PHILADELPHIA BAR ASSOCIATION
Business Law Section
1101 Market Street, 11th Floor
Philadelphia, PA 19107-2911
Phone: (215) 238-6300
Fax: (215) 238-1159
Subject: File No. S7-30-98
June 30, 1999
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Re: Release No. 33-7606A; 34-40632A; IC-23519A; File No. S7-30-98
Dear Mr. Katz:
On behalf of the Business Law Section of the Philadelphia Bar Association, we are pleased to submit comments on the amendments proposed by the Securities and Exchange Commission in Release No. 33-7606A; 34-40632A; IC-23519A (hereinafter, the "Release"). These comments were prepared by an ad hoc committee formed by the Business Law Section’s Securities Regulation Committee to review and comment upon the Commission’s proposals in the Release and Release No. 33-7607; 34-40633; IC-23520. The members of the committee represent a broad cross-section of securities law practitioners in Philadelphia. Those participating in this process are named below following the signatures. To the extent issues covered by the Release are not addressed below, we make no comment.
Table of Contents
We commend the Commission for the work embodied in the Release. We appreciate the Commission’s efforts to modernize securities regulation to accommodate vast changes in the capital markets that continue at an ever-increasing pace. We also acknowledge the difficulty inherent in seeking to balance the demands of issuers and others dependent on the capital markets with the federal securities laws’ paramount objective of investor protection.
Substantively, however, we conclude overall that the Release falls far short of these intentions and objectives. While we applaud many of the specific concepts and proposals in the Release, others we believe to be seriously flawed. We particularly approve of the proposals on communications and research reports at the time of an offering, the rationalization of movement between public and private offerings and some of the proposed enhancements in disclosure in filings made under the Securities Exchange Act of 1934, as amended. On the other hand, we believe that the Form A and B eligibility requirements and filing procedures, the cutbacks on shelf offerings, the elimination of Exxon Capital transactions and the liability issues presented by the "free writing" and other communications proposals could significantly impede the capital formation process. On balance, were we compelled to choose between adoption and rejection of the Release as a package, we would choose rejection.
In view of the many worthwhile proposals included in the Release, however, we suggest, to the extent that your proposals are to be revised and re-proposed, that the re-proposals be in separate releases, each dealing with a single subject or group of closely related subjects. This procedure will allow parties interested in each topic to focus on the particular topic, and will allow the broad categories of proposals to move forward on separate tracks and at a timetable appropriate for each. We note in this regard the experience of the American Law Institute with the Federal Securities Code. By bundling the replacement of all six securities statutes in a single piece of legislation, the ALI presented Congress and the interested public with a document that was so massive and comprehensive that it proved overwhelming. As a result, the Code as a whole never attracted meaningful legislative attention. However, the Code's proposals did move forward as separate legislative or administrative initiatives which were enacted separately at various times spanning a number of years after the ALI had completed its codification project.
Our comments to a number of the Commission’s specific proposals are as follows:
The proposals seek to fully revamp the principal forms available for registration of transactions under the Securities Act of 1933, as amended. As they relate to the information required to be included in registration statements, the changes are essentially minor and noncontroversial. However, mechanically, the proposal poses a number of issues. These issues relate principally to the issuer qualification thresholds for registration on the new proposed short form, Form B, the types of transactions permitted to be registered on Form B and the thresholds for status as a "seasoned" issuer for purposes of the new proposed long form, Form A. Moreover, our analysis of these issues is linked closely with our views concerning the Commission’s proposals relating to communications in connection with offerings registered on the new forms.
We do not object conceptually to creating a highly streamlined registration mechanism that is not accessible to all issuers currently eligible for Form S-3. However, the difficulties relating to the proposed Form A registration system make it an unattractive alternative to the 30% of the Form S-3 issuers that will not be eligible for the Form B registration system. Thus, on balance, we would rather the Commission adopt refinements to the existing registration system incorporating the positive aspects of the proposals than replace the system wholesale with the process reflected in the Release. Nevertheless, for the purposes of our detailed comments below, we will assume the adoption of the Release’s proposals.
We do not categorically object to the establishment of standards for issuer eligibility to register securities on Form B or to incorporate by reference information in a Form A registration statement. However, issuers must have certainty that they are eligible to register securities on the registration form they have chosen and that they are permitted to incorporate by reference information in the manner they have selected. Therefore, we believe, at a minimum, a safe harbor should be established so that if an issuer receives certain representations from the appropriate people, including underwriters, or persons who may be deemed underwriters, the issuer can be certain that it is on the proper form or has incorporated by reference information in an appropriate manner.We understand the Commission’s concerns about allowing an issuer a safe harbor for filing on the proper registration form, effective upon effectiveness of the registration statement, when the issuer, in fact, designates the effective time of its registration statement. However, the revocation of the Section 401(g) safe harbor will add an inappropriate level of uncertainty for issuers while addressing an area where we do not believe abuses have occurred in the past.
We believe the proposals concerning issuer eligibility for Form B contain positive elements. However, the approach is too far reaching. Specifically, we believe the proposed Form B eligibility requirements will present unwarranted obstacles to issuers’ capital raising transactions and will expose issuers unnecessarily to increased Securities Act liability without meaningful corresponding investor benefit.
In two areas, we perceive significant deficiencies in the Form B eligibility proposal which are not apparent in Form S-3. First, Form S-3 distinguishes between eligibility criteria for registering primary and secondary sales. Secondly, the practical elimination of Form S-3-type forward incorporation by reference beyond the time period surrounding a particular offering poses difficulties for issuers, particularly issuers of investment grade debt.
We are aware of the Commission staff’s concerns about transactions that are registered as secondary offerings to take advantage of the short-form registration and forward incorporation by reference afforded by Form S-3 but which, in the staff’s view, are more appropriately characterized as primary offerings. We believe the elimination of the ability to register legitimate secondary transactions on short forms with Form S-3-type forward incorporation by reference is too drastic a remedy.
Indeed, we believe that a substantial majority of venture capital transactions and private equity investments in publicly owned issuers depend on the issuers’ ability to register resales on a short form with Form S-3-type forward incorporation by reference. Moreover, investors in privately issued securities, particularly equity securities, of publicly owned issuers demand the ability to have prompt liquidity in their investments -- even if they do not have any current plan to distribute the securities at the time they purchase them. Often, the terms of securities issued to private investors contain provisions that penalize issuers – and therefore their other security holders – in price and other terms of the transaction if those issuers cannot promptly facilitate liquidity in these types of private investments.
The requirement to file a new registration statement, with the associated internal and external review and signature requirements, in response to a private investor’s desire for liquidity – even where the investor may not sell any of the investment – will add substantial time and cost to the transaction and increase the private investor’s risk on the investment. These factors may well increase private investors’ requirements for returns on their investments and, thus, negatively affect issuers and their other security holders.
b. Investment Grade Debt Offerings
The lack of Form S-3-type forward incorporation by reference in Form B will also adversely affect issuers’ offerings of investment grade-rated debt securities, including medium-term notes particularly. The review and signature requirements for Form B registration statements, contrasted with the requirements for preparing a Rule 424(b) prospectus, will add considerable time to the process through which much investment grade rated debt is offered and sold. This delay will decrease the efficiency of an effective process that is well-developed in the U.S. capital markets and, we believe, will increasingly be subjected to pressure from outside the U.S., particularly from the European Union.
Medium-term note, or "MTN," transactions typically are sold under an issuer’s pre-established MTN program marketed through dealers. The market for MTN securities is highly liquid and prices, which are readily quoted, are based primarily on the issuer’s credit rating, and the securities’ interest rate and maturity rather than the disclosure included in the issuer’s registration statement or prospectus relating to the offering. Issuers often arrange and price MTN transaction in a matter of hours or minutes. Following pricing, the issuer prepares a Rule 424(b) prospectus pricing supplement to reflect the terms of the securities being sold. In the current environment there is no time to prepare and file a separate Form B registration statement for each MTN transaction. And, given the participants in the market it is inconceivable that any level of additional protection for investors could justify the delay and uncertainty that the resulting delay would bring.
Moreover, we do not believe that the exercise of obtaining directors’ signatures in this context is likely to increase investor protection. State law imposes obligations on corporate boards of directors in approving capital financing plans and authorizing appropriate officers to act to complete the contemplated transactions. We do not believe that by artificially imposing further board review to satisfy the signature page requirement of a Securities Act registration statement will afford meaningful additional protection. It will, however, slow the process and add cost and uncertainty which, under the current circumstances, we do not believe can be justified.
