SEC Adopts Major Securities Offering Reform
The SEC recently approved final rules that significantly modify the registration, communications and offering processes under the Securities Act of 1933, as amended. The new rules will be effective December 1, 2005. The most significant changes include:
- Four New Issuer Classifications, including one for "well-known seasoned issuers" (WKSIs) that will benefit from the most significant reforms;
- Communications Reforms that codify prior SEC guidance and practice regarding gun-jumping prohibitions and the use of "free writing prospectuses";
- Shelf Registration Reforms that create more flexibility in the shelf registration process, particularly with respect to WKSIs; and
- Liability Reforms that modify and clarify certain aspects of offering participants' liability under the Securities Act. The new rules also create additional disclosure requirements. The SEC is expected to issue guidance on transitional issues related to the new rules prior to their effectiveness.
This Update highlights the key elements of the new rules and offers practical guidance.
Four New Issuer Classifications
The new rules provide companies with varying degrees of flexibility in conducting securities offerings depending on their membership in one of four primary categories based on their reporting history under the Securities Exchange Act of 1934, as amended, and equity market capitalization or fixed income issuance history.
Well-Known Seasoned Issuers (WKSIs). WKSIs generally must:
- meet the eligibility requirements of Form S-3 (including being current and timely in Exchange Act reports for at least one year);
- have either $700 million of worldwide public equity float or have issued an aggregate of $1 billion of non-convertible securities, other than common equity, in registered primary offerings for cash (excluding exchange offers), in the prior three years; and
- not be an "ineligible issuer" (as discussed below).
As discussed below, WKSIs qualify for a variety of simplified securities registration procedures. Generally, a company will determine annually whether it is a WKSI.
Seasoned Issuers. Seasoned issuers are Exchange Act reporting companies that are eligible to use Form S-3 for primary offerings of securities.
Unseasoned Issuers. Unseasoned issuers are Exchange Act reporting companies that are not "seasoned" issuers.
Non-Reporting Issuers. Non-reporting issuers are companies not required to file Exchange Act reports (regardless of whether they file those reports voluntarily).
Some Issuers Ineligible Under New Rules
Ineligible issuers will not be permitted to avail themselves of many of the benefits of the new rules, including the benefits of being a WKSI. Ineligible issuers generally include:
- Exchange Act reporting companies that have not been current in their filing obligations during the prior 12 months;
- blank check companies, shell companies or penny stock issuers;
- limited partnerships offering and selling securities other than through a firm commitment underwriting; and
- companies that have filed for bankruptcy, have been the subject of refusal or stop orders or violated the antifraud provisions of the federal securities laws within the prior three years.
In addition, investment companies and business development companies are not covered by many of the new rules, as they are subject to separate regulatory frameworks.
The term "gun-jumping" refers to impermissible publicity during the pre-filing or waiting period, including any offers prior to the filing of a registration statement. The new rules revise the gun-jumping provisions of federal securities laws and eliminate certain barriers to open communications relating to securities offerings, with the most liberal treatment afforded in descending order to WKSIs, seasoned issuers and unseasoned and non-reporting issuers.
Bright-Line, 30-Day Rule. Under the new rules, all companies (with limited exceptions) may communicate freely up to 30 days prior to filing a registration statement for a public offering without risk of violating gun-jumping provisions, as long as the communications do not refer to the securities offering. Any communication made in reliance on this bright-line exclusion must be made "by or on behalf of the issuer," meaning that an agent or representative of the company authorizes the release or dissemination of the communication before it is made; an underwriter or other offering participants cannot use the rule. Companies must also take reasonable steps to prevent the information from being republished or redistributed during the 30-day pre-filing period in order to qualify for the safe harbor.
Permitted Pre-Filing Offers for WKSIs. The new rules will permit WKSIs to engage in unrestricted oral and written offers at any time before the filing of a registration statement (including the 30-day, pre-filing period) without risk of violating the gun-jumping provisions. However, a written offer made under this exemption would meet the definition of a "free writing prospectus" (as discussed below) and must include a legend and, in most cases, be filed with the SEC promptly upon the filing of the related registration statement.
Safe Harbors for Regularly Released Communications. Under the new rules, the SEC has adopted two safe harbors from the gun-jumping provisions for continuing ongoing business communications – one for reporting issuers and one for non-reporting issuers.
