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Division of Corporation Finance:

Revised Staff Legal Bulletin No. 3 (CF)

Action:   Publication of Corporation Finance Staff Legal Bulletin

Date:   October 20, 1999

Summary:   This staff legal bulletin provides the Division of Corporation Finance's views regarding the Section 3(a)(10) exemption from the Securities Act of 1933's registration requirements. The bulletin also expresses the Division's views regarding the Securities Act resale status of securities that are received in transactions exempt from registration pursuant to Section 3(a)(10). Finally, the bulletin, originally issued on July 25, 1997, is revised to provide the Division's views on the availability of the Section 3(a)(10) exemption after the enactment of Section 302 of the Securities Litigation Uniform Standards Act of 1998.

Supplementary Information:   The statements in this legal bulletin represent the views of the staff of the Division. This bulletin is not a rule, regulation, or statement of the Securities and Exchange Commission. Further, the Commission has neither approved nor disapproved its content.

Contact Person:   For further information please contact Cecilia D. Blye, Special Counsel, at (202) 942-2900.

1. Overview

Section 3(a)(10)1 of the Securities Act2 is an exemption from Securities Act registration for offers and sales of securities in specified exchange transactions.3 Before the issuer can rely on the exemption, the following conditions must be met.4

  • The securities must be issued in exchange for securities, claims, or property interests; they can not be offered for cash.5
     
  • A court or authorized governmental entity6 must approve the fairness of the terms and conditions of the exchange.
     
  • The reviewing court or authorized governmental entity must:
    • find, before approving the transaction, that the terms and conditions of the exchange are fair to those to whom securities will be issued;7 and
    • be advised before the hearing that the issuer will rely on the Section 3(a)(10) exemption based on the court's or authorized governmental entity's approval of the transaction.
       
  • The court or authorized governmental entity must hold a hearing before approving the fairness of the terms and conditions of the transaction.
     
  • A governmental entity must be expressly authorized by law to hold the hearing, although it is not necessary that the law require the hearing.
     
  • The fairness hearing must be open to everyone to whom securities would be issued in the proposed exchange.
     
  • Adequate notice must be given to all those persons.
     
  • There cannot be any improper impediments to the appearance by those persons at the hearing.

The Section 3(a)(10) exemption is available without any action by the Division or the Commission. Issuers that are unsure of whether the exemption is available for a specific contemplated transaction may, however, seek the Division's views by requesting a "no-action" position from the Division.

This bulletin discusses the issues that commonly arise in those "no-action" requests. The Division believes that, by making its views on these issues more widely known, issuers will better understand when the exemption is available. Also, by making the Division's views more widely known, this bulletin should decrease those situations in which an issuer is uncertain whether the exemption is available for a contemplated transaction.

As originally issued8, Staff Legal Bulletin No. 3 discussed the effect of the National Securities Markets Improvements Act9 on exchanges approved by courts and authorized government entities. NSMIA amended Section 18 of the Securities Act10 to preclude any state from requiring registration or qualification of "covered securities."11 The bulletin expressed the Staff's view that NSMIA precluded reliance on a fairness hearing conducted under state securities laws as the basis for a claim of exemption pursuant to Section 3(a)(10), for any security that was a "covered security" prior to the hearing.

Section 302 of the Securities Litigation Uniform Standards Act of 199812 amends Section 18(b)(4)(C) to add securities issued under Section 3(a)(10) of the Securities Act as a category of securities exempt from the definition of "covered securities." As a result, an issuer now may rely upon a fairness hearing conducted under state securities law to perfect an exemption under Section 3(a)(10) for securities that otherwise would be deemed covered securities. The Division's views on this matter are discussed more completely in Section 4.B.2., below.

2. Timing of No-Action Requests

The Division will not issue a no-action response concerning a transaction after the fairness hearing has been held. An issuer must, therefore, submit its no-action request before the fairness hearing. If an issuer submits a no-action request very close to the fairness hearing date, the Division may not have adequate time to consider the issues presented and respond before the fairness hearing.13

3. Timing of Security Holders' Votes

When an issuer solicits security holders' votes on the transaction before the fairness hearing, it is offering the securities to be issued in the transaction. This solicitation ordinarily requires either registration or an exemption.

