SEC Issues Interpretive Guidance on Rule 144(d) Holding Period for Securities Exchanged in an UP-C Structure | Practical Law

SEC Issues Interpretive Guidance on Rule 144(d) Holding Period for Securities Exchanged in an UP-C Structure | Practical Law

The SEC's Division of Corporation Finance issued interpretive guidance on the application of the Rule 144 holding period under the Securities Act to shares of a publicly traded C-corporation that the holder received in exchange for interests in an umbrella tax partnership in connection with an "UP-C" structure.

SEC Issues Interpretive Guidance on Rule 144(d) Holding Period for Securities Exchanged in an UP-C Structure

by Practical Law Corporate & Securities
Published on 15 Nov 2016 • USA (National/Federal)
The SEC's Division of Corporation Finance issued interpretive guidance on the application of the Rule 144 holding period under the Securities Act to shares of a publicly traded C-corporation that the holder received in exchange for interests in an umbrella tax partnership in connection with an "UP-C" structure.
On November 1, 2016, the SEC's Division of Corporation Finance (Division) issued interpretive guidance on the application of the Rule 144 holding period under the Securities Act to shares of a publicly traded C-corporation that the holder received in exchange for interests in an umbrella tax partnership in a common transaction for pre-IPO owners of companies that employ an Umbrella Partnership – C-corporation (UP-C) structure. The Division's guidance came in response to a request from attorneys at Simpson Thacher & Bartlett LLP, Paul, Weiss, Rifkind, Wharton & Garrison LLP, and Latham & Watkins LLP.
The UP-C structure is designed to preserve more favorable pass-through tax treatment for pre-IPO owners of a business. An UP-C structure allows certain pre-IPO owners of a business to continue to own their economic interests in a pass-through entity, typically a limited partnership or limited liability company, following an IPO instead of converting the pass-through entity to a C-corporation before closing the IPO. Following the IPO, the pass-through entity, which directly or indirectly owns and operates the company's assets, is itself owned by:
  • A newly formed, publicly traded C-corporation.
  • The pre-IPO owners of the pass-through entity, who may be founders, investors, management, or other equity holders.
In an UP-C structure, a newly formed C-corporation that has no material assets or operations conducts an IPO by selling stock to the public. This new publicly traded holding company then uses the proceeds of the offering to purchase partnership interests in an existing operating pass-through entity that is treated as a partnership for US federal income tax purposes (the Operating Partnership). The publicly traded C-corporation typically has two classes of stock:
  • Class A common stock entitling the holder to voting and economic rights, which is the class of shares the public purchases in the IPO.
  • Class B common stock entitling the holder to voting rights but no economic rights, which is the class of shares the pre-IPO owners of the Operating Partnership receive.
The Class B common stock has voting rights but no economic rights because the pre-IPO investors continue to receive their economic interests in the business through their direct ownership interest in the Operating Partnership. The pre-IPO owners' interests in the Operating Partnership, together with their shares of the holding company's Class B common stock, can be exchanged for the holding company's Class A common stock on a proportional basis, which is generally only done when a pre-IPO owner wishes to sell some or all of its interests in the company.
Until now, the publicly traded holding companies (the C-corporations) in these UP-C structures have typically registered the issuance of Class A common stock to exchanging pre-IPO owners (or their resale of Class A common stock) in order to avoid subjecting these pre-IPO owners to a new holding period under Rule 144. The registration process for these transactions, according to the attorneys' letter, involved significant time and expense.
The attorneys' letter requested the Division's interpretive guidance on the start of the Rule 144 holding period for shares exchanged in an UP-C structure with the following characteristics:
  • All of the company assets are owned directly or indirectly by the Operating Partnership.
  • The Operating Partnership (directly or through its subsidiaries) is the entity through which the publicly traded C-corporation operates its business.
  • The publicly traded C-Corporation owns interests in the Operating Partnership, which are the only material assets of the corporation, and the corporation serves as the general partner, managing member, or functional equivalent of the Operating Partnership (directly or indirectly).
  • Owners of the Operating Partnership hold interests that were acquired in unregistered offerings, and the interests are restricted securities for purposes of Rule 144.
  • Interests in the Operating Partnership are exchangeable for corporation shares in a manner that maintains economic parity between corporation shares and partnership interests (such as a 1:1 unit to share ratio).
  • Partnership units represent the same right to the same proportional interest in the same underlying pool of assets.
  • The corporation shares are registered under Section 12 of the Exchange Act and are publicly traded on a national securities exchange.
  • There is no public market for interests in the Operating Partnership, which are restricted securities under Rule 144 and which are also frequently subject to contractual restrictions on transferability.
  • The exchange of Operating Partnership interests for corporation shares is contemplated by, and the terms are provided for, in the original UP-C governing documents.
  • Pre-IPO owners who exchange their interests in the Operating Partnership for corporation shares are not required to pay any additional consideration for the corporation shares.
The Division's response clarifies that, under the facts described in the request, the Rule 144(d)(1) holding period for the corporation shares acquired in exchange for the interests in the Operating Partnership would begin on the acquisition of the interests in the Operating Partnership, not on the acquisition of the corporation shares received at the time of the exchange. The response stated that, in reaching this conclusion, the Division noted in particular the representations that:
  • The pre-IPO owners paid the full purchase price for the interests in the Operating Partnership at the time they were acquired from the Operating Partnership.
  • The UP-C governing documents contemplate and provide the terms for the exchange of interests in the Operating Partnership for corporation shares such that the pre-IPO owners have the same economic risk as if they were holders of the corporation shares during the entire period they hold the interests in the Operating Partnership.
  • No additional consideration is paid by the pre-IPO owners for the corporation shares.
The Division's response also states that any different facts or conditions might require the Division to reach a different conclusion.
For information on the use of the UP-C structure in connection with private equity sponsor-backed IPOs, see Article, Recent Trends in IPOs of Private Equity Sponsor-Backed US Companies.