Upsizing and Downsizing Your IPO

Client Alert

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Number 1053 July 14, 2010

Latham & Watkins Corporate Department

Capital Markets Group

“

The purpose of

this

Client Alert

is to provide you

with the tools

you need to react

quickly and wisely

to questions about

pricing outside the

range when the

moment of truth

arrives.

”

Upsizing and Downsizing Your IPO

The reds have been printed; the deal is

on the road; and the champagne is on

ice. Now, all that is left is for the IPO

investors to step up and buy the stock.

It’s a tempting moment to relax — but

an experienced deal lawyer knows

better. This is the time to start preparing

for the possibility that the deal will be

wildly oversubscribed or will struggle

mightily. In either case, the question

that will shortly come your way is

“How much can the deal be upsized or

downsized at pricing?”

To answer that seemingly simple

question, you will need to break it into

three component parts:

• Was your registration statement

accurate and complete as of the time

it became effective?

• Have you provided investors with all

the information they need to make an

informed investment decision prior to

confirming orders?

• Do you owe the SEC any additional

filing fees?

Getting to the bottom of these points is

a surprisingly complex undertaking. The

rules in this area are technical and not

always intuitive, and you may be asked

to make some difficult judgment calls

under significant time pressure. The

purpose of this Client Alert is to provide

you with the tools you need to react

quickly and wisely to questions about

pricing outside the range when the

moment of truth arrives.

Getting Started:

The Importance of the

Earlier Filings

Let’s start with a review how you got to

where you are now.

When you first filed the registration

statement, you had to complete the

“Calculation of Registration Fee” table

on the front cover. The primary purpose

of the fee table was to calculate the

amount of filing fees required to be

paid to the SEC at that time. Several

amendments later, when your deal was

ready to go to investors, a preliminary

prospectus was filed showing the

number of shares expected to be sold

and a “bona fide” estimate of the

price range per share as required by

Regulation S-K Item 501(b)(3). That

range was very likely a $2 range, in

keeping with the informal SEC Staff

policy for deals expected to price below

$20 per share (if the upper limit is above

$20 per share, the informal policy is

that a price range of up to 10 percent

of the upper limit is bona fide). The

price range prospectus was circulated

to investors at the beginning of the road

show.

Now, the deal is on the road. Investor

feedback is rolling in. If investor demand

is stronger than anticipated, the issuer

and the selling stockholders may want

to sell more shares or increase the price

per share being sold, or both. On the

other hand, if a crisis in some far-away

part of the world happens to come to

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roost while your deal is on the road, the

underwriters may have to struggle to

complete a smaller deal, involving fewer

shares or a lower price per share, or both.

Let’s review the tools in your toolbox for

upsizing or downsizing your deal.

Options Prior to Effectiveness

Until your registration statement has

been declared effective by the SEC,

you can revise your deal all you want

in a pre-effective amendment with a

new price range and/or a new number

of securities to be sold. You may need

to pay additional filing fees if you are

upsizing, but it’s no problem to do so. If

demand is through the roof, this may be

an option to consider.

However, using a pre-effective

amendment to upsize or downsize a

deal after the price range prospectus

has been distributed to investors is

typically a last resort in our experience.

Among other things, there can be

unwelcome timing implications (for

example, you will need to obtain a new

auditor’s consent and updated signature

pages and clear any comments from

the SEC Staff on the new disclosure).

In addition, the new filing containing

the amended price range could send a

signal to the market about pricing that

may be premature. Particularly for deals

that are in trouble and may need to

be downsized, refiling the registration

statement with a revised price range can

spell disaster.

Options After Effectiveness

Those who qualify for the special

treatment offered by Rule 430A and

the related rules will find it much

more attractive to make the necessary

changes to the terms of the deal after

effectiveness.

In most cases, therefore,

the question for the deal team will

be whether the proposed changes to

the number of shares to be sold and

the price per share qualify for Rule

430A’s magic? Put another way, the key

question is this:

“Assuming we go effective on a

registration statement containing the

same price range prospectus that was

circulated to investors, how far can

the deal be upsized or downsized at

pricing and after effectiveness without

having to go back to the SEC for

permission?”

In order to understand the magic of

Rule 430A, you will need to master the

interplay between several key provisions

of the Securities Act and a number of

rules and Compliance and Disclosure

Interpretations (C&DIs) published by

the SEC Staff. Once you have mastered

these rules, you will need to answer

these three questions:

• Is the “Section 11 file” complete as of

the effective time of the registration

statement?

• Is the “Section 12 file” complete as of

the time you want to start confirming

orders?

• Do you owe the SEC any more filing

fees?

Section 11 and Section 12

Let’s start with a few words about

the primary liability provisions of the

Securities Act.

Section 11(a) of the Securities Act

imposes liability if any part of a

registration statement, at the time

it became effective, “contained an

untrue statement of a material fact or

omitted to state a material fact required

to be stated therein or necessary

to make the statements therein not

misleading.” Section 11 liability only

covers statements made in a registration

statement at effectiveness. We think

of the registration statement at the

magic moment of effectiveness as the

“Section 11 file.” This is a helpful way

to remember that Section 11 is a highly

technical provision, in the sense that it

looks only at: (a) what is or is deemed

to be in the registration statement (b) at

the time it became effective.

By contrast, Section 12(a)(2) of the

Securities Act is not limited to the

registration statement and is not linked to

the moment of effectiveness. It imposes

liability on any person who offers or

sells a security in a registered offering

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by means of a prospectus, or any oral

communication, which contains “an

untrue statement of a material fact or

omits to state a material fact necessary in

order to make the statements, in the light

of the circumstances under which they

were made, not misleading.” Section

12(a)(2) is less technical and more holistic

than Section 11. Section 12(a)(2) takes

into account all oral statements, free

writing prospectuses and statements in

the price range prospectus, rather than

focusing exclusively on the registration

statement.

