Not Your Father's Stock Market

Lawyers say the regulatory reforms of the Securities and Exchange Commission will make it profoundly easier to raise capital through public offerings of stocks and bonds, while facilitating more frequent and timely communications with investors.

The new rules – scheduled to take effect Dec. 1 – could mean less work for lawyers on each public offering registration with the SEC, but possibly more public registrations to do in the long run. The liberalized rules on investor communication will also create more kinds of communications to review and track for lawyers.

“There will be more work for lawyers with more things to keep track of out there, in part because you can’t just say ‘no’ to as many things under these rules,” says Todd B. Pfister of Foley & Lardner’s Chicago office.

The increased clarity of the new communications rules will also be a source of comfort to many. “They provide much needed and welcome guidance on what we can do and when we can do it,” asserts John M. Oakey III from Williams Mullen in Richmond, Va.

Historically, the SEC has maintained subjective tests for restriction of communications to the market during periods surrounding public offerings under so-called “gun-jumping” rules.

But the parameters of the gun-jumping rules have been “somewhat vague and always made outside counsel a bit nervous,” according to Andrew J. Merken of Burns & Levinson in Boston, adding that the bright lines and safe harbors for communications under the new rules will be a relief.

A streamlined offering process available to the largest public companies will also facilitate sales of securities during windows of opportunity at minimal expense.

“This is the most significant reform in the offering process since 1933 [when] Professor Louis Loss of Harvard advocated the registration of individual companies rather than individual offerings,” says Brinkley Dickerson of Troutman Sanders in Atlanta. “These rules move us closer to that system for large companies.”

Other changes that facilitate public offerings and investor communications for all companies are expected to help raise money in the marketplace while reducing the expense of public access, an important development in the wake of Sarbanes-Oxley.

“This is the biggest thing since Sarbanes, which layered on costs to being public or going public. These changes provide some relief to public companies at a time when the capital markets are not so vibrant,” adds Richard Rafferty of Strasburger & Price in Dallas.

But lawyers also caution that a few new disclosure burdens are tucked into the rules. And if the regulations are interpreted with too much license, investors could be harmed.

“We’ll have to wait and see if scam artists figure out ways to exploit the new rules or bypass the public protections of the securities laws,” Michael O’Brien in the Boston office of Bingham McCutchen cautions.

Easier Stock Offerings

Lawyers generally agree that while the rule changes facilitate increased access to capital markets for all stock issuers, the biggest companies will reap the most benefits.

The rules facilitate stock offerings by a newly recognized class of “well-known seasoned issuers” (otherwise known as WKSIs), essentially those companies with $700 million in equity value or $1 billion in outstanding debt securities.

These issuers make up roughly 30 percent of all public companies, but closer to 95 percent of the market’s value. The SEC conceded that the rules changes would add little to the flow of information generated by hordes of analysts following these large companies, according to Dickerson, who is also a teacher at the SEC Institute.

Dickerson says the new “automatic shelf registration” for WKSIs “eliminates a lot of uncertainties in the offering process.” This filing mechanism allows for immediate market access without SEC review – a process that otherwise takes 60 to 90 days if the agency has comments on offering related documents.

A WKSI could literally “file an automatic registration statement on December 1 and sell that day,” O’Brien explains.

As a result, a WKSI can hit a narrow window of market opportunity. “A given industry sector could be hot for just one or two months, and this will help large companies raise money in those time frames,” explains Pfister.

Furthermore, the filing itself is streamlined and allows for incorporation of more material by reference to other filings or supplements. “It’s a slim document with no requirement for a specified amount of securities [for immediate sale] and a simple prospectus supplement to incorporate information from [other filings],” notes Oakey.

Merken says the ability to adjust the amount of securities to be sold at any one time is an important change because of the need to make flexible adjustments in a fast changing modern market. “Historically, naming too big a number at a given time,” he explains, “could scare the market and it was hard to get it just right.”

Filing fees tied to sales were higher for prior forms of shelf registration, forcing issuers to project an amount of sales over a period of years, according to Benjamin G. Lombard of Reinhart Boerner Van Deuren in Milwaukee. “Now you can just pay as you go,” says Van Deuren, noting that issuers can put off payments of tens of thousands of dollars in fees with offerings done in stages.

Management members who want to sell certain kinds of restricted stock in shelf offerings can now decide on a selling price and number of shares later in the process, he adds, where previously attorneys had to name the shareholders and the exact selling amounts upon filing.

In fact, the new process is now so streamlined for rapid market timing that some lawyers predict it will be the underwriters – not the SEC – that will slow up an offering with legal concerns. Nothing else will slow the accelerated pace.

David D. Joswick of Michigan-based Miller Canfield says the due diligence process will be crunched into a much shorter time frame making “it more important than ever to have a large stable of experienced lawyers and other professionals at hand.” The changes will help cement relationships with counsel and bankers that are otherwise put into “beauty contests” because familiarity with a company will be so critical to speed of service, Joswick predicts.

Companies of all sizes will benefit from other changes, such as those permitting shelf registrations good for longer periods of time and larger amounts of total sales, according to O’Brien.

He adds that the SEC’s adoption of an “access equals delivery” philosophy regarding investor information will help the offering process for all. Under this model, a company will no longer need to deliver a final prospectus at or before sale if it has been filed electronically.