The proposals include eligibility requirements for the types of transactions issuers may register on Form B. We have concerns regarding Form B’s eligibility requirements for some of the transactions described in the proposals. Our concerns with regard to specific Form B-eligible transactions are included below.
a. QIB-Only Offerings
We believe the proposed availability of Form B to seasoned Form A issuers that offer their securities only to QIBs will increase access to capital markets for Form A issuers. However, we do not believe any QIBs, such as dealers and investment advisors, should be excluded from QIB-only offerings without strong justification. We do not believe the Commission’s conclusion that dealers and investment advisors do not generally purchase securities for their own accounts offers that justification. Perhaps a qualification requiring that a dealer purchase solely for its investment account would satisfy the Commission’s concerns in this area.
The Release intimates that the Commission intends to allow the QIB-only offering to supplant Rule 144A/Exxon Capital transactions. We believe that Exxon Capital transactions should continue to be permitted. Not all Form A issuers will qualify for QIB-only offerings. Moreover, some issuers may elect to privately place securities in the 144A market to provide more flexibility in the means of disclosure than would be available in a registered transaction.
We are deeply concerned that in proposing to afford issuers the flexibility of QIB-only offerings, the Commission has revived the defunct "presumptive underwriter" doctrine. We believe the uncertainty created by the potential imposition of underwriter status to purchasers in a QIB-only offering will decrease liquidity in QIB-only offered securities. Moreover, the threat of being presumed an underwriter may discourage a QIB from participating at all in the QIB-only offering.
The Commission has requested comment regarding the dollar threshold for being a QIB. We believe the dollar threshold for QIB status should not be revised upward. Although increases in market indices have, in effect, lowered the threshold since its introduction, we do not believe these increases justify similar increases in the threshold. We suggest the Commission study various types of institutional investors, such as private investment funds, to determine whether the knowledge and experience of the individuals directing their investments would justify decreases in the threshold.
b. DRIPs, DSPP and Offerings to Existing Security Holders
We do not object to many of the Commission’s proposals regarding the use of Form B by seasoned Form A issuers for offerings, such as DRIPs, DSPPs and offerings to existing security holders. Limitations on amounts of securities that may be offered by issuers, or on amounts of securities that may be purchased by any particular investor seem appropriate in light of the Commission’s goal of preventing these types of offerings from being used as mechanisms for avoiding Form A registration requirements. We support this goal. Our observations regarding the specific elements of the proposals are as follows.
The proposals relating to the registration of DRIP offerings appear to require, in effect, that a registration statement be filed for each dividend. Otherwise, keeping a registration statement effective and relying on forward incorporation by reference will require the issuer to file as offering material large amounts of information, much of which will probably be immaterial, and subject itself (and others) to Section 11 liability on the filed material. This seems unduly burdensome in the context of DRIPs, DSPPs and other recurring offerings.
We suggest that a more appropriate way to curb abuses perceived by the Commission in connection with DRIPs and DSPPs would be to more narrowly define these offerings. Features of plans that the Commission believes are commonly abused can be prohibited from the transactions able to be registered on Form B by a seasoned Form A issuer.
The Commission has proposed Form A to replace current Forms S-1 and S-2 for offerings by unseasoned issuers and issuers that do not satisfy the $250 million public float requirement of Form B. Little change is proposed to the information required through Form A as compared to the current registration forms. The principal changes pertinent to Form A issuers relate to the delivery of prospectus information and the timing of effectiveness of Form A registration statements.
Form A would permit a "seasoned" issuer to incorporate by reference information about the issuer. Under the proposals, an issuer may become seasoned in two ways. An issuer that has been reporting under the Exchange Act for at least 24 months and has filed at least two annual reports would be considered seasoned. In addition, an issuer that has been reporting for at least 24 months and has a public float of $75 million or more, regardless of the number of annual reports filed, would be considered seasoned. The proposals do not explain the Commission’s justification for this distinction.
The requirement that an issuer lacking a public float of $75 million must have filed two annual reports lacks justification and adds a level of complexity without, in our view, adding meaningful benefit. This is particularly so in light of the fact that the $75 million public float test is proposed to be imposed on Form A issuers before they may determine the timing of the effectiveness of their registration statements. We do not understand why that requirement should be imposed twice. While two annual reports would ensure that an issuer’s independent auditors had performed two post-IPO audits, we doubt that this distinction will matter much, since extensive information would have been provided in earlier filings. We suggest that the Commission simply define "seasoned" as having attained a reporting history of a specified number of months and remove the public float requirement.
b. 24-Month Requirement
We further question the rationale for the 24-month requirement for seasoning an issuer. The Release does not specifically justify the 24-month period. If one of the primary goals of the Release is to foster increased attention, and attach increased importance, to issuers’ Exchange Act reporting, there seems no justification for prolonging the period before an issuer can incorporate its Exchange Act reports by reference into its Securities Act documents. Accordingly, we believe limiting the seasoning requirement to 12 months for incorporation by reference and retaining the $75 million public float threshold that an issuer must meet before it can control the timing of the effectiveness of its registration statements is more consistent with the Commission’s goals in that it will more readily permit incorporation by reference, which we believe is a worthy goal, and will limit the ability of an issuer to have its registration statements become effective without staff review.
In the Release the Commission notes that only 105 Forms S-2/F-2 were filed in 1996. We suspect that in most of those offerings the issuer did not elect to deliver company information through separate incorporated documents. Despite our views, described above, with respect to incorporation by reference, we also suspect that this situation is unlikely to change if the proposals are adopted. Issuers, in collaboration with their underwriters and in recognition of their underwriters’ marketing objectives, often still elect to include company information in the prospectus for marketing purposes, even in Form S-3 registered offerings, which do not require delivery of incorporated documents. Nonetheless, we believe that the incorporation/delivery method permitted by Form A is a forward-looking and useful alternative to including all the company information in the prospectus and should be retained.
C. Timing of Form A Offerings
The Commission is proposing to allow a seasoned issuer on Form A to control the timing of effectiveness if:
The public float test at the $75 million level seems to us to be appropriate here. In response to the Commission’s request for comment, we see no justification to alter the test at this time.
While the "recently reviewed" test may be helpful, it will depend to a great degree on how flexible the Commission staff will be in reviewing filings upon request. The mechanics of the review process – i.e., timing and uniformity – will need to be worked out and readily known by Form A issuers. The arbitrariness of this standard as articulated in the Release and the lack of certainty surrounding the current Exchange Act report review system seems to provide little comfort to an issuer with a public float of less than $75 million. Additionally, issuers will need to receive a "no further comment" notice in order to demonstrate that they have fully complied with Commission staff comments. We particularly note that these mechanics would not resolve a situation where comments are reasonably in dispute or other staff review issues.
We support the Commission’s efforts to permit issuers to designate the timing of their registration statements once the procedural safeguards discussed above are worked out. In response to the Commission’s request for comment, we see no justification for excluding certain types of offerings from the timing procedures permitted to seasoned issuers.
In response to the Commission’s request for comment, we believe that the requirement that underwriters concur with the designation of effectiveness of a Form A registration statement set forth by issuers is not burdensome in light of the potential liability of the underwriters for the contents of the registration statement. Similar to acceleration requests in the current system, an informal written communication is simple and a good practice to retain in order to avoid a misunderstanding respecting the timing of effectiveness of a registration statement and the liability associated with its contents.
We commend the Commission for proposing new rules and rule amendments designed to address some concerns related to communications by issuers and underwriters which arise during the pre-filing, waiting and post effective periods. These proposals, for the most part, take into account and recognize changes in the way issuers communicate with securities markets and recognize the realities of the sale of securities in today’s market. We are concerned, however, about the enhanced potential liability for some of these communications. Specifically, we do not believe that the information required to be filed under proposed Rule 425 should be subject to any higher measure of liability than under Rule 10b-5 of the Exchange Act. Furthermore, we are concerned about the ability of a Form B issuer to determine with precision when the first offer will be made for purposes of making a timely filing under proposed Rule 425. We are also concerned that the proposed filing of free writings, especially as such free writings may be made available to investors over the Internet, may discourage the growing use of electronic technology in effectively communicating to the investing public. Finally, we believe that the safe harbor for factual business communications and regularly released forward looking information could be expanded. These points and others are further amplified below.
We heartily endorse the Commission’s proposal to remove all restrictions on offering communications for Form B eligible issuers during the pre-filing period. As the Release points out, there is an abundance of information about these issuers and any communications by them during this period is not likely to have the effect of conditioning the market for offers by them. We also believe that the Form B eligibility standard is appropriate. While there could be enhanced criteria related to public float or trading volume above the Form B eligibility standard to qualify for removal of all restrictions on offering communications during this period, maintaining the same standard makes sense and provides a level of consistency.
