Rule 430A from a 40,000 foot perspective: If you are… Then you And you can… But you would need to… should use… Upsizing Instruction to Increase the price • File an immediately your deal Rule 430A(a) per share and/or effective registration number of shares, statement under Rule 462(b) so long as the to register the increase in aggregate size of the shares/increase in deal revised deal does not size (or a post-effective exceed 120 percent amendment if the increase of the amount shown is greater than 20 percent) in the fee table in • Consider whether the registration additional disclosure (oral statement at the time or by means of a free of effectiveness writing prospectus) needs to be delivered to purchasers prior to confirmation of sale 3 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert If you are… Then you And you can… But you would need to… should use… Downsizing C&DI 627.01 Decrease the price • Consider whether your deal per share and/or additional disclosure (oral decrease the number or by means of a free of shares sold, so writing prospectus) needs to long as the size of be delivered to purchasers the revised deal is prior to confirmation of sale not less than the lower end of the deal size reflected in the price range prospectus minus 20 percent of the maximum deal size reflected in the price range prospectus Now that you have the big picture, let’s and price represent no more than a go through it again at a more granular 20 percent change in the maximum level. aggregate offering price set forth in the “Calculation of Registration Fee” table in the effective registration Instruction to Rule 430A(a) statement. [Emphasis added.] Rule 430A’s most important contribution to pricing outside the range is found in In other words, where the 20 percent the instruction to paragraph (a), which safe harbor threshold is not exceeded, states (in full): changes in price and deal size can be poured backwards in time into the Instruction to Paragraph (a). A registration statement using a Rule decrease in the volume of securities 424(b) filing of the final prospectus after offered or change in the bona fide the effectiveness of the registration estimate of the maximum offering statement and will be deemed to have price range from that indicated in been part of the registration statement at the form of prospectus filed as part the time it became effective for purposes of a registration statement that is of Section 11. This is a very useful declared effective may be disclosed device indeed. It allows you to change in the form of prospectus filed with the size of your deal by 20 percent in the Commission pursuant to Rule either direction without having to go 424(b) or Rule 497(h) under the back to the SEC. This timing advantage Securities Act so long as the decrease is critical when you are trying to price in the volume or change in the price a deal. Having to go back to the SEC range would not materially change to get a post-effective amendment the disclosure contained in the declared effective is often not consistent registration statement at effectiveness. with holding a book of orders together Notwithstanding the foregoing, any (particularly in the context of a deal increase or decrease in volume (if the that is being downsized). As a result, total dollar value of securities offered understanding the exact scope of this 20 would not exceed that which was percent safe harbor is critical. registered) and any deviation from the low or high end of the range may be reflected in the form of prospectus C&DI 227.03 (January 26, 2009) filed with the Commission pursuant C&DI 227.03 reads (in full) as follows: to Rule 424(b)(1) or Rule 497(h) if, in Question: A registrant omits pricing the aggregate, the changes in volume information from the prospectus 4 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert in a registration statement at the changes to your registration statement time of effectiveness in reliance on without SEC review (i.e., without filing Rule 430A. Is it required to reflect a post-effective amendment) even if pricing information or the inclusion of those changes are material. This special additional securities in a post-effective privilege is limited to pricing information amendment? as contemplated by Rule 430A, but it Answer: The second sentence of the is a very special privilege nevertheless. Instruction to Rule 430A provides The second point is equally important that a Rule 424(b) prospectus — changes in excess of 20 percent may supplement may be used, rather than not be material (and hence may not a post-effective amendment, when require SEC review of a post-effective the 20% threshold is not exceeded, amendment). regardless of the materiality or non- How can this be, you ask? Good materiality of resulting changes to question. Consider, for example, a $1 the registration statement disclosure billion offering that is half primary and that would be contained in the Rule half secondary shares. If the secondary 424(b) prospectus supplement. When shares are reduced to $250 million, but there is a change in offering size the primary shares stay at $500 million, or deviation from the price range the offering has been reduced by 25 beyond the 20% threshold noted in percent but the reduction may well the second sentence of the Instruction, not be material. There will still be a a post-effective amendment would very substantial public “float” after the be required only if such change or offering and the proceeds to the issuer deviation materially changes the (and hence the use of proceeds), the pro previous disclosure. Regardless of the forma number of shares outstanding and size of the increase, in the case of a the pro forma earnings per share will not registration statement that is not an change at all. This sort of fact pattern automatic shelf registration statement, is right in the center of C&DI 227.03’s a new registration statement must fairway. be filed to register any additional securities that are offered. Additional securities cannot