Staff Says Zero Cost Collar on UP-C Stock Underlying OP Units Doesn’t Violate Short Sale Rule

Yesterday Corp Fin issued an interpretive letter expressing the view that insiders of UPREITs and similar tax-structured UP-C’s who own units in the operating partnership won’t violate Section 16(c) if they hedge their OP units by entering into zero cost collars covering the underlying Up-C stock.

As discussed in our Model Form 29, OP units generally are convertible into the parent UP-C’s common stock on a one-for-one basis. OP units are otherwise illiquid, though, so investment banks generally aren’t willing to enter into hedging arrangements relating to OP units, although they are willing to hedge the publicly traded UP-C stock. That creates a potential problem for UP-C insiders who want to hedge their OP units by hedging the underlying UP-C stock, because Rule 16c-4 provides that entering into a put-equivalent derivative security is a sale of the underlying security for purposes of Section 16(c), and the staff generally takes the position that securities underlying a derivative security are not “owned” for purposes of Section 16(c).

The staff’s new interpretive letter, issued to BAML, allows insiders to enter into zero cost collars relating to UP-C stock underlying OP units, where the strike price of the bank’s call option is at or above the market price, and the strike price of the insider’s put option is below the market price. The staff’s position is that an insider is considered to “own” the UP-C stock underlying OP Units for purposes of Section 16(c) and Rule 16c-4.

The staff’s letter is consistent with its position in Credit Suisse First Boston (Mar. 18, 2004).