United States: SEC Levels Playing Field: Any Company Will Now Be Able To "Test The Waters"

Last Updated: October 2 2019
Article by Cydney Posner

This morning, without the benefit of an open meeting, the SEC announced that it had voted to adopt a new rule, Rule 163B, and other amendments that will level the playing field by expanding the JOBS Act's "test-the-waters" reform beyond emerging growth companies to apply to all issuers. The new rule will allow a company (and its authorized representatives, including underwriters) to engage in oral or written communications, either prior to or following the filing of a registration statement, with potential investors that are, or are reasonably believed to be, qualified institutional buyers (QIBs) or institutional accredited investors (IAIs) to determine whether they might be interested in the contemplated registered securities offering. The new rule is designed to allow the company to gauge market interest in the deal before committing to the time-consuming prospectus drafting and SEC review process or incurring many of the costs associated with an offering. SEC Chair Jay Clayton remarked that the "final rule benefits from the staff's experience with the test-the-waters accommodation that has been available to EGCs since the Jumpstart Our Business Startups Act (JOBS Act)....Investors and companies alike will benefit from test-the-waters communications, including increasing the likelihood of successful public securities offerings." The amendments were adopted largely as proposed, with some tweaks designed to address aspects of the proposal that commenters suggested could raise uncertainty for issuers seeking to rely on the rule. The new rule will become effective 60 days after publication in the Federal Register.

Corp Fin took a similar step in 2017 when it extended to all IPOs (and most follow-on offerings made in the first year post-IPO) the JOBS Act reform that allowed the confidential submission of draft registration statements. That accommodation has generally been well-received. (See this PubCo post.) Currently, the JOBS Act permits only EGCs to test the waters (although "well known seasoned issuers" can engage in similar communications under a different rule). In the Proposing Release, the SEC indicated that its experience with EGCs and test-the-waters communications, together with the sophistication of the investors that would be eligible to receive these communications, led the SEC to believe that it was "appropriate to expand the accommodation to all issuers." The SEC observed, in the Proposing Release that, it expects that allowing more companies to test the waters

"could help issuers to better assess the demand for and valuation of their securities and to discern which terms and structural components of the offering may be most important to investors. This in turn could enhance the ability of issuers to conduct successful offerings and lower their cost of capital. To the extent this is the case, the proposed rule could encourage additional registered offerings in the U.S. [The SEC believes] that increasing the number of registered offerings can have long-term benefits for investors and our markets, including improved issuer disclosure, increased transparency in the marketplace, better informed investors, and a broader pool of issuers in which any investor may invest."

Generally, there are a number of restrictions on issuer communications during the offering process. In the absence of this reform or other exemption, written and oral offers prior to filing of a registration statement are prohibited under Section 5, a violation referred to as "gun-jumping." Section 5(c) prohibits any written or oral offers prior to the filing of a registration statement, and after filing, Section 5(b)(1) limits written offers to a "statutory prospectus" that conforms to Section 10.

New Rule 163B will provide an exemption from Section 5(b)(1) and Section 5(c) of the Securities Act for test-the-waters communications by all issuers—including non-reporting issuers, EGCs, non-EGCs, WKSIs, and, not discussed in this post, investment companies—whether before or after filing of the registration statement, to potential investors that the issuer (or person authorized to act on its behalf) has a reasonable belief is a QIB or IAI. Test-the-waters communications that comply with the rule would not need to be filed with the SEC, and no specific legends would be required. When reviewing offerings, the Corp Fin staff anticipates requesting that issuers furnish the staff for review any test-the-waters communications used in connection with an offering, consistent with current practice for EGCs.

That's not to say that investor protections have exactly been eviscerated under the new rule. Notably, these communications would still be considered "offers" under the Securities Act, and both oral and written communications before and after filing would be subject to Section 12(a)(2) liability. The anti-fraud provisions of the federal securities laws would also be applicable. And, should the issuer decide to go ahead with an offering, all investors would receive a Section 10(a) prospectus subject to Section 11 and Section 12(a)(2) liability. Companies subject to Reg FD would also need to consider whether any information in the communication would trigger obligations for public disclosure under Reg FD or could be excluded, for example, if confidentiality agreements were obtained from potential investors.

