SEC Adopts Securities Offering Reform

Introduction

The Securities and Exchange Commission recently adopted extensive reforms of the public offering process under the Securities Act of 1933, referred to as the Securities Act.  The new rules will be effective on December 1, 2005.  The reforms involve three main areas:

• Liberalizing the use of written and electronic communications before and during registered public offerings,
• Streamlining the shelf registration process for seasoned issuers and modernizing the prospectus delivery requirements, and
• Redefining and expanding securities law liability standards for public offerings.

The SEC’s actions are based on two major premises:

• Technology advances have fundamentally changed the way in which companies communicate with the capital markets, causing SEC communication rules and registration procedures to become unduly restrictive and outdated.
• Reporting standards under the Securities Exchange Act of 1934, referred to as the Exchange Act, have improved sufficiently to permit a “company registration” disclosure system for public offerings, based primarily on Exchange Act reports rather than a unique registration statement for each offering.

The primary beneficiary of the SEC reforms will be a new category of large reporting companies called “well-known seasoned issuers” (or “WKSIs”) that will be eligible for automatic shelf registration and the most liberal communication rules.  Generally, a WKSI is (1) an S-3 eligible issuer which (2) has a public equity float of $700 million or more, or in the case of debt (or straight preferred) offerings, has issued $1 billion in SEC-registered debt (or straight preferred) securities in the last three years.*

The new rules identify three other categories of issuers for the purpose of eligibility to take advantage of certain of the reforms.  A “seasoned issuer” is eligible to use Form S-3 to register primary offerings.  An “unseasoned issuer” is a reporting company that does not meet the requirements for a primary offering on Form S-3.  A “non-reporting issuer” does not file Exchange Act reports.  An issuer’s status in one of the four categories will substantially affect how the issuer may conduct a public offering.

Liberalizing Communications

In its proposing release, the SEC described the current restrictions on offers and pointed out that they raise questions for public companies that comply with the current extensive continuing disclosure requirements under the Exchange Act.  Moreover, the current rules inhibit desirable means of communication, make impossible the use of term sheets which would be useful for complex securities, and ignore the need for a flexible regime created by globalization. 

The SEC has effected liberalization by using its powers to define terms and to grant exemptions.  The cumulative effect of the rules changes will be as follows:

• WKSIs may engage at any time (including before filing) in oral or written communications, including the use at any time of the free writing prospectus described below, subject to enumerated conditions (including, in specified cases, filing with the SEC). 
• All issuers who file reports with the SEC under the Exchange Act will be permitted to continue to publish, at any time, regularly released factual business information and forward-looking information. 
• Non-reporting issuers will be permitted to continue to publish, at any time, factual business information that is regularly released to persons other than in their capacity as investors or potential investors. 
• In addition to the exemption for factual information and forward-looking information for reporting companies and factual information for non-reporting companies, the new rules exempt from the definition of “offer” all communications by the issuer made more than 30 days before filing, provided that the communication does not “reference” the offer and “the issuer takes reasonable steps within its control” to prevent republication during the 30 days prior to filing.
• After filing, all issuers (and not just WKSIs) will be permitted to use free writing prospectuses.  A free writing prospectus is any “written communication” that is an offer to sell securities.  Subject to filing and legend requirements, issuers in registered offerings will for the first time be permitted to make offers in writing before effectiveness of the registration statement other than by means of a statutory preliminary prospectus or red herring.  The definition of “written communication” is very broad and includes “all forms of electronic media.” 
• A broader category of routine communications will be excluded from the definition of “prospectus” in connection with the notice of the filing of a registration statement.
• The exemptions for research reports are expanded.

The use of the free writing prospectus is governed by new Rule 433.  A writing which meets the conditions of the rule is exempt from Section 5(b)(1) and (2) of the Securities Act and is deemed to satisfy Section 10(b).  In other words, the “prospectus” satisfies the statutory standard even though it doesn’t tell the whole story.  From the proposing and adopting releases, it is clear that this concept is intended to cover a wide range of communications, including:

• Supplemental sales literature used before effectiveness,
• Media coverage,
• Electronic road shows, and
• Issuer websites.

It is too early to tell whether this “one size fits all” approach is really practical, when one considers the normal requirement for a legend and filing with the SEC.  It is also unclear whether underwriters will be happy to take advantage, or to let issuers take full advantage, of the proposed liberalization, as prospectus liability under the Securities Act will attach to each free writing prospectus. 