be registered by C&DI 627.01 (April 24, 2009) post-effective amendment except So far, so good. It all seems pretty on automatic shelf registration clear — Rule 430A allows you to go up statements. [Emphasis added.] or down 20 percent from the maximum aggregate offering price reflected in the This C&DI establishes two important fee table. But one key question remains points: unresolved: • For purposes of Rule 430A (and What does Rule 430A have to say about hence the Section 11 file), retroactive the deal size actually reflected in the changes in price within the 20 percent prospectus circulated to investors, as threshold can be made after the fact opposed to the maximum deal size by way of a Rule 424(b) prospectus reflected in the fee table? What if (as is even if the effects of those changes often the case) these two amounts are are material, and not aligned? • Even changes outside the 20 percent This is where C&DI 627.01 comes into threshold can be made using a Rule play. C&DI 627.01 reads (in full) as 424(b) prospectus if the changes do follows: not materially change the disclosure. 627.01 The instruction to paragraph These are important points — and (a) of Rule 430A provides that not entirely intuitive — so let’s spend changes in volume and price another minute here. Rule 430A representing no more than a 20% effectively lets you make pricing-related change in the maximum offering price set forth in the registration statement 5 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert fee table may be made pursuant to a this means that you will want to use Rule 424(b)(1) prospectus supplement. C&DI 627.01 when downsizing and the The 20% threshold may be calculated instruction to paragraph (a) of Rule 430A using the high end of the range when upsizing. in the prospectus at the time of effectiveness and may be measured The Section 12 File and the from either the high end (in the case of an increase in the offering price) Importance of Common or low end (in the case of a decrease Sense in the offering price) of that range. Knowing whether you are within the [Emphasis added] Rule 430A safe harbor is not the end C&DI 627.01 permits you to calculate of the analysis — after all, the Rule the 20 percent amount for purposes contemplates that there could be of downsizing your deal in a very material changes to the disclosure that favorable way. As an alternative to the would fall within the safe harbor. Rule 20-percent-of-the-amount-in-the-fee- 430A is a fabulous tool for dealing with table approach contemplated by the the Section 11 file, but it doesn’t help instruction to paragraph (a) of Rule you with the Section 12 file. Let’s tackle 430A, C&DI 627.01 allows you to derive the Section 12 file now. your 20 percent amount by multiplying the upper end of the range in the Securities Act Rule 159; Free price range prospectus by 20 percent.4 Writing Prospectuses; Exchange You can then add that amount to the Act Rule 15c2-8(b) upper end of the range in the price Rule 159, which was introduced as range prospectus if you are upsizing, or part of the securities offering reforms subtract that amount from the bottom that became effective in 2005, adds of the range if you are downsizing, to an important wrinkle to the Section 12 figure out what share count and price landscape. Rule 159 makes clear that, per share will be within the safe harbor. for purposes of Section 12, information Since 20 percent of the upper end of the conveyed to a securities purchaser price range is by definition greater than after the time of sale does not count 20 percent of the lower end of the price for purposes of determining whether range, C&DI 627.01 effectively broadens the Section 12 file was complete at the the scope of the Rule 430A safe harbor moment that liability attaches. In other for troubled deals. words, Section 12 liability is a function The approach in C&DI 627.01 represents of what you actually gave or told the an alternative to the approach in the purchaser prior to confirming the order instruction to paragraph (a) of Rule — anything delivered after the moment 430A, and the SEC Staff takes the of truth does not count. positions that you cannot “mix and This means that those material pricing match” between the C&DI and the changes that can be retroactively instruction to paragraph (a). As a result, poured into the Section 11 file after the if you are following C&DI 627.01 you fact under Rule 430A must actually be may not take 20 percent of the amount conveyed to purchasers in real time reflected in the fee table and subtract prior to confirming orders in order for that from the lower end of the price the Section 12 file to be up to snuff. range, even though that might yield a There are a number of ways to transmit lower floor on your transaction than 20 the required information — the rules percent of the upper end of the range are agnostic as to the actual method of (since the fee table often registers a conveyance — but the key point is that larger transaction than the upper end of the conveyance must be made and it the range). Either you calculate using must be made prior to confirming orders. the fee table or you calculate using the range in the price range prospectus, but Market practice is that simple you can’t have it both ways. In practice, information that can be effectively 6 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert reduced to sound bites is conveyed • The level of beneficial ownership by orally. It is customary in deals pricing members of senior management or within the range, for example, to convey other significant stockholders; and the final pricing information orally. • Dilution. Oral conveyance is also used in many The goal is to have disclosure that upsizing and downsizing scenarios. allows investors to see how changes in The easiest example of this would be share price or deal size ripple through a 20 percent decrease in deal size in critical elements of the disclosure. an all-secondary offering by a selling Ideally, the price range