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Frequently Asked Questions
  Staff Interpretation Letter 2005-38
Identification Number 885
This is in response to your letters regarding a proposed private placement of shares of the company’s common stock and warrants expected to be consummated in July 2005 (the “Proposed Transaction”).  Specifically, you asked whether the Proposed Transaction would be aggregated with a convertible note and warrant offering completed in December 2004, (the “Prior Transaction”) for purposes of Marketplace Listing Rule 4350(i)(1)(D) (the “Rule”).  Your question relates also to the applicability of Rules 4350(i)(1)(A) and 4350(i)(1)(B)
According to the information you provided, in the Prior Transaction, the company sold a convertible promissory note (the “Note”) and a related warrant (the “Warrant”), each having a term of five years.  The Note is convertible into approximately 19.9% of the pre-transaction outstanding shares, and the Warrant is exercisable for approximately 1.6% of the pre-transaction outstanding shares.  No officers, directors, employees or consultants of the company participated in the Prior Transaction.  Although both the Note and the Warrant contain anti-dilution provisions, the Note cannot be converted into more than 19.9% of the pre-transaction shares at a discount unless shareholder approval is obtained, and the exercise price of the Warrant is subject to a minimum price which is a premium to both the market and book value immediately preceding the signing of the definitive agreement.  Accordingly, shareholder approval of the Prior Transaction was not required by the Rule.  The use of the proceeds was for general working capital purposes, general corporate purposes, and the repayment of certain outstanding indebtedness.
You stated that in the Proposed Transaction, the company will sell shares of common stock equal to approximately 14% of the pre-transaction outstanding shares (the “Proposed Transaction Stock”) and warrants exercisable for up to 9% of the pre-transaction outstanding shares (the “Proposed Transaction Warrants”) to purchasers including three capital management firms, and three directors and three officers of the company (the “Insiders”).  The Insiders will purchase, in the aggregate, up to approximately 3% of the shares being issued, and no other officers, directors, employees, or consultants of the company will participate in the transaction.  The price paid by the Insiders will be no less than the greater of book and market value at the time of the definitive agreement.  The price paid for the common stock by the other purchasers will be at a discount to the market price, and the exercise price of the Proposed Transaction Warrants will be no less than the greater of book and market value immediately preceding the execution of the definitive agreement unless shareholder approval is obtained.  The Proposed Transaction Warrants will not be exercisable until six months after closing.
You stated that the Initial Investor had no involvement in the negotiation of the Proposed Transaction.  However, pursuant to the terms of the Prior Transaction, this investor has a right of first refusal with respect to any subsequent securities offering for two years.  Under this right, the Initial Investor has notified the company that it intends to participate in the Proposed Transaction, purchasing approximately 24% of the shares to be sold.
You stated that the company had not contemplated the Proposed Transaction at the time of the Prior Transaction and that there were no contingencies between the two transactions.  In addition, you stated that events subsequent to closing of the Prior Transaction gave rise to the need for additional financing.  Specifically, you stated that events identified by the company in its second quarter 2005 caused it to incur additional losses, resulting in the breach of financial covenants in its credit facility.  The covenants will be amended as part of the Proposed Transaction.
According to a Schedule 13G filed with the Securities and Exchange Commission, four shareholders, with aggregate holdings equal to approximately 20.5% of the company’s outstanding shares of commons stock, constitute a group (the “Group”) within the meaning of Rule 13d-5(b).  The Group is the largest holder of the company’s common stock; the next largest owns approximately 10%.  Members of the Group will participate in the Proposed Transaction, and the Group will remain the largest shareholder following the Pending Transaction.
Following our review of the information you provided, we have determined that the shares to be issued in the Proposed Transaction will not be aggregated with the shares issued in the Prior Transaction for purposes of the Rule because: (i) the Proposed  Transaction was not contemplated at the time of the Prior Transaction; (ii) there were no contingencies between the two transactions; (iii) the investor in the Prior Transaction will participate in the Prior Transaction only to limited extent and only because of the right of first refusal; and (iv) approximately seven months will have passed between the two transactions.  In addition, based on your representations regarding the Proposed Transaction, shareholder approval is not required under Listing Rule 4350(i)(1)(D) because less than 20% of the common shares and voting power outstanding on a pre-transaction basis will be issued at a price less than market and book value .  In that regard, while approximately 22% of the pre-transaction shares outstanding could be issued in the Proposed Transaction, the Proposed Transaction Warrants may not be exercised until six months after the date of closing and the exercise price of those warrants will be greater than book and market value.  As such, the Proposed Transaction Warrants will not count towards the 20% calculation for purposes of Listing Rule 4350(i)(1)(D).  Shareholder approval is not required pursuant to Listing Rule 4350(i)(1)(A) because the shares issued to the Insiders will not be at a discount.  In addition, given the size of the Group’s current ownership position and because the Group will remain the largest shareholder, the Proposed Transaction will not result in a change of control and, therefore, will not require shareholder approval under Listing Rule 4350(i)(1)(B).
Publication Date*: 7/31/2012 Mailto Link Identification Number: 885
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