Under Securities Act Rule 159 (which

we discuss in greater detail below),

Section 12 looks to the sum of what

investors have been told at the time the

underwriters confirm orders. Section

12’s focus, therefore, is the price range

prospectus sent to investors and any

additional information that may have

been conveyed to investors (orally or in

writing) on or before the time of pricing.

We think of this collection of information

as the “Section 12 file.”

In order to deal with all of the issues

that arise in the context of changing

the size and price of an IPO after the

registration statement has been declared

effective, you will need to keep in mind

both your “Section 11 file” and your

“Section 12 file.”

Rule 430A

Rule 430A is a very special rule. It

permits a registration statement to be

declared effective without containing

final pricing information. Instead,

it allows you to insert information

retroactively into a registration

statement and have it be treated as if

it were there as of its effective date.

Rule 430A provides that pricing-

related information (which includes

the price per share and the number of

shares offered) that is contained in a

prospectus filed pursuant to Rule 424(b)

after effectiveness of the registration

statement will be deemed to have been

part of the registration statement as of

the effective date. In other words, Rule

430A allows you to tinker with your

“Section 11 file” after the fact and have

the changes travel backwards in time.

Rule 430A is a particularly useful tool

for complying with Section 11, and we

are going to review all of its glorious

twists and turns below. Keep in mind,

however, Rule 430A’s two important

limitations. First, it only applies to

pricing information.

And second,

Rule 430A does not help you make

corrections to your “Section 12 file,” as

it does not allow you to retroactively

add to the information actually given to

investors at the time of pricing.

Here is a summary of Rule 430A from a

40,000 foot perspective:

If you are… Then you

should use…

And you can… But you would need to…

Upsizing

your deal

Instruction to

Rule 430A(a)

Increase the price

per share and/or

number of shares,

so long as the

aggregate size of the

revised deal does not

exceed

120 percent

of the amount shown

in the fee table in

the registration

statement at the time

of effectiveness

• File an immediately

effective registration

statement under Rule 462(b)

to register the increase in

shares/increase in deal size

• Consider whether

additional disclosure (oral

or by means of a free

writing prospectus) needs to

be delivered to purchasers

prior to confirmation of sale

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Now that you have the big picture, let’s

go through it again at a more granular

level.

Instruction to Rule 430A(a)

Rule 430A’s most important contribution

to pricing outside the range is found in

the instruction to paragraph (a), which

states (in full):

Instruction to Paragraph (a). A

decrease in the volume of securities

offered or change in the bona fide

estimate of the maximum offering

price range from that indicated in

the form of prospectus filed as part

of a registration statement that is

declared effective may be disclosed

in the form of prospectus filed with

the Commission pursuant to Rule

424(b) or Rule 497(h) under the

Securities Act so long as the decrease

in the volume or change in the price

range would not materially change

the disclosure contained in the

registration statement at effectiveness.

Notwithstanding the foregoing, any

increase or decrease in volume (if the

total dollar value of securities offered

would not exceed that which was

registered) and any deviation from

the low or high end of the range may

be reflected in the form of prospectus

filed with the Commission pursuant

to Rule 424(b)(1) or Rule 497(h) if, in

the aggregate, the changes in volume

and price represent no more than a

20 percent change in the maximum

aggregate offering price set forth in

the “Calculation of Registration Fee”

table in the effective registration

statement. [Emphasis added.]

In other words, where the 20 percent

safe harbor threshold is not exceeded,

changes in price and deal size can be

poured backwards in time into the

registration statement using a Rule

424(b) filing of the final prospectus after

the effectiveness of the registration

statement and will be deemed to have

been part of the registration statement at

the time it became effective for purposes

of Section 11. This is a very useful

device indeed. It allows you to change

the size of your deal by 20 percent in

either direction without having to go

back to the SEC. This timing advantage

is critical when you are trying to price

a deal. As a result, understanding the

exact scope of this 20 percent safe

harbor is critical.

C&DI 227.03 (January 26, 2009)

C&DI 227.03 reads (in full) as follows:

Question: A registrant omits pricing

information from the prospectus

in a registration statement at the

time of effectiveness in reliance on

Rule 430A. Is it required to reflect

pricing information or the inclusion of

additional securities in a post-effective

amendment?

If you are… Then you

should use…

And you can… But you would need to…

Downsizing

your deal

C&DI 627.01 Decrease the price

per share and/or

decrease the number

of shares sold, so

long as the size of

the revised deal is

not less than the

lower end of the

deal size reflected

in the price range

prospectus minus

20 percent of the

maximum deal size

reflected in the price

range prospectus

• Consider whether

additional disclosure (oral

or by means of a free

writing prospectus) needs to

be delivered to purchasers

prior to confirmation of sale

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Answer: The second sentence of the

Instruction to Rule 430A provides

that a Rule 424(b) prospectus

supplement may be used, rather than

a post-effective amendment, when

the 20% threshold is not exceeded,

regardless of the materiality or non-

materiality of resulting changes to

the registration statement disclosure

that would be contained in the Rule

424(b) prospectus supplement. When

there is a change in offering size

or deviation from the price range

beyond the 20% threshold noted in

the second sentence of the Instruction,

a post-effective amendment would

be required only if such change or

deviation materially changes the

previous disclosure. Regardless of the

size of the increase, in the case of a

registration statement that is not an

automatic shelf registration statement,

a new registration statement must

be filed to register any additional

securities that are offered. Additional

securities cannot be registered by

post-effective amendment except

on automatic shelf registration

statements. [Emphasis added.]

