Understanding the Concept of "Affiliate" Under Federal Securities Laws and Its Implications
Federal securities laws rely on the concept of “affiliate” in various contexts, impacting everything from registration requirements to exemption eligibility and exchange compliance. The importance of determining "affiliate" status resonates through the Securities Act, the Exchange Act, and listing standards on Nasdaq and NYSE, making it a critical term for legal compliance and strategic planning. In this blog, we’ll explore the Securities Act’s definition of an “affiliate” and discuss its implications for Rule 144, Section 4(a)(7), and Form S-3 eligibility.
What Is an "Affiliate" Under the Securities Act?
The Securities Act defines “affiliate” under Rule 405, describing an affiliate as “[a]n affiliate of, or person affiliated with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the person specified.” This definition also applies in Rule 144, which is commonly used for resales of restricted securities.
Key Factors in Determining “Control”
Determining whether someone is an affiliate is often a facts-and-circumstances analysis, with no strict line marking control. Here are factors that are frequently considered in making an affiliation determination:
Ownership Percentage: The most obvious indicator of control is share ownership, especially if it reaches a majority stake. While a 51% stake usually implies control, cases have shown that even a 10% or 40% stake may indicate control in certain situations.
Management Roles: Holding positions such as officer or director often points to control, though it’s not definitive on its own. For example, some cases find that board members or high-level executives are affiliates, while others consider additional factors before making this determination.
Voting Control: Control over voting rights or influence over shareholder votes can indicate affiliation, especially if a person or group can direct corporate decisions or act as a unified group.
Business Relationships: When a significant portion of a company’s revenue is generated through business relationships with another entity, control may be implied. This can happen, for example, if one company provides 70% of another company’s income.
Other Influential Relationships: Other relationships, such as family, social, or financial ties, may indicate control if they allow one person to impact the company's policies and decisions. Courts have considered informal groups acting in concert as affiliates if they collectively influence company direction.
Implications of Being an Affiliate
Determining affiliation is crucial because it affects compliance under various rules and forms. Here are some of the primary implications:
1. Rule 144 – Safe Harbor for Resale of Restricted Securities
Rule 144 under the Securities Act provides a safe harbor for the resale of restricted securities by establishing conditions that, if met, allow sellers to confidently rely on the Section 4(a)(1) exemption for transactions not involving an issuer, underwriter, or dealer. However, the requirements differ for affiliates and non-affiliates. Key implications for affiliates under Rule 144 include:
Current Public Information: Affiliates must ensure the issuer has current public information available.
Volume Limitations: Affiliates are limited by how much they can sell within a 90-day period, often referred to as the "drip rule."
Manner of Sale Requirements: Affiliates must sell shares through a broker-dealer.
Form 144 Filing: Affiliates are required to file a Form 144 with the SEC before making a sale.
For non-affiliates, many of these restrictions are lifted after meeting certain holding periods, making Rule 144 a more flexible exemption for them.
2. Section 4(a)(7) – Resale Exemption
The FAST Act introduced Section 4(a)(7), creating an exemption for private resales of securities that still provides key disclosures and protections. This exemption can be particularly useful for affiliates who may otherwise struggle with public resale due to the requirements of Rule 144.
When an affiliate relies on Section 4(a)(7), they must provide potential buyers with a statement about their affiliate status, along with a certification that they do not have knowledge of any violations of securities laws by the issuer. This exemption requires disclosures but does not allow shares to become freely tradeable, limiting its usefulness in many cases.
3. Form S-3 Eligibility – Primary Shelf and Baby Shelf Rules
Form S-3 is an efficient registration option that allows for streamlined filings by issuers, especially in at-the-market (ATM) offerings and forward-incorporated shelf registrations. However, S-3 eligibility hinges on the “non-affiliate” status of a company’s float, calculated based on the portion of its shares held by non-affiliates.
Primary Shelf Eligibility: If the non-affiliate float meets the $75 million minimum threshold, the company is eligible to file Form S-3 for primary offerings.
Baby Shelf Rule: If the non-affiliate float is below $75 million, the company can still use Form S-3 for offerings up to one-third of the float within a rolling 12-month period.
Calculating the non-affiliate float requires careful consideration of which shareholders are deemed affiliates. This can be dynamic, changing as shareholders move in and out of affiliate status, thereby impacting the company’s registration capacities over time.
Conclusion
Understanding who qualifies as an affiliate is essential under federal securities laws, impacting compliance, exemption availability, and eligibility for registration forms like S-3. As we explored here, affiliation is a nuanced determination based on multiple factors, including share ownership, management roles, and relationships that indicate control. For affiliates, Rule 144 provides a path to resale, albeit with more restrictions than for non-affiliates. Likewise, Section 4(a)(7) offers an additional resale exemption for affiliates.
Ultimately, the affiliation status influences compliance at multiple levels, from resale exemptions to registration forms. Companies should carefully assess their relationships with shareholders to ensure compliance, while affiliates should remain aware of the requirements applicable to their securities transactions. This initial overview of affiliation will continue in Part 2, where we’ll address the critical distinction between primary and secondary offerings.
Source: Content insights on the "affiliate" concept in securities law are derived from Securities Law Blog.