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Compliance & Reporting
Rule 144A qualified institutional buyer rules: who qualifies and how status is verified
Under Rule 144A a seller may resell restricted securities, securities bought in a private placement that cannot be resold to the public without registration, to a qualified institutional buyer (QIB) without SEC registration and without a holding period.
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855-622-9009A QIB is an institution that owns and invests on a discretionary basis at least $100 million in securities of issuers it is not affiliated with. The measure is securities held, not total assets.
Rule 144A QIB requirements
- A qualified institutional buyer owns and invests on a discretionary basis at least $100 million in securities of unaffiliated issuers; a registered dealer qualifies at $10 million.
- A seller may rely on four methods to establish reasonable belief that a buyer is a QIB, and a different date limit applies to each.
Where the issuer does not report to the SEC, the buyer has the right to obtain, and must have received before the sale, a very brief statement of the business and the issuer’s recent financial statements.
What Rule 144A is and who can use it
Rule 144A is a safe harbor from SEC registration for resales of restricted securities to QIBs, or to buyers the seller reasonably believes are QIBs. The seller does not have to be a QIB.
The issuer cannot use the safe harbor for its own sales. In a 144A offering the issuer sells to an initial purchaser, a broker-dealer, and the initial purchaser resells to QIBs under the rule.
Since September 23, 2013 a seller may use general solicitation and advertising, provided it sells only to QIBs or to buyers it reasonably believes are QIBs.
The $100 million securities test
A QIB must own and invest on a discretionary basis at least $100 million in securities of issuers that are not affiliated with it. What counts is set out in Rule 144A(a)(2) to (a)(4):
- Excluded: bank deposit notes and certificates of deposit, loan participations, repurchase agreements, securities subject to a repurchase agreement, and currency, interest rate and commodity swaps.
- Valued at cost, unless the entity reports its holdings at market value in its financial statements and no current cost information is available.
- Included: securities held by a consolidated subsidiary whose investments the entity manages, except where that subsidiary is itself majority-owned by a company that does not report to the SEC.
Two things do not count: total assets, since only securities of unaffiliated issuers qualify; and securities the buyer holds without discretionary investment authority over them.
How a seller verifies QIB status
Under Rule 144A(d)(1) the seller may use four non-exclusive methods to establish that a buyer meets the securities test, with a date limit on each:
- The buyer’s most recent publicly available annual financial statements, dated within 16 months of the sale, or 18 months for a foreign buyer.
- The most recent publicly available information the buyer filed with the SEC, another government agency or a self-regulatory organization, within the same 16 or 18 months.
- The most recent publicly available information in a recognized securities manual, within the same 16 or 18 months.
- A certification by the buyer’s chief financial officer or another executive officer of the securities owned and invested on a discretionary basis as of a date on or since the close of the buyer’s most recent fiscal year; for a family of investment companies, an executive officer of the adviser certifies for the family.
The certification has no month limit. Its date must fall on or after the buyer’s most recent fiscal year end, so once that year has closed the seller can no longer rely on a certification dated before the year end.
What a Rule 144A transaction must include
The seller, and anyone acting for it, must sell only to a QIB or a buyer it reasonably believes is a QIB, and must take reasonable steps to make the buyer aware that the seller may be relying on Rule 144A.
The securities cannot, when issued, be of the same class as securities listed on a U.S. exchange or quoted on an automated inter-dealer quotation system, and cannot be securities of an open-end investment company, unit investment trust or face-amount certificate company registered under the Investment Company Act. The same restriction applies to convertibles, exchangeables and warrants close enough to a listed class to be treated as part of it.
