Lorimar, Inc.

Nov 4, 1985

SEC-REPLY-1:

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

October 3, 1985

RESPONSE OF THE OFFICE OF CHIEF COUNSEL

DIVISION OF CORPORATION FINANCE

Re: Lorimar, Inc. ("Lorimar")

Bozell & Jacobs, Inc. ("B&J")

Incoming letter dated July 18, 1985

While the question is not free from doubt, on the basis of the facts presented, this Division will not recommend any enforcement action to the Commission if Lorimar, in reliance on your opinion as counsel that registration is not required, acquires the shares of B&J without registering the deferred payment rights under the 1933 Act. In arriving at this position, we have particularly considered the following: (1) the deferred payment rights are granted to the selling shareholders not as an investment, but as an integral part of the consideration for the sale, not as an investment, but as an integral part of the consideration for the sale, a substantial portion of which is being paid in cash at the time the shares of B&J are acquired by Lorimar; (2) the deferred payment rights do not represent an ownership interest in the acquired business or Lorimar; (3) most holders of an ownership interest in the acquired business or Lorimar;(3) most holders of the deferred payment rights will be employees of B&J, and can be expected to remain with the acquired business and contribute their efforts directly toward its profitability, upon which the deferred payment right will be based; and (4) the deferred payment rights are not transferable other than by operation of law. In these circumstances, the Division will raise no question if the deferred payment rights are issued without qualification of an indenture under the 1939 Act.

Because this position is based on the representations made to the Division in your letter, it should be noted that any different facts or conditions might require a different conclusion. Moreover, this letter merely expresses this Division's position regarding enforcement action and does not purport to express any legal conclusion with respect to the question presented.

Sincerely,

William E. Toomey

Assistant Chief Counsel

INQUIRY-1:

LAW OFFICES OF

BUCHALTER, NEMER, FIELDS, CHRYSTIE & YOUNGER

(a PROFESSIONAL CORPORATION)

SUITE 700

700 SOUTH FLOWER STREET

LOS ANGELES, CALIFORNIA 90017

TELEPHONE (213) 626-6700

July 18, 1985

Securities and Exchange Commission

Division of Corporation Finance

Officeof Chief Counsel

450 Fifth Street, N.W.

Washington, D.C. 20549

Re: Lorimar, Inc. - Request for No-Action Letter Concernining Deferred Payments In An Acquisition Transaction

Gentlemen:

Request

We hereby request that the Commission Staff concur with our view that the contractual deferred payment right described in this letter (i) is not a security for purposes of the Securities Act of 1933, as amended (the "Securities Act"); and (ii) may be made without the qualification of an indenture under the Trust Indenture Act of 1939 (the "Trust Indenture Act"). If the Commission Staff concurs with our view, we request that the Staff state in writing that it would not recommend any enforcement action to the Commission if the merger described below takes place without such registration or qualification.

Facts

Lorimar, Inc., a Delaware corporation ("Lorimar"), and its subsidiaries are primarily engaged in the development, acquisition, production and distribution of television series, made-for-television movies and mini-series produced for network and/or pay television and feature-length motion pictures produced for initial theatrical exhibition. In 1983, Lorimar acquired Kenyon & Eckhardt Incorporated ("K & E"), an advertising agency which plans, creates and places advertising in various media for a number of major companies.

Lorimar's common stock is traded on the American Stock Exchange and the Pacific Stock Exchange, and Lorimar is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended ("Exchange Act"). During the last two years, Lorimar has been active in the public market. In January 1984, Lorimar completed a public offering consisting of $50,000,000 face amount of 8-7/8% convertible subordinated debentures due January 15, 2004. In June 1984, $43,102,000 principal amount of the 8-7/8% debentures were converted into 1,933,640 shares of Lorimar common stock at a reduced conversion price of $22.29 per share. In October 1984, Lorimar completed a public offering consisting of $115,000,000 face amount of 8-7/8% convertible subordinated debentures due October 15, 2004.

