28 SEPTEMBER 1999
Securities and Exchange Commission
450 Fifth Street, N. W.
Washington, D. C. 20549
Attention: Mr. Jonathan G. Katz, Secretary
RE: The Regulation of Securities Offerings (File No. S7-30-98)
Ladies and Gentlemen:
The Committee on the Federal Regulation of Securities of the Section of Business Law of the American Bar Association submits this letter in response to the Securities and Exchange Commission's request for comments on The Regulation of Securities Offerings, Release No. 33-7606 (November 3, 1998) as amended by Release No. 33-7606A (November 13, 1998) [63 FR 67174 (December 4, 1998)] (the "Proposing Release").1The Committee consists of approximately 2,000 members of the securities bar who practice in-house and as outside counsel. The Committee has previously filed a separate comment letter responding to the request for comments in the Proposing Release regarding asset-backed securities.2
Given the scope and importance of the Proposing Release, we augmented our typical comment letter procedures. In addition to having ten drafting sub-committees prepare the first drafts of sections of this comment letter, we sponsored a panel at the Committee's Spring Meeting on April 16, 1999. A draft of this comment letter was circulated for comment among numerous members of the Committee and has received the general agreement of the majority of those who responded. We also distributed the draft for review by an editorial board that is geographically diverse and includes lawyers who represent issuers, underwriters and institutional investors, and the comments expressed in this letter have received the general agreement of the majority of the members of that board. Altogether, over 120 Committee members participated in this process. This letter, however, does not represent the official position of the American Bar Association, the Section on Business Law, or the Committee, and does not necessarily represent the views of all who reviewed it.
The general agreement of the great majority of the members who drafted and reviewed this comment letter may be summarized as follows:
A Recognition of Current Market Realities
As identified in the Proposing Release, we recognize the changes that are occurring in our capital markets which warrant a review of the securities offering process. These changes include:
The Fundamental Flaws of the "Aircraft Carrier"
While recognizing the ongoing changes that are occurring in the marketplace, we do not believe the Aircraft Carrier achieves the Commission's goal of making the registration system more workable for issuers and underwriters and more effective for investors. After extensive consideration and debate, we have concluded that the proposals are fundamentally flawed. Many of the proposals are based on premises that are either faulty or out-of-date. With respect to other proposals, the underlying premises are given unwarranted importance, when compared to their adverse effect on market efficiency and undue burdens on capital formation. These premises include:
While a number of the proposals have merit, we are reluctant to characterize them as positive or negative and be perceived as "cherry picking." Rather, we recommend:
1. the withdrawal of the "Aircraft Carrier";
2. a thorough economic study of the registration system, particularly the communications process; and
3. re-proposal, as necessary, after completion of further study.
To facilitate an understanding of our comment letter, we have organized the Table of Contents in a sentence and topic format. We have also included an alternative proposal to the "Aircraft Carrier". Our alternative is premised on our belief that reform does not require an entirely new registration system like the "Aircraft Carrier" and that only incremental change is warranted, other than changing the existing regulation of communications.
TABLE OF CONTENTS Page
I. INTRODUCTION
1
A. The proposals in the Proposing Release are fundamentally flawed and should be
withdrawn.
3
1.The proposals constitute a marked departure from a system that is the gold
standard of capital formation.
3
2. The Proposing Release strikes the wrong balance.
4
3. The current registration system “ain’t broke”.
5
4. In general, the proposals are not an improvement on the present régime,
and in many cases are impractical. 5
5. A cost-benefit analysis is essential.
6
6. The Proposing Release would unnecessarily expand and increase liability.
7
B. The sparse evidence of “selective disclosure” does not warrant the adoption
of an entirely new system. 9
C. Our capital markets have benefited from intelligent, rational administration
of federal securities laws. 12
D. Regulation can accommodate innovations in capital formation without compromising
investor protection or the public interest.
14
E. Irrespective of the ultimate fate of the “Aircraft Carrier” proposals, the
Commission should make adequate provision for offerings of Asset-Backed
Securities.
15
II. REGISTRATION AND DISCLOSURE POLICY
16
A. The shelf registration process and current registration forms are superior
to the proposed regulatory structure.
