The Securities and Exchange Commission (SEC) has proposed amendments to its rules that would eliminate the use of investment grade credit ratings as a condition for short-form registration of securities. In 2008, the SEC proposed to eliminate the use of investment grade credit ratings as a condition to the eligibility for "short-form" registration on Form S-3 or F-3. That proposal languished in light of opposition from most commentators. Last year's enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, however, required the SEC to remove references to credit ratings from its rules under the Securities Act of 1933 (1933 Act) and the Securities Exchange Act of 1934 (1934 Act). Accordingly, the SEC is now proposing amendments that are substantially similar to those it proposed in 2008, as well as soliciting comments on their impact on public companies and other market participants and the availability of other alternatives that it should consider.
The SEC Proposes to Replace Credit Ratings Transaction Requirement for Use of Form S-3
To be eligible to use Form S-3 (references in this advisory to Form S-3 also refer to Form F-3) as a shortform to register securities under the 1933 Act, a public company must meet the form's registrant requirements (which generally pertain to reporting history under the 1934 Act) and at least one of the transaction requirements of the form. One such transaction requirement permits public companies to register primary offerings of non-convertible securities if the securities are rated investment grade by at least one nationally recognized statistical rating organization. Instead of investment grade credit ratings as a transaction requirement, the SEC proposes — as it also did in 2008 — that a primary offering of nonconvertible securities be eligible for registration on Form S-3 if the company has issued at least $1 billion of non-convertible securities (other than common equity) for cash in transactions registered under the 1933 Act during the past three years (as measured from a date within 60 days of the filing of the registration statement). Non-convertible securities issued in private placement transactions or in registered exchange offers (such as private placements and so-called Rule 144A offerings) would not count towards the $1 billion threshold. In determining compliance with the proposed $1 billion threshold, the SEC would use the same standards that are used in determining whether a public company is a "well-known seasoned issuer" (WKSI) although, unlike a WKSI, the new Form S-3 eligibility criteria could be met by a public company that is an "ineligible issuer" under the 1933 Act.
Certain Public Companies, Especially Operating Subsidiaries of Many Utility Holding Companies, Could Lose S-3 Eligibility
With its proposal, the SEC is seeking to reduce reliance on credit ratings as a measure of Form S-3 eligibility while preserving eligibility for those public companies that are widely followed in the market. Although the SEC preliminarily believes its proposal is the most workable alternative for determining whether a public company is widely followed in the marketplace so that Form S-3 eligibility is appropriate, the more relevant question seems to be whether the proposal is an adequate replacement of the investment grade transaction requirement condition. Moreover, through comments received on its 2008 proposal, the SEC is aware that its proposal may make Form S-3 unavailable to certain high-quality, investment grade public companies, weakening their ability to access the public market. The SEC pointed out in its proposal that many wholly owned, state-regulated operating subsidiaries of utility holding companies that currently are so-called "seasoned issuers" eligible to use Form S-3 would lose that eligibility if the proposal is adopted because they could not meet the $1 billion threshold and would not satisfy any other transaction requirement condition. The SEC suggested alternative approaches in its proposal that would be relevant to such operating subsidiaries, including the following:
- should the SEC include a provision in Form S-3 that would allow such an operating subsidiary to continue to register offerings on Form S-3 (even if it cannot meet the $1 billion threshold) because either it is regulated by state utility commissions or its parent is eligible to register a primary offering on Form S-3?
- are there certain key financial metrics that would be useful proxies in evaluating eligibility for use of Form S-3?
Practical Consequences if the SEC's Proposal is Adopted
If the SEC's proposal is adopted, public companies that do not meet the three-year, $1 billion transaction requirement condition (and do not meet any other applicable transaction requirement condition) will not be able to use the "short-form" registration afforded by Form S-3. As a result, these companies will need to consider and evaluate other methods for issuing their securities in compliance with the 1933 Act, each of which will likely result in higher costs of financing, other increased burdens in the offering process and changes in routines that have been constant for decades.
Public companies that are not eligible for Form S-3 may register their securities under the 1933 Act on Form S-1. Although Form S-1 permits "backward" incorporation by reference of reports filed under the 1934 Act, unless engaged in a continuous offering of securities (e.g., those that are offered promptly after effectiveness and will continue to be offered in the future, such as medium-term notes), public companies that are ineligible to use Form S-3 would not be able to conduct "delayed" offerings "off the shelf" (such as traditional bond offerings) and instead would be required to conduct one specific offering at a time. This offering process would subject such a company to the risk of SEC review for each offering and could result in a "speed bump," inhibiting the ability to conduct opportunistic offerings when market conditions are optimal without the availability of an effective shelf registration statement.
Alternatively, a public company that would be ineligible to use Form S-3 could choose to forego the 1933 Act registration process altogether and access the capital markets by conducting a private placement, either by way of a direct placement with investors pursuant to Section 4(2) of the 1933 Act or by way of a Rule 144A offering through an investment bank acting as initial purchaser. Although these financing approaches would remove timing uncertainties associated with an SEC review, conducting private placements often results in an "illiquidity premium" because investors receive restricted securities (unless registration rights are negotiated as part of such financings and the restricted securities are exchanged for securities registered under the 1933 Act). In addition, transaction costs may be higher to conduct a private placement, particularly if a registered exchange offer is contemplated after the private placement. If public companies access the private placement market as opposed to registering their securities under the 1933 Act as a result of losing their S-3 eligibility by virtue of the SEC's proposal, the private placement would not be subject to the strict liability standard of Section 11 of the 1933 Act, a policy development that would be an unintended and unfortunate consequence from the perspective of the SEC.
Pillsbury's Energy Capital Markets team, which works routinely with a significant number of U.S. utility companies, believes that the SEC, as evidenced by its detailed requests for comments, is looking to accommodate utility companies that historically have been eligible to use Form S-3, so it will be particularly important for these companies to be active in providing feedback to the SEC on its proposal. Comments should be submitted by March 28, 2011.