The “Morgan Stanley” letter provides the securities law disclosure guidance for most issuances of equity-linked registered structured notes in the U.S. market. Its provisions are often consulted in considering the permissibility of registered notes linked to a single stock, a basket of two or more stocks, and even equity indices.1
The Morgan Stanley letter provides that robust disclosure about the issuers of the underlying stock or stocks is not required where those issuers are SEC-reporting companies (registered under the Exchange Act) and the issuers either
- a brief discussion of the underlying issuer’s business;
- a reference to the availability of information about the underlying issuer that has been filed with the SEC; and
- information regarding the market price of the underlying stock, as required under SEC Regulation S-K.
The letter was issued in 1996. Since that time, substantial changes have occurred as to how investors obtain information about SEC-reporting companies. These changes have substantially increased the ease with which investors can obtain this information. This article discusses those changes, and considers what the Morgan Stanley letter might have looked like if it were issued today, in light of the availability of information to modern-day investors.
1996: Obtaining Information About Public Companies
Many readers of this publication may remember that it wasn’t as easy in 1996 as it is today to obtain information about public companies.
Electronic Exchange Act filing via EDGAR was not mandatory for all public companies until 2002, when foreign private issuers became subject to mandatory electronic filing. If you wanted to review an issuer’s financial statements before it was an EDGAR filer, you could mail order them from the SEC, or visit the SEC’s public reference room in Washington or at certain other locations. You could also purchase these reports from certain commercial distributors.
In addition, surfing the Internet in 1996 wasn’t as easy as it is today. Some readers may remember how much time it took to download a long filing such as an annual or quarterly report, and the not-so-user-friendly formatting of financial statements and other tables on the EDGAR system at that time.
Since 1996, in addition to mandatory EDGAR filings, virtually all investors have easy access to EDGAR filings from their desktop, due to the popularity of browser software, which many take for granted today. In addition, most public companies have an “investor information” section on their website, where investors can conveniently obtain business and financial information about the company. Moreover, companies often have a Facebook page, a LinkedIn page, and a Twitter account, and use other social media channels. All of these make information available almost instantaneously.
Investors do not have to turn to an issuer’s annual report to see historical stock prices or recent stock prices. A variety of widely used news websites and business and investor websites all make this information easily available. Many of these services provide convenient (and often free) tools for accessing other useful information about historical stock prices, including graphs, and the ability to compare the performance of a particular stock against the performance of its peers, or against a relevant sector index or broader market index.
The enhanced availability of information is not limited to companies registered under the Exchange Act. In 2008, the SEC modernized its exemption for foreign private issuers under Exchange Act Rule 12g3-2(b). This provision enables companies that are public outside of the U.S., but who have a significant number of U.S. shareholders without having had a public offering in the U.S., to avoid registering under the Exchange Act if they satisfy certain requirements. These requirements include maintaining a website with English language business and financial information that can be accessed by U.S. shareholders. These companies now include a significant number of non-U.S. issuers that have ADRs which trade in the U.S. over-the-counter market with “Level I” ADR programs, but do not file periodic reports with the SEC.
In a nutshell, the amount of information about virtually all public companies, and the ease with which an individual investor can access that information, has expanded beyond the imagination of a securities lawyer or regulator in 1996.
What Would a Morgan Stanley Letter Look Like Today?
The Morgan Stanley letter rests on the SEC’s conclusions as to whether there are sufficient U.S. market interests in and sufficient publicly available information about the issuer of the underlying stock. If we could engage in some time travel, and bring today’s informational resources back to 1996, the Morgan Stanley letter might have had somewhat different contents.
One Year as a Public Company. The Form S-3/Form F-3 prong of the Morgan Stanley letter is understood to contemplate a one-year “seasoning period” of public company status for an underlying stock. However, fairly similar information will exist as to a public company today immediately upon effectiveness of a registration statement, and will be available to an investor with just a couple of clicks on a PC. That is, the IPO registration statement and prospectus will include several years of audited financial statements and robust information about a company’s business and management, similar in scope to the Exchange Act reports filed by a company with a longer reporting history. As for recent examples, consider
Market Capitalization. Form S-3/F-3 eligibility for a primary offering requires a public float of at least $75 million. This amount is considered a proxy for the magnitude of public interest in a company. In today’s market, that number may not be considered very large, or difficult to achieve. For example, the smallest companies in the S&P MidCap Index have a market capitalization of $1.2 billion or more.the IPOs of companies such as Google and Facebook during the last few years. The information in these companies’ SEC filings had been widely studied and followed by institutional and retail investors even before the effective date of the IPO.
However, can we imagine smaller companies that have comparable publicly available information and a significant degree of market interest? Factors such as the number of analysts that maintain coverage of a company and companies that have significant trading volume and that have not made any announcement of an event (such as a late annual or quarterly report) that might call into question the reliability of its public filings all might end up being potential candidates for linking under a reconsidered Morgan Stanley letter.
Registration Under the Exchange Act. The Morgan Stanley letter presumes that there would only be sufficient information about companies that are registered under the Exchange Act. But perhaps that presumption is less relevant than in the past. At the time of the Morgan Stanley letter, foreign private issuers that sought an exemption from registration under the Exchange Act needed to comply with Rule 12g-3-2(b)’s provisions, which have been amended since that time. Under the current rule, “12g-3-2(b) companies” must make English language financial statements and other information available on a public website. A significant number of major international “blue chip” companies utilize this exemption, for example, in connection with a Level I ADR program in which their ADRs are traded in the over-the-counter market in the U.S. These companies, especially the ones that are of the most interest to U.S. investors, typically have disclosures that are regulated by an experienced non-U.S. regulator or stock exchange, and that are audited by a major accounting firm. There may be a set or subset of these companies that could be deemed worthy of the Morgan Stanley letter’s exemption.
In addition, because Exchange Act registration is a requirement of the Morgan Stanley letter, exchange traded funds, which register their securities under the Exchange Act, are eligible for linking, but more traditional mutual funds, which register with the SEC only under the 1940 Act, remain ineligible. In today’s market, information about these types of companies is readily available to investors through a combination of EDGAR filings, websites maintained by the fund sponsor, and business and financial portals.
Policy Implications and Alternative Investment Structures
Because the Morgan Stanley letter is not available for the underlying assets described in this article, issuers who wish to link to them in order to meet an investor’s investment goals need to do so using a non-registered program, such as structured CD, bank notes, Rule 144A, or Regulation D. These types of instruments are not necessarily subject to the requirements of the Morgan Stanley letter. (Of course, linking to these types of underlying assets does raise disclosure questions and suitability questions that must be appropriately addressed by the issuer and the underwriter before any offering is completed.)
From an investor protection perspective, investors may be better served if these types of instruments could be issued under a registered program. Investors would obtain the liability protections of Section 11 and Section 12 of the Securities Act, and the offering documents would need to include (or incorporate by reference) the full “disclosure package” of a registered offering. Because these offering documents would be publicly available on EDGAR, activity could be easily monitored by the SEC and other market participants. An updated Morgan Stanley letter would remove these offerings from the shadows, and reflect the changes to the marketplace since 1996.