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Table of Contents
June 30, 1999
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: SEC Release Regarding the Regulation of Securities Offerings (File No. S7-30-98)
Dear Mr. Katz:
We are submitting this letter in response to the request of the Securities and Exchange Commission (the "Commission" or "SEC") for comments regarding the Commissions proposal (the "Reform Proposal") to change the regulatory framework established for the conduct of offerings registered under the Securities Act of 1933 (the "Securities Act")1 . We appreciate the opportunity to participate in this important undertaking and intend our comments to be helpful to the Commission in its efforts to change the way offerings are conducted to reflect the realities of todays fast-paced financial markets and advanced communications technology while maintaining investor protection.2
The Reform Proposal, which represents the culmination of years of reflection by the Commission and its staff regarding the overall effectiveness of the current regulatory structure for offerings in the United States, covers five major topics: (i) registration system reform; (ii) communications around the time of an offering; (iii) prospectus delivery requirements; (iv) integration of private and public offerings; and (v) periodic reporting under the Securities Exchange Act of 1934 (the "Exchange Act"). Because of the breadth of the Reform Proposal, we have divided our comments into two parts. The first part contains a broad overview of the most significant aspects of the Reform Proposal and its likely impact on the way offerings are conducted today. The second part contains a more detailed analysis of certain of the specific rule changes and new rule proposals set forth in the Release.
We fully support the Commissions position, which is a touchstone of the Release and of the Commissions reform efforts generally, that investor protection must be paramount. Our comments and suggestions in this letter have been developed with that goal in mind. Our concern is that while the Reform Proposal seeks to heighten investor protection (for example, by mandating delivery of written information prior to investment decisions by investors and by increasing the availability of the remedies in Sections 12(a)(1) and 12(a)(2) of the Securities Act in various circumstances), the practical consequences of many of the Commissions proposed reforms are much less clear. For example, the proposed filing and liability provisions for free writing and offering information could discourage rather than promote communication to investors, and ultimately reduce the availability of information below what it is today. The proposed Form A/Form B registration framework and accompanying information delivery requirements could have the consequence of moving offerings out of the registered market and into the Rule 144A or offshore markets. These proposed changes could also cause the exclusion of retail investors from offerings in which some of them at least now participate, not because such offerings are unsuitable for retail investors, but because timing and delivery requirements are likely to cause them to be excluded.
Thus, while we agree with the Commission staff that the regulatory framework for offerings is in need of clarification and modernization, we are concerned that there are parts of the Reform Proposal itself that require clarification and other areas in which the Reform Proposal represents a step backward, rather than forward. We are also skeptical that the current registration process needs to be completely replaced (with the attendant cost and delay inherent in implementing a new system) in order to achieve the Commissions desired result. Indeed, in our view, many of the most important of the Commissions proposed reforms could be implemented today in the context of the existing system. By following such an approach, the Commission could more than adequately address and remedy the problems that have been identified in the current system. For these reasons, and as further discussed below, we do not believe the Reform Proposal should be adopted as proposed.
We suggest instead that the Commission, after evaluating what will doubtless be a myriad of comments addressing the Reform Proposal, repropose specific appropriate proposals contained in the Release for further comment. We are aware that certain members of the Commission staff have made statements opposing reproposal, but we believe that failure to repropose would be highly inadvisable. We note that in much smaller undertakings, for example in connection with the adoption of Rule 144A and Regulation S under the Securities Act, the Commission has deemed it appropriate to repropose the relevant rules to reflect the comments and concerns of interested parties. Particularly in light of the sweeping changes the Release envisions with respect to the current offering process and the significant public comment that the Reform Proposal will receive, we strongly recommend that the Commission repropose those specific provisions of the Release that would contribute to positive reform.
A. Summary of the Commissions Proposed Registration and Offering Framework
The over-arching framework for the Reform Proposal consists of the creation of two new forms for registration under the Securities Act Form B and Form A.3 The new forms would be used by both U.S. and non-U.S. issuers, thus eliminating the need for the separate set of registration forms that exist today for foreign private issuers. The professed goal of the Commission in proposing these new forms, with their attendant requirements, is to attract more issuers to the registered market by making registration an easier and more rational process.
The Reform Proposal recognizes the need for issuers to be able to access the markets quickly and efficiently to raise capital and acknowledges that the uncertainty of potential Commission staff review has often forced issuers to turn to the private or offshore markets to satisfy their capital raising needs. Accordingly, under Form B, large seasoned issuers (and, in connection with certain types of offerings, certain smaller seasoned issuers) would be granted the ability to control the timing of effectiveness of their registration statements. Under Form A, certain seasoned smaller issuers would, like Form B issuers, also be allowed to incorporate Exchange Act reports by reference and control the timing of effectiveness of their registration statements. Moreover, rather than being required to pay upfront filing fees with respect to all securities that may be offered over time under a particular registration statement, as is the case with "shelf" registration today, issuers would be permitted to submit filing fees on a "pay-as-you-go" basis. The Reform Proposal also eliminates the need to deliver a final prospectus in connection with a registered transaction on either Form B or Form A. Instead, unless an investor specifically requests that one be delivered to it, a final prospectus need only be made "available" to investors. Finally, communications in connection with offerings on these forms would also be substantially liberalized.
The foregoing proposals represent positive steps in modernizing the registration process by recognizing the changing nature and speed of the marketplace and the technological advances that have made investor access to information easier, quicker and more critical. However, the Reform Proposal also calls for a basic restructuring of the system for registered offerings and a variety of filing and other requirements that substantially, if not entirely, negate their positive aspects. For example, although certain issuers would, as noted above, be allowed to control the timing of effectiveness of their registration statements, they would be required to bear the risk of after-the-fact determinations by the Commission staff that, in the case of Form B issuers, they were "disqualified" from using Form B or, in the case of Form A issuers, they were not entitled to incorporate by reference. The potential consequences are particularly steep: the issuer and the underwriters could be found to have violated Section 5 and thus be subject to potential rescission claims from investors pursuant to Section 12(a)(1) of the Securities Act. This is simply too high a price to pay for freedom from prior staff review.
In addition, although the new registration process is intended, according to the Commission, to encourage registration by making timing both faster and more predictable, seasoned issuers under the Reform Proposal would be required to furnish offering information to investors in writing (in the form of term sheets or, in certain cases, preliminary prospectuses) prior to the date investors make their investment decision, where today that information generally is communicated orally. Thus, the proposed delivery requirement is likely, in practice, to slow the offering process considerably and, as a consequence, subject issuers and underwriters to greater market risk and result in lost opportunities for investors. Moreover, although the communication of offering-related materials would be liberalized under the Reform Proposal, any such "free writing" materials would be required (except in certain limited circumstances) to be filed with the Commission, thus expanding potential liability and resulting in the disclosure in many instances of proprietary or "branded" information about financial products or portfolio strategies. Faced with these consequences, issuers and underwriters are likely to provide less rather than more information to investors, to exclude certain categories of investors (especially retail investors) from offerings and to turn more readily to the private placement market (using Rule 144A or otherwise) or to offer securities outside the United States pursuant to Regulation S. Thus, although it seems clear in the Release that the Commission wishes to encourage issuers to register their offerings under the Securities Act and promote greater information flow to investors, we are concerned that the totality of the Commissions proposed reforms may, on balance, have the exact opposite effect.
It has been suggested that the Reform Proposal has been designed as a unified whole, with inextricable linkages between the adoption of the basic Form A/Form B system, delivery of written information before investment decisions and numerous new filing requirements, on the one hand, and the elimination of regulatory barriers to issuer access to the registered market (such as effectiveness on demand and pay-as-you-go registration), liberalized communications and elimination of final prospectus delivery, on the other. We do not agree this is the case.
On the contrary, many of the positive and laudable aspects of the Commissions proposals can, we believe, be adopted within the framework of the existing registration system. The proposals to remove barriers to immediate market access (such as "effectiveness on demand" and "pay-as-you-go" registration) can be easily added to the existing shelf registration system and Forms S-3 and F-3. The very desirable elimination of final prospectus delivery requirements, establishment of concrete procedures for converting public to private offerings and vice-versa, and liberalization of research through expansion of Securities Act Rules 137, 138 and 139 also can be accomplished easily within the existing framework. Liberalization of other "free writings" raises difficult issues of liability standards that the Commission must address, but this does not depend on a new registration framework, on the elaborate new filing requirements contained in the Reform Proposal or on new categories of "offering information" or other classifications that raise unnecessary liability concerns for offering participants.
We are also concerned that the Reform Proposal discards large portions of the existing offering system, which have worked well for market participants, on the basis of perceived isolated or theoretical abuses, where the cost of the proposed change to markets and market participants would be higher than the benefits of the proposed "reforms". We do not believe the Commission has identified or articulated abuses, for example, in the cases of current access to information, procedures for information dissemination and incorporation by reference, the use of Exxon Capital exchange offers (or the similar procedures available for non-reporting, non-U.S. issuers), or the availability of shelf registration for secondary offerings by smaller seasoned issuers, that justify the broad changes proposed and the corresponding costs and disadvantages to issuers that such changes would entail.
As the remainder of our letter elaborates, therefore, we favor the Commission proceeding within the framework of the existing registration system and reproposing for adoption within that framework the aspects of the Release that would promote investor protection and be advantageous for investors, issuers and other market participants.
B. Comparison of the Proposed Registration Framework to the Existing System
As discussed above, the Commission believes that the Reform Proposal will ease the registration process and thereby encourage more issuers to register offerings of their securities under the Securities Act rather than turn to the private or offshore markets. The Commission also believes that its proposed reforms regarding the liberalization of communications will encourage issuers and market intermediaries to provide investors with more information regarding offerings of securities and that this increase in information will benefit the market as a whole. To determine whether the Reform Proposal would achieve the Commissions goals, we believe it would be helpful to examine the primary elements of the proposed registration framework and compare them to the existing system. As we believe is demonstrated below, notwithstanding its positive aspects, the Reform Proposal, taken as a whole, would adversely affect the offering process -- without producing any significant increase in investor protection or in the information furnished to the investor community -- to the detriment of all market participants.
1. Effect on Issuers
a. Issuers Currently Eligible to Use Shelf Registration Procedures for Delayed Primary Offerings
The Reform Proposal would allow Form B issuers (the analogue to short-form shelf filers today) to control the timing of market access by providing for Form B registration statements to be declared effective on demand. The Form B proposal would also permit the payment of registration filing fees on a "pay-as-you-go" basis. We believe these two proposals represent positive steps in reforming the offering process and we support them.
However, the need for the issuer to file, and for an underwriter to deliver, a term sheet or preliminary prospectus prior to the investors agreement (oral or otherwise) to purchase would introduce timing and compliance risk not present in shelf takedowns today. The risk of delay resulting from mandatory, pre-sale delivery of a written summary of terms would be exacerbated if the Commission also were to eliminate (as suggested in the Release) delayed shelf registration by large seasoned issuers. Rapid market access today is facilitated by the shelf practice of having on file, in advance of any particular offering, the pre-agreed terms of securities, transactional disclosure and offering and settlement procedures (including agreed-upon underwriting agreements, comfort letters, legal opinions and other offering and closing documentation). These benefits would be lost if shelf registration (in its current form) is abandoned.
Even with shelf registration, we would expect that in most cases the term sheet or preliminary prospectus delivery requirement would in many cases add at least a day (and, in the best case, would add several hours) to the time at the end of which an issuer and underwriters would agree on price and underwriters could orally "sell" securities. What today happens in as little as minutes and often in a couple of hours will be stretched out as issuers and underwriters and their respective counsel prepare or complete (even if the template is previously prepared), review, EDGARize, file and actually deliver the required information to all investors. While the Commission might be hopeful that this will be a rapid process and that layers of review are unnecessary, the need for accuracy will be paramount given the Section 11 and 12(a)(2) liability that attaches to the document, and delivery will be carefully monitored, and pricing and sales delayed in the meantime, because of the Section 12(a)(1) liability that may be involved.
This delay will of course have economic consequences, in terms of possible costs to issuers in losing near-immediate access once they have effective registration statements and in accepting pricing delays or increases to deal with timing uncertainties. We are not in a position to estimate those costs, but note that they have not been measured in the Reform Proposal. These timing and delivery pressures are also likely to cause issuers and underwriters to concentrate on the narrowest possible investor base in pricing and selling an offering. As a result, other investors, principally retail investors, can be expected to be excluded from offerings in which they now participate, at least to some extent, not because the offering is not suitable for them, but because of the new proposed delivery and related requirements.
Given technological advances in the delivery of information and especially the very broad use of the EDGAR program to date and the promise that, as the technology improves, its use will increase, we believe the Commissions concern regarding delivery of information is misplaced. Access by the market and by investors to information is crucial; delivery is unimportant. We believe, therefore, that the Commission should focus on availability of information and access, and that incremental changes to the current system of integrated disclosure should be considered in that light. It is clear that the Reform Proposal is grounded in concern for retail investors obtaining necessary information. While we certainly favor putting all investors in a position to obtain information, we believe the Reform Proposal insufficiently recognizes that investors have essentially real-time access to up-to-date information currently and that this access and the efficient market should be the starting point of the Commissions analysis of changes in information availability.
By the Commissions own count, an estimated 1,427 issuers4 that are currently eligible to use delayed shelf registration procedures would be ineligible for Form B and thus unable to access the market as rapidly as today. In addition, use of Form B, an important element of the flexibility included in the Reform Proposal, would be denied to a significantly broader range of issuers than use of current Form S-3/F-3 or shelf registration. For example, an issuer would be disqualified from using Form B in the event of certain legal violations or Commission actions against the issuer, its directors, executive officers or underwriters, a "going concern" qualification by its accountants or a failure to amend an Exchange Act report in accordance with a staff comment. We do not believe these limitations on Form Bs use are warranted or appropriate and urge the Commission not to narrow shelf eligibility (or the equivalent under the Reform Proposal) below current Form S-3/F-3 standards.
Moreover, because Form B would be essentially "effective on demand", the Commission has also proposed to exclude Form B registration statements from Rule 401(g), which provides that a registration statement is deemed to be on the proper form once it has been declared effective. This change would have a significant negative impact on issuers and market intermediaries because an after-the-fact determination by the Commission that an offering was improperly registered on Form B could be interpreted as subjecting offering participants to liability and possible rescission claims under Securities Act Section 12(a)(1). Indeed, this risk of Section 12(a)(1) liability alone may be enough to cause certain issuers to avoid registration altogether if the private or Euro markets provide a viable alternative -- clearly not the Commissions intended result.
b. Issuers Not Currently Eligible to Use Shelf Registration
Procedures for Delayed Primary Offerings
The proposed liberalization of communications would allow smaller or unseasoned issuers to "test the waters" before incurring the expense of a registered offering and would facilitate the release of factual or forward-looking information, as well as other information, even as the commencement of the offering approaches. In addition, the liberalization of restrictions on marketing could provide advantages in offerings involving significant marketing efforts. These improvements, however, would have to be balanced in each case against the need to file free writing materials with the Commission and the resulting increased liability risk and disclosure of proprietary information.