Responses to comments

In response to comments, the SEC determined not to adopt the provision of the proposed rule that would have made the rule unavailable for a communication that was in technical compliance with the rule, but was part of a plan or scheme to evade the requirements of Section 5 of the Securities Act. The SEC stated that it was persuaded by concerns expressed by commenters that the language of the provision could create uncertainty and limit the utility of the rule; some of these commenters had asserted that the provision created uncertainty because it was unclear how permissible communications could even be part of a scheme to evade Section 5.

In addition, in response to comments, the SEC is amending Rule 405 to clarify that written communications used in reliance on Rule 163B or on Section 5(d) of the Securities Act are not free-writing prospectuses.

Another subject that received a fair amount of comment was the SEC's statement in the proposing release that information in Rule 163B communications must not conflict with material information in the related registration statement. Commenters pointed out that it was certainly possible that "circumstances or messaging may change between the time the pre-filing Rule 163B communications are made and the time of filing, causing the information in the test-the-waters materials to differ from information in the related registration statement." In response, the SEC indicated that, based on staff observations in reviewing test-the-waters communication to date, the information in those communications has generally been consistent with the information in the registration statements. In addition, the SEC confirmed in the adopting release that the statement was intended as a reminder that, even though the communications were exempt, issuers still needed to "take care to ensure that they are made in compliance with other provisions of the federal securities laws." (In that context, the SEC noted that, because "Rule 163B communications are subject to Section 12(a)(2) and the anti-fraud provisions of the federal securities laws, there may be liability concerns if a Rule 163B communication materially conflicts with the information in a registration statement.") The SEC also cautioned issuers to keep in mind that these communications "must not contain material misstatements or omissions at the time the statements are made." Nevertheless, the SEC "recognize[d] that between the time of the Rule 163B communication and the time a registration statement is filed, disclosures may be changed in order to reflect a change in circumstances or offering terms. We also clarify, as one commenter suggested, that this statement is intended to provide guidance to issuers on their obligations under the federal securities laws and is not a condition to the availability of Rule 163B." [Emphasis added.]

In response to comments requesting clarification that a test-the-waters communication be deemed not to be a "general solicitation," which could disqualify an immediately subsequent private placement, the SEC would say only that

"whether a test-the-waters communication would constitute a general solicitation depends on the facts and circumstances regarding the manner in which the communication is conducted....Where an issuer wishes to pursue a private placement in lieu of a registered offering immediately after engaging in test-the-waters communications, the issuer should consider whether the test-the-waters communication was conducted in such a way as to constitute a general solicitation. If the communication constitutes a general solicitation, the issuer should consider whether the private offering exemption upon which the issuer is relying allows for general solicitation and, if it does not, whether the investors in the private placement were solicited by means of such a test-the-waters communication, or through some other means that would otherwise not foreclose the availability of the exemption."

The release notes that the SEC's 2007 framework for analyzing how an issuer can conduct simultaneous registered and private offerings continues to apply. The SEC does, however, "confirm that communications made under Rule 163B generally would not be deemed 'Directed Selling Efforts' under Rule 902(c) for purposes of Regulation S."

The SEC also assuaged another concern raised by a commenter regarding the ramification of a QIB's or IAI's passing test-the-waters information on to nonqualified parties, notwithstanding reasonable preventative steps taken by the issuer, such as confidentiality agreements. The SEC stated that, "where an issuer has taken reasonable steps to prevent test-the-waters communications from being shared with non-QIBs and non-IAIs and such information is nonetheless shared, such circumstances, in themselves, would not give rise to Section 5 liability for the issuer or the need for any cooling-off period."

Scope of eligible Issuers

Under the final rule, all issuers—including non-reporting issuers, EGCs, non-EGCs, WKSIs and investment companies (including registered investment companies and business development companies)—will be eligible to rely on the rule. The issuer and any person authorized to act on its behalf—including underwriters—will be able to rely on the exemption to provide permitted oral or written communications to qualified potential investors.