Streamlining the Shelf Registration Process

The new rules provide for greater flexibility in the shelf registration process for all seasoned issuers (which include S-3/F-3 eligible issuers for primary offerings) and also provide for a special automatic shelf registration regime for WKSIs. 

Improved Flexibility for Shelf Registration for All Seasoned Issuers.  Rule 415, as currently in effect, limits the amount of securities that may be registered on a shelf registration statement to an amount that the issuer actually intends to offer or sell within two years from the effective date of the registration statement.  The amended version of Rule 415 eliminates this limitation, so that a seasoned issuer may now register an unlimited amount of securities on a shelf registration statement, although the issuer must still specify the total amount of securities to be registered.  Under revised Rule 415, issuers must file a new updated and restated shelf registration statement every three years and, in the case of a non-WKSI (i.e., in the case of a seasoned issuer), the new shelf registration statement must be declared effective by the SEC.  In addition, Rule 415 has been amended to eliminate current restrictions on primary “at the market” equity offerings, including the volume limit and the requirement to identify the underwriters in the registration statement.

For seasoned issuers, the revised rules retain many current requirements for disclosure in the base prospectus, including general descriptions of the types of securities to be offered and possible plans of distribution.  However, the new rules give a seasoned issuer greater flexibility to make material changes to the disclosure in the base prospectus, including the description of the plan of distribution, by means of prospectus supplement or incorporated Exchange Act reports.  Issuers may also continue to make material changes by post-effective amendment.  The revised rules codify the current general practice that seasoned issuers may omit from the base prospectus of a shelf registration statement at the time it is declared effective any information “unknown or not reasonably available” to the issuer.  A seasoned issuer with an effective resale registration statement following a private placement will generally be able to add the identity of selling shareholders by means of a prospectus supplement instead of a post-effective amendment.  In addition, the revised rules will allow primary offerings (takedowns) on Form S-3 or F-3 to occur immediately after effectiveness of a shelf registration statement, thereby eliminating the SEC’s current prohibition on the use of a “convenience shelf” (i.e., a shelf registration under which an issuer effects a takedown immediately following effectiveness).

Automatic Shelf Registration and Additional Flexibility for WKSIs.   WKSIs will benefit from substantially increased flexibility in connection with their primary and secondary shelf registration statements.  The SEC has stated that the new rules are meant to encourage large issuers to raise capital through the registration process and to facilitate the registration of rights offerings by eligible foreign private issuers.

With respect to WKSIs, the new rules permit:

• Streamlined shelf registration without review by the SEC,
• Automatic effectiveness of shelf registration statements upon filing,
• Pay-as-you go filing fees (under the new rules, such fees will be payable only in connection with a specific takedown, although an issuer may pay them in advance if it wishes, and there is also a cure provision for a failure to pay a fee on time), and
• The ability to add new classes of securities and related issuers, or to reflect fundamental changes in certain information, by filing post-effective amendments which will also be automatically effective upon filing. 

The automatic shelf registration process will allow a WKSI to register unlimited amounts of different types or classes of securities on a shelf registration statement which becomes automatically effective so that sales can take place immediately after filing.  The automatic shelf registration may cover both primary and secondary offerings, without allocation between the two types of offering.

A WKSI will also be permitted to omit from the base prospectus contained in a universal shelf registration statement a significant amount of information which under the current rules must be included in the base prospectus prior to effectiveness.  The information which WKSIs will be able to omit under the new rules includes:

• Descriptions of securities (with the exception of the identification of the type or class of securities),
• The plan of distribution,
• The offer price,
• Whether the offering is primary or secondary, and
• The identity of the underwriters.

The omitted information may then be added to a prospectus by means of:

• An automatically-effective post-effective amendment,
• An Exchange Act report (e.g., a Form 8-K or, in the case of a foreign private issuer, a Form 6-K) which is incorporated by reference in the shelf registration statement, or
• A prospectus supplement which will be deemed part of the shelf registration statement.

If a WKSI chooses to add new types of securities or new issuers or guarantors (i.e., eligible majority-owned subsidiaries), it will not be able to add this information in a prospectus supplement or in an Exchange Act report incorporated by reference but rather will be required to file a post-effective amendment to its shelf registration statement.  However, such a post-effective amendment will be automatically effective upon filing in the same manner as the original shelf registration statement.

