Goodwin Insights April 16, 2019

Developments in the Use of “At-the-Market” Offering Programs by REITs

“At-the-market”, or ATM, offering programs provide public real estate investment trusts (“REITs”) and other issuers an efficient means of raising capital over time by allowing a company to tap into the existing trading market for its shares on an as-and-when-needed basis. Under a typical ATM offering program, a listed company incrementally sells newly issued shares on the exchange through a designated broker-dealer at prevailing market prices, rather than via a traditional underwritten offering at a fixed price. See our alert “At The Market Offerings: Raising Equity Capital in Volatile Markets” for a general description of how ATM offering programs work and a discussion of attendant securities law and other considerations.

In recent years, public REITs from across all sectors have been among the most active users of the ATM model as a low-cost, flexible supplement to more traditional capital raising activities. At the beginning of 2019, at least 115 public REITs had ATM programs in place, covering the sale of nearly $40 billion of new equity securities. During the fourth quarter of 2018, thirty-five equity REITs tapped their ATM programs, raising more than $2.8 billion.[1] Issuances by REITs under ATM programs have corresponded with a relative decline in the frequency of underwritten equity offerings.

In this alert, we discuss unique aspects and recent developments in the uses and structures of REIT ATM programs, including:

  • sales immediately following earnings announcements;
  • sales during insider trading blackout periods;
  • timing of reporting significant ATM issuances;
  • effecting block trades and bought deals under ATM programs;
  • incorporation of forward sales within ATM programs; and
  • expansion of ATM programs for use with preferred stock.

Sales Immediately Following Earnings Announcements

Some issuers wait several days or more between announcing earnings and filing the corresponding periodic report (i.e., Quarterly Report on Form 10-Q or Annual Report on Form 10-K), and this window can sometimes be a uniquely favorable time to access the market (for example, if an issuer reports strong earnings that result in an immediate rise in its stock price). From the issuer’s perspective, a blanket ATM lockout during this window could therefore represent a meaningful opportunity cost. Conversely, from the sales agents’ perspective, the issuer will have announced material new information in the form of earnings but the information will not yet have been incorporated by reference into the ATM offering prospectus (since earnings releases are only “furnished” to the SEC, not filed) and the sales agents and their advisers will not have had the opportunity to perform any due diligence on the new information. 

While some ATM sales agreements restrict sales under the ATM program during this period entirely, others allow them after an interim diligence “bringdown” has been satisfactorily completed. The requirements associated with this interim bringdown can vary among ATM sales agreements. Some agreements will permit ATM sales in the period between the earnings announcement and the filing of the corresponding periodic report so long as the company assures the sales agents that the to-be filed report will not contain any “surprises” for investors, i.e., no meaningful discrepancies from, or additions to, the overall information conveyed in the earnings release. The form of this assurance varies from informal CFO assurance over the phone to more formal written certifications. Often, an interim bringdown will require delivery by the issuer of various legal deliverables and potentially the filing of a Current Report on Form 8-K with “flash” results from the earnings release under Item 8.01, which would be “filed” and thus incorporated by reference into the ATM prospectus. This information can be filed within the same Form 8-K that contains the regular quarterly furnishing of the earnings release. REITs negotiating new ATM sales agreements should consider the incremental cost and potential liability associated with interim bringdowns, particularly where the period between earnings and filing of the corresponding periodic report is expected to be more than just a few days. 

Sales During Insider Trading Blackout Periods

While issuers and executing broker-dealers often do not use any special selling efforts in connection with ATM sales, the antifraud provisions of the federal securities laws apply to ATM sales in the same manner as to traditional underwritten offerings. Thus, an issuer cannot sell any shares under an ATM program while in possession of material nonpublic information (“MNPI”) or where the previously filed prospectus otherwise now contains a material misstatement or omission. Indeed, ATM sales agreements include express prohibitions on placing of orders or effecting sales at times when the issuer is in possession of MPNI or the prospectus otherwise contains a material misstatement or omission. Some agreements are even more restrictive and provide that an issuer may not deliver any sales orders to the broker-dealer at a time when insiders would not be permitted to sell shares under the company’s own insider trading policy (i.e., around the end of fiscal quarters and when other blackout periods are in effect). In recent years, however, numerous REIT ATM issuers have successfully resisted inclusion of this blanket restriction. After all, traditional underwritten offerings can and commonly do occur in the first weeks following a quarter end, even if company insiders would typically be blacked out during that period. The determination of whether an issuer is in possession of MNPI and whether the prospectus contains a material misstatement or omission is a facts-and-circumstances analysis that must be made in connection with any proposed sales, irrespective of particular dates and windows that may be prescribed in an insider trading policy. Thus, the same way an issuer would be restricted from effecting sales under its ATM program even if the insider trading window is open if it were in possession of MNPI, an issuer that finds itself inside a trading blackout under its insider trading policy but is in fact not in possession of MNPI and the prospectus does not contain a material misstatement or omission should arguably not be restricted from effecting such sales. In other words, it is the possession or non-possession of MNPI and whether the prospectus contains a material misstatement or omission that should be the determining factors, not the particular date on the calendar.