16
1. Proposed forms for Securities Act registration should not be adopted.
17
a. Proposed Form A.
17
i. A 7 or 3 calendar day preliminary prospectus delivery requirement
would seriously impede the underwritten distribution process and
place many offerings in jeopardy. 17
ii. Issuers should be permitted to incorporate by reference or deliver
company information.
18
iii. Issuer’s ability to time effectiveness of registration statement
is illusory. 20
iv. Definition of “seasoned” issuer should not be complex.
21
v. Specific comments on the text of the proposed form.
22
(A) Should include definition of “seasoned issuer”.
22
(B) “General Instructions” to the form should be revised.
22
(C) The proposed certifications on the signature page should not be
adopted. 23
b. Proposed Form B.
23
i. Shelf registration is without question one of the Commission’s
most successful regulatory innovations, and has operated without
abuse since 1982.
23
ii. Proposed Form B is fundamentally flawed and would disrupt capital
formation. 25
(A) Current sell, then document process should continue to be
permitted.
25
(B) Term sheet delivery requirement should be eliminated.
28
iii. Form B’s eligibility requirements should be revised.
29
(A) Disqualification under so-called “bad boy” provisions should
not be adopted. 29
(B) The existence of unresolved comments in connection with staff
review of Exchange Act filings should not block financings.
29
(C) Penalty for filing on the incorrect form should be clarified
and eased. 30
(D) Financial eligibility criteria should not be changed. 31
(E) Secondary offerings should be permitted on Form B. 32
iv. Specific comments on the text of the proposed form.
33
(A) The proposed certifications on the signature page should not
be adopted. 33
(B) Forward incorporation by reference should be permitted on Form B.
34
(C) Interim incorporated reports cannot be new registration
statements.
35
(D) After-market prospectus constructive delivery creates an update
problem in all offerings.
35
c. Proposed Form C.
i. The Commission should adopt an omnibus Form M-A instead of proposed
Form C. 36
2. The metaphysics of integration of private and public offerings.
37
a. Integration initiatives are a welcome response to a complex issue.
37
i. Completed private offering.
38
ii. Abandoned private offering.
40
iii. Abandoned public offering.
41
iv. Expanded Rule 152.
43
v. Lock-up agreements.
44
vi. Withdrawal of registration statements.
45
b. We encourage the Commission to rationalize law and lore with more systemic
revisions. 45
3. Repeal of Exxon Capital A/B exchange offers is unwarranted.
47
4. Small Business Issuers.
51
a. Several of the Commission’s proposals would have a disproportionate
impact upon, and unduly burden capital formation by, smaller business
issuers. 51
i. Prospectus delivery requirements would prolong and delay offerings,
thereby increasing the risk of missing market opportunities.
52
ii. Smaller business issuers should be permitted to use Form B to register
resales by selling security holders.
52
iii.Pre-filing communications proposals would impose a greater burden
on smaller business issuers. 53
iv. The “free writing” and “offering information” proposals are
especially burdensome for small issuers. 53
v. Proposed Rule 152(b) is extremely helpful, but should be revised
to provide greater flexibility for smaller business issuers.
53
vi. Definition of “small business” should not include a public float test.
54
vii.Incorporation by reference should be permitted in Form SB-2.
54
viii. Exchange Act proposals would unduly burden smaller business issuers.
55
ix. Increased exposure to liability for directors and officers is a
concern to smaller business issuers.
55
5. Foreign Issuers.
55
a. Existing reluctance of foreign issuers to access US public capital
markets may increase.
55
i. Enhanced exposure to liability.
57
ii. Reduced eligibility for short-form registration.
58
iii. Elimination of Exxon Capital exchange offers.
59
iv. Interference with multi-market timing constraints.
60
v. Accelerated filing of annual reports.
60
III. COMMUNICATIONS WITH INVESTORS
61
A. Benefits of the Commission’s “free writing” proposals are seriously
threatened by filing requirements and indiscriminate application of
civil liabilities.
61
1. Proposed framework for communications with investors.
61
a. Proposals would have a chilling effect on communications with
the market.
63
b. Proposals would re-define the offering period.
64
i. “Factual business” and “forward-looking” communications
during the offering period. 65
(A) Written communications.