This C&DI establishes two important

points:

• For purposes of Rule 430A (and

hence the Section 11 file), retroactive

changes in price within the 20 percent

threshold can be made after the fact

by way of a Rule 424(b) prospectus

even if the effects of those changes

are material, and

• Even changes outside the 20 percent

threshold can be made using a Rule

424(b) prospectus if the changes do

not materially change the disclosure.

These are important points — and

not entirely intuitive — so let’s spend

another minute here. Rule 430A

effectively lets you make pricing-related

changes to your registration statement

without SEC review (i.e., without filing

a post-effective amendment) even if

those changes are material. This special

privilege is limited to pricing information

as contemplated by Rule 430A, but it

is a very special privilege nevertheless.

The second point is equally important —

changes in excess of 20 percent may not

be material.

How can this be, you ask? Good

question. Consider, for example, a $1

billion offering that is half primary and

half secondary shares. If the secondary

shares are reduced to $250 million, but

the primary shares stay at $500 million,

the offering has been reduced by 25

percent but the reduction may well

not be material. There will still be a

very substantial public “float” after the

offering and the proceeds to the issuer

(and hence the use of proceeds), the pro

forma number of shares outstanding and

the pro forma earnings per share will not

change at all. This sort of fact pattern

is right in the center of C&DI 227.03’s

fairway.

C&DI 627.01 (April 24, 2009)

So far, so good. It all seems pretty

clear — Rule 430A allows you to go up

or down 20 percent from the maximum

aggregate offering price reflected in the

fee table. But one key question remains

unresolved:

What does Rule 430A have to say about

the deal size actually reflected in the

prospectus circulated to investors, as

opposed to the maximum deal size

reflected in the fee table? What if (as is

often the case) these two amounts are

not aligned?

This is where C&DI 627.01 comes into

play. C&DI 627.01 reads (in full) as

follows:

627.01 The instruction to paragraph

(a) of Rule 430A provides that

changes in volume and price

representing no more than a 20%

change in the maximum offering price

set forth in the registration statement

fee table may be made pursuant to a

Rule 424(b)(1) prospectus supplement.

The 20% threshold may be calculated

using the high end of the range

in the prospectus at the time of

effectiveness and may be measured

from either the high end (in the case

of an increase in the offering price)

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or low end (in the case of a decrease

in the offering price) of that range.

[Emphasis added]

C&DI 627.01 permits you to calculate

the 20 percent amount for purposes

of downsizing your deal in a very

favorable way. As an alternative to the

20-percent-of-the-amount-in-the-fee-

table approach contemplated by the

instruction to paragraph (a) of Rule

430A, C&DI 627.01 allows you to derive

your 20 percent amount by multiplying

the upper end of the range in the

price range prospectus by 20 percent.

You can then add that amount to the

upper end of the range in the price

range prospectus if you are upsizing, or

subtract that amount from the bottom

of the range if you are downsizing, to

figure out what share count and price

per share will be within the safe harbor.

Since 20 percent of the upper end of the

price range is by definition greater than

20 percent of the lower end of the price

range, C&DI 627.01 effectively broadens

the scope of the Rule 430A safe harbor

for troubled deals.

The approach in C&DI 627.01 represents

an alternative to the approach in the

instruction to paragraph (a) of Rule

430A, and the SEC Staff takes the

positions that you cannot “mix and

match” between the C&DI and the

instruction to paragraph (a). As a result,

if you are following C&DI 627.01 you

may not take 20 percent of the amount

reflected in the fee table and subtract

that from the lower end of the price

range, even though that might yield a

lower floor on your transaction than 20

percent of the upper end of the range

(since the fee table often registers a

larger transaction than the upper end of

the range). Either you calculate using

the fee table or you calculate using the

range in the price range prospectus, but

you can’t have it both ways. In practice,

this means that you will want to use

C&DI 627.01 when downsizing and the

instruction to paragraph (a) of Rule 430A

when upsizing.

The Section 12 File and the

Importance of Common

Sense

Knowing whether you are within the

Rule 430A safe harbor is not the end

of the analysis — after all, the Rule

contemplates that there could be

material changes to the disclosure that

would fall within the safe harbor. Rule

430A is a fabulous tool for dealing with

the Section 11 file, but it doesn’t help

you with the Section 12 file. Let’s tackle

the Section 12 file now.

Securities Act Rule 159; Free

Writing Prospectuses; Exchange

Act Rule 15c2-8(b)

Rule 159, which was introduced as

part of the securities offering reforms

that became effective in 2005, adds

an important wrinkle to the Section 12

landscape. Rule 159 makes clear that,

for purposes of Section 12, information

conveyed to a securities purchaser

after the time of sale does not count

for purposes of determining whether

the Section 12 file was complete at the

moment that liability attaches. In other

words, Section 12 liability is a function

of what you actually gave or told the

purchaser prior to confirming the order

— anything delivered after the moment

of truth does not count.

This means that those material pricing

changes that can be retroactively

poured into the Section 11 file after the

fact under Rule 430A must actually be

conveyed to purchasers in real time

prior to confirming orders in order for

the Section 12 file to be up to snuff.

There are a number of ways to transmit

the required information — the rules

are agnostic as to the actual method of

conveyance — but the key point is that

the conveyance must be made and it

must be made prior to confirming orders.

Market practice is that simple

information that can be effectively

reduced to sound bites is conveyed

orally. It is customary in deals pricing

within the range, for example, to convey

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the final pricing information orally.

Oral conveyance is also used in many

upsizing and downsizing scenarios.

The easiest example of this would be

a 20 percent decrease in deal size in

an all-secondary offering by a selling

stockholder. All the investor needs to

know in that case is how many shares

are being sold and at what price — there

are no collateral disclosure implications

to the change in deal size in that

example.

The disclosure in the price

range prospectus will not otherwise

change at all.

