Electronic auction system for partnership interests will be qualified matching service
Electronic auction system for partnership interests will be qualified matching service
October 10, 2018
In a private letter ruling (PLR), IRS has determined that a platform operated by a corporation, which will match potential buyers and sellers of partnership interests through non-public online listings at non-firm prices, will be a qualified matching service and will not be an “established securities market” under Reg § 1.7704-1(b). The fact that a partnership’s interests are listed for purchase or sale on the platform won’t cause the partnership to be treated as “publicly traded” under Code Sec. 7704.
Background. Under Code Sec. 7704(a), a publicly traded partnership is treated as a corporation. A publicly traded partnership includes any partnership, the interests of which are either traded on an “established securities market” or are readily tradable on a secondary market or the substantial equivalent thereof. (Code Sec. 7704(b))
An “established securities market” includes national securities exchanges either registered under the Securities Exchange Act of ’34 (’34 Act) or exempt from registration thereunder, foreign securities exchanges subject to similar requirements, any regional or local exchange, and an interdealer quotation system that regularly disseminates firm buy or sell quotations by identified brokers or dealers by electronic means or otherwise. (Reg § 1.7704-1(b))
Partnership interests are considered “readily tradable on a secondary market” if certain requirements are met, including if such interests are regularly quoted by any person (e.g., a broker or dealer), and bid or offer quotes are made available to the public by any person ready to effect purchases or sales at the quoted prices for itself or on behalf of others.
However, under a safe harbor in Reg § 1.7704-1(g)(1), certain transfers of partnership interests are disregarded in determining whether the partnership is readily tradable on a secondary market or the substantial equivalent thereof, including the transfer of a partnership interest through a “qualified matching service.”
Matching services may be provided by (i) the general partner of the partnership, (ii) the underwriter that handled the issuance of the partnership interests, or (iii) an unrelated third party. (Reg § 1.7704-1(g)(4))
Under Reg § 1.7704-1(g)(2), a matching service is a “qualified matching service” if the following requirements are met:
(1) the matching service consists of a computerized or printed listing system that lists customer’s bid and/or ask prices in order to match partners who want to dispose of their interests in a partnership with persons who want to buy those interests;
(2) matching occurs either by matching the list of interested buyers with the list of interested sellers or through a bid and ask process that allows interested buyers to bid on the listed interest;
(3) the selling partner cannot enter into a binding agreement to sell the interest until the 15th calendar day after the date information regarding the offering of the interest for sale is made available to potential buyers (available date);
(4) the closing of the sale cannot occur before the 45th calendar day after the available date;
(5) the matching service displays only quotes that do not commit any person to buy or sell partnership interests at the quoted price or quotes that express interest in a partnership interest without an accompanying price, and does not display quotes at which any person is committed to buy or sell a partnership interest at the quoted price;
(6) the listing customer’s information is removed from the matching service within 120 calendar days after the available date and, following any removal (other than by reason of a sale of any part of such interest), no interest in the partnership is entered into the matching service by the listing customer for at least 60 calendar days; and
(7) the sum of the percentage interests in partnership capital and profits represented by partnership interests that are sold or otherwise disposed of, other than in transfers not involving trading, during the tax year of the partnership does not exceed 10% of the total interest in partnership capital and profits.
Facts. Corporation X and its subsidiaries (collectively X) propose to create and operate an auction platform (Platform) that will provide limited and infrequent opportunities to buy and sell third party partnership interests. X intends to structure the Platform to satisfy the qualified matching service requirements set out in Reg § 1.7704-1(g).
The Platform will be an electronic system that periodically conducts auctions via a password protected internet-accessible application. The general public will not be able to access the Platform or view any information regarding auctions and partnership interests available on the Platform. Instead, access to the Platform will only be available to certain accredited investors who have been granted access to the Platform as potential buyers (Potential Buyers), those partners who have indicated an intent to sell their partnership interests as explained below (Potential Sellers), and broker-dealers, financial advisors, or similar representatives, acting on their own behalf or on behalf of the participants they represent (collectively, including Potential Buyers and Potential Sellers, Potential Participants).