Moreover, although these issuers would (as is the case today) continue to be subject to Commission staff review under Form A, their access to the market would, in any event, be slowed by the proposed requirement to deliver a preliminary prospectus at least 3, and as much as 7, days before pricing and to deliver a supplement with any material changes at least 24 hours before pricing. The Commissions proposal to require that secondary offerings meet the same eligibility criteria for registration on Form B as primary offerings also would make conventional at-the-market secondary offerings of common stock or of convertible or high yield debt of all but large, seasoned issuers (i.e., those eligible to register on Form B) not merely more burdensome because of the inability to incorporate by reference, but effectively impossible due to the 3/7 day in advance preliminary prospectus delivery requirement under Form A.5
c. Proposed Elimination of "Exxon Capital" Exchange Offers
The Commission has also proposed to repeal its line of letters permitting so-called "Exxon Capital exchange offers" (the "Exxon Capital Letters")6 if the registration reforms proposed in the Release are adopted, and has indicated in the Release that it may repeal its policy with regard to these exchange offers even if the proposed reforms are not adopted. This proposal underlines the Commissions desire to make Rule 144A a less attractive alternative for accessing the U.S. markets. The Commission does not identify in the Release any abuses or other reasons for its proposed change. The elimination of Exxon Capital exchange offers would foreclose issuers not eligible to control registration effectiveness from an attractive means of raising capital at the most favorable rates. The proposed change would be especially problematic for non-U.S. issuers because of the time they require to reconcile their financial statements to U.S. generally accepted accounting principles ("U.S. GAAP") and the resulting substantial delay in accessing the U.S. public market. Both U.S. and non-U.S. issuers of high yield debt have relied heavily on Exxon Capital procedures to facilitate access to the U.S. institutional market, particularly in the context of significant acquisitions or recapitalizations that involve substantial time for preparation of the financial information required for a registered offering. Although Rule 144A offerings would still be available to these issuers, Rule 144A buyers would, as a result of the elimination of the Exxon Capital exchange offer, no longer be able to resell publicly except pursuant to Rule 144 (with its attendant delay) or through resale registration (if and to the extent it remains possible under the Reform Proposal and, in any event, subject to incremental liability under Securities Act Section 12(a)(2)). In addition, many large institutional investors (e.g., insurance companies and mutual funds) that have "basket" limitations with respect to the amount of restricted securities they may hold may not be able to purchase Rule 144A securities in the secondary market until their restricted baskets free up, thus reducing the liquidity that has made the Rule 144A market so successful. These investors may also fear participating in the Commissions proposed alternative to the Exxon Capital exchange offer -- Form B QIB-only offerings -- because of the Commissions in terrorem language in the Release regarding "indirect distributions" (raising once again the spectre of the "presumptive underwriter" doctrine).
Non-U.S. issuers have also used a procedure similar to the Exxon Capital exchange offer procedure that permits a two-step approach into the U.S. markets.7 Under this procedure, which is not specifically discussed in the Release, a non-U.S. issuer offers its securities, which can include equity securities, under Rule 144A, and at a later date, in connection with a subsequent registered public offering or an exchange listing or Nasdaq quotation in the United States, conducts a registered exchange offer for the Rule 144A securities. This approach has been widely used and, based on our very substantial experience with non-U.S. issuers, the existence of this procedure has been a factor in the decision by many non-U.S. issuers to enter the U.S. markets.
d. Enhanced Reporting Requirements under the Exchange Act
In connection with its registration reform, the Commission has also proposed enhanced reporting requirements under the Exchange Act. In particular, the Commission has proposed several new items that must be reported under the Exchange Act and has proposed to accelerate the timing of several other reportable items. These proposals indicate the Commissions desire to improve Exchange Act disclosure as well as to further integrate the Securities Act and Exchange Act disclosure systems. We agree that, for the most part, these proposals will improve Exchange Act disclosure and support them. However, we also observe that the proposed changes to the signature and certification requirements for both Exchange Act and Securities Act filings, which are intended to increase director oversight, are simply impractical, and although likely to result in delay and inconvenience, are not likely to result in the more meaningful participation by directors sought by the Commission.
2. Effect on Underwriters
a. Registration Process
As noted above, the elimination of the requirement to deliver a final prospectus would remove a significant element of time pressure from underwriters and other participants selling in registered offerings, and we strongly support this proposal. Particularly as settlement time frames move toward T+1, the requirement to deliver a final prospectus at or prior to delivery of securities will become impossible to comply with. Advanced information technology has made mandatory prospectus delivery an anachronism, and while the availability of a final prospectus remains an essential element of antifraud protection, its timing, as the Release acknowledges, has never been effectively linked to an investment decision.
This positive step, however, is needlessly predicated on a proposal that would require, even in the case of large, seasoned issuers, the delivery of term sheets or preliminary prospectuses to investors prior to the date the investment decision is made (not the later time of settlement), and, in the case of smaller or unseasoned issuers, the delivery of material updating information at least 24 hours prior to pricing -- inflexible requirements that would serve to delay, and thus heighten the risk of, the offering process and introduce significant compliance concerns for underwriters. Moreover, as a trade-off for "effectiveness on demand" registration, underwriters, as discussed above, also could be subject to greater risk of Section 5 violations, and the resulting availability of rescission rights to investors, through after-the-fact determinations that registration was not on the proper form or that the registration statement did not contain required information.
The liberalization of restrictions on offering materials would permit underwriters flexibility in their offering procedures. In certain offerings, especially those with extensive marketing and a global component, there may be advantages over the present restrictive system. However, the requirement to file free writing materials with the Commission, and the application of Section 12(a)(2) liability with respect to these materials, would substantially reduce the advantages and increase the attendant risk. Filing, which would make even private communications public, might result in liability for an underwriter to the entire universe of investors, rather than just to the few (or one) to whom the communication was specifically directed. Moreover, the filing requirement would preclude the possibility that an underwriter could engage in proprietary communications with its own customers (reflecting, for example, customized financial analysis) or distribute "branded" materials (including specially designed financial products) as part of the offering process. Finally, the Reform Proposal would further heighten the risk of liability for the underwriters generally (as well as for the issuer) if the communications of an underwriter were treated, as the Reform Proposal suggests is possible, as "offering information" and thus required to be included in the registration statement, with the resulting Section 11 liability for all offering participants. We believe the net result of all of these concerns and uncertainties will be to significantly diminish the advantage of the liberalized offering procedures and make them much less likely to be utilized.
As part of its relaxation of restrictions on offers and communications generally, the Commission has also proposed significant liberalization of the restrictions on publication of research by underwriters and other offering participants, as a result of both the general relaxation of restrictions on offers as described above and broadening of the specific exemptions in the Commissions rules regarding research. We support these changes. Further, under the proposals permissible qualifying research reports would not be required to be filed with the Commission as "free writing" material.
However, the Commission proposes to delete from the current research safe harbors the provisions that exclude such qualifying research from the definition of "prospectus". As a result, under the proposed new regime, Section 12(a)(2) liability for defective disclosure may apply in certain circumstances to research disseminated in accordance with the Commissions research safe harbors where it would not apply to qualifying research under any circumstances today. The Release does not suggest that there is evidence that the current versions of Rules 138 and 139 have been used in an abusive way in connection with offerings and we believe the conditions in the existing and proposed rules, both as to issuers and publishers of exempt research, continue to provide sufficient protection against any abusive use of research. On the other side of the equation, we believe that subjecting this research to Section 12(a)(2) liability will raise significant issues for broker-dealers, who will likely curtail their publication of research that relies on the exemptive rules. The consequence could well be a decrease in available research and information for investors. The Commission should thus resist the temptation to change the liability standard for such research, rely on the existing standard (which the Commission does not suggest is inadequate) and thereby opt for greater flow of research and information.
c. Due Diligence Procedures
The Commissions intention that its proposed procedures facilitate immediate market access could place greater pressure on what is already often a very limited opportunity for an underwriter to perform adequate due diligence, particularly in the context of shelf registration. Recognizing this concern, the Commission has proposed modifications to existing Securities Act Rule 176, which provides guidance as to what constitutes adequate due diligence procedures.
First, the Commission would explicitly provide that the guidance of the rule would be applicable in evaluating procedures under not only Section 11 but also Section 12(a)(2) of the Securities Act. Second, in certain circumstances, the rule would add six new "positive factors" -- all of which (with one possible exception relating to whether research analysts are routinely "brought over the wall") are largely consistent with current underwriters practices -- that would support the conclusion that an adequate due diligence investigation had been undertaken. We support both of these proposals.
The six new factors, however, are only proposed to be relevant in the context of equity and non-investment grade debt offerings by issuers that are marketed and priced within five days. Yet, the most rapid market access under both the current system and the proposed new system involves offerings of investment grade debt. Moreover, the relevant period to assess time pressure on the underwriters ability to do diligence is not between commencement of marketing and pricing, as the Commission suggests, but between the initial decision by an issuer to proceed and the commencement of marketing. We would favor applying Rule 176 to all offerings and would propose that the five-day condition be eliminated.
The Commission has again rejected a "safe harbor" approach for establishing a due diligence defense and continues to emphasize that an underwriters investigation must be reasonable under all facts and circumstances. As a result, the uncertainties that have long concerned underwriters will continue even if the proposed modifications to Rule 176 are adopted. As discussed further below, we believe, instead, that meaningful protection for underwriters could be achieved without sacrificing investor protection by creating a rebuttable presumption that a due diligence defense has been established through compliance with Rule 176.
The Commission acknowledges that the current integration doctrine has resulted in uncertainty among offering participants and their counsel and has significantly restricted the ability of issuers to switch between public and private offerings. The Release proposes several amendments to current Rule 152 to allow issuers more flexibility by providing safe harbors that (i) allow a completed or abandoned private offering to be followed by a public offering and (ii) allow a private offering to be commenced after abandonment of a registered public offering. These changes would include guidance regarding registration of resales in so-called "PIPES" and similar offerings.
The Commission has not, however, provided any new guidance concerning the general integration doctrine and, in particular, has not provided additional guidance or proposals regarding "side-by-side" public and private offerings, even where all investors in the private offering are QIBs or other institutional investors and general solicitation has not been used to identify or contact any such investors.
Moreover, with respect to the proposed "public to private" safe harbor, the additional flexibility comes with a punitive price: if the securities are first offered in the private offering within 30 days after abandonment of the public offering, the issuer and underwriters must agree in writing to accept Section 11 and Section 12(a)(2) liability for the offering documents used in the private offering. This would impose a greater liability standard on the issuer and underwriters in the private offering than the Rule 10b-5 liability standard that was found by the U.S. Supreme Court to apply to that type of offering.8 Since we agree with the Commission that offers as such should be deregulated, we see no reason to change the standard of liability appropriate for an offering in which all the purchasers are eligible private purchasers simply because some of the offerees in an earlier offering may have been members of the general public.
D. Exchange Act Reporting Enhancements
The Commission, as noted above, has proposed several changes to Exchange Act disclosure requirements intended to improve the quality and the timeliness of information in the periodic reports filed by reporting companies. Among other things, these revisions would (i) extend risk factor disclosure to Exchange Act reports of all issuers; (ii) expand the items of disclosure required to be reported on Form 8-K and accelerate the due dates for reporting Form 8-K events; and (iii) accelerate the reporting of quarterly and annual financial information, such as earnings announcements. We support the substance of these proposals, although we suggest that the Commission carefully consider the proposed timing requirements.
Among the changes that may prove problematic to reporting companies, as suggested above, are (i) the proposed requirement that the principal executive officers and a majority of the board of directors sign Form 10-Q (in the case of U.S. reporting companies) and Form 20-F (in the case of non-U.S. reporting companies) and (ii) the proposed requirement that all signatories to those reports (as well as to Form 10-K, which currently must be signed by the principal executive officers and a majority of the board) certify that they have read the report and that to their knowledge the report contains no material misstatements or omissions. The certification requirement, in particular, is plainly impractical in light of the last minute changes that routinely are made to these reports. It is also unclear what personal liability (in addition to Rule 10b-5 liability) those signing these reports would face as a result of this proposed new certification requirement, and any such incremental liability would introduce an invidious distinction between those who sign the report and those who do not.
II. SPECIFIC COMMENTS WITH RESPECT TO THE RELEASE
A. Securities Act Registration
As indicated above, we do not support the adoption of either the Form B or Form A offering framework. We are nonetheless commenting below on the specifics of the Form B and Form A proposals both in the event the Commission continues its consideration of these aspects of the Reform Proposal and because some of the comments have applicability in connection with our recommended modifications to the current framework.
1. Form B Offerings
a. Eligibility Based on Size of Issuer
Form B would be available to register any offering9 by a "seasoned" issuer that has (x) a public float of at least $75 million and an average daily trading volume ("ADTV") of at least $1 million, or (y) a public float of at least $250 million. Unlike Regulation M under the Exchange Act, which uses a worldwide ADTV measure, ADTV for purposes of Form B eligibility would be based solely on U.S. trading markets. As a result, non-U.S. issuers without a substantial U.S. trading market would be required to meet the $250 million public float test.10 For purposes of Form B, an issuer would be considered "seasoned" if it had (i) at least a one year reporting history and had filed at least one annual report with the Commission, (ii) filed all Exchange Act reports due, and (iii) timely filed all such reports within the 12 month period immediately preceding the Form B filing.
As noted above, the public float and ADTV requirements of Form B would, by the Commissions own count, make Form B unavailable to 1,427 or approximately 30% of those issuers eligible to file on Form S-3/F-3 today. We believe this would be an unfortunate result, particularly in light of the Commissions stated intention to encourage registration and ease the registration process, and is also unnecessary given the absence of any evidence that the current eligibility standards have led to abuse. We urge the Commission to retain the same eligibility standards as those currently applicable to todays Form S-3/F-3 filers.
We believe that the requirement to have filed at least one annual report is a sufficient measure of seasoning for Form B purposes and therefore suggest that the one year reporting history requirement be eliminated. In addition, we would encourage the Commission to allow larger, unseasoned foreign private issuers to be eligible for Form B registration. For this purpose, we suggest that unseasoned foreign private issuers who have a worldwide ADTV of at least 1 million and a public float of at least $500 million (based, as noted in footnote 10, on all classes of outstanding equity securities) be permitted to register on Form B offerings that are underwritten on a firm commitment basis. Again, this would promote U.S. registration as a viable alternative to offering securities privately or offshore and will be especially important if the Vitro line of letters is repealed11 . Although we recognize that registration on demand by unseasoned issuers would permit use of disclosure that had never been subject to prior staff review, we believe the heightened liability of offering participants in registered offerings, coupled with analyst scrutiny of these issuers in the global marketplace, will provide sufficient assurance of adequate disclosure by these registrants.
b. Eligibility Based on Type of Offering
Form B would also be available to seasoned issuers that do not meet the size-based eligibility criteria with respect to the registration of offerings solely to certain types of QIBs, certain offerings to existing security holders, offerings of non-convertible investment grade securities, and market-making transactions by broker-dealers affiliated with the issuer.
(i) Offerings to QIBs
By proposing to allow seasoned issuers of any size to use Form B to register offerings made solely to certain QIBs, the Commission hopes to increase the number of registered offerings that would otherwise be made in reliance on Rule 144A. As a result of the requirements for Form B QIB-only offerings, however, the proposal may not achieve the Commissions desired result.
As the Commission notes in the Release, registration on Form B would offer two advantages over offerings currently conducted in accordance with Rule 144A: (1) securities fungible with those listed on a U.S. securities exchange or quoted on Nasdaq could be offered and sold on Form B, and (2) securities offered on Form B would not constitute "restricted securities" for purposes of Securities Act Rule 144 and thus generally would be freely resaleable. However, unlike under Rule 144A, certain QIBs would be ineligible to purchase in a Form B QIB-only offering. Because of the Commissions concern that a Form B QIB-only offering may be used as a means to effect an indirect distribution to the broader U.S. public, the Commission is proposing to exclude dealers and investment advisers from the categories of QIBs eligible to participate in a Form B QIB-only offering. The Commission also warns that the use of these provisions by an issuer to effect an indirect distribution through QIBs would violate Section 5, and has suggested that issuers may wish to adopt procedures to prevent this from occurring.