prospectus stockholder. All the investor needs to will present key disclosures in an “if/ know in that case is how many shares then” format (“We will apply the net are being sold and at what price — there proceeds from this offering first to repay are no collateral disclosure implications all borrowings under our credit facility to the change in deal size in that and then, to the extent of any proceeds example.5 The disclosure in the price remaining, to general corporate range prospectus will not otherwise purposes,” for example). change at all. Finally, where the changes are so More complicated deal changes may fundamental that the original price require that a free writing prospectus range prospectus must be completely summarizing the changes be circulated rewritten, it may be necessary to to accounts in writing as contemplated recirculate a completely new price by Rule 433. An example of this range prospectus in order to satisfy situation might be a decrease in offering Exchange Act Rule 15c2-8(b). Rule size that results in a change to the 15c2-8(b) requires that brokers and use of proceeds flowing through the dealers participating in an IPO “deliver pro formas. The decision whether to a copy of the preliminary prospectus convey the new information orally or in to any person who is expected to writing will in part depend on whether receive a confirmation of sale at least the price range prospectus circulated 48 hours prior to the sending of such to investors contained “sensitivity confirmation.” [Emphasis added.] analysis” explaining how the company’s plans would change if the actual The line between a complete proceeds turned out to be more or less recirculation and a supplemental than the amount assumed in the price circulation of changed pages is a blurry range prospectus. The more sensitivity one. The free writing prospectus concept analysis that is included in the price introduced by Rule 433 in the 2005 range prospectus, the more likely it securities offering reforms was intended, will be possible to convey the missing we believe, to obviate the need for a full information orally at the time of pricing. recirculation of a completely new price This is a point to keep in mind in the range prospectus in all but the most early drafting sessions. extreme cases. However, when changed pages become so pervasive that the There is no hard-and-fast rule about original price range prospectus can no how much sensitivity analysis will do, longer be said to be “the preliminary and what topics need to be covered. prospectus” within the meaning of Rule Some items to evaluate might include: 15c2-8(b), then a full recirculation may • Use of proceeds, particularly where be required. If the changes are less than stated uses would need to be changed pervasive, a free writing prospectus or new uses added (for example, summarizing the changes should suffice. in the case of unexpectedly large The key import of this distinction proceeds) between a full recirculation of a • Pro forma earnings per share new price range prospectus and a • The size of the “float” after the supplemental circulation of a free offering writing prospectus summarizing the • The company’s financial condition changes relates to timing. If you generally 7 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert have tripped the Rule 15c2-8(b) wire, Chances are, you opted to calculate you need to give investors 48 hours the registration fee for purposes of the (generally thought to mean two full fee table under Rule 457(o). You could business days)6 to consider the revised have used Rule 457(a) instead, but since disclosure. If you are in free writing doing so would let the market know the prospectus land, however, you may likely per share price (i.e., maximum conclude that investors only need a deal size divided by the number of few hours (or even minutes) to digest shares registered), most deal teams opt the new disclosure. The SEC Staff has, to use Rule 457(o).8 It’s unusual in our to date, refrained from offering any experience for a deal team to elect to guidance on the question “How long is tip its hand about the expected price long enough?” as it relates to delivery per share at the time the registration of new information for purposes of Rule statement is first filed. 159 and Section 12. The prevailing view When the time comes to file your price among law firms is that most information range prospectus, you have a choice: can be digested upon receipt and only either keep using Rule 457(o), or refile very complicated changes need a full your fee table under Rule 457(a). business day to be absorbed. Somewhat complicated changes may need more If you choose to refile under Rule 457(a), than a few minutes to be digested but you will not have to pay more filing fees less than a full business day. if your offering price per share later increases — that’s baked right into the We continue to feel that the better text of the Rule. You will, however, be view of Rule 433 and the free writing required to pay additional filing fees if prospectus that it ushered in is that you later increase the number of shares a properly crafted and conveyed free to be offered, even if the total offering writing prospectus should eliminate the size (number of shares sold times sale need for a full recirculation in all but the price) does not go above the original most extreme cases.7 estimate used to calculate the original filing fee. The added shares will need to Filing Fee Issues — be registered, either on an immediately Securities Act Rules 457 effective registration statement under Rule 462(b) or via a post-effective and 462(b) amendment — we discuss below how that is done. Rule 457 If you stick with Rule 457(o), you will not Although Rule 457 deals with the have to file a new registration statement seemingly mundane issue of the and pay additional filing fees if your per calculation of the registration fee, share price goes down and you increase the choice you make under Rule 457 the number of shares offered so as