Structured Thoughts - Volume 7, Issue 2 February 10, 2016

Is There a Standard Form of Rule 144A Representation Letter?

My file of Rule 144A representation letters has been growing fatter, and I'm not sure why.

I would have hoped that by now there would be just one great form that I could point to, and recycle the rest of them. After all, it should be kind of simple - investor represents to broker-dealer that it's a QIB. The broker-dealer files the letter in a safe spot, and the purchase price for the securities is wired. (Maybe there's also a closing dinner?)

So, why are so many forms floating around?

Aside from many lawyers' natural instinct to add text and make comments, there are a variety of reasons why some letters differ from one another.

Additional Legal Qualifications. The representation letter may need to cover more ground than just QIB status. For example, the relevant securities that are being offered may be limited to "qualified purchasers" under the 1940 Act, "eligible contract participants" for commodities purposes, etc.

FINRA Suitability Rules. By selling to an "institutional account" that is exercising independent judgment, a broker-dealer may have fewer obligations under FINRA's suitability rules. For example, the broker-dealer may be selling to a registered investment adviser that is exercising investment discretion for one of its customers. The broker-dealer may wish to have the investor acknowledge this, in order to help document and record the broker-dealer's process in making the sale.

Are You Sure You Know What You're Doing? A key notion behind Rule 144A is that QIBs are more likely to understand what they are buying. Still, in the event of a complex transaction, the broker-dealer may often want to memorialize this point. Similarly, in the case of a reverse inquiry transaction, it may be worthwhile to note that the terms were proposed by the investor, and not the issuer. In the case of an offering of a structured product with a complex underlier, such as the

broker-dealer's own proprietary index, the broker-dealer would often like the investor to acknowledge that it understands that underlier, and that it had all the information it needed about the index prior to making an investment decision.

Legal Obligations of the Investor. The investor, especially if it operates in a regulated industry, may be subject to a variety of legal and contractual obligations that may impact its ability to invest in different types of instruments. Accordingly, the broker-dealer may ask the investor to represent that it has done its homework, and confirm that the investment is permissible for it under the circumstances.

Long-Term Relationship? The representation letter may be intended to last for a long time, and cover many years of offerings, as opposed to a single discrete offering. The broker may want the investor to have a "duty to update" the representations in the letter if its QIB (or other) status ever changes.

Feeling Conflicted. In connection with a variety of transactions, the broker-dealer or its affiliates may wear multiple hats, and may (quite lawfully) have multiple interests. For example, the broker-dealer's research division may have expressed a rating or recommendation as to an underlying asset that is the opposite of the view underlying a structured note. The broker-dealer may wish to memorialize the fact that the investor fully understood the situation, in order to avoid future claims from being made to the contrary.

Informational Advantages. A broker-dealer, somewhere in its organization, may have material non-public information relating to the relevant issuer, or the relevant underlying asset. Notwithstanding the existence of appropriate ethical walls, the broker-dealer may wish to have the investor record the fact that it was aware of this possibility.

Resale Restrictions. The offered security may be subject to a variety of resale restrictions under applicable securities, investment company, commodity or other laws. Violation of these transfer restrictions could, in some cases, involve the issuer or the broker-dealer in legal proceedings that they would obviously prefer to avoid. Accordingly, the letter may explicitly restate these restrictions, and/or obligate the investor to properly observe them.

ERISA Concerns. The broker-dealer and the issuer wish to avoid any implication that they are acting as a fiduciary to an investor that is subject to ERISA. Accordingly, they may wish to have the investor represent that it is not an employee benefit plan that is subject to ERISA.

Who Can Rely? The broker-dealer selling the instrument may have good reason to be looking out for the welfare of parties other than itself. Accordingly, the representation letter may include third party beneficiary provisions that entitle the issuer of the security and potentially other parties to rely on the representations that are set forth in the letter.

Issuer Representations and Frequent Issuers

Introduction

In the prior article, we discussed the representations that sophisticated investors may provide to broker-dealers in connection with securities offerings. We now turn our attention to the representations made by the issuers.

For most structured note programs, whether offered on a registered basis or a non-registered basis, the issuer makes a variety of representations about its business, finances and the offering documents. These are typically set forth in a program agreement or similar agreement with the distributors. These representations may be quite lengthy and detailed, or in the case of many seasoned issuers, may be more limited.

This program agreement is executed at the commencement of the program, while the actual offerings may take place over a period of years. Accordingly, how do the...