We disagree strongly with the Commissions proposed exclusion of dealers and investment advisers from Form B QIB-only offerings. These entities are frequent participants in Rule 144A offerings and their exclusion (resulting, in particular, in the inability of investment advisers to purchase for managed accounts) will significantly diminish the attractiveness of the proposal. In addition, we believe the Commissions in terrorem warning regarding the use of Form B QIB-only offerings to effect "indirect distributions", which threatens to recreate the uncertainty of the old "presumptive underwriter" doctrine, is inappropriate and will make the proposal unworkable. The Commission has pointed to no evidence of abuse that would warrant the exclusion of particular categories of QIBs or the resurrection of a doctrine that has long been abandoned by the Commission and its staff.12
In fact, to achieve the Commissions objective and lessen reliance on Rule 144A, we recommend that the Commission expand the categories of eligible investors in these offerings to include those institutional "qualified purchasers" that the Congress identified as being sophisticated enough to fend for themselves in offerings by entities exempt from registration under the Investment Company Act of 1940 (the "Investment Company Act")13 . In response to the Commissions specific inquiry regarding the sufficiency of current QIB thresholds, we believe the QIB definition in Rule 144A should more closely reflect the new standard that Congress has set and, thus, that the threshold for QIB status should be lowered from $100 million to $25 million.14
We note that because of Form Bs seasoning requirement, non-reporting foreign issuers currently eligible to use Rule 144A would not be eligible to use Form B for QIB-only or, for that matter, any other Form B offerings. Although the Commission points out that these issuers may not take advantage of the availability of Form B for QIB-only offerings even if offered to them (since, by registering on Form B, these issuers would need to reconcile their financial statements to U.S. GAAP and would become subject to Exchange Act reporting requirements), we believe this opportunity should not be automatically foreclosed. Accordingly, as noted above, we urge the Commission to allow some category of large, unseasoned foreign private issuers to use Form B for QIB-only, as well as other, offerings.
We also urge the Commission to allow unseasoned issuers of any size to register on Form B firm commitment offerings of non-convertible debt or preferred securities solely to QIBs. While we oppose the repeal of the Exxon Capital procedures, we believe the combination of three proposals by the Commission in connection with offerings to QIBs on Form B (or Form S-3/F-3, if retained) could encourage many offerings to be undertaken on a registered basis that are currently undertaken in reliance on Rule 144A with subsequent Exxon Capital exchange offers: (1) eliminate the restriction on participation by dealers and investment advisers, as discussed above; (2) explicitly retract the suggestion that the "presumptive underwriter" doctrine would apply to such offers, also as discussed above; and (3) extend eligibility for the Form (and, more importantly, assured immediate effectiveness) to offerings of non-convertible debt and preferred securities by unseasoned issuers. As noted above with respect to our suggestion to allow certain unseasoned foreign private issuers to register offerings on Form B, we recognize that registration by unseasoned U.S. issuers on Form B would permit use of disclosure without prior staff review, but we believe expedited registration procedures are appropriate given the nature of the offerees -- sophisticated institutions that have long been recognized by the Commission as being able to fend for themselves without Commission oversight -- and the existence of Section 11 liability with respect to the offering participants.
(ii) Market Making Transactions by Affiliated Broker-Dealers
Broker-dealers that are affiliates of an issuer are currently required to deliver prospectuses in connection with market making transactions in the issuers securities. The Commission proposes to reduce the burden on affiliated broker-dealers of having to deliver a prospectus in market making transactions by allowing these transactions to be registered on Form B.
Although the availability of Form B would, perhaps, "reduce the burden" on affiliated broker-dealers, we do not believe bona fide market making transactions by an affiliated broker-dealer should be subject to prospectus delivery or, indeed, registration at all. The Release acknowledges that these transactions are no different in substance than any secondary market transaction. Accordingly, we urge the Commission to use its newly acquired exemptive authority under NSMIA to exempt these market making transactions entirely from registration under the Securities Act.15
c. Prospectus Delivery
Under proposed Rule 17316 , no final prospectus would be required to be delivered in connection with Form B offerings unless an investor specifically requests that one be delivered to it.17 As previously discussed, we support this proposal and believe it represents a necessary change in the registration process given the systemic benefits of further reducing settlement delay and the availability of prospectuses through EDGAR and other means. We disagree, however, with the Commissions proposal that the final prospectus be required to be filed with the Commission prior to the transmission of confirmations or, in order to rely on proposed Rule 165 (permitting the use of free writing materials during the offering period), prior to "sale". Turning to the latter point first, a requirement to file the final prospectus prior to sale (even if only as a condition to the use of free writing materials and assuming that the Commission would clarify that the final prospectus for these purposes need not include pricing information) would introduce the same kind of delay and heightened risk to the securities distribution process that we noted in our discussion of mandatory delivery of transactional information. Once again, the systemic cost more than outweighs the benefit of accelerated availability of written information.
As for the proposal that the final prospectus be filed with the Commission prior to the transmission of confirmations (even again assuming the final prospectus would not be required at this time to include pricing information), we believe it is unwise to place unnecessary pressure on back-office procedures by continuing to link final prospectus availability and delivery of confirmations when it is far more important to facilitate compression of the settlement period. The filing of a final prospectus will, of course, continue to be an essential element of the antifraud protections under the Securities Act, but those protections are not materially heightened by holding the transmission of confirmation information hostage to that filing.
Proposed Rule 172 and revised Rule 15c2-8(b) would require the delivery of "transactional information" to investors and the filing of this information with the Commission before the date binding investment decisions are made18 . Two alternatives with respect to the delivery of transactional information are proposed in the Release. Under the first proposal, transactional information would be contained in a term sheet that would, among other things, summarize the material terms of the securities in summary format, name any selling security holder, and identify a contact person to whom questions may be directed and from whom documents defining the terms of the securities may be obtained. Under the alternative proposal, the transactional information would consist of the information currently required by Forms S-3 and F-3 and would be contained in a traditional preliminary prospectus that must be on file with the Commission and delivered to investors before the date the investment decision is made.
These proposals would significantly increase the burden on large seasoned issuers with effective shelf registration statements. These issuers do not currently have to deliver any information (including a term sheet) to investors prior to sale or at any time prior to the mailing of confirmations. Instead, only a final prospectus supplement, which, in the case of medium-term note ("MTN") programs can be a final pricing supplement, is filed with the Commission following sale and delivered to investors with the confirmation. The requirement to deliver and file a document containing final terms prior to any sales will interfere with the current practice of shelf issuers, who often determine to proceed with an offering based on market conditions and price on the same day. The delay imposed by having to deliver a written term sheet (or under the Commissions alternative proposal, a preliminary prospectus) prior to sales will have real economic and market costs and will be more likely to drive issuers away from the registered market rather than to it.19
The cost of mandatory delivery requirements in terms of deterring registration is far higher than the benefits they may offer to certain investors in certain offerings. In many offerings, such as investment grade debt offerings (where investment decisions are made primarily on the basis of credit rating and interest rate and where this information can be effectively and quickly communicated orally), there is simply no need to deliver a written term sheet. In other, more complex offerings, market forces themselves will drive what information needs to be delivered to investors prior to sale in order for them to make informed investment decisions. The key, in the case of securities eligible to be offered under Form B, is to retain the flexibility to allow the market to dictate the timing, method and content of transactional information. In the absence of any observed pattern of abuse, existing protections for aggrieved investors under the Securities Act and (at least for any misunderstanding over fundamental terms) under contract law continue to be adequate.
d. Form B Disqualifications
Proposed Form B would not be available if the issuer was subject to one of the disqualifications set forth in the form. Issuers disqualified from using Form B generally fall into four categories: (i) issuers whose offerings have been identified as potential vehicles for fraudulent and manipulative schemes that harm investors, such as blank check companies and penny stock companies; (ii) issuers with potentially significant liquidity problems, such as issuers that have defaulted on material indebtedness, that have received "going concern" qualified audit opinions, or that have been involved recently in insolvency or bankruptcy proceedings; (iii) issuers that have abused or violated the registration system or other federal securities laws, including issuers that were (or whose respective executive officers, directors, partners, or underwriters were) convicted of securities fraud or business-related fraud or perjury; and (iv) issuers that fail to resolve Commission staff comments on incorporated Exchange Act reports.
As discussed above, we believe the Commissions disqualification proposal is in certain respects unworkable and, in the absence of demonstrated abuse, unwarranted. We continue to believe that, except with respect to the proposed disqualification with respect to blank check companies and companies offering penny stock (offerings that, as noted in the Release, "have been identified as potential vehicles for fraudulent and manipulative schemes that harm investors"), the disqualifications for Form B eligibility should not go beyond what Form S-3/F-3 currently require. Thus, for example, the "going concern" problem should continue to be resolved by disclosure, not disqualification20 . Moreover, the so-called "bad boy" disqualification provision would appear to apply to many of the largest and most well-respected underwriting firms.21 Thus, the Commission would, as a practical matter, be forced to establish an exemptive procedure that would utilize Commission and private resources with little net result.
Finally, we believe linking availability of Form B to the resolution of staff comments on Exchange Act reports is inappropriate and unjustified. Issuers should continue to have their current responsibility (and flexibility) to make materiality judgments with respect to staff comments and proceed on that basis.
The scope of these disqualifying events is particularly troublesome in light of the potential drastic consequences of an after-the-fact determination that Form B use was unavailable. Investors could take the position that they are entitled to rescission under Section 12(a)(1) without any defect in disclosure and without any culpability in connection with the offering by any party, against not only the issuer but also the underwriters and other offering participants.
e. Content of Disclosure and Applicability of Liability Provisions
The proposed rules with respect to Form B attempt to distinguish between two categories of information that may be disclosed by or on behalf of the issuer during the offering period: "offering information" and "free writing" materials. Offering information would be required to be filed as part of the registration statement and, therefore, would be subject to Section 11 liability. "Free writing" materials, although generally subject to a filing requirement, need not be filed as part of the registration statement and would be subject to Section 12(a)(2) liability. Unfortunately, the distinction between the two categories of information, which is critical to understanding the Commissions proposed filing requirements and assessing liability risk, is not at all clear, and the consequences of getting it wrong -- potentially rescission for a Section 5 violation for failing to file a complete registration statement -- are disastrous.
"Offering information" is defined, among other things, to include "offering information disclosed by or on behalf of the issuer, other than information communicated orally." The problems inherent in defining a term by using the term itself are obvious. "Free writing" materials would include "all written information disclosed by or on behalf of the issuer during the offering period, other than offering information, factual business communications and limited notices of proposed offerings." Without clearly delineating the scope of the term "offering information", the definition of "free writing materials" likewise is problematic.
Moreover, the Release does not state whether any separate free writing should be considered on its own or in the context of all information then available for purposes of determining liability under Section 12(a)(2). We assume these communications should be viewed in the context of all information provided to the investor, but would urge the Commission in connection with any liberalization of free writing to confirm that this assumption is correct.
Finally, the definition of "offering period", which is critical to determining what information is required to be filed in a registration statement, rests on the vague concept of "first offer" and the resulting 15-day look-back period. This imprecision is unacceptable when Section 12(a)(1) liability could attach.
f. Forward Incorporation by Reference
Form B provides that incorporation by reference cuts off upon delivery of a term sheet or preliminary prospectus. This runs directly contrary to the theory of integrated disclosure. Requiring filing of a post-effective amendment rather than an Exchange Act filing merely introduces possible delay and additional filing requirements. (The requirement does not, it should be noted, mandate delivery of new information subsequent to the term sheet, but only forecloses incorporation by reference.) Finally, this provision would apparently require issuers, even seasoned ones, to file post-effective amendments, rather than merely filing periodic reports under the Exchange Act, throughout the proposed newly imposed Rule 174 dealer prospectus delivery period to reflect any post-offering developments. This seems unnecessary and unjustified and appears to provide nothing by way of added investor protection.
g. Timing of Effectiveness
Under the Form B proposal, an issuer could file a registration statement on Form B at any time prior to the first sale of the registered securities. The issuer would also be able to control when the registration statement becomes effective under the Securities Act without the need for staff review. Because effectiveness would be within the control of the issuer, the Commission has requested comment on whether the issuer should be required to file as an exhibit to the registration statement evidence of the underwriters concurrence in the timing decision. We do not believe the incremental administrative burden of filing the concurrence is justified.
h. Delayed Shelf Offerings
The Commission believes that Form B would provide issuers with the same or greater flexibility as delayed shelf registration on Forms S-3 and F-3 today. For example, the Commission notes that, unlike current shelf registration requirements, issuers using Form B would not need to pre-file a base prospectus in order to access the market at will. Because a Form B registration statement need only be filed, and filing fees paid, for the then-current offering, there would be no need for an issuer to register more securities, or file more transaction-related information, than is needed for the immediate offering.
Although the Commission believes that the flexibility offered by Form B would largely eliminate the incentive for Form B issuers to conduct delayed shelf offerings, it is proposing to retain (with certain modifications) the delayed shelf registration system for Form B issuers. Form B would provide that any transactional disclosure (including information that would be filed today as prospectus supplements under Securities Act Rule 424(b)22 and all historical and future-incorporated Exchange Act reports) used in connection with the Form B offering would be a part of the effective registration statement and therefore would be subject to liability for material misstatements or omissions under Section 11. In addition, information regarding the offering off the shelf would be required to be filed prior to sale, rather than up to two business days after pricing or first use as is currently permitted under Rule 424.
As previously stated, we believe the existing delayed shelf registration system should be retained. Although we support the proposals to allow effectiveness on demand and "pay-as-you-go" filing, we believe these proposals can easily be incorporated into the current shelf registration system. We have already discussed why the systemic cost of the Commissions proposal to accelerate the delivery and filing of transactional information outweighs its potential benefit in limited circumstances. Furthermore, we believe the amount of securities that may be registered on the shelf should not be limited to the amount that may reasonably be expected to be sold within a two-year time period (or, indeed, any other time period).23 We see no useful purpose for this artificial limitation, and accordingly, it should be eliminated.
i. Secondary Offerings
The proposed rules would require that secondary offerings meet the same eligibility criteria for registration on Form B as primary offerings. This proposal, which represents a very significant departure from current practice, is intended by the Commission to eliminate what it characterizes as an inadvertent incentive for "issuers not to register primary sales and to distribute to the public indirectly through third parties." For the same reasons, the Commission is also proposing the elimination of the special current reduced eligibility criteria for resales of control or restricted securities acquired by affiliates and others pursuant to employee benefit plans.
Under the Reform Proposal, secondary offerings of securities of issuers not eligible to use Form B would have to be registered on Form A. Since only "seasoned" Form A issuers -- i.e., those who have been reporting for at least 2 years and meet either the $75 million public float or two annual report requirement -- are eligible to incorporate their Exchange Act reports by reference, this proposal is likely to increase the cost of any secondary offering of securities of an Exchange Act reporting company that would not be "seasoned" for Form A purposes.
Of far greater concern, however, is the Commissions proposal to make delayed shelf registration, including for secondary offerings, unavailable to Form A issuers.24 This would eliminate the possibility of conventional at-the-market secondary offerings of securities of these issuers, which may be the most common form of resale of restricted and control securities. Venture capitalists holding restricted securities (because, for example, they invested in a company prior to its initial public offering) and executives with stock would be but two of the classes of investors adversely affected by this limitation, with negative consequences not only for them but also for issuers looking for capital or talented executives.
