United States: Securities Offering Reform: Prospectus Delivery Proposal

On November 3, 2004, the Securities and Exchange Commission proposed new rules (http://www.sec.gov/rules/proposed/33-8501.pdf) that would significantly modify and advance the registration, communications and offering framework of the Securities Act of 1933. The proposals would enhance the disclosure requirements under that Act and the Securities Exchange Act of 1934 — which have both undergone significant changes since the enactment of the Sarbanes-Oxley Act of 2002 — and continue the SEC’s long-term effort to integrate the disclosure requirements, as well as other offering processes, under both of these Acts. The release is subject to a 75-day comment period, which expires on January 31, 2005, and the SEC is seeking comment on virtually all of the topics covered in its proposals.

This Client Alert is one of three separate Client Alerts summarizing the SEC’s principal proposals that are described in our overview Client Alert entitled "Securities Offering Reform: A Takeoff from the Aircraft Carrier". Specifically, this Client Alert covers the proposal to adopt an "access equals delivery" model that will minimize the requirements to deliver a hard copy of a final prospectus, as well as to clarify that investors should have all the information necessary to make their investment decision at the time of sale. This Client Alert also covers other topics in the proposal, including a requirement to include risk factor disclosure in annual reports on Form 10-K and update them in quarterly reports on Form 10-Q. In particular, the SEC’s proposals would dramatically simplify the registration, communication and offering processes for a new category of issuers that have reporting histories and are presumptively the most widely followed in the marketplace, which the SEC calls "well-known seasoned issuers." (For a definition of well-known seasoned issuer and other categories of issuers, see our overview Client Alert.)

Because of the technical nature of the proposed reforms — which took the SEC nearly 400 pages to summarize and promulgate — we have also prepared separate Client Alerts for the other two principal proposals covered by the SEC’s release:

• our Client Alert entitled "Securities Act Reform: Shelf Registration Proposal" covers the proposal to simplify the shelf registration process, including automatic effectiveness of registration statements for WKSIs that will permit them to issue securities without any potential delay arising from SEC staff review

• our Client Alert entitled "Securities Act Reform: Communications Proposal" covers the proposal to formalize and liberalize communications that can be used by or on behalf of companies in connection with their offerings, other than by means of the customary statutory prospectus, including the use of "free writing prospectuses," with the most flexibility afforded to WKSIs

Moreover, the SEC’s proposals modify and clarify the principal liability provisions of the Securities Act, which have varying standards of liability associated with untrue statements of or omissions to state material facts in connection with an issuer’s offering of its securities. These liability standards are discussed as applicable in the context of each of our Client Alerts.

Section 5 of the Securities Act requires that a sale of a security be "accompanied or preceded by a prospectus." The SEC has interpreted this requirement quite literally in the past, requiring that a physical prospectus be delivered to a purchaser of a security no later than the time the confirmation of the sale is delivered. The SEC notes in the release that purchasers of securities usually do not receive the final prospectus until after they have already made their investment decision, so the prospectus does not provide them with any additional information. However, the SEC believes that the prospectus does provide value in memorializing the terms of the securities for the aftermarket. Given the theory that the final prospectus plays a more important role after closing than before, and the wide dissemination of securities filings via EDGAR and the Internet, the SEC has proposed adopting an "access equals delivery" model for most securities offerings. In essence, issuers and underwriters would no longer need to print and mail prospectuses to all purchasers of a security prior to closing. They would be deemed to have met their prospectus delivery requirements by filing the final prospectus on EDGAR within the time frame required by the SEC’s Rule 424.

Issuers and underwriters would be able to send out written confirmations and allocations of securities without being accompanied or preceded by a final prospectus, provided that:

• the registration statement has been declared effective;

• neither the issuer, the underwriter nor any participating dealer is the subject of a proceeding under Section 8A of the Securities Act in connection with the offering; and

• the issuer has filed the final prospectus with the SEC within the time required by the SEC’s rules.

The access equals delivery procedure would not be available to all types of transactions. For example, business combinations and exchange offers are subject to proxy rules, tender offer rules and state law provisions that require delivery of documentation to holders. Prospectuses related to securities offered in these transactions would still need to be delivered rather than just filed on EDGAR, in order to retain consistency among the various rules and regulations applicable to these transactions. Also, offerings pursuant to Form S-8 would be excepted from the access equals delivery procedures, as the final prospectus is never filed with the SEC and these offerings do not raise the same types of issues as other capital formation transactions.