Lorimar and Bozell & Jacobs, Inc., a Delaware corporation ("B & J"), have executed a Letter of Intent with respect to the proposed acquisition by Lorimar of B & J. B & J is primarily engaged in the advertising business. The approximately 1,171,000 sharesof common stock of B & J issued and outstanding are held by 176 persons, all of whom are employed with B & J. Approximately 65.24% of the outstanding stock of B & J is held by director-employees of B & J. The B & J common stock is not publicly traded on any national securities exchange or through NASDAQ and is not registered under Section 12 of the Exchange Act.

Under the terms of the Letter of Intent, B & J will be acquired by Lorimar through a statutory merger with an indirect wholly-owned subsidiary of Lorimar in accordance with the general corporation law of the State of Delaware (the "Merger"). The Merger requires the approval of a majority of the outstanding shares of B & J. Stockholders of B & J who dissent from the Merger and follow specified statutory procedures prescribed by Delaware law will have the right to receive the fair value of their shares through an appraisal. Upon the effectiveness of the Merger, the indirect wholly-owned subsidiary of Lorimar will cease to exist, and B & J will continue in existence as the surviving corporation (sometimes referred to as the "Surviving Corporation").

In connection with the Merger, the Surviving Corporation will enter intofive year employment contracts with four key executive officers of B & J. Moreover, it is expected that the present employees of B & J, many of whom are stockholders of B & J, will remain with the Surviving Corporation. It is anticipated that the operations of K & E and B & J will be combined, and that the present B & J executive officers will have significant control over the combined Lorimar advertising group.

On the effective date of the Merger, each of the issued and outstanding shares (except dissenting shares) of B & J will be converted into a right to receive form Lorimar a pro rated portion of the purchase price. Pursuant to the terms of the Letter of Intent, the purchase price consists of $25,000,000 in cash delivered at the closing (the "Initial Payment") and a right to receive in cash, without interest thereon, the deferred payments (the "Deferred Payments") described below.

The Deferred Payments consist of three annual payments following the Closing Date of $5,000,000, $5,000,000 and $5,750,000, respectively. The Deferred Payments are subject to reduction if the combined domestic advertising revenue of K & E and B & J in 1986 does not reach certain levels. Specifically, for each $1.00 that the combined actual domestic advertising revenue of K & E and B & J is less than the combined domestic advertising revenue of K & E and B & J projected for 1986, (to be agreed upon by the parties and set forth in the definitive merger agreement), the Deferred Payments will be reduced by $0.80, up to a maximum reduction of $6,000,000. Such reduction, if any, will be applied first against the payment due three years from the Closing Date and then, to the extent necessary, against the payment due two years from the Closing Date. In addition, Deferred Payments are subject to reduction if the representations and warranties made by B & J in the definitive merger agreement are not true and correct.

The right to the Deferred Payments (the "Deferred Payment Rights") will be set forth only in the definitive merger agreement and will not be evidenced by any form of certificate or instrument. The Deferred Payment Rights will not be transferable, except by (i) will or the laws of descent and distribution or (ii) operation of law. The holders of Deferred Payment Rights will have no rights as stockholders of Lorimar or the Surviving Corporation and will have no voting ordivident rights. The Deferred Payments do not bear any stated interest, although, for tax purposes they are assumed to include interest at the imputed rate prescribed by the Internal Revenue Code of 1954, as amended and the rules and regulatiions of the Treasury Department.

In our view (i) the Deferred Payment Rights are not securities under the Securities Act because they are not encompassed by the broad definition of a "security" when viewed in terms of economic reality and the intention of all the parties concerned, and (ii) the Deferred Payment Rights are not covered by the Trust Indenture Act, which relates to the Issuance of separate and distinct evidence of indebtedness such as notes, bonds, and certificates of participation.

Discussion

Securities Act of 1933, As Amended

The definition of a security under the Securities Act is set forth in Section 2(1) of the Act. That section provides that "unless the context otherwise requires" the following are securities for purposes of the Securities Act:

"[A]ny note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trustcertificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly known as a "security", or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing."