Accordingly, we disagree with the Commissions proposal to change the criteria for the availability of short-form registration for secondary offerings to be the same as those for primary offerings. This proposal continues the theme throughout the Release of prophylactically closing avenues the Commission believes might be used by unscrupulous issuers to offer their securities indirectly to the broader U.S. public. The problem of indirect public distributions should continue to be addressed as it is today -- through narrowly focused adjustments to rules that are targeted at and proportionate to the abuses and through transaction-specific Section 5 actions brought against particular offending issuers and other market participants. The Commission should not impose a blanket prohibition on widely used and legitimate capital raising efforts of smaller and unseasoned issuers.
2. Form A Offerings
a. Incorporation by Reference; Effectiveness
Under the Reform Proposal, Form A would be the basic form for registration under the Securities Act and would be available for any offering for which no other form is authorized or prescribed. An issuer using Form A would be permitted to incorporate Exchange Act reports by reference if it was not subject to one of the disqualifications set forth in the form (identical to those discussed above for Form B) and (i) has been reporting under the Exchange Act for at least 24 months and has a public float of at least $75 million, or (ii) has been reporting under the Exchange Act for at least 24 months and has filed at least two annual reports with the Commission. To incorporate by reference, Form A issuers must also be current in filing their Exchange Act reports and have timely filed all such reports during the preceding 12 months.
All information incorporated by reference into Form A would be subject to Section 11 liability and would have to be delivered to investors together with the initial delivery of the prospectus. If the issuer is not seasoned (and cannot, therefore, incorporate by reference), all information regarding the company must be set forth in full in the prospectus. The content of this company information would be the same as is currently required under Forms S-1 and F-1.
In response to the Commissions inquiry regarding the sufficiency of the seasoning period for incorporation by reference by Form A issuers, we believe the same standard used for Form B (or Form S-3/F-3) seasoning should be used to determine eligibility to incorporate by reference on Form A. Accordingly, we suggest that the Commission use the filing of one annual report as the appropriate measure of seasoning for Form A issuers. In addition, we believe the mandated delivery of incorporated reports is unnecessarily burdensome. Accordingly, we recommend that the requirement to deliver incorporated reports be triggered only by an investors specific request.
b. Prospectus Delivery
Offerings on Form A would require delivery of a traditional preliminary prospectus. Delivery of a preliminary prospectus would be required by means reasonably designed to arrive no later than (i) 7 days before pricing of an issuers initial public offering or an offering registered within one year thereafter and (ii) 3 days before pricing otherwise. Material changes to the transaction or company information contained in the preliminary prospectus would have to be delivered to investors in writing by means reasonably designed to arrive at least 24 hours prior to pricing. As discussed above, the focus of the Commissions rules should be on availability of, and access to, information, via EDGAR or other means, and not on actual delivery. A delivery requirement will delay offerings and interfere with book-building processes (as underwriters identify additional investors during the course of an offering and deliver a preliminary prospectus after ascertaining interest only at that point). In addition, the delivery requirement will require underwriters to organize larger mailings to categories of investors who may not have an interest or to whom they may not subsequently market, in order to assure that the delivery requirement is satisfied, or -- more likely -- will cause underwriters to exclude categories of investors (most likely, retail investors) from offerings if the risk of delay and compliance costs and complexities do not justify the potential benefit. To the extent that any delivery requirements are retained, we offer three changes to make these requirements more practical:
· Form A issuers eligible for registration on demand should also be eligible for a less restrictive advance delivery requirement than 3 days. We already have questioned the wisdom of denying these issuers the full benefit of short-form registration they have today, and introducing a mandatory 3 day delay in completing sales only exacerbates the unfairness. If any mandatory waiting period is justifiable -- and we continue to believe it is not -- a 24 hour period should be sufficient.
· Second, the consequence of failure to deliver the required information to each investor, as required by proposed Rule 174(b), is too severe. In effect, the appearance or identification of a single new investor, underwriter or selling group member (resulting, for example, from a decision to increase the size of the offering) would set the clock back at least a full 3 or 7 days. This sort of timing delay is unrealistic in todays fast-paced markets and could severely limit the sales efforts necessary to ensure the success of securities offerings by smaller or unseasoned issuers. Accordingly, the rule should be satisfied by the availability of a preliminary prospectus, or by its delivery to those new investors identified, or who approach the underwriters or other offering participants, after the relevant deadline has passed.
· Finally, the requirement to deliver material updating changes should provide that this information be delivered to the investor by any means the issuer determines to be appropriate (including by electronic transmission, facsimile or oral communication) at any time prior to the time the investor makes a binding decision to invest.
The Commission has proposed that no final prospectus would be required to be delivered in connection with Form A offerings, although one would, as in the case of Form B offerings, be required to be filed. The concerns previously expressed with respect to the timing of filing the final prospectus in the context of Form B offerings apply equally here as well.
c. Content of Disclosure and Applicability of Liability Provisions
The information required to be included in a Form A registration statement would be the same as is now required under current Forms S-1, S-2, F-1 and F-2. Information contained in the registration statement (including all Exchange Act reports incorporated therein by reference) would be subject to Section 11 liability. Section 12(a)(2) liability would attach to all information contained in the prospectus, to any free writing materials used in connection with the offering and to all oral communications used to offer or sell the securities (other than those communications taking place more than 30 days prior to the filing of the Form A registration statement).
As discussed above and as further discussed below, the terms "free writing materials" and (since it is used to determine the scope of "free writing materials") "offering information" need to be better defined in order to understand the filing obligations and liability risks associated with these communications.
d. Delayed Shelf Offerings
The Release states that delayed shelf offerings of securities pursuant to Securities Act Rule 415 would not be available for primary or secondary offerings registered on Form A.25 We believe that proposal is unwarranted, particularly if, as the Commission proposes, Exxon Capital exchange offer procedures are eliminated. As discussed above, delayed shelf registration is vitally important for resales by holders of privately placed securities (including affiliates) of smaller or unseasoned issuers not eligible to use Form B. The inability of an issuer to offer resale registration to these investors using delayed shelf procedures would thus only discourage legitimate private placement activity and increase the cost of capital for those issuers who can least afford it.
3. Offerings by Foreign Governments
Foreign governments eligible under proposed Rule 462 to control the timing of effectiveness of their registration statements would be those that (i) are registering offerings on Schedule B of at least $250 million where such offerings are underwritten on a firm commitment basis, and (ii) have registered an offering under the Securities Act within the three most recent years.
Under proposed Rule 172, foreign government issuers registering a firm commitment underwriting in excess of $250 million more than one year after the effective date of their initial registered offering would be permitted to follow prospectus delivery procedures similar to those under Form B by filing with the Commission, and delivering to investors before sale, either a term sheet or (under the Commissions alternative proposal) preliminary prospectus. For other foreign government issuers, Form A procedures, requiring delivery of a preliminary prospectus no later than 3 or 7 days before pricing, and delivery of material updating changes at least 24 hours before pricing, would apply.
We believe, for the same reasons expressed above with respect to Form B and Form A issuers, that the term sheet and prospectus delivery requirements will not be workable and should not be imposed on foreign government issuers. Moreover, while we support the Commissions proposal to allow certain foreign government issuers effectiveness on demand, we believe that, comparable to todays shelf procedures for these issuers, the appropriate prior registration window period should be five, rather than three, years.26
Finally, we note that the criteria for establishing when a foreign government issuer would be able to control the timing of effectiveness of its registration statements may be unnecessarily limiting. Certain well-covered foreign government issuers may in fact engage in offerings that do not meet the $250 million threshold, and it seems anomalous to require different procedures simply because such an issuer determines to raise $200 million at one particular time rather than $250 million. In our experience, coverage of a foreign government issuer is generally based on the aggregate amount of debt the sovereign has outstanding. Accordingly, we suggest that, in addition to the Commissions proposed eligibility criteria, an alternative measure based on the aggregate amount of debt outstanding (e.g., $500 million or more) be permitted.27
The Commission adopted the U.S. - Canadian multijurisdictional disclosure system ("MJDS") in 1991 in an effort to facilitate cross-border securities offerings and periodic reporting by eligible Canadian issuers. In general, the MJDS allows eligible Canadian issuers to satisfy registration and reporting requirements under the Securities Act and the Exchange Act through the use of disclosure documents prepared under Canadian securities law.
In the Release, the Commission proposes to replace the current minimum public float criteria for the MJDS forms (i.e., Forms F-8, F-9, F-10, F-80 and 40-F) with Form Bs public float/ADTV thresholds. In addition, the public float thresholds would be measured in U.S., rather than Canadian, dollars (currently, certain MJDS form requirements use Canadian dollar thresholds).
If these modifications to the MJDS are adopted, certain Canadian issuers currently eligible to use the MJDS would no longer be able to do so. Moreover, because MJDS forms do not require prior staff review, MJDS issuers whose previous offerings were registered under the Securities Act on MJDS forms or who file their annual reports with the Commission on Form 40-F will not be eligible to use Form B. These proposals will serve only to limit the utility of the MJDS, and we urge the Commission not to adopt them. Instead, we recommend that the Commission continue to foster the MJDS by permitting MJDS issuers to use Form B even where these issuers have used MJDS forms to register Securities Act offerings or have in the past filed annual reports on Form 40-F. In addition, given the premises underlying the MJDS and the linked nature of the U.S. and Canadian trading markets, we propose that ADTV be calculated by combining both U.S. and Canadian trading volume.
5. Aftermarket Prospectus Delivery
The Commission has proposed the imposition of a uniform 25-day aftermarket prospectus delivery period for all dealer transactions. Currently, only initial public offerings have an aftermarket prospectus delivery period (of 90 days for unlisted securities and 25 days for listed securities). The Commission believes that in the wake of the Gustafson decision the uniform 25-day period would ensure that Section 12(a)(2) liability would exist in dealer transactions following all registered offerings.
We do not believe dealers participating in secondary market transactions generally should be subject to prospectus liability. Prospectus liability for underwriters under the Securities Act is intended to apply to the distribution of securities into the market and is predicated on a relationship of privity with the issuer not shared by dealers who are not participating in that distribution. As the releases proposing and adopting Rule 174 indicate, the aftermarket prospectus delivery requirement was intended to ensure that adequate information about the issuer and the trading of the securities in question was widely disseminated in the market. In response to the increasingly efficient dissemination of market information and the development of the integrated disclosure system, Congress and the Commission have over time shortened, and in many cases eliminated, the aftermarket prospectus delivery requirement as unnecessary. Nothing cited in the Release justifies the step backward of now extending the requirement to new transactions.28
To the extent the change in post-offering prospectus delivery is motivated by a desire to clarify standing issues for registered offerings in light of Gustafson, we believe this can be more directly addressed by the adoption of a Commission rule defining the term "prospectus" under Section 12(a)(2).
6. Concurrent Exchange Act Registration
Under the present registration system, issuers that desire to register their securities under both the Securities Act and the Exchange Act must file two separate registration forms: a Securities Act registration statement and an Exchange Act registration statement on Form 8-A. The Commission is proposing to allow for concurrent Exchange Act registration, and to eliminate the separate Form 8-A filing requirement, when a securities offering is registered under Form A, B or C, or by a foreign government issuer under Schedule B. We see no benefit to the separate Form 8-A requirement and support the Commissions proposal in this regard. Indeed, we believe this proposal can and should be adopted today, regardless of whether the other reforms contained in the Release are adopted.
B. Exxon Capital Transactions
As noted above, the Commission has stated its intention to repeal the Exxon Capital Letters if the proposals set forth in the Release are adopted and, perhaps, even if they are not adopted.
With certain exceptions, the Exxon Capital Letters allow issuers that have privately placed straight debt and certain straight preferred securities to file a registration statement offering to exchange registered (but otherwise substantially identical) securities for those privately placed. Holders participating in the exchange could then resell the new securities generally without complying with the registration or prospectus delivery requirements of the Securities Act. The premise behind the Exxon Capital Letters for straight debt and preferred securities, which the Commission does not dispute, is that, although the types of securities for which it is used continue to trade even after the exchange offer in the institutional market, institutional investors will accept a lower yield for unrestricted securities. In our experience, institutional investors increasingly demand that issuers effect an Exxon Capital exchange offer -- not so that they can quickly resell their securities to retail investors (as the Commission apparently fears), but rather to free privately placed securities from their "restricted" baskets. Without this procedure, institutional investors with restricted basket limitations may be less willing and less able to participate in private offerings, significantly disrupting the legitimate capital raising efforts of issuers. This will be particularly true if, as already noted and reiterated below, institutional investors are also denied effective resale registration rights except in the case of Form B offerings.
Although the Release does not address this issue, we presume that the repeal of the Exxon Capital Letters would also preclude use by non-U.S. issuers of the procedures permitted by the Vitro line of letters pursuant to which non-U.S. issuers offering common equity securities or securities convertible into common equity securities can access the U.S. public markets in a two-step process involving first an institutional offering under Rule 144A followed by a subsequent registered public offering.29 As a result, non-U.S. issuers wishing to access the U.S. market would have two substantially less desirable alternatives. They could register their initial offering, which, because of the time required for reconciliation of their financial statements to U.S. GAAP and what is often a lengthy SEC review process, would subject them to significant market risk. Alternatively, they could place shares in the United States under Rule 144A and either offer traditional registration rights (the value of which will be materially impaired by the proposed elimination of delayed secondary offerings by other than Form B issuers) or not offer registration rights, leaving the initial investors with restricted securities and even less liquidity. Choosing the first alternative may ultimately raise no capital if the market window closes during the lengthy preparation period, while choosing the latter will certainly raise the cost of capital for these issuers and may well make markets outside the United States the only reasonable choice.
The Commission has not demonstrated any evidence of abuse associated with these transactions, nor advanced any theory that would justify imposing increased cost and procedural burdens on issuers that wish to effect a registered exchange offer. Accordingly, we urge the Commission to continue to provide the flexibility that the Exxon Capital and Vitro procedures afford.
C. Communications During the Offering Process
Under the current regime, offers are prohibited before a registration statement is filed.30 After filing, any written offer must be made exclusively through the prospectus included in the registration statement. Sales of securities may be made only after a registration statement has been declared effective. Moreover, under the existing system, even after effectiveness written offering material other than the prospectus may be used only if it is accompanied or preceded by a final prospectus.
In the Reform Proposal, the Commission acknowledges that the existing regulatory scheme unnecessarily hinders legitimate communications around the time of an offering that would be helpful to investors. In addition, the Commission recognizes that the current distinction between permissible communications and illegal offers violating Section 5 is not clear and requires a "facts and circumstances" analysis. To reduce this uncertainty and promote the dissemination of more information regarding offerings to all investors, the Commission proposes to eliminate many of the current restrictions on communications prior to, during and after offerings.
We agree that the current restrictions with regard to the dissemination of communications around the time of an offering unnecessarily limit information flow to investors and support the Commissions proposal to liberalize these communications. However, we believe the other aspects of the Commissions communications proposal, in particular the associated filing requirements, will discourage rather than promote more widespread dissemination of information to investors in connection with an offering.
For example, under the Form B proposal, any materials disseminated by an underwriter that could be deemed "offering information" (a term which, as discussed above, is vague and ill-defined) would be required to be filed as part of the registration statement. As a consequence, the issuer and each other underwriter participating in the offering would be subject to Section 11 liability with respect to these materials. This risk is not one that the issuer or the other underwriters should be required, nor will they be willing, to bear.