More complicated deal changes may

require that a free writing prospectus

summarizing the changes be circulated

to accounts in writing as contemplated

by Rule 433. An example of this

situation might be a decrease in offering

size that results in a change to the

use of proceeds flowing through the

pro formas. The decision whether to

convey the new information orally or in

writing will in part depend on whether

the price range prospectus circulated

to investors contained “sensitivity

analysis” explaining how the company’s

plans would change if the actual

proceeds turned out to be more or less

than the amount assumed in the price

range prospectus. The more sensitivity

analysis that is included in the price

range prospectus, the more likely it

will be possible to convey the missing

information orally at the time of pricing.

This is a point to keep in mind in the

early drafting sessions.

There is no hard-and-fast rule about

how much sensitivity analysis will do,

and what topics need to be covered.

Some items to evaluate might include:

• Use of proceeds, particularly where

stated uses would need to be changed

or new uses added (for example,

in the case of unexpectedly large

proceeds)

• Pro forma earnings per share

• The size of the “float” after the

offering

• The company’s financial condition

generally

• The level of beneficial ownership by

members of senior management or

other significant stockholders; and

• Dilution.

The goal is to have disclosure that

allows investors to see how changes in

share price or deal size ripple through

critical elements of the disclosure.

Ideally, the price range prospectus

will present key disclosures in an “if/

then” format (“We will apply the net

proceeds from this offering first to repay

all borrowings under our credit facility

and then, to the extent of any proceeds

remaining, to general corporate

purposes,” for example).

Finally, where the changes are so

fundamental that the original price

range prospectus must be completely

rewritten, it may be necessary to

recirculate a completely new price

range prospectus in order to satisfy

Exchange Act Rule 15c2-8(b). Rule

15c2-8(b) requires that brokers and

dealers participating in an IPO “deliver

a copy of the preliminary prospectus

to any person who is expected to

receive a confirmation of sale at least

48 hours prior to the sending of such

confirmation.” [Emphasis added.]

The line between a complete

recirculation and a supplemental

circulation of changed pages is a blurry

one. The free writing prospectus concept

introduced by Rule 433 in the 2005

securities offering reforms was intended,

we believe, to obviate the need for a full

recirculation of a completely new price

range prospectus in all but the most

extreme cases. However, when changed

pages become so pervasive that the

original price range prospectus can no

longer be said to be “the preliminary

prospectus” within the meaning of Rule

15c2-8(b), then a full recirculation may

be required. If the changes are less than

pervasive, a free writing prospectus

summarizing the changes should suffice.

The key import of this distinction

between a full recirculation of a

new price range prospectus and a

supplemental circulation of a free

writing prospectus summarizing the

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changes relates to timing. If you

have tripped the Rule 15c2-8(b) wire,

you need to give investors 48 hours

(generally thought to mean two full

business days)

to consider the revised

disclosure. If you are in free writing

prospectus land, however, you may

conclude that investors only need a

few hours (or even minutes) to digest

the new disclosure. The SEC Staff has,

to date, refrained from offering any

guidance on the question “How long is

long enough?” as it relates to delivery

of new information for purposes of Rule

159 and Section 12. The prevailing view

among law firms is that most information

can be digested upon receipt and only

very complicated changes need a full

business day to be absorbed. Somewhat

complicated changes may need more

than a few minutes to be digested but

less than a full business day.

We continue to feel that the better

view of Rule 433 and the free writing

prospectus that it ushered in is that

a properly crafted and conveyed free

writing prospectus should eliminate the

need for a full recirculation in all but the

most extreme cases.

Filing Fee Issues —

Securities Act Rules 457

and 462(b)

Rule 457

Although Rule 457 deals with the

seemingly mundane issue of the

calculation of the registration fee,

the choice you make under Rule 457

will have a significant impact on your

options at the moment of truth.

Remember that you initially filed your

registration statement with a fee table,

calculated either:

• Under Rule 457(o) on the basis of the

amount of proceeds the issuer wanted

to raise, or

• Under Rule 457(a) on the basis of the

number of shares to be sold and a

bona fide estimate of the sale price

per share.

Chances are, you opted to calculate

the registration fee for purposes of the

fee table under Rule 457(o). You could

have used Rule 457(a) instead, but since

doing so would let the market know the

likely per share price (i.e., maximum

deal size divided by the number of

shares registered), most deal teams opt

to use Rule 457(o).

It’s unusual in our

experience for a deal team to elect to

tip its hand about the expected price

per share at the time the registration

statement is first filed.

When the time comes to file your price

range prospectus, you have a choice:

either keep using Rule 457(o), or refile

your fee table under Rule 457(a).

If you choose to refile under Rule 457(a),

you will not have to pay more filing fees

if your offering price per share later

increases — that’s baked right into the

text of the Rule. You will, however, be

required to pay additional filing fees if

you later increase the number of shares

to be offered, even if the total offering

size (number of shares sold times sale

price) does not go above the original

estimate used to calculate the original

filing fee. The added shares will need to

be registered — we discuss below how

that is done.

If you stick with Rule 457(o), you will not

have to file a new registration statement

and pay additional filing fees if your per

share price goes down and you increase

the number of shares offered so as to

maintain the original aggregate offering

price. See C&DI 640.05. You will,

however, be required to pay additional

filing fees if you keep the same number

of shares and increase the per share

price (thereby increasing the aggregate

deal size).

Which route is preferable? Refiling

under Rule 457(a) allows you to increase

the price per share (but not the number

of shares) without filing an additional

registration statement. By contrast,

staying with Rule 457(o) allows you

to increase the number of shares and

decrease the price per share so as to

maintain overall deal size, without filing

an additional registration statement.

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So it all boils down to whether you

think you will be upsizing price only

(and leaving the number of shares

unchanged) or will be playing with both

price and number of shares in order to

keep the same total aggregate deal size.