Timing of Reporting Sales

Sales of a significant number of shares under an ATM program in a given quarter (incrementally and/or through block trades or bought deals) that lead to a discernable increase in the number of shares outstanding at the end of the quarter may result in short-term earnings or FFO dilution per share. Because sales under an ATM program are generally not required to be disclosed until the filing of the issuer’s periodic report covering the relevant quarter, investors and market analysts often are not able to accurately factor in the effect of ATM sales on FFO and other estimates in real time. This could have the unintended consequence of an issuer missing consensus estimates solely or in part due to significant but undisclosed quarterly sales under an ATM program. As noted below with respect to significant block trades or bought deals effected under an ATM program, issuers should consider when the aggregate level of activity under an ATM program may warrant public disclosure sooner than the next occurring quarterly report. 

Block Trades and Bought Deals under ATM Programs

Traditional ATM programs are often referred to as “dribble-out” programs since they typically provide for incremental sales of a relatively small number of shares at a time. In recent years, however, we have seen an uptick in uses of ATM programs to conduct larger one-off block trades[2] that are negotiated and executed between identified parties rather than anonymously over the exchange. Likewise, a growing number of sales agreements specifically provide for direct sales to the sales agents, acting as principals, in one-off trades akin to bought deals. These block trades and bought deals are often initiated on a reverse inquiry basis from the buy-side or the sales agents.

To be sure, any issuer with an effective shelf registration statement with sufficient remaining capacity can also effect a block trade or bought deal at any time outside an ATM program. Moreover, if the issuer is a well-known seasoned issuer (WKSI), as are many REITs, a new shelf registration statement registering an unlimited number of securities can be filed and deemed automatically effective at any time (as can a post-effective amendment to an existing shelf), including immediately prior to effecting a block trade or bought deal. Nevertheless, issuers may prefer to conduct block trades or bought deals within an existing ATM program for several reasons, including pre-empting potential negative market reaction that sometimes accompanies standalone trades, and fast and cost-efficient execution since the sales agents are likely current on diligence and legal deliverables. Because block trades and bought deals differ from incremental dribble-out sales under ATM programs from both a mechanical and regulatory perspective, an issuer must consider several additional factors before and after effecting any such trades or deals:

Sales Agreement. As an initial matter, before effecting a block trade or bought deal under an ATM program, the issuer and the sales agents must confirm that the sales agreement governing the ATM program provides for the ability to do this type of trade or deal. Many sales agreements reference possible block trades or bought deals but provide little further detail on terms or mechanics, and some do not contemplate block trades or bought deals at all. In most instances, this can be easily remedied by executing a brief amendment to the sales agreement that explicitly provides for effecting one-off larger trades under the ATM program and outlines the applicable mechanics and procedures. For example, some sales agents might insist on a full diligence “bringdown” and typical legal deliverables before taking principal risk in a bought deal. This determination can, however, turn on how large a contemplated trade is or how long has passed since the last periodic diligence bringdown.

Prospectus Supplement. The “Plan of Distribution” section in a typical ATM program prospectus supplement will describe the issuer’s ability to periodically sell limited amounts of stock into the market at at-the-market prices during the life of the program. Often, the disclosure also includes a statement to the effect that sales may also be made in privately negotiated transactions to or through a market maker other than on an exchange. Nevertheless, where a proposed block trade or bought deal is sufficiently large relative to the overall size of the ATM program, is priced at a significant enough discount to market, or otherwise involves non-ordinary facts and circumstances, additional disclosure might be warranted. In such instances, a brief supplement to the initial prospectus supplement should be filed under Rule 424(b) disclosing the details of the block trade or bought deal and updating the “Plan of Distribution” and other sections of the prospectus supplement as necessary. Assuming the availability of an effective shelf registration statement, the filing of a prospectus supplement can be done in real time without prior SEC review or other delay. Alternatively, the issuer can convey the information to the market by means of a Form 8-K filing, which would be automatically incorporated by reference into the ATM registration statement and prospectus.

