Investment Banks Beware: General Solicitation Problem in Private Deals May Cost You a Fee

We are aware of some recent situations where investment banks have inadvertently published research or otherwise disclosed publicly a private offering, while engaged as a participant in the offering. Depending on the circumstances, this can lead to a blown private placement for the issuer (and the investment bank), a requirement to indemnify the issuer or other investment bank participants, or expulsion of the investment bank from the deal. At best, this situation is the source of incredible discomfort, anxiety and analytic brain damage for everyone involved.

A very brief (we promise) review of the relevant legal issues. First and foremost, we're talking here about private offerings, including:

• traditional institutional placements
• PIPEs
• Rule 144A offerings

While these transaction types may ultimately involve some kind of registration of a public offering of the securities issued,or securities to be exchanged for those securities as in the case of Rule 144A deals, the original issuance of securities is always pursuant to a private placement under one or more provisions of the Securities Act or related SEC rules, such as Regulation D.

One of the key elements of any private placement is, of course, that it is "private". One of the ways the courts and the SEC have given life to this tricky interpretive issue is to limit what is said about the offering before it begins and while it is underway. For example, Regulation D expressly requires as a condition to the rule that there be no general solicitation. The terms of Reg D refer to advertisements, articles or other published communication and to seminars and other meetings whose attendees are invited by public communication. The SEC interprets general solicitation broadly, suggesting that any prospective offeree have a "pre-existing relationship" directly or indirectly with the issuer.

Assuring the private nature of an offering means that not only the issuer, but any party acting on its behalf, must refrain from generally soliciting offerees. Similarly, it's their "pre-existing relationship" with an offeree which may satisfy the no general solicitation requirement. That means investment banks working with an issuer must be sensitive to these requirements at all times.

While there are no precise rules to this effect, the SEC has indicated in the public offering context that its concern with publications by issuers and those acting on its behalf begins in the 30 day period preceding the filing of a registration statement. A corresponding point in a private placement might be said to be the commencement of discussions with prospective investors. During this period, and while the offering is underway, an investment bank participating, or expecting to participate, in the offering should refrain from any public comment regarding the issuer which might be construed as an "offer" of the issuer's securities.

What constitutes an "offer"? This issues continues to perplex everyone involved in the offering process. With the help of the SEC, it may be easier to conclude what is not an "offer". For example, SEC Rules 137, 138 and 139 each provide a safe harbor from being deemed an offer for research reports published by investment banks, which meet the requirements of one or more of the rules. These rules are not exclusive, and it is always possible to argue a particular public statement is not an "offer".These rules can only be applied in the private placement context by analogy as they specifically deal with publication of research in the context of publicly filed registration statements.

In general, Rule 137 offers a safe harbor for research reports by broker dealers which are not participating in the offering. Rule 138 relates to research about debt or equity, when the offering is of respectively, equity or debt. Rule 139 offers a safe harbor for research by S-3 eligible issuers, or by other '34 Act filers where the research is part of a larger compendium of research and involves no positive change in recommendation.

To protect the firm, investment bankers should communicate with compliance early in the engagement process about necessary "no write" or other restrictions that may be appropriate for a particular issuer. What happens if you don't pay attention to this issue? Depending on the circumstances, any one of the following remedies may be employed:

• delay of the offering to permit the effects of the improper general solicitation to dissipate
• a request by the issuer or other participants that the offending investment bank hold them harmless if the offering is not exempt
• expulsion of the offending investment bank on the theory that its "offerees" will no longer be part of the offering and therefore its "general solicitation" does not taint an otherwise valid private placement

Don't let this happen to you.