With respect to the aspect of the Commission’s proposal relating to the ability of dealers to make offers to buy and the ability of issuers and underwriters to make offers to sell securities prior to the filing of a Form B, we believe that the parties involved in offering the securities of these issuers are generally quite sophisticated and effectively represented, and that the ability to engage in these negotiations prior to the filing of a Form B registration statement should not lead to abuse. From the point of view of investor protection, the filing and prospectus delivery requirements must still be met prior to an investor purchasing a security.
We also support the Commission’s proposal to impose a bright-line communications safe harbor of 30 days prior to the filing of a registration statement for issuers other than those that are Form B eligible. This is a practical and workable solution to a problem that has plagued the offering process for some time. The 30-day period seems to be an appropriate length of time. We would support the notion of a slightly longer prospectus delivery requirement if an issuer falls outside the safe harbor. It is certainly a logical remedy and preferable to a potential violation of the rule.
We commend the Commission for also allowing in its proposal the publication of factual business information and regularly released forward looking information during the 30-day safe harbor period. We would suggest that the Commission modify the proposed list of factual business information to include in addition to "factual information required to be set forth in any Exchange Act report the issuer is required to file" information voluntarily filed by an issuer in an Exchange Act report. Our reason for suggesting this is that an issuer should be able to file information voluntarily with the Commission during this 30-day safe harbor period and still be able to take advantage of the safe harbor. While many of these may be covered by "factual information about the issuer, already contained in the list of safe harbor permissible information," it would be preferable to include within these exceptions a voluntary filing under the Exchange Act.
The exception for regularly released forward information requires that the issuer for the last two fiscal years must have customarily released the information. While engaging in a particular practice for two fiscal years clearly establishes a pattern, we would suggest that one year would be sufficient.
We commend the Commission’s efforts to amend Rule 135 and 135c. Both rules currently require a mechanistic approach and often prohibit the disclosure of relevant information, the most significant of which is the naming of the underwriter. We are certainly aware of public disclosure by reporting companies that wish to name the underwriter or placement agent in an offering for a great many reasons. Some issuers believe that a well-known, respected underwriter or placement agent will reflect well on the issuer and the offering. We see no reason why disclosure of this information should not be permitted. The elimination of this prohibition is commendable. We would also suggest that issuers have more flexibility in describing proposed offerings.
We agree wholeheartedly with the Commission that the waiting period should be a time of open dialogue between the issuer and potential investors. We also are aware of the disparity of information that results from the current practice of conducting road shows for selected institutional investors. We understand that this practice has led to these institutions receiving more information about an issuer than individual investors, which can also lead to selective disclosure. For these reasons, we agree with the Commission’s proposal that issuers be permitted to freely communicate in any form without each communication having to meet the requirements of Section 10 under the Securities Act. The Commission’s proposed Rule 165 requires compliance with the prospectus delivery requirements of proposed Rule 172, the filing requirements of proposed Rule 425 and the requirement to file a final prospectus prior to the first sale. While we agree in principal with the first two predicates, we question why the filing of a final prospectus is necessary before the first sale, since under current Rules 424 and 430A, sales are permitted in the period two to five days prior to the filing of the final prospectus. While we support the requirement that the free writing material be filed with the Commission, we would suggest that it not be subject to liability under Section 12(a)(2).
The imposition of Section 12(a)(2) liability can be expected to cast a chill on utilization of new communication mediums, which we believe the Commission would like to encourage, especially where liability under Rule 10b-5 would serve to protect investors. The imposition of Section 12(a)(2) liability in such contexts would potentially create a great deal of uncertainty in managing the content of such communications and decrease its effectiveness and quality. This is especially true where investors may legitimately ask issuer representatives for relevant information in such public forums and such representatives might be hesitant to respond if all such statements carry with them the enhanced standard of liability. Claims under Rule 10b-5 would still allow investors to press legitimate claims of securities fraud based on the contents of such communications.
The Commission’s proposed Rule 425 could be construed to require the filing of certain types of communications that may appear on the Internet. According to the Release, "free writing" includes, but is not limited to, sales literature and selling documents that include forward-looking information. A "writing" is deemed to include electronic information and other "future uses of changing communications technology," but does not include information disseminated orally. In certain instances, a "free writing" must be filed with the Commission.
Recent advances in electronic communications technology have blurred the lines between "oral" and "written" communications, as in the almost contemporaneous transcription of analyst conference calls on the Internet. The level of analysis ostensibly required by the foregoing proposals to determine whether a communication is written or oral, or required to be filed, may act to discourage the growing use of such effective investor communication tools. We believe that the exceptions to filing of certain "free writings" as are set forth in proposed Rule 425 help address this concern in a limited way, but substantial disincentives to the legitimate use by issuers of electronic technology to communicate with investors still remain.
With the widespread dissemination of issuer information over the Internet, it will be difficult to require issuers to affirmatively withhold or try to prevent dissemination of certain offering related information from the markets in the limited communications period under the "bright-line" communications safe harbor provided in proposed Rule 167. Issuer offering information contained on earlier unexpurgated versions of issuer web pages may now, in practice, be archived and stored on other third-party Internet information provider server computers well into the limited communications period. Such archiving facilitates the speed of Internet access to such computers. It also may be difficult to ascertain whether the Commission would deem these third-parties to be acting on behalf of an issuer. This may especially be true where there are pre-existing marketing relationships for the issuer’s goods and/or services. Also, a requirement imposed on issuers to make an effort to ascertain the identities of all such providers and to request that such information be deleted would be difficult to satisfy and impose a significant burden on such issuers.
With respect to the request for comments regarding the updating of the EDGAR system, we submit the additional suggestion that an issuer make any multimedia prospectus available on an openly accessible web site. The address of that site should be filed with the Commission, and the site should make available to those accessing the site any software plug-ins or other display technology necessary to view the multimedia prospectuses.
IV. Research Reports
We applaud generally the Commission’s desire to liberalize certain aspects of the exemptions concerning research reports set forth in proposed Rules l37, 138 and 139 and have the following specific comments relative to those Rules.
A. Rule 137
We support the proposal to delete the requirement of publication "in the regular course of business" and the disqualifying provisions of paragraph (b), which will serve to enhance the potential flow of information.
We believe Rules 137 and 139 could be improved by providing that only managing and co-managing underwriters of a particular offering need to satisfy the safe harbor provisions of the rules and that other syndicate participants would not be subject to the prohibitions that currently exist. This would be a beneficial change because the current safe harbors create numerous compliance issues for brokers who have published research reports and thereafter are invited to participate in the syndicate of an offering. In this regard, syndicate members are normally invited to participate after the preliminary prospectus has been prepared and shortly before commencement of the road show. Their participation is confirmed only shortly prior to a pricing. Finally, syndicate members do not participate in the due diligence process or have access to the same information and due diligence investigation available to managers and co-managers.
This modified approach would also benefit discount brokerage firms that carry (but do not prepare) third party research reports and Internet search providers and search engines that likewise distribute research reports. Each of the foregoing conduits "distributes" research reports but does not prepare it and does not have the same interest as, for example, a managing underwriter that would otherwise have a strong desire to promote if permitted. These changes would provide a bright line standard for specific limited types of activity that would involve a disqualifying interest and therefore add greater certainty to paragraphs (a) and (c) of the rule. The changes therefore would enhance compliance and increase the potential universe of research material available to investors.
B. Rule 138
We raise the same issues and comments concerning Rule 138 as were previously outlined under the Rule 137 discussion. In addition, we ask whether certain portions of the language in paragraph (b) were intentionally drafted to further a purpose (e.g., paragraph (b)(1) incorporates Rule 138(a)(3), which requires publication in the ordinary course, but paragraph (b)(2) requires publication with reasonable regularity in the ordinary course). (Emphasis added). In response to the requests for comment, the proposed one-year foreign issuer trading history appears appropriate given that foreign regulatory standards generally are more lax than U.S. standards (e.g., U.K. reporting standards require announcement and reporting of results only twice per year). In addition, the safe harbor should cover debt issuers that previously terminated a reporting obligation because, in many cases, such issuers still have reporting obligations – albeit lesser obligations – under indentures or other governing contractual instruments and the need for third party views are important.
