What Is SEC Staff Legal Bulletin No. 4 (SLB 4)?

A corporate spin-off is a method for a parent company to separate a subsidiary, creating a new, independent entity. This process involves distributing the subsidiary’s shares to the parent company’s existing shareholders, raising the question of whether the distribution constitutes a “sale” under the Securities Act of 1933. If deemed a sale, the shares must be registered with the Securities and Exchange Commission (SEC), a complex and costly process.

To provide clarity, the SEC’s Division of Corporation Finance issued Staff Legal Bulletin No. 4 (SLB 4). This bulletin, while not a formal rule, represents the staff’s views on how a company can conduct a spin-off without triggering registration requirements. It provides a non-exclusive safe harbor, outlining five conditions that, if met, allow the distribution to proceed without registration.

SLB 4 addresses the concern that a spin-off could be used to create a public market for a company’s shares without providing investors with the information required in a registered offering. By adhering to the bulletin, a parent company demonstrates that the transaction is a legitimate corporate reorganization, not a disguised public offering. This allows for a more efficient separation of business lines.

Core Conditions for Exemption

Valid Business Purpose

The spin-off must have a valid business purpose, as simply wanting to create a public market for the subsidiary’s stock is not sufficient. The purpose must be genuine and aimed at improving the parent or subsidiary’s operations or strategic position. Acceptable purposes include separating business lines to enhance management focus, allowing each entity to develop its own strategy, or improving access to capital.

Other valid reasons involve creating distinct equity-based incentive programs, resolving a conflict of interest, or unlocking shareholder value by allowing the market to value each business independently. The parent company’s management and board must determine and document this purpose, as it forms the rationale for the transaction.

Pro Rata Distribution

The distribution of the subsidiary’s shares to the parent company’s shareholders must be done on a pro rata basis. This means each shareholder receives a proportionate number of shares in the new company based on their ownership percentage in the parent company. For instance, if a shareholder owns 1% of the parent’s stock, they must receive 1% of the subsidiary’s shares being distributed.

This condition is linked to the concept of “value” in securities law. Because shareholders are not paying any new consideration for the shares and are receiving them based on their existing ownership, the distribution is viewed more like a dividend than a sale. If shareholders were required to exchange parent company shares or pay cash, the transaction would be considered a sale.

Shareholder Information

The parent company must provide its shareholders with adequate information about the spin-off transaction and the subsidiary. This information must be sent to shareholders before the spin-off occurs, allowing them to be informed about the new company they will own. The goal is to prevent a public market from forming without necessary public disclosures about the subsidiary’s business and financial condition.

The information provided must be robust. The SEC staff has specified that the disclosure should be similar in quality and scope to what would be required in a proxy statement under Regulation 14A or an information statement under Regulation 14C of the Securities Exchange Act of 1934.

Parent Company Reporting Status

To rely on the SLB 4 safe harbor, the parent company must be a reporting company under the Securities Exchange Act of 1934. This means the company is already obligated to file regular reports with the SEC, such as Form 10-K annual reports and Form 10-Q quarterly reports. The parent company must also be current in all its reporting obligations at the time of the spin-off.

This requirement helps ensure that the market is not being introduced to a completely unknown entity. Because the parent is a reporting company, investors have access to its financial history and other disclosures. This existing public information provides a context for understanding the spin-off and the business being separated.

Information Statement Requirements

To satisfy the shareholder information condition, a company must prepare and disseminate a comprehensive information statement. Although a spin-off often does not require a shareholder vote, the disclosure must be substantially equivalent to the information required by Regulation 14A or 14C. This document serves as the primary source of information about the subsidiary, ensuring transparency for shareholders and the future market for the subsidiary’s stock.

The statement must include:

• Audited financial statements for the subsidiary prepared in accordance with Generally Accepted Accounting Principles (GAAP). This includes two years of balance sheets and three years of statements of income, cash flows, and changes in equity.
• Pro forma financial statements presenting how the subsidiary might have looked financially if it had been an independent company, showing adjustments for items like corporate overhead costs.
• A detailed narrative section, Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), providing management’s perspective on financial results, trends, and uncertainties affecting the business.
• A thorough description of the subsidiary’s business, its properties, and the industry in which it operates, providing narrative context to the financial data.
• An outline of the risk factors specific to the subsidiary’s business and its status as a newly independent company, such as reliance on major customers or competition.
• Information on the individuals who will serve as the new directors and executive officers, including their business experience and compensation arrangements.
• Details on the post-spin-off security ownership structure, showing how many shares will be held by directors, officers, and major shareholders.

Achieving Public Company Status and Tradability

Meeting the conditions of SLB 4 allows a company to distribute subsidiary shares without registering them under the Securities Act of 1933. However, this does not automatically make the subsidiary a public reporting company or its shares tradable. A separate, distinct process must be followed to accomplish this.

The first step is registering the subsidiary’s class of securities under the Securities Exchange Act of 1934. This is done by filing a registration statement on Form 10 with the SEC. The informational content of the Form 10 is extensive and largely mirrors the details provided in the information statement. Once the Form 10 becomes effective, the subsidiary is a mandatory SEC reporting company.

The act of filing the Form 10 and becoming a reporting company does not on its own create a trading market. For the shares to be quoted on an over-the-counter (OTC) market, a broker-dealer must initiate a quotation. This process is governed by SEC Rule 15c2-11, which is designed to prevent fraudulent or manipulative practices in the quotation of securities.

Before a broker-dealer can initiate a quote, it must conduct due diligence on the new company by reviewing the information in its Form 10. After completing its review, the broker-dealer must file a Form 211 with the Financial Industry Regulatory Authority (FINRA). Only after FINRA approves the Form 211 can the broker-dealer begin publishing quotes, allowing the shares to be publicly traded.

Treatment of Spun-Off Shares

The status of the shares received by shareholders in a spin-off depends on their relationship with the newly independent company. For shareholders who are not considered affiliates, the shares they receive are unrestricted. This means the securities are not subject to any holding period or other resale limitations under federal securities laws.

These non-affiliate shareholders can freely sell their shares in the public market as soon as trading begins. The SEC’s view is that because sufficient current information about the new company is available to the public, there is no need to restrict the resale of shares held by ordinary investors. This liquidity is a benefit for shareholders.

In contrast, shareholders who are classified as affiliates of the new company receive shares that are considered “restricted securities.” An affiliate is a person who controls the issuer, which includes directors, executive officers, and shareholders who own a significant portion of the company’s stock, often considered to be 10% or more.

These individuals are subject to the resale provisions of SEC Rule 144. While the typical holding period for restricted securities does not apply to shares received in a registered spin-off, other limitations do. Affiliates are subject to volume limitations, restricting them from selling more than 1% of the outstanding shares of the company in any three-month period. Sales must also be conducted as ordinary brokerage transactions, and a notice of the proposed sale must be filed with the SEC on Form 144.