Date: 2/16/2011
By: Sunny J. Barkats, Managing Partner
Re: WHO IS AN "AFFILIATE"?
Definition of “Affiliate”
Rule 405 of the Securities Act of 1933, as amended, defines an “affiliate of an issuer” as “a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common controls with, such issuer.” However, directors, executive officers and beneficial owners of a substantial percentage of an issuer’s outstanding equity securities are generally deemed to be affiliates of an issuer; also Section (a)(1) of Rule 13e-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), also defines “affiliate” of an issuer in relevant part as”…a person that directly or indirectly through one or more intermediaries controls, is controlled by, or is under common control with such issuer.” The determination of whether a person controls an issuer is based on totality of the facts and circumstances; under Rule 12b-2 of the Exchange Act, which provides definitions applicable to Rule 13 of the Exchange Act, “the term ‘control’ (including the terms ‘controlling,’ controlled by’ and ‘under common control with’) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities by contract, or otherwise.”
What Percentage of Ownership of Outstanding Stock Constitutes “Control”?
There is no hard and fast rule governing when control will and will not be found to exist based on percentage voting-stock ownership for purposes of Rule 12b-2. To the contrary, the Securities and Exchange Commission (the “SEC”) refuses to make abstract determinations regarding the presence or absence of control, and will not issue No-Action letters on the subject.[1] The test of control is based on the facts and circumstances of the transaction and the parties thereto. There is a significant body of case law finding that ownership of a certain percentage of stock is not determinative of control. Most of these cases involve a finding of control where a minimal amount of equity was owned.[2] However, those cases suggest that ownership of a seemingly significant amount of stock does not automatically signal control.[3]
The term “control[4]” (including the term “controlling” “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through ownership of voting securities, by contract, or otherwise. The rule of thumb is that an individual or entity that holds roughly 10% or more of an issuer’s outstanding equity securities has the ability to exercise some degree of control. The reasoning behind seems to be that when a shareholder owns sufficient stock in a corporation that management is likely to be responsive to or influenced by the shareholder’s requests or demands, thus, the SEC says the shareholder is an affiliate of the corporation.
Conclusion
Under the safe harbor adopted by the SEC, a person who is not an executive officer or a shareholder owning 10% or more of any class of voting equity securities of a specified person will be deemed not to control such specified person. An “executive officer” is defined in Exchange Act Rule 3b-7. The 10% ownership test is to be determined consistent with the Exchange Act, Rule 13d-3. A person who cannot rely on the 10% ownership prong of the safe harbor will not be deemed to be, or presumed to be, an affiliate. Rather a facts and circumstances analysis of control will be necessary. Only executive officers, directors that are also employees of an affiliate, general partners and managing members if an affiliate will be deemed to affiliates.
[1] Procedures Utilized by the Division of Corporate Finance for Rendering Informal Advice, Interpretive Release No. 33-6253, 45 FR 72644 (Nov. 3, 1980); see, e.g. Textron, Inc., SEC No-Action Letter, LEXIS 4050 (Dec. 1980).
[2] For a full discussion and thorough list of cases see LOUIS J. LOSS & JOEL SELIGMAN, SECURITIES REGULATION VOLUME IV 1707-1712.
[3] See, e.g., Kennecott Copper Corp. v. Curtiss-Wright Corp., 449 F. Supp. 951 (S.D.N.Y.), aff’d in part and rev’d in part, 584 F. 2d 1195 (2d Cir. 1978); Graphic Sciences, Inc. v. International Mogul Mines, Ltd., 397 F. Supp. 112, 125 (D.C.D.C. 1974)
[4] Technically, the definitions contained in Rule 405 relate to terms used in Securities Act Rules 400 through 494 or terms used in Securities Act registration form. The Definitions of “control” is a reliable definition for general Securities Act purposes.
No comments:
Post a Comment