C. Rule 139
As with Rule 138, we repeat the same concepts and comments from the Rule 137 discussion with equal weight here. In light of the speed at which information passes by Internet and e-mail, we do not see a particularly compelling need for differentiating the treatment of focused research for issuers that have been reporting for more than or less than one year. In point of fact, there may often be more fulsome disclosure in a newly effective registrant’s SEC filings (brought about by Securities Act Form requirements and underwriters/professionals’ drafting involvement), and more detailed and more current information about a "new" registrant as compared to those that have made more filings (in number) over a greater than one year period. We also believe that the reasonable regularity requirement could be improved by a "brighter" line standard that would presume reasonable regularity if research is, for instance, (i) initiated at least 60 days before the filing of a registration statement or the offering of securities under a shelf registration statement and (ii) updated periodically (e.g., two times in any given twelve-month period). The foregoing tests, however, should not preclude successful IPO growth companies from accessing the capital markets with follow-on or secondary offerings that retain managing or co-managing underwriters that participated in the IPO and subsequently issued research reports. These entities are frequently the most knowledgeable market professionals that could express an opinion and, therefore, such opinions should not be limited. As a result, Rule 139 could presume that any such initiated research report was issued with reasonable regularity as long as it was issued some reasonable period (e.g., 30-60 days) after the expiration of any quiet period limitation. As with Rule 138, we have a similar issue of drafting intent with respect to Rule 139(a)(2). For instance, clause (i) incorporates an "ordinary course" publication requirement, while clause (ii) requires publication with reasonable regularity in the ordinary course. (Emphasis added).
D. Research Reports and Regulation S
The Proposal would apply Rules 138 and 139 to research reports published in the United States by an underwriter who is acting on behalf of an issuer in an offshore offering. The concern is that such reports may constitute directed selling efforts in the United States prohibited by Regulation S. We applaud the Commission’s recognition that this concern stifles information otherwise available to the market. However, we believe that the Proposal is too restrictive in addressing this problem.
The prohibition of U.S. directed selling efforts was appropriate when Regulation S was adopted because, as originally adopted, securities issued in Regulation S transactions were not restricted securities and were accordingly, in many cases, subject to the risk that such securities would be virtually immediately resold in the United States. Directed selling efforts in the United States might therefore have been used to facilitate the distribution the offshore offering because United States market activity would provide ready liquidity for the offshore investors.
With the amendments to Regulation S to treat securities issued in such offerings as restricted securities, there is no incentive to engage in directed selling efforts in the United States. Therefore, any research published in the United States should be considered other than directed selling efforts. Accordingly, limitations such as the requirement that research have been regularly issued seem unnecessary.
V. Impact on Canadian Issuers and the Multi-Jurisdictional Disclosure System
A. The Multi-Jurisdictional Disclosure System
Under the Release, large, seasoned Canadian Issuers will be required to elect, in advance of an offering, by filing a Form 20-F rather than the MJDS Form 40-F, to be treated as a Form B issuer rather than as an MJDS issuer. We expect that such issuers will do so because of the greater flexibility offered in the Form B offering process.
The Release does not explain why such an advance election is required. We are unaware of any significant concern about the adequacy of Canadian Annual Reports which are filed with the Commission on Form 40-F. In view of the substantial similarity between the Canadian disclosure requirements and the requirements of Form 20-F, we believe that it is unnecessary to exclude the MJDS filings as the basis for Canadian issuers’ eligibility for
The Release also seeks to increase the public float requirement for MJDS to match the requirement for Form B. MJDS was an appropriate action to facilitate cross-border transactions in which the regulatory regimes of each country were substantially equivalent. If we are correct that large, seasoned Canadian issuers will file Form 20-F to obtain Form B eligibility, then the increase in the public float requirement for MJDS eligibility would seem to effectively end MJDS. If that is the Commission’s goal, it should do so explicitly. Our experience with MJDS does not warrant such action.
In light of the impact of the decease in the value of the Canadian dollar since MJDS was adopted, it might be appropriate to express the eligibility for MJDS in United States dollars as contemplated by the Release.
B. Timing of Form 20-F
We agree with the Release’s recognition that United States investors should have more prompt access to the information found in Form 20-F. However, merely moving the arbitrary six month filing requirement to five months would seem an imperfect method of achieving timely disclosure in the United States. We would propose a rule which would require the filing of the Form 20-F within a specified period after the filing of financial statements or other mandated securities disclosure in the issuer’s home county. Until the uniform disclosure contemplated by the proposed amendments to Form 20-F is adopted, this period should be long enough to allow for the preparation of the United States disclosure documents after the home country documents are filed. We would suggest that 45 days would be an appropriate period.
C. Form 6-K
We agree with the Release’s requirement to both encourage voluntary disclosure on Form 6-K and to mandate that the filing of a Form 6-K to address material developments notwithstanding any required home country disclosure. These seem appropriate for the protection of United States investors.
VI. Integration of Registered and Unregistered Offerings
We commend the Commission for proposing rules designed to address this important topic. Particularly in the area of lockup agreements and private placements following abandoned public offerings, the rules should provide much-needed guidance on the application of integration principles. On the other hand, we believe that much of the regulatory approach to completed private offerings preceding public offerings has been articulated in interpretive letters and the staff’s disposition of issues raised in the comment process. Therefore, we are concerned that the failure of the Release to acknowledge that much of proposed Rule 152(a) is in fact a codification of existing staff positions may result in uncertainty as to the current position of the staff. For example, based on the relevant interpretive letters, we believe that Rule 152 clearly is available for a private offering that is completed after the issuer has determined to file a registration statement, but before the filing of the registration statement. Therefore, statements in the Release referencing questions such as, "whether the safe harbor is available when the registered offering was contemplated at the time of the private offering," without noting that the question has clearly been answered in the affirmative may inadvertently lead to confusion among practitioners. While the footnote references to Verticom, Inc. and subsequent letters are helpful, we encourage the Commission to specifically acknowledge that much of Rule 152(a) codifies current staff positions.
B. Completed Offerings
As stated above, we believe that Rule 152(a), for the most part, constitutes a codification of current staff positions. Nevertheless, we strongly support the efforts of the Commission to clearly articulate in a regulation the standards underlying a determination that a completed private offering will not be considered part of a subsequent registered offering. Accordingly, subject to limited exceptions described below, we strongly support the treatment of completed public offerings and resales proposed in Rule 152(a).
1. Issuer Transactions
We generally support the Commission’s definition of circumstances under which an offering would be considered completed, as articulated in Rule 152(a)(2). In connection with private offerings in which the purchase price has not been paid, it would be helpful to include an instruction with respect to the requirement that purchasers be unconditionally obligated to pay the purchase price, subject to conditions that are not within the control of any purchaser. The instruction should state that among conditions that are not deemed within the control of any purchaser is the issuance by the Commission of an order of effectiveness with respect to a resale registration statement.
In addition, at least in the context of a private placement by a non-reporting company, we believe that the requirement that the purchase price be fixed and not contingent upon the market price of securities at or around the time of the registered offering should not be applicable. For companies that have not yet gone public, the sale of securities in certain contexts could raise "cheap stock" concerns. The Commission accounting staff regularly scrutinizes prices paid for an issuer’s securities in the period preceding a public offering when those prices are less than the estimated public offering price. At times, the staff may insist that an issuer recognize compensation expense when the private offering price is below the estimated public offering price. Issuers may avoid this problem by pegging the private offering purchase price to the public offering price. Moreover, we believe that if a determination has been made to purchase securities in a bona fide private offering, an investment decision has been rendered even if the precise price that may be paid is subject to market conditions. Except in the case where a resale registration statement is ordered effective concurrently with the closing of the private offering and the purchaser immediately resells all shares purchased, the purchaser will bear at least some degree of market risk.
We support proposed paragraphs (a)(3) of Rule 152, which we believe codifies the staff's position that the offer of securities underlying convertible securities or warrants will be deemed completed (and, therefore, not integrated with a registered offering) if the offering of the convertible securities or warrants is completed. We also support the proposal to clarify, in proposed paragraph (a)(4) of Rule 152, that certain recapitalizations will not be integrated with initial public offerings.