to will have a significant impact on your maintain the original aggregate offering options at the moment of truth. price. See C&DI 640.05. You will, Remember that you initially filed your however, be required to pay additional registration statement with a fee table, filing fees if you keep the same number calculated either: of shares and increase the per share price (thereby increasing the aggregate • Under Rule 457(o) on the basis of the deal size). amount of proceeds the issuer wanted to raise, or Which route is preferable? Refiling • Under Rule 457(a) on the basis of the under Rule 457(a) allows you to increase number of shares to be sold and a the price per share (but not the number bona fide estimate of the sale price of shares) without filing an additional per share. registration statement or post-effective amendment. By contrast, staying with Rule 457(o) allows you to increase the number of shares and decrease the 8 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert price per share so as to maintain overall at effectiveness — even though that fee deal size, without filing an additional table was calculated at the old price registration statement or post-effective per share. See C&DI 640.03. To take an amendment. So it all boils down to example, imagine that your fee table whether you think you will be upsizing at effectiveness reflected 11.5 million price only (and leaving the number of shares and a price range of $8-$10 per shares unchanged) or will be playing share, for a maximum aggregate deal with both price and number of shares in size of $115 million. At pricing, the order to keep the same total aggregate number of shares is increased by 1.5 deal size. Many deal teams elect to million and the price is increased to $12 switch to Rule 457(a) at the time of per share. The number of additional printing the price range prospectus, shares times the price equals $18 because increasing the price per share million. Since this is less than 20 percent at pricing is a more likely outcome than of $115 million (i.e., $23 million), you increasing the number of shares and could use Rule 462(b) to register the decreasing the price. new shares. The fact that the entire deal is actually being upsized by more than 20 percent (since $115 million plus Rule 462(b) 20 percent equals $138 million, and How do you go about adding additional 13 million shares times $12 per share shares (if you are using Rule 457(a)) or equals $156 million) is disregarded if increasing the deal size (if you are using you are using Rule 457(a). Rule 457(o))? You have two choices — either file an immediately effective The calculation is done differently if registration statement under Rule 462(b), you are staying with Rule 457(o). In that or file a post-effective amendment and case, you multiply all of the shares being wait for the SEC Staff to declare you offered (including the additional shares) effective.9 by the new price per share and then look to see if you have increased total If you can qualify to use Rule 462(b), deal size by more than 20 percent. See that is the better route — it eliminates C&DI 640.04. This makes sense, since the additional step of clearing the post- Rule 457(o) looks to total deal size. To effective amendment with the SEC use our example above, 20 percent of Staff.10 Rule 462(b) is available if: the original maximum deal size equals • You file the new registration $23 million. Because 13 million shares statement prior to the time are being offered at a new price per confirmations are sent, and share of $12, total deal size would be $156 million, which is more than the • The increase in price and share original deal size plus 20 percent ($115 count together represent an increase million plus $23 million equals $138 of no more than 20 percent of the million). As a result, you could not use previous maximum aggregate offering Rule 462(b) to register the additional price (as set forth in the fee table at deal size and would instead have to file effectiveness). a post-effective amendment. There is a curious wrinkle to how the 20 percent amount is calculated for purposes of Rule 462(b), again Some Examples of How It depending on whether you refiled your All Fits Together fee table under Rule 457(a) or stayed Is your head spinning at this point? It with Rule 457(o). If you are using Rule should be. Let’s start with the following 457(a), you multiply the number of basic facts and then try various upsizing additional shares by the new offering and downsizing scenarios to help price and then look to see whether the illustrate how the rules work: increase in deal size associated with the added shares is more or less than 20 • Maximum aggregate deal size in percent of the deal size in the fee table the fee table at effectiveness is $115 million 9 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert • The price range prospectus reflects a that the price is now $12 per share and range of $8-$10 per share, 10 million the maximum deal size is $138 million firm commitment shares and 1.5 (post greenshoe). Ideally, the price million greenshoe shares, for a total range prospectus already disclosed of 11.5 million shares (including the what the proceeds would be used greenshoe)11 for if the deal raised more cash than • The minimum aggregate deal size originally assumed, so there is no need in the price range prospectus is $92 to elaborate on that point. million (including the greenshoe), There would be no need to pay while the maximum aggregate deal additional fees via a Rule 462(b) size in the price range prospectus is registration statement if you calculated $115 million (including the greenshoe) your filing fee for purposes of the fee Scenario 1: At pricing, the price is table using Rule 457(a), because the increased to $12 but the number of number of shares to be sold has not shares stays the same, for a total changed — this, as we pointed out aggregate deal size of $138 million above, is the primary benefit of Rule (post greenshoe). 