- Reporting Issuers. All reporting issuers may continue to publish factual business and forward-looking information that has been regularly released by the company in the ordinary course of its business.
- Non-Reporting Issuers. Non-reporting issuers (including IPO companies) may continue to disseminate factual business information, but not forward-looking information, that has been regularly released by the company in the ordinary course of business, but only if the information is intended for use by persons other than in their capacity as investors or potential investors.
Factual business information includes factual information about the company, its business and its financial developments, advertisements of company products or services and dividend notices. Forward-looking information includes projections of revenues, income (loss) per share, capital expenditures, dividends, capital structure or other financial items; statements about plans for future operations; statements about future economic performance (of the type generally disclosed in MD&A); and assumptions underlying or related to any of these items. These new requirements codify long-standing SEC guidance and practice.
The safe harbors are nonexclusive, meaning that an issuer can still assert that a communication failing to meet the safe harbor is permissible under existing gun-jumping rules (for example, the communication does not constitute an "offer" under existing guidelines). Practically, the safe harbors conform with the current practice of viewing such information as not an "offer" (offers are prohibited by the current gun-jumping rules).
Trap for the Unwary
Review Past Practice Carefully. The SEC intends the new safe harbors to enable a company to continue its past ordinary-course practice of publicly releasing or disseminating factual business and forward-looking information. The release or dissemination of information, as well as the dissemination method, just before or during a registered offering must be consistent in timing, manner and form with the company's past practice. Although the rule does not establish any specific measurement period to satisfy the "regularly released" requirement, each company should carefully consider its track record before relying on the new safe harbor protection.
Free Writing Prospectuses
What Is a Free Writing Prospectus? The new rules provide increased flexibility, subject to certain conditions, in the use of "free writing prospectuses." A "free writing prospectus" is any written or graphic communication that constitutes an offer to sell, or a solicitation of an offer to buy, securities that are or will be the subject of a registration statement, other than a prospectus meeting statutory requirements. Written communications include communications that are written, printed or broadcast on television or radio. Graphic communications include communications via any form of electronic media, such as audiotapes, videotapes, facsimiles, CD-ROMs, emails and websites.
Use of Free Writing Prospectuses. The new rules specify when each class of issuer may use free writing prospectuses.
- WKSIs may use free writing prospectuses at any time before or after the filing of a registration statement.
- Seasoned issuers may use free writing prospectuses after the filing of the related registration statement (containing a statutory prospectus).
- Non-reporting and unseasoned issuers may use free writing prospectuses only after a registration statement has been filed and only if the free writing prospectus is accompanied or preceded by the most recent statutory prospectus. If the free writing prospectus is distributed in electronic form, an active hyperlink to the statutory prospectus can satisfy this requirement. As a practical matter, this requirement will likely prohibit the use of advertisements or other types of publicly disseminated written communications by unseasoned and non-reporting issuers due to the difficulty of ensuring that all recipients receive the statutory prospectus.
Free Writing Prospectus Content Requirements. All permissible free writing prospectuses must:
- include a prominent legend indicating that the free writing prospectus relates to a registered public offering and stating where the statutory prospectus is available (with a recommendation that investors read it);
- not conflict with information in the related registration statement (although it may go beyond the substance of information in the registration statement); and
- not include other impermissible legends, such as those disclaiming liability, accuracy, completeness or reliance by investors.
If these requirements are not met, the communication will not qualify as a permissible free writing prospectus and may only be used if it meets the requirements for a statutory prospectus.
Free Writing Prospectus Filing Requirements. A free writing prospectus that contains no substantive changes or additions from material previously filed with the SEC need not be filed. Filing requirements for a free writing prospectus for the company differ from those that apply to other offering participants.
- Filing Requirements for a Company. A company generally must file a free writing prospectus with the SEC if
- the free writing prospectus is prepared, used or referred to by the company,
- the free writing prospectus contains material information about the company or its securities that has been provided by or on behalf of the company that is not already included or incorporated in the prospectus or a filed free writing prospectus, or
- any portion of the free writing prospectus comprises a description of the final terms of the securities or the offering.
