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Strategies & Market Trends : Shorting stocks: Broken stocks - Analysis
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To: Troy Shaw who wrote (1636)8/12/1998 7:16:00 AM
From: Q.  Read Replies (1) of 2506
 
Troy, re. <<the 5% limit >>

Almost all of the Reg. D and Reg. S private placements of convertible securities that I have seen include a covenant that the fund shall at no time hold more than 4.9% of the shares outstanding. If somebody did own more than 5%, they would be required to report all their transactions to the SEC. This is a sort of attention that I'm sure they don't want. There might be some additional reason for the 5% limit, but that is the only one that I'm aware of. In any case, you will see it in almost every deal. And it's a good requirement to see if you are a short-seller, because it indicates that the fund is more interested in selling the common stock than holding it.

When a fund has convertibles whose value exceeds 5% of the market cap, it simply converts into common in globs, called 'tranches', which are smaller than 5% of the shares outstanding. It sells these shares, and then it goes back for another tranche. That way it can sell off shares amounting to >5% of shares outstanding without exceeding momentarily the 5% limit.

There is another limit you will often see, of 20% of shares outstanding. This is an exchange rule for Nasdaq, which says that a Nasdaq company can't issue enough shares to dilute by more than 20% without seeking shareholder approval. An exception is given when the NASD can be persuaded that the co. would otherwise fold immediately (and Syquest got such an exemption in 1996 with its first convertible private placement.)
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