X will receive an indication of interest from a partner or partners to sell limited partnership interests. Information on the offering of the interest or interests for sale will be posted on the Platform and made available to Potential Participants, including the quantity of each interest offered for sale and the current financial information regarding the partnerships whose interests will be offered on the date of the posting (the Announcement Date). Thereafter, a bid and ask process will begin (the Auction Period) in which Potential Buyers will be permitted to submit indications of interest to buy the partnership interests, including quantity and price, as well as to revise and/or rescind such non-firm quotes.
During the Auction Period, Potential Sellers will also be permitted to revise and/or rescind their indications of interest to sell, including adding a limit price to their indications of interest. Only Potential Sellers who submitted an indication of interest prior to the Announcement Date will be permitted to participate in the Auction Period, and only up to the quantity of interest they initially indicated they wished to sell. During this Auction Period, the Platform may make available an anonymized range of such non-firm quotes of Potential Buyers and/or Potential Sellers, and X will collect information from Potential Participants, including contracts and other documentation necessary to process the transactions.
On a date not earlier than 15 days after the Announcement Date, the Platform will close the Auction Period and match the buyers’ and sellers’ quotes. Only at this time will the Potential Buyers’ and Potential Sellers’ quotes become binding (if they are able to be matched). In no circumstances will a Potential Seller be able to enter into a binding agreement (i.e., complete a successful auction) with respect to the sale of the interest until the 15th calendar day after the Announcement Date.
In general, the Platform will pair Potential Sellers and Potential Buyers using an order-matching algorithm or methodology, although other pricing mechanisms may also be used in certain circumstances. X may also work with partnerships’ administrators, Potential Participants’ administrators, transfer agents and custodians to assist in the completion of all necessary back office activities.
Proceeds will be released to sellers on a date (the Closing Date) no earlier than 45 days after the Announcement Date. X (or a third-party firm) will act as paying agent for Potential Buyers in the context of the transfer of purchase proceeds and will hold the purchaser’s proceeds in escrow for a period of time prior to the Closing Date. X represents that no loan, advance, or other acceleration of payment to a seller will be made prior to the Closing Date. X will receive a commission for its services, which will be deducted from the escrowed funds upon the Closing Date. If no trade is executed within 120 calendar days after the Announcement Date, then the auction with respect to the interests will be cancelled and the Potential Seller’s information removed from the Platform.
The Potential Seller will not be permitted to put its interest on the Platform for 60 calendar days after its removal. X will maintain contemporaneous records to document the Announcement Date and compliance with the 15-day and 45-day periods. The Platform will monitor the transfers it makes with respect to each partnership such that the sum of percentage interests in partnership capital or profits transferred on the Platform during a tax year of a partnership does not exceed 10% of the total interests in partnership capital or profits.
Representations. X represents that the Platform will not be:
(a) a national securities exchange registered under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f) (the ’34 Act);
(b) a national securities exchange exempt from registration under section 6 of the ’34 Act because of the limited volume of transactions;
(c) a foreign securities exchange that, under the law of the jurisdiction where it is organized, satisfies regulatory requirements that are analogous to the regulatory requirements under the ’34 Act;
(d) a regional or local exchange; or
(e) an interdealer quotation system that regularly disseminates firm buy or sell quotations by identified brokers or dealers by electronic means or otherwise.
PLR’s conclusions. In the PLR, IRS ruled that:
(1) The Platform will not be an established securities market under Reg § 1.7704-1(b);
(2) The Platform will meet the requirements to be a qualified matching service under Reg § 1.7704-1(g); and
(3) A partnership whose interests are displayed or offered for purchase or sale on the Platform will not be considered to be publicly traded solely by reason of being offered for purchase or sale and/or sold through the Platform and may rely on this ruling provided:
… it is not revoked,
… that the sum of the partnership interests transferred during the tax year of the partnership (other than through private transfers described in Reg § 1.7704-1(e)) does not exceed 10% of the total interests in partnership capital or profits determined as provided in Reg § 1.7704-1(k), and
… the Platform continues to operate in a manner consistent with the facts as represented.
IRS added that maintenance of information required to permit a partnership to make the calculations, and the actual making of the calculations, relating to qualification for any applicable safe harbor in Reg § 1.7704-1 will be the sole responsibility of the partnerships whose interests are traded and not the responsibility of X.