2. Resale Transactions
We support the codification of the staff position that a resale registration statement covering securities sold in a bona fide private offering may be filed at any time following completion of private offering. However, we do not agree with the proposed exclusion from the safe harbor of resales by affiliates of the issuer or dealers that have purchased directly from the issuer or an affiliate. In its discussion of this exclusion, the Commission stated that in resale transactions by affiliates of the issuer or a broker-dealer that has purchased directly from the issuer or an affiliate, "there are questions as to whether the offering is a true resale transaction or a primary offering by the issuer." For the following reasons, we do not believe that this is a sufficient concern to prevent application of the safe harbor to offerees and broker-dealers:
a. It seems very unlikely that an issuer engaged in the process of preparing a registration statement for filing with the Commission would simultaneously be seeking to use affiliates or broker-dealers as conduits for additional public sales of its securities. Certainly, in the context of a private placement preceding an initial public offering, there will be no public trading markets into which affiliates or broker dealers could sell their securities, so that it would not be practical for an issuer to use affiliates or broker-dealers as conduits for a primary offering in this context.
b. It is not uncommon for issuers to obtain "seed money" from affiliates and broker-dealers to permit them to fund necessary expenditures in the period preceding the filing of a registration statement, particularly in the case of an initial public offering. The uncertainty regarding the ability to resell securities that could result from the safe harbor exclusion may discourage affiliates and broker-dealers from engaging in these transactions. As a result, an issuer’s ability to obtain needed capital pending the filing of a registration statement could be severely impaired.
c. Even assuming that an affiliate or broker-dealer was acting as a conduit for a primary offering by the issuer, we do not believe that any practical harm would result from the use of a resale registration statement. Any resale by an affiliate or broker-dealer would require the delivery of a prospectus in connection with the transaction. Moreover, under the amendments to Form B as proposed, neither affiliates nor broker-dealers (or, for that matter, anyone else) could utilize a Form B registration statement for resales if the registrant could not utilize the Form B for primary offerings. Therefore, the most likely abuse in this area under present regulation, namely, the use of a registration statement form that would not be available in a primary offering, would no longer be a concern.
To the extent that the Commission believes that the use of affiliates or broker-dealers to disguise a primary offering is nevertheless a concern, we believe the concern is already addressed by limiting the resale safe harbor to resales following "bona fide" private offerings. If an issuer utilizes affiliates or broker-dealers as conduits for primary offerings, the "private" offering would not be "bona fide" and the rule would not be available. If further protection is deemed required, a preliminary instruction could specifically state that the rule will not be available if a sale to an affiliate or broker-dealer is, in fact, part of a primary offering.
3. Lock-up Agreements
We commend the Commission for proposing a rule that clearly permits the registration of securities that are subject to lock-up agreements. The proposal constitutes a practical approach that recognizes the legitimate business reasons underlying the use of lock-up agreements. Therefore, we support adoption of the rule, subject to the following:
a. We believe that Rule 159(a) should be revised to make it clear that the term "family members" is applicable to each of the groups that may be parties to lock-up agreements under the proposed rule, including holders of 5% or more of the voting equity securities of the company or other entity to be acquired. Moreover, the term "family members" should be defined in the rule (a definition similar to that for "immediate family" in Rule 16a-1(e) would be appropriate).
b. We do not believe that the ability to utilize registration in this context should be conditioned on whether votes will be solicited from shareholders who would be ineligible to purchase in an offering under Section 4(2) or 4(6) of the Securities Act or Rule 506 of Regulation D. The Commission stated that this condition "would make certain that registration under the Securities Act is required to accomplish the business combination." The Commission reasoned that if votes are solicited only from persons who could purchase under one of the private offering exemptions, "the entire transaction would be more akin to a private placement and registration of only resales would follow from that characterization." We respectfully disagree. The mere fact that a public offering may be made to someone who is an "accredited investor" does not make the offering any less of a public offering because of the accredited nature of the investor. If an investor will be making an investment decision based upon a prospectus meeting the requirements of Section 10 under the Securities Act, the investor’s status as an "accredited investor" should not raise concerns requiring resales. (The application of the proposed rule becomes even more draconian and uncertain when applied to a person who is not an accredited investor, but who may be deemed to satisfy the financial sophistication conditions of Rule 506(b)(2)(ii). Issuers should not be compelled to make inquiries regarding the financial sophistication of equity holders of the entity to be acquired.)
We note that the Commission’s traditional concern in this area, namely that resales by affiliates of the entity to be acquired may constitute a distribution requiring registration under the Securities Act, is already addressed. Rule 145 defines those persons who are deemed to be underwriters and sets forth resale provisions designed to prevent unregistered distributions. Therefore, if the Commission nevertheless believes that some limitation on the nature of the class of persons being solicited is necessary, we suggest that subparagraph (c)(2) of proposed Rule 159 require only that votes be solicited from shareholders of the company who are not affiliates of the entity to be acquired.
We believe Rule 159 should be available if persons owning less than 100% of the voting equity of the entity have signed lock-up agreements; we do not believe that a percentage lower than 100% is necessary. While we believe it should not matter what percentage had been locked up if a significant number of shareholders had not been, we would prefer that companies not be compelled to engage in a "head count" to determine the applicability of the rule. In our view, subject to the limitations set forth above, the Commission has articulated a practical approach to this area without any meaningful risk to investor protection. In addition, we believe that the rule should apply to lock-ups in connection with tender offers. We believe the regulatory concerns with respect to integration are essentially the same for tender offers and Rule 145(a) transactions. Therefore, we do not believe that different conditions are necessary in connection with tender offers.
C. Abandoned Offerings
We commend the Commission for addressing this area, which also has been subject to a good deal of uncertainty in recent years.
1. Private to Public
We generally support the provisions of Rule 152(b), which permits issuers who have abandoned a private offering to subsequently register an offering (on a registration form other than on Form B) under certain conditions. However, we question the need for subparagraph (2) of Rule 152(b), which requires that the registrant not file a registration statement for 30 days following the abandonment of a private offering if offers were made to persons ineligible to purchase in an offering in accordance with Section 4(2) or 4(6) or Rule 506. We believe that subparagraph (3) of Rule 152(b), which requires that the issuer and persons acting on its behalf not be engaged in general solicitation or general advertising, will provide sufficient protection against abuses of the private offering process.
In the Release, the Commission states that the provisions of Rule 152(b)(2) and (3) "would protect against issuers who had no intention of making a private offering abusing the safe harbor by making public offers before filing the registration statement containing the full and balanced disclosure." Clearly, this risk is appropriately addressed in Rule 152(b)(3). On the other hand, if an offer in a private offering is being made in a fashion consistent with the concept of a private offering (i.e., no general solicitation or general advertising), we do not believe there is a meaningful potential for abuse resulting from offers to ineligible offerees, even if the offers were made within 30 days prior to the filing of a registration statement. In the context of offerings on a form other than Form B, the offerees will be receiving a prospectus containing or incorporating the disclosures required under the appropriate form. The disclosure likely will be more comprehensive than the disclosure used in the private offering. Moreover, the issuer and the underwriter will be subject to liability under Sections 11 and 12(a)(2) of the Securities Act. In addition, the rule is not available if the private offering is not "bona fide," so that abuses of the safe harbor could be addressed by enforcement action.
If the Commission nevertheless believes that the perceived abuse must be addressed in some form other than the enforcement process, we would suggest permitting the filing of the registration statement within 30 days following private offerings to ineligible offerees, provided that no sales may be made to the ineligible offerees. In addition, those purchases by private placement offerees who are qualified to purchase in the private offering could be limited to a specified percentage of the securities sold the public offering. By limiting the percentage of the offering that could be sold to eligible offerees solicited during the private phase, the Commission would ensure that the public offering was not in fact a mechanism designed to permit private offerees to obtain freely tradeable shares. We believe that the appropriate maximum percentage should be 50%.
In addition, we believe that the provisions of proposed Rule 152(b)(4), which requires that no securities be sold in the private offering, may cause some confusion. If the private offering is a "best efforts" offering in which a specified minimum amount of sales is required to close the offering, an issuer should be able to terminate the offering and rely on Rule 152(a)(1) in connection with the offering since the minimum has been achieved (this assumes that the requirements of proposed Rule 152(a)(2) have been met). While the Commission states that "the prohibition against sales would make sure that all purchasers have the protection of Section 11 liability," that philosophy is inconsistent with the traditional philosophy behind Rule 152. Plainly stated, if an offeree meets the qualifications for a private offering exemption and if the offering is conducted in the manner consistent with the private offering exemption, Section 11 liability should not apply.
On the other hand, we believe that the prohibition on general solicitation and the notification provisions embodied in the proposed rule are appropriate measures to address the differing nature of public and private offerings.
Finally, we do not believe that an issuer should be required to file materials used in the private offering either under proposed Rule 425 or as part of the effective registration statement. If an issuer conducts a bona fide private offering, and satisfies the other conditions of the rule (other than subparagraph (b)(2), which, as noted above, we believe is unnecessary), an investor’s attention will be appropriately directed to the public offering, and both the issuer and the offeree should rely solely on the prospectus as the focus of disclosure and liability. While issuers may file private offering selling materials as an alternative means of meeting the requirement of subparagraph (b)(5), we believe it is much more likely that issuers will choose to notify offerees that the public offering prospectus supersedes the private offering materials and that the offerees’ indications of interest are deemed rescinded.
2. Public to Private
We commend the Commission for its efforts to address a particularly difficult and unclear area of the law. However, we believe that one element of the proposed notification requirements can be simplified and that the proposed liability provisions are unnecessary.
