Knobias ClipReport (8-10-2007)

Submitted from Knobias ClipReport

The world of private placements has historically been a dark place with the landscape littered with performance crazed firms and capital-searching companies being a main ingredient in their diet. Companies looking for money and time frequently enlisted the help of these brokers and institutional investors to finance their operations and execute business plans to allow them to become self sustaining.

On the other hand, investors have also become prey to companies with little hope for the future, whether known or not, that received funding eventually paid out to management for little or no return for the fund or institutions.

The reasoning has caused an influx of 144A deals over the past few years where companies would receive the financing and the assurance that share prices of registered shares wouldn’t be affected. The lack of a secondary market became an obstacle for many institutional investors to accept these types of illiquid securities.

In its simplest term, companies need money and institutional investors need liquidity, less risk, and return... Enter NASDAQ Stock Market Inc. (NDAQ).

The equity exchange recently announced that the SEC has approved their new centralized system for 144A securities. The fully automated platform, which is an outgrowth of NASDAQ’s 17 year old system, is the first electronic system for accessing and displaying 144A issue trading and quotation. It will effectively create a secondary market for qualified institutional buyers (QIBs) and qualified brokers to facilitate and execute trading in these unregistered securities.

The system will bring transparency and liquidity to what has been at times very dark. It will allow institutions to also value their portfolios in real time. “In the past, 144’s owners would have to set up meetings with other QIB’s to liquidate all or parts of their positions. They would also have to contact other QIB’s and brokers to gauge the value of their shares for mark to market calculations. This new system allows for that to happen electronically,” noted NASDAQ Executive Vice President John Jacobs.

But NASDAQ isn’t the only firm that saw the need for a new system. Merrill Lynch, Lehman Brothers, Morgan Stanley, and Citigroup are developing an electronic trading platform for this type of unregistered shares.

Goldman Sachs also recently developed their own system, GSTrUE, which was catered to Oaktree Capital and subsequently used for Apollo Management to trade their unregistered shares.

But NASDAQ doesn’t feel that the other systems will be in competition with the PORTAL. “Our platform is neutral,” noted Jacobs. “We expect all firms to participate in the PORTAL; hence it’s a different model. We don’t see them as competition but rather as a complimentary product.”

A perceived problem of the expanded liquidity and trading expected in PORTAL was the fact that after a private company reaches 500 investors, they are forced to becoming a fully public, reporting entity under the Securities Exchange Act of 1934. The fear of being forced to become public was a reason for companies considering this type of funding to be wary and choose other alternatives.

“Not so,” says Jacobs. “This has become an unwarranted fear. No one has been able to point to a single 144A company that has been forced to register because they triggered the 500 shareholder test in the 17 year history of 144A.”

To reassure the companies participating, PORTAL will also institute shareholder tracking. “The Bank of New York in collaboration with the DTC will institute a shareholder tracking system to be implemented into the PORTAL for shares that need tracking,” said Jacobs. “But of the many deals we’ve done through July, none have asked for shareholder tracking.”

To become a QIB, institutions must manage at least $100 million in assets. To become a qualified broker, $10 million in non affiliate securities must be managed. To reach 500 investors and be forced to become public, a 144A would have to become divided between enough QIBs and brokers to make up the difference between company founders and management and the 500 threshold. It’s just not a very likely scenario.

In any event, with the advent of this electronic private placement market, companies considering a traditional IPO should have an attractive new option to gain simpler and less expensive access to the capital they need. “We feel this could be a new step for companies in their trek to become public. We envision companies beginning their life cycles as private, PORTAL, and then public on NASDAQ,” noted Jacobs.

The becoming public part could also be another reason for the development of the PORTAL system. NASDAQ will have an upper hand of sorts to list companies that are reaching the stage where they want or need to become public. It’s also another revenue stream for the equity index in the form of subscription fees paid for the right to trade in the PORTAL and also application fees to list the 144A’s, though there will not be any per share fee for trades.

“We may have a subscription fee, and small application fees. We don’t want to hinder the number of deals at all,” says Jacobs.

With the number of deals done by NASDAQ growing and the percentage of total deals in equity growing from 5% historically to 15% this year, the aspect of adding a composite or subindex could allow for retail to gain entry into this market down the road. But until that time, providing the liquidity and transparency in an otherwise dark market is enough of a service for the time being. “The market needed it and that’s why we built it. It’s going to be a good thing for all involved,” finished Jacobs. With the history of private placements, many are sure to agree.


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