A practical issue arises because many statutes governing fairness hearings require security holders to vote before the hearing, at a time when the issuer cannot be certain that it will be able to rely on the Section 3(a)(10) exemption. In these situations, the Division has not objected to a vote before the fairness hearing, even though this means an investment decision is made before the fairness hearing. The Division takes this view because the timing is required by the governing statute and, under that statute, the transaction is not effected unless the court or authorized governmental entity approves it. In the Division's view, the issuer should submit to the court or authorized governmental entity the disclosure materials offering the securities before it mails them to the offerees.

4. Division Analysis of the Requirements Underlying the Exemption

A. The Securities Must Be Issued in Exchange for Securities, Claims, or Property Interests14

For a discussion of exchanges that are "partly for cash," see footnote 5.

This requirement generally does not raise interpretive issues.15 However, it is important to note that when options, warrants, or other convertible securities are issued in the Section 3(a)(10) transaction, Section 3(a)(10) does not exempt the later exercise or conversion.

This is different than transactions that are exempt under Section 1145 of the U.S. Bankruptcy Code.16 Section 1145 specifically exempts the later exercise or conversion from Securities Act registration.17

B. A Court or Authorized Governmental Entity Must Approve the Exchange's Terms and Conditions

1. Appropriate Authorization for Governmental Entity Approval

If a governmental entity is approving the exchange, that entity must be authorized by statute:

  • to hold a hearing on the transaction, although it is not necessary that the statute require the hearing; and
     
  • to approve the fairness of the exchange's terms and conditions.18

In this analysis, the statute must require the entity to conclude affirmatively that the exchange is fair to the security holders participating in the exchange .19 For example, the statute must require the governmental entity to conclude that the terms and conditions of the exchange are "in the best interest of shareholders" or "fair" to shareholders, not that the exchange is "not unfair," "not unreasonable," "not prejudicial," or "not counter to the best interest of shareholders."20. Moreover, as previously discussed in footnote 7, the governmental entity must find the terms and conditions to be fair both procedurally and substantively.

If there is a question as to whether the statute authorizes the governmental entity to hold a hearing on the transaction and to approve the fairness of the exchange's terms and conditions, it may be clear from the actual practice of the authorized governmental entity. For example, in State Mutual Life Assurance Company (March 23, 1995), the Division relied on an opinion from counsel to the Division of Insurance of the Commonwealth of Massachusetts that the relevant statute authorized the Massachusetts Insurance Commissioner to make the requisite fairness determination.

If an issuer intends to rely on the Section 3(a)(10) exemption, it may want to look at prior Division no-action responses and see if the particular statute has ever been the basis for a Division no-action position. If the statute has been the basis for a favorable Division position, the issuer should consider whether the language of the statute has changed since the Division took that favorable position.

2. The Effect the Securities Litigation Uniform Standards Act Has on Exchanges Approved by Governmental Entities

Issuers have raised questions on how the recently enacted Securities Litigation Uniform Standards Act affects the scope of the Section 3(a)(10) exemption for transactions approved by governmental entities.

NSMIA amended Section 18 of the Securities Act to preempt any state from requiring the registration of "covered securities." As amended by NSMIA, Section 18 also preempted any state law that authorized a state fairness hearing relating to the registration, or exemption from registration, of securities that were "covered securities" before the hearing. An issuer, therefore, could not use such a hearing as a basis for relying on the Section 3(a)(10) exemption.21

Section 302 of SLUSA amends Section 18 to add securities issued under Section 3(a)(10) of the Securities Act as a category of securities exempt from the definition of covered securities.22 According to congressional statements made during consideration of Section 302 of SLUSA, NSMIA's prohibition of reliance on certain state fairness hearings to perfect a Section 3(a)(10) claim of exemption with respect to "covered" securities was inadvertent. Section 302 is a technical correction that is intended to correct an inadvertent effect of NSMIA.23 As a result, it is the staff's view that securities that otherwise would be covered securities, and therefore exempt from the registration or qualification provisions of state securities laws, are removed from the definition of "covered security" if they are offered and sold in reliance on Section 3(a)(10).24 Accordingly, an issuer now may rely upon a fairness hearing conducted under state securities law to perfect an exemption under Section 3(a)(10) for securities that otherwise would be covered securities. An issuer may perfect a claim of exemption under Section 3(a)(10) by relying on any state procedure that provided a valid basis for the Section 3(a)(10) exemption before NSMIA was enacted. Statements to the contrary in the original Staff Bulletin No. 3 therefore are no longer valid.