Proposed subparagraph (c)(1) of Rule 152 would require that the issuer notify all offerees in the public offering of its abandonment of the offering if a registration statement has not been filed. We believe this requirement is burdensome and unnecessary to protect those persons who will not be offerees in the subsequent private offering. For persons other than offerees in the subsequent private offering, a public announcement should provide sufficient notification. Such an announcement could be made in the form of a press release, or, for a reporting company, by the filing of a Form 8-K. On the other hand, where a registration statement was not filed in connection with a public offering, we believe specific notice should be given to persons who are offerees in the private offering so that they clearly understand the different nature of the private offering. In this regard, we support the notification provisions of proposed subparagraph (c)(3)(i) of Rule 152.
We strongly disagree with the proposed imposition of Section 11 or Section 12(a)(2) liability in the context of a private offering that commences within 30 days following an abandoned public offering. We note that the safe harbor of Rule 152(c) relates only to offerings exempt from registration under Section 4(2) or 4(6) of the Securities Act. Accordingly, the offerees will be limited to those persons who, by virtue of their status as accredited investors or possession of the requisite financial sophistication, can fend for themselves. Assuming the other conditions for a private offering are met, these offerees will have the opportunity to directly ask questions of the issuer and to otherwise obtain information necessary to evaluate the merits and risks of the offering. Moreover, it is likely that the disclosure such persons receive in an environment following a withdrawal of the public offering will be of a higher quality than that which would be available if the private offering did not follow a withdrawn public offering. We simply fail to understand the concern that "offerees in the private offering may still be influenced by the public offering." Persons who are able to "fend for themselves" would most likely approach the private offering with some degree of circumspection in light of the fact that the public offering was abandoned. Investors who are eligible to participate in these offerings will have the opportunity to ask questions of the issuer to determine the factors that led to the abandonment of the public offering, while also having the benefit of the comprehensive disclosures contained in the registration statement.
We believe that the imposition of liabilities in this context is an inappropriate remedy to what appears to be the concern behind this proposal, namely that the issuer in the private offering may have the benefit of a general solicitation. Even if that is the case, we believe that the practical effect of perceived harm is minimal at worst. Moreover, in certain contexts, the problem may be derived from an overly broad application of the concept of general solicitation. We believe that in the context of a "quiet filing," where a registration statement has been filed but no substantive offering efforts have commenced, a general solicitation has not occurred. Prior to the filing of an initial amendment to these registration statements, selling efforts generally have not commenced and no public announcement (other than, perhaps, a press release in accordance with requirements of Rule 134) has been made. The imposition of Section 11 liability in this context seems particularly onerous. As a matter of administrative discretion (similar to that proposed to be applied to lock-up agreements) we urge the Commission to determine that there is no need for a remedy here.
Moreover, we do not believe there is much risk that issuers would use the public offering process with a view to "influencing" potential private offering investors. We simply do not believe that an issuer would expend the time, effort and expense of filing a registration statement and subject itself to the attendant regulatory scrutiny as part of a scheme to effect a private offering through otherwise impermissible general solicitation. In the very unlikely event an issuer engages in such a scheme, suitable enforcement remedies can be imposed.
D. Definition of Private Offering
We do not believe that separate reference to Rule 506 should be made in the definition of a private offering. Rule 506 is a safe harbor under Section 4(2). We believe that the separate specification of Rule 506 may cause confusion as to the status of offerings that comply with Section 4(2) but do not comply with the conditions of Rule 506. We believe a reference to Section 4(2) or 4(6) of the Securities Act is sufficient.
E. Proposed Changes to Rule 477
We support the adoption of Rule 477 as proposed. We believe that issuers should have the ability to determine unilaterally when to withdraw a registration statement. We do not believe that the absence of Commission discretion with regard to the determination to withdraw a registration statement would have any adverse impact on investor protection.
F. General Observations
We have found few areas of securities law to be subject to as much recent controversy and uncertainty as integration. Therefore, we commend the Commission for undertaking to address this area by regulation. Although, as noted above, we believe that certain aspects of the proposals should be modified, we believe integration safe harbors should be adopted, regardless of the Commission’s disposition of other aspects of the proposals.
Moreover, as a result of the experience of some members of the committee in dealing with integration issues in recent years, we wish to add the following suggestions:
a. The comment process should not be used as a forum to introduce significant staff policies: We believe that the staff’s approach to integration in recent years inadvertently has been a cause of a great deal of the confusion in this area. Rather than addressing this area by regulation, by interpretive release, or even by interpretive or no-action letters, the staff has introduced, and then modified, many of its major positions in this area through the comment process. This is a singularly unsatisfactory method of initiating significant regulatory change. Practitioners are not generally privy to staff comments, which are not publicly available. As a result, much of the information available to the private bar with respect to the staff’s positions was derived from a private periodical, containing second hand summaries of staff positions taken in the comment letter process. We believe that the term "metaphysics" (not a complimentary term) was imposed in this area not only due to the substance of certain staff positions, but due to the process by which these positions were articulated. We respectfully suggest that more public and appropriate means of articulating significant positions be utilized in the future.
b. The staff should abandon its position regarding the filing of a registration statement constituting general solicitation: We believe that the position of the Division of Corporation Finance that the filing of a registration statement constitutes a general solicitation should not be applied in certain contexts. The use of "quiet filings," particularly in the context of initial public offerings, has become much more prevalent in recent years. Although these filings are "public" in the sense that the registration statement is accessible by the public, no real soliciting efforts are made in connection with these filings. Where no meaningful solicitation effort has been made, we believe no general solicitation should be deemed to have occurred.
c. Consider whether certain conditions proposed in the rule are necessary to address perceived abuses and whether the "abuses" actually raise investor protection concerns: The integration proposals seem to incorporate what may be characterized as a "quid pro quo" approach. It appears that virtually every significant modification to restrictive integration principles is coupled with a condition designed to remedy a perceived abuse. We believe that in some cases, the abuse does not, as a practical matter, raise investor protection concerns. In other cases, the proposed remedy does not appear to be reasonably related to the concerns raised. For example, as noted above, the proposed imposition of liability in connection with private offerings following public offerings appears to be directed more towards the staff’s discomfort concerning general solicitation that may have occurred prior to the private offering rather than any substantive need to protect the class of offerees that would purchase securities in the private offering. We urge the Commission to consider whether this approach is necessary or appropriate in the public interest or for the protection of investors.
d. Acknowledge the validity of the "five-factor" test in an instruction to Rule 152: We think it is important that the Commission, in the text accompanying footnote 473 to the Release, confirmed that the "five-factor" test relating to integration, first articulated in Securities Act Release No. 4552 (November 6, 1962), continues to apply today. In our experience, the staff has at times been very reluctant to entertain non-integration arguments based on the application of the test. In this regard, we believe that a staff legal bulletin or other guidance regarding the applicability of the five-factor test would be helpful. We are particularly concerned that issuers not be denied the ability to offer securities in connection with bona fide acquisitions, strategic alliances and similar transactions during the pendency of a public offering. We believe that under the five-factor test, the offering of securities in such transactions typically should not be integrated with a concurrent public offering. While the staff has recently been more flexible in addressing this area, we believe that a specific acknowledgment of the continued viability of the five-factor test in Rule 152, similar to that currently in Rule 502(a), would be appropriate.
e. Reconsider statements in the Release regarding integration of offerings underlying transferable warrants and convertible securities: In the Release, the Commission articulates an interpretation regarding the integration of offers underlying transferable options, warrants and convertible securities which we do not believe is mandated by law. For example, in footnote 122 of the Release, the Commission states: "If the underlying security is issuable within one year of the company’s issuance of the convertible security or transferable warrant, the underlying security would be part of the offering of the convertible security or transferable warrant." We do not believe that the application of the one-year period is mandated by law or the need for investor protection. Section 2(3) of the Act states that a right to convert a security into another security or to subscribe for another security will not be deemed to be an offer or sale of such other security if the right "cannot be exercised until some future date." We recognize that an offer of an underlying security should be deemed to be occurring where an underlying security is issuable within a very short time after the issuance of the warrant or convertible security. However, we believe that the one year period referenced by the Commission is simply too long. By analogy, we believe the six month period utilized in Rule 502(a) under the Act in determining that offers should not be integrated for the purposes of Regulation D would be appropriate here.
VII. Proposals Relating to Exchange Act Disclosure
We generally support the inclusion of risk factor disclosures for quarterly and annual reports. We believe that a number of issuers are currently including risk factor disclosure in their filings. We do not believe, however, the Commission should require risk factor disclosure about specific matters that are in addition to those referred to in Item 503 of Regulation S-K. Each issuer should tailor these factors to encompass its specific business and financial risks. The general categories of Rule 503, with a few specific examples, provide adequate guidance to issuers.
