New legislation has been passed which, among other things, adds additional flexibility to the laws governing the IPOs of emerging growth companies and provides a new exemption for private resales of securities. The legislation also requires the SEC to adopt changes to Regulation S-K and prepare a study regarding additional potential changes to Regulation S-K. Many of the new provisions are automatically effective and do not require any additional rule-making by the SEC.
Changes for emerging growth companies
The new legislation includes the following changes which effect the IPOs of emerging growth companies (EGCs).1
- IPO roadshow can commence in 15 days (decreased from 21) after public filing of confidential S-1 submissions. An EGC can confidentially submit draft registration statements to the SEC for review in connection with its IPO. Previously, the EGC would have to publicly file the confidential submission and all amendments with the SEC no later than 21 days before the EGC commenced a roadshow. This 21 day period has been reduced to 15 days. This change is effective immediately.
- Grace period in the event EGC status is lost. According to current SEC interpretive guidance, an issuer that loses its EGC after it confidentially submits a registration statement can no longer avail itself of the provisions available to EGCs. Under the new legislation, an issuer that qualified as an EGC at the time it confidentially submitted a registration statement or publicly filed a registration statement, but ceases to be an EGC thereafter, may continue to be treated as an EGC until the earlier of the date on which the issuer consummated its IPO or the end of the one-year period beginning on the date that the issuer ceased to be an EGC. This change allows the issuer to continue to be able to “test the waters” and take advantage of the reduced disclosure obligations for an EGC during the IPO process notwithstanding that the issuer will no longer be able to avail itself of the continuing benefits that would have come with EGC status following its IPO. This change is effective immediately.
- Ability to omit financial statements which would not be required at time of effectiveness. Presently an EGC must include two years of audited financial statements in a confidential submission or a filing of its registration statement. Under the new legislation, the SEC must revise Forms S-1 and F-1 to indicate that a registration statement filed (or submitted for confidential review) by an EGC prior to an IPO may omit financial information for historical periods otherwise required by Regulation S-X as of the time of filing or confidential submission if (x) the omitted financial information relates to a historical period that the EGC reasonably believes will not be required to be included in the Form S-1 or F-1 at the time of the IPO and (y) prior to distributing a preliminary prospectus to investors, such registration statement is amended to include all financial information required by Regulation S-X at the date of such amendment. This means that if an EGC submits its IPO registration statement in January 2016, and previously would have been required to include audited financial statements for 2013 and 2014, it can instead file the registration statement without the financial statements for 2013 if prior to distributing the preliminary prospectus it includes audited financial statements for 2014 and 2015. The SEC must adopt new rules by January 3, 2016 reflecting these changes, but EGCs may omit such financial information starting on January 4, 2016 even if Forms S-1 and F-1 are not yet amended.
On December 10, 2015, the SEC released two new Compliance and Disclosure Interpretations to address certain situations arising under the new financial statement flexibility provided for in the legislation. Specifically, the SEC stated that an EGC issuer may not omit interim financial statements from its filing or confidential submission for a period that has financial information that will be included within the required financial statements covering a longer interim or annual period at the time of the offering, even though the shorter period will not be presented separately. For example, a calendar year-end EGC that submits or files a registration statement in December 2015 and reasonably expects to commence its offering in April 2016 when annual financial statements for 2015 and 2014 will be required may under the new legislation omit its 2013 annual financial statements from the December filing. However, the issuer may not omit its nine-month 2014 and 2015 interim financial statements because those statements include financial information that relates to annual financial statements that will be required at the time of the offering in April 2016.
The SEC also clarified that an EGC issuer may omit financial statements of other entities from its filing or confidential submission if it reasonably believes that those financial statements will not be required at the time of the offering. For example, the issuer could omit financial statements of an acquired business required by Rule 3-05 of Regulation S-X if the issuer reasonably believes those financial statements will not be required at the time of the offering.