Many deal teams elect to switch to Rule

457(a) at the time of printing the price

range prospectus, because increasing

the price per share at pricing is a more

likely outcome than increasing the

number of shares and decreasing the

price.

Rule 462(b)

How do you go about adding additional

shares (if you are using Rule 457(a))

or increasing the deal size (if you are

using Rule 457(o))? You will need to file

an immediately effective registration

statement under Rule 462(b).

Rule 462(b) is available if:

• You file the new registration

statement prior to the time

confirmations are sent, and

• The increase in price and share

count together represent an increase

of no more than 20 percent of the

previous maximum aggregate offering

price (as set forth in the fee table at

effectiveness).

There is a curious wrinkle to how

the 20 percent amount is calculated

for purposes of Rule 462(b), again

depending on whether you refiled your

fee table under Rule 457(a) or stayed

with Rule 457(o). If you are using Rule

457(a), you multiply the number of

additional shares by the new offering

price and then look to see whether the

increase in deal size associated with the

added shares is more or less than 20

percent of the deal size in the fee table

at effectiveness — even though that fee

table was calculated at the old price

per share. See C&DI 640.03. To take an

example, imagine that your fee table

at effectiveness reflected 11.5 million

shares and a price range of $8-$10 per

share, for a maximum aggregate deal

size of $115 million. At pricing, the

number of shares is increased by 1.5

million and the price is increased to

$12per share. The number of additional

shares times the price equals $18

million. Since this is less than 20 percent

of $115 million (i.e., $23 million), you

could use Rule 462(b) to register the

new shares. The fact that the entire

deal is actually being upsized by more

than 20 percent (since $115 million plus

20 percent equals $138 million, and

13 million shares times $12 per share

equals $156 million) is disregarded if

you are using Rule 457(a).

The calculation is done differently if

you are staying with Rule 457(o). In that

case, you multiply all of the shares being

offered (including the additional shares)

by the new price per share and then

look to see if you have increased total

deal size by more than 20 percent. See

C&DI 640.04. This makes sense, since

Rule 457(o) looks to total deal size. To

use our example above, 20 percent of

the original maximum deal size equals

$23 million. Because 13 million shares

are being offered at a new price per

share of $12, total deal size would be

$156 million, which is more than the

original deal size plus 20 percent ($115

million plus $23 million equals $138

million). As a result, you could not use

Rule 462(b) to register the additional

deal size above 20 percent.

Some Examples of How It

All Fits Together

Is your head spinning at this point? It

should be. Let’s start with the following

basic facts and then try various upsizing

and downsizing scenarios to help

illustrate how the rules work:

• Maximum aggregate deal size in

the fee table at effectiveness is $115

million

• The price range prospectus reflects a

range of $8-$10 per share, 10 million

firm commitment shares and 1.5

million greenshoe shares, for a total

of 11.5 million shares (including the

greenshoe)

• The minimum aggregate deal size

in the price range prospectus is $92

million (including the greenshoe),

while the maximum aggregate deal

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Latham & Watkins | Client Alert

size in the price range prospectus is

$115 million (including the greenshoe)

Scenario 1: At pricing, the price is

increased to $12 but the number of

shares stays the same, for a total

aggregate deal size of $138 million

(post greenshoe).

This is within Rule 430A’s safe harbor,

because the increased price per share

(from $10 to $12) when multiplied

by the number of shares (10 million

plus the 1.5 million greenshoe shares)

yields a maximum aggregate deal size

($138 million) that does not exceed

the maximum aggregate offering

size reflected in the fee table plus 20

percent ($115 million plus $23 million

equals $138 million). (You include the

greenshoe shares in these calculations,

because you need to have registered

and paid fees for all securities sold in

the offering.) You can ignore the price

range prospectus for the moment, since

the instruction to Rule 430A(a) says you

look to the maximum deal size in the

fee table to calculate the 20 percent

amount for purposes of upsizing. The

fee table will always reflect a total deal

size that is greater than or equal to the

deal size reflected in the price range

prospectus (at least if you used Rule

457(o) to compute the fee table), so you

can see why the instruction is the way

to go in an upsizing scenario — you get

to calculate the 20 percent off a bigger

base and hence get a larger increase.

Because you are within Rule 430A, the

new deal size and share price will be

deemed to be part of the Section 11 file

at the time the registration statement

became effective once the final

prospectus is filed under Rule 424(b).

The Section 12 file can be handled with

an oral statement to accounts at the

time of confirming orders to the effect

that the price is now $12 per share and

the maximum deal size is $138 million

(post greenshoe). Ideally, the price

range prospectus already disclosed

what the proceeds would be used

for if the deal raised more cash than

originally assumed, so there is no need

to elaborate on that point.

There would be no need to pay

additional fees via a Rule 462(b)

registration statement if you calculated

your filing fee for purposes of the fee

table using Rule 457(a), because the

number of shares to be sold has not

changed — this, as we pointed out

above, is the primary benefit of Rule

457(a). If you calculated your filing

fee using Rule 457(o), on the other

hand, you would need to register the

additional deal size, and this could be

done by filing a Rule 462(b) registration

statement.

Scenario 2: At pricing, the price is

increased to $14 and the number

of shares is increased to 12 million

(pre greenshoe) and 13.8 million

(including the greenshoe), for a

total aggregate deal size of $193.20

million (post greenshoe).

This is outside the Rule 430A safe

harbor, since the new total maximum

aggregate deal size ($193.20 million)

is more than 20 percent above the

maximum deal size reflected in the

fee table ($115 million plus $23 million

equals $138 million). That’s not the

end of the story, of course. Remember

that C&DI 227.03 permits you to pour

this information back into the Section

11 file at the time of effectiveness via

a Rule 424(b) prospectus even if your

deal size changes by more than the

20 percent safe harbor amount, if the

increase in deal size does not materially

change the disclosure. You might be

able to conclude that the changes

were immaterial — for example, if the

sensitivity analysis in the price range

prospectus gave investors enough

information to track the changes through

the disclosure.

