SLB 4 | DART – Deloitte Accounting Research Tool

Staff Legal Bulletin No. 4 (CF)

ACTION: Publication of CF Staff Legal Bulletin

DATE: September 16, 1997

SUMMARY: This staff legal bulletin states the Division of Corporation Finance's views regarding whether Section 5 of the Securities Act of 1933 applies to spin-offs. This bulletin also addresses related matters, including how securities received in spin-offs may be resold under the Securities Act.

SUPPLEMENTARY INFORMATION: The statements in this legal bulletin represent the views of the staff of the Division of Corporation Finance. 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 Mark W. Green, Deputy Chief Counsel at (202) 942-2900. For further information regarding foreign company spin-offs, please contact Felicia Kung, Special Counsel, Office of International Corporate Finance at (202) 942-2990.

1. What Is A "Spin-Off"?

In a "spin-off," a parent company distributes shares of a subsidiary to the parent company's shareholders.

2. What Is This Bulletin's Purpose?

Even though companies do not have to request the Division's views on a proposed spin-off, many companies do. This bulletin discusses our views on issues that commonly arise in those requests.1

The Division will no longer respond to requests for its views on the issues we address in this bulletin. We will respond when a company asks for our views on novel or unusual issues in a proposed spin-off.

3. What Are the Basic Concerns About Spin-Offs?

A subsidiary must register a spin-off of shares under the Securities Act if the spin-off is a "sale" of the securities by the parent.2 Also, when a company that reports under the Exchange Act spins-off shares of a company that does not report under the Exchange Act, the spin-off raises concerns because it may:

result in an active trading market for the spun- off shares without adequate public information about their issuer; and
violate the anti-fraud provisions of the Securities Act and the Exchange Act.3

4. Does the Subsidiary Have to Register the Spin-Off Under the Securities Act?

> A. The Subsidiary Does Not Have to Register the Spin- Off if Five Conditions are Met

It is the Division's view that the subsidiary does not have to register a spin-off under the Securities Act when:4

the parent shareholders do not provide consideration for the spun-off shares;
the spin-off is pro-rata to the parent shareholders;
the parent provides adequate information about the spin-off and the subsidiary to its shareholders and to the trading markets;
the parent has a valid business purpose for the spin-off; and
if the parent spins-off "restricted securities," it has held those securities for at least two years.

> B. An Explanation Of The Conditions

>> 1. The parent shareholders do not provide consideration for the spun-off shares

If the parent shareholders provide consideration for the spun-off shares, the parent would be transferring the spun-off securities for value. This transfer of securities for value is a "sale" under the Securities Act. So, when shareholders provide consideration, the subsidiary must register the spin-off unless an exemption is available.

>> 2. The spin-off must be pro rata

When the spin-off is pro rata, the parent shareholders have the same proportionate interest in the parent and the subsidiary both before and after the spin-off. If a spin-off is not pro rata, the shareholders' relative interests change and some shareholders give up value for the spun-off shares. Ordinarily, Securities Act registration would be required if a spin-off is not pro rata.

>> 3. The parent must provide adequate information to its shareholders and the trading markets

Whether the parent provides adequate information about the spin-off and the subsidiary to its shareholders and the trading markets depends on whether the subsidiary is an Exchange Act reporting company or a non-reporting company before and after the spin-off. In this discussion, we assume the parent is a reporting company.5

>>> a. Non-reporting subsidiary

If the subsidiary is a non-reporting company, the parent provides adequate information if, by the date it spins-off the securities:

it gives its shareholders an information statement that describes the spin-off and the subsidiary and that substantially complies with Regulation 14A or Regulation 14C under the Exchange Act; and
the subsidiary registers the spun-off securities under the Exchange Act.6

>>> b. Reporting Subsidiary

If the subsidiary is a reporting company, the parent may provide less information about the spin-off to its shareholders. In this situation, the parent provides adequate information if, by the date it spins-off the securities:

the subsidiary has been subject to the Exchange Act reporting requirements for at least 90 days;
the subsidiary is current in its Exchange Act reporting; and
the parent gives its shareholders information about the ratio it used to compute the number of shares distributed for each share held, how it will treat fractional shares, and the spin-off's expected tax consequences.7

If the reporting subsidiary has not been reporting for 90 days or is not current in its Exchange Act reporting, the parent may provide adequate information in the same manner as for a non- reporting company.8

>>> c. Foreign companies

When the parent and subsidiary are foreign, the parent provides adequate information if, by the date it spins-off the securities:

it gives its U.S. shareholders an information statement that describes the spin-off and the subsidiary and that substantially complies with Regulation 14A or Regulation 14C; and
the subsidiary registers the spun-off securities under the Exchange Act.