Congress stated that the Act defines "the term security in sufficiently broad and general terms so as to include within that definition the many types of instruments that in our commercial world fall within the ordinary concept of a security." n1 The legislative history of the Securities Act indicates that Congress assumed the ordinary concept of a security connoted some form of investment. The intent of the Securities Act was seen as "regulating the sale of investment securities to the innocent public." n2 Non-transferable contract rights for deferred payments are thus not specifically identified in the definition of a "security," nor is there any indication in the legislative history that they were specifically intended to be covered.

The Commission Staff has on several occasions taken the view that an earn-out right in connection with the acquisition of a business is not a security under the Securities Act. In Lifemark Corporation (available November 17, 1981), the Staff was requested to take a no-action position in connection with the sale of a proprietary hospital by a general partnership made up of doctors admitting patients to that hospital. The purchase price consisted of cash, the assumption of certain debts, and a right to receive earn-out payments equaling a specified percentage of the hospital's net revenues over the following twelve years. In Lifemark Corporation, the Staff indicated that it would take a no-action position should such contractual earn-out rights be granted without registration under the Securities Act.

A subsequent letter, The Northwestern Mutual Life Insurance Company, (available March 3, 1983) involved the acquisition of a regional brokerage house, which had116 shareholders and issued outstanding common stock that was not traded over a national exchange or through NASDAQ and not registered under Section 12 of the Exchange Act. The purchase price consisted of cash paid at closing and the right to receive earn-out payments equal to a percentage of the consolidated net income of the acquired company for a five year period. As in Lifemark Corporation, the SEC staff indicated that it would take a no-action position if the earn-out rights were not registered under the Securities Act.

In Lifemark Corporation and The Northwestern Mutual Life Insurance Company the Staff predicated its conclusion on a number of grounds. First, the contractual earn-out right was granted as an integral part of the consideration for the same of a business and not as an investment. Second, the earn-out right did not represent an ownership interest in the acquiring corporation or acquired corporation. Third, most of the holders of the earn-out rights were employees of the acquired company and expected to remain with the acquired business and contribute their efforts directly toward the profitability upon which the earn-out right was based.

The Deferred Payment Rights are similar to the earn-out rights at issue in Lifemark Corporation and The Northwestern Life Insurance Company. Neither the B & J stockholders nor Lorimar view the transaction as involving an additional "investment" by the B & J stockholders. Indeed, the B & J stockholders are selling their investment in B & J. They are receiving a deferred non-interest bearing cash payment in annual installments the aggregate amount of which is contingent on the revenue performance of B & J and K & E. Deferred payments and earn-outs are typical methods for structuring the consideration paid in acquisition transactions to reduce the buyer's risk that certain expectations about the acquired company will not be realized. The Deferred Payments, therefore, are an integral component of the total purchase price paid by Lorimar. Further, the Deferred Payment Rights have none of the characteristics of a security -- they cannot be transferred (except by operation of law); they do not represent an equity ownership interest in Lorimar or B & J and there is no possibility of such an interest; they have no intrinsic value so that they can be pledged or otherwise used as an ordinarysecurity; and they entitle the owner to no voting or dividend rights nor do they bear stated interest. Finally, each of the holders of the Deferred Payment Rights will continue as employees of the Surviving Corporation and contribute to its profitability.