- Filing Requirements for Other Offering Participants. A free writing prospectus prepared, used or referred to by an offering participant, other than the company, generally does not need to be filed unless it distributed by or on behalf of such offering participant in a manner reasonably designed to lead to its broad unrestricted dissemination.
Underwriters Can Use Restricted Access Websites. A website with restricted access that is limited to an underwriter's customers or a particular subset of these customers, or an email communication distributed only to these customers, is not considered an "unrestricted" dissemination of information and does not trigger the free writing prospectus filing requirement.
Free Writing Prospectus Generally Must Be Filed on or Before the Date of First Use. A free writing prospectus that is required to be filed must be filed on or before the date of first use, unless it contains the final terms of the securities, in which case it must be filed within two days of the later of the date on which the final terms were established or the date of first use. However, the new rules allow companies to cure any unintentional or immaterial failure to file a free writing prospectus if a good faith and reasonable effort is made to comply and the free writing prospectus is filed as soon as practicable after the discovery of the failure to file.
Trap for the Unwary
Retain Record of Any Unfiled Free Writing Prospectus. Companies are required to retain any free writing prospectuses that are not filed for three years from the date of the initial offering of securities to which the free writing prospectus relates. Any immaterial or unintentional failure to retain a free writing prospectus will not result in a loss of the exemption, as long as a good faith and reasonable effort was made to comply with the record retention requirement. However, if a good faith and reasonable effort is not made, the conditions to the use of the free writing prospectus will not have been met, resulting in a retroactive violation of Section 5 of the Securities Act that entitles the investor to rescission right. To reduce this risk, companies should adopt and adhere to written procedures regarding the retention of free writing prospectuses.
Electronic Road Shows. Electronic road shows are permissible under current rules based on a number of no-action letters and informal guidance from the SEC. The SEC's new rules supersede these no-action letters for registered public offerings. Under the new rules, electronic road shows will be treated as free writing prospectuses and will be permitted on an expanded and simplified basis and in multiple versions designed for different audiences, subject to specified conditions, which may include making one version of the presentation generally available to the public.
The new rules provide that electronic road shows that are transmitted live (in real time to a live audience) will be treated as oral communications and will not require filing or be subject to the limitations on free writing prospectuses. All other electronic road shows will constitute free writing prospectuses, but will not need to be filed with the SEC, unless the road show relates to an IPO (in which case the company must file the road show materials unless it makes at least one version of a road show available in electronic form to an unrestricted audience). In either case, presentation materials, such as visual aids, will generally be treated under the same standards as the road show itself. Regardless of whether a road show constitutes a written communication, all road shows that are offers are subject to Section 12(a)(2) liability under the Securities Act.
Trap for the Unwary
Media Communication May Be Free Writing Prospectus. If a member of the press attends a road show and writes an article containing information from the road show, the article is a free writing prospectus that is subject to the rules, unless the road show is readily accessible to an unrestricted audience. If the company pays for, gives consideration for the preparation of or refers to the article, the company must either:
- satisfy the conditions for use of a free writing prospectus as of the time of the publication; or
- file the free writing prospectus with the SEC within four business days after becoming aware of its publication, unless the substance of the communication was previously filed with the SEC.
The company's filing obligation may be met by filing the media publication, all the information provided to the media or a transcript of the interview or similar materials that the company provided to the media.
Other Communication Reforms
Safe Harbor From Free Writing Prospectus Requirements for Historical Information on Company's Website. Although historical information is generally not considered to be an offer under the federal securities laws, the SEC included a safe harbor in the new rules to provide additional certainty regarding the treatment of historical information posted on a company's website. Historical information posted on a company's website will be deemed not to constitute a free writing prospectus if it:
- is identified as historical information;
- is located in a separate section of the company's website;
- has not been incorporated by reference into or otherwise included in a prospectus for the offering; and
- has not otherwise been used or referred to in connection with the offering.
Trap for the Unwary
Information on a Website May Be Free Writing Prospectus. The SEC has made clear that an offer on a company's website, or on a third-party website hyperlinked from the company's website, is, unless exempt, a free writing prospectus subject to the requirements discussed above.