There may be situations where the subsidiary will not register the spun-off securities under the Exchange Act (for example, the Rule 12g3-2(a) or 12g3-2(b) exemption from registration may be available). Whether the parent provides adequate information in these situations requires an analysis of all of the facts and circumstances.9 We will continue to consider requests for "no-action" positions from foreign companies that do not intend to register the spun-off shares under the Exchange Act.

>> 4. Valid Business Purpose for Spin-Off

When there is a valid business purpose for a spin-off, it is less likely that the parent indirectly will receive value for the spun-off shares through the creation of a market in those securities.10 The Division has recognized the following as examples of valid business purposes for a spin-off:

allowing management of each business to focus solely on that business;
providing employees of each business stock-based incentives linked solely to his or her employer;
enhancing access to financing by allowing the financial community to focus separately on each business; or
enabling the companies to do business with each other's competitors.

In our view, there is not a valid business purpose for a spin-off when the purpose is:

creating a market in the spun-off securities without providing adequate information to the shareholders or to the trading markets;
the creation of a public market in the shares of a company that has minimal operations or assets; or
the creation of a public market in the shares of a company that is a development stage company that has no specific business plan or whose business plan is to engage in a merger or acquisition with an unidentified company.

Other than the business purposes discussed above, the facts of a particular situation will determine whether the business purpose is valid. Accordingly, the parent must determine whether there is a valid business purpose for the spin-off.

>> 5. If the parent spins-off "restricted securities," the parent must have held those securities for at least two years

A company that spins-off "restricted securities" may be an underwriter in the public distribution of those securities.11 The Division believes, however, that the parent would not be an underwriter of the spun-off securities and the subsidiary would not have to register the spin-off under the Securities Act when:

the parent has held the "restricted securities" at least two years; and
the spin-off satisfies the conditions described above.12

This two-year holding period position does not apply where the parent formed the subsidiary being spun-off, rather than acquiring the business from a third-party.

5. Does Securities Act Rule 145 Require the Subsidiary To Register A Spin-Off?

Securities Act Rule 145 requires specified transactions to be registered under the Securities Act when investors decide whether to accept a new or different security in exchange for their existing security. For example, when shareholders vote on a plan or an agreement for the transfer of assets in consideration for the issuance of securities, Rule 145(a)(3) may deem that vote to be a "sale" under the Securities Act.

Parent companies often ask their shareholders to vote on proposed spin-offs. Further, spin-offs may include the transfer of assets to the subsidiary.

Based on Rule 145(a)(3), the Division generally has refused to say that the subsidiary does not have to register a spin-off where the parent's shareholders vote on an asset transfer from the parent to the subsidiary.13 However, we have reconsidered this position where the parent wholly owns the subsidiary. In this situation, we will no longer require Securities Act registration of a spin-off solely as a result of a shareholder vote on the asset transfer. The reason for the change in our view is that, when the other conditions described in response to Question 4, immediately above, are met, the vote on the asset transfer does not change the overall nature of the transaction.14

6. When an Independent Agent Aggregates and Sells Fractional Shares, Does the Subsidiary Have to Register those Sales?

The distribution ratio in many spin-offs would result in many shareholders receiving fractional shares. Rather than issue fractional shares, the parent often hires an independent agent to combine the fractions, sell the shares and provide the proceeds to shareholders.

We believe that the subsidiary need not register an independent agent's sales of combined fractional shares if the spin-off meets the conditions described in response to Question 4, above, and:15

the independent agent makes the sales in the open market;
the independent agent, in its sole discretion (that is, without influence by the parent or the subsidiary), determines when, how, through which broker- dealer and at what price to make its sales; and
the independent agent and the broker-dealers it uses are not affiliates of the parent or the subsidiary.