The revised rules do not apply to registration statements filed in connection with business combination transactions or exchange offers.  In the case of issuers qualifying as WKSIs based solely on the amount of debt issued in the past three years, such issuers qualify for automatic shelf registration only for offerings of non-convertible securities other than common equity securities.

Form S-1 Reforms.  The revised rules amend Form S-1 to permit issuers that have filed at least one annual report and are current in their reporting obligations to incorporate by reference from its previously filed Exchange Act reports.  As a result of the expanded incorporation by reference into Form S-1, the rules eliminate Form S-2.

Prospectus Delivery Reforms.  The revised rules eliminate the requirement for physical delivery of a final prospectus if investors have access to a final prospectus properly filed with the SEC.  In this “access equals delivery” model, issuers, underwriters and dealers are not required to actually deliver a final prospectus before written confirmations or allocations are sent to investors or in connection with aftermarket trading.  Underwriters must provide investors with a notice stating that the sale was made pursuant to a registered offering.

Redefining Liability Standards 

The new rules also address significant liability issues under the Securities Act.  Section 11 of the Securities Act assigns civil liability for untrue statements of a material fact in a registration statement at the time it becomes effective or the omission of a material fact required to be stated in such registration statement or necessary to make the statements in the registration statement not misleading.  Section 12(a)(2) of the Securities Act assigns civil liability for offers or sales of a security by means of a prospectus or oral communication which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading.

Changes in the Treatment of Prospectus Supplements for Section 11 Liability Purposes.  Under the new rules, a prospectus supplement used in a shelf offering in connection with a takedown will be deemed to be part of the relevant registration statement as of the earlier of the date it is first used or the date/time of the first contract of sale of securities to which the prospectus supplement relates. As a result, the prospectus supplement will be subject to liability under Section 11 of the Securities Act.  In other words, for Section 11 liability purposes, for each shelf takedown using a prospectus supplement, a new effective date will be established for the relevant shelf registration statement, which will be the date the prospectus supplement was deemed part of the shelf registration statement.  However, the new effective date will not be considered the filing of a new registration statement for purposes of determining form eligibility and will not, by itself, require the filing of additional consents of experts.

Under the current rules, there is inconsistency concerning the date at which various participants’ liability is assessed in shelf takedowns:

• On the one hand, an issuer’s liability, and the liability of experts (e.g., auditors), directors and officers signing the registration statement, is tied to and assessed at the effective date of the registration statement, which “effective date” is often the date of filing of the issuer’s latest Annual Report on Form 10-K or 20-F, as applicable (the so-called “Section 10(a)(3) update”).
• On the other hand, the liability of an underwriter is tied to and assessed at the time the underwriter became an underwriter for a specific shelf takedown.

The new rules correct this mismatch by providing that liability for both the issuer and any underwriter(s) will be determined as of the takedown date.  However, the liability of the other shelf offering participants identified above will be determined as before, i.e., such participants’ liability will be assessed at the date of the issuer’s most recent annual report (i.e., the date of the Section 10(a)(3) update) or, if later, at the effective date of the relevant shelf registration statement.  This limitation of the new liability effective date to issuers and underwriters also appears to eliminate potential questions concerning the need to obtain new consents of auditors at the time of a particular shelf takedown.

New Rules Under Section 12(a)(2).  The new rules seek to address the discrepancy between the time at which an investor makes his or her investment decision, on the one hand, and the later time of availability of a final prospectus (and perhaps other information), on the other.  For purposes of Section 12(a)(2), the new rules establish liability based on the information conveyed to the investor at the time an investor enters into a contract for sale and becomes committed to the purchase of securities.  As a result, under the new rules, information delivered to an investor after the investor has made his or her investment decision will not be taken into account in determining whether an investor received all material information in connection with the sale of a security.  As a practical matter, the new rules will base liability on the preliminary prospectus or preliminary prospectus supplement (including any Exchange Act reports incorporated by reference) at the time the investor commits to purchase the security and any free writing prospectus that is provided to an investor.  Any modifications, clarifications and corrections in the final prospectus or prospectus supplement (including any subsequently filed Exchange Act reports) will not alter liability under Section 12(a)(2).  In addition, the new rules will make issuers in a primary offering a “seller” for purposes of Section 12(a)(2), which imposes liabilities on sellers of securities. 

Effectiveness

The new rules will be effective on December 1, 2005.  Until that date, issuers must continue to comply with the existing rules.  The relatively long transition period is intended to give issuers and underwriters an opportunity to modify their offering procedures to fit the new rules.