NYSE Regulation. As described above, a block trade or a bought deal can facilitate the sale of a large number of shares in an “off-market” transaction, which is de facto negotiated and effected privately rather than over the principal trading exchange. Absent disclosure, the identity of the buyer will generally not be known to the market. As a result, the New York Stock Exchange (“NYSE”) has expressed concern about the possibility of using ATM programs to sidestep NYSE shareholder approval requirements for certain stock issuance transaction.

Specifically, Section 312.03 of the NYSE Listed Company Manual provides, in relevant part, that shareholder approval is required prior to the issuance of common stock (or securities convertible into or exercisable for common stock):

  • to a director, officer or substantial shareholder of a listed company, or to their affiliates, if the number of shares to be issued exceeds either 1.0% of the outstanding shares of common stock or 1.0% of the outstanding voting power prior the issuance;
  • if the securities issued will equal or exceed 20% of the outstanding shares of common stock, by number or vote; or
  • if the issuance will result in a change of control.

For issuances to substantial shareholders and for issuances in excess of 20%, Section 312.03 provides certain exceptions to the shareholder approval rule, including any public offering for cash and issuances of common stock for cash at a price at least as great as the “Minimum Price” (defined by the NYSE as the lower of the last closing price or the average closing price for the preceding five trading days). Sales under an ATM program in brokers’ transactions over the facilities of the NYSE will generally satisfy the public-offering-for-cash exception under Section 312.03. In the NYSE’s view, however, large block trades or bought deals made “off-market” typically would not satisfy the public-offering-for-cash exception, even if ostensibly executed under an existing ATM program. Accordingly, if the cash price in an ATM block trade subject to Section 312.03 was not at least as great as the Minimum Price, the shareholder approval requirement under the Section could be violated.

To ensure that issuers do not use block trades or bought deals under an ATM program to bypass its shareholder approval rules, the NYSE now requires each listed company submitting a supplemental listing application for an ATM program to accompany its application with a “312.03 Confirmation Letter” from an authorized officer representing to the NYSE, among others, that the issuer understands that sales under the ATM program that are not “at-the-market” are subject to the applicable shareholder approval rules of Section 312.03. 

The NYSE considers any two or more sales made in transactions that are not “at-the-market” to be a series of related transactions and therefore aggregated for the purposes of Section 312.03.

Forward Sales within ATM Programs

A relatively recent addition to ATM programs is the inclusion of a forward sale election. As of March 31, 2019, we counted over 25 REIT ATM programs that currently include this feature. 

Forward Stock Offerings. Forward stock offerings have been in use for some time. Essentially, a forward sale permits an issuer to lock in today’s price for its securities, while not actually issuing any shares until a future date of its choosing. For example, if an issuer believes that its current market price represents a favorable cost of capital, then the issuer — whether or not it currently needs capital —could enter into a contract with a dealer pursuant to which the issuer agrees to sell, and the dealer agrees to purchase, a fixed number of shares at a fixed price at any time during the term of the contract (typically 6-12 months from the trade date). In a traditional (non-ATM) forward stock offering, the issuer notifies the dealer, known in this capacity as the “forward purchaser”, of its desire to enter into a forward contract and the desired number of shares to be covered by the contract. The forward purchaser then borrows the same number of shares from one or more stock lenders and it or one of its affiliates proceeds to sell the shares into the market in an underwritten public offering, in reliance upon the issuer’s effective registration statement and relevant prospectus supplement.[3] The issuer does not immediately receive any proceeds from the public offering, all of which are retained by the forward purchaser. At any time during the term of the contract, presumably at a time when the issuer has need for capital, it would have the right to take these securities “off the shelf” by exercising its settlement election to sell all or part of the shares to the forward purchaser at the agreed forward price. At settlement, the issuer delivers the newly issued shares to the forward purchaser, who then returns them to its securities lender(s) to close out its short position.