The Section 12 file will also need to be

addressed. This can be done either with

an oral statement to accounts at the time

of confirming orders or by distributing a

Rule 433 free writing prospectus prior to

confirming orders to those expected to

purchase shares. The decision whether

to convey the new information orally or

in writing (via a free writing prospectus)

will depend on the complexity of the

changes.

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Latham & Watkins | Client Alert

Finally, don’t forget that you would need

to register additional shares and pay

additional fees, whether you used Rule

457(a) (since the number of shares being

registered has increased) or Rule 457(o)

(as a result of the increase in transaction

size). On our facts, if you refiled under

Rule 457(a) at the time of printing the

price range prospectus you would not

be able to register the additional shares

via an immediately effective Rule

462(b) registration statement, because

the additional number of shares (2.3

million) multiplied by the new price

per share ($14) equals $32.20 million,

which is more than 20 percent of the

maximum offering price at effectiveness

($23 million). Similarly, if you used Rule

457(o) you would have to file a new

registration statement under Rule 462(b),

since the increase in total deal size

(from $115 million to $193.20 million) is

greater than 20 percent.

Scenario 3: At pricing, the price is

decreased to $6 but the number of

shares stays the same, for a total

aggregate deal size of $69 million

(post greenshoe).

At first glance, this might appear to

be outside the Rule 430A safe harbor

since the new total maximum aggregate

deal size ($69 million) is less than

the maximum deal size reflected in

the fee table minus 20 percent ($115

million minus $23 million equals $92

million). But remember C&DI 627.01,

which allows you to focus on the price

range in the price range prospectus

rather than the amount reflected in

the fee table. Following C&DI 627.01,

you would calculate the 20 percent

threshold by using the high end of the

range (20 percent of $115 million equals

$23 million) and then deducting that

amount from the low end of the range

($92 million). This approach ($92 million

minus $23 million) lets you reduce the

deal to $69 million with the greenshoe,

and gives you maximum flexibility.

C&DI 627.01 is your best choice in

a downsizing scenario — you get to

decrease deal size beyond the level that

the instruction to Rule 430A(a) would

otherwise allow. The decreased pricing

information can be included in a Rule

424(b) prospectus and will be deemed

to be part of the Section 11 file at

effectiveness.

The Section 12 file issues may well

be more interesting in this example,

depending in part on whether the

disclosure in the price range prospectus

included sensitivity analysis explaining

what the issuer would do if the deal

got downsized to such an extent. If it

did, an oral explanation of the smaller

deal size may be sufficient to provide

investors with the missing information.

If not, particularly if the use of proceeds

will need to change, a free writing

prospectus summarizing the changes

may be advisable.

Because there is no increase in

aggregate deal size or number of shares

being offered, there is no need to pay

additional fees or file a Rule 462(b)

registration statement. In fact, the

question whether additional filing fees

are due never comes up in a downsizing

scenario.

Scenario 4: At pricing, the price

is decreased to $4 but the number

of shares is increased, for a total

aggregate deal size of $69 million

(post greenshoe).

The answer to this scenario is the

same as scenario 3, since both yield a

minimum deal size of $69 million. In

other words, the aggregate size of the

deal did not decrease by more than

20 percent (calculated using the C&DI

627.01 methodology) because of the

increase in the number of shares to

be sold. We believe that the SEC Staff

would consider this scenario to be within

Rule 430A, notwithstanding the steep

decrease in the per share price (from $8

to $4).

Some Additional Things to

Bear in Mind

Negative Assurance Letter Practice

Negative assurance letter practice

among law firms changed following the

adoption of the Securities Act reforms in

2005, particularly because of Rule 159’s

12 Number 1053 | July 14, 2010

Latham & Watkins | Client Alert

focus on the information in investors’

hands at the time of pricing. Negative

assurance letters now cover three

important items:

• The registration statement as of its

effective date, as measured against

the requirements of Section 11 of the

Securities Act

• The final prospectus, as of its date and

as of the closing date, as measured

against the requirements of Section 12

of the Securities Act, and

• The “Pricing Time Disclosure

Package” as of the time the

underwriters commence to confirm

orders, as measured against the

requirements of Section 12 of the

Securities Act.

This last bullet point was added to

address Rule 159. It requires the

negative assurance provided by the

issuer’s and the underwriters’ law firms

to speak to the collection of information

conveyed to prospective purchasers

at the time the underwriters begin to

confirm orders. The magic of Rule 430A

and its permission to go back in time to

rewrite history is critical for the negative

assurance given in the first bullet point

above, which relates to the Section 11

file, but it is of no use for purposes of the

third bullet point, which relates to the

Section 12 file.

The way to satisfy Rule 159 is to actually

convey information to accounts. In the

context of a deal that is being upsized or

downsized at the last minute, conveying

information — or even preparing the

information so that it can be conveyed

— may not be easy to do in a timely

manner. As a result, the deal team will

be under pressure to make important

materiality judgments on a real-time

basis.

FINRA Issues

IPOs are subject to FINRA Rule 5110

(sometimes referred to as the Corporate

Financing Rule). The underwriters of

your IPO will be FINRA members, and

the Corporate Financing Rule will limit

the amount of compensation they (and

other distribution participants for that

matter) may receive in connection with

the IPO. The Corporate Financing Rule

also prohibits certain practices that

FINRA has determined to be “unfair or

unreasonable” and contains filing and

disclosure requirements.

