United States: Securities Offering Reform: A Takeoff From The Aircraft Carrier

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 SEC’s proposals would enhance the disclosure requirements under that Act and the Securities Exchange Act of 1934 ¾ which have both undergone significant changes since the enactment of the Sarbanes-Oxley Act of 2002 ¾ 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.

Rather than propose a comprehensive overhaul reminiscent of the SEC’s now-sunk "Aircraft Carrier" proposals of 1998, the new proposals work within the existing registration and offering structure that has been afloat since the initial adoption of shelf registration in the early 1980s. In particular, the 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." A well-known seasoned issuer ¾ or "WKSI" ¾ is generally a company eligible to file a registration statement for an offering of debt or equity securities on Form S-3 or Form F-3 that either has a "public float" of at least $700 million or has issued at least $1 billion of registered debt over the past three years and registers only debt securities. Although the proposals do not focus on private offerings of securities, such as Rule 144A offerings, given the increased flexibility afforded to the registration process in the proposal, it is clear that the SEC intends to encourage the use of SEC-registered offerings over the widespread reliance on Rule 144A offerings by issuers, particularly WKSIs.

Our Related Client Alerts

This Client Alert provides an overview of the SEC’s proposal. In addition, because of the technical nature of the proposed reforms ¾ which took the SEC nearly 400 pages to summarize and promulgate ¾ we have prepared a separate and more detailed Client Alert for each of the three principal proposals covered by the SEC’s release:

• our Client Alert entitled "Securities Offering 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 Offering 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
• our Client Alert entitled "Securities Offering Reform: Prospectus Delivery Proposal" 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; that Client Alert also covers other topics in the SEC’s 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

Moreover, the proposals modify and clarify the principal liability provisions of the Securities Act of 1933, 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.

The SEC’s proposals would divide issuers into various categories, including the newly-coined term WKSI:

• "well-known seasoned issuer" or "WKSI":

• "ineligible issuer" includes a laundry list of disqualifications, including an issuer having entered into a settlement during the prior three years with any government agency involving allegations of violations of federal securities laws

• "seasoned issuer": a company eligible to use Form S-3 or Form F-3 to register primary offerings on its own behalf or on behalf of its subsidiary or parent company

• "unseasoned issuer": a company that is required to file, or that voluntarily files, SEC reports, but is not eligible to use Form S-3 or Form F-3

• "non-reporting issuer": a company that is not yet required to file SEC reports, including a company filing for an initial public offering, or IPO

The SEC believes that $700 million of public float for a reporting issuer indicates that it has a demonstrated market value. Similarly, the $1 billion debt issuance threshold for issuers of public debt indicates that they are in the group of most-active issuers in the U.S. public capital markets. Also, the issuers that meet these proposed thresholds for WKSI status generally have high levels of analyst coverage, institutional ownership and trading volume. According to the SEC’s data for 2003, these issuers represented about 30% of listed issuers and about 95% of U.S. equity market capitalization. The SEC believes that it is appropriate to provide greater communications and registration flexibilities to WKSIs beyond that provided to other issuers, including other seasoned issuers.

Many types of offerings contemplated by the SEC’s rules can be accomplished by using a prospectus that is complete at the time of the effectiveness of the related registration statement. However, other types of securities offerings ¾ so-called "shelf" registrations ¾ require updated or additional information in the form of a prospectus supplement at the time securities are "taken off the shelf." Currently, there are no formal rules specifying the relationship between the prospectus included in the original registration statement ¾ often referred to as the "base prospectus" ¾ and any later-filed prospectus supplements. Consequently, the SEC has proposed rules that would both codify certain existing practices and clarify other procedures necessary for an issuer to update its registration statement.

The SEC has proposed automatic shelf registration for WKSIs, which would allow WKSIs to register an unspecified amount of different types of securities on a registration statement that would be automatically effective upon filing, without SEC staff review. To make use of the automatic shelf registration process, an issuer would be required to meet the eligibility requirements for a WKSI both on the initial filing date of the registration statement and again at the time each prospectus supplement is issued. The automatic shelf registration process, together with the loosening of the restrictions on communications, would provide WKSIs with the flexibility to use a free writing prospectus to structure transactions and to market these transactions in an expeditious manner.

In this context, the SEC expects that issuers will need to evaluate if there are any material disclosure or accounting issues that the staff has raised on any of the issuer’s SEC periodic reports that remain unresolved. Moreover, the SEC will require disclosure of written staff comments that were received 180 days before an issuer’s fiscal year end that the issuer believes are material and remain unresolved at the time the issuer files its next annual report on Form 10-K or Form 20-F.