The difference between the Deferred Payments discussed herein and the earn-out rights in Lifemark Corporation and The Northwestern Life Insurance Company lies in Lorimar's commitment to pay at least $9,750,000 over a three year period with an additional amount to be paid (up to $6,000,000) if certain revenue levels are achieved. The commitment to pay $9,750,000 characterizes the Deferred Payment Rights as purchase money loans rather than an investment interest in Lorimar and/or B & J. For example, in Oliver v. Bostetter, n3 where a controlling stockholder bought the stock of other stockholders by issuance of a note, the Court found that, by the sale of stock in exchange for the note, the stockholders had sought to terminate, not continue, their investment. The interest on the note was not considered to be the type of profit that was significant under the securities laws, particularly in light of the intentions of the parties -- neither side had investment in mind as a motivation for the issuance or purchase of the note. Similarly, in Emilco Industries v. Pro's, Inc., n4 the seventh circuit was asked to rule on whether a cash down payment and issuance of a five year promissory note given in connection with the purchase of the assets of a division of Pro, Inc. constituted the issuance of a security. The Court held that the note was not a security and its reasoning is equally appropriate here. The Court reasoned that the five year note was given in lieu of a cash payment and was therefore in the nature of a loan to the purchaser rather than an investment by the payee of the note. Finally, in Altman v. Knight, n5 the court found that a five year promissory note for $15,000,000 as part of the $25,000,000 acquisition price for an operating company was not a security under the Securities Exchange Act of 1934, as amended, because the instrument was a purchase money note accepted as a cash substitute. With respect to the additional $6,000,000 payable under the Deferred Payments, the contingent nature of the amount payable is similar to the earn-out situations previously discussed. Therefore,in our view, the Deferred Rights do not require that the Staff reach a conclusion contrary to its position taken in Lifemark Corporation and The Northwestern Life Insurance Company. n6

Further, a conclusion that the Deferred Payment Rights are not securities requiring registration under the Securities Act as investment contracts, evidences of indebtedness or interests in a profit sharing arrangement is supported by various Supreme Court decisions.

A. The Deferred Payment Right is Not an Investment Contract

In SEC v. W.J. Howey Co., the Supreme Court definedan investment contract as a "scheme (which) involves an investment of money in a common enterprise with profits to come solely from the efforts of others." n7 This test has been reaffirmed by the Supreme Court in two subsequent cases. In United Housing Foundation, Inc. v. Forman, the Supreme Court applied the test to find that shares of "stock" entitling a purchaser to purchase an apartment in a housing cooperative were not securities for purposes of the federal securities laws. n8 In International Brotherhood of Teamsters v. Daniel, the Court applied the Howey test and held that an employee's interest in a compulsory, non-contributory pension plan did not constitute a security. n9

The Deferred Payment Rights do not involve an investment of money by B & J stockholders. The Deferred Payments are cash substitutes for a portion of the purchase price of a business. The B & J stockholders will be converting their investment in the business of B & J into cash, not making an additional investment in B & J. Although each B & J stockholder is giving consideration for the Deferred Payment Right throughthe exchange of their B & J stock, the Daniel case suggests that this type of consideration is not what Howey meant by an "investment of money." In the Daniel case, the Supreme Court held that an employee's participation interest in a compulsory non-contributory pension plan does not constitute a security. In analyzing whether the employee's interest was an investment contract, the Court found that no investment of money occurs in a non-contributory plan and rejected the argument that an employee's contribution is his labor. n10 The Court stated that "[I]n every decision of this court recognizing the presence of a "security" under the Securities Acts, the person found to have been an investor chose to give up a specific consideration in return for a separable financial interest with the characteristics of a security." n11 B & J stockholders will receive the Initial Payment at closing. It is not possible to allocate which B & J stock is being bought for the Initial Payment and which stock is being bought for the Deferred Payments.

Although there is a potential reduction of the amount of the Deferred Payments and, arguably,the holders of Deferred Payment Rights have an interest in the actual combined revenue of K & E and B & J in 1986, that is not, in our view, the type of profit contemplated by the definition of investment contract. In the Forman case, the Supreme Court held that profits mean "either capital appreciation resulting from the development of the initial investment . . . or a participation in earnings resulting from the use of investors' funds. . . ." n12 Thus, the "profits" are a part of the purchase price for the B & J stock, and they come primarily from the efforts of the holders of the Deferred Payment Rights rather than from "use of" their "funds" that they have "invested" and the reliance on others to produce such "profits."