If the type of compensation going to

the underwriting group consists only

of the “spread” (i.e., the discount off

the public offering price), the upsizing

or downsizing of an IPO should not

trigger additional issues under Rule

5110. However, Rule 5110 includes

many other “items of value” received

by the underwriters around the time of

the IPO in the calculation of aggregate

underwriting compensation. If aggregate

underwriting compensation exceeds a

certain percentage of the total offering

proceeds, the underwriters may need

to obtain the FINRA “no objections”

opinion required by the SEC in order

for the registration statement to be

declared effective. A change in the size

of your deal could potentially change

the total underwriting compensation as a

percentage of deal proceeds in a manner

that would require a visit to FINRA. In

practice, that may be difficult to achieve

under the timing pressure that always

exists at the moment of truth.

FINRA Rule 2720 contains additional

requirements that apply to public

offerings in which a participating FINRA

member is deemed to have a “conflict of

interest” (i.e., an interest in the outcome

of the offering beyond its role as an

underwriter or selling group member).

The rule provides that a conflict of

interest exists whenever five percent or

more of the net offering proceeds will

be directed to a FINRA member or its

affiliates or other “related persons.”

Accordingly, if an offering is downsized,

you will need to re-assess whether the

conflict of interest provisions of Rule

2720 are triggered. Among other things,

Rule 2720 will generally require the

participation of a FINRA-approved

“qualified independent underwriter”

and inclusion of prominent disclosure

as to the nature of the conflict in the

prospectus.

13 Number 1053 | July 14, 2010

Latham & Watkins | Client Alert

NYSE/Nasdaq Issues

Both the NYSE and the Nasdaq’s listing

rules exempt “controlled companies”

— that is, companies of which more

than 50 percent of the voting power

is held by an individual, a group or

another company — from certain listing

requirements relating to corporate

governance. For example, controlled

companies are exempt from the

requirement to have a board composed

of a majority of independent directors.

When you are doing an IPO for a

controlled company, you should keep an

eye out for the potential effect of selling

more shares on the controlled company

analysis — if your deal is upsized at the

moment of truth, it’s possible that the

company will not longer be “controlled”

for purposes of this exemption.

Tying It All Together

So how does all of this fit together, you

ask? Simple, really. The underwriters

and the issuer should start the dialogue

about how the market is reacting to the

deal while the road show is progressing.

These are the types of questions that

may come up:

• Is there sufficient demand for the

stock within the suggested range?

• If not, is it possible to get a smaller

deal done within the range or may we

need to reduce the deal’s size and the

per share price?

• If the size of the deal decreases, will

the use of proceeds need to change?

• Is there sufficient excess demand that

we can increase the price to a price

that is above the top end of the range?

• Can we increase the price above the

range and increase the number of

shares being offered?

• If the deal size increases, what will

the extra proceeds be used for?

• What did we say in the price range

prospectus sent to investors about

what would happen to our use of

proceeds if the deal were to be

upsized or downsized?

It is important to get this dialogue going

long before it is time to price the deal

so the deal team can plan for every

possible outcome. Bear in mind that:

• A free writing prospectus reflecting

new disclosures may need to be

drafted and circulated to prospective

investors expected to purchase stock

in the offering before orders can be

confirmed, or a telephone script for

the conversation with those investors

may need to be prepared

• A final prospectus containing

appropriate disclosure must in any

event be drafted and filed under Rule

424(b)

• The accountants’ comfort letters may

need to change to reflect the revised

disclosure

• A Rule 462(b) registration statement

to register additional shares or

transaction size may need to be

prepared, and extra filing fees may

need to be paid

• A Rule 462(d) post-effective

amendment to add a new Exhibit 5.1

opinion covering additional shares

may need to be drafted and filed

• If there are other changes that do not

qualify as pricing information within

the meaning of Rule 430A or if Rule

430A’s 20 percent safe harbor is not

available, a post-effective amendment

to the registration statement may

need to be prepared and filed,

and the SEC Staff must declare it

effective, and

• In the most extreme cases, an entirely

new price range prospectus must

be drafted and recirculated to all

investors expecting to purchase stock

in the offering.

All these steps take time. There is no

substitute for advance planning, which

comes in two phases — before and

during/after the road show. Before the

road show, it is very handy if the price

range prospectus is drafted to include

appropriate sensitivity analysis along the

lines discussed above. Good advance

planning and carefully crafted disclosure

in the price range prospectus may make

it possible to conclude that a change

in deal size is not a material change

in the disclosure, taken as a whole.

During and after the road show, as soon

as it becomes clear that an upsizing or

downsizing is even a possibility, the

deal team should be reviewing the

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Latham & Watkins | Client Alert

options under the rules described above

and preparing revised disclosure, free

writing prospectuses, telephone scripts,

etc., as needed.

Timing is critical and there is little

margin for error. Be prepared!

Summary

This is tricky stuff. However, with

appropriate advance planning and

carefully crafted disclosure in the

price range prospectus, it is possible

to navigate the many technical

requirements and focus on the judgment

calls. What is a material change to the

disclosure depends in part on what was

disclosed in the first instance, so the

advance planning really begins at the

first drafting session. Those who are

thinking ahead to pricing from the very

beginning will have an easier time when

they get there, even if the deal changes

materially at the moment of truth.

Endnotes

Remember, though, that there are situations in

which you may conclude that filing a pre-effective

amendment is unavoidable. One example would

be where you are certain before effectiveness

that your deal is going to be dramatically

downsized or upsized: failing to refile exposes

you to the risk of tripping over Regulation S-K

Item 501(b)(3), which requires an IPO issuer

to include a “bona fide estimate” of the price

range in the preliminary prospectus it circulates

to potential investors. In the ordinary course,

you would seek to go effective at some point

prior to the close of the stock market —

2:00 p.m. Eastern time is often chosen.