In addition to the automatic shelf registration process, the SEC has proposed a number of helpful, general reforms in the shelf registration context:

• the elimination of a ceiling on the amount of securities to be registered under a registration statement, which instead would have a finite life of three years with any unsold securities or unused fees to be carried forward to a new registration statement

• the ability for an issuer to add to the list of selling security holders after a registration statement has been declared effective (for example, where a transfer of restricted securities has occurred after a private placement has been completed) by providing the required information in a prospectus supplement, thus eliminating unnecessary delay to the offering

• the elimination of the requirements that an issuer conducting an "at-the-market" offering of voting stock may not sell additional voting stock in excess of 10% of the aggregate market value of its currently outstanding voting stock held by non-affiliates and that all such offerings must be sold through an underwriter named in the prospectus

• the ability for an issuer to commence a primary offering promptly after a shelf registration statement has been declared effective

• the establishment of a pay-as-you-go filing fee system under which an issuer would pay a small initial filing fee at the time of filing its initial registration statement and then, for each takedown, would pay an additional amount at the time of filing a prospectus supplement

The Securities Act of 1933 currently restricts the types of communications that issuers, underwriters and other offering participants may use during a registered public offering. Before a registration statement is filed, all offers, whether oral or written, are prohibited; the term "offer" has been interpreted very broadly for these purposes and includes any communication that would have the effect of conditioning the market for a securities offering. Between the filing of a registration statement and its effectiveness, subject to limited exceptions, offers made in writing (including by e-mail or Internet) are limited to a "statutory prospectus" that conforms to specified SEC-information requirements. After a registration statement is declared effective, offering participants must continue to make any written offers through a statutory prospectus, but they may use additional written offering materials if a final prospectus precedes or accompanies those materials. Violations of these restrictions are commonly referred to as "gun-jumping."

As a starting point for its communications proposal, the SEC has proposed a rule making clear that all electronic communications, including Internet communications, e-mails and other electronic and web-based communications (except for most telephone communications), are graphic and, therefore, written communications. The overall effect of the SEC’s communications proposal, however, is intended by the SEC to enhance the ability of offering participants to make written offers outside the statutory prospectus, which are known as "free writing prospectuses." Varying levels of restrictions and conditions to the use of these free writing prospectuses would apply depending on the category of issuer, with WKSIs having the most flexibility on the theory that communications by WKSIs would have the least potential for conditioning the market for a securities offering. The communications proposal generally provides the following:

• two separate exemptions ¾ or so-called "safe harbors" ¾ from the gun-jumping provisions for ongoing communications for:

• two separate safe harbors from the gun-jumping provisions for communications that occur prior to the filing of a registration statement, but are not covered by the safe harbors described above, for:

The proposal would expand the scope of permissible factual information about an offering itself, including the details of road shows, and would permit the disclosure of any security ratings reasonably expected to be assigned, but would not permit the use of a detailed term sheet for the securities being offered, which instead would be covered by a free writing prospectus. In addition, the two safe harbors described above that apply prior to filing a registration statement would not apply to issuers with shelf registration statements on file, whether or not effective, to whom the prohibition on all offers in the gun-jumping provisions would not apply.

The most significant aspect of the communications proposal is the concept of a "free writing prospectus," which would be defined as any written offer of a registered security except for statutory prospectuses and written offers otherwise permitted or exempted by existing rules or the new proposed rules (including the safe harbors and exemptions discussed above and offers made after a final prospectus has been sent or given). As proposed, a free writing prospectus (or the information contained in a free writing prospectus) would have to be filed with the SEC.

In addition to the filing conditions, the proposal also includes eligibility, legend and record retention requirements for the permitted use of free writing prospectuses, including the following:

• a WKSI could use a free writing prospectus at any time

• a seasoned issuer (or an offering participant with respect to a WKSI or a seasoned issuer) could use a free writing prospectus after the filing of a registration statement containing a statutory prospectus (which would include a preliminary prospectus or a base prospectus in a shelf offering)

• an issuer that is not a seasoned issuer (or an offering participant with respect to an issuer that is not a seasoned issuer) could use a free writing prospectus after the filing of a registration statement containing a statutory prospectus, which would include a preliminary prospectus

Because a preliminary prospectus for an IPO that does not contain an estimated price range does not satisfy the requirements for a statutory preliminary prospectus, and since the price range in recent years generally has not been disclosed in the registration process until close to the time that an issuer is ready to commence its road show, there may be a limited time period during which free writing prospectuses may be used in an IPO.

Under the free writing prospectus regime proposed by the SEC, in most cases, filing would not be required for free writing prospectuses prepared by underwriters or dealers. Information prepared by underwriters (including proprietary information) on the basis of, but, importantly, not containing, issuer information would usually not need to be filed. However, underwriter written communications that meet the "broad unrestricted dissemination" standard set forth in the proposal would require filing by the underwriters.