With respect to the Commissions suggestion that road show presentations be filed as free writing materials, we begin by noting that the Commissions long-standing position that road show presentations constitute oral communications has had the salutary effect of encouraging communication of information in its most helpful form.31 Treating such presentations, and related visual aids, as written materials and requiring them to be filed can be expected to chill their use as a result of concerns regarding possible Section 12(a)(2) liability to an expanded universe of potential litigants. Accordingly, we believe any reversal of this position under the guise of liberalizing communications will serve only to create a road block to future road show presentations.
Although we acknowledge the Commissions concern with respect to selective disclosure to investors by issuers, a principal source of free writing material is, in fact, likely to be sales literature prepared by underwriters or dealers -- a part of their selling activities that traditionally has been treated as independent of the issuer. As such, its filing should not be considered necessary to address selective disclosure concerns, which revolve around the relationship between an issuer and its shareholders. Indeed, requiring the filing of this material will only inhibit its use for a number of reasons. First, documents prepared by underwriters and dealers often include proprietary or "branded" material, or may be directed to or prepared especially for a particular investor or class of investors. Public disclosure of this material will be unacceptable for obvious commercial reasons. Second, even if liability under Section 12(a)(2) for this material, as proposed by the Commission, were appropriate (which, as discussed below, is debatable), expanding the potential plaintiffs from those to whom the material is given to all who purchased securities in the offering is inappropriate. Finally, the compliance burden on broker-dealers in determining what must be filed as "free writing materials" (even if the definitional problems with the term can be fixed) will be needlessly heavy.
The standard of liability to apply to free writing used by underwriters and dealers raises difficult issues and a difficult choice for the Commission. There is certainly logical support for the proposition embodied in the Reform Proposal that written offering material in a registered offering should be subject to Section 12(a)(2), the statutory liability standard for written offers under the Securities Act. On the other hand, the existing "free writing" exception in the statute excludes permitted written materials from the definition of "prospectus" and thus from Section 12(a)(2) liability. Granted that the existing exception applies only to material delivered with or after delivery of a final statutory prospectus. However, with integrated disclosure and electronic availability of disclosure materials, the informational backdrop for delivery of the free writing materials that the Reform Proposal would permit, at least for seasoned issuers, is not significantly different from that under the statute after a final prospectus is delivered. The theory of the Securities Act is thus arguably best followed by not applying Section 12(a)(2) liability to the proposed free writing materials. Finally, it is almost certainly the case that one of the Commissions objectives, greater availability and dissemination of information, will be more consistently realized if the Section 12(a)(2) standard is not applied. We believe the choice for the Commission in the end depends on the degree to which it embraces the objective of fostering greater flow of written information.
2. Communications Made Before Filing by Form B and Seasoned Schedule B Registrants
Proposed Rule 166 would eliminate all current prohibitions against communications made before filing of a registration statement with respect to securities registered on Form B. The elimination of the current prohibition against pre-filing offers would also be extended to firm-commitment underwritten offerings of securities of seasoned foreign government issuers, provided the offering involves more than $250 million of securities. For these purposes, a foreign government would be considered to be seasoned if at least one year has elapsed since its initial public offering. We agree that issuers eligible to use Form B and seasoned foreign government issuers registering firm commitment underwritings of more than $250 million32 should be permitted to communicate freely during the pre-filing period. We do not believe it is necessary or appropriate to limit applicability of this proposal to certain subsets of Form B issuers or to require a longer seasoning period before issuers can take advantage of the proposed rule.
Free writing materials used after the commencement of the Form B offering period (and prior to registration) would be required to be filed under proposed Rule 425 at the time of filing of the registration statement. Under proposed Rule 167(a), however, communications made before the commencement of the Form B offering period would not constitute an "offer" for purposes of Section 5 (whether or not a registration statement was filed or effective), and thus would not be required to be filed. Although we believe from our reading of the Release that the Commissions intention is that a communication used prior to the Form B offering period would also not be considered an "offer" or "prospectus" for purposes of Section 2(a)(10) or 12(a)(2) under the Securities Act,33 we urge the Commission to make this clear by explicitly referencing these Sections in proposed Rule 167(a).
The Form B "offering period" for this purpose is defined as the period beginning 15 days prior to the "first offer" made by or on behalf of the issuer in connection with the offering and ending upon the completion of the offering. The term "first offer", however, which is critical to determining the commencement of the offering period and the associated filing requirements, is not defined in the Release or in the proposed rules. How will the issuer or other offering participants know when the "first offer" has taken place, particularly in a world in which communications with investors have been liberalized? We believe the Commission needs to develop a more concrete, bright-line definition of the commencement of the Form B offering period.
3. Communications Made Before Filing by Form A Registrants
Proposed Rule 167(c) would provide that a communication made by or on behalf of a Form A registrant more than 30 days prior to the filing of a registration statement would not constitute an "offer" in violation of Section 5 and thus need not be filed. We support this proposal and believe that 30 days is an appropriate "cooling off" period for pre-filing communications in connection with Form A offerings. As noted above with respect to proposed Rule 167(a), however, we request that the Commission explicitly state that these communications are likewise excepted from Sections 2(a)(10) and 12(a)(2).
The 30-day "bright-line" safe harbor, however, would be available only if "reasonable steps" were taken to ensure that a permissible communication is not redistributed or republished outside the safe harbor period. The introduction of this "reasonableness" standard, with its inherent ambiguity, adds uncertainty with respect to the availability of the safe harbor -- thereby diminishing its utility -- and should be eliminated. Moreover, in response to the Commissions request for comment as to whether communications prior to the commencement of the 30-day period should be filed, we do not believe there is any justification for such a requirement.34
During the 30-day period prior to filing of the registration statement, communications constituting offers under Section 5 would be prohibited, subject to exceptions for the issuance of certain factual or forward-looking information and brief announcements of the type currently permitted by Securities Act Rule 135. Proposed Rule 169 would provide a safe harbor allowing the dissemination of certain "factual business communications" by issuers, underwriters or participating dealers and would essentially codify the Commissions view that factual business communications do not violate Section 5.35 Such factual business communications would not be required to be filed with the Commission.
We generally agree with and support the Commissions proposal regarding factual business communications (which is largely a codification of existing guidance) but suggest that the scope of the proposed Rule 169 safe harbor be expanded to include forward-looking statements that relate to factual business developments. In our experience, it is common for a press release relating to a factual matter to include a description of the expected effect of the factual development, and we believe the Commission should welcome rather than discourage the dissemination of this information into the marketplace. We note that the Commission historically has indicated that forward-looking statements at the time of an offering could constitute an illegal offer under Section 5, but has expressed particular concern with respect to financial projections, such as those concerning revenues, income, earnings per share or share value.36 In recent years, the former restrictions against forward-looking statements have been liberalized and the Commission generally has promoted the release of forward-looking statements.37 We believe that broadening the scope of the factual communications safe harbor to encompass forward looking statements that do not involve financial projections would address the Commissions concerns while being consistent with the recent developments favoring the release of forward-looking information.
We also believe the suggestion in the Release that factual business communications satisfying the requirements of the proposed Rule 169 safe harbor could be subject to Section 12(a)(2) liability if they are used during the offering period to offer securities should be retracted.38 If the purpose of the safe harbor39 is to provide guidance with respect to the types of factual business communications that may be disclosed to the public during the offering period (and, indeed, to encourage the dissemination of this information), we do not understand the meaning of this suggestion and believe it will only serve to diminish the utility of the safe harbor. Any concern the Commission may have about the use of materially misleading factual business communications by an issuer to facilitate an offering is adequately addressed by the availability of Rule 10b-5 and its more appropriate scienter requirements. Accordingly, we request that the Commission expressly confirm that factual business communications made in reliance on the proposed Rule 169 safe harbor are not "offers" within the meaning of Section 2(a)(10), nor subject to liability as a "prospectus" under Section 12(a)(2).
Proposed Rule 168 would provide a safe harbor for the dissemination of certain regularly-released forward-looking information by an issuer, underwriter or participating dealer. To qualify for the safe harbor, the issuer must be subject to the reporting requirements of the Exchange Act at the time of the communication. Forward-looking statements would be considered regularly-released if the issuer has customarily released information of the same type in the ordinary course of its business during the two fiscal years and any interim period prior to the communication. The safe harbor would also require that the time, manner and form in which the information is released be consistent with the issuers past practice. Such forward-looking statements would constitute free writing material and be required to be filed with the Commission under proposed Rule 425 and would be subject to Section 12(a)(2) liability. We support the Commissions proposal to provide a safe harbor with respect to regularly released forward-looking information; however, we do not believe this type of forward-looking information, especially if not prepared by the issuer, should be subject to any filing requirement. Moreover, as discussed above in the context of proposed Rule 169, we believe the Rule 169 safe harbor for factual business communications should be expanded to include -- and the scope of proposed Rule 168 correspondingly narrowed to exclude -- forward-looking statements (other than financial projections) that relate to factual business developments.
4. Communications Made After Filing the Registration Statement
Proposed Rule 165, applicable to all offerings, would allow free writing materials to be disseminated after the filing of a registration statement, but these materials would generally have to be filed. Proposed Rule 425 would exclude from this filing requirement (i) factual business communications; (ii) research reports, as discussed below, used in reliance on Rules 137, 138, 139, 165 or 166; (iii) any information used in connection with a Form S-8 offering, a dividend or interest reinvestment plan registered on Form B, or a direct stock purchase plan; and (iv) confirmations of sales.
The availability of proposed Rule 165 would be conditioned on: (i) the delivery of required term sheets or preliminary prospectuses, (ii) "any" free writing materials used being filed as required under proposed Rule 425, and (iii) a prospectus satisfying the requirements of Section 10 (excluding, we assume, pricing information under Rule 430A) being filed prior to the first sale. As discussed above, we believe the delivery of term sheets or preliminary prospectuses should not be mandated, that free writing materials (other than those prepared by the issuer) should not be subject to filing and that the filing of the final prospectus be required at or prior to settlement (or, if settlement moves to T+1, no later than two business days after settlement), rather than "sale". Proposed Rule 165 should thus be modified accordingly.
Although proposed Rule 425 would clearly provide that research reports are not required to be filed as free writing, the proposed rules do not make clear if there are circumstances under which a research report could be considered "offering information", and therefore required to be filed as part of the registration statement. Accordingly, we request that the Commission clearly state that research reports prepared in accordance with the Commissions research safe harbors (i.e., Rules 137, 138 and 139) would not be deemed "offering information".
D. Research Reports
The Release also proposes amendments to the current research safe harbor rules to relax the restrictions on the distribution of research reports in registered offerings as well as in unregistered offerings under Rule 144A and Regulation S. We generally support the Commissions proposals with respect to the dissemination of broker-dealer research reports and believe these proposals (with the modifications noted below) could and should be implemented today.
1. Rule 137
Current Rule 137, in general, allows a broker-dealer to circulate research reports about a reporting issuer that is conducting an offering if the broker-dealer is not participating in the offering and the research is published by the broker-dealer in the regular course of its business. Proposed amendments to Rule 137 would expand the current safe harbor by including within its scope non-reporting issuers and eliminating the requirement that the research report be published in the regular course of business. By eliminating the "regular course of business" requirement, the amended rule would allow non-participating broker-dealers to commence publishing research at the time of an offering. We agree with and support this proposal.
2. Rule 138
Currently, Rule 138 provides a safe harbor for the publication of research by a broker-dealer participating in a registered offering of an issuers securities, provided that the research report relates to securities different than those being offered. The existing Rule 138 safe harbor is available only for research concerning certain seasoned domestic and foreign issuers and certain large, unseasoned foreign issuers.40 To rely on the current Rule 138 safe harbor, the research must be published by the broker-dealer in the regular course of its business.
Under the proposed amendments to Rule 138, the existing safe harbor would be expanded to apply to research reports relating to the securities of virtually all reporting issuers. In addition, Rule 138 would be available for research regarding a larger universe of non-reporting foreign private issuers (i.e., those that satisfy the Form B public float /ADTV requirements and whose equity securities trade on a designated offshore securities market)41. Rule 138 would, however, continue to require that the research be prepared by the broker-dealer in the regular course of its business. We believe the expanded coverage of Rule 138 is warranted and we support this proposal.
The Commission notes that reliance on the Rule 138 safe harbor would not be necessary in the case of offerings registered on Form B and firm commitment underwritten offerings of at least $250 million by seasoned foreign government issuers. In the case of issuers filing on Form A, the exemption under Rule 138 would only be necessary during the 30-day period prior to filing when communications are restricted. In addition, Rule 138 research would not have to be filed as free writing materials under proposed Rule 425. However, because the Commissions proposed research exemptions now relate only to violations of Sections 5(b)(1) and 5(c), a Rule 138 research report could potentially give rise to Section 12(a)(2) liability. There is no suggestion that the current Rule 138 (or Rule 139) safe harbor has been abused. On the other hand, applying the Section 12(a)(2) standard could cause investment banks to curtail their publication of research that relies on the exemptive rules. Under these circumstances, the Commission should retain the existing liability standard (which it does not suggest is inadequate), which would further the Commissions goal of encouraging greater flow of information to investors. We believe this would be the correct approach for exempted research even if the Commission determined to apply the stricter Section 12(a)(2) standard to other categories of free writing that it chooses to permit.
Moreover, as noted above, the Release fails to make clear whether a research report could be considered "offering information" (and hence subject to filing and Section 11 liability) under the proposed regime. We request that the Commission confirm that qualifying Rule 138 research would not be deemed "offering information".
3. Rule 139 42
Rule 139 currently contains two safe harbors for the publication of research relating to any class of an issuers securities by a broker-dealer participating in the offering of securities by that issuer. Rule 139(a) provides a safe harbor for the publication of "issuer-specific" (or "focused") research reports by broker-dealers participating in offerings of securities of certain seasoned, reporting issuers and large, non-reporting foreign private issuers. Rule 139(b) provides a safe harbor for the publication of "industry-wide" research reports by broker-dealers participating in offerings of securities by less seasoned reporting issuers and certain large, non-reporting foreign private issuers. Among other conditions, the current safe harbor for industry-wide research requires that the report not contain a more favorable recommendation of the issuers securities than the one made in the last publication by the broker-dealer. Both safe harbors require that the research be distributed by the broker-dealer with reasonable regularity in the normal course of its business.43
The proposed amendments to Rule 139 would preserve the current distinction between industry-wide research and issuer-specific research but would extend the Rule 139 safe harbor for issuer-specific research to all offerings of securities by issuers with a one-year reporting history. The proposed issuer-specific safe harbor would also apply in offerings by first-time Schedule B registrants of more than $250 million underwritten on a firm commitment basis44 and offerings by non-reporting foreign private issuers that (i) meet the Form B public float/ADTV (measured on a worldwide basis) tests and (ii) whose equity securities have traded for at least one year on a designated offshore securities market. The amended safe harbor would eliminate the current requirement that issuer-specific research have been published by the broker-dealer with reasonable regularity (i.e., the initiation of research coverage would be permitted), but would continue to require that the research be published in the normal course of business of the broker-dealer. We believe these proposed modifications to Rule 139 are improvements and support them. We recommend, however, that the rule be further expanded to cover issuer-specific research reports prepared and disseminated in connection with offerings by unseasoned issuers that meet the Form B public float/ADTV thresholds. In response to the Commissions suggestion that, if the rule were to be expanded in this manner, these reports would have to be filed with the Commission, we do not believe any such filing requirement is necessary; indeed, this requirement would discourage the dissemination of these reports.
