SEC Staff Legal Bulletin addresses Legality and Tax Opinions in Registered Offerings

Staff Legal Bulletin No. 19, published on October 14 by the SEC's Division of Corporation Finance, provides guidance on legality and tax opinions issued in connection with registered offerings of securities under the Securities Act of 1933.  The bulletin covers the requirements for such opinions, the Division's views regarding the required elements for these opinions and the filing of consents to include these opinions in registration statements.

Legality Opinions

Item 601(b)(5)(i) of Regulation S-K requires that all 1933 Act filings include an opinion of counsel regarding the legality of the securities being offered and sold pursuant to the registration statement.  As a general rule, counsel’s signed legality opinion must be filed as an exhibit to the registration statement before it becomes effective, and the opinion may not be subject to any unacceptable qualifications, conditions or assumptions.  In general, legality opinions must state that the securities are legally (or validly) issued, fully paid, non-assessable and, if debt securities, binding obligations of the registrant.

Among other things, the bulletin:

• confirms the Division will not accelerate the effectiveness of a registration statement if counsel does not opine that the securities will be legally issued, but if counsel opines that the securities are not fully paid or are assessable, the effectiveness of the registration statement may be accelerated as long as the disclosures about partial payment or assessability are adequate;
• states that when a foreign corporate registrant registers the offer and sale of shares, foreign counsel or U.S. counsel that is competent to opine on the applicable foreign law must provide a legal opinion in the same manner as for a U.S. registrant, and that counsel must opine on the laws of the registrant’s jurisdiction of incorporation, including whether the shares are legally issued, fully paid and non-assessable as those terms are understood under U.S. law;
• notes Counsel must opine on the legality of registered offers of options, warrants or rights to purchase securities, as well as on the legality of the underlying securities; 
• clarifies that when the registrant registers the offer and sale of units comprised of two or more underlying securities, the opinion must address the legality of each component of the unit, as well as the unit itself; and
• affirms that purchasers of securities in registered offerings are entitled to rely on the opinion, and that the Division does not accept any limitation on reliance. 

 Tax Opinions

Regulation S-K requires opinions on tax matters for filings on Form S-11, filings to which 1933 Act Industry Guide 5 applies, roll-up transactions and other registered offerings where the tax consequences are material to an investor and a representation about the tax consequences is included in the filing.  Legal counsel or an independent public or certified accountant can provide the Item 601(b)(8) tax opinion, which supports the tax matters and the consequences to shareholders.  A revenue ruling from the Internal Revenue Service also will satisfy the requirement.  Among other things, the bulletin:

• indicates that tax opinions only have to address material federal tax consequences, and the registrant may recommend in the prospectus that investors seek the advice of their tax counsel or an adviser with respect to any state tax consequences;  
• advises that a tax opinion should address and express a conclusion for each material federal tax consequence, should identify the applicable IRS provision, regulation or revenue ruling, and if counsel or the accountant is unable to opine on a material tax consequence, the opinion should state that fact, provide the reason and discuss possible alternatives and risks to investors; 
• agrees that a tax opinion may be conditioned or qualified as long as the disclosure is adequate, that counsel or the accountant must disclose the assumptions on which the opinion is based, and that assumptions about future facts or conduct, if limited and reasonable, are acceptable;  
• explains that counsel or an accountant may issue a “should” or “more likely than not” opinion if there is a lack of authority that directly addresses the tax consequence of the transaction, conflicting authority or significant doubt about the tax consequences, and that in these instances the staff expects an explanation, including a description of the degree of uncertainty.

Issuers Discuss Impact of Dodd-Frank Durbin Amendment

On October 1, new Federal Reserve Board guidelines went into effect to implement interchange fee reform provisions of Dodd-Frank Act Section 1075 (the Durbin Amendment).  As a result, banks with holdings of $10 billion or more now have a rate cap on what they can charge merchants for processing debit card transactions (21 cents plus 0.05% of the transaction, compared to the current average of 44 cents per transaction).  Affected companies have been striving to project the impact of the new rules on their business in SEC filings.

USA Technologies, Inc. (NASDAQ: USAT), which has a 19 year history in the small ticket electronic payments industry and the unattended Point of Sale market, has been notified by its U.S. credit and debit card processor that Visa and MasterCard will significantly raise their interchange fees for small ticket category transactions paid for through debit cards issued by regulated banks as defined under the Durbin Amendment.  In its Form 10-K filed 9/27/11, USAT states the interchange rate would increase on October 1 from 1.55% of a transaction plus 4 cents, to 0.5% of a transaction plus 22 cents, which represents an increase of approximately 247% based on a transaction of $1.67, which was the average transaction experienced by USAT during the fiscal year ended June 30, 2011.  Approximately 82% of the transactions handled by the USAT network in FY11 consisted of small ticket debit card transactions.  Of such transactions, USAT estimates that 70% were debit transactions from regulated banks.  USAT and its card processor are currently in discussions with the card associations to analyze the impact of the rate increases and to negotiate a viable rate structure. 

The Toronto-Dominion Bank (NYSE: TD) strived to quantify the impact of the  new Federal Reserve rules in the “How Our Businesses Performed” section of its 3Q11 earnings news release filed with a Form 6-K on September 1.  "As a result of the Durbin Amendment, revenue at U.S. Personal and Commercial Banking is expected to decline by approximately US$50-60 million pre-tax per quarter, excluding mitigation strategies.  One third of that impact is expected in the fourth quarter of fiscal 2011 and the first full quarter impact is expected in the first quarter of fiscal 2012.  We are formulating plans to recover this lost revenue over the next 2 years, but not specifically in the debit product."