457(a). If you calculated your filing fee using Rule 457(o), on the other This is within Rule 430A’s safe harbor, hand, you would need to register the because the increased price per share additional deal size, and this could be (from $10 to $12) when multiplied done by filing a Rule 462(b) registration by the number of shares (10 million statement.12 plus the 1.5 million greenshoe shares) yields a maximum aggregate deal size Scenario 2: At pricing, the price is ($138 million) that does not exceed increased to $14 and the number the maximum aggregate offering of shares is increased to 12 million size reflected in the fee table plus 20 (pre greenshoe) and 13.8 million percent ($115 million plus $23 million (including the greenshoe), for a equals $138 million). (You include the total aggregate deal size of $193.20 greenshoe shares in these calculations, million (post greenshoe). because you need to have registered This is outside the Rule 430A safe and paid fees for all securities sold in harbor, since the new total maximum the offering.) You can ignore the price aggregate deal size ($193.20 million) range prospectus for the moment, since is more than 20 percent above the the instruction to Rule 430A(a) says you maximum deal size reflected in the look to the maximum deal size in the fee table ($115 million plus $23 million fee table to calculate the 20 percent equals $138 million). That’s not the amount for purposes of upsizing. The end of the story, of course. Remember fee table will always reflect a total deal that C&DI 227.03 permits you to pour size that is greater than or equal to the this information back into the Section deal size reflected in the price range 11 file at the time of effectiveness via prospectus (at least if you used Rule a Rule 424(b) prospectus even if your 457(o) to compute the fee table), so you deal size changes by more than the can see why the instruction is the way 20 percent safe harbor amount, if the to go in an upsizing scenario — you get increase in deal size does not materially to calculate the 20 percent off a bigger change the disclosure. You might be base and hence get a larger increase. able to conclude that the changes Because you are within Rule 430A, the were immaterial — for example, if the new deal size and share price will be sensitivity analysis in the price range deemed to be part of the Section 11 file prospectus gave investors enough at the time the registration statement information to track the changes through became effective once the final the disclosure — but in practice this prospectus is filed under Rule 424(b). may not matter since you may still need The Section 12 file can be handled with a post-effective amendment to register an oral statement to accounts at the the additional deal size (as we explain time of confirming orders to the effect below). 10 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert Regardless of which approach is taken range in the price range prospectus — Rule 424(b) prospectus or post- rather than the amount reflected in effective amendment — the Section the fee table. Following C&DI 627.01, 12 file will also need to be addressed. you would calculate the 20 percent This can be done either with an oral threshold by using the high end of the statement to accounts at the time of range (20 percent of $115 million equals confirming orders or by distributing a $23 million) and then deducting that Rule 433 free writing prospectus prior to amount from the low end of the range confirming orders to those expected to ($92 million). This approach ($92 million purchase shares. The decision whether minus $23 million) lets you reduce the to convey the new information orally or deal to $69 million with the greenshoe, in writing (via a free writing prospectus) and gives you maximum flexibility. will depend on the complexity of the C&DI 627.01 is your best choice in changes. a downsizing scenario — you get to decrease deal size beyond the level that Finally, don’t forget that you would need the instruction to Rule 430A(a) would to register additional shares and pay otherwise allow. The decreased pricing additional fees, whether you used Rule information can be included in a Rule 457(a) (since the number of shares being 424(b) prospectus and will be deemed registered has increased) or Rule 457(o) to be part of the Section 11 file at (as a result of the increase in transaction effectiveness. size). On our facts, if you refiled under Rule 457(a) at the time of printing the The Section 12 file issues may well price range prospectus you would not be more interesting in this example, be able to register the additional shares depending in part on whether the via an immediately effective Rule disclosure in the price range prospectus 462(b) registration statement, because included sensitivity analysis explaining the additional number of shares (2.3 what the issuer would do if the deal million) multiplied by the new price got downsized to such an extent. If it per share ($14) equals $32.20 million, did, an oral explanation of the smaller which is more than 20 percent of the deal size may be sufficient to provide maximum offering price at effectiveness investors with the missing information. ($23 million). Similarly, if you used Rule If not, particularly if the use of proceeds 457(o) you would have to file a post- will need to change, a free writing effective amendment, since the increase prospectus summarizing the changes in total deal size (from $115 million may be advisable. to $193.20 million) is greater than 20 Because there is no increase in percent. In both cases, you would have aggregate deal size or number of shares to wait for the SEC Staff to declare your being offered, there is no need to pay post-effective amendment effective additional fees or file a Rule 462(b) before any sales are confirmed. registration statement. In fact, the Scenario 3: At pricing, the price is question whether additional filing fees decreased to $6 but the number of are due never comes up in a downsizing shares stays the same, for