The winding road to reward: Rule 144A securities offerings can be a good source of capital for mutual insurance companies, but getting there requires effort.
* In a Rule 144A offering, an investment bank or syndicate of investment banks purchases the securities from the company and then resells the securities to investors at a higher price.
* The disclosure and due diligence requirements of a Rule 144A offering might come as a surprise to a company whose only experience in raising capital has been through traditional private placements.
* One advantage of Rule 144A to mutual companies is the ability to use existing statutory-basis financial statements in the offering circular.
For insurance companies tapping the capital markets in turbulent times, exempt offerings to institutional investors under Rule 144A of the Securities Act of 1933 remain a popular alternative to financings registered with the Securities and Exchange Commission, on the one hand, and private placements on the other hand. While the process of "going public"--issuing securities under a registration statement filed with the SEC--has entered the business folklore, the dynamics of a Rule 144A offering may be less familiar to insurance professionals, even internal legal start, particularly with mutual and other nonpublic insurers.
In particular, the disclosure and due diligence processes associated with Rule 144A offerings may be novel for these kinds of issuers. While the work involved may exceed that required by private placements, these offerings do not require the more extensive and transformative efforts that accompany public offerings. Similarly, while Rule 144A offerings may not offer the liquidity advantages of a public offering, these transactions require less time, are not subject to a schedule determined in part by the speed and scope of SEC review, and yet can still provide benefits that exceed those of traditional private placements.
Issuing stock, debt or other securities to investors in a public offering involves registering the securities and the company with the SEC, thus subjecting the company to extensive disclosure and corporate governance requirements imposed by law (including the recent Sarbanes-Oxley legislation and related rules). Enacted by the SEC in 1990, Rule 144A enables a company to offer its securities, through one or more investment banking firms acting as "initial purchasers," to institutional investors in a private transaction exempt from this registration requirement. Since the enactment of the rule, a robust secondary market has developed for securities issued pursuant to the rule, with the result that Rule 144A issues, particularly debt securities, can attain some of the liquidity of publicly traded securities.
Generally, any type of security is eligible for the Rule 144A exemption, so long as securities of the same class are not traded on any national securities exchange or quotation system. A mutual company, which by definition cannot issue stock, can issue debt securities or surplus notes in a Rule 144A offering. Rule 144A was the method principally used by a number of life mutuals during the surplus note wave of the mid-1990s. More recently, a number of intermediate stock holding companies within mutual holding company structures have used Rule 144A to issue senior notes.
For all these and other nonpublic insurers, Rule 144A effectively provides a vehicle to issue debt securities in a private offering to a broad range of institutional investors simultaneously without undertaking a public offering and without the attendant SEC review and post-offering ongoing disclosure requirements, but at the same time achieving better execution and liquidity than are generally available in private placements to a limited number of investors.
Knowing the Ground Rules
In order to qualify for the exemption from registration, the securities must be offered in a private transaction exclusively to defined classes of large institutions referred to in Rule 144A as "qualified institutional buyers," or "QIBs." The public policy underlying Rule 144A assumes that, because of their size and sophistication, QIBs do not need the protection of the registration requirements of the securities laws. The rule provides generally that if securities are sold to QIBs in a private transaction (without publicity or general solicitation of buyers), the sale will be exempt from the registration requirements of the Securities Act. To ensure the availability of the rule for subsequent resales by initial investors, the issuing company must provide to proposed secondary market purchasers, on request, certain narrative and financial disclosure about itself (essentially, a very brief description of its business and its most recent financial statements, which may be statutory-basis rather than based on generally accepted accounting principles, or GAAP).
Because the relevant information that must be kept current in order to satisfy this requirement is minimal compared to that required of SEC registrants, the rule is attractive to mutual and other nonpublics because they are spared the more exacting disclosure requirements imposed upon public companies. Even if aspects of Sarbanes-Oxley are ultimately imposed on mutual and other nonpublic insurance companies by insurance regulators, as is currently being considered, the difference between being subject to the periodic reporting requirements of the Securities Exchange Act of 1934, and not being subject to such requirements, is a singular one that colors every major business decision in the life of the company.
