Similar to cheap stock issues, the SEC continues to focus on the conversion price embedded in convertible preferred stock and debt securities issued within one year of an IPO. Occasionally, a company will issue convertible securities within a short period before an IPO with a conversion price below the expected IPO price. The SEC staff believes this issue to be a valuation issue similar to the issue of cheap stock, and it has approached it in a similar manner.
 
In some cases, the SEC staff has required the IPO price be used as the market price of its common stock in measuring the beneficial conversion feature (BCF). Convertible securities issued within one year prior to the filing of an initial registration statement with a conversion price below the initial offering price are presumed to contain an embedded BCF. To overcome this presumption, a registrant should provide sufficient, objective, and verifiable evidence to support its assertion that the accounting conversion price represented fair value at the issuance (commitment) date. If the SEC determines that there is a BCF, the “in the money” portion would be reduced from the net income available to common shareholders, lowering earnings per share.
 
With the introduction of guidance on determining fair values, significant focus has been placed on the appropriateness of the fair value assigned to the underlying stock in connection with such transactions. Judgment is required when determining the fair values for securities that are not actively traded. As a result, third-party valuation specialists are often employed to determine the fair values of such securities.