2. Management Report to Audit Committee
We oppose the recommendation of the Advisory Committee to require the filing as an exhibit to Form 10-K of a management report to the audit committee of the board of directors which would disclose the procedures, if any, established to assure the accuracy and adequacy of Exchange Act reports.
At the outset, we note that the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees issued its report after the Aircraft Carrier Release was issued. Chairman Levitt and members of the SEC staff have said that a separate release and rule proposal will be issued regarding audit committees. We concur with this separate treatment as a general matter, and believe that audit committees should not be dealt with as part of the Aircraft Carrier Release.
We also have the following specific concerns and objections regarding the production of a management report and its filing as an exhibit to Form 10-K:
a. Management and the board of directors already have fiduciary obligations which require that Exchange Act reports be produced in a manner consistent with these fiduciary obligations. We believe that existing obligations are sufficient to require that Exchange Act reports be produced with the appropriate care and diligence by management and with the appropriate level of oversight by audit committees and boards of directors. As noted above, the manner in which these responsibilities are fulfilled in the context of an individual company should be left to management and the audit committees of the company and not to some "common denominator" standard.
b. The obligation on the part of management to deliver such a report would require that the audit committee develop standards for the review and evaluation of the Management Report and prepare a formal analysis and evaluation of each report. This new layer of formal standards and review would inhibit the process of preparing Exchange Act reports by issuers – a process which necessarily is, at least in part, a flexible and informal process which should change frequently as an issuer’s business develops.
c. To limit liability on the part of management and the audit committee, many issuers would be likely to engage outside consultants, at significant expense, to develop formal procedures for management to follow in the preparation of Exchange Act reports and formal standards for review and evaluation of the management report by the audit committees. This would be likely to have the undesirable effect of standardizing all such procedures. Notwithstanding this action, we believe that the management report and the subsequent evaluation of the management report by an audit committee would increase the potential liability of management and audit committees.
d. We believe that a requirement that the management report be filed as an exhibit to Form 10-K might inhibit the free flow of information and ideas between management and audit committees as a result of the standardization and homogenization referred to above.
e. Finally, we question the materiality of a management report to the marketplace. We also have difficulty in determining what its contents might be, taking into account the difficulty in identifying and describing all of the many procedures utilized by management to assure the accuracy and adequacy of Exchange Act reports.
As an example of the potential effect of the proposed requirement, we suggest the following hypothetical. Suppose it is asserted with respect to a reporting company that (1) the financial disclosure contained in a Form 10-Q was inadequate and (2) the audit committee should have identified the inadequacy and caused it to be corrected before the filing was made. In all likelihood, the issue that will be disputed and litigated will no longer be whether the procedure that the audit committee followed was adequate to meet its responsibility – a state law issue. Instead, the issue litigated is likely to be whether the audit committee followed its own published procedure and whether it failed to disclose the procedure it actually followed – a federal securities law claim. Of course, the state law claim still could, and no doubt would, be asserted. But the issue that we assume would be easier to prove and therefore would be focussed upon would be the federal disclosure issue. In this example, there would be no development of the law as to what constitutes the required legal standard for audit committee procedures.
We applaud the Commission’s efforts to participate in and enhance the dialog among members of the securities bar and others as to what constitutes good practice in the areas of procedures for the preparation of Exchange Act reports, including due diligence procedures. However, we do not believe that disclosure rules that require a company to disclose its procedures in these areas furthers this process. Rather, we believe it stifles the process. We believe that the Commission would much better serve the dialog in this area if, when it did act – such as in the Caterpillar matter – it would broadly disseminate the undertakings it imposes in settlements for discussion among the bar.
We have significant reservations regarding the proposal to require selected financial data to be filed under Form 8-K within 60 days after the end of each fiscal year and within 30 days after each fiscal quarter. We believe that at the very least, this requirement should be phased in over time.
The market is generally urging this information for more actively followed issuers. We believe, however, that the Commission should not establish requirements that accelerate what the market demands. The cost of compliance can be substantial if accelerated reporting were to require substantial changes to an issuer’s accounting systems. Therefore, this requirement should be implemented over a period of time that is consistent with most issuers’ planning cycles on the basis of market float and ADTV.
We recognize the Commission’s concern that the current practice by many companies of issuing press releases to announce quarterly and annual earnings much earlier than their filing of annual and quarterly reports may result in selective disclosure. We agree that not all investors subscribe to publications that carry these releases and that their content may vary from issuer to issuer. We believe, however, that access to the Commission’s EDGAR System is presently also selective, limited as it is to those with access to the Internet. Over time the use and access to EDGAR may become more uniform.
Because of the different accounting practices among companies and the serious consequences of failing to file timely a Form 8-K report, such as loss of the use of Form S-8 or the use of the resale provisions of Rule 144, a more voluntary approach should be considered. If a company issues a press release to report quarterly and annual earnings information, it should be required to file a Form 8-K report within one or two business days after the issuance of the release. As a result, the information would be accessible on EDGAR, but would be limited to those companies that have the capability of issuing such information on an accelerated basis. As the market demands more information from other issuers, the number of issuers becoming subject to the Form 8-K filing requirement will increase.
As an alternative to the proposal to add a financial reporting requirement to Form 8-K, the Commission has requested comment on whether companies should be required to file quarterly reports on Forms 10-Q or 10-QSB within 30 days after the end of their first three quarters and annual reports within 60 days after their fiscal year end.
We do not believe it is practicable for most companies to modify their reporting procedures to enable them to meet an accelerated reporting schedule. More and more companies are able to release earnings information within such time periods. Requiring companies to prepare and file complete periodic reports within such time frames, however, seems burdensome. Small companies with limited staff resources would be hard pressed to complete the reports within these time frames. Larger companies with international business operations may find it difficult to gather information in a timely manner. Review by counsel and independent accountants and review and sign off by executives and board members is a time consuming process. These problems are compounded by the increase in the type of information that issuers are required to include in their reports, such as market risk information, the proposed additional risk factor disclosures and other segment information. Many companies have difficulty preparing such information within existing time frames.
We generally agree with this proposal. The instructions to the form, however, should make it clear that only material changes trigger a reporting obligation. For example, if an issuer with no history of paying dividends amends the dividend restriction covenant in a financing agreement, no reporting obligation should be triggered.
Given the difficulties that some issuers encounter in preparing reports to be filed via EDGAR, we believe that filing a Form 8-K report within one business day is too short. Review of the filing by counsel or independent auditor, coordinating with an EDGAR service provider, if necessary, and obtaining requisite sign off of the filing from executives make a one-day time period impracticable. The deadline for any of these filings should not be shorter than two business days.
The Commission has proposed to expand the number of persons required to sign certain Exchange Act filings and to require new certifications on Exchange Act reports intended to ensure that a reporting company's senior management and board of directors have read the filings. We agree that the increased importance of periodic reporting requires that reporting companies develop improved procedures for preparation of Exchange Act reports. We believe, however, that the signature and certification requirements as proposed are inappropriate means of achieving that objective.
First, we do not disagree in principle that the signatory requirements for the Exchange Act forms named in the proposal might ultimately be the same as those of the Form 10-K. Nevertheless, as the Commission explicitly suggests in the Release, this will entail a significant change in the behavior of company management, which in turn will require education and an opportunity to modify existing corporate procedures. This will be particularly true in large, complex companies. To ensure that reporting companies have a chance to respond appropriately before Section 18 liability is imposed on these new signatories, we suggest that the Commission make the new Exchange Act signatory requirements effective a period of time after date of adoption of the rule. We would further suggest that the period be one year.
We do not believe the certification requirements should be adopted. First, we find the basis for the proposal unconvincing. The Release cites the conclusion of the Advisory Committee, noted in footnote 552, that "senior management of reporting companies routinely execute the signature pages for Exchange Act reports without having or reviewing the report itself" and that "board members devote less attention to Exchange Act reports that they devote to Securities Act filings." There has never been a certification requirement with respect to Securities Act filings, yet the Commission makes no suggestion that the disclosure in Securities Act filings is inadequate. Nevertheless the certification proposal is applied to both Exchange Act and Securities Act filings. We also observe that these procedural deficiencies in Exchange Act reports have existed despite the fact that, as the Commission notes at footnote 554 of the Release, the Commission amended Form 10-K in 1980 to require additional signatories, including a majority of the board, in order to cause directors and officers to pay more attention to Exchange Act reporting.
The system generally contemplated by theRelease – like the systems suggested in previous Commission task forces and advisory committees – would subject periodic reports to more intense and more frequent review by the Commission. We believe such scrutiny will itself cause reporting companies to modify internal procedures to improve the quality of disclosure. In that environment, an additional certification requirement seems excessive.