In addition to the interchange fee cap, Durbin contains a provision that prevents card networks from contractually requiring that their debit cards be transacted exclusively on one debit network.  This will free merchants up to choose a network from a pool of competitors, potentially resulting in a lower per-transaction cost on their side and a further hit to interchange fee revenue on the bank’s side.  PSB Holdings Inc. (OTCBB: PSBQ) touched on this facet of the legislation in the MD&A section of Form 10-Q filed 8/15/11:  “While the new rules technically do not apply to us as a smaller bank, the impacts are expected to become uniform for the industry over time as merchants use their new authority and options to process customer card activity across a wider number of providers. While the timing is uncertain, these fully implemented changes could lower our annualized debit card interchange revenue by approximately $234, down approximately 36% from current revenue levels.”

Resale of Preferred issued pursuant to the Small Business Lending Fund

First Bancorp/NC Form S-3 on 9/30/2011 (SEC file no. 333-177096)
First PacTrust Bancorp, Inc. Form S-3 on 9/29/11 (file no. 333-177055)
Horizon Bancorp Form S-3 on 9/26/11 (file no. 333-177007)

The Treasury Department is the initial selling securityholder of senior non-cumulative perpetual preferred shares recently registered by issuers that have participated in the Small Business Lending Fund (SBLF).  Enacted into law as part of the Small Business Jobs Act of 2010, the SBLF is a $30 billion fund that encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion.  By press release dated September 28, the Treasury Department states that the final wave of funding through the SBLF has brought the total funding for the program to more than $4 billion going to 332 banks across the country. 

First Bancorp, a bank holding company headquartered in Troy, North Carolina, received an investment of $63.5 million in the company’s preferred stock on September 1.  The initial dividend rate on the preferred stock was 5% and can fluctuate on a quarterly basis during the first 10 quarters during which the  preferred stock is outstanding, based upon changes in the amount of the issuer's “Qualified Small Business Lending" as compared to a baseline level.  The First Bancorp preferred stock qualifies as Tier 1 capital, is non-voting except in limited circumstances and may be redeemed at any time at the company’s option. 
 
The issuances of the preferred stock were completed in private placements to Treasury exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.  First Bancorp filed the corresponding securities purchase agreement on Form 8-K dated September 6.  First PacTrust Bancorp ($32 million) and Horizon Bancorp ($12.5 million) filed their securities purchase agreements with the Secretary of Treasury on Form 8-Ks dated August 30 and August 26, respectively.

Registrant to Offer IPO Shares by Modified Dutch Auction

WhiteGlove Health, Inc., which on September 16 filed Amendment No 9 to its Form S-1, would be the first issuer to use the “OpenIPO” distribution method since 2007.  “OpenIPO” is WR Hambrecht + Co.’s trademarked name for an auction-based approach to the determination of public offering price and share allocation in which all investors, including company insiders, have an equal opportunity to receive an allocation of shares at the same price.  The investment bank was an underwriter in the eleven auction method IPOs that have closed since 2005.

For issuers using "OpenIPO", the underwriters solicit bids from potential investors that specify both the price and the number of securities the bidder wishes to purchase.  Prospective investors must open a brokerage account with one of the underwriters and deposit money into it.  These funds back the bids made in the auction.  The auction begins as soon as a preliminary prospectus is available and closes after the registration is declared effective. At any point within that window, bids can be canceled or modified and investors can make multiple bids at multiple prices.

At the close of the auction, the underwriters determine a “clearing price,” or the highest price at which all offered shares can be sold.  Once a clearing price is set, the issuer and the underwriters establish the public offering price.  The public offering price may be less than, but cannot exceed, the clearing price.  All of an investor’s bids at or above the clearing price will be considered and cumulated at the close of the auction.  The public offering price determines the allocation of shares to potential investors, with all valid bids submitted at or above the public offering price receiving a pro rata portion of the shares bid for.  Each of an investor’s successful bids will be treated separately for purposes of allocation and rounding of lots to multiples of 100 or 1,000 shares.

Benihana Inc. to Resubmit Reclassification Proposal

Benihana's special meeting proposal to simplify its capital structure by reclassifying each Class A common share into one share of common stock (previously reported in this space on June 10) did not receive the required approval by a majority of the outstanding common shares on September 12.  All other classes of stock voted a majority of shares outstanding in favor of the proposal.  The reclassification proposal required the higher burden of not just a majority of shares voting, but a majority of all outstanding common shares. 

Benihana of Tokyo, Inc. ("BOT"), the company's largest shareholder owning approximately 36.8% of the common shares and 26.8% of the voting power, expressed concerns about the reclassification proposal in a letter to the Benihana Inc. board of directors that is included as an exhibit to the Schedule 13D filed June 22 (SEC file no. 005-48717).  On August 5, BOT filed a Proxy Statement on Form DEFC14A to solicit votes against the proposed reclassification, stating it "would benefit certain of the Company’s insiders...while diluting and disenfranchising the vast majority" of the common stockholders.

In a press release filed by Benihana with a Form 8-K on September 12, the company indicated that it would re-file an S-4 Registration Statement to enable stockholders to vote again on the reclassification proposal as soon as possible.  Regarding such vote, the company said that it has been informed by BFC Financial Corporation that it intends to convert additional shares of its Series B preferred stock into common stock prior to the new record date to help obtain shareholder approval.  The new Form S-4 was filed on September 14, file no. 333-176842.