Limited Safe Harbor From Gun-Jumping Provisions for Post-Filing Press Releases. Rule 134 under the Securities Act provides a safe harbor from the gun-jumping provisions for limited public notices about an offering made after a company files its registration statement. The new rules expand the information permitted in these public notices to allow more information about the company and its business and about the terms of the securities being offered, as well as factual information about the offering itself, such as the anticipated schedule of the offering and the mechanics of transactions in connection with the offering process.
New "Access Equals Delivery" Model for Final Prospectuses. Under current rules, once a registration statement has been declared effective, a final prospectus must be physically delivered to an investor prior to or at the time a confirmation of a sale is delivered. The new rules create an "access equals delivery" model for final prospectuses. Prospectus delivery requirements will be satisfied if a company files a timely final prospectus with the SEC (via EDGAR, the SEC's electronic filing system) and sends a notice to each investor, no later than two business days after the completion of the sale, advising that the sale was made pursuant to a registration statement or a final prospectus. This change will enable companies to avoid printing and delivering physical copies of the final prospectus to all investors.
Shelf Registration Reforms
In addition to the communications reforms described above, the new rules also establish significantly more flexible procedures for shelf registration offerings, particularly for WKSIs. These reforms include:
- automatic shelf registration for WKSIs;
- streamlined shelf registration procedures for all companies;
- adoption of an "access equals delivery" model for delivery of a final prospectus; and
- expansion of the use of incorporation by reference in Securities Act filings for most companies.
Automatic Shelf Registration for WKSIs. Under the new rules, WKSIs will be eligible to file automatic shelf registration statements and post-effective amendments that are effective immediately upon filing, without SEC review. A WKSI will not have to specify in the registration statement the amount of securities to be offered, the allocation of the registered securities between those to be offered on a primary and secondary basis, a description of the securities (other than the name or class of securities) or the plan of distribution.
WKSIs can essentially make unlimited sales off their shelf registrations, remit registration fees on a "pay-as-you-go" basis and provide the pertinent registration information in a prospectus supplement used at the time of the offering. If the WKSI chooses, it can file the information in Exchange Act reports, such as a current report on Form 8-K or a quarterly report on Form 10-Q, and incorporate the information by reference into a prospectus supplement. WKSIs may use the automatic shelf registration statement to register specific types of securities depending on how the company qualifies as a WKSI. A company that qualifies as a WKSI based on worldwide value of common equity held by non-affiliates ($700 million or more) will be eligible to conduct an offering for any kind of security on an automatically effective shelf registration statement. A company that qualifies as a WKSI based on the aggregate value of issuances of its non-convertible securities (other than common equity) in registered offerings for cash during the three prior years ($1 billion or more) may only use the automatic shelf registration statement to register investment-grade, non-convertible securities (other than common stock) unless the value of its common equity held by non-affiliates is at least $75 million, in which case it may register any security using an automatically effective shelf registration statement. A company's eligibility for filing an automatic shelf registration statement is determined at the date of the initial filing of the registration statement and at the time of the filing of each amendment to the registration statement.
Expanded Incorporation by Reference for Form S-3. For all shelf registration statements on Form S-3, all required information may be incorporated by reference to Exchange Act reports. In addition, selective information in certain shelf registration statements, such as the identification of selling security holders, may be omitted from the base prospectus and included in a prospectus supplement or incorporated by reference from reports filed with the SEC, instead of being included in a post-effective amendment.
Expansion of Shelf Registration to Three Years. Under current rules, a company may only register an amount of securities that it reasonably expects to be offered and sold within two years. For primary shelf registration statements, the SEC is eliminating that rule and providing instead that an unlimited amount of securities may be registered, but a shelf registration statement can only be used for three years. A company may, however, include unsold securities from a previous registration statement in a new registration statement. In addition, to eliminate any gaps while waiting for a new registration statement to become effective, a company that is not a WKSI may extend its use of a registration statement for up to six months beyond the three-year term if a company files a new registration statement within the three-year period (any new registration statement filed by a WKSI becomes effective immediately upon filing).
More Liberal Requirements for at-the-Market Offerings of Equity Securities by WKSIs and Seasoned Issuers. An "at-the-market offering" is an offering of securities into an existing trading market for outstanding shares of the same class at other than a fixed price on or through the facilities of a national securities exchange or to or through a market maker. The new rules will permit WKSIs and seasoned issuers to conduct at-the-market offerings of equity securities without identifying an underwriter in the registration statement or limiting the amount that can be sold in such offering.