The Howey test requires that the profit "come solely from the efforts of others," although Daniel suggests that "primarily from the efforts of others" may be a more pertinent test. In the case of an advertising firm such as B & J, the revenues come primarily from the sales activities of the employees of the business who solicit and retain the firm's clients. Lorimar is acquiring the business of B & J and the recipients of the Deferred Payment Rights are stockholders and employees of B & J. After completion of the Merger, all of these employees will remain with the Surviving Corporation, other than a few who may retire. Moreover, the Surviving Corporation will enter into five year employment contracts with key executives of B & J who will have significant control over the combined operations of K & E and B & J.

B. The Deferred Payment Right Is Not an Evidence of Indebtedness or an Interest in a Profit-Sharing Agreement.

The Deferred Payment Rights are not an evidence of indebtedness and do not represent an interest in a "profit-sharing arrangement," because the context of the issuance of the Deferred Payment Right requires that it not be considered a security.

The Supreme Court has stated that it adheres to the basic principle:

"[I]n searching for the meaning and scope of the word "security" in the Act[s], form should be disregarded for substance and the emphasis should be on economic reality." n13

Further, the Court noted in this regard:

"[I]n construing these [federal securities] Acts against the backgroundof their purpose, we are guided by a traditional canon of statutory construction: "A thing may be within the letter of the statute and yet not within the statute, because not within its spirit nor within the intention of its makers." " n14

In holding that cooperative stock was not a security, the Court stated that common sense suggested that purchasers of the so-called "stock" would not likely believe or expect that they were purchasing securities covered by the federal securities laws because the "stock" did not contain the usual attributes of a share of common stock (e.g., voting and dividend rights).

Most recently, however, in Landreth Timber Co. v. Landreth n15 the Supreme Court held that the sale of stock in connection with the sale of an entire business constituted the sale of a security. The Supreme Court predicated its holding on the basis that the stock sold contained all the attributes of common stock (e.g. voting and dividend rights) and, therefore, since stock is clearly included in the definition of a security, reliance could not be placed on the economic realities in which the stock was sold. The Supreme Court's holding limits the scopeof the "economic reality" analysis when the instrument at issue is clearly within the definition of a security, but does not limit its use when the nature of the instrument or right is not readily apparent. Therefore, an analysis of the economic reality of a transaction is proper when the right or instrument involved is not on its face a security as defined by Section 2(1).

Since the Deferred Payment Rights are not defined by Section 2(1) and it is not readily apparent that they consist of an evidence of indebtedness or profit-sharing arrangement, whether the Deferred Payment Rights are securities must, therefore, be viewed from the economic realities of the transaction. Economic realities, the context in which the Deferred Payment Rights are given, and common sense all lead to the conclusion that the Deferred Payment Rights are not securities. In analyzing these factors, the intent of the "purchasers" of the right (the B & J stockholders) and the "sellers" of the right (Lorimar) is critical. In this case, the economic transaction is the sale of a business for cash. The buyer of the business, Lorimar, has an interest inpurchasing the business on the terms most favorable to itself, including, if possible, deferring a portion of the cash purchase. Moreover, Lorimar is purchasing the business for the price negotiated because it has certain expectations of the future income prospects of the business of B & J when it is combined with Lorimar's existing advertising agency, K & E. To the extent these expectations are not met, the parties agree that Lorimar should have certain set-off rights against the Deferred Payments. The B & J stockholders have no expectations that they are receiving an evidence of indebtedness or interest in a profit-sharing arrangement in the nature of a security.

It is our view, based on the Staff's positions in Lifemark Corporation and The Northwestern Mutual Life Insurance Company and the reasoning of the Supreme Court decisions discussed above that the Deferred Payment Rights are not securities subject to the registration provisions of the Securities Act.

Qualification Under the Trust Indenture Act

We are also of the view that qualification under the Trust Indenture Act is not required because the Deferred Payment Right does not constitute securities subjectto the requirements of the Trust Indenture Act. No certificates will be issued pursuant to the Merger, and the amounts involved are neither fixed nor interest-bearing.

Section 304(a)(1) of the Trust Indenture Act limits its coverage to:

"(A) A note, bond, debenture or evidence of indebtedness whether or not secured, or

(B) A certificate of interest or participation in any such note, bond, debenture, evidence of indebtedness or certificate."