The proposed rules, as written, apply only to final prospectuses. In transactions in which there is an obligation to deliver a preliminary prospectus, such as initial public offerings, the preliminary prospectus would still need to be delivered. The SEC, has, however, requested comment as to whether or not this access equals delivery procedure should be extended to cover these transactions. The SEC has also requested comment as to whether or not the access equals delivery procedure should be available for continuous and best efforts offerings (such as "registered direct" offerings), where the final prospectus may be used by the issuer and underwriters or placement agents to offer and sell the securities.

Also, non-reporting or unseasoned issuers would continue to be required to provide the final prospectus before or with any written offer, such as a free writing prospectus, that is made after the availability of a final prospectus.

In the release, the SEC notes that while delivering a prospectus to purchasers at closing does not help them make an investment decision, it does serve as notice that they have received registered securities. The SEC has therefore proposed that in transactions using the access equals delivery procedure, a notice be delivered to the purchasers informing them that the securities were sold pursuant to an effective registration statement. This notice must be sent no later than two business days after completion of the sale. The purchaser would still be able to request a physical copy of the prospectus if it wanted one, but that prospectus could be delivered after closing.

Dealers participating in registered securities offerings are currently required to deliver prospectuses in the aftermarket for up to 90 days after the effective date of the registration statement, depending upon the type of transaction. In most cases, dealers would instead be able to make use of the access equals delivery procedure, so they would not be required to deliver prospectuses in aftermarket transactions.

In addition, if a current final prospectus has been filed with the SEC, final prospectuses would no longer be required to be delivered in connection with market making transactions by dealers affiliated with issuers.

The requirement that copies of prospectuses be sent to national securities exchanges would also be satisfied by the access equals delivery procedure.

The adoption of the access equals delivery model could contribute to ongoing efforts to shorten the time between pricing and closing to less than T+3, because the logistical obstacle of waiting for prospectuses to be printed and delivered before closing would be removed.

The proposal includes an interpretation by the SEC — which reflects a "core concept" of the Securities Act — that accurate and complete information regarding an issuer and its securities being offered is available to investors at the time of the "contract of sale," when they make their investment decisions. This interpretation, as applied to the proposal, modifies and clarifies the three principal liability provisions of the Securities Act, which have varying standards of liability associated with untrue statements of or omissions to state material facts in connection with an issuer’s offering of its securities. Under these provisions, purchasers of an issuer’s securities in a registered offering have private rights of action if, in the case of Section 11, there are untrue statements in a registration statement or omissions required to be included or necessary to make the statements in the registration statement not misleading at the time the registration statement becomes effective and, in the case of a seller’s liability to purchasers for offers or sales by means of a prospectus or oral communication under Section 12(a)(2), there are untrue statements in the prospectus or communication or omissions necessary in order to make the statements therein, based on the circumstances under which they were made, not misleading. Section 17(a)(2) is a general anti-fraud provision providing that it shall be unlawful for any person in the offer and sale of a security to obtain money or property by means of these untrue statements or omissions necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.

In keeping with the SEC’s views that investors do not rely on the final prospectus in making their investment decision, the release clarifies that liability for purposes of Sections 12(a)(2) and 17(a)(2) will be imposed based on the information that purchasers actually possess at the time of sale, and not on the basis of information that they are given only later, such as in the final prospectus. Therefore, under this interpretation, issuers and others with liability under these provisions would need to ensure that investors have, at the time of sale, all the material information they need to make their investment decision; these issues cannot be dealt with in the final prospectus. While the sale of a security has traditionally been viewed as taking place when a confirmation is sent to the investor, which is required to be accompanied or preceded by a final prospectus, the SEC’s interpretation suggests that there may be other — and, possibly, earlier — times to apply the liability standards of the Securities Act of 1933. In this regard, the SEC notes that oral contracts for sales of securities are permitted under the laws of those states that have adopted UCC Article 8-113 and requests comment as to whether or not the proposal should address evidentiary issues regarding information that is conveyed to an investor at the time of sale.

Under the reforms relating to communications discussed in the release, issuers will have more options available to them for conveying information to purchasers. Liability under Sections 12(a)(2) and 17(a)(2) would be based not just on the information contained in the registration statement and preliminary prospectus, but also on other information conveyed to investors, including that in oral communications, previously filed Exchange Act reports and free writing prospectuses. In order to take advantage of the flexibility provided by these alternative methods of communications, issuers would need to comply with the requirements of the communications proposals, including the requirements that certain types of free writing prospectuses be filed with the SEC. Also, given the fleeting nature of oral communications, to the extent information is provided orally, some kind of contemporaneous record of what information is provided in telephonic or face-to-face meetings should be made, especially if there is updated information that is only provided orally.