From the standpoint of execution, Rule 144A offerings resemble underwritten public offerings, in that an investment bank or syndicate of investment banks, acting as the initial purchaser of the offering, purchases the securities from the company and then resells the securities to investors at a higher price, retaining the difference, which represents the commission or "discount" earned by the bank or banks for their services. Investors are not directly involved in the process; terms of the offering are negotiated between the company and the initial purchasers. This allows the company to deal with a single counterparty rather than multiple investors. In this and other respects, the process of conducting and completing a Rule 144A offering can be more efficient than that associated with a traditional private placement, in which multiple investors might not act together as a group and the process generally lacks the centralization and uniformity imposed by having a single underwriting investment bank or syndicate.
Companies that are already public can and do use Rule 144A to raise capital on an expedited basis without SEC review, to issue securities with complex features that may be inappropriate for public investors, or for other purposes. In these contexts, the speed and flexibility available under Rule 144A, relative to public offerings, are most pronounced, since the public company issuer can rely on its periodic filings under the securities laws to satisfy, in part, the relevant informational requirements of Rule 144A. In addition, being a public company facilitates the initial purchasers' due diligence, since the company will already be in the habit of accommodating the due diligence needs of underwriters and the information requests of investors and securities analysts.
A Rule 144A offering by a mutual or other nonpublic company (for example, the wholly owned subsidiary of a public company or a mutual holding company) will create the need for due diligence and disclosure that may be more extensive than what the company has previously undergone in prior capital-raising via private placements or institutional lending. The disclosure and due diligence requirements of a Rule 144A offering for a privately held or mutual insurer may not be as exhaustive as those associated with a public offering, but might come as a surprise to a company whose only experience in raising capital has been through traditional private placements. With legal and financial advisers experienced in both SEC-registered and Rule 144A capital-raising, however, the offering process does not have to be daunting.
The Offering Circular--Telling the Company's Story
Like securities offerings generally; a Rule 144A offering is subject to the anti-fraud requirements of the securities laws, and, accordingly, all disclosure materials used to market the transaction must be materially accurate and complete. To this end, an "offering circular." or OC (also known as an offering memorandum), is prepared as the principal disclosure document associated with the transaction, containing detailed disclosure on the issuer's business, results and financial condition. In addition to a narrative description of the company's business, the OC contains the most recent audited financial statements (as well as unaudited financial information for subsequent interim periods) and management's discussion and analysis of the company's recent results.
One advantage of Rule 144A to mutual companies is the ability to use existing statutory-basis financial statements in the OC rather than having to prepare new financial statements in accordance with GAAP, as would be required in an SEC registration statement. All of these aspects of the OC, plus risk factors, a detailed description of the securities being offered and underlying legal documents, and other disclosure, are designed to approximate the elements of a prospectus in an SEC-registered deal. Beyond the usefulness of a substantial offering document for marketing purposes, this extensive disclosure is intended to protect offering participants against possible claims of misrepresentation later.
As noted above, an offering circular, though not a public prospectus, must satisfy the relevant anti-fraud requirements of the securities laws. In general, practitioners believe that the disclosure requirements pertaining to public offering prospectuses are a good guide for determining what types of, and how much, disclosure to provide in the OC, and in this way the OC preparation, review and comment process can resemble that for a prospectus in a public offering with certain exceptions--for instance, Rule 144A offering circulars typically do not provide the kind of detailed data on executive compensation required for public companies under the securities laws. This is in contrast to whatever disclosure or promotional materials might be prepared in connection with a traditional private placement, in which the company has far more latitude in determining the content and level of detail of offering materials in light of the small number of investors involved and their ability to conduct directly with the company any business, legal or other due diligence investigation they wish.
