“Free at last,” managers of taken-private companies might be tempted to shout. No more demands by Wall Street to meet quarterly earnings targets. No more tipping their hand to rivals through quarterly filings with the Securities and Exchange Commission. And, blessedly, no more Sarbanes-Oxley.
In reality, managers of buyout-backed companies soon encounter an even more demanding set of quarterly targets—the one imposed by bankers who don’t take kindly to missed interest payments.
In addition, bond-holders (in deals financed with privately placed high-yield debt) typically demand registration rights that allow them to exchange their privately placed bonds for bonds registered with the SEC. Unlike privately placed bonds, registered bonds are freely tradable, helping to ensure liquidity for investors. The rub: Borrowers that register their securities with the SEC must continue to file 10-Qs, 10-Ks and related documents.
As a result, targets of many of the largest take-privates from the last decade continue to file quarterly and annual earnings reports with the SEC, providing a wealth of data to investors, rivals, analysts, and the merely curious.
But relief could be on the way. Recent amendments to Rule 144, an SEC rule governing privately placed securities, reduce the time required for bond-holders, along with other investors, to wait before they can sell privately placed, restricted securities on the open market. The amendments also eliminate limitations on sales once the waiting period is over.
Attorneys speculate that once the credit crunch runs its course, borrowers may feel emboldened enough to ask bond-holders to forego registration rights since they enjoy so much more liquidity under the new rules. Registration is time-consuming for borrowers, and the ongoing requirement to file Sarbanes-Oxley-compliant earnings reports can cost companies some $2 million per year, according to one estimate. Borrowers also would prefer not to have to disclose, in a public forum, their intimate financial results.
For the moment, high-yield bonds remain such a tough sell that borrowers have limited leverage to ask bond-holders to give up registration rights. And it’s not clear whether bond-holders will ever relinquish registrations rights even in a frothy market. Peter J. Loughran, partner at Debevoise & Plimpton, sees little change for borrowers that haven’t already been filing earnings reports with the SEC. For those that have been, bond-holders might not require SEC reporting registration, provided the borrower makes the earnings reports available some other way. That said, Loughran pointed out that some investors have policies that require them to hold registered securities.
Under the old Rule 144, bond-holders had to wait at least a year after acquiring restricted securities before selling their holdings. Between the first-year anniversary and the second, they could sell securities under certain conditions, such as not exceeding caps on the number of bonds they could sell in any given quarter. After the second anniversary of the offering, bond-holders could sell their securities free of Rule 144 requirements. Not a terribly liquid situation.
So borrowers always agreed to replace the restricted bonds with freely tradable, registered securities within six months to a year of the original offering. In legal circles this has become known as an “A/B exchange offer.” Under SEC rules, the borrower files an S-4 to register the securities, then 10-Qs, 10-Ks and related documents for up to a year after that. The SEC reporting requirements may end there. But under covenants imposed by bond-holders in the private placement documents, the company continues filing with the SEC as a “voluntary filer.”
Under the new rules, provided an issuer continues to file reports with the SEC, bond-holders can begin selling their securities after six months, and face no restrictions on sales after that. For companies that don’t have to file reports with the SEC, the minimum holding period before selling is one year. After that, the bonds become freely tradable.
For more on the amendments to Rule 144, contact Peter J. Loughran, partner Debevoise & Plimpton, 212-909-6375; John A. Bick, partner, Davis Polk & Wardwell, 212-450-4350; or Rod Miller, partner Weil Gotshal & Manges, 212-310-8716.
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