Just about everybody agrees: investors in structured products should understand their risks and rewards prior to making a purchase, and many of these investors would benefit from clear materials that explain the products and their risk factors. Accordingly, many market participants have attempted to create these types of materials in order to help educate these investors. They have created websites, brochures and other materials in furtherance of these goals. This article discusses the treatment of these types of educational materials under the federal securities laws.
The principal issue is that, under certain circumstances, written materials about securities, other than the “statutory prospectus,” can be deemed to be a “free writing prospectus” under the Securities Act of 1933. As a result, even though these materials can be created with noble purposes in mind, using them may have legal consequences. These consequences include potential filing requirements, the possibility of addressing comments from the SEC or FINRA, and even potential liabilities if these documents are deemed to be misleading offering materials.
What Is a Prospectus, and What Is a Free Writing Prospectus?
In “plain English,” a “prospectus” is a carefully prepared document (often somewhat long) organized in the manner required by the securities laws, which offers a securities and contains a significant amount of legally required language about them. In addition, we have Section 2(a)(10) of the Securities Act—it defines a “prospectus” (subject to a variety of exceptions) as: “any prospectus, notice, circular, advertisement, letter, or communication, written or by radio or television, which offers any security…”
We would like to think that this statutory definition is consistent with the “plain English” definition. However, the U.S. SEC has historically viewed the matter quite differently, such that a wide variety of written materials produced by an offering participant that described or discussed the relevant securities could be deemed to be offering the securities and, therefore, could be a “prospectus.”
What was the practical impact of this broad definition? Until December 2005, when the SEC’s “Securities Offering Reform” regulations became effective, just about the only written materials that were created and provided to potential investors in connection with a securities offering was the statutory prospectus. Little else could be created in connection with a registered offering.
The Securities Offering Reform regulations introduced the new document known as a “free writing prospectus.” Revised Rule 405 under the 1933 Act provides that a “free writing prospectus” is “any written communication…that constitutes an offer to sell or a solicitation of an offer to buy the securities relating to a registered offering…made by means other than…” certain specified types of documents, including the statutory prospectus. The new rules made these documents subject to a variety of requirements relating to content, filing, liability and record retention. To the extent that the SEC had historically applied a relatively broad reading of the word “prospectus,” practitioners tend to believe that a wide range of materials may be deemed to be a “free writing prospectus.”15
When Are Educational Materials Deemed to Be Free Writing Prospectuses?
With this in mind, we have set forth a variety of illustrative factors (note this is not intended to be an exhaustive list) to consider in making the determination as to whether any particular document constitutes a free writing prospectus. As you can see, this may be a fact-specific determination, based on the relevant circumstances.
Who Is Preparing or Distributing the Document? The U.S. securities laws are focused on offering participants, such as the issuer, the underwriter, a distributor or an entity acting on their behalf. In contrast, news publications and investor information services may have a variety of obligations under applicable laws, but they are not typically regulated by the Securities Act.
Who Are the Intended Recipients of the Materials? Educational materials may be intended for “internal use only,” such as a broker-dealer’s financial advisors. Alternatively, they may be intended for use by retail investors. The more likely it is that the materials will come into the hands of retail investors, the more likely it may be that they will be deemed to be free writing prospectuses, because the recipients are in greater need of the protections of the securities laws and may be less well equipped to differentiate between the educational materials and actual offering documents. Accordingly, materials intended for internal use only, or use for financial professionals only, should be marked as such, and policies and procedures should be implemented to prevent them from being forwarded to retail investors. In contrast, the inclusion of these materials on a website that is accessible to the public, without password protection, would render them more likely to come into the hands of retail investors.
Is the Document Being Used in Connection With an Actual Offering? Educational materials may take on an entirely different characterization when furnished to investors in connection with a live offering. For example, if a financial advisor provides the materials to an investor in connection with the prospectus for that offering, the materials are more likely to be deemed to constitute a free writing prospectus. Accordingly, materials that are intended to be used solely for educational purposes are typically created under policies that prohibit financial advisors from furnishing them simultaneously with, or alongside, the prospectuses for current offerings.
How Closely Does the Document Relate to any Offered Securities? Educational materials may vary from actual offerings in a variety of ways:
- the educational materials will not reference a specific offering or CUSIP, and they are designed to be “generic” about the relevant products;
- the educational materials will not reference a specific issuer but instead will focus on the nature of the relevant securities and their terms; and
- to the extent that the educational materials are included on a website, they will be separated from any offering documents for actual offerings through different menus, and an “exit menu” or similar means will be used to make it clear to anyone viewing the educational materials that they are separate and apart from any offering materials on the website.