In Great Western Financial Corporation (available April 14, 1983) the Commission's Staff agreed that an earn-out right contingent on future income was not a debt instrument subject to the Trust Indenture Act. As discussed above, in our view the treatment accorded by the Commission Staff to contractual earn-out rights is equally applicable to the Deferred Payment Rights.

In Food Fair, Inc. (available January 19, 1981), the Commission Staff indicated that it would not recommend enforcement action to the Commission when a bankrupt's proposed plan for arrangement contemplated the payment to certain of its creditors of 50% of the bankrupt's positive net cash flows ("Excess Cash Flow Payments") over the ensuing six years of the bankrupt'soperations. The Excess Cash Flow Payments considered in that instance were set forth as obligations only in the bankrupt's plan or arrangement, and were not evidenced by separate certificates or evidences of indebtedness. The staff stated such Excess Cash Flow Payments would not be deemed to be debt securities within the meaning of Section 304(a)(1) of the Trust Indenture Act and that the plan of arrangement could be implemented without the qualification of a trust indenture, also see, Rospatch Corp. (available October 26, 1981).

The Merger similarly contemplates deferred payments of cash to B & J stockholders. The obligation to make Deferred Payments will be set forth only in the acquisition Agreement. No certificates of indebtedness are to be issued to evidence any obligations, and the Deferred Payments bear no interest. A portion of the Deferred Payments is contingent upon B & J and K & E achieving certain revenue levels. The Deferred Payments should, therefore, not be regarded as debt securities subject to the Trust Indenture Act, because the protective provisions of the Trust Indenture Act are not necessary in the situation posed, and they are ill-suited to such obligations.

Conclusion

On the basis of the foregoing, it is our view that (i) the Deferred Payment Rights are not securities for purposes of the Securities Act and (ii) the Deferred Payment Rights may be made without the qualification of an indenture under the Trust Indenture Act. Therefore, we request that the Commission Staff indicate that it would not recommend to the Commission any enforcement action if the Deferred Payment Rights were issued without registration under the Securities Act and without the qualification of an indenture under the Trust Indenture Act.

If you have any questions or wish to discuss this matter further, please call the undersigned or Cary D. Cooper of this office. In addition, if the Staff believes that it may not agree with the conclusions expressed in this letter, of if the Commission Staff believes it beneficial for any other purpose, we request the opportunity to confer with the Commission Staff prior to a written response to this letter.

Please acknowledge receipt of the enclosed by date stamping the enclosed copy and returning it to our office in the enclosed self-addressed envelope.

Very truly yours,

BUCHALTER, NEMER, FIELDS,

CHRYSTIE & YOUNGER

By Mark A. Bonenfant

________________________________

n1 H.R. Rep. No. 85, 73rd Cong., 1st Sess., 11 (1933).

n2 77 Cong, Rec. 2940 (1933) (Remarks of Rep. McFadden). See also, id. at 2912 (remarks of Rep. Mapes).

n3 426 F. Supp. 1082 (D. Md. 1976).

n4 543 F.2d 38 (7th Cir. 1976).

n5 431 F. Supp. 309 (S.D.N.Y. 1977).

n6 In Newell National Company (available June 14, 1971), the Staff took a contrary position in a fact situation involving a contractual earn-out right in connection with the acquisition of a business. However, we believe that the Staff's more recent positions reflect the better view supported by case law subsequent to Newell National Company that nontransferable rights which represent purchase money consideration and not an investment interest are not securities under the Securities Act.

n7 328 U.S. 293, 301 (1945).

n8 421 U.S. 837 (1975).

n9 439 U.S. 551 (1979).

n10 Id. at 560.

n11 Id. at 559.

n12 421 U.S. 837, 852 (1975).

n13 United Housing Foundation v. Forman, 421 U.S. 837, 848 (1975).

n14 Id. at 849.

n15 Fed. Sec. L. Rep. (CCH) P92,047 [1985 Current].