Because the market has not yet closed, you

would typically not be in a position to know with

certainty that you will be pricing outside the

range set forth in the prospectus at that time.

The time of “effectiveness” is a key moment

in the IPO. Among other things, securities

cannot be sold until the registration statement

is declared effective. Rule 430A allows an IPO

to price as many as 15 business days after

effectiveness, but it is most common to price on

the day of effectiveness (which is also the time

the underwriters will begin confirming orders).

The actual closing of the transaction happens

some number of days later.

Rule 430A defines pricing information as:

information with respect to the public offering

price, underwriting syndicate (including any

material relationships between the registrant

and underwriters not named therein),

underwriting discounts or commissions,

discounts or commissions to dealers, amount

of proceeds, conversion rates, call prices and

other items dependent upon the offering price,

delivery dates, and terms of the securities

dependent upon the offering date[.]

We’re assuming that the prospectus at

effectiveness is the same price range prospectus

circulated to investors — in other words, that you

have not refiled with a different range.

Note, however, that one consequence might be

a material change to the ownership structure,

for example if the change resulted in a control

group’s retention (or loss) of control over the

company.

In other words, if prospective investors actually

have the revised preliminary prospectus in their

hands at 9:00 a.m. on Monday morning, it would

be appropriate to price on Tuesday after the

market closes.

One wrinkle in Rule 433 that could be construed

to require a full recirculation in a very limited

circumstance deserves discussion.

Rule 433(b)(2)(i) requires that an IPO issuer’s

free writing prospectus be:

accompanied or preceded by the most recent

. . . [preliminary] prospectus [on file with the

SEC]; provided, however, that use of the

free writing prospectus is not conditioned on

providing the most recent such prospectus if

a prior such prospectus has been provided

and there is no material change from the

prior prospectus reflected in the most recent

prospectus[.]

This proviso is puzzling, since in most cases

there would not be a reason to circulate a

free writing prospectus if there were nothing

material to report. We choose, therefore, to

interpret the proviso as meaning that a free

writing prospectus for an IPO issuer is only

allowed to convey material changes if the free

writing prospectus and the original preliminary

prospectus (and each other broadly distributed

free writing prospectuses, if any), taken together,

contain materially the same information as

is at the time on file with the SEC. We think

that this interpretation is more in keeping with

the overall purpose of Rule 433 — namely, to

encourage sending information to accounts on

an as-needed, real-time basis.

In any event, however, note 1 to paragraph

(b)(2)(i) of Rule 433 makes clear that this

technical issue is not a problem for a free

15 Number 1053 | July 14, 2010

Latham & Watkins | Client Alert

writing prospectus delivered by e-mail as long

as it includes a hyperlink to the most recent

preliminary prospectus on file with the SEC. As

a result of this helpful note, every free writing

prospectus to be sent by e-mail in connection

with an IPO should include such a hyperlink.

In situations where the underwriters are able

to distribute free writing prospectuses to all

accounts by e-mail, there is no need to struggle

with the interpretive issue discussed in the prior

paragraph.

There is a technical reason why it is generally

preferable to chose Rule 457(o) at the outset.

The SEC Staff informally takes the position that

if you raise your price range in a preliminary

prospectus contained in a pre-effective

amendment from the range used to calculate

the filing fee and you originally elected to

proceed under Rule 457(a), then the 20 percent

safe harbor contemplated by the instruction to

paragraph (a) of Rule 430A is calculated on the

basis of the original maximum aggregate offering

price and not the offering price range contained

in the price range prospectus distributed to

investors. This qualification can be eliminated if

you “voluntarily” pay an additional filing fee when

you increase your offering range, but doing so

defeats the primary benefit of Rule 457(a) (i.e.,

you do not need to go back to the SEC if you

increase your estimated price per share). This

SEC Staff position can be a trap for the unwary

issuer who elected to use Rule 457(a) originally

to calculate the filing fee and later seeks to

upsize. There is no such hidden problem for

users of Rule 457(o), as they are required to pay

additional filing fees at the time they upsize their

deal, and they know it.

You will also need to remember to include a

new Exhibit 5.1 opinion on the legality of the

additional securities being registered. This can

be done by means of an immediately effective

post-effective amendment under Rule 462(d).

Note, by the way, that Rule 462(b) works for

an increase in transaction size in a Rule 457(o)

deal, even though the text of Rule 462(b) speaks

only of “registering additional securities.” See

C&DI 640.04.

The “greenshoe” is jargon for the underwriters’

over-allotment option — that is, the contractual

right to purchase some number of additional

shares from the issuer after the closing of the

offering. “It is so named because it was first

used in connection with a 1963 secondary

offering of shares of common stock of The

Green Shoe Manufacturing Company, the

Boston-based manufacturer of Stride-Rite shoes

(not green shoes for leprechauns as some

have supposed).” Charles J. Johnson, Jr. and

Joseph McLaughlin, Corporate Finance and the

Securities Laws at 2-38 (4th ed. 2009).

When calculating the increase in deal size for

Rule 462(b) purposes, do not overlook the

underwriters’ overallotment option – you will

need to register a sufficient number of shares

(and pay enough fees) to cover both the primary

as well as any option shares to be sold in the

IPO.

Having said that, you would need to be

comfortable that the price range in the price

range prospectus circulated to investors (and

included in the registration statement at the time

of effectiveness) was in fact a “bona fide” price

range as required by Regulation S-K Item

501(b)(3).

Among other things, the Corporate Finance Rule

limits the greenshoe to 15 percent of the amount

of securities being offered in the IPO (excluding

the greenshoe). See FINRA Rule 5110(f)(2)(J).

16 Number 1053 | July 14, 2010

Latham & Watkins | Client Alert

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