Regulatory Landscape Concerning Rule 415
and Recent SEC Proposals

The staff of the United States Securities and Exchange Commission (the “Staff”) has been increasingly scrutinizing transactions involving private investments in public equity, or PIPE transactions. This scrutiny has been grounded in the Staff’s position on Rule 415 of the Securities Act of 1933, as amended (“Rule 415”), which is the rule utilized by issuers to subsequently register for resale shares issued pursuant to a PIPE transaction. Prior to the Spring of 2007, issuers selling shares pursuant to a PIPE transaction typically were never prohibited from registering as a valid secondary offering under Rule 415 an amount of shares exceeding thirty percent (30%) of their outstanding public float (i.e., the number of outstanding shares held by non-affiliates).

However, recently, the Staff seems to have changed its position in relation to the extent to which an issuer can register the shares it sells in a PIPE transaction. In fact, the Staff now appears to consider thirty percent (30%) of public float as an acceptable threshold in connection with secondary offerings pursuant to Rule 415. An issuer filing a registration statement for a secondary offering under Rule 415, representing more than thirty percent (30%) of its public float, is being deemed to be engaged in a primary offering by the Staff. As a result, under the current regulatory landscape, the issuer would have to (i) meet the higher eligibility criteria of a Form S-3 registration statement which currently requires an issuer to have a public float exceeding $75 million; and (ii) each of the selling securityholders named in the registration statement must be identified as an underwriter, subjecting them to Section 11 and therefore exposing them to liability for misstatements or omissions in the registration statement.

The Staff became concerned with this issue based on potentially abusive transaction structures involving convertible notes with floating conversion prices These transactions generally consist of convertible notes or other convertible securities being issued with floating conversion prices based on the market price immediately prior to conversion resulting in conversions often for more than the total number of outstanding shares. The Staff has taken the position that public investors are often unaware of the risk that these transactions create due to the issuer’s stock price trading down over time. However, the Staff has indicated that Rule 415 is not designed to impair the “classic” PIPE structure, where an issuer sells shares of common stock at a discount to the market (with warrants that are exercisable at a premium to market).

Consequently, many issuers are registering less shares than they would have registered in the past to avoid being caught within the purview of effectuating a primary offering Although the Staff has not released definitive guidance on this issue, the Staff has indicated that it is focused on several factors including (i) the size of the offering being registered (ii) indicia of control by the selling securityholders; and (iii) whether there is a view toward distribution.

Size of the Offering Being Registered

Offerings of shares representing more than 30% of the issuer’s public float would likely be considered a primary offering. For purposes of the 30% public float test, the numerator includes all fully-diluted securities held by the selling stockholder (including any shares issuable upon exercise of warrants or conversion of convertible securities, without regard to any "blocker" provisions), while the denominator would only include actual outstanding shares held by non-affiliates and the warrants held by the individual seeking registration (i.e. not on a “fully diluted” basis).

Indicia of Control

Indicia of control by the selling stockholders, including any board representation or other contractual provisions enabling control of the issuer; the more control, the more likely the Staff would view the resale offering as a primary offering.

View towards Distribution

Another issue is the extent to which selling stockholders have a view towards distribution of the securities; the sooner investors are able to resell their securities after the issuance in the PIPE transaction, the more likely the Staff would view the transaction as a primary offering. Although not specifically addressed by the Staff, lock-up agreements may be able to address this concern.

Moving Forward

Although Gersten Savage has had recent success in getting registration statements on Form SB-2 effective where such registration statements registered in excess of 30% of the issuer’s public float, it is difficult to accurately assess exactly how the Staff will respond to a particular filing moving forward. However, we do anticipate that additional information regarding this matter will be available in the near future as the comment process continues. We are hopeful that the Staff will ultimately provide clarity on this issue and restore some of the stability to the PIPE market. Lately the Staff appears to be standardizing its comments with respect to the Rule 415 issue and requiring additional disclosure relating to (i) the dilutive impact of the present offering with past transactions; (ii) the amount of funds actually received by the issuer; (iii) the fees paid or payable by the issuer; and (iv) increased risk disclosure.

Moreover, on May 23, 2007, the Staff voted to propose, among other items, two items of importance in relation to the Rule 415 issue:

1. Create a new category of issuers called “smaller reporting companies.” This category would include most companies with a public float of below $75 million; integrate the provisions of Regulation S-B into Regulation S-K; and amend Forms S-3 and F-3 to allow companies with a public float below $75 million to take advantage of shelf registration on these forms, as long as (x) they meet all other eligibility requirements for use of the forms; (y) they are not shell companies and have not been shell companies for at least one year; and (z) they do not sell more than 20% of their public float on Form S-3 or F-3 in any given year; and
    
2. Amend Rule 144 to shorten the holding period for resales by non-affiliates of reporting companies from one year to six months.

Currently, the Staff is soliciting comments on these proposals through July 23, 2007.

Notwithstanding, until more clarity is available, feel free to contact any of the following persons with questions or comments.

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