7. Are Spun-Off Securities "Restricted Securities" Under Rule 144?

It is the Division's view that securities received by shareholders in a spin-off that meets the conditions described in response to Question 4, above, generally are not "restricted securities."16

In rare situations, however, a large shareholder of the parent so controls the parent that the shareholder essentially decides whether to do the spin-off. In these infrequent situations, we view the spin-off as a privately negotiated transaction between the parent and that shareholder, with that shareholder getting restricted securities.17 The other shareholders get securities that are not restricted.

8. Can The Subsidiary Consider Itself To Meet the Exchange Act Reporting Requirements of Rule 144 On The Date Of The Spin- Off, Rather Than Wait 90 Days?

Affiliates of a spun-off company may want to sell securities that they received in the spin-off. Absent registration under the Securities Act, affiliates must sell these securities under Rule 144 or another appropriate exemption.

These affiliates can only rely on Rule 144 if the subsidiary has been a reporting company for at least 90 days.18 We believe that the subsidiary satisfies this reporting requirement on the date the parent spins-off the securities (that is, before 90 days have passed) if:19

the spin-off meets the conditions described in response to Question 4, above;
the parent is current in its Exchange Act reporting;
the subsidiary will have substantially the same assets, business, and operations as a segment or subsidiary about which the parent has reported extensive segment data20 and other financial and narrative disclosure in its Exchange Act periodic reports for at least 12 months before the date it spins- off the securities.21

9. Can the Subsidiary Consider the Parent's Reporting History When Determining Whether It Is Eligible to Use Form S-3?

A spun-off company may want to register offers and sales of securities on a Form S-3. Generally, one requirement a company must meet to use Form S-3 is that it has timely filed required Exchange Act reports for at least 12 months.22 If a spun-off subsidiary meets the conditions described in response to Question 8, immediately above, we believe that it also may consider its former parent's Exchange Act reports in determining whether it satisfies Form S- 3's reporting history requirement.23

10. Can The Subsidiary Use Form S-8 To Register Offers and Sales to Parent Employees Before the Spin-Off?

Form S-8 permits a reporting company to register offers and sales of securities to specified people under employee benefit plans. These people include:

employees of the reporting company's parent;
employees of the reporting company's subsidiaries; and
former employees of these companies if the Form S- 8 registers the offer and sale of shares underlying non- transferable options that were granted during their employment.24

After the subsidiary becomes a reporting company — but before the spin-off occurs — the subsidiary may want to grant options to parent employees who will not be employees of the subsidiary after the spin-off. It will want to grant these options to make the parent employees financially "whole," because the parent options those employees hold may lose value in the spin-off. A spun-off subsidiary often will want to use Form S-8 to register its shares underlying these options.

We believe that the subsidiary may use Form S-8 to register the offer and sale of securities underlying these "make-whole" options if the spin-off meets the conditions described in response to Question 4, above and:25

the options are not transferable;26
the parent has not had any unusual grant activity under its option plans; and
the employees of the parent and the subsidiary will receive the same information about the subsidiary's stock option plans under which it grants the options.

11. Does Exchange Act Section 16 Apply to Spin-Offs?

Exchange Act Section 16 applies to the officers, directors, and principal security holders of most companies with a class of equity securities registered under the Exchange Act. Section 16 requires these people to file ownership reports and subjects them to potential "short-swing" profit liability for their purchases and sales of the company's equity securities. Exchange Act Rule 16a-9(a) exempts the receipt of securities in a spin-off from Section 16 if all holders of a class of securities participate in the spin-off on a pro rata basis.

Anyone subject to Section 16 still would have to file a Form 3 when the subsidiary registers a class of spun-off equity securities under the Exchange Act.

Footnotes

This bulletin does not address:

whether the anti-fraud provisions of the Securities Act and the Securities Exchange Act of 1934 apply to spin-offs; or
those spin-offs where the parent distributes securities whose value is determined, at least in part, by reference to a distinct part of the parent's business (for example, "targeted stock"). These spin- offs differ from traditional spin-offs because the parent retains the part of the business that determines the return on the distributed securities.

The term "sale" is defined in Section 2(a)(3) of the Securities Act. Even though the parent is the seller of the securities in a spin-off, the subsidiary has to file the registration statement because it is the issuer of the securities.

The Commission discussed these spin-offs and the concerns they raise in Release No. 33-4982 (July 2, 1969).