Under existing interpretations of the gun-jumping provisions and SEC staff practice, information about an issuer or an offering furnished by the issuer or its representative that is published by the media is deemed by the SEC to be an impermissible written offer. The SEC staff has required issuers to delay offerings and either to disavow the statements or to include them in a revised prospectus and thus have those statements become subject to securities law liability. Under the proposal, if any offering participant has provided information to the media about an issuer or an offering that would constitute an offer (whether orally or in writing) and the information is published or broadcast in any form (including the publication of information obtained at an electronic road show with a limited audience or a live road show to which the media were invited), then the publication or broadcast generally would be considered a free writing prospectus that must be filed with the SEC.

The proposed free writing prospectus rules raise a panoply of issues with respect to electronic road shows, which, to date, have been conducted in reliance on a series of SEC no-action letters. Under the proposal, the SEC would clarify that electronic road shows are written communications that also would be considered free writing prospectuses subject to filing unless certain conditions are satisfied. Live road shows otherwise would continue to be considered oral communications. An electronic road show (or its script) would not be subject to filing except for material issuer information not previously included or incorporated by reference in the registration statement or a free writing prospectus related to the offering, provided the issuer makes at least one version of a "bona fide electronic road show" (which would be a version of the road show that covers the same general areas but need not address all of the same subjects or provide the same information as other versions) readily available electronically to any potential investor at the same time as the electronic road show and files any issuer free writing prospectus or material issuer information used at an electronic road show (other than the road show itself). Although the proposal does not require that road shows be made available to unrestricted audiences, they likely will encourage broader availability of road shows to all investors (whether institutional or retail), especially when the conditions to avoid filing are taken into account.

The proposal also would make clear that an offer of an issuer’s securities that is contained on an issuer’s website or hyperlinked from the issuer’s website would be a free writing prospectus. Thus, if a hyperlink was included within a written communication used to offer the issuer’s securities (such as a free writing prospectus), the hyperlinked information would be considered part of that written communication. The SEC has stated that issuers in registration should be able to segregate historical information properly identified as such on their websites into an archival section so that it remains accessible to the public but will not be presumed to be reissued or republished for these purposes or considered a current offer, provided that the information is not incorporated or otherwise included in a prospectus or used, identified, updated or modified in connection with the offering or otherwise. Issuers therefore should take great care in using hyperlinks and maintaining their websites.

The proposal would also make incremental amendments to existing safe harbors for the publication of research reports.

• Rule 137, which provides that a non-offering participant broker or dealer that publishes or distributes research will not be considered an underwriter, would be expanded to apply to securities of any issuer rather than solely to securities of those issuers that are required to file SEC reports

• Rule 138, which provides that a broker or dealer participating in a distribution of one type of the issuer’s securities may publish or distribute research confined to another type of the issuer’s securities, would be expanded to cover research reports on all reporting issuers that are current in their SEC periodic reports (rather than only seasoned issuers) and would require that the broker or dealer must have previously published or distributed research reports of the types of securities that are the subject of the reports in the regular course of its business

• Rule 139, which provides that a broker or dealer participating in a distribution of securities of a seasoned issuer may publish research concerning the issuer or any class of its securities if that research is in a publication distributed with reasonable regularity in the normal course of its business, would be amended to eliminate the requirement that the report be published with reasonable regularity, provided that the broker or dealer must, at the time of use, have published or distributed research reports about the issuer or its securities, though there is no minimum time period or requirement that the same securities be covered

In addition, the proposal would:

• permit a broker or dealer to publish a more favorable recommendation under the safe harbor of Rule 139 than the one made in its last publication

• provide that research reports meeting the conditions of Rules 138 and 139 would not be considered offers or general solicitation or general advertising in connection with Rule 144A offerings, nor would they constitute directed selling efforts or be inconsistent with the offshore transaction requirements of Regulation S

Section 5 of the Securities Act of 1933 requires that a sale of a security be "accompanied or preceded by a prospectus," which has resulted in the physical delivery of a final prospectus 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 it does not provide them with any information that would affect their investment decision.

Consequently, the SEC has proposed adopting an "access equals delivery" model for most securities offerings. Under this model, issuers and underwriters would no longer need to print and mail prospectuses to all purchasers of a security prior to closing, but they would be deemed to have met their prospectus delivery requirements by filing the prospectus on EDGAR. The proposal would require that a notice indicating that the sale was made pursuant to a registration statement, in lieu of the final prospectus, be sent to each purchaser. The purchaser would still be able to request a physical copy of the final prospectus, which could be delivered after closing. Written confirmations and notices of allocations of securities may be sent after the effectiveness of the registration statement without being accompanied or preceded by a final prospectus, provided that the issuer has filed the final prospectus with the SEC. Also, dealers would generally benefit from the access equals delivery model, as they would not be required to deliver prospectuses in aftermarket transactions.

