On June 20, 2007, the Securities and Exchange Commission (the "SEC") proposed amendments to its rules and regulations that would expand the class of issuers eligible to use Forms S-3 and F-3 for primary securities offerings. Under the proposed amendments, eligible issuers would include companies with a "public float" of less than $75 million that satisfy the other eligibility conditions described below. In the proposing release, the SEC emphasizes the advantages to smaller companies of shelf registrations. While it recognizes the concern that this would allow periodic takedowns without any further SEC staff review subsequent to the initial filing of the registration statement, the SEC believes this risk is justified by the benefits for smaller companies. The SEC has requested comments by August 27, 2007; the effective date for the proposal, if adopted, is uncertain. This proposal is one of a series of measures by the SEC to modernize and improve the process of capital raising and reporting requirements for smaller companies.
Form S-3 (and its analogue, Form F-3 for foreign issuers) is the most simplified registration form. It may only be used by an issuer that has been required to report under the Securities Exchange Act of 1934 (the "Exchange Act") for a minimum of 12 months and has met the timely filing requirements set forth under Form S-31. The offering, and the issuer, must meet the eligibility tests prescribed by the Form. Use of Form S-3 (and Form F-3) is advantageous in that it maximizes the ability of the issuer to incorporate by reference from Exchange Act filings, including filings made after the effective date of the Form S-3 (known as "forward incorporation").
Form S-3 was last revised in 1992. Among other things, those revisions required that the issuer have a "public float"2 of at least $75 million to be eligible to use Form S-3 for primary offerings by the issuer itself. At that time, the SEC stated that the $75 million float requirement would limit use of Form S-3 principally to corporations traded on the NYSE or NASDAQ that were generally followed by at least three analysts.
Commentators have noted that the SEC's reliance on the effective markets hypothesis guided the adoption of the tiered registration system, including Form S-3 and its incorporation by reference of Exchange Act filings into the Securities Act of 1933 registration statement. The SEC now desires that smaller companies obtain the benefit achieved from the greater flexibility and efficiency in accessing capital markets afforded by Form S-3. Citing the great advances in electronic dissemination and accessibility to company information since the last revisions to Form S-3, the SEC is proposing expansion of the use of Forms S-3 and F-3 and the periodic takedowns of securities permitted by shelf registration.
Expansion of Eligibility for Use of Forms S-3 and F-3
The SEC's proposed revisions would allow a reporting company with less than $75 million in public float to register a primary offering of its securities on Form S-3 if it:
- meets the other registrant eligibility conditions for the use of Form S-3;3
- is not a shell company and has not been a shell company for at least 12 calendar months before filing the registration statement;4 and does not sell more than the equivalent of 20% of its public float in primary offerings over any 12-month period.
Any reporting company that wishes to utilize Form S-3 must have timely filed all of its applicable Exchange Act reports during the 12 calendar months and any portion of a month preceding the filing of the registration statement. The proposals would extend the ability to use Form S-3 to all eligible reporting companies, including those whose securities are not traded on a national securities exchange but are quoted on the Over-the-Counter Bulletin Board or Pink Sheets quotation services.
The SEC has issued parallel rules to expand the eligibility requirements of Form F-3 to include smaller foreign private issuers.
These proposed amendments would provide smaller companies with the benefits of (i) automatic updating of their registration statements with "forward incorporation" of their subsequently filed Exchange Act reports and (ii) shelf offerings under Rule 415. The SEC, in proposing the amendments, concluded that the scope of disclosure obligations and liability of smaller public companies under the federal securities laws are sufficiently comparable to those of the largest reporting companies such that the proposed expansion of Form S-3 primary offering eligibility should not adversely impact investors.
Determination of Amount of Securities to be Sold
To ascertain the amount of securities that may be sold pursuant to Form S-3 or Form F-3, a company needs to:
- determine its public float immediately prior to its intended sale; and
- aggregate all of its primary offering sales conducted under the new rules during the previous 12-month period (including the intended sale) to determine whether the 20% limitation would be exceeded. The proposed amendment provides a number of examples of this calculation under various scenarios.
The proposal would require a registrant to compute its public float by reference to the price at which its common equity was last sold, or the average of the bid and asked prices of its common equity, in the principal market for the common equity as of a date within 60 days prior to the date of sale.
Because the 20% sale restriction is calculated by reference to the registrant's public float immediately prior to a contemplated sale, as opposed to the time of initial filing of the registration statement, the amount of securities that could be sold by the registrant could increase over time. In addition, because Form S-3 registrants that meet the $75 million float threshold at the time of filing of their Form S-3 are not required to decrease the amount of securities sold under the Form S-3 in the event their public float falls below $75 million subsequent to the effective date of the Form S-3, the SEC has proposed that the 20% restriction on additional sales by an issuer be lifted if the registrant's float increases to $75 million or more subsequent to the effective date.
In calculating the aggregate gross sales price to be sold in a primary offering, a reporting company would be required to include the sales of any equity securities as well as debt securities. If a reporting company offers securities that are convertible into or exercisable for equity shares, such as convertible debt or warrants, it would calculate the amount of securities it may sell in any period of 12 calendar months by reference to the aggregate market value of the underlying equity shares in lieu of the market value of the convertible shares. The aggregate market value of the underlying equity would be based on the maximum number of shares into which the securities sold in the prior period of 12 calendar months are convertible as of a date within 60 days prior to the date of sale, multiplied by the same per share market price of the registrant's equity used for purposes of calculating its public float. The SEC believes that calculating the 20% cap based on the market value of the underlying securities makes it less likely that convertible securities would be structured and offered in a manner designed to avoid the 20% limitation.
In April 2006, the SEC's Advisory Committee on Smaller Public Companies (the "Advisory Committee") recommended that the SEC allow any reporting company whose shares are listed on a national securities exchange, NASDAQ, or quoted on the Over-the-Counter Bulletin Board electronic quotation service, be eligible to use Form S-3 if it has been reporting under the Exchange Act for at least one year and is current in its reporting at the time of filing. However, General Instruction I.B.3. to Form S-3 limits the use of the Form for secondary offerings to securities "listed and registered on a national securities exchange or quoted on the automated quotation system of a national securities association," a restriction that excludes the securities quoted only on the Over-the-Counter Bulletin Board or Pink Sheets. Notwithstanding the Advisory Committee's recommendation, the proposed amendments do not amend the Form S-3 eligibility rules for secondary offerings because of the potential for abusive primary offerings disguised as secondary offerings. As such, the proposal pertains only to Form S-3 eligibility for primary securities offerings and is not intended to encompass or otherwise affect existing requirements for secondary offerings on Form S-3. This seems somewhat anomalous, in that such issuers will be able to use Form S-3 for certain primary offerings but not for secondary offerings, a reversal of the typical principle that placed greater restrictions on the use of Form S-3 for primary offerings.
The ability to conduct primary offerings on Forms S-3 and F-3 confers significant advantages on eligible reporting companies in terms of cost savings and capital formation. Therefore, the SEC's proposal would have a significant effect on those companies that do not meet the current $75 million threshold by allowing them to take advantage of the considerable benefits enjoyed by eligible companies. The most significant benefit includes the ability to access the capital markets on a timely basis and to conduct primary offerings on a delayed and continuous basis because of the automatic continuous updating of Forms S-3 and F-3 resulting from the forward incorporation by reference of Exchange Act periodic reports into the registration statement. By having more control over the timing of their offerings, these companies can take advantage of desirable market conditions, thus allowing them to raise capital on more favorable terms, including pricing, or to obtain lower interest rates on debt.