The seller documents those conditions with:
- An offering memorandum
- Restrictive legends on the securities
- Transfer procedures under which it verifies the buyer’s status before each resale
Which institutions qualify as QIBs
The entity types that qualify at the $100 million test are listed in Rule 144A(a)(1):
- Insurance companies
- Registered investment companies
- Small business investment companies and rural business investment companies
- Certain employee benefit plans and certain trust funds
- Business development companies
- 501(c)(3) organizations
- Corporations, partnerships, limited liability companies, and Massachusetts or similar business trusts
- Registered investment advisers
The SEC added limited liability companies and rural business investment companies in Release 33-10824, adopted August 26, 2020 and effective December 8, 2020.
The same release added a catch-all: any institutional accredited investor of a type not otherwise listed qualifies if it meets the $100 million test, and an entity relying on the catch-all may be formed for the purpose of buying the securities on offer.
Three entity types are tested differently:
- A registered dealer qualifies with $10 million in securities of unaffiliated issuers, and securities from an unsold allotment in a public offering do not count. A registered dealer acting as riskless principal for a QIB qualifies with no dollar test.
- A bank or savings and loan association must meet the $100 million test and hold an audited net worth of at least $25 million, shown in annual financial statements dated within 16 months of the sale, or 18 months for a foreign bank.
- An investment company that belongs to a family of investment companies counts the securities owned by the whole family.
What information a buyer is entitled to under Rule 144A(d)(4)
Where the issuer neither reports under the Exchange Act, nor is exempt under Rule 12g3-2(b), nor is a foreign government eligible to register on Schedule B, the holder and any buyer the holder designates have the right to obtain from the issuer on request, and the buyer must have received at or before the sale:
- A very brief statement of the nature of the issuer’s business and the products and services it offers.
- The issuer’s most recent balance sheet, profit and loss statement and retained earnings statement, and similar statements for whichever part of the two preceding fiscal years the issuer has been in operation, audited to the extent reasonably available.
The information is presumed reasonably current when:
- the balance sheet is dated less than 16 months before the resale and the income statements are for the 12 months before it,
- where the balance sheet is six months old or more, further income statements are provided from the balance sheet date to within six months of the resale, and
- the business statement is dated within 12 months.
A foreign private issuer may instead meet the timing rules of its home country or principal trading market.
No form is prescribed for the offering memorandum’s financial statements beyond that requirement. Where the initial purchasers want a comfort letter, the memorandum has to include audited annual statements and reviewed interim statements, because those are the statements the auditor can give comfort on.
Resales of Rule 144A securities
Securities bought under Rule 144A remain restricted securities. A holder may resell them under Rule 144A to another QIB, under a registration statement, or under another exemption, including a permitted sale to a buyer who is not a QIB.
QIB status is tested at the time of each sale; a holder does not have to remain a QIB after buying. At each transfer the seller verifies the buyer’s status, the transfer agent applies the legend and its instructions, and the seller records the exemption used for the transfer.
What the auditor delivers in a Rule 144A offering
The initial purchasers in a 144A offering ask the issuer’s auditor for a comfort letter on the financial information in the offering memorandum. Two conditions apply under PCAOB AS 6101 and its AICPA counterpart, AU-C 920:
- The initial purchasers must first give the auditor a written representation that their due diligence on the offering is substantially consistent with what they would perform as underwriters in a registered offering.
- The auditor may give negative assurance on interim financial information only where it has reviewed that information under the applicable review standard. Without a review, the letter reports the procedures performed and the findings, and nothing more.
The representation exists because an initial purchaser in a 144A offering has no statutory due diligence defense under Section 11 of the Securities Act; a named underwriter in a registered offering has that defense and gives no such letter.
An issuer planning a 144A offering needs reviewed interim statements, a comfort-letter timetable agreed with the initial purchasers, and an auditor independent under the standard the letter cites.
Talk to an auditor before you price
If you are preparing a 144A offering, send us the offering timetable, the periods to be presented in the memorandum and the name of the initial purchasers’ counsel. We will tell you which figures we can give comfort on and what we need from you for the interim review before pricing.
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Reviewed by George Dimov, CPA. Dimov Audit works with issuers, dealers and institutional investors across all 50 states.
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