Because, as amended, Section 18 exempts all securities issued in reliance on Section 3(a)(10) from the definition of "covered securities," such securities are no longer exempt from the registration or qualification provisions of any state securities laws.

3. Information That Must Be Available to the Court or Authorized Governmental Entity When It Makes Its Fairness Determination

The issuer must advise the court or authorized governmental entity before the hearing that the issuer will rely on the Section 3(a)(10) exemption based on the court's or authorized governmental entity's approval of the exchange. It is the Division's view that the reviewing court or authorized governmental entity making the fairness determination "must have sufficient information before it to determine the value of both the securities, claims or interests to be surrendered and the securities to be issued in the proposed transaction."25

4. Foreign Courts

It is the Division's view that the term "any court" in Section 3(a)(10) may include a foreign court.26

In connection with no-action requests in these situations:

  • all requirements that apply to exchanges approved by U.S. courts must be met; and
     
  • the issuer must provide the Division with an opinion from counsel licensed to practice in the foreign jurisdiction that says that before the foreign court can give its approval, it must consider the fairness of the proposed exchange to persons receiving securities in the exchange.27

C. Before Approval, the Court or Authorized Governmental Entity Must Hold a Hearing on the Fairness of the Exchange; This Hearing Must Be Open to Everyone to Whom Securities Would Be Issued in the Proposed Exchange

The court or authorized governmental entity must:

  • hold a hearing to determine whether the proposed exchange's terms and conditions are fair to all those who will receive securities in the exchange; and
     
  • approve the fairness of the terms and conditions of the proposed exchange.28

The hearing must be open to everyone to whom securities would be issued in the proposed exchange.

The issuer must provide appropriate notice of the hearing in a timely manner.29 Section 3(a)(10) does not specify the information that must be included in the required notice.

Although the anti-fraud requirements of the federal securities laws would govern disclosure, the Division does not address the adequacy or appropriateness of the information provided to persons who have a right to appear at the hearing. In connection with no-action requests, the Division will consider the adequacy of the notice only to the extent that it:

  • adequately advises those who are proposed to be issued securities in the exchange of their right to attend the hearing; and
     
  • gives them the information necessary to exercise that right.

An issuer that intends to rely on the Section 3(a)(10) exemption should consider whether, as a practical matter, imposing prerequisites to appearance will prevent those persons from having a meaningful opportunity to appear at that hearing.30

5. Resale Status of Securities Received in a Transaction Exempt From Securities Act Registration Pursuant to Section 3(a)(10)

In the Division's view, holders must resell securities received in Section 3(a)(10)-exempt exchanges in the manner permitted by Securities Act Rule 145(c) and (d).31 These Rule 145(c) and (d) resale limitations apply only to holders that were affiliates of any party to the exchange at the time of the Section 3(a)(10)-exempt sale.

Generally, Rule 145(d) provides three appropriate methods for unregistered resales by these holders:

  • resales that meet all of the Rule 144 requirements, except for the holding period and notice filing requirements (Rule 145(d)(1));
     
  • resales by persons who are not affiliates of the issuer and have held the securities for at least one year from the date of the Section 3(a)(10)-exempt transaction without regard to Rule 144, except for the current public information requirement (Rule 145(d)(2)); and
     
  • resales by persons who are not, and for the last three months have not been, affiliates of the issuer and have held the securities for at least two years from the date of the Section 3(a)(10)-exempt transaction without regard to Rule 144 (Rule 145(d)(3)).

It is the Division's view that securities received in a Section 3(a)(10)-exempt transaction may be resold in the following manner:

1. Persons may resell their Section 3(a)(10) securities without regard to Rules 144 or 145(c) and (d) if they:
  a) are not affiliates of any party to the transaction before the transaction;
  and
  b) are not affiliates of the issuer of the Section 3(a)(10) securities after the transaction.
2. Persons may resell their Section 3(a)(10) securities in the manner permitted by Rule 145(d)(1), (d)(2), or (d)(3) if they:
  a) are affiliates of any party to the transaction before the transaction;
  but
  b) are not affiliates of the issuer of the Section 3(a)(10) securities after the transaction.32
3. Persons may resell their Section 3(a)(10) securities in the manner permitted by Rule 145(d)(1) if they:
  a) are affiliates of any party to the transaction;
  and  
  b) are affiliates of the issuer of the Section 3(a)(10) securities after the transaction.
The resale provisions of Rule 145(d)(2) or (d)(3) would not be available to this third group because Rule 145(d)(2) and Rule 145(d)(3) are not available to affiliates of the issuer of the Section 3(a)(10) securities.
1 15 U.S.C. §77c(a)(10). Section 3(a)(10) reads as follows:

Except with respect to a security exchanged in a case under title 11 of the United States Code, any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court or by any official or agency of the United States or by any State or Territorial banking or insurance commission or other governmental authority expressly authorized by law to grant such approval.