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.

Because the proposed rules apply only to final prospectuses, in transactions in which there is an obligation to deliver a preliminary prospectus, such as IPOs, the preliminary prospectus would still need to be delivered. However, the SEC has requested comment as to whether or not this access equals delivery model should be extended to IPOs. The access equals delivery procedure would not be available in certain contexts, including business combinations and exchange offers that are subject to federal and state law provisions that require delivery of documentation to holders and offerings pursuant to Form S-8.

The proposal includes an interpretation by the SEC ¾ which reflects a "core concept" of the Securities Act of 1933 ¾ 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 of 1933, 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, including private rights of action by purchasers of an issuer’s securities in a registered offering under Section 11 and seller’s liability to purchasers for offers or sales by means of a prospectus or oral communication under Section 12(a)(2), as well as the general anti-fraud provision of Section 17(a)(2).

In keeping with the SEC’s views that investors do not rely on the final prospectus in making their investment decision, the proposal 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. The proposal would codify the SEC’s interpretation that information conveyed to an investor after the time of sale should not be taken into account in determining whether or not the information conveyed to an investor at the time of a sale by or on behalf of a seller (including an issuer, underwriter or participating dealer) was materially deficient under Section 12(a)(2) or Section 17(a)(2). Therefore, 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. 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 ¾ and, possibly, earlier ¾ 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 communications proposal, issuers will have more options available to them for conveying information to purchasers. Liability under Section 12(a)(2) and Section 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 SEC 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 proposal, 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, a 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 may also have the effect of encouraging issuers and their underwriters to recirculate preliminary prospectuses to disclose recent developments not previously disclosed that otherwise would have been disclosed in the final prospectuses.

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.

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 arrangements. The proposal clarifies 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. A communication by an underwriter or a dealer participating in an offering would not be on behalf of the issuer solely by virtue of that participation, but depending on the facts and circumstances, a communication by an underwriter or a dealer could be such a communication to the extent it contains issuer information.

The proposal would clarify that information contained in a prospectus supplement or incorporated by reference would be deemed a part of and included in the registration statement for purposes of liability under Section 11. For a prospectus supplement filed in connection with a takedown of securities off the shelf, the information in the prospectus supplement would be deemed a part of the registration statement as of the date it is first used or the date of the first contract of sale of securities in the offering to which the prospectus supplement relates, whichever is earlier. The SEC believes that the proposal would eliminate the unwarranted and disparate treatment afforded underwriters and issuers under Section 11, inasmuch as issuers may not be subject to the same liability as that of underwriters in shelf takedowns occurring a significant time after the registration statement’s initial effectiveness.

In addition, the proposal also would provide that ¾ again, for liability purposes only ¾ a new effective date is created for a shelf registration statement in a takedown offering, with the new effective date being the date on which the prospectus supplement is deemed a part of the registration statement as described above.

A free writing prospectus would not be considered part of a registration statement (unless the issuer elected to file it as part of a registration statement) and therefore would not be subject to liability under Section 11. Regardless of whether a free writing prospectus is filed, however, any person using a free writing prospectus would be subject to liability under Section 12(a)(2) and the anti-fraud provisions of the federal securities laws, as all free writing prospectuses would have the same statutory liability as oral offers and statutory prospectuses. Written communications not constituting offers and, therefore, not prospectuses within the meaning of the Securities Act of 1933, including certain of the communications safe harbors proposed by the SEC discussed above, would not be subject to disclosure liability applicable to prospectuses under Section 12(a)(2). These written communications would, however, be subject to liability under the anti-fraud provisions of the federal securities laws, including Rule 10b-5 under the Securities Exchange Act of 1934. It is clear from the proposing release that the SEC’s faith in the investor protection provided by the liability provisions of Section 12(a)(2) and the anti-fraud provisions of the federal securities laws is a key factor underlying the proposal to permit "free writing" beyond the statutory prospectus and not requiring any particular information to be included (other than a legend), as is the case with statutory prospectuses.

Although virtually all issuers include risk factors in registration statements filed under the Securities Act of 1933, it is not uncommon for certain issuers ¾ including, for example, well-seasoned NYSE-listed companies ¾ to exclude them from their SEC periodic reports. However, the SEC has proposed revising Form 10-K and Form 10 to require risk factor disclosure in plain English, which would include the same kinds of risks currently disclosed in 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 materially changed during that quarter.

In recognition of the limited use of Forms S-2 and F-2 in recent years, as well as changes in the securities markets since the forms were adopted, including the proposal to permit most issuers that have filed at least one annual report to incorporate existing information by reference into their filings on Forms S-1 an F-1, the proposal would eliminate Forms S-2 and F-2.

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.