Identifying the Issuer
A threshold question to be addressed before the OC drafting process begins is to identify the actual issuer of the securities being off, red. In the case of a parent company with numerous subsidiaries, this may not be as straightforward as it seems. While the securities might be offered by the ultimate parent company, a downstream subsidiary could instead be the issuer if this is desired by the company and its investment bankers. Offerings by a subsidiary, such as an intermediate entity in a mutual holding company structure or a particular operating subsidiary, raise special questions for participants in the working group responsible for preparing disclosure or conducting due diligence. For example, all or most of the company's regularly prepared disclosure and due diligence materials, including its past presentations to rating agencies, will tend to relate to the entire consolidated group--not the subsidiary alone. In addition, in a consolidated group where product lines or segments do not break neatly across legal entities, finding the right narrative for the business of the entity actually issuing the securities may require significant attention.
Despite the lack of SEC review, the OC, typically drafted as an initial matter by the company or its outside law firm, will be subject to a careful drafting and revision process as the company's counsel, the initial purchasers and initial purchasers' counsel provide comments and suggestions on the draft. Nonlawyers are often surprised at the amount of time and attention this requires from insurance company staff. Indeed, the company disclosure section and management's discussion and analysis often require multiple drafts and rounds of comments, including working group conference calls and meetings, before everyone is signed off: While this effort is somewhat more involved than for a typical private placement memorandum, being spared the effort and expense of preparing and filing an SEC registration statement, and the time and uncertainty involved in SEC review and comment, represents a major advantage over the public-offering process.
The Due Diligence Process
In addition, an extensive due diligence process typically accompanies a Rule 144A offering by a nonpublic company. This due diligence process serves to confirm and enhance the quality of the disclosure being provided in the OC, and it assists the initial purchasers in establishing legal defenses to potential liability for subsequently alleged misrepresentations in the OC. As part of the due diligence process, the initial purchasers, like underwriters in a registered offering, require, as a matter of practice and custom, an accountant's comfort letter on all financial information contained in the OC, and disclosure or negative assurance letters from both the initial purchasers' and the company's respective counsel. These requirements heighten the scrutiny applied during Rule 144A due diligence and reflect a more formalized process than that associated with typical private placements, in which comfort letters and disclosure letters are generally not rendered.
The Rule 144A due diligence process can be divided into two parts, although these are closely related: documentary, or legal, due diligence, and "management" due diligence. Management due diligence involves sessions featuring members of the company's senior management, the initial purchasers and both sets of counsel. Management due diligence is often based on a management presentation, such as might be given to a rating agency, although more detail may be needed for Rule 144A purposes. These presentations are most productive and informative when participants include the most senior officers within each major function of management--finance, accounting, investments, legal, underwriting, actuarial, marketing and so on.
In documentary due diligence, both sets of counsel seek to review all material documents that relate to the issuing company's business, and to that end generally submit a request list to the company ahead of time. The company typically sets up a "data room" for this purpose and hosts the relevant lawyers over a number of days to review the materials.
The due diligence needs of lawyers and bankers sometimes surprise company staff. Due diligence will proceed most smoothly when the needs and expectations of the company on the one hand, and those performing due diligence on the other hand, are brought into line early in the process. Company staff should be expected to provide all the information that the lawyers and bankers need in a timely and complete fashion, mindful that the anti-fraud requirements of the securities laws must be complied with. Similarly, lawyers and bankers performing due diligence should take care to tailor their requests and inquiries to the company's business and the particular circumstances of the offering, always being mindful of the natural limits that exist on company resources.
A successful Rule 144A offering by a mutual or other nonpublic company can take place only through the efforts of numerous lawyers, bankers and insurance company staff. A more sophisticated and visible capital-raising method than a private placement to a handful of investors, a Rule 144A offering is nonetheless less time-consuming, resource-intensive and transformative than a public offering, and might be thought of as something of a hybrid of the two from the standpoint of process, function and content. A clear understanding up front of the requirements and parameters of a Rule 144A offering, and the efforts required from transaction participants, can go a long way toward avoiding misunderstandings and producing a successful and efficient process.
Daniel A. Rabinowitz is special counsel with the law firm Sullivan & Cromwell LLP, New York.
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|Title Annotation:||Rule 144A Offerings|
|Comment:||The winding road to reward: Rule 144A securities offerings can be a good source of capital for mutual insurance companies, but getting there requires effort.(Rule 144A Offerings)|
|Author:||Rabinowitz, Daniel A.|
|Date:||Dec 1, 2004|
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