New England Biz Law Update
On July 19, in an encyclopedic 468-page “Release,” the Securities and Exchange Commission rewrote the rule book for the sale of securities. The SEC action is consistent with its original proposal in November 2004.
The new regulatory scheme takes effect Dec. 1. The SEC has issued transition guidance for pending offerings at www.sec.gov/divisions/corpfin/transitionfaq.htm.
Initial Principles
We are riding on a sea change in the regulatory landscape. Certain long-standing touchstones of SEC enforcement have been abandoned.
For example, reliance on paper is a thing of the past. The regulatory scheme assumes electronic access to SEC, company and underwriter electronic portals. The final, paper copy of the prospectus will be an historical anomaly.
Also, bigger is better. The SEC has afforded the biggest companies the most latitude. As the Release points out, the SEC finds more reporting problems with smaller companies (notwithstanding that the governance failures that brought us the Sarbanes-Oxley Act occurred among very large companies).
The most important regulatory event for an issuer is not the issuance of securities, but the maintenance of accurate public information. It ought to be easy, the SEC now concedes, to issue securities if the investing marketplace possesses all material data.
Reporting under the Securities Exchange Act of 1934, for decades a secondary exercise, for larger companies now replaces emphasis on disclosure incident to the issuance of securities under the Securities Act of 1933.
Lots of additional information, available electronically or in meetings or in hard copy, even during the period in which securities are being offered, is now a good thing. “Free writing,” additional disclosure materials coincident with a securities offering, is now permitted, rather than being treated as anathema.
Changes in ’34 Act Reporting
A sharpened understanding of the reforms begins by analysis of the seemingly modest changes to ’34 Act.
The Release requires inclusion of risk factors in annual reports on Form 10-K. Present practice is inconsistent as inclusion is not specifically mandated. Material changes to risk factors must be contained in quarterly reports on Form 10-Q. Finally, SEC comments on prior ’34 Act disclosure, which were raised more than 180 days before year-end and which remain unresolved upon the due date of Form 10-K, must be specifically disclosed.
The theory of the Release is that ’34 Act reporting must be materially correct at all times. The issuance of new securities ought to follow as a matter of course. These changes to ’34 Act reporting set the table for liberalize securities offerings.
Over the last few years, and particularly as a result of Sarbanes-Oxley, the scope and timeliness of ’34 Act reports have been tightened. These last tweaks ensure that somebody reading an issuer’s ’34 Act reports, and indeed only those reports, nonetheless as a practical matter would possess all material information.
The Favored Players
Excluding a tier of non-players (penny stocks, non-reporting companies, companies not in ’34 Act compliance), the world has been classified into “well known seasoned issuers” (WKSIs; get used to the acronym), “seasoned issuers” and “reporting issuers that are not seasoned issuers.”
WKSIs are issuers with over $700 million of publicly held float (or issuers of more than $1 billion of public debt within the last three years). The Release states that they represent between 25 percent and 30 percent of all publicly traded companies.
Seasoned issuers are generally those companies eligible to issue securities on Form S-3 (compliant with ’34 Act reporting and with a public float of at least $75 million).
Unseasoned issuers are everyone else not on the prohibited list that are required to file under the ’34 Act.
Free Writing
Except in the case of IPOs, all issuers (WKSIs, seasoned and unseasoned) are now permitted to disclose historical company information and forward-looking information, of a type and in a manner consistent with past disclosure practices, without “jumping the gun” before the registration statement is filed, and without publishing an unauthorized “prospectus” after the registration statement is filed.
Any issuer can release any information it wants, more than 30 days prior to the filing of a registration statement, provided such information does not mention the offering and the issuer does not redistribute within that period.
Startlingly, WKSIs (which are presumed as a practical matter to have accurate information in the marketplace at all times) can make offers of securities, even prior to filing any registration statement, on condition that there be a registration statement on file prior to actual sale.
After a registration statement is filed, any WKSI, as well as any seasoned and any unseasoned issuer, can generate any other written material that it wishes, provided such free writing contains a legend and is thereafter promptly filed with the SEC. For non-reporting and unseasoned issuers, such free writing must be accompanied by or preceded by a prospectus (remember, again, that for WKSI’ no prospectus is required).
There is interpretative overlay to permissible content of free writing.
Even though free writing must be filed with the SEC, that filing does not make the free writing part of the registration statement.
However, free writing cannot conflict with the registration statement. To avoid the risk that differing articulations constitute inconsistencies, the practice may develop that free writings will be added to the registration statement.
How will underwriters apply due diligence procedures to free writing? What will be the role of professional advisers such as attorneys and accountants? In order to control information, will underwriters decline to use the free writing option except in circumstances where specific technical information is intended to be conveyed?
What are the ground rules for free writing content?
In August, 2005, at a dialog held in Chicago, Alan Beller (director of the SEC’s Division of Corporate Finance) said that Regulation S-K (which defines disclosure content) would not be applicable, but Regulation G (limiting non-GAAP financials) will be applied.
The Release provides that a prerecorded road show, while a free writing, need not be filed, and that a real time road show (even if telecast) is an oral exercise and not a free writing prospectus.
Since an investor will be deemed to receive disclosure only of such matters actually in his possession prior to making the purchase, it is likely that underwriters also will convey the contents of post-filing amendments by electronic delivery; underwriters may collect e-mail addresses at road shows.
Rule 134, which permits a so-called “tombstone” advertisement disclosing the pendency of an offering, has been expanded to provide information about the securities being offered and the plan of distribution. This expansion is consistent with acceptance of “free writing.”
