It’s (Rule) 415 – Do You Know Where Your Children Are?

So “children” is my metaphor for small-cap public companies, and Rule 415 is an SEC regulation that I hadn’t even heard of until two weeks ago.

It turns out that the SEC appears to be looking to crack down on some of the more punitive PIPE structures when microcap companies (under $75 million market cap?) seek to raise significant amounts of capital (greater than perhaps 30-50% of their market cap?). According to the November 1, 2006 issue of the PIPEs Report, by classifying such transactions under Rule 415(a)(1), the SEC “now views these deals as primary offerings and the investors as underwriters.”  

I can’t explain exactly what the SEC’s reasoning is here (I guess that’s what the lawyers are for!), but the result is that shares purchased under a PIPE deal of this sort may not in fact turn out to be registerable as quickly as before – or in the worst case they might never turn out to be registerable (and thus would ultimately have to be sold under Rule 144).

To be clear, I don’t have a lot of sympathy for “fast money” investors in general and for the purveyors of the so-called “death spiral converts” in particular. But as a VC who sometimes invests in PIPEs as a way of accessing a different segment of the biopharmaceutical development market, I fear that the SEC risks throwing the baby out with the bathwater in this instance.

I don’t have a problem with the average time to getting PIPE shares registered increasing recently from seven to nine weeks (as calculated by Sagient Research), as we tend to be long-term holders who are trying (although not always succeeding) to build underlying company value. But the open-ended risk of non-registration is a real problem.  

Specifically, it has caused investors – albeit a minority of them so far – to pull out of PIPE deals fully supported by company managements and their Boards, and it has forced terms to become tougher on companies that oftentimes are already having significant difficulties of one sort or another.

The insidious nature of the current situation is that as far as I know the SEC hasn’t promulgated a formal definition of which types of transactions will fall into this black hole, and you don’t find out about any difficulties in registering your PIPE securities until long after your money has gone into the company. And that’s bad for investors and companies alike.

Here’s hoping that the SEC can (1) Quickly resolve the present uncertainty and (2) Do so in a fair and reasonable manner that protects a fundraising mechanism that many public companies in the Life Sciences and other industries have used to great advantage.

At least then we we’ll really know where our children are.