On February 19, 2019, the Securities and Exchange Commission (the "SEC") issued a release (the "Release") proposing new Rule 163B under the Securities Act of 1933, as amended (the "Securities Act") to expand the use of "test-the-waters" ("TTW") communications currently limited to emerging growth companies ("EGCs") to all issuers (or any person authorized to act on their behalf). TTW communications (oral or written communications by issuers, or their authorized representatives, with certain investors made before or after a registration statement (that covers the securities to be offered) is filed with the SEC) are designed to determine whether there is sufficient investor interest in a contemplated registered securities offering. The SEC hopes that proposed Rule 163B, if enacted, will encourage more issuers to access the capital markets through a registered offering.
I. Executive Summary
Key parts of proposed Rule 163B are:
- TTW available to all issuers and their agents: All issuers (including non-EGCs) or any person authorized to act on their behalf (including underwriters or dealers) would be permitted to engage in TTW communications;
- Timing: TTW communications could be made prior to or after the filing of a registration statement with the SEC;
- Only for certain investors: TTW communications could only be made to prospective investors that are, or reasonably believed to be, qualified institutional buyers ("QIBs")3 or institutional accredited investors ("IAIs")4;
- No verification requirement: Issuers would not be required to verify an investor's status so long as they "reasonably believe" the potential investor meets the QIB or IAI requirements;
- No legend or filing requirements: Any TTW communications would not need to be filed with the SEC or include any specific legend;
- Non-exclusive: The rule would be non-exclusive, meaning issuers could rely on other exemptions;
- Liability: Any TTW communication would constitute an "offer" under the SEC rules and thus be subject to liability under the federal securities laws; and
- Other considerations: TTW communications must not conflict with material information in the related registration statement, and issuers will need to consider any applicable obligations under Regulation FD.
Section 5 of the Securities Act and related rules restrict communications by issuers during various phases of the securities offering process. For example, Section 5(c) generally prohibits written and oral offers prior to the filing of a registration statement, absent an exemption,5 and Section 5(b)(1), which applies once a registration statement is filed, limits written offers to a "statutory prospectus" that includes the information required by Section 10 of the Securities Act.6 A violation of these provisions is known as "gun-jumping."7
The SEC has gradually taken steps to liberalize these gun-jumping rules, and in 2012, the Jumpstart Our Business Startups Act (the "JOBS Act") created, among other things, Section 5(d) of the Securities Act and introduced the concept of TTW communications.8 Under Section 5(d), EGCs (and their authorized agents) are permitted to engage in oral or written communications with QIBs and IAIs to "test-the-waters" before or after the filing of a registration statement to determine investor interest in a contemplated registered offering.9 The accommodations provided by the JOBS Act have provided EGCs with increased flexibility to communicate with potential investors and, it appears, have encouraged them to access the public markets.10 For example, since the enactment of the JOBS Act, approximately 87% of IPOs that have been declared effective have been by EGC issuers,11 and certain studies have shown that 38% and 23% of EGCs engaged in TTW communications in 2015 and 2016, respectively.12
Proposed Rule 163B responds to requests that the SEC expand the JOBS Act provisions, including TTW communications, to non-EGCs13, and if enacted "would result in greater harmonization of offering process requirements between EGC and non-EGC issuers."14
III. Proposed Rule 163B
The SEC's proposed Rule 163B would permit any issuer or its authorized agent to engage in TTW communications with potential investors that are, or that the issuer reasonably believes are, QIBs or IAIs either prior to or following the filing of a registration statement with the SEC in order to determine investor interest in a registered securities offering.
