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Frequent debt issuers rely on medium-term note programs (“MTNs”) to offer their securities quickly in response to market opportunities. Some issuers may issue 20 or more notes a day at certain points in their monthly marketing cycle. Are there limitations on the aggregate principal amount of notes that can be issued under these MTN programs? If so, where or how are these limits set? How are they determined? What happens if any of these limits is exceeded?
We discuss these questions in the context of exempt offerings of structured notes, as well as offerings of structured notes registered under the Securities Act. Similar concepts apply, of course, to offerings of traditional debt securities.
EXEMPT OFFERINGS
We start with any internal limits on issuances imposed by the issuer itself, and also those included in the offering and operative documents.
Board resolutions. An issuer’s board resolutions authorizing the creation of an MTN program usually will set an upper limit on the aggregate principal amount of securities that may be issued. It is important to check how this limit is expressed:
- Issued – this means that the total issued amount is fixed, whether or not some of the securities have matured or been redeemed
- Issued and outstanding – this means that securities that have matured or been redeemed will not be counted in the total, so a larger amount of securities can be issued over a longer period of time until the “issued and outstanding” amount is reached (if ever)
- Variation: Outstanding during a certain time period, such as a calendar year, after which a further board resolution would be required to increase the amount
A board may delegate the authority to set limits on the aggregate principal amount issued to a committee or certain authorized officers.1
Disclosure and Operative Documents. Where are these limits disclosed or specified, and what is the difference?
If an issuer authorizes a certain principal amount of debt securities to be issued under its MTN program, the offering memorandum for the MTN program will usually disclose on the front cover that amount, and whether it is purely an issuance amount or if it excludes securities that have matured or been redeemed (“outstanding at any time”). The distribution agreement for the MTN program will also state that amount on the cover page. The indenture (or agency agreement) for the MTN program generally will not include the issuance limit, in order to avoid having to re-execute those documents upon a periodic renewal.
Why is this important? MTN programs operate pursuant to a distribution agreement. In that agreement, the issuer makes a representation that the securities to be issued are “duly authorized, and, when the securities are issued and delivered pursuant to this agreement, the securities will have been duly executed, authenticated, issued and delivered ….” Issuer’s counsel will be required to opine to much the same in the opinion addressed to the distributor.
Under the distribution agreement, all of the issuer’s representations therein will be made and deemed made at the following times:
- Upon execution of the distribution agreement
- At each acceptance by the issuer of an offer to purchase securities
- At each settlement date for the issuance of securities
- Upon the delivery of an officer’s certificate to the distributors as part of a set of diligence deliverables (officer’s certificate, comfort letter and opinion of counsel)
If the issuer has oversold the amount authorized by the board resolutions, it cannot sell securities to the distributors without breaching its representation that such securities are duly authorized.
Those are the operative documents where the limits on issuances are included, and where any issuance above the limit would give rise to a contractual claim by the distributor against the issuer.2
What about the limit stated on the cover page of the offering memorandum? As a disclosure matter, could it give rise to a claim by some clever plaintiff’s lawyer representing a purchaser whose debt securities did not pay off as they hoped in the event of an oversale?
It is hard to imagine such a claim, which would have to be brought under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 thereunder. The plaintiff would have to allege that the maximum offering amount stated in the offering memorandum was a material misstatement or omission, reliance on that disclosure and causation showing that the oversale of securities beyond the amount stated in the offering memorandum caused the plaintiff’s loss. Such a claim would also require proof of intent, which would be difficult.
REGISTERED OFFERINGS
Even though the amount of debt securities issued under a registered MTN program may be within the issuer’s internal limits, as expressed in the board resolutions, it is possible that the amount sold might exceed the amount registered with the Securities and Exchange Commission (“SEC”) under the Securities Act. In that case, the oversold debt securities would be unregistered securities.
A “well-known seasoned issuer” (a “WKSI”) is eligible to file an automatic shelf registration statement to register offers and sales of securities. A WKSI can either register a fixed amount of securities and pay the filing fee in advance under Rule 456(a) under the Securities Act or it can register an indeterminate amount of securities and defer payment of all or a portion of the registration fee under Rules 456(b) and 457(r) under the Securities Act. If Rule 456(a) is used, takedowns off of the Registration Statement on Form S-3ASR will be limited to the stated registered amount.
WKSIs that choose to “pay-as-you-go” under Rules 456(b) and 457(r) under the Securities Act defer paying a filing fee in advance, but instead pay a fee at the time of the filing of the final pricing supplement for any offering. At that time, the filing fee is deducted from the issuer’s fee account with the SEC.
Each approach has its advantages and disadvantages. WKSIs that use Rule 456(a) do not have to keep paying a fee each time that they take down securities from the shelf. However, they have to keep track of their remaining shelf capacity, as discussed below. Issuers that are not WKSIs but are eligible to use Form S-3 must use Rule 456(a) and also must keep track of their remaining shelf capacity.3 WKSIs that defer payment have to ensure that their account at the SEC has enough money in it to cover the filing fees at the time of an issuance.4 Again, a matter of keeping track internally.