66
c. Impact on electronic communications.
67
2. “Free writing” and “offering information”.
68
a. “Free writing” materials should not be filed.
68
b. Concept of “offering information” should be narrowed.
69
c. Further comments on the Commission’s proposed “free writing” and
“offering information” standards.
70
i. Standard for identifying “first offer” is vague.
70
ii. “By or on behalf of the issuer” should be narrowed.
71
iii. Failure to file should not create civil liability.
72
iv. Clarify no “material change updates” are required.
72
3. Research Reports.
72
a. Research safe harbors should be expanded for registered offerings.
74
i. Rule 137.
74
ii. Rule 138.
75
iii. Rule 139.
77 77
(A) Focused reports.
77
(B) Industry reports.
78
b. Research safe harbors should encompass all unregistered offerings.
79
c. Safe harbors for proxy solicitations should encompass all
transactions.
80
IV. PERIODIC EXCHANGE ACT REPORTS
A. Issuer press releases and analysts’ reports assist investors and enhance
efficient markets. 81
1. Investors rely on information disseminated by a company's press
releases and conference calls with research analysts.
81
2. Proposed revisions to disclosure required in annual and quarterly
reports. 83
a. Risk factor disclosure should apply solely to a company’s business
and not to the terms of its securities or offerings.
83
b. Quarterly information should not be subjected to liability under
Section 18 of the Exchange Act.
84
c. Requiring a filed “Management Report to Audit Committee” would not
enhance the quality of Exchange Act reporting.
85
3.Interim reports on Form 8-K.
86
a. Timely disclosure of annual and quarterly results of domestic
companies is desirable. 86
i. Requiring S-K Item 301 information in Form 8-K would delay
release of earnings information.
86
ii. Current due dates for Forms 10-K and 10-Q should be retained.
88
b. Form 8-K should be amended to require disclosure of a limited
number of specified corporate events.
89
i. Material modifications to the rights of security holders.
90
ii. Departure of chief executive officer, chief financial officer,
chief operating officer, or president.
91
iii. Material defaults on senior securities.
92
iv. Reliance on prior audit.
93
v. Name changes.
94
vi. Due dates for reporting events.
94
4. Signatures.
96
a. Exchange Act reports and registration statements.
96
b. Securities Act filings.
98
5. Proposed expansion of disclosure in Form 6-K submissions is relatively
benign. 98
6. Potential liability and other valid concerns militate against extending
“plain english" requirements to Exchange Act reports. 98
B.Notwithstanding its unfettered right to review Exchange Act reports, the
staff should work efficiently and expeditiously in order not to impede an
issuer’s access to capital markets. 99
1. Proposed staff review policy should be revised to provide a greater
degree of certainty to the process. 99
V. LIABILITY 101
A. The Commission’s proposals would alter the liability régime with inappropriate
and unpredictable consequences. 101
1. Issuers would be subjected to unforeseen liability arising from a latent
violation of Section 5 of the Securities Act. 102
2. Directors and officers would be exposed to increased liability
unnecessarily. 103
3. Underwriters would have increased exposure to liability for latent
violations of Section 5 of the Securities Act. 103
B. Proposed guidance concerning “reasonable investigation” and “reasonable
grounds for belief” defenses under Sections 11 and 12(a)(2) of the Securities
Act is deficient. 104
1. Rule 176 should provide a rebuttable presumption that underwriters have met
“due diligence” obligations. 104
C. Abuses arising out of “selective disclosure” are not pervasive and do not
justify the sweeping changes proposed. 105
1. The Commission inappropriately seeks to resurrect a “parity-of-information”
theory rejected by the Supreme Court in Chiarella v. United States, and
impose liability for violation. 105
VI. STATUTORY AUTHORITY 110
A. The Commission has not identified bases for its proposals to “modernize” and
“rationalize” its registration and disclosure policy. 110
1. Legislative history. 110
2. Federal Administrative Procedure Act. 112
a. Formal rulemaking. 113
3. Cost-benefit analysis. 114
4. The Commission should publish notice of, and solicit comment on, incremental
revisions to registration and disclosure requirements under the existing
integrated disclosure system. 117
VII.AN ALTERNATIVE PROPOSAL 118
A. The underlying premise of the Committee’s Alternative Proposal is that no serious
problems exist with the registration process that warrant major overhaul and
disruption of current practices. There are problems that should be corrected;
however, most of these can be addressed through focused rulemaking or changes
in administrative practice. 120
B. The Committee’s alternative is based upon further enhancement of the Commission’s
integrated disclosure system and existing shelf registration process. 121
VIII. CONCLUSION 128
Appendix I - “Walk-Through of a Form B Offering” 108
***********************************************************************************
Every generation, the Commission revisits its regulations to address developments and anticipate trends that affect capital formation and investor protection. In the early 1980s, the Commission adopted the integrated disclosure system,3which has, with modifications, been the regulatory framework for over 15 years.
