Tag Archives: Convertible Debt

Tacking onto the Holding Period of Convertible Notes under Rule 144

Does Accrued Interest Affect the Holding Period Under Rule 144(d)?

When Convertible Promissory Notes with accrued but unpaid interest are exchanged for stock in a public company, the Rule 144 holding period for the Notes can be tacked to the holding period for the stock under Rule 144(d)(3)(ii) only if the exchange consists only “of other securities of the same Issuer.”

That means no additional consideration can be paid in the exchange other than the securities themselves and is consistent with Section 3(a)(9) of the Securities Act of 1933,

Accrued Interest is Not Considered Additional Consideration Under Rule 144

This brings up the question of whether or not accrued but unpaid interest on the Note is construed by the SEC as additional consideration inconsistent with Rule 144(d)(3)(ii).

The SEC’s position is that the right to receive payment for the accrued interest is not additional consideration, and the holding period for the Convertible Promissory Notes can be tacked to the holding period for all shares of stock received in the exchange.

Rule 144 Securities Lawyer Opinion Letters for Debt Conversions

Matheau J. W. Stout, Esq. reviews Notes at no cost in preparation for issuing Rule 144 legal opinions for debt holders in OTC Markets and OTC Bulletin Board companies.  Debt holders can email documents to mstout@otclawyers.com or call Matt Stout at (410) 429-7076 for a free consultation on Rule 144, or on the Section 4(a)(1) alternative to Rule 144 if the securities are at least 2 years old.

What Information Does a Court Need to Approve the Fairness of a 3(a)(10) Transaction?

In a 3(a)(10) transaction, the Issuer must advise the Court before the fairness hearing that the Issuer plans to rely on the Section 3(a)(10) exemption and that this reliance will be based on the Court’s Order, approving the exchange of the bona fide claims for the Issuer’s securities.

The SEC takes the view that the Court making the fairness determination

“must have sufficient information before it to determine the value of both the securities, claims or interests to be surrendered and the securities to be issued in the proposed transaction.”

As a practical matter, if drafted properly, the Complaint, Answer, Settlement Agreement and draft Order that the Court reviews prior to the fairness hearing should provide all of the language necessary to satisfy this requirement.

Convertible Debt of Pink Sheet and Bulletin Board Companies

Perhaps the foremost concern of the buyers of a public vehicle, or of any major investor seeking to purchase a large stake in a OTC Bulletin Board or OTC Pink Sheet issuer, is the existence of aged convertible debt.  This is not only true from a balance sheet perspective, but also true because of the potential for the conversion of aged debt into large blocks of free trading stock under SEC Rule 144 or the provisions of 4(1).

Conversion Features May Not Be Public Information if the Issuer is Not Current in its OTC Markets Filings

Because Pink Sheet issuers do not have to file SEC Form 8-K, the fact that management may have just taken out a large loan with high interest and severe default provisions may not come to light for a full quarter, if the issuer is Pink Current.  OTC Markets Quarterly and Annual Reports do not require a photocopy of the actual Convertible Promissory Note to be included, although its terms are supposed to be fully outlined within the Notes to the financial statements and within the Annual Disclosure itself.

If the issuer is Pink Yield Sign or Pink Stop Sign, information on that loan, including the principal amount, interest rate, and maturity date may not be publicly available at the moment a securities attorney is reviewing the OTC Markets filings.  Perhaps most importantly, the conversion features of the loan may not be known.

Pink Sheet Issuers Rarely File Interim Reports to Disclose Convertible Debt

While one could argue that OTC Pink Sheet issuers should be filing Interim Disclosures and Interim financials when a debt of material size is undertaken, the fact is that this rarely happens, both due to lack of knowledge on the part of management and due to the perceived cost associated with the filings.

For this reason, it is recommended that any group performing due diligence on an OTC Pink Sheet retain a securities lawyer to not only review the filings, but request the actual debt instruments from the company for review.  Even when these debts are not mentioned in the filings, once must presume they exist and proceed accordingly.  Securities lawyer, Matt Stout, is available to perform due diligence on all tiers of OTC Markets Pink Sheet issuers.

Convertible Debt of OTC Bulletin Board and OTCQB Issuers

SEC reporting public companies file Forms 10-Q, 10-K and 8-K, among others, with the SEC using the EDGAR filing system.  OTC Issuers that retain PCAOB registered auditors and undergo the quarterly and annual audits are the only companies eligible to be quoted on the OTC Markets tiers known as OTCQX and OTCQB.

During the process of an audit, issuers are required to obtain confirmation’s of debt owed to each creditor, which show the terms and current balance.  Auditors then use these debt confirmations to provide the loans payable figures found in 10-Q and 10-K reports.

Likewise, FINRA’s OTCBB or OTC Bulletin Board only posts quotations for issuers which are current SEC filers, all of which are undergoing PCAOB audits.

OTCBB and OTCQB Issuers Should Report Debt on Form 8-K

Having an OTC issuer’s stock quoted on the OTC Bulletin Board or the OTC Markets OTCQB tier implies that the companies are “currently reporting” with the SEC. This fact gives investors, and securities attorneys doing due diligence, some degree of peace of mind since in theory, all material events, including the taking on of convertible debt, should be reported.

Form 8-K, known as the “Current Report” is used whenever there is the occurrence of a “material event” in a company’s operations.   There are several common events that trigger an 8-K filing.  Convertible Notes of any size should be considered by the management of OTC public companies to be material, and the news, whether perceived as good or bad, should be found in the filings.  In reality, however, this is not always the case.

It is important to remember that reviewing an issuer’s filings is only the first step in performing due diligence for a securities lawyer.  The next step should always be asking questions about what is not shown in the SEC and OTC Markets filings, even if the issuer is an SEC reporting company.

For further information on how aged convertible debt can be reviewed in OTC Bulletin Board and Pink Sheet companies, contact Matheau J. W. Stout, securities lawyer at (410) 429-7076.