On September 26, 2019, the Securities and Exchange Commission (SEC) adopted new Rule 163B and related amendments under the Securities Act to expand the permitted use of "testingthe-waters" communications to all companies regardless of size or reporting status, including business development companies (BDCs) and other registered investment companies. The new rule enables any issuer, including those that are not an emerging growth company (EGC) or any person authorized to act on the issuer's behalf, to make oral and written offers to qualified institutional buyers (QIBs) 1 and institutional accredited investors (IAIs) 2 before or after the filing of a registration statement to gauge investors' interest in an offering.

This new rule is a much-anticipated development that will level the playing field for issuers seeking to evaluate market interest prior to a registered public offering and represents an additional example of the SEC taking concerted action to encourage public capital formation.

The rule will become effective 60 days following its publication in the Federal Register.


In 2012, Congress passed the Jumpstart Our Business Startups Act (JOBS Act) to ease regulatory burdens on smaller companies and encourage public and private capital formation. The JOBS Act created a new class of issuers, EGCs, with less than $1 billion (subsequently increased to $1.07 billion) in annual revenues and implemented a number of changes to the initial public offering (IPO) process, including establishing a transitional "on-ramp" that provides for scaled disclosure for EGCs.

As part of these reforms, the JOBS Act significantly eased long-standing restrictions on "gunjumping" under Section 5 of the Securities Act by permitting EGCs, or persons authorized to act on their behalf, to make testing-the-waters communications before or after the filing of a registration statement. Testing-the-waters communications may solicit nonbinding indications of interest but may not solicit a binding commitment or customer order. Offerings for which EGCs may test the waters include IPOs, exchange offers, follow-on offerings and stock merger-related offerings.

Testing-the-waters activities vary from deal to deal. Typically, in a capital markets transaction, they resemble a roadshow presentation where management meets with potential investors and gives a presentation describing the issuer and the proposed offering. Representatives of the lead underwriter(s) usually arrange and accompany management at these meetings. Written materials may be used, although investment banks' internal policies vary and some limit or prohibit written materials. Most often, management uses a presentation that resembles a roadshow deck but does not leave behind and carefully limits any other written materials. 3

New Rule 163B

The SEC's new rule, Securities Act Rule 163B, expands testing-the-waters accommodations to permit any issuer, or any person authorized to act on its behalf, to engage in oral or written communications with potential investors that are, or are reasonably believed to be, QIBs or IAIs, either prior to or following the filing of a registration statement, to determine whether such investors might have an interest in a contemplated registered securities offering.

Under Rule 163B:

  • All issuers are entitled to rely on the exemption, including nonreporting issuers, EGCs, non-EGCs, well-known seasoned issuers (WKSIs) and BDCs and other registered investment companies.
  • Testing-the-waters communications will not need to be filed with the SEC or required to include any specific legend.
    • The release, however, notes that the SEC staff anticipates requesting, in connection with its review of a registration statement, that any testing-the-waters communication used in connection with the offering be furnished to the staff for review, as has been its practice when reviewing offerings conducted by EGCs.
  • Issuers will not be required to otherwise verify an investor's QIB or IAI status as long as they reasonably believe the potential investor meets the requirements of the rule.
    • The SEC did not adopt specific steps or methods to establish a reasonable belief, or to require issuers to take reasonable steps to verify, that the intended recipients of testing-the-waters communications are QIBs or IAIs.


1 In general, a QIB is any entity included within one of the categories of "accredited investor" defined in Rule 501 of Regulation D, acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers not affiliated with the entity ($10 million for a brokerdealer).

2 An IAI refers to any institutional investor that is also an accredited investor, as defined in Rule 501 of Regulation D (generally an entity not formed for the purpose of investing in the securities being offered with total assets in excess of $5 million).

3 Although there is no prohibition on using or providing copies of the registration statement that was confidentially submitted to the SEC for testing-the-waters communications (often referred to as the "pink herring" prospectus), a number of investment banks prohibit such practice. Similarly, while there is no prohibition on recording testing-the-waters presentations and posting them on a restricted access site such as NetRoadshow, these practices are rare. However, investment banks may permit presentation materials to be made available for a limited time and on a restricted access basis on NetRoadshow in order to facilitate telephonic meetings. Finally, there is no prohibition on conducting testing-the-waters meetings with groups of more than one QIB and/or IAI, but it is uncommon to do so, and investment banks often prefer to conduct meetings with potential investors one-on-one.

Originally published by Harvard Law School Forum on Corporate Governance and Financial Regulation

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