2 15 U.S.C. §77a et seq.
3 The Trust Indenture Act of 1939 does not include an exemption that is the equivalent of Section 3(a)(10) of the Securities Act. If an issuer is relying on Section 3(a)(10) to offer and sell debt securities without Securities Act registration, it should note that the Trust Indenture Act would still apply to that offering.
4 The staff derives these conditions from the language of Section 3(a)(10) and positions expressed by the General Counsel of the Commission in a letter excerpted in Securities Act Release No. 312 (March 15, 1935) [11 FR 10953].
5 Section 3(a)(10) also exempts sales of securities that are "partly in such exchange and partly for cash...". It is the Division's view that Section 3(a)(10) exempts transactions that are predominantly exchanges and that the "partly for cash" language is intended merely to permit flexibility in structuring those exchanges. The Division has not received no-action requests that raise the issue of whether the exchange is truly an exchange or whether the level of cash involved changes its nature. Because this analysis necessarily would be very fact-specific, the Division is not able to give specific guidance on the issue in this staff legal bulletin. To the extent the issue is presented in a transaction, an issuer may wish to request a no- action position from the staff on that particular transaction.
6 Authorized governmental entities may include state insurance commissions, state corporation or securities commissions, state banking agencies, etc.
7 In the Division's view, the reviewing court or authorized governmental entity must find the terms and conditions of the exchange to be fair both procedurally and substantively.
8 Staff Legal Bulletin No. 3 (CF) (July 25, 1997).
9 Pub. L. No. 104-290 (1996).
10 15 U.S.C. §77r.
11 "Covered securities" are defined in Section 18 to include, among others, securities listed or approved for listing on the New York Stock Exchange, the American Stock Exchange, or the Nasdaq National Market System.
12 Pub. L. No. 105-353 (1998).
13 Generally, the Division strives to respond to requests for no-action within 30 days of receipt. It makes every effort to satisfy the time schedule of the requestor, but may not be able to accommodate a very short deadline.
14 For a discussion of exchanges that are "partly for cash," see footnote 5.
15 Despite the "exchange" requirement of Section 3(a)(10), the Division has not objected to the issuance of shares as attorneys' fees without registration in reliance on the Section 3(a)(10) exemption, so long as those securities amount to no more than one-third of the securities issued in the settlement. See e.g., Sulcus Corp. (June 19, 1996); The Score Board (November 3, 1995); Aura Systems, Inc. (July 8, 1994).
16 11 U.S.C. §1145.
17 See, e.g., Allied Leisure Industries, Inc. (October 4, 1979) and Canadian Conquest Exploration, Inc. (April 6, 1989).
18 Where an issuer will use court approval as a basis for relying on the Section 3(a)(10) exemption, the court also must make this finding. It is not necessary, however, that the court be expressly authorized by statute to do so. See Securities Act Release No. 312 (March 15, 1935). See also the discussion in the Foreign Courts subsection of this bulletin for the requirements for a foreign court to approve the exchange.
19 In 1938, the staff of the Commission stated its view that:

[A] commission or authority must be authorized to grant approval of the fairness of the terms and conditions of the issuance and exchange, from the point of view of the persons to whom the securities are issued in the exchange, and this authority must be express. This seems to be the proper interpretation if the requirement of a hearing upon the fairness of the terms and conditions is not to be rendered meaningless. As a result many commissions, such as public service commissions, whose authorization may be required for the reorganization of certain companies, will be found not to have the requisite authority because [they are] not authorized to pass upon the interest of the security holders. (emphasis added)

