In November 2004, the US Securities and Exchange Commission (SEC) published proposed rules that would substantially change the registration, communications and offering processes under the Securities Act of 1933. The proposals were the most far-reaching set out by the SEC since the demise of its 1998 so-called Aircraft Carrier release and have far-reaching effects both for domestic and non-US issuers.
After a public comment period that ended in January 2005 and internal reworking of certain aspects of the proposed rules, the SEC unanimously adopted new rules at an open meeting on June 29. The new rules will be one of William Donaldson's long-term contributions to the US capital markets; he was able to pass the final rules just a day before he stepped down. The new rules appear to be largely consistent with the original proposals, as had been expected given the generally supportive comments submitted to the SEC. Although the text of the rules was published only on July 19 and the new rules are not yet effective, the SEC has indicated that it has made some adjustments that counsel should be aware of.
What type of issuer are you?
The amount of flexibility granted to issuers under the new rules largely depends on the category of the issuer, which is determined by the issuer's reporting history and its equity market capitalization or amount of debt issuance. The rules divide issuers into four categories: (i) non-reporting issuers (including all companies conducting an initial public offering (IPO) and non-US companies listing in the US markets for the first time); (ii) unseasoned issuers; (iii) seasoned issuers; and (iv) well-known seasoned issuers (WKSIs). The new rules provide the greatest flexibility to WKSIs, which are a new class of super-seasoned issuers that are current and have been timely in their periodic Securities Exchange Act of 1934 reports for at least one year and have either $700 million of worldwide public common equity float or have issued at least $1 billion of non-convertible securities, other than common equity, in SEC-registered offerings for cash, in the preceding three years.
The SEC received various comments in regards to the definition of WKSIs suggesting that other thresholds might be preferable. Several expressed concern that the criteria for WKSI status as proposed would not, as the SEC suggested, succeed in increasing the number of registered rights offerings by foreign issuers because a large portion of rights offerings are conducted by foreign private issuers experiencing economic difficulty. As a result, commenters suggested, many foreign private issuers might not be able to satisfy the $700 million public float requirement for WKSI status due to decreases in the market price of their stock. The SEC did not revise its definition to change the WKSI thresholds, but it did state at the open meeting that the final rule release would include a directive to its staff to review the WKSI thresholds and to report back to the SEC in three years with any recommendations for improving or refining these rules.
The SEC did, however, otherwise respond to comments on the proposed definition, which would have required the issuer to have $700 million in common equity market capitalization. Responding to concerns that this definition might, when considered in light of other SEC rules, limit the calculation to equity held in the US, the SEC changed the definition so that it now refers to worldwide public float and equity held in non-US markets can be included in the calculation. The SEC had also proposed that debt WKSIs - those issuers who qualify for WKSI status because they have issued at least $1 billion in registered non-convertible securities in the past three years - would only be permitted to use the WKSI forms to register debt securities. As adopted, the SEC will allow those issuers to register, as WKSIs, common equity and convertible securities as long as they also have a $75 million public equity float.
Consistent with the 2004 proposals, certain issuers will be deemed ineligible issuers and so will not be entitled to the benefits of the new rules. Many commenters had criticized the proposed definition of ineligible issuer as potentially excluding a large number of issuers unnecessarily. For example, the proposed definition would have captured within the category of ineligible issuer an issuer that had violated any of the US federal securities laws. The SEC did not clearly state in the open meeting what the final definition of ineligible issuer will be, but the staff did state that ineligible issuers will include those issuers that have violated the anti-fraud provisions of the federal securities laws. This tightening of the definition is a welcome relief in light of the potentially expansive scope of the exclusion as originally proposed, and seems more consistent with the SEC's goal of excluding truly bad actors from the benefits of the new rules. Similarly, the flexibility provided by the new rules generally will not be available to blank-cheque companies, penny stock issuers or shell companies - all types of issuers the SEC generally appears to view with some scepticism.
Offering communications
In keeping with the 2004 proposals, the new rules introduce a new concept: the free-writing prospectus. A free-writing prospectus is any written communication, including an electronic communication, constituting an offer of securities other than the statutory prospectus filed with the SEC as part of the securities registration process. The definition of free-writing prospectuses includes media publications such as newspaper interviews and magazine articles as well as electronic road shows. As a general rule, all issuers and other offering participants (including underwriters) will be allowed to use free-writing prospectuses after filing a related registration statement, subject to certain conditions (including, in some cases, filing the free-writing prospectus with the SEC). With respect to unseasoned and non-reporting issuers, the statutory prospectus must precede or accompany certain free-writing prospectuses. It is unclear whether, as suggested in the proposed rules, it will be necessary for an issuer undertaking an IPO to have included a price range in its filed registration statement before it will be able to use free-writing prospectuses or otherwise communicate with the market about its offering. This issue is of much practical importance in light of the typical practice of establishing a price range fairly late in the IPO registration process. If a price range is required, the opportunity to use free-writing prospectuses might be limited absent a shift toward earlier disclosure of the price range.
Free-writing prospectuses will be subject to liability under the anti-fraud provisions of the securities laws and Sections 12(a)(2) of the Securities Act but will not be subject to Section 11 of the Securities Act. Practitioners had been concerned about the potential liability of one offering participant (an underwriter for example) for a free-writing prospectus prepared by another offering participant (the issuer or another underwriter for example). Without going into details, the SEC staff stated at the open meeting that the final rule release will address cross-liability issues among offering participants that might arise from the use of free-writing prospectuses. Even if the cross-liability issues are adequately addressed, it remains to be seen how widely free-writing prospectuses will be used. At least initially, it is expected that issuers and underwriters will prohibit or severely limit the use of free-writing prospectuses by other offering participants through contractual limitations in the underwriting documentation.