With respect to industry-wide research, the proposed amendments to Rule 139 would extend the safe harbor to all issuers, regardless of their size or reporting history. The proposed amendment would also eliminate the current requirement that industry-wide research not contain a more favorable recommendation than the last one made by the broker-dealer, but in that case would require the report to include the last two opinions or recommendations published while the broker-dealer was not a participant in an offering of the issuers securities. We strongly support the Commissions proposal to eliminate the current prohibition on recommendation upgrades, but do not agree with the requirement mandating disclosure of the prior two recommendations given. We believe sufficient controls already exist to protect investors and that mandated disclosure of prior recommendations is unnecessary and, in the context of research already in circulation at the time a broker-dealer becomes a participant in an offering, impossible to implement.45 Moreover, with respect to the suggestion that broker-dealers be required to describe prominently in an issuer-specific or industry-wide research report the capacity in which they are acting in connection with the distribution, we believe, for the same reasons expressed above with respect to disclosure of past recommendations, that imposition of this requirement is unnecessary and, where the research has been prepared and is already in circulation (through electronic databases or otherwise) prior to the time the broker-dealer becomes a participant in a distribution, or its participation otherwise becomes publicly known, simply not practical.
In response to the Commissions query as to whether to retain the "reasonable regularity" requirement with respect to distribution of industry-wide research reports regarding unseasoned or non-reporting issuers (other than for the foreign government and large foreign private issuers described above) and projections, we urge the Commission to eliminate this requirement. We agree with the Commissions view, expressed in connection with the elimination of this requirement for issuer-specific reports, that the "normal course" requirement is sufficient to protect against "hyping" and, therefore, that the "reasonable regularity" requirement is unnecessary.
Finally, our views regarding not applying Section 12(a)(2) to Rule 138 research set forth above apply equally to Rule 139. We also note that the Rule 139 safe harbor, like the Rule 138 safe harbor, is ambiguous regarding whether protected research could be deemed "offering information", and we request clarification in each case that it would not.
4. Related Amendments for Offerings Under Regulation S and Rule 144A46
The Commission is also proposing to amend Rules 138 and 139 to provide safe harbors for the publication of research in connection with unregistered offerings under Regulation S and Rule 144A. The proposed amendments generally would provide that research published under Rules 138 and 139 would not constitute "directed selling efforts" under Regulation S or an offer to a person other than a QIB in the context of an offering under Rule 144A.
The proposed safe harbor for Regulation S and Rule 144A offerings would be limited to research reports concerning issuers about whom issuer-specific research could have been published (i.e., issuers with a one year reporting history, larger foreign private issuers and certain Schedule B registrants). Generally, the conditions for the Regulation S and Rule 144A safe harbors would be identical to the conditions that would apply to registered offerings, except that the safe harbor for Regulation S and Rule 144A would require that the research be published in a publication that the broker-dealer distributes with reasonable regularity. For the reasons expressed above, and particularly since the investors in these types of offerings are generally thought by the Commission to be capable of fending for themselves and not in need of Commission protection, we believe the "reasonable regularity" requirement is unnecessary and should be eliminated. We also do not believe there is any reason to limit the industry-wide safe harbor in connection with these offerings and recommend that this safe harbor be expanded to include all issuers about whom these reports could be distributed if the offering were registered.
Moreover, as noted in footnote 46, we believe that the proposed research safe harbor for unregistered offerings should be expanded to cover offerings conducted in reliance on the exemption from Securities Act registration provided by Regulation D. Accordingly, we urge the Commission to expressly provide that research satisfying the requirements of Rule 138 or 139 will not be deemed to constitute "general solicitation or general advertising" within the meaning of Rule 502(c) of Regulation D.
E. Underwriters Due Diligence
Section 11 of the Securities Act provides a defense to underwriters liability for materially defective disclosure (the so-called "due diligence defense") if the underwriter "had, after reasonable investigation, reasonable ground to believe and did believe" that the statements in the registration statement were true and there was no omission to state a material fact. Section 12(a)(2) provides a defense to liability for materially defective disclosure in a prospectus or oral communication for persons who did not know, and in the exercise of reasonable care could not have known, of the untruth or omission.
Rule 176, adopted at the time of establishment of the integrated disclosure system, identifies eight broad circumstances that the Commission found relevant in determining whether a person has satisfied Section 11s reasonable investigation standard. Current Rule 176, however, does not provide any guidance as to what constitutes reasonable care under Section 12(a)(2). The Commissions proposed revisions to Rule 176 would remedy this omission by expressly stating that the rule would apply to both the "reasonable care" standard of Section 12(a)(2) and the "reasonable investigation" standard of Section 11. The revisions would also add to the rule the following six additional "positive factors" that would support the conclusion that the reasonable investigation and reasonable care standards had been met:
· Whether the underwriter reviewed and conducted a reasonable inquiry into the registration statement (including all documents incorporated by reference).
· Whether the underwriter discussed the information in the registration statement with relevant executive officers (including the chief financial officer or chief accounting officer) and the chief financial officer or chief accounting officer certified that he or she had examined the registration statement and, that to the best of his or her knowledge, it does not contain an untrue statement or material omission.
· Whether the underwriter has received an auditors comfort letter under Statement on Auditing Standards ("SAS") 72.
· Whether the underwriter has received an opinion from issuers counsel that nothing has come to its attention that has caused it to believe that the registration statement contains an untrue statement of a material fact or omits to state a material fact (a "Rule 10b-5 letter").47
· Whether the underwriter has received a "Rule 10b-5 letter" from its own counsel.
· Whether the underwriter has employed and consulted a research analyst that (i) has followed the issuer or the issuers industry on an ongoing basis for at least 6 months immediately prior to commencement of the offering and (ii) has issued a report on the issuer or its industry within the 12 months immediately prior to the commencement of the offering.
All six factors, as the Commission notes in the Release, largely reflect current market practice by underwriters in securities offerings. However, the Commission has proposed to limit the application of these factors to equity and non-investment grade debt offerings by large seasoned Form B issuers that are marketed and priced in fewer than five days. Most offerings that are marketed and priced in such a short period are in fact investment grade debt offerings, whereas equity and high-yield debt offerings generally have longer marketing periods that often include road shows. In addition, under both the existing and proposed registration rules, underwriters are subject to the most severe time pressures in the conduct of due diligence during the period from the issuers decision to proceed with an offering until the date marketing is commenced. Accordingly, we believe the rule, as proposed to be expanded, will be of little practical utility and recommend that the coverage of the rule be further expanded to include Form A offerings as well as all offerings of investment grade debt and that the 5-day limitation be eliminated. With respect to investment grade debt offerings (in particular, MTN programs and similar continuous offerings), the rule should acknowledge that accountants comfort letters, counsel opinions and officers certificates may be obtained on a periodic basis (e.g., quarterly or annually).
In addition, while we believe most underwriting firms at times follow the sixth new "positive factor" and consult a research analyst in connection with certain offerings in which they participate, we note that "Chinese wall" procedures followed by these firms generally limit this contact except under prescribed circumstances. Accordingly, since the presence of this item as a positive factor would essentially require underwriters to bring their analysts "over the wall" in connection with all offerings, we do not believe this factor should be included.
The Release solicits comment on whether other factors should be included within Rule 176, such as performance by accountants of a SAS 71 review of quarterly financial information or a Statement on Standards for Attestation Engagements No. 8 review of the issuers MD&A disclosure. The Release also requests comment on whether the conduct by independent qualified professionals of an annual Exchange Act disclosure review and the issuance of a report similar in substance to a Rule 10b-5 letter should be added as an additional positive factor. Except for the SAS 71 review, which we believe is relatively customary (indeed, it is often a condition of the engagement of major accounting firms) and not unduly expensive, effectively imposing the remaining factors would be unreasonably burdensome to issuers and should not be included within the rule.
Although we believe the proposed revisions to Rule 176 (if the modifications suggested above are adopted) may aid courts in determining whether an underwriter has performed adequate due diligence in connection with an offering, we continue to believe underwriters should be provided with at least a rebuttable presumption of having established a due diligence defense to Section 11 and 12(a)(2) liability if the factors set out in Rule 176 are met. Shifting the burden to the plaintiff to prove that, notwithstanding compliance with the factors in Rule 176, the underwriters nevertheless failed to act reasonably in not discovering a material misstatement or omission appropriately recognizes the substantially less control over disclosure underwriters have as a practical matter given the increasing speed of the markets and the integrated disclosure system.
For the same reasons, we also believe the Commission should expressly acknowledge that the indemnification of underwriters by issuers is not against public policy.48 This would allow underwriters to protect themselves from the costs of litigation except, as a practical matter, where misstatements or omissions were fundamental and effectively masked the issuers insolvency. Investors would remain protected in all circumstances (since, of course, indemnification would not diminish the right of investors to bring suit against the issuer or the underwriters) and underwriters would continue to have sufficient exposure (including from a reputational perspective) to provide incentive for their conduct of due diligence.
F. Integration of Registered and Unregistered Offerings
The Commission acknowledges in the Release that the current integration doctrine has resulted in uncertainty among offering participants and their counsel and has significantly restricted the ability of issuers to switch between public and private offerings.49 Accordingly, the Commission has proposed several amendments designed to clarify situations in which integration would not be required. We generally support these proposals and believe that, with the modifications noted below, they could be adopted today regardless of any action taken on the other proposals set forth in the Release.
The Commission has not, however, provided any new guidance concerning the general integration doctrine and, in particular, has not provided additional guidance or proposals regarding "side-by-side" public and private offerings, even where all participants in the private offering are QIBs or other institutional investors (and thus able to fend for themselves without Commission oversight) and general solicitation has not been used to identify or contact such investors. Accordingly, we request that the Commission expressly acknowledge that a private offering may be so conducted concurrently with a registered offering without being integrated with the registered offering.
1. Public Offering Subsequent to Completed or Abandoned Private Offering
Rule 152, as proposed to be amended, would contain two safe harbors for public offerings50 that follow private offerings. First, Rule 152 would preserve the existing safe harbor for private offerings that are completed prior to the commencement of a public offering. A clarification would also be added to the existing safe harbor to permit issuers to register the resale of securities that were originally sold by the issuer in a completed private offering, for example in so-called "PIPES" transactions.
Although we believe the revised rule provides necessary clarification with regard to the integration of a public offering with a completed private offering, we do not agree with the Commissions decision to exclude from the safe harbor the registration of resales by affiliates or broker-dealers that have purchased securities directly from the issuer or an affiliate of the issuer. The Commission states that this exclusion is based on its fear that the resale transaction may actually be a disguised primary offering. Although there may be particular situations in which this fear would be justified, we do not believe it is a sufficient basis for excluding legitimate resale transactions by affiliates and broker-dealers from the comfort of the safe harbor. We also note that the registration process will provide purchasers in these transactions with the same detailed disclosure and liability protections as in a primary offering by the issuer (assuming the issuer were eligible to use the same registration procedure for a primary offering as for the proposed secondary offering, a factor the Commission could reasonably take into account in determining the bona fides of the transaction).
Second, revised Rule 152 would provide a new safe harbor for an abandoned private offering that is subsequently followed by a public offering. To ensure the safe harbor would not be abused by issuers that never really intended to conduct a private offering, the proposed rule would also require that (i) neither the issuer nor any person acting on its behalf have engaged in any form of general solicitation or general advertising, and (ii) the issuer delay filing the registration statement for 30 days if securities were offered in the private offering to any person ineligible to purchase in an offering under Section 4(2) or Section 4(6) of the Securities Act or Rule 506 thereunder. In connection with this latter requirement, we note that, in general, any investor could participate under proper circumstances in a Section 4(2) private placement and that up to 35 non-accredited investors may participate in a Rule 506 private placement. Accordingly, we are not certain of the Commissions intent in connection with this requirement.
2. Private Offering Subsequent to Abandoned Public Offering
In the Release, the Commission reiterates its position that the public filing of a registration statement (even a so-called "quiet" filing) for an offering constitutes a general solicitation for that offering. Although we disagree with that position, it does force issuers that currently seek to convert a public offering into a private offering generally to allow six months to elapse to be certain that the offerings will not be integrated.51 The Release proposes a new safe harbor under Rule 152 that would allow an issuer to commence a public offering, for example, to assess the markets interest in the issuers securities. If the offering were not successful, the issuer could, under the proposed safe harbor, subsequently convert the offering into a private offering.
In general, in order for an issuer to rely on the new "public to private" safe harbor, the following conditions must be satisfied:
· any filed registration statement must be withdrawn;
· if a registration statement has not been filed (for example, in the case of a Form B registrant), all offerees must be notified that the public offering has been abandoned;
· no securities must have been sold in the public offering;
· if the securities are first offered in the private offering more than 30 days after abandonment of the public offering, the issuer must notify each purchaser in the private offering that the offering is not registered, the securities are restricted and the investors do not have the protections of Section 11 of the Securities Act;52 and
· if the securities are first offered in the private offering within 30 days after abandonment of the public offering, the issuer and underwriters must agree in writing to accept Section 11 and Section 12(a)(2) liability for the offering documents used in the private offering.53
As noted above, we generally support this proposal. However, we believe the requirement to notify all "offerees" that the public offering has been abandoned is unnecessary and unworkable. In addition, we do not believe the imposition of a stricter liability standard than would otherwise apply to a private offering is appropriate where all purchasers are eligible purchasers in a private offering.
Finally, the Commission should revisit and reverse its position that a "quiet filing" of a registration statement constitutes general solicitation and triggers the proposed provisions of Rule 152. In the case of a quiet filing, where no preliminary prospectus has been circulated and no selling efforts commenced by underwriters and dealers, withdrawal of the registration statement should be the only requirement. Indeed, the very terms of the conditions the Commission proposes to impose, such as the notification to all "offerees" of the abandonment of the public offering, supports the conclusion that a quiet filing should not be viewed as general solicitation or offering activity.
3. Lock-Up Agreements
Recognizing that the use of lock-up agreements in connection with business combinations has become common and acknowledging the legitimate business reasons for this practice, the Commission is proposing to codify staff guidance permitting the registration of offers and sales under certain circumstances where lock-up agreements have been signed. Proposed Rule 159 would allow the registration of those offers and sales where:
· The lock-up agreements involve only executive officers, directors, affiliates, founders and their family members, and holders of 5% or more of the voting equity securities of the company being acquired;
· The persons signing the agreements own less than 100% of the voting equity securities of the company being acquired; and
· Votes will be solicited from shareholders of the company being acquired who have not signed the agreements and who would be ineligible to purchase in an offering under Section 4(2) or Section 4(6) of the Securities Act or Rule 506 thereunder.
We support the Commissions proposal with respect to lock-up agreements, but point out that, as noted above, Section 4(2) does not impose any eligibility requirements on purchasers in such transactions and Rule 506 permits the participation of up to 35 non-accredited investors. As a result, any investor would, potentially, be eligible to participate in a transaction exempt from registration under either such provision and, therefore, the third requirement of the proposed rule might be impossible to satisfy. Accordingly, we suggest that in connection with the third element that must be satisfied the Commission explicitly refer (if this is its intention) to "persons who are not accredited investors".54
G. Exchange Act Disclosure
Recognizing the increasing importance of Exchange Act disclosure to investors in both the primary and secondary markets, the Release includes certain proposals intended to improve the quality and the timeliness of information contained in the periodic reports filed by reporting companies. The proposals also attempt to address the problem of selective disclosure by issuers to investors by proposing, among other things, that companies accelerate their reporting of quarterly and annual financial information, such as earnings announcements.