Milton V. Freeman, A Summary of Administrative Interpretations of the Securities Act of 1933, As Amended at 280-81 (draft of May 1, 1938) (citations omitted). This position was restated in the Report of the Task Force on Disclosure Simplification (March, 1996) (the "Task Force Report").
20 Examples of appropriate statutory standards in favorable Division responses to no-action requests include requirements that the entity determine that the transaction:
(1) "adequately protects the interests of depositors, other creditors and shareholders" ( Minowa Bancshares, Inc., November 26, 1990); (2) be "fair and equitable" to shareholders ( Farm Family Mutual Insurance Co., April 2, 1996); (3) promotes the "public convenience and advantage and the interest of [the merging] institutions, their members, stockholders and depositors" ( CFX Corp., April 19, 1996); and (4) "is such that an intelligent and honest man, a member of the class concerned and acting in respect of his interest, might reasonably approve" (The Hongkong and Shanghai Banking Corporation Ltd., January 23, 1991).
21 Of course, as noted in the original SLB 3, not all state fairness hearings relating to exchanges of securities were preempted by NSMIA. The preemption did not apply to state fairness hearing procedures outside the scope of state securities laws, such as those authorized by state corporation, banking or insurance law and not relating to registration, or an exemption from registration, or securities. Issuers were never precluded from using such hearings as a basis for relying on the Section 3(a)(10) exemption.
22 Section 18(b)(4)(C), 15 U.S.C. §77r(b)(4)(C).
23 Congressman Christopher Cox noted in House discussion of SLUSA that Section 302 of SLUSA was intended to make a "... technical correction to [NSMIA]." He explained that:

This correction restores the viability of Section 3(a)(10) of the Securities Act of 1933, which provides a voluntary state-law alternative to federal securities registration. ... Although [NSMIA] does not amend Section 3(a)(10), it inadvertently impeded its operation. I appreciate the Chairman's consideration in including a curative technical amendment endorsed by the California securities regulatory authority in the manager's amendment.*.

* 144 Cong. Rec. H6052, H6060 (daily ed. July 21, 1998)(statement of Rep. Cox).
24 The Division first published its views regarding this matter in letters to Food Lion, Inc. (1/13/99) and Maverick Networks (1/25/99).
25 See Task Force Report at page 60. See also Information Resources, Inc. (February 27, 1995); Applied Magnetics Corp. (May 30, 1995); and Gensia Inc. (June 23, 1995).
26 See, e.g., Lucas Industries plc (August 20, 1996); Symantec Corp. (November 22, 1995); Orbital Sciences Corp. (October 13, 1995); Minera Andes, Inc. (September 21, 1995); Cadillac Fairview, Inc. (May 26, 1995); LAC Minerals Ltd. (June 27, 1991); The Hongkong and Shanghai Banking Corporation Ltd. (January 23, 1991).
27 The Division requires this additional opinion because the fairness standard in foreign jurisdictions often is derived from case law that interprets and applies the statute(s), rather than from the specific language of the statute(s). The opinion of foreign counsel should state clearly that:
  • under applicable law, the court cannot approve the exchange unless it finds the transaction to be fair to the persons who will receive the securities;
  • those persons will receive notice of, and have the right to appear at, the fairness hearing; and
  • the issuer will advise the court before the hearing that it will rely on the Section 3(a)(10) exemption and not register the exchange under the Securities Act based on the court's approval of the exchange.
28 As noted in footnote 7, we believe that the reviewing court or authorized governmental entity must find both the terms of and procedures for the exchange to be fair.
29 For example, if the securities are held in bearer form there must be appropriate publication of the notice.
30 The Division has not objected to the mere requirement to file a notice of an intention to appear. For examples of favorable staff responses to no-action requests where the filing of a notice of an intention to appear was required, see Digicon Inc. (August 19, 1996); Canadian Pacific Ltd., (June 26, 1996); Cadillac Fairview, Inc., (May 26, 1995).
31 The Division initially expressed these positions in the no-action response to St. Ives Holding Company, Inc. (July 22, 1987) and continues to follow them in its analysis of these issues. The Commission recently proposed to eliminate the resale limitations of Rule 145(c) and (d). If this proposal is adopted, the staff's position regarding resale conditions will be reassessed.
32 In computing the holding period of the Section 3(a)(10) securities for purposes of Rule 145(d)(2) or (d)(3), such persons may not "tack" the holding period of the securities exchanged for the Section 3(a)(10) securities in the Section 3(a)(10)-exempt transaction.

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