a total scenario. aggregate deal size of $69 million Scenario 4: At pricing, the price (post greenshoe). is decreased to $4 but the number At first glance, this might appear to of shares is increased, for a total be outside the Rule 430A safe harbor aggregate deal size of $69 million since the new total maximum aggregate (post greenshoe). deal size ($69 million) is less than The answer to this scenario is the the maximum deal size reflected in same as scenario 3, since both yield a the fee table minus 20 percent ($115 minimum deal size of $69 million. In million minus $23 million equals $92 other words, the aggregate size of the million). But remember C&DI 627.01, deal did not decrease by more than which allows you to focus on the price 20 percent (calculated using the C&DI 11 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert 627.01 methodology) because of the information — or even preparing the increase in the number of shares to information so that it can be conveyed be sold. We believe that the SEC Staff — may not be easy to do in a timely would consider this scenario to be within manner. As a result, the deal team will Rule 430A, notwithstanding the steep be under pressure to make important decrease in the per share price (from $8 materiality judgments on a real-time to $4).13 basis. Some Additional Things to FINRA Issues Bear in Mind IPOs are subject to FINRA Rule 5110 (sometimes referred to as the Corporate Financing Rule). The underwriters of Negative Assurance Letter Practice your IPO will be FINRA members, and Negative assurance letter practice the Corporate Financing Rule will limit among law firms changed following the the amount of compensation they (and adoption of the Securities Act reforms in other distribution participants for that 2005, particularly because of Rule 159’s matter) may receive in connection with focus on the information in investors’ the IPO. The Corporate Financing Rule hands at the time of pricing. Negative also prohibits certain practices that assurance letters now cover three FINRA has determined to be “unfair or important items: unreasonable” and contains filing and • The registration statement as of its disclosure requirements.14 effective date, as measured against If the type of compensation going to the requirements of Section 11 of the the underwriting group consists only Securities Act of the “spread” (i.e., the discount off • The final prospectus, as of its date and the public offering price), the upsizing as of the closing date, as measured or downsizing of an IPO should not against the requirements of Section 12 trigger additional issues under Rule of the Securities Act, and 5110. However, Rule 5110 includes • The “Pricing Time Disclosure many other “items of value” received Package” as of the time the by the underwriters around the time of underwriters commence to confirm the IPO in the calculation of aggregate orders, as measured against the underwriting compensation. If aggregate requirements of Section 12 of the underwriting compensation exceeds a Securities Act. certain percentage of the total offering This last bullet point was added to proceeds, the underwriters may need address Rule 159. It requires the to obtain the FINRA “no objections” negative assurance provided by the opinion required by the SEC in order issuer’s and the underwriters’ law firms for the registration statement to be to speak to the collection of information declared effective. A change in the size conveyed to prospective purchasers of your deal could potentially change at the time the underwriters begin to the total underwriting compensation as a confirm orders. The magic of Rule 430A percentage of deal proceeds in a manner and its permission to go back in time to that would require a visit to FINRA. In rewrite history is critical for the negative practice, that may be difficult to achieve assurance given in the first bullet point under the timing pressure that always above, which relates to the Section 11 exists at the moment of truth. file, but it is of no use for purposes of the FINRA Rule 2720 contains additional third bullet point, which relates to the requirements that apply to public Section 12 file. offerings in which a participating FINRA The way to satisfy Rule 159 is to actually member is deemed to have a “conflict of convey information to accounts. In the interest” (i.e., an interest in the outcome context of a deal that is being upsized or of the offering beyond its role as an downsized at the last minute, conveying underwriter or selling group member). 12 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert The rule provides that a conflict of • Is there sufficient excess demand that interest exists whenever five percent or we can increase the price to a price more of the net offering proceeds will that is above the top end of the range? be directed to a FINRA member or its • Can we increase the price above the affiliates or other “related persons.” range and increase the number of Accordingly, if an offering is downsized, shares being offered? you will need to re-assess whether the • If the deal size increases, what will conflict of interest provisions of Rule the extra proceeds be used for? 2720 are triggered. Among other things, • What did we say in the price range Rule 2720 will generally require the prospectus sent to investors about participation of a FINRA-approved what would happen to our use of “qualified independent underwriter” proceeds if the deal were to be and inclusion of prominent disclosure upsized or downsized? as to the nature of the conflict in the It is important to get this dialogue going prospectus. long before it is time to price the deal so the deal team can plan for every NYSE/Nasdaq Issues possible outcome. Bear in mind that: Both the NYSE and the Nasdaq’s listing • A free writing prospectus reflecting rules exempt “controlled companies” new disclosures may need to be — that is, companies of which more drafted and circulated to prospective than 50 percent of the voting