1. Annual and Quarterly Reports
Item 503 of Regulation S-K currently requires companies to include in most Securities Act registration statements an analysis of the most significant risk factors associated with an investment in their securities. The Commission proposes to extend risk factor disclosure to Exchange Act registration statements and periodic reports. Under the proposed scheme, all reporting companies would be required to provide annual risk factor disclosure. For U.S. reporting companies filing quarterly reports, the Commission is also proposing that material changes in risk factor disclosure be reported quarterly. By proposing this disclosure in Exchange Act reports, the Commission hopes to ensure timely disclosure about the significant risk factors associated with a companys future financial performance irrespective of a public companys decision to register an offering. We agree that this disclosure is equally as important to secondary market investors as to primary market investors and support this proposal. However, we do not believe the Commission should attempt to identify other risk factors (which tend to be issuer-specific) beyond those items currently contained in Item 503.
With respect to foreign private issuers, the Commission proposes to accelerate the due date for their annual reports on Form 20-F from six months after the end of their fiscal year to five months after the end of their fiscal year. The Commission believes this proposal would reduce the gap in the due dates for annual reports filed by domestic issuers and foreign issuers without an undue cost increase to foreign issuers. We disagree with the Commissions assumption that accelerating the due date for filing Form 20-F will not be unduly costly or burdensome to foreign private issuers. Although some foreign private issuers may indeed be able to produce the requisite financial information, including U.S. GAAP reconciliation, and the other detailed disclosure required by the form within the proposed time frame, a significant number (many of whom may also have to translate this information into English) will not be. We do not believe the possible marginal benefit that may be achieved in receiving earlier disclosure by foreign private issuers justifies the considerable burdens it will place on these issuers. This proposal would only serve to undermine the Commissions efforts to encourage foreign issuers to access the U.S. public markets in connection with their capital raising efforts.55
The Commission seeks comment on the recommendation of the Advisory Committee on the Capital Formation and Regulatory Processes (the "Advisory Committee") to require the filing of a management report to the audit committee of the board of directors of a company. The report would be filed as an exhibit to Form 10-K and would disclose the procedures established to assure the accuracy and adequacy of Exchange Act reports. We do not believe a report of this type, which is likely to be boilerplate, will meaningfully improve disclosure, and accordingly believe the Commission should not attempt to change existing corporate governance practices by attempting to impose this requirement on reporting companies.
2. Current Reports on Form 8-K
Many companies issue press releases about their annual and quarterly results well before the due dates for filing their Exchange Act reports containing this information. The Commission notes in the Release that the issuance by companies of press releases to disclose quarterly and annual performance information yields an uneven flow of disclosure to investors. In order to promote a more uniform and even flow of material company disclosure to investors, the Commission proposes to require domestic reporting companies to report selected financial data on Form 8-K. The report would be due on the earlier of (x) the date companies issue a press release containing earnings information, and (y) the date that is 30 days after the end of each of the first three quarters of their fiscal year, or the date that is 60 days after the end of their fiscal year. As an alternative to this new Form 8-K requirement, the Commission seeks comment as to whether it should instead accelerate Form 10-Q and 10-K filing deadlines to 30 and 60 days, respectively, after the ends of the periods covered.
We concur in the Commissions proposal to report selected financial data on Form 8-K within the time frames proposed but believe that accelerating the timing of filing of Forms 10-Q and 10-K will impose significant burdens on reporting companies, with insufficient incremental benefit to investors to justify that change. Forms 10-Q and 10-K already require an increasing amount of detailed disclosure regarding, among other things, market and other risk and business segment reporting. Shortened time frames for filing these reports could very well result in less careful and considered disclosure or the failure to meet the reporting deadline -- which would have severe repercussions with respect to the ability of those companies to use Form B or incorporate by reference on Form A (since the proposed "seasoning" requirement under these forms includes a requirement that all Exchange Act reports have been timely filed within the past 12 months).
In addition to the disclosure requirements for annual and quarterly results, the Commission proposes to expand the items of disclosure that reporting companies must report on Form 8-K to include: (a) material modifications to the rights of security holders; (b) the departure of a chief executive officer, chief financial officer or certain other key officers; (c) material defaults on senior securities; (d) auditor notifications with respect to the inability of the registrant to rely on a prior audit report or the denial of consent with respect to the inclusion of a prior audit report in a Commission filing; and (e) company name changes. We agree with the Commission that the disclosure of this information is of interest to investors and should be reported promptly on Form 8-K. However, we believe the disclosure required with respect to the reason for the departure of a key officer should be analogous to the disclosure currently required by Form 8-K and Item 304 of Regulation S-K with respect to changes in accountants (i.e., whether the departure is due to resignation or dismissal, and the nature of the disagreement, if any, that led to the resignation or dismissal).
Following the suggestion of the Advisory Committee, the Commission proposes to accelerate the general deadline for filing reports on Form 8-K from the existing 15 calendar days to 5 calendar days. The Commission, however, also proposes that a number of events currently required or proposed to be required to be reported on Form 8-K -- including resignation of a director, departure of a chief executive officer, chief financial officer or certain other key officers, material defaults on senior securities, resignation of auditors or notification by auditors that the company may no longer rely on a prior audit or that the auditors will not consent to the use of a prior audit -- be reported within one business day. We agree that more timely reporting of material events would benefit investors and agree that 5 days or, for certain items, one business day is the proper reporting time frame, but we note that if the proposed signature and certification requirements are adopted as proposed, this latter time frame will be unworkable (especially in the case of companies with worldwide boards).
3. Signatures and Certifications
In order to encourage board awareness of and participation in the disclosures made on Exchange Act forms, the Commission proposes to revise the signatures section of all Exchange Act registration statements and periodic reports to mandate that the signatories must certify that they have read the registration statement or report and that, to their knowledge, the document contains no material misstatements or omissions. The Commission also proposes to expand the number of persons required to sign Forms 8-A, 10, 20-F, 40-F and 10-Q to include the principal executive officers and a majority of the board of directors of the registrant. With respect to current reports on Forms 8-K and 6-K, the Commission does not propose to require that a majority of the board of directors sign the reports but would instead require that the signatory for the registrant certify that he or she had provided a copy of those reports to the board.
The Commission is likewise proposing to amend signature requirements for registration statements under the Securities Act to require that the persons signing certify that they have read the registration statement and that, to their knowledge, it contains no material misstatements or omissions.
We do not believe that requiring additional director and officer certifications as to material misstatements or omissions in Exchange Act reports or Securities Act filings is feasible. As a practical matter, these documents are routinely finalized at late night sessions at a financial printer or in the registrants offices, at which the senior executive officer signatories would rarely, and a majority of the board never, be present. Although powers of attorney may be used to address this sort of practical difficulty, their use would appear to be inconsistent with the purpose of the certifications.
We also doubt the utility of expanding the signatories required for Forms 8-A and 10-Q and suggest they be treated in the same manner as the Commission proposes to treat Forms 6-K and 8-K.
4. Form 6-K Submissions
Form 6-K requires a foreign private issuer to furnish the Commission with all the material information that the foreign issuer: (i) discloses or is required to disclose under the laws of its domicile or place of incorporation; (ii) files or is required to file with stock exchanges that list its securities; or (iii) distributes or is required to distribute to its security holders.
Unlike Form 8-K, Form 6-K does not explicitly encourage voluntary disclosure that is not dependent upon foreign requirements. The Commission proposes to add an instruction to Form 6-K to encourage foreign issuers to submit voluntarily information that the issuer deems to be significant to its security holders. Like other information submitted on Form 6-K, any information submitted voluntarily on Form 6-K would not be deemed filed for purposes of Section 18.
The Commission also proposes to revise Form 6-K to include four new items in the list of examples of what issuers would disclose on Form 6-K if the information is disclosed under applicable foreign requirements: (a) changes in the issuers name; (b) material modifications to the rights of security holders; (c) any material defaults on indebtedness, material arrearages in dividends and other material delinquencies; and (d) departure of the issuers chief executive officer, chief financial officer, chief operating officer or president.
Since the revisions to Form 6-K involve voluntary submissions to the Commission or the reporting of information already required to be reported under home country laws or that is otherwise made public by the foreign issuer through stock exchange filings or distributions to its security holders, we can see little harm in their inclusion. Accordingly, we support this proposal.
5. Use of Plain English in Exchange Act Reports
The Commission solicits comment on whether the plain English rules should be extended to cover (a) all materials that are a part of the prospectus, including other parts of Exchange Act reports that are incorporated by reference into that document, or (b) all Exchange Act periodic reports, regardless of whether they are incorporated by reference into a Securities Act registration statement.
We agree that disclosure in Exchange Act reports, as in Securities Act registration statements, should be clear and easily understandable by investors. We believe, however, that the imposition of the plain English rules should be implemented gradually and with sufficient time for reporting companies to adjust their disclosure, if and as necessary, to comply with these rules.
H. Staff Review Policy
As previously noted, the Commission staff would not review Form B registration statements prior to effectiveness 56 and, as a consequence, the Commission is proposing to exclude Form B registration statements from Rule 401(g)57, which provides that registration statements, once declared effective, are deemed to be on the proper form. The Commission also states that it will screen Form B filings after effectiveness to determine if there are any "red flags" and, if it finds that the offering was not eligible for registration on Form B or omitted any required "offering information", it will refer the issuer to the Division of Enforcement or take other appropriate action. A finding that filing on Form B was improper or omitted required information could also result in claims for rescission by all investors in that offering. We believe these consequences are too draconian. We therefore strongly urge the Commission not to exclude Form B from the coverage of Rule 401(g).
We would be pleased to respond to any inquiries regarding this letter or our views on the Reform Proposal and the Release generally. Please contact Alan L. Beller or Leslie N. Silverman in New York at 212-225-2000 or Edward F. Greene in London at 44-171-614-2200.
Very truly yours,
/s/ CLEARY, GOTTLIEB, STEEN & HAMILTON
cc: The Honorable Arthur Levitt, Chairman
The Honorable Norman S. Johnson, Commissioner
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Paul R. Carey, Commissioner
The Honorable Laura S. Unger, Commissioner
Harvey J. Goldschmid, General Counsel, Office of General Counsel
Brian J. Lane, Director, Division of Corporation Finance
Anita T. Klein, Senior Special Counsel, Division of Corporation Finance
Paul M. Dudek, Chief, Office of International Corporate Finance
Annette L. Nazareth, Director, Division of Market Regulation
TABLE OF CONTENTS
[Note: Page References are to Original Hard Copy Version Filed with the SEC]
Click on Link to Jump to Specific Section
I. OVERVIEW 3
A. Summary of the Commissions Proposed Registration and Offering Framework 3
B. Comparison of the Proposed Registration Framework to the Existing System 5
1. Effect on Issuers 5
a. Issuers Currently Eligible to Use Shelf Registration Procedures for Delayed Primary Offerings 5
b. Issuers Not Currently Eligible to Use Shelf Registration Procedures for Delayed Primary Offerings 7
c. Proposed Elimination of "Exxon Capital" Exchange Offers 8
d. Enhanced Reporting Requirements under the Exchange Act 9
2. Effect on Underwriters 9
a. Registration Process 9
b. Communications 10
c. Due Diligence Procedures 11
C. Integration 12
D. Exchange Act Reporting Enhancements 12
II. SPECIFIC COMMENTS WITH RESPECT TO THE RELEASE 13
A. Securities Act Registration 13
1. Form B Offerings 13
a. Eligibility Based on Size of Issuer 13
b. Eligibility Based on Type of Offering 14
i. Offerings to QIBS 15
ii. Market Making Transactions by Affiliated Broker-Dealers 17
c. Prospectus Delivery 17
d. Form B Disqualifications 19
e. Content of Disclosure and Applicability of Liability Provisions 21
f. Forward Incorporation by Reference 22
g. Timing of Effectiveness 22
h. Delayed Shelf Offerings 22
i. Secondary Offerings 23
2. Form A Offerings 24
a. Incorporation by Reference; Effectiveness 24
b. Prospectus Delivery 25
c. Content of Disclosure and Applicability of Liability Provisions 26
d. Delayed Shelf Offerings 26
3. Offerings by Foreign Governments 27
4. MJDS Offerings 28
5. Aftermarket Prospectus Delivery 28
6. Concurrent Exchange Act Registration 29
B. Exxon Capital Transactions 30
C. Communications During the Offering Process 31
1. General 31
2. Communications Made Before Filing by Form B and Seasoned Schedule B Registrants 33
3. Communications Made Before Filing by Form A Registrants 34
4. Communications Made After Filing the Registration Statement 36
D. Research Reports 36
1. Rule 137 37
2. Rule 138 37
3. Rule 139 38
4. Related Amendments for Offerings Under Regulation S and Rule 144A 40
E. Underwriters Due Diligence 41
F. Integration of Registered and Unregistered Offerings 44
1. Public Offering Subsequent to Completed or Abandoned Private Offering 44
2. Private Offering Subsequent to Abandoned Public Offering 45
3. Lock-Up Agreements 47
G. Exchange Act Disclosure 48
1. Annual and Quarterly Reports 48
2. Current Reports on Form 8-K 49
3. Signatures and Certifications 50
4. Form 6-K Submissions 51
5. Use of Plain English in Exchange Act Reports 51
H. Staff Review Policy 52
Footnotes1SEC Release No. 33-7606A; 34-40632A; IC-23519A (Nov. 13, 1998) (the "Release"). Because of the size and breadth of the Release, it has often been referred to by the Commission staff and others as the "Aircraft Carrier" release. 2To facilitate your review of this letter, we have attached a table of contents as Appendix I. 3A third form, Form C, is also being proposed and would be used for business combinations. Our comments with respect to the Form C proposal, insofar as it raises issues separate from those discussed with respect to proposed Forms A and B, have been included in our comment letter to the Commission dated April 5, 1999, submitted in connection with the Commissions release regarding proposed changes to the regulatory scheme applicable to business combinations. See SEC Release 33-7607; 34-40633; IC-23520; File No. S7-28-98 (Nov. 3, 1998). 4Although the text accompanying footnote 84 of the Release states that the number of issuers ineligible for Form B due to size would be 1,175, under the "Cost-Benefit Analysis" discussion, the Commission indicates that the number of issuers currently eligible for Form S-3/F-3, but who would be unable to satisfy Form Bs public float and ADTV requirements, may be as high as 1,427 (or 30% of those firms currently eligible to use delayed shelf registration procedures). See "Table: Impact of Proposed Form Requirements on Registrants" and accompanying text under Part XIV(B) of the Release; see also footnote 631 of the Release under "Paperwork Reduction Act". 5We note that although the Release asserts that delayed shelf registration would not be available to Form A issuers, no change appears to have been made to existing Securities Act Rule 415 to effect this result. 6See, e.g., Exxon Capital Holdings Corp., SEC No-Action Letter (avail. May 13, 1988); Morgan Stanley & Co. Inc., SEC No-Action Letter (avail. June 5, 1991). 7See, e.g., Vitro, Sociedad Anonima, SEC No-Action Letter (avail. Nov. 19, 1991); Corimon C.A. S.A.C.A., SEC No-Action Letter (avail. Mar. 22, 1993) (collectively, the "Vitro line of letters"). 8See Gustafson v. Alloyd Co., 513 U.S. 561 (1995) ("Gustafson"). 9We note that Form B, unlike current Forms S-3 and F-3, is not limited exclusively to offerings for cash. We believe that this is a positive change and one that should be made to Forms S-3 and F-3 today. 10The Release indicates that "public float" for form eligibility purposes would be determined on the basis of the aggregate market value of an issuers outstanding voting and non-voting common equity and that "ADTV" would be calculated on the basis of the issuers equity securities (we assume, since "equity" is not limited to "common equity" in the case of the ADTV test, preferred securities would be included in this calculation). We note, however, that, particularly in the case of certain non-U.S. issuers, preferred equity (which in many cases may be the functional equivalent of non-voting common equity) may be more widely held and more actively traded in the market than the issuers common shares. Accordingly, we recommend that (like the ADTV test) the public float test (in both Form B and Form A) permit at least foreign private issuers to determine eligibility on the basis of the aggregate market value of all classes of the issuers outstanding equity securities. We believe this same change should also be made to Form F-3 today (and should be considered for U.S. issuers registering on Form S-3). 11We reiterate, however, that because of the longer preparation lead time for a registered offering than a Rule 144A offering, even this proposal would not neutralize the deleterious effect on participation by non-U.S. issuers in the U.S. capital markets resulting from a repeal of the Vitro line of letters. 12See, e.g., American Council of Life Insurance, SEC No-Action Letter (avail. May 10, 1983). 13See National Securities Markets Improvement Act of 1996 ("NSMIA"), in which "qualified purchaser" was defined (for purposes of the Investment Company Act) to include, among certain others, "any person . . . who in the aggregate owns and invests on a discretionary basis, not less than $25,000,000 in investments." 14We believe that the $10 million threshold for dealers continues to be appropriate. 15We note that, if the Commission is concerned about the potential conflict of interest present in transactions with affiliates, existing rules of the Commission and various self-regulatory organizations currently require broker-dealers to disclose their affiliation with the issuer prior to or at the time of sale. See, e.g., Exchange Act Rule 15c1-5; Conduct Rule 2240 of the National Association of Securities Dealers, Inc. 16Proposed Rule 173 would not exempt offerings by investment companies from the final prospectus delivery requirements. The Commission does not provide a basis for this difference in treatment in the Release. We believe the same considerations we discuss with regard to offerings by other issuers apply equally to offerings by investment companies and, accordingly, that offerings by investment companies should benefit from the final prospectus delivery exemption. 17Rule 15c2-8(d) currently requires participating broker-dealers to comply with the written request of any person to receive a copy of the final prospectus. The Commission queries whether issuers should also be required to comply with a purchasers request for a copy of the final prospectus. In light of Rule 15c2-8(d), we do not believe the imposition of this additional burden on issuers is necessary in connection with underwritten offerings, but agree that some mechanism should be put in place for offerings by issuers in which broker-dealers do not participate.