In the past, he says, “there were always possible snafus in delivery of the final prospectus that could allow a large investor to back out of a purchase [by rule].” In effect, that investor had a “put” that allowed them to walk away, O’Brien notes.

Dickerson observes there will be another large offering benefit from the access equals delivery change – no need to absorb printing and mailing costs for delivery of all the prospectuses. “That cost can be huge, even millions of dollars for investment banking firms,” he says, noting that financial printers will be severely impacted.

Communications to the Market

Experts say the access-equals-delivery model will facilitate more communication via the Internet, but they generally agree that the most welcome changes for lawyers come from new safe harbors from gun-jumping penalties.

Again, WKSIs benefit the most with a liberalized general exemption. “Essentially, they can say whatever whenever, just as long as they are true and accurate,” quips Dickerson.

Rafferty says this makes sense because “the market now has a river of information on bigger companies that leavens the effect of any one piece of information.”

For all companies, new rules 168 and 169 also protect publication of “regularly released” factual information, and Rule 163A creates a “bright-line” period protecting all communications more than 30 days prior to registration that do not reference an offering.

This means that lawyers are less likely to lock horns with management over “good news” releases that the SEC once viewed as “conditioning the market.”

R. Brian Ball of Williams Mullen’s Richmond, Va. office says that a new product rollout by a company more than 30 days before an offering is something that used to cause concern for lawyers and frustrations for managers. “There used to be agonizing discussions about this, but now even a careful practitioner won’t likely say you can’t do it,” he asserts.

Rafferty agrees, adding that lawyers now know when their clients can attend industry conferences to talk about their companies, a practice that was often a subject of consternation and debate in the past.

And if something does go wrong, the new rules provide possible remedies.

“There are mechanisms to fix problems in these rules,” says Joswick, pointing to the SEC intervention in the Google offering after an interview with Playboy was unexpectedly released near the offering date. Such an interview might now be saved by the filing of a “free-writing prospectus” that supplements material already on file with the SEC.

The free-writing tool can also be used to permit a mass release of pre-recorded “road shows” for investors – a technology tactic that was in doubt before now. Some say that such a tool might be used to edit and control the legality and consistency of a sales pitch for an offering company while reducing expense of mass distribution.

Michael A. Hickey in the Boston office of Kirkpatrick & Lockhart Nicholson Graham says the Google offering is a good example of one for which a free-writing might be used to facilitate pre-recorded road shows for retail brokers who sell to mass audiences. However, he says live road shows won’t disappear because “traditional institutional investors still want to see live people and ask questions. But for a retail deal sold to retail brokers a [free-writing] supplement might work.”

Fortunately, the SEC also clarified that live shows do not constitute prepared selling material that necessitates a filing or disclosure for each show.

But Rafferty suggests it will be while before underwriters get comfortable with the use of free-writing supplements. “A whole lot of people – lawyers for the underwriters, bankers, and issuers – are involved in the drafting of a prospectus, and they are not just going to allow casual use of supplements they have not approved,” he says.

Oakey agrees, adding that underwriting or dealer agreements are likely to prohibit free-writing entirely or at least condition approval on prior review until people get comfortable with the ability of issuers to use the new tools safely.

The SEC also responded to heavy inquiries about the keeping of historical information on an issuer’s website – information that could otherwise subject an issuer to liability for presenting dated material that is deceptive to investors.

While the agency clarified that information will not become an “offer” solely by virtue of being accessed on website, Hickey says that stock issuers should follow traditional tests for whether the information could be misleading to investors.

O’Brien adds that groups representing some investors were not entirely happy with the new rules, pointing, for example, to the AARP comment that Internet access is not delivery for retired investors without computers.

New Disclosure Obligations

Some new disclosure obligations could be easily overlooked, including one that will affect all public companies.

Most significantly, every company will now have to make risk-factor disclosures in their periodic Exchange Act reports as well as their offering registrations.

Ball adds that this has been an area of focus for the SEC, predicting that the new rules will lead to “beefing up” of risk-factor analyses used in the past. “You can’t just put out some boilerplate about industry risks,” he warns.

Dickerson suggests that “you should be able to read the risk factors and actually know who the issuer is.” He adds that forward-looking statements should already be conditioned with very cautionary language under the 1995 Reform Act.

Practitioners also agree that specific risks related to litigation, accounting matters, environmental exposures or other regulatory risks must be assessed carefully.

But Rafferty suggests that this greater emphasis on risk-factor discussion will only help in-house counsel who often tangle with management over how to characterize risks.

“The CEOs and CFOs are optimists, and specific risks are often included at the behest of the general counsel. This will help them in risk-factor debates,” he explains.

And for those companies that have received comments from SEC staff on their Exchange Act reports, there is now a rule that requires disclosure of those comments in annual reports.

Hickey says this gives the SEC a very strong lever in disagreements with companies over accounting treatments or financial disclosures.

Dickerson adds that “it is hard to see how companies could thumb their noses at the SEC over differences in accounting theory [with this disclosure requirement]. Their audit committees would have heart failure now.”

As if that were not enough to make issuers bend to the SEC’s view, there is another strong force at work now, according to O’Brien.

“Management does not want to make differences with the SEC public – it is the kind of stuff that is fodder for plaintiffs’ class-action attorneys,” he warns.

Questions or comments can be directed to the publisher at [email protected]. John Cunningham is a freelance writer who practiced law for 16 years, serving as general counsel for a publicly held restaurant company and a news editor for Lawyers Weekly publications.