power investors expected to purchase stock is held by an individual, a group or in the offering before orders can be another company — from certain listing confirmed, or a telephone script for requirements relating to corporate the conversation with those investors governance. For example, controlled may need to be prepared companies are exempt from the • A final prospectus containing requirement to have a board composed appropriate disclosure must in any of a majority of independent directors. event be drafted and filed under Rule When you are doing an IPO for a 424(b) controlled company, you should keep an • The accountants’ comfort letters may eye out for the potential effect of selling need to change to reflect the revised more shares on the controlled company disclosure analysis — if your deal is upsized at the • A Rule 462(b) registration statement moment of truth, it’s possible that the to register additional shares or company will not longer be “controlled” transaction size may need to be for purposes of this exemption. prepared, and extra filing fees may need to be paid Tying It All Together • A Rule 462(d) post-effective amendment to add a new Exhibit 5.1 So how does all of this fit together, you opinion covering additional shares ask? Simple, really. The underwriters may need to be drafted and filed and the issuer should start the dialogue • If there are other changes that do not about how the market is reacting to the qualify as pricing information within deal while the road show is progressing. the meaning of Rule 430A or if Rule These are the types of questions that 430A’s 20 percent safe harbor is not may come up: available, a post-effective amendment • Is there sufficient demand for the to the registration statement may stock within the suggested range? need to be prepared and filed, • If not, is it possible to get a smaller and the SEC Staff must declare it deal done within the range or may we effective, and need to reduce the deal’s size and the • In the most extreme cases, an entirely per share price? new price range prospectus must • If the size of the deal decreases, will be drafted and recirculated to all the use of proceeds need to change? investors expecting to purchase stock in the offering. 13 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert All these steps take time. There is no 2:00 p.m. Eastern time is often chosen. substitute for advance planning, which Because the market has not yet closed, you comes in two phases — before and would typically not be in a position to know with certainty that you will be pricing outside the during/after the road show. Before the range set forth in the prospectus at that time. road show, it is very handy if the price range prospectus is drafted to include 2 The time of “effectiveness” is a key moment in the IPO. Among other things, securities appropriate sensitivity analysis along the cannot be sold until the registration statement lines discussed above. Good advance is declared effective. Rule 430A allows an IPO planning and carefully crafted disclosure to price as many as 15 business days after in the price range prospectus may make effectiveness, but it is most common to price on it possible to conclude that a change the day of effectiveness (which is also the time in deal size is not a material change the underwriters will begin confirming orders). in the disclosure, taken as a whole. The actual closing of the transaction happens During and after the road show, as soon some number of days later. as it becomes clear that an upsizing or 3 Rule 430A defines pricing information as: downsizing is even a possibility, the information with respect to the public offering deal team should be reviewing the price, underwriting syndicate (including any options under the rules described above material relationships between the registrant and preparing revised disclosure, free and underwriters not named therein), writing prospectuses, telephone scripts, underwriting discounts or commissions, etc., as needed. discounts or commissions to dealers, amount of proceeds, conversion rates, call prices and Timing is critical and there is little other items dependent upon the offering price, margin for error. Be prepared! delivery dates, and terms of the securities dependent upon the offering date[.] Summary 4 We’re assuming that the prospectus at effectiveness is the same price range prospectus This is tricky stuff. However, with circulated to investors — in other words, that you appropriate advance planning and have not refiled with a different range. carefully crafted disclosure in the 5 Note, however, that one consequence might be price range prospectus, it is possible a material change to the ownership structure, to navigate the many technical for example if the change resulted in a control requirements and focus on the judgment group’s retention (or loss) of control over the calls. What is a material change to the company. disclosure depends in part on what was 6 In other words, if prospective investors actually disclosed in the first instance, so the have the revised preliminary prospectus in their advance planning really begins at the hands at 9:00 a.m. on Monday morning, it would first drafting session. Those who are be appropriate to price on Tuesday after the thinking ahead to pricing from the very market closes. beginning will have an easier time when 7 One wrinkle in Rule 433 that could be construed they get there, even if the deal changes to require a full recirculation in a very limited materially at the moment of truth. circumstance deserves discussion. Rule 433(b)(2)(i) requires that an IPO issuer’s Endnotes free writing prospectus be: 1 Remember, though, that there are situations in accompanied or preceded by the most recent which you may conclude that filing a pre-effective . . . [preliminary] prospectus [on file with the amendment is unavoidable. One example would SEC]; provided, however, that use of the be where you are certain before effectiveness free writing prospectus is not