Investor status

Under the final rule, Rule 163B communications must be directed to potential investors that are, or that the issuer reasonably believes to be, QIBs or IAIs, including non-U.S persons who are also QIBs or IAIs. As explained in the Proposing Release, the limitation in the Rule to these types of investors was crafted to ensure that these communications were directed only to investors that are "financially sophisticated and therefore do not require the same level of protections of the Securities Act's registration process as other types of investors." As summarized in the Adopting Release, generally, a QIB "is a specified institution that, acting for its own account or the accounts of other QIBs, in the aggregate, owns and invests on a discretionary basis at least $100 million in securities of unaffiliated issuers." An IAI "is any institutional investor that is also an accredited investor, as defined in paragraph (a) of Rule 501 of Regulation D." The SEC declined to expand the list of potential recipients to, among others, individual accredited investors, as some commenters had suggested, because, at least initially, the SEC considered it best to include only "those institutional investors that the Commission has long recognized as having the ability to fend for themselves. Also, the intent of the exemption is to help issuers gauge market interest in a potential offering, and limiting the communications to institutional investors will allow issuers to accomplish this goal while mitigating any potential adverse effects on investors."

The final rule includes the "reasonable belief" standard as proposed. As stated in the Proposing Release, so long as the company "established a reasonable belief with respect to the potential investor's status based on the particular facts and circumstances," the company should not be subject to a Section 5 violation, even if the potential investor may have provided false information or documentation. As proposed, the SEC is not providing any specific guidance in the final rule regarding how to establish "reasonable belief" out of concern that the guidance "would become a de facto minimum standard. Instead, [the SEC believes] issuers should continue to rely on the methods they currently use to establish a reasonable belief regarding an investor's status as a QIB or accredited investor pursuant to Securities Act Rules 144A and 501(a), respectively." Because the steps are not specified, companies will have more "flexibility to use methods that are cost-effective but appropriate in light of the facts and circumstances of each contemplated offering and each potential investor." The SEC rejected the argument that, without mandatory specific steps, companies would use a "check-the-box" or other self-certification method and end up soliciting non-qualified investors. Rather the SEC "reiterate[d] that the steps necessary to establish a reasonable belief as to investor status will be dependent on the facts and circumstances of the contemplated offering and each potential issuer."


As summarized in the final release, Rule 144A(d)(1) sets forth non-exclusive means to determine whether a prospective purchaser is a QIB, identifying "the following non-exclusive methods of establishing the prospective purchaser's ownership and discretionary investment of securities: (i) the prospective purchaser's most recent publicly available financial statements; (ii) the most recent publicly available information appearing in documents filed by the prospective purchaser with the Commission or another U.S. federal, state, or local government agency or self-regulatory organization, or with a foreign governmental agency or self-regulatory organization; (iii) the most recent publicly available information appearing in a recognized securities manual; or (iv) a certification by the chief financial officer, a person fulfilling an equivalent function, or other executive officer of the purchaser, specifying the amount of securities owned and invested on a discretionary basis by the purchaser as of a specific date on or since the close of the purchaser's most recent fiscal year.


The final rule will be non-exclusive, as proposed, allowing companies to rely on other communications rules and exemptions, such as Section 5(d) or Rules 163, 164 or 255, when available. However, the SEC cautioned, to the extent an issuer decides to rely on another exemption or rule for those same communications, the issuer will need to take care to comply with the requirements of those other rules. For example, as observed in the Proposing Release, Rule 163, which allows WKSIs to test the waters, does not restrict communications to any particular group of investors, but is not available for use by underwriter offering participants and requires legending and filing. As a result, if a WKSI begins with QIBs only under Rule 163B, but later expands beyond the types of investors permitted under that rule, to claim exemption under Rule 163, the WKSI "must have complied with Rule 163's legending requirements from the start of any communications with non-QIBs or non-IAIs, and would have to file the legended materials if a registration statement is filed." (Note that the Proposing Release includes a very convenient table that summarizes these other provisions and helps to identify some of the finer distinctions. )

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.

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