The new rules also address significant liability issues under the Securities Act.
Liability for Material Misstatements or Omissions. Under the new rules, only the information conveyed to the investor at or prior to the time of sale will be taken into account for purposes of liability for offers or sales by means of a prospectus or oral communication under Section 12(a)(2) of the Securities Act and for liability under Section 17(a)(2) of the Securities Act, which is a general anti‑fraud provision providing that it is unlawful for any person to offer or sell a security by means of these untrue statements or omissions of information necessary to make the statements made, in light of the circumstances under which they were made, not misleading. The time of sale for these purposes is the date that the investor agrees to purchase the securities, including a commitment pursuant to an oral contract. Under the new rules, companies will need to ensure that any required disclosures are either included in the preliminary prospectus or are conveyed to investors before pricing an offering. This requirement will likely encourage companies to adopt procedures designed to provide a record that investors were not permitted to finalize their investment decisions until they were provided access to all the information required to be disclosed under the Securities Act.
Prospectus Supplements. The new rules provide that information in a prospectus or prospectus supplement will be deemed part of the related registration statement and, therefore, subject to liability under Section 11 of the Securities Act for material misstatements or omissions in the registration statement. Each takedown from a shelf registration statement will have its own effective date for Section 11 liability purposes, which will be the earlier of the date the prospectus supplement is first used or the date and time of the first contract of sale to which the prospectus supplement relates.
Free Writing Prospectuses Generally Exempt From Section 11 Liability. Under the new rules, free writing prospectuses will not be subject to liability under Section 11 of the Securities Act (unless the company elects to make the free writing prospectus part of the registration statement), but will be subject to liability for offers or sales by means of a prospectus or oral communication under Section 12(a)(2) of the Securities Act and the antifraud provisions of the securities laws. Additional Disclosure Required by New Rules
Must Disclose Unresolved SEC Comments in Annual Report. Upon effectiveness of the new rules, WKSIs and accelerated filers will be required to include disclosure in their annual reports filed with the SEC regarding any written SEC comments that were issued to them more than 180 days prior to the end of the fiscal year to which the annual report relates, if the comments are material and remain unresolved at the time of filing.
Must Disclose Risk Factors in Annual and Periodic Reports. Companies will now be required to include disclosure and discussion of risk factors in their annual reports filed with the SEC in a similar fashion as is already required in registration statements. Many companies already include such disclosure and discussion voluntarily. Although in the adopting release the SEC discourages companies from unnecessarily restating or repeating the risk factors in quarterly reports, companies that file quarterly reports on Form 10-Q will need to evaluate their previous disclosure regarding risk factors and include in the quarterly report any additional disclosure needed to reflect any material changes to the previous disclosure.
Voluntary Filers Must Disclose Status. Upon effectiveness of the new rules, companies that qualify as non-reporting issuers but choose to file Exchange Act reports voluntarily must disclose their status as "Voluntary Filers" when filing Exchange Act reports.
Website Disclosure Required for Non-Seasoned Issuers for Incorporation by Reference Into Form S-1. The new rules will allow companies that have filed at least one annual report and are current in their Exchange Act filings to incorporate previously filed Exchange Act reports into registration statements on Form S-1. To do so, a company must also include the incorporated information on its website, including a hyperlink to the materials filed on EDGAR, and identify the incorporated materials in the Form S-1. The company may not incorporate future Exchange Act filings. With these changes, the SEC is also eliminating Form S-2 as no longer necessary.
The adopting release for the new rules does not describe how existing public companies are to transition to these new regulatory regimes. The SEC has informally stated that it is assessing transition issues related to the reforms, such as whether a company that qualifies as a WKSI under the final rules can convert its existing shelf registration statement into an automatic shelf registration statement or whether the company will need to file a new automatic shelf registration statement. The SEC has indicated that it plans to issue guidance before the final rules take effect (on December 1, 2005) to address transition issues.
Additional Information This Update is intended only as a summary of the key provisions of the final rules discussed above. You can find all 468 pages of the adopting release at http://www.sec.gov/rules/final/33-8591.pdf. You can find discussion of other topics of interest to public companies on our website.