The forward price is set initially at the price to the public in the public offering, less underwriting discounts. During the life of the trade, the initial forward price will (i) increase each day by a financing rate (usually the overnight bank funding rate or the fed funds opening rate), minus a spread, to reflect interest being earned by the forward purchaser on the process of its short sale, and (ii) decrease by the per share amount of any ordinary dividends paid by the issuer on the common stock, to reflect the fact that the forward purchaser must pass through those dividends to its stock lender(s).  The forward price is also subject to adjustment for certain corporate actions, such as extraordinary dividends or spin-offs.

Forwards Stock Offerings with ATM Execution. In recent years, a number of public REITs have established ATM programs that include the ability to sell shares on a forward basis. When using this feature, instead of selling newly issued company shares into the market, the ATM sales agent will borrow existing shares and sell them short into the market, but do so for the account of the designated forward purchaser (typically a derivatives dealer affiliate of the sales agent). Unlike a traditional forward offering, the period during which the sales agent executes the short sales is not a single day but a number of days as instructed by the issuer. The initial forward price will be based on the volume weighted average price per share of the daily sales during the designated execution period.

As described above, forward stock offerings can benefit REITs seeking to lock-in favorable costs of equity capital. However, adding a forward feature to a new or existing ATM may prove not to be useful or practical for all REITs, particular in instances where limited stock borrow makes opening the initial short position too expensive or otherwise uneconomical. Moreover, given the securities law and accounting considerations (described below), forward contracts for use within an ATM program must be carefully constructed. Counsel must ensure that the REIT’s disclosure and offering documents contemplating a forward ATM are adequate and its auditors and accounts must ensure proper accounting treatment for the forward contract.

Cash Settlement or Net Share Settlement. While most issuer share forward transactions are ultimately full physically settled, meaning that the REIT will issue the full number of shares underlying the contract in exchange for the agreed forward price per share, the forward contract will also typically provide the REIT the right to elect cash settlement or net-share settlement for all or part of the trade. In cash settlement, the party out-of-the-money pays the cash value of the position to the other party rather than exchanging any shares. For example, if the market price at settlement is higher than the forward price, then the REIT would pay a cash amount to the forward purchaser equal to the difference per share between the market and forward price. If the market price is lower than the forward price, then the forward purchaser would pay this cash amount to the REIT. Under net-share settlement, the counterparty that owes value to the other party under the forward will deliver a number of shares with a current value equal to cash amount that would have been payable under a cash settlement. To the extent the REIT elects cash or net-share settlement, the forward purchaser will close out its hedge position by purchasing a corresponding number of REIT shares in the open market and use those shares to close out its short position by returning the shares to its stock lender(s).[4] Because the dealer’s covering purchases may be deemed to be caused by the REIT’s election to cash or net-share settle, the REIT must deliver a representation to the dealer that it is not in possession of material nonpublic information on the date of its cash or net-share settlement election and make other representations commonly required to establish the affirmative defense provided by Rule 10b5-1 under the Exchange Act.

We note that the tax treatment of any cash settlement payment received by a REIT may be unclear for purposes of the gross income tests applicable to REITs. Accordingly, REITs would be well advised to elect cash settlement under a forward contract only if the REIT first determines that it can satisfy the gross income requirements even if the cash settlement payment is treated as non-qualifying income.

Accounting Considerations. For accounting purposes generally, ATM forward contracts are not marked-to-market under FAS 133 because the forward contract is a freestanding derivative indexed solely to the company’s own stock. If appropriately structured, the forward contract will be classified as equity under ASC 815 and, when the company issues the stock on settlement date (the date the company receives the cash and delivers the shares to the forward purchaser), the company records the common stock at its fair value.

For purposes of calculating earnings per share, issuers with outstanding forward contracts will generally seek to use the treasury stock method, pursuant to which the share count used in calculating earnings per share is increased to account for outstanding equity derivatives only to the extent the derivatives would, on a current mark-to-market basis, entitle their holders to purchase shares from the company at price below the current market price. So at times when the company is “out of the money” on the forward, meaning that the market price exceeds the forward price, then the outstanding share count is increased to the extent (but only to the extent) of mark-to-market gain (i.e., the excess of the number of shares that would be issued to the counterparty upon full physical settlement over the number of shares that could be purchased in the open market using the proceeds receivable upon full physical settlement).