In the open meeting, the SEC staff stated that they had rethought their treatment of road shows generally and electronic road shows in particular. According to the staff, the final rules will not focus on the mechanism by which information is communicated, and therefore any live communication in real time to a live audience will be considered oral, regardless of the means of transmission. As oral communications, live road shows will not be subject to any of the limitations that apply to writings, including free-writing prospectuses. For example, a road show disseminated over the internet to remote participants in multiple locations will be a live road show rather than an electronic road show as long as the characteristics of real time and live communications are present. As a general rule, electronic road shows will be treated as free-writing prospectuses but they will not have to be filed except in connection with IPOs. For IPOs, electronic road shows will have to be filed as free-writing prospectuses, but the SEC staff stated at the open meeting that the final rules will retain the element of the 2004 proposals that an electronic road show does not have to be filed as long as at least one bona fide version of the electronic road show is made generally available to a broad audience.
As expected, the new rules update and liberalize permitted offering activities and communications to allow more information to reach investors by revising the Securities Act rules limiting so-called gun-jumping or pre-offering conditioning of the market. Here again, the degree of flexibility will be driven by the category into which an issuer falls, with the greatest flexibility being afforded to WKSIs (which will be essentially unlimited in their ability to engage in oral and written communications) and the least (though still incrementally beneficial) flexibility being afforded to non-reporting issuers.
Flexibility for shelf registrations
The new rules also include revisions modernizing the operation of shelf registrations under the Securities Act for eligible domestic and non-US issuers. The new rules establish a more flexible version of shelf registration, referred to as automatic shelf registration for offerings by WKSIs. Automatic shelf registration will permit automatic effectiveness, pay-as-you-go registration fees and the ability to exclude additional information from base prospectuses. As the name suggests, these rules will permit WKSIs to conduct registered offerings without the delay and unpredictability associated with the SEC review process.
The revisions to the shelf registration procedures also include a number of helpful changes that remediate perceived flaws and inefficiencies that have been identified since the SEC's 1982 adoption of Rule 415, codifying shelf registration procedures. These include: (i) replacing the requirement that issuers register only securities they intend to offer within two years with a requirement that the issuer update the registration statement with a new registration statement that is filed every three years; (ii) eliminating restrictions on at-the-market equity offerings for certain issuers; (iii) permitting immediate takedowns of securities off shelf registration statements; and (iv) permitting additional disclosures to be included through prospectus supplements and incorporated Exchange Act reports (rather than post-effective amendments), including information relating to the issuer's plan of distribution and the identity of selling security holders (but only if the securities to be sold are outstanding when the registration statement goes effective).
The SEC appears to have retreated slightly from its initial proposal that each issuance of a prospectus supplement for a shelf offering would constitute a new effective date for the related registration statement for purposes of determining liability. At the open meeting the SEC staff explained that, pursuant to the final rules, a prospectus supplement filing would only create a new effective date for the registration statement with regard to the issuer and any underwriters. The filing of a prospectus supplement will not constitute a new effective date for the registration statement with regard to officers and directors of the issuer or any experts with respect to the registration statement (such as the independent auditors). The SEC staff explained that there had been valid and compelling concerns that creating a new effective date with regard to officers, directors and experts could introduce new speed bumps in the offering process as these parties might feel obliged at the time of any such filing to take additional, time-consuming steps to further their due diligence defences.
Access equals delivery
With the adoption of these rules, the SEC has made a dramatic, but highly anticipated, change to its regulatory regime for prospectus delivery by adopting a model that access equals delivery. Under this model, filing a final prospectus with the SEC and complying with other conditions will enable offering participants to conduct securities offerings without printing and delivering final prospectuses.
The SEC has also reaffirmed its interpretation and adopted an interpretive rule that, for purposes of disclosure liability under Section 12(a)(2) and Section 17(a)(2) of the Securities Act, liability attaches to the information conveyed to the investor at the time of sale rather than being affected by information that is only included in a subsequent final prospectus or otherwise conveyed after the time of sale. Earlier commentary on the proposed rules had lamented that this type of liability analysis also would create speed bumps in the capital raising process, but the SEC staff was careful to note at the open meeting that liability would be based on information conveyed at the time of sale and that the rules and interpretation do not mandate physical delivery or the delivery of any particular documents. Although one cannot speak definitively before publication of the final release, the implication seems to be quite clear that investors will be charged with knowledge of public disclosure made contemporaneously with a sale.
Disclosure in Exchange Act reports
The new rules will require domestic issuers to include risk factor disclosure in their annual reports on Form 10-K. This change will not apparently apply to foreign private issuers who file annual reports on Form 20-F. In addition, in one apparent effort to counterbalance the increased flexibility for issuers under the new rules (including the automatic effectiveness provisions, which will eliminate the SEC staff's ability to delay effectiveness of a registration statement until all SEC comments are resolved), the new rules also provide some corresponding leverage for the SEC staff. Under the new rules, accelerated filers and WKSIs will be required to disclose in their annual reports any written SEC staff comments that were issued more than 180 days before the end of the fiscal year to which the annual report relates that remain unresolved at the time of filing the annual report if the issuer believes those comments to be material. The new rules will probably ratchet up the pressure on issuers to resolve open SEC comments before the annual report publication date.
John White and Andrew Pitts are partners at Cravath Swaine & Moore LLP in New York