Scope of Proposed Rule 163B
Availability to all Issuers and their Authorized Agents
Proposed Rule 163B would be available to all issuers, including non-reporting companies, EGCs, nonEGCs, well-known seasoned issuers ("WKSIs")15 and investment companies (including those issuers that are, or are considering becoming, registered investment companies or business development companies).16
In addition, proposed Rule 163B would be available to those authorized to act on behalf of an issuer, including the underwriters or dealers participating in the offering.17 This is a benefit currently afforded to EGCs under Section 5(d), but is not generally available for non-EGCs. For example, Rule 163 provides a limited exemption for WKSIs to engage in TTW communications made "by or on behalf of the issuer itself," but does not apply to any offering participants (even if the issuer has authorized the communication).18 In 2009, the SEC proposed amendments to Rule 163(c) to allow pre-filing communications by the underwriters or dealers acting as the agent to a WKSI issuer,19 but the SEC never adopted a final rule.
Timing of any TTW Communications
Subject to certain exceptions,20 non-EGCs are currently not permitted to engage in TTW communications prior to the filing of a registration statement that covers the securities being offered (including during the time between the confidential submission and the initial public filing with the SEC). However, proposed Rule 163B would allow all issuers to have TTW communications prior to or following the filing of a registration statement.
No Verification Requirement
Under proposed Rule 163B, all issuers and those authorized to act on their behalf would only be able to engage in TTW communications with potential investors that are, or who the issuer reasonably believes are, QIBs or IAIs. This is an expansion of the current TTW rules available to EGCs under Section 5(d), which does not include such a "reasonable belief" standard. Furthermore, issuers (or their authorized agents) would not be required to verify an investor's status as long as they "reasonably believe" the potential investor meets the statutory requirements based on the specific facts and circumstances.21 The Release does not specify the steps an issuer must take in order to establish a reasonable belief, but notes that issuers should continue to rely on the methods they currently use to make such determinations.22
No Legend or Filing Requirements
Any TTW communications made under proposed Rule 163B would not be required to be filed with the SEC or to include any specific legend (consistent with TTW communications made under Section 5(d)).23 The SEC believes that QIBs and IAIs are sufficiently sophisticated to assess investment opportunities without the protection of additional safeguards (such as a legend or an SEC filing).24 However, as is currently the practice for TTW communications made under Section 5(d), the SEC staff may request that an issuer provide the SEC with copies of any TTW communications made under proposed Rule 163B.25
Non-exclusivity of the Proposed Rule
The proposed Rule 163B would be non-exclusive such that any attempted compliance with the rule would not prohibit reliance on any other available Securities Act exemptions (such as Rule 255, Rule 163, Rule 164, and Section 5(d) of the Securities Act).26 However, the Release clarifies that if an issuer is relying on the availability of another exemption with respect to TTW communications, then the conditions of such other exemption must be satisfied irrespective of proposed Rule 163B.27
Securities Law Liability and Material Non-Public Information
As is currently the case for TTW communications made under Section 5(d) of the Securities Act, any TTW communications made under proposed Rule 163B, while exempt from the gun-jumping provisions of Section 5 of the Securities Act, would still be considered an "offer" (as defined in Section 2(a)(3) of the Securities Act), and therefore be subject to the securities law liability provisions, including Section 12(a)(2) of the Securities Act, the anti-fraud provisions of the Securities Act and the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.28
Any TTW communications made under proposed Rule 163B may not conflict with material information contained in the registration statement covering the securities to be offered.29 In addition, any issuers subject to Regulation FD will need to determine whether any information in a TTW communication would trigger any disclosure obligations under Regulation FD or whether an exemption would apply.30 Absent another exemption, issuers may want to consider entering into confidentiality agreements with recipients of their TTW communications.
IV. Conclusion & Next Steps
With Rule 163B, the SEC is proposing to expand certain benefits previously afforded to EGCs under the JOBS Act to all issuers and their authorized agents. The SEC hopes that, by allowing all issuers to "test-the-waters," the proposed rule will provide all companies with a cost-effective method for preliminarily assessing valuation, market interest and the attractiveness of offering terms before incurring the costs associated with pursuing a registered offering,31 and will therefore help make registered securities offerings more attractive to certain issuers that otherwise would have relied on private placements or not pursued an offering.32
The SEC is seeking comments on the Release until April 19, 2019.