The SEC’s rules that classify issuers are not always widely followed beyond the securities bar. However, one of the most active current debates about the federal securities laws concerns the potential loss of “well known seasoned issuer” (WKSI) status by large financial institutions as a result of becoming “ineligible issuers” and the SEC’s policies as to granting waivers. Many of the issuers potentially affected by this debate are issuers of registered structured notes. As a result, this article discusses the steps that distributors of structured notes need to consider or take when one of their issuers becomes an ineligible issuer and a waiver is not granted.17
WKSIs and Ineligible Issuers
WKSIs enjoy certain privileges under the federal securities laws, including the ability to use an automatically effective shelf registration statement. This type of registration statement is not subject to prior review and comment by the SEC and helps issuers to enter the market more quickly and on a cost-effective basis.
However, what the SEC rules giveth, the SEC rules also may taketh. An issuer that is an “ineligible issuer” (see SEC Rule 405 for the definition) will cease to be a WKSI. A company can become an ineligible issuer under a variety of circumstances, including as a result of certain violations of the federal securities laws. It won’t surprise the readers of this publication that, notwithstanding significant institutional efforts to comply with these laws, in the context of a large diverse financial institution, violations can arise that result in ineligible issuer status.
Limited Content of FWPs – Form of Red Herring
Free writing prospectuses (FWPs) became permissible in December 2005, following the SEC’s “securities offering reform” rule-making process. In the structured note industry, market participants have become quite accustomed to using these rules to create a variety of marketing materials, including short-form red herrings, detailed term sheets, and product brochures, which were prohibited under the old rules. However, Rule 164, which provides the framework for the use of FWPs, significantly limits their use by ineligible issuers. Specifically, ineligible issuers are only permitted to use FWPs that set forth the terms of an offering. The use of detailed FWPs is prohibited for ineligible issuers. This restriction applies not only to materials prepared by the issuer itself, but also to other offering participants, such as underwriters and dealers. As a result:
- many types of marketing materials for structured products become off-limits for an ineligible issuer and its distributors; and
- ineligible issuers are forced to revert to the “traditional” long form “preliminary pricing supplements,” with the issuer’s robust base offering documents attached.18
The timing of ineligible issuer status is important here. For purposes of Rule 164, the “ineligible issuer status” is assessed at the time that a new offering is commenced. Accordingly, this facet of ineligible issuer status − the loss of the use of many FWPs − will typically come into play more quickly than the requirement to amend a shelf registration statement, as described in the next section.
Distributors of products offered by these issuers are encouraged to review their marketing materials to ensure that they comply with the applicable requirements. Dealers may also be subject to contractual restrictions that will expressly limit their ability to create materials that conform to the now reduced content restrictions of Rule 164 that are applicable to ineligible issuers.
New Shelf Registration Statement
Once an ineligible issuer files its first annual report with audited financial statements, it will cease to be able to utilize its automatically effective WKSI shelf registration statement. In a “Compliance and Disclosure Interpretation,” 19 the SEC provided a bit of a remedy to smooth the transition from the automatically effective registration statement to a traditional non-WKSI registration statement. That is, when the issuer becomes an “ineligible issuer,” it may file an amendment to its existing WKSI shelf on the form that it is then eligible to use – typically, Form S-3 (for U.S. issuers) or Form F-3 (for non-U.S. issuers).
For most financial institution issuers, the non-WKSI form of Form S-3/F-3 will not differ much from that of a WKSI shelf registration statement. However, when taken together with the required legal opinions, auditor consents, and other required exhibits, the preparation and filing of the new registration statement is not an insubstantial undertaking and requires careful planning. In addition, at some point after the new shelf is filed, many issuers will restate their “MTN prospectus supplement” and structured note product supplements to reflect the filing of the new shelf registration statement, as well as make a variety of related changes to their red herrings and final pricing supplements to reflect the filing and its contents. For underwriters, amendments to their existing program agreements with the relevant issuer which relate to ineligible issuer status are likely to be required and negotiated between the parties.
As a result, in connection with the new registration statement filing, distributors should review the materials that they use, both internally and with investors, that describe the relevant issuer’s disclosure documents. These will likely require updates to match up with the issuer’s new base prospectus and related documents.
A Brief Note on Canadian Issuers
Every cloud has a silver lining, at least, sort of. Canadian issuers that file registration statements in the United States under the Multi-Jurisdictional Disclosure System (MJDS)20 are not eligible to be WKSIs. These Canadian issuers were not necessarily pleased in 2005 when the new rules did not provide to them the benefits of a WKSI shelf. However, if such an issuer were to become an ineligible issuer, it would not need to re-file its shelf registration statement. On the other hand, such a Canadian issuer and its distributors would be subject to the limitations on the use of FWPs under Rule 164 that apply to ineligible issuers.
Ineligible issuer status will significantly impact the documentation used in connection with structured note and other registered securities offerings. When apprised of an upcoming development of this nature, distributors will need to review carefully their suite of offering documents in order to carefully plan their upcoming offerings and to make any necessary changes.