We also fail to see how such a requirement could practicably be implemented. The test of the certification addresses "this report." This would appear, strictly speaking, to require that each person certifying the report must have read the last draft and that no further changes could be made. Given the difficulty in reaching members of the board of directors and key management in today's companies, this would be nearly impossible. More importantly, we do not believe that the quality of disclosure is likely to be appreciably better even if all of the proposed signatories have actually read the report. Most of those persons are deeply familiar with only a portion of any reporting company’s affairs, and will inevitably need to rely on others, usually company officers, to supply accurate disclosure on other matters. What is important in that case is that the reporting company establish a procedure suitable to its business that elicits response from appropriate persons in the organization and results in accurate disclosure.
We have also considered whether, in addition to the express prophylactic intent behind the certification requirement, the Commission intends to subject signatories to new liabilities for false certifications. If so, we believe the Commission should say so expressly. In any event, we believe the securities laws already provide adequate means of redress for disclosure inadequacies without adding such a new basis for liability, if that was intended.
D. Solicitation of Comment Regarding Plain English in Exchange Act Reports
The initial sense of the committee was to give a positive comment on this proposal, with a possible suggestion that the plain English requirements be phased in over time. In light of proposed liability provisions for Exchange Act reporting, however, we believe that the plain English requirements should not be imposed at this time on Exchange Act reports.
While we generally feel that plain English will ultimately be required for all securities filings, we concluded that the prudent course of action at this time is to see how plain English is construed in Securities Act filings. We believe that plain English has not been fully developed by issuers and the staff, and the courts have yet provide guidance. Without a better understanding of the treatment of plain English by these constituencies, we believe extending the principles to Exchange Act reports is premature.
A. New Definition of a Small Business Issuer
The Commission proposes to raise the annual revenue ceiling for determining small business issuer status from $25 million to $50 million and to eliminate the public float test. We support this proposal.
The Commission proposes to permit "seasoned" small business issuers to incorporate previously filed Exchange Act reports to satisfy certain of the disclosure requirements of Form SB-2. (The form does not permit forward incorporation by reference.) To be considered seasoned for these purposes, a small business issuer would have to have been subject to the Exchange Act reporting requirements for at least a 24-month period, have timely filed all of its Exchange Act reports during the 12 months immediately preceding the filing of the registration statement and have filed at least two Exchange Act annual reports.
These issuers would be subject to the same requirements to deliver Exchange Act reports to investors as Form A issuers relying on incorporation by reference of Exchange Act reports. The small business issuer would have to deliver copies of its recent Exchange Act reports (Form 10-KSB and most recent Form 10-QSB) it incorporates by reference in the Form SB-2 with the prospectus and state in the prospectus that it will provide the investors any report that is incorporated by reference but not provided with the prospectus. We believe that seasoned small business issuers should have the freedom either to include company-related disclosure in full in the prospectus or, as an alternative, be permitted to incorporate by reference without delivering certain mandated reports.
The Commission has asked whether the "seasoning" period should be shortened to 12 months. As the Commission has indicated in its Release, small business issuers are less likely to be followed by securities analysts. Accordingly, we do not believe a "seasoning" period shorter than 24 months would be appropriate.
"Seasoned" small business issuers would be subject to the same disqualifications as issuers filing registration statements on Forms A or B. We do not support this proposal.
The Commission also asked if the requirement to deliver Exchange Act reports should be expanded to require delivery of all Exchange Act quarterly reports and reports on Form 8-K filed by the small business issuer since the end of its latest fiscal year. We believe that, if incorporation by reference and delivery is adopted for seasoned small business issuers, requiring delivery of these additional documents would be unnecessary and potentially confusing to investors and would increase the costs of registration to small business issuers without a corresponding benefit. The value of earlier quarterly reports is questionable, since year-to-date interim financial statements would be included in the latest Exchange Act quarterly report. Also, as the Commission has indicated elsewhere in the Release, investors would have access to the other quarterly reports and reports on Form 8-K through the Commission’s EDGAR system.
C. Form SB-3
The Commission proposes a new Form SB-3 for registration of securities of small business issuers to be issued in exchange offers or business combination transactions. The prospectus included in the registration statement also could serve as a proxy or information statement, if required. Seasoned small business issuers could incorporate Exchange Act reports in these registration statements in the same manner and on the same conditions as those discussed above with respect to Form SB-2. The proposals involve little substance change from the current provisions of Form S-4 applicable to small business issuers. Accordingly, we support their adoption.
D. Rule 504
The Commission proposes that securities issued by an Exchange Act reporting company upon the conversion of convertible securities or exercise of warrants that were offered pursuant to the exemption from registration provided by Rule 504 of Regulation D before the issuer became an Exchange Act reporting company would be exempt from registration pursuant to that rule. Any offers of such underlying securities occurring after the issuer became an Exchange Act reporting company also would be exempt. As a condition to the availability of this relief, the convertible securities or warrants, when issued, must have been immediately convertible or exercisable or first convertible or exercisable within one year of issuance. This would prevent issuers from taking advantage of Rule 504 in anticipation of becoming a reporting company. We support this proposal.
The Commission asks whether the exemption should be available regardless of when the convertible securities or warrants first become convertible or exercisable. The one year cut-off is consistent with the positions taken by the Commission’s Staff in other contexts. Moreover, one year after issuance investors may need additional information about the issuer before making a decision to convert or exercise. As noted above in our discussion of the proposals on integration of public and private offerings, we believe that the one-year standard should be reduced to six months. If such a change were adopted, we would support a similar change in the context of Rule 504.
The Commission also asks whether the exemption should be available to an issuer who issues convertible securities or warrants pursuant to Rule 504 at a time when it could have foreseen that it was about to become an Exchange Act reporting company. We believe that in light of the other proposed conditions, such a condition would inject uncertainty and would be unnecessary.
E. Registration Fees
The Commission proposes to permit small business issuers to pay their registration fees shortly before the effectiveness of their registration statements rather than upon the filing of the registration statement. The Commission believes that small business issuers frequently scale back the amount of their offering prior to effectiveness and, therefore, small business issuers would not be required to pay a fee on an amount in excess of what it intends to sell in the offering. We support this proposal.
F. Acceleration of Due Dates For Quarterly and Annual Reports
The Commission has asked whether Exchange Act quarterly reports of U.S. reporting companies should be filed within 30 days after the end of their first three fiscal quarters and whether their Exchange Act annual reports should be filed within 60 days after the end of their fiscal year. We do not support mandating reports for small business issuers that require detailed financial and other information to be filed within these time frames.
G. Public and Private Offering Flexibility
Of particular importance to small business issuers would be a new safe harbor that would allow issuers to change their minds about making a public offering and switch to a private offering, and vice versa. We support these proposals.
H. Other Proposals Affecting Small Business Issuers
The Commission proposes to permit seasoned small business issuers, other than transitional small business issuers, to use Form B for offerings solely to QIBs, certain offerings to existing security holders, offerings of non-convertible investment grade securities and market-making transactions by affiliated market makers. We support these proposals.
The Commission also proposes to permit small business issuers that are the subject of an offering registered on Form C to provide the information about themselves required by Form SB-3. We believe this proposal is consistent with the Commission’s treatment of small business issuers generally and we therefore support it.
We do not support requiring small business issuers to file selected financial information in Form 8-K reports in advance of their quarterly or annual reports.
Very truly yours,
Gregory H. Mathews
Chair, Business Law Section
Merritt A. Cole
Chair, Securities Regulation Committee
John B. Wright, II
Chair, Aircraft Carrier and M&A Release
Comment Letter Committee
AIRCRAFT CARRIER AND M&A RELEASE COMMENT LETTER COMMITTEE
Barry M. Abelson
N. Jeffrey Klauder
Christine J. Arasin
Justin P. Klein
William G. Lawlor
Justin W. Chairman
Brian J. Lynch
Robert W. Cleveland
Brian M. McCall
Merritt A. Cole
H. John Michel, Jr.
Albert S. Dandridge, III
Donald S. Morton
David S. Denious
Ann C. Mulé
Robert A. Friedel
Paul T. Porrini
Joseph P. Galda
John F. Reilly
Gail P. Granoff
Carl W. Schneider
Patricia A. Gritzan
Richard A. Silfen
Gerald J. Guarcini
Herbert Henryson II
Gary Arlen Smith
Richard P. Jaffe
Robert N. Sobol
James W. Jennings
Raymond K. Walheim, Secretary
John W. Kauffman
J. Peter Wolf
Mark K. Kessler
John B. Wright, II, Chair