The Commission also questions whether broker-dealers should be required to maintain records of the distribution of information regarding securities offerings in which they participate (required records could, for example, include, term sheets, prospectuses and free writing materials). We believe that Exchange Act Rule 17a-4, which among other things requires that a broker-dealer maintain records of "all communications sent [by the broker-dealer] . . . relating to his business as such" and other recordkeeping rules of relevant self-regulatory organizations are sufficient and no new recordkeeping requirements need be adopted. If the Commission determines to propose a new recordkeeping rule in this regard, it should only require that broker-dealers maintain records of offering-related information that they themselves (as opposed to others within the syndicate or selling group) distribute.18We note that the Release states that the term sheet should include a legend advising investors to read, before making their investment decision, the documents filed by the issuer with the Commission, but proposed Rules 172 and 15c2-8 do not include this requirement. Although we do not believe this requirement would be burdensome (assuming the term sheet proposal is adopted), we also do not believe that the inclusion of such "boilerplate" language is necessary. 19To the extent the Commission were to require the delivery of transactional information to investors in Form B offerings, proposed Rule 172 should, at the very least, be modified to require that the term sheet (or preliminary prospectus) be sent in a manner reasonably designed to arrive before the "time" the investment decision is made, rather than the "date" this decision is made. 20See SEC Release No. 33-6512; 34-20654 (Feb. 15, 1984), in which the Commission announced the rescission of an earlier position relating to certification of financial statements and stated that registrants would be permitted to offer their securities, notwithstanding an accountants going concern qualification, so long as full and fair disclosure is made of the registrants financial difficulties and its plans to overcome them. The Commissions expressed rationale for rescinding its prior interpretive position, originally issued in Accounting Series Release No. 115, was its "conclusion that the interpretation expressed therein is inconsistent with the objectives and operation of the Commissions integrated disclosure system." 21See, e.g., SEC Release No. 34-40900, Administrative Proceeding File No. 3-9803 (Jan. 11, 1999) and accompanying Orders Making Findings and Imposing Sanctions (administrative orders imposing sanctions against 28 broker-dealers and several individuals for violations of certain antifraud and other provisions of the federal securities laws in connection with market-making activities on the Nasdaq stock market). 22Under the Reform Proposal, transactional information disclosed to investors before the end of the offering period, which today generally would be filed as a prospectus supplement under Rule 424(b), would have to be filed as part of the effective Form B registration statement or in a post-effective amendment. Given the Commissions proposed requirement that signatories to the registration statement certify that they have read it and it contains no material misstatement or omission, compliance with the post-effective amendment procedure mandated under Form B will, as a practical matter, be impossible to achieve in a timely manner. 23See Securities Act Rule 415(a)(2). 24See text preceding footnote 185 of the Release. Although the Commission does not appear to have implemented this proposal through any change in Rule 415, it certainly proposes to make delayed secondary offerings significantly more burdensome to maintain, even for seasoned Form A issuers, because no post-effective incorporation by reference is permitted under Form A and, even more importantly, a preliminary prospectus would be required to be delivered at least 3 days in advance of sale. 25See Part V.C.1 of the Release. As noted above, no amendment to Rule 415 has been proposed to implement this change. 26See footnote 2 to SEC Release No. 33-6424 (Sept. 2, 1982); see also Republic of Venezuela, SEC No-Action Letter (avail. Nov. 24, 1980).
We note that the Commission staff has, through the no-action letter process, permitted seasoned foreign government issuers to voluntarily file with the Commission annual reports on Form 18-K and to incorporate those filings into their Securities Act registration statements by reference. See, e.g., United Mexican States, SEC No-Action Letter (avail. Feb. 25, 1994); Republic of Colombia, SEC No-Action Letter (avail. Feb. 3, 1997). We suggest that the Commission codify this interpretive position in the context of its registration reform proposals relating to foreign government issuers.27 If this suggestion is adopted by the Commission, conforming changes should be made to other aspects of the Reform Proposal applicable to Schedule B registrants (e.g., proposed Rules 166 and 139). 28We do not believe the short-covering activity by underwriters cited by the Commission constitutes evidence of a need for continued prospectus liability following completion of a distribution. On the contrary, these transactions represent purchases by the underwriters in the secondary market to cover sales previously made by them in excess of their allotments. Sales that might be made by former underwriters contemporaneously with these short-covering purchases clearly are not part of the distribution (see, for example, the definition of "completion of participation of a distribution" in Rule 100(b) of Regulation M) and bear no indicia of transactions requiring the imposition of stricter liability on the sellers. 29See footnote 7 above. 30Rules 135 and 135c under the Securities Act currently provide issuers with a safe harbor with respect to the communication of certain limited information regarding a proposed offering. In connection with its proposals liberalizing communications generally, the Commission proposes to merge the two rules into one. We agree with this proposal but suggest that the ability to correct inaccuracies not be limited to persons who have previously published a Rule 135 notice. We also suggest that the prohibition in Rule 135 against naming the underwriters no longer appears justified or to serve any useful purpose and, in the spirit of liberalized communications, should be eliminated. 31Recent staff no-action letters regarding the status of road show presentations as oral communications include Private Financial Network, SEC No-Action Letter (avail. Mar. 12, 1997); Net Roadshow, Inc., SEC No-Action Letter (avail. Sept. 8, 1997); Bloomberg L.P., SEC No-Action Letter (avail. Dec. 1, 1997); and Thomson Financial Services, Inc., SEC No-Action Letter (avail. Sept. 4, 1998). 32If our suggestion above with respect to an alternative measure for foreign government issuers based on outstanding debt is adopted, proposed Rule 166 should be modified accordingly. See footnote 27 above. 33See, e.g., footnote 349 of the Release and accompanying text. 34Although the Commission characterizes the 30-day period as a "bright-line" safe harbor, footnote 300 of the Release would appear to blur that line by noting that "an issuer could not use [a] Section 10 prospectus at a point more than 30 days before filing and then fail to file it as part of the registration statement because it is not an offer." We request clarification from the Commission as to the meaning of this statement. 35See SEC Release Nos. 33-5009 (Oct. 7, 1969) and 33-5180 (Aug. 16, 1971). 36See SEC Release No. 33-5180 (Aug. 16, 1971). 37See Section 102(c)(1) of the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (1995). 38See text accompanying footnote 189 of the Release. 39We note that proposed Rule 169 expressly provides that factual business communications would not include information about the registered offering. 40Only blank check companies, shell companies and companies offering penny stock would be excluded from the new safe harbor. 41For this purpose, ADTV would be measured on a worldwide, rather than U.S. only, basis. Moreover, the proposed amendments would eliminate the current requirement in Rule 138 that the equity securities of a foreign private issuer have a one year trading history on the designated offshore securities market. 42Like the Rule 138 safe harbor, reliance on the Rule 139 safe harbor would not be necessary in the case of Form B offerings or large underwritten Schedule B offerings and, in the case of Form A offerings, would only be necessary during the 30-day pre-registration period. 43We note that Rule 138 (currently and under the proposed revisions to the rule) refers to a "regular course" of business requirement, while Rule 139 refers to "normal course" of business. In addition, in various places in the Release, the Commission refers to an "ordinary course" requirement. Although we understand the terms to have an identical meaning in practice, we believe it would be helpful if the Commission were to use consistent terminology in the rules. In this regard, we suggest that either the term "normal" or the term "ordinary" be used, since "regular" may be confused with the "reasonable regularity" concept. 44If our suggestion above with respect to an alternative measure for foreign government issuers based on outstanding debt is adopted, proposed Rule 139 should be modified accordingly. See footnote 27 above. 45We also note that in adopting Regulation M under the Exchange Act, the Commission eliminated the former Rule 10b-6 prohibition against research upgrades in connection with the dissemination of research satisfying the Rule 139(a) safe harbor, but imposed no requirement to disclose prior recommendations. 46We note that in the Release the Commission expresses its view that, regardless of whether the proposed changes to the research safe harbors are adopted, broker-dealers may currently publish research reports satisfying the current Rule 138 and 139 safe harbors (other than the requirement that the offering be registered under the Securities Act) without that research being deemed to constitute "directed selling efforts" for purposes of Regulation S. See text accompanying footnote 367 of the Release. We understand that certain members of the Commission staff have also informally expressed the view that Rule 138 or Rule 139 qualifying research would likewise not be deemed to constitute an offer to a person other than a QIB for purposes of Rule 144A. We request that the Commission formally confirm this position. We also urge the Commission to expand the scope of this position to cover offerings conducted in reliance on Regulation D under the Securities Act by expressly stating that qualifying research also would not be deemed to constitute "general solicitation or general advertising" within the meaning of Rule 502(c) of Regulation D. Given the amount of time that is likely to elapse prior to the adoption of the proposed new research safe harbor for unregistered offerings, we believe that immediate clarification of the Commissions position is warranted. 47Although the discussion of this item in the Release indicates that the Rule 10b-5 letter from issuers counsel would also have to address whether the registration statement contained any "unfair" statements (which would be a significant change from current practice), we note that no such reference appears in the language of the proposed rule and therefore assume that this reference in the discussion portion of the Release is an inadvertent error. 48See, e.g., Globus v. Law Research Services, Inc. 418 F.2d 1276 (2d Cir. 1969), affg 287 F. Supp. 188 (S.D.N.Y. 1968), cert. denied 397 U.S. 913 (1970). 49For existing staff guidance on this issue, see generally, Black Box, Inc., SEC No-Action Letter (avail. June 26, 1990); Squadron, Ellenoff, Pleasant & Lehrer, SEC No-Action Letter (avail. Feb. 28, 1992); Circle Creek AquaCulture V.L.P., SEC No-Action Letter (avail. Mar. 26, 1993). 50Rule 152 currently provides a safe harbor only for transactions under Section 4(2) of the Securities Act. Proposed revisions to the rule would expand the safe harbor to cover private transactions covered under Section 4(6) and Rule 506 under the Securities Act. We agree that this proposed expansion is warranted. We disagree, however, with the proposed exclusion of Rule 505 offerings. The basis for this exclusion is apparently that non-accredited investors may purchase in a Rule 505 offering. We note that up to 35 non-accredited investors may purchase in a Rule 506 offering, and that Section 4(2) itself places no limit on the number of, nor requires any level of sophistication with respect to, the investors that may participate in a Section 4(2) placement. Accordingly, we see no reason for the distinction. 51Relying on the Commissions five-factor test, the issuer could commence a private offering prior to the end of the six month period, but the issuer would run the risk that the Commission or a court would disagree with its analysis. 52Both the discussion in the Release and the proposed rule refer only to the unavailability of Section 11 protection in connection with offers made after the 30-day "cooling-off" period. As determined by the Supreme Court in Gustafson, we note that Section 12(a)(2) liability would likewise not apply to the private offering and request that the Commission make this clear. 53As set forth in the Release, the Commission clearly intends to impose Section 11 and Section 12(a)(2) liability for sales made within the 30-day period. The proposed rule, however, does not appear to implement this intention. In fact, under proposed Rule 152(c)(3)(ii), if securities are offered both before and after the 30 days following abandonment, only Section 11 liability would apply with respect to sales made on or before the 30th day, while only Section 12(a)(2) liability would apply to sales made after the 30th day. 54We also note that, as currently written, this third requirement could be interpreted to mean that votes must be solicited only from those persons that did not sign lock-up agreements and that are not eligible to purchase in an offering under Section 4(2), Section 4(6) or Rule 506. We suggest, therefore, that this requirement be re-written as follows: "In addition to those votes solicited from persons who have signed lock-up agreements, votes will also be solicited from shareholders of the company being acquired who have not signed such agreements and who [are not accredited investors]". 55Similar timing and related concerns are raised by the Commissions proposals with respect to changes in the permitted age of financial statements of non-U.S. issuers. See SEC Release No. 33-7637; 34-41014; IC 1182A (Feb. 2, 1999) and our comment letter with respect thereto dated May 18, 1999. 56The Commission solicits comment on whether staff review should apply to Form B offerings of "novel" securities, and requests guidance as to how "novel" should be defined for this purpose. The securities markets are constantly changing and new products are being developed all the time. Accordingly, we believe it would be impossible to define what would constitute a "novel" security. Moreover, given the purpose of Form B, we do not believe that any Form B offerings should be subject to automatic review by the staff. (Although the Release does not address or solicit comment with respect to whether the Commission should review offerings of "novel" securities by Form A issuers eligible for effectiveness on demand, we believe, for the same reasons expressed above with respect to Form B, that it should not.) 57Although not discussed in the Release, proposed Rule 401(g) would also exclude from its coverage all other registration statements that become effective on demand, including those filed by certain seasoned issuers on Form A and Schedule B. If by this change these issuers, like Form B issuers, would be subject to potential rescission claims by investors resulting from an after-the-fact determination by the Commission that the form used or, more likely, that incorporation of information by reference was improper, we believe the exclusion of these registration statements from the coverage of Rule 401(g) is also