conditioned on that your deal is going to be dramatically providing the most recent such prospectus if downsized or upsized: failing to refile exposes a prior such prospectus has been provided you to the risk of tripping over Regulation S-K and there is no material change from the Item 501(b)(3), which requires an IPO issuer prior prospectus reflected in the most recent to include a “bona fide estimate” of the price prospectus[.] range in the preliminary prospectus it circulates to potential investors. In the ordinary course, This proviso is puzzling, since in most cases you would seek to go effective at some point there would not be a reason to circulate a prior to the close of the stock market — free writing prospectus if there were nothing 14 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert material to report. We choose, therefore, to 9 Whichever route is chosen, you will also need to interpret the proviso as meaning that a free remember to include a new Exhibit 5.1 opinion writing prospectus for an IPO issuer is only on the legality of the additional securities being allowed to convey material changes if the free registered. This can be done by means of an writing prospectus and the original preliminary immediately effective post-effective amendment prospectus (and each other broadly distributed under Rule 462(d). free writing prospectuses, if any), taken together, 10 Note, by the way, that Rule 462(b) works for contain materially the same information as an increase in transaction size in a Rule 457(o) is at the time on file with the SEC. We think deal, even though the text of Rule 462(b) speaks that this interpretation is more in keeping with only of “registering additional securities.” See the overall purpose of Rule 433 — namely, to C&DI 640.04. encourage sending information to accounts on 11 The “greenshoe” is jargon for the underwriters’ an as-needed, real-time basis. over-allotment option — that is, the contractual In any event, however, note 1 to paragraph right to purchase some number of additional (b)(2)(i) of Rule 433 makes clear that this shares from the issuer after the closing of the technical issue is not a problem for a free offering. “It is so named because it was first writing prospectus delivered by e-mail as long used in connection with a 1963 secondary as it includes a hyperlink to the most recent offering of shares of common stock of The preliminary prospectus on file with the SEC. As Green Shoe Manufacturing Company, the a result of this helpful note, every free writing Boston-based manufacturer of Stride-Rite shoes prospectus to be sent by e-mail in connection (not green shoes for leprechauns as some with an IPO should include such a hyperlink. have supposed).” Charles J. Johnson, Jr. and In situations where the underwriters are able Joseph McLaughlin, Corporate Finance and the to distribute free writing prospectuses to all Securities Laws at 2-38 (4th ed. 2009). accounts by e-mail, there is no need to struggle 12 When calculating the increase in deal size for with the interpretive issue discussed in the prior Rule 462(b) purposes, do not overlook the paragraph. underwriters’ overallotment option – you will 8 There is a technical reason why it is generally need to register a sufficient number of shares preferable to chose Rule 457(o) at the outset. (and pay enough fees) to cover both the primary The SEC Staff informally takes the position that as well as any option shares to be sold in the if you raise your price range in a preliminary IPO. prospectus contained in a pre-effective 13 Having said that, you would need to be amendment from the range used to calculate comfortable that the price range in the price the filing fee and you originally elected to range prospectus circulated to investors (and proceed under Rule 457(a), then the 20 percent included in the registration statement at the time safe harbor contemplated by the instruction to of effectiveness) was in fact a “bona fide” price paragraph (a) of Rule 430A is calculated on the range as required by Regulation S-K Item basis of the original maximum aggregate offering 501(b)(3). price and not the offering price range contained in the price range prospectus distributed to 14 Among other things, the Corporate Finance Rule investors. This qualification can be eliminated if limits the greenshoe to 15 percent of the amount you “voluntarily” pay an additional filing fee when of securities being offered in the IPO (excluding you increase your offering range, but doing so the greenshoe). See FINRA Rule 5110(f)(2)(J). defeats the primary benefit of Rule 457(a) (i.e., you do not need to go back to the SEC if you increase your estimated price per share). This SEC Staff position can be a trap for the unwary issuer who elected to use Rule 457(a) originally to calculate the filing fee and later seeks to upsize. There is no such hidden problem for users of Rule 457(o), as they are required to pay additional filing fees at the time they upsize their deal, and they know it. 15 Number 1053 | July 14, 2010 Latham & Watkins | Client Alert If you have any questions about this Client Alert, please contact one of the authors listed below or the Latham attorney with whom you normally consult: Brian G. Cartwright Kirk A. Davenport +1.202.637.2274 +1.212.906.1284 firstname.lastname@example.org email@example.com Washington, D.C. New York Alexander F. Cohen Joel H. Trotter +1.202.637.2284 +1.202.637.2165 firstname.lastname@example.org email@example.com Washington, D.C. Washington, D.C. Client Alert is published by Latham & Watkins as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the attorney with whom you normally consult. A complete list of our Client Alerts can be found on our website at www.lw.com. If you wish to update your contact details or customize the information you receive from Latham & Watkins, please visit www.lw.com/LathamMail.aspx to subscribe to our global client mailings program. 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"IPO Number 1053 July 14 2010"