New Securities Act exemption for private resales
The so-called 4(1 ½) exemption is an unofficial resale exemption developed by securities law professionals and informally recognized by the SEC. Its basis is found in case law, SEC interpretative guidance and policy considerations. The 4(1 ½) exemption has been used to permit private resales of restricted securities by shareholders or affiliates of issuers where Sections 4(a)(1) (allowing sales by persons other than an issuer, underwriter or dealer) or 4(a)(2) (allowing private placements by issuers) are not clearly available. The 4(1 ½) exemption has also seen use in side-by-side offerings made to both qualified institutional buyers in reliance on Rule 144A and institutional accredited investors in reliance on the 4(1 ½) exemption. In circumstances where a Rule 144 or Rule 144A safe harbor are not available, sellers have relied on the 4(1 ½) exemption as well. An October 6, 2015 Report from the House of Representatives Committee on Financial Services (the House Report) also indicated that there was concern around the liquidity of secondary trades in securities issued under the recently enacted “Regulation A+” such that a framework for private resales of restricted securities was needed.
New Section 4(a)(7) is an exemption from the registration requirements of Section 5 and codifies many of the elements relied upon in 4(1 ½). The exemption is available for resales immediately. To qualify for the new exemption, a resale of restricted securities must meet the following requirements:
- Accredited investor. Each purchaser must be an “accredited investor” as defined under Rule 501 of Regulation D.
- Prohibition on general solicitation or advertising by the seller. Neither the seller nor any person acting on the seller’s behalf (as opposed to the issuer) may engage in any form of general solicitation or advertising to offer and sell the securities. This is in contrast to the current practice under 4(1 ½) where publicity by the issuer itself during the offering period would cause concern.
- Information requirement. For transactions in the security of an issuer that is not subject to reporting requirements under the Securities Exchange Act of 1934, the issuer must provide, upon request of the seller, to the seller and a prospective purchaser (and a seller in all cases shall make available to a prospective purchaser) the following information (which must be reasonably current in relation to the date of the resale):
- the exact name of the issuer and the issuer’s predecessor (if any);
- the address of the issuer’s principal executive offices;
- the exact title and class of the security;
- the par or stated value of the security;
- the number of shares or total amount of the securities outstanding as of the end of the issuer’s most recent fiscal year;
- the name and address of the transfer agent, corporate secretary, or other person responsible for transferring shares and stock certificates;
- a statement of the nature of the business of the issuer and the products and services it offers, which shall be presumed reasonably current if the statement is as of 12 months before the transaction date;
- the names of the officers and directors of the issuer;
- the names of any persons registered as a broker, dealer, or agent that shall be paid or given, directly or indirectly, any commission or remuneration for such person’s participation in the offer or sale of the securities;
- the issuer’s most recent balance sheet and income statement (which must cover the last two fiscal years, be prepared in accordance with US GAAP or IFRS (in the case of a foreign private issuer), have a balance sheet not more than 16 months old (with an income statement corresponding to 12 months prior to the balance sheet date) and an interim profit and loss statement if the balance sheet is as of a date more than six months before the transaction date); and
- if the seller is a control person with respect to the issuer, a brief statement regarding the nature of the affiliation, and a statement certificated by such seller that they have no reasonable grounds to believe that the issuer is in violation of the securities laws or regulations.
- Issuer disqualification. The new exemption is not available for transactions where the seller is the issuer or a direct or indirect subsidiary of the issuer.
- Bad actor prohibition. The exemption is not available where the seller or any person that has been or will be paid (directly or indirectly) remuneration or a commission for their participation in the offer or sale of the securities is a “bad actor” under Rule 506(d)(1) of Regulation D or subject to a statutory disqualification under Exchange Act Section 3(a)(39).
- Business requirement. The issuer must be engaged in business and not in the formation stage or in bankruptcy or receivership. Additionally, the issuer cannot be a blank check company, blind pool, or a shell company that has no specific business plan or purpose or has indicated that the issuer’s primary business plan is to engage in a merger or combination of the business with, or an acquisition of, an unidentified person.
- Underwriter prohibition. The transaction is not with respect to a security that constitutes the whole or part of an unsold allotment to, or a subscription or participation by, a broker or dealer as an underwriter of the security or a redistribution.
- Outstanding class requirement. The security that is the subject of the transaction must be of a class that has been authorized and outstanding for at least 90 days prior to the date of the transaction.