The proposal does not limit liability only to the time the contract of sale is entered into by the investor. The final prospectus would still need to include all of the information called for by the SEC’s disclosure rules, and liability under Section 12(a)(2) would still apply to the final prospectus as of its date.

The treatment of information incorporated by reference would also be affected by this interpretation:

• subsequently provided information deemed part of or incorporated by reference into a registration statement or prospectus would not modify or supersede any information conveyed to an investor at the time of sale (including the time of the contract of sale) for purposes of determining the information conveyed to an investor at or prior to that time; and

• information contained in a document that is deemed part of or incorporated by reference into a registration statement or prospectus would modify or supersede the information contained in the registration statement or prospectus itself.

In the past, there has been uncertainty as to whether or not an issuer is a "seller" for purposes of Section 12(a)(2) under certain types of underwriting agreements. These rules clarify that an issuer would be considered a seller for this purpose in connection with primary offerings of securities, regardless of the structure of the underwriting arrangements, as to any communications made by or on behalf of the issuer. The following communications would be deemed to be made by or on behalf of an issuer:

• the issuer’s registration statement and any SEC-filed preliminary prospectus or prospectus supplement relating to the offering

• any free writing prospectus prepared by or on behalf of the issuer

• information about the issuer or its securities provided by or on behalf of the issuer and included in any other free writing prospectus

• any other communication made by or on behalf of the issuer

Forms S-2 and F-2 were intended to permit companies that had been reporting under the Exchange Act for a period of time, but had a limited public float, to incorporate certain information into their registration statements by reference, but not as much as Forms S-3 and F-3 would permit. However, few filers have used Forms S-2 and F-2 in recent years. There have been many changes in the securities markets since the forms were adopted, including the real-time availability of SEC filings via the EDGAR system. These factors, in combination with the SEC’s proposal to permit most issuers that have filed at least one annual report to incorporate certain information by reference into their filings on Forms S-1 and F-1, have led the SEC to propose eliminating Forms S-2 and F-2.

Although virtually all issuers include risk factors in registration statements filed under the Securities Act of 1933, it is not uncommon for certain issuers — including, for example, well-seasoned NYSE-listed companies — to exclude them from their SEC periodic reports. The SEC has proposed revising Forms 10-K and 10 to require risk factor disclosure in plain English. This would include the same kinds of risks currently required in Securities Act registration statements, except, of course, for risks related to a particular offering of securities. While an issuer would not be required to restate all of these risks each quarter in its quarterly report on Form 10-Q, the issuer would be required to update any risks that had changed during that quarter. Although many issuers, primarily smaller capitalization and emerging growth companies, currently include risk factors in their quarterly reports on Form 10-Q, the SEC believes that all issuers should be required to update risk factor disclosure in their quarterly reports as they already need to undertake a review of changes in their operations, financial results and conditions and other circumstances in order to prepare other portions of the quarterly report, including the financial statements and MD&A.

Filers that are not required as a matter of law to file Exchange Act reports, but continue to do so for contractual, investor relations or other reasons are known as "voluntary filers." The SEC has proposed that these voluntary filers would be required to indicate their status by means of checking a box on the cover page of their annual report on Form 10-K, 10-KSB or 20-F. Voluntary filers would not be able to become "seasoned issuers" under the communications and offering procedure proposals included elsewhere in the release.

Our securities practice team works together with our securities litigation team and white collar defense and corporate investigation team to monitor developments in the federal securities laws and at the SEC, the NYSE and Nasdaq. As indicated above, the SEC is seeking comment on virtually all of the topics covered in its proposals and the comment period expires on January 31, 2005. While we expect that the proposals will receive meaningful public comment, we also expect that the SEC will adopt final rules that reflect many of the more significant proposals included in the SEC's release. We will issue additional Client Alerts addressing significant developments affecting the proposals as they occur.

If you wish either to obtain a more detailed explanation of the proposals and their ramifications or develop a new comprehensive and adaptive strategy to meet the changing landscape, please contact the Pillsbury Winthrop securities attorney with whom you work or one of the co-leaders of the Pillsbury Winthrop securities practice team, Stanton D. Wong in San Francisco or Todd W. Eckland in New York.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.