If the spin-off does not meet these conditions and the subsidiary registers the spin-off, it should look to Securities Act Rule 457(f) to determine the filing fee. Although that rule does not specifically mention spin-offs, it contains provisions that help to determine the proper fee. Consistent with Rule 457(f)(1), the Securities Act filing fee is based on the market value of the spun-off securities as specified in Rule 457(c). If there is no market for those securities, consistent with Rule 457(f)(2), the filing fee is based on the book value of the spun-off subsidiary's assets.

In five situations over the last ten years, the Division has provided its views to a non-reporting U.S. parent that proposed to spin-off a non-reporting subsidiary. In these situations, the parent provides adequate information if, by the date it spins-off the securities:

the parent shareholders get an information statement that describes the spin-off and the subsidiary and that substantially complies with Regulation 14A or Regulation 14C;
the holders of the spun-off securities can only transfer the securities in specific, limited situations (this is to make sure that no public market develops in those securities before the subsidiary registers them under the Exchange Act);
the information statement tells the holders about the transfer limits;
the spun-off securities have a legend on them that describes the transfer limits; and
the spun-off subsidiary's stock transfer books include stop transfer instructions that indicate the transfer limits.

Our no-action letter to Axion Inc. (September 17, 1996) discusses these transfer limits and how they apply to later purchasers. We will continue to provide our views on non- reporting company spin-offs when requested.

See Collins & Aikman Corporation (February 5, 1997) and WMS Industries, Inc. (February 25, 1997).

See Trinity Industries, Inc. (February 27, 1997).

Under appropriate circumstances involving a reporting subsidiary that has not been reporting for 90 days, the parent or the subsidiary may use other methods to provide adequate information to the parent's shareholders and to the trading markets. For example, it may be appropriate for:

the parent to provide the subsidiary's initial public offering prospectus to the parent's shareholders upon their request (Signet Banking Corp. (February 14, 1995)); or
the subsidiary to file a Form 10-K before the spin-off (Pacific Telesis Group (February 14, 1994)).

See, e.g., AB Electrolux (April 28, 1997) and British Gas plc (December 4, 1996).

This concern is addressed in SEC v. Datronics Engineers, Inc., 490 F.2d 250 (4th Cir. 1973), cert. denied 416 U.S. 937 (1974) and SEC v. Harwyn Industries, 326 F.Supp. 943 (S.D.N.Y. 1971).

The term "restricted securities" is defined in Securities Act Rule 144(a)(3).

If the parent is a closely-held investment entity, Rule 144 permits distributees to "tack" their holding period to that of the parent. The position discussed in this section does not affect this interpretation of Rule 144.

See Summit Energy, Inc. (March 29, 1988).

Of course, if a parent company is subject to the Exchange Act proxy rules, it will have to comply with those rules in connection with the shareholders' vote.

See Alco Standard Corporation (February 14, 1997).

See Alco Standard Corporation (February 14, 1997). Sales by the spun-off company's affiliates, however, would be subject to Rule 144, except for the holding period requirement of Rule 144(d), absent registration or another appropriate exemption.

See Valhi, Inc. (December 23, 1994).

Rule 144(c)(1).

See Alco Standard Corporation (February 14, 1997).

The segment data reported must include at least: revenues; operating profit or loss; identifiable assets; expenses from depreciation, depletion and amortization; capital expenditures; and any other information required by Statement of Financial Accounting Standards ("FAS") No. 14 (Financial Reporting for Segments of a Business Enterprise) or, for fiscal years beginning after December 15, 1997, FAS No. 131 (Disclosures about Segments of an Enterprise and Related Information). Further, the parent's Exchange Act reports must have discussed the spun-off segment as a separate segment in the Description of Business and MD&A sections.

It is not adequate if the parent has included "liquidated operations" or "discontinued operations" information regarding the spun-off segment.

General Instruction I.A.3. to Form S-3.

See Alco Standard Corporation (February 14, 1997).

See General Instruction A.1.a. to Form S-8. A company that is a subsidiary can only use Form S-8 to offer and sell securities to employees of another subsidiary of that company's ultimate parent if the other subsidiary also is a parent of the company or is a subsidiary of the company.

See Getty Petroleum Corp. (December 9, 1996).

For this purpose, these options are still considered not transferable if holders can transfer them only to the limited extent described in Merrill Lynch & Co., Inc. (May 16, 1996).