Preferred Stock ATM Programs

A growing number of public REITs, particularly mortgage REITs, have expanded their use of ATM programs to include opportunistic selling of preferred equity securities, either in conjunction with a common stock ATM program or independently. While the mechanics of selling preferred stock through an ATM program are substantially similar to selling common stock, there are a few items to consider with respect to preferred stock programs:

Listed Series. An ATM program by definition is a means of selling newly-issued securities into the pre-existing trading market for that same class of securities. Accordingly, sales of preferred stock under an ATM program can only be effected if the issuer has previously made an offering of the same series of preferred stock and (either simultaneously or subsequently) registered the outstanding shares and effected their listing on a national securities exchange.

Rate and Terms. Unlike common stock, where the cost and terms of raising new equity capital are fairly straightforward, preferred stock comes in many flavors and varieties (e.g., cumulative, perpetual, redeemable and/or convertible), has a fixed liquidation preference and generally pays a fixed dividend for the life of the security. A dividend rate or, for example, conversion or redemption terms that were set at the time the series was first offered to investors months or years in the past may not be acceptable to the REIT in the context of securities to be sold today. However, since as above, sales under an ATM can only be of the same series of a preferred stock listed on a national exchange, the original rate and terms are fixed for the duration of the program. 

Selling at a Premium or Discount. Nevertheless, much like the purchase and sale of any security in the secondary market, sales by an issuer of preferred securities under an ATM program will be made at or near the prevailing market price, i.e., often at either a discount or premium, as the market adjusts for changes in dividend yield, perceived credit risk and other factors. (Indeed, there have been numerous traditional underwritten follow-on offerings of an existing class of preferred stock by REITs in recent years that priced at either a discount or premium.) Accordingly, so long as the current market price is within a reasonable range of the stated liquidation preference, there should not be a problem with selling new shares of an existing class of preferred stock into the market through an ATM program.[5]

If yield expectations, the REIT’s credit profile or other factors have changed meaningfully since the original issue of the relevant series of preferred, then a sale of new shares of the series through the ATM program may be more problematic — not necessarily as a strict securities law or other regulatory matter, but as a business proposition for both the issuer and sales agent. There may be good reasons, for example, for why an issuer would not want to be seen as selling its own securities at a steep discount, notwithstanding any changes in the marketplace. There may also be instances where even if a preferred stock is trading at a premium but there is a company redemption election at the stated liquidation preference that will become available in the near term, an issuer or sales agent would not want to be seen as redeeming securities at a price less than that at which it recently sold them through the ATM program.

Perhaps in an effort to solve for these concerns, we have seen instances where REIT issuers have conducted a relatively small initial public offering of a new series of preferred stock, containing a fixed dividend rate, liquidation preference and other terms presumably currently acceptable to the REIT, followed closely by the filing of an ATM program registering a much larger amount of the same series for future sale. The smaller front-end offering lowers the risk of a failed offering and establishes a market, and the follow-up ATM program permits the REIT to continue to access this market subject to demand and other market conditions.

Corporate associates Elena Hera and Matthew Schoenfeld contributed to the writing of this article.

[1] By property sector, single-tenant REITs raised the most capital ($870.4 million) during the quarter, followed by healthcare REITs ($630.2 million).

[2] Although the term is not defined under the securities laws, Rule 10b-18 under the Securities Exchange Act of 1934, as amended, refers to a “block” as a quantity of shares with a purchase price of $200,000 or more or a quantity of shares of at least 5,000 with a purchase price of at least $50,000.

[3] The forward purchaser’s hedge sales under the issuer’s registration statement, and subsequent return of shares obtained from the issuer to the forward purchaser’s stock lender(s), is addressed in the SEC’s “Goldman II” no-action letter dated October 9, 2003.

[4] Since the dealer’s covering purchases could be deemed to be caused by the REIT’s election to cash or net-share settle the forward, the dealer’s purchases should be structured as if Rule 10b-18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), was applicable.

[5] We note that issuers contemplating selling shares of their own preferred stock at a premium to its stated liquidation preference should consult with their tax advisors to ensure that the transaction does not give rise to concerns under the “fast-pay stock” rules in Treasury Regulations section 1.7701(l)-3.