Special Rules for IPOs
An IPO issuer shares with unseasoned, seasoned and WKSI issuers the right to publish factual business information (but not forward-looking information) as it has done in the past. However, no free writing prospectus is permitted unless preceded or accompanied by a statutory prospectus (which means that there will be no free writing in an IPO unless there is a price range specified in the filing).
This requirement can be mediated by the inclusion in the free writing of an electronic hyper-link to the statutory prospectus. Prerecorded IPO road shows must be filed with the SEC unless made electronically available.
Liberalized Offerings
Historically either not permitted or tightly regulated by the SEC, a “shelf offering” is a registration statement covering securities that are not to be offered immediately, but rather are to be “placed on the shelf” for future sale. Many substantial limitations on the shelf offering process are swept away by the Release.
For seasoned issuers (unseasoned issuers remain ineligible) a new shelf registration must be filed every three years. A requirement that a shelf is limited to securities reasonably expected to be sold within the next two years is eliminated.
A shelf registrant may take down some of the shares immediately (the SEC had not permitted immediate take down because, by definition, the securities being sold were not “on the shelf”).
Material amendments to the S-3, including changes in the plan of distribution or the identification of new sellers, now may be provided by an immediately effective “supplement,” or by incorporation by reference from a 㽪 Act filing.
The contents of the original “base” prospectus, filed with the registration statement, have been reduced under new Rule 430B.
A shelf registration for a seasoned issuer still is subject to SEC review. The Release provides that if a new shelf is filed within the three-year period, the prior shelf may be utilized for an additional six months to assure continuous offerings while the new filing is reviewed.
But the big bonanza here is handed to the WKSIs. They are entitled to an “automatic shelf registration,” which is effective upon filing without review.
It can be filed without specifying the securities covered, the number of shares, the aggregate offering price, and (since the provisions of Rule 430B require so little information in an automatic shelf registration) the filing might be no more than two pages long.
The automatic shelf registration could cover securities which already have been broadly offered, as WKSIs are entitled to free-write at any time, including pre-filing.
If a WKSI wishes, at take-down it can specify the type of security, the number of shares, and the name of the seller. The applicable fee can be paid at that time.
This means there is no such thing as a traditional registration statement for a well-known seasoned issuer. You can free-write before or after, you can offer before, you can file two pages with the SEC, it’s immediately effective, and whenever you sell you give the SEC notice and a check for the filing fee.
Rule 144A offerings also may be absorbed with this new process. Continuous offering of securities based upon ’34 Act filings has arrived, at least for the top 30 percent of U.S. companies.
WKSIs (and seasoned issuers) can continue to file regular-way S-3s, for identified offerings for identified sellers. If there is some reason that a WKSI would want to delay the effectiveness of a registration statement, it can file its S-3 and have the S-3 processed and reviewed.
What about the unseasoned issuer? Aside from permitting free writing, the SEC has amended Form S-1 (typically utilized by unseasoned issuers) to permit liberalized incorporation of ’34 Act filings. This modest advance can be understood as a step toward the integration of reporting under the ’34 Act with the ’34 Act process.
Will automatic shelf registration be expanded beyond WKSIs, as many commentators had suggested? The Release directs the SEC staff “to undertake a study in three years after the full implementation of the rules as to the operation of the definition of well-known seasoned issuers” to consider the matter.
At-The-Market Offerings
Current practice requires that at-the-market equity offerings under a shelf be effected through an underwriter identified in the registration statement. This requirement has been eliminated in light of the level of information available to investors through “enhanced Exchange Act reporting.”
The Release also discontinues amount limitations which protected the integrity of the trading markets.
PIPEs
The Release addresses the interface between shelf practice and the explosion of PIPEs (the sale of private equity which is subsequently registered by the issuer).
Since a WKSI can file an automatic shelf registration statement which permits the subsequent identification of sellers, securities and amounts, the shelf can be utilized to cover the PIPE shares.
If you are a seasoned issuer but not a WKSI, you can identify selling security holders by supplement rather than by amendment, after the effectiveness of a shelf registration, only if all of the following elements are satisfied: The registration statement identifies the initial offering in which the securities were sold; the initial offering is completed; and the securities are issued prior to the initial filing.
This requirement prohibits a seasoned issuer from using a shelf to register both the shares of traditional PIPEs (in which the shares are not issued until the registration process is complete), and of most nontraditional PIPEs (where the stock is issued and thereafter registered).
What’s Next?
It seems inevitable that WKSIs will file automatic shelf registration statements, and that there will be a proliferation of free writing, as well as an expansion of risk factor filings under the ’34 Act that will fall in line with ’34 Act practice.
In the next few years, the population of public companies may change. Unless the study of the impact of Sarbanes-Oxley, now being conducted by the SEC’s Advisory Committee on Smaller Public Companies, results in relief from the cost of compliance, more companies may privatize and fewer companies may undertake an IPO.
Beyond that, as the SEC speculates, the market will sort it all out. The SEC will monitor the market and, three years from now, will determine whether the continuous offering option which has been handed to 30 percent of registrants will be expanded to include S-3 eligible companies, or to include all but IPO issuers.
If weaker companies are driven from the public landscape by Sarbanes-Oxley, by tightened shell company rules (also enacted this June by the SEC), and by the costs of enhanced governance requirements, perhaps the SEC ultimately will be induced to expand automatic shelf registration to all issuers.
But as for now, there is no doubt about it: Bigger is better.
Stephen M. Honig is a member of Duane Morris’ corporate department in the firm’s Boston office. You can reach him at [email protected]. Additional information on the new rules affecting the sale of securities can be found at www.duanemorris.com/alerts/alert1962.html.