Securities purchased in a Section 4(a)(7) transaction will be deemed to have been acquired in a transaction not involving any public offering, such transaction shall not be considered a “distribution” for purposes of Section 2(a)(11), and the securities purchased will be “restricted” securities within the meaning of Rule 144. However, Section 4(a)(7) does not contain the holding periods or, for affiliates of the issuer, volume limitations and manner of sale restrictions contained in Rule 144. Therefore, sellers could sell restricted securities under Section 4(a)(7) without complying with the six month or one year holding period requirements of Rule 144, and affiliates of the issuer will be able to use Section 4(a)(7) for resales of restricted or control securities in excess of, and without counting against, the Rule 144 volume limitations and without complying with the Rule 144 manner of sale requirements.
The text of Section 4(a)(7) specifically provides that it is not the exclusive means for establishing an exemption from the registration requirements of Section 5 and that transactions effected in accordance with Section 4(a)(7) are not subject to state Blue Sky laws. In addition, notwithstanding adoption of the new exemption, the unofficial 4(1 ½) exemption will remain available (for example, in situations where the issuer information requirement is not satisfied).
Forward incorporation by reference for smaller reporting companies
Smaller reporting companies, or SRCs, as defined in Securities Act Rule 405 are issuers that either have less than $75m in public common equity float (calculated as of the end of the issuer’s most recently completed second fiscal quarter) or, if the issuer has no public float, less than $50m in revenue during its previous fiscal quarter. SRCs benefit from longer filing deadlines than accelerated filers and scaled disclosure requirements. The new legislation instructs the SEC to revise Form S-1 to permit SRCs to forward incorporate by reference in a registration statement any documents that the company files with the SEC after the effective date of such registration statement. Forward incorporation by reference has traditionally only been available to companies eligible to file on Form S-3 or F-3. SRCs will be able to update their Form S-1 registration statements through forward incorporation by reference without having to file post-effective amendments. The practical implication of being able to forward incorporate by reference on Form S-1 is that, subject to review of any implementing rules that are adopted by the SEC, SRCs will be able to utilize Form S-1 as a shelf registration statement for secondary resales of securities. However the ability to conduct primary shelf offerings will still be dependent on the issuer’s Form S-3 or F-3 eligibility. The SEC must amend Form S-1 to reflect these changes by January 18, 2016.
Disclosure modernization and simplification
- Form 10-K summary. Presently, Form 10-K does not provide for the inclusion of a summary section and companies have not undertaken to include such a summary on their own. The House Report states that investors find it difficult to locate important information about an issuer in its Form 10-K as they are often “hundreds of pages long.” Under the new legislation, the SEC must issue regulations by June 1, 2016 that will permit issuers to include a summary page on Form 10-K. The summary page must include a cross-reference (by electronic link or otherwise) to the related material in Form 10-K.
- Regulation S-K revisions. The new legislation directs the SEC to revise Regulation S-K by June 1, 2016 (1) to reduce the burden on EGCs, accelerated filers, smaller reporting companies, and other smaller issuers, while still providing all material information to investors, (2) to eliminate provisions required for all issuers that are duplicative, overlapping, outdated or unnecessary and (3) for which the SEC determines that no further study is necessary in order to determine the efficacy of such revisions. Regulation S-K is the set of rules that lays out the detailed disclosure requirements (other than financial statement requirements) needed in registration statements, periodic reports, proxy materials and other SEC filings.
- Regulation S-K study. The SEC must issue a report to Congress by November 28, 2016 that (a) determines how to modernize and simplify Regulation S-K in a manner that reduces the costs and burdens on issuers while still providing all material information, (b) emphasizes a company by company approach that allows relevant and material information to be disseminated to investors without boilerplate language or static reporting requirements while preserving completeness and comparability of information across registrants and (c) evaluates methods of information delivery and presentation for discouraging repetition and disclosure of immaterial information. Such report must also contain specific and detailed recommendations (i) to modernize and simplify Regulation S-K and (ii) to improve the readability and navigability of disclosure documents and to discourage repetition and the disclosure of immaterial information. The SEC will then have a further 360 days from the date of issuing the aforementioned report to Congress to issue proposed rules implementing the recommendations contained in the report.