Any issuer (including a WKSI) that uses Rule 456(a) to register the offer and sale of a specific amount of securities must have internal procedures to keep track of the dollar amount of securities that have been sold and the remaining capacity on the shelf registration statement. If the issuer loses track of its remaining shelf capacity and oversells the amount that is registered pursuant to the shelf registration statement, it will have sold unregistered securities.
This happened to a large frequent issuer. The issuer, which had been a WKSI but lost its WKSI status, oversold the amount of securities that it had registered on its Form F-3. The issuer conducted a rescission offer for the unregistered securities and also paid a civil penalty.
According to the issuer, its failure to identify external regulatory limits on the sale of the relevant securities and the failure to monitor against these limits had led it to conclude that it had a material weakness in certain aspects of its internal control environment and that, as a consequence, its internal control over financial reporting and disclosure controls and procedures as of the relevant fiscal year end were not effective. Plaintiff’s attorneys commenced class actions against the issuer based on Exchange Act Section 10(b) and Rule 10b-5 thereunder.
If an issuer has oversold its registered shelf capacity, the Exhibit 5 opinion of counsel as to the due authorization of the securities could be called into question. However, that opinion usually includes an assumption to the effect that “at or prior to the time of the delivery of any such security, the Board of Directors (or a duly authorized committee thereof) of the issuer shall have duly authorized the issuance and sale of such security and such authorization shall not have been modified or rescinded ….” Nonetheless, prior to issuing such an opinion, diligence by counsel would require a review of the matters that we cover here, including reviewing program authorizations and limits.
Of course, program authorizations, authorized amounts, issued amounts, etc. should be the subject of diligence in connection with program renewals, program amendments, and syndicated takedowns.
OCC REGISTRATION OF OFFERINGS OF DEBT SECURITIES BY NATIONAL BANKS
National banks issuing debt securities must file a registration statement with the Office of the Comptroller of the Currency (“OCC”) under 12 C.F.R. Part 16 (the “Securities Offering Rules”) unless an exemption from registration is available. Although the securities of national banks are exempt from registration under the Securities Act by virtue of Section 3(a)(2) thereof, unless an exemption is available from the Securities Offering Rules,5 the national bank must file a registration statement with the OCC.6
Most national banks with bank note programs tailor their offerings to fit within the exemption provided by 12 C.F.R. Part 16.6, which requires, among other things, offerings of nonconvertible debt in $250,000 minimum denominations, sales to only accredited investors (as defined in Rule 501(a) under the Securities Act), the debt is “investment grade” (as defined in 12 C.F.R. Part 16.2(f)) and the offering document is filed with the OCC.
Because the offering memorandum filed with the OCC would state the aggregate principal amount of debt securities to be offered, the national bank issuer should ensure that they do not oversell that amount.
Although Section 3(a)(2) securities are not exempt from registration with the OCC under 12 C.F.R. Part 16.5(a), securities exempt from registration under Section 3(a)(3) of the Securities Act (maturity of 270 days or less and meeting the “current transaction” requirement) are within 12 C.F.R. Part 16.5(a). Therefore, if a national bank’s bank note program allows for, and issues, bank notes that qualify for the Section 3(a)(3) exemption, those issuances would not be counted against the amount stated on the cover page of the offering memorandum filed with the OCC.
CREATING A GOOD TRACK RECORD
Frequent issuers (such as issuers of structured notes) should have in place written policies and procedures that address monitoring of issuances to ensure that neither internal limits (such as board resolutions) nor external limits (such as SEC filing fees) are exceeded.
These procedures might address, among other things:
- Personnel dedicated to the task, with backups. In considering personnel, different approaches will inevitably be required for each institution. Also, it may be necessary for the institution’s Treasury funding group to monitor certain amounts, such as the internal limits and the registration fees, since these relate to the issuer and the issuer’s programs and its registration statements. One or more funding groups within the affiliated broker-dealer may be responsible for monitoring issuances undertaken by their groups. These may need to be reconciled.
- Periodic audits of the tracking function. It will be essential to test that the functions work reliably.
- A set amount of registered securities under which the issuer would refile the shelf to register an amount within the limits set by the board
Some issuers have their outside counsel assist with tracking issuances of their structured notes. However, the issuer is ultimately responsible for ensuring that there is available shelf capacity.
Footnotes
1 As a diligence point and particularly when drafting an opinion on due authorization, the issuer’s charter documents must be checked to ensure that
any committee is duly constituted and to consider whether there are any limits on issuances of securities in the charter documents.
2 The discussion above also applies to commercial paper programs and other continuous offering programs.
3 The Form S-3 cannot be post-effectively amended to increase the registered amount (except under the limited circumstances provided by Rule
462(b) under the Securities Act). Form S-3ASR can only be post-effectively amended to register additional securities pursuant to Rule 413(b).
4 If there are insufficient funds in an issuer’s account with the SEC, the printer will usually alert the issuer as the printer will receive a message from the
SEC’s EDGAR system that the filing cannot be made.
5 12 C.F.R. Part 16.5 provides exemptions from registering under Part 16.3, but specifically excludes Section 3(a)(2) of the Securities Act.
6 See 12 C.F.R. Part 16.3 (registration requirement); 12 C.F.R. Part 16.15 (form and content – issuers may use Securities Act registration forms).
Originally published in REVERSEinquiries: Volume 7, Issue 2.
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