The Commission is to be commended for its thought-provoking analysis of the challenges to our nation's continuing preeminence in global capital markets. The Proposing Release clearly represents a substantial commitment on the part of the Commission to its traditional role of proactive regulation of our markets. When approximately 48 percent of US households own stock and 69 million individuals own shares in a public company, mutual fund, retirement savings account or pension fund investment account,4regulation of our capital markets is not just a "Wall Street" issue, but one that affects all Americans. As citizens and members of the private bar, we appreciate this commitment, and are pleased to have an opportunity to contribute in a meaningful manner to this process.
Several proposals suggest positive regulatory innovations for our capital markets, and represent a forward-looking approach to the Commission's disclosure and registration régime. For example, the Commission's integration proposals are a welcome response to a complex and often arcane area of federal securities practice. Permitting seasoned issuers to determine the time of effectiveness of their registration statements makes sense as does "exempting" these registration statements from pre-effective review by the staff of the Division of Corporation Finance ("staff"). Relaxing the rules governing communications with the market by issuers, underwriters and other offering participants to encourage "free flows" of information is a welcome breath of fresh air. However, on balance the proposals in the "Aircraft Carrier" are impractical and, if adopted, would seriously erode the efficiency of US capital markets.
Recognizing the technological and financial developments that have occurred since its adoption of integrated disclosure, the Commission has declared that its overall goal in the Proposing Release is "to make the registration system more workable for issuers and underwriters and more effective for investors in today's capital markets."5 We share and support that overall goal. Unfortunately, we believe that the proposals do not achieve that goal and, indeed, conflict with it.
Traditionally, the private securities bar has worked in close harmony with the Commission in its rulemaking activities. Obviously, there have been proposals and interpretations with which we have disagreed. On those occasions when we have disagreed, we have, nonetheless, tried to be supportive of the Commission and have offered suggestions designed to improve the rule proposals.
In this case, however, we are unable to support the major proposals in the Proposing Release because, in our judgment, the underlying premises of the "Aircraft Carrier" are fundamentally flawed. The problems with the approach taken in the Proposing Release are basic and systemic, and cannot be readily cured or adequately addressed without re-thinking the proposed regulatory régime.6 Rather, it is our considered judgment, based upon our expertise and experience, that the Proposing Release should be withdrawn because it is irremediably flawed.
Moreover, the Proposing Release does not proffer objective evidence of abuse or harm to investors that would justify rescission of the very successful shelf rule,7 which was introduced over 15 years ago. For example, the "Aircraft Carrier" does not cite empirical studies that would justify either this proposal or, indeed, any regulation that would impose additional costs and burdens on issuers and selling securityholders, who rely on shelf registration to provide quick and efficient access to capital markets.
It is apparent to us that many of the proposals in the "Aircraft Carrier" are, at best, impractical and, if adopted, would materially impede the efficacy and efficiency of a system for capital formation that works and is the envy of the world. The proposed régime would also impose increased and unnecessary costs and liability on issuers, officers and directors of issuers, underwriters, and broker/dealers, without providing significant corresponding benefits to investors and the public interest. Simply put, the substantial costs and regulatory burdens of the proposed new régime outweigh the purported benefits.
A. The proposals in the Proposing Release are fundamentally flawed and should be withdrawn.
Our concerns about the Proposing Release include:
1. The proposals constitute a marked departure from a system that is the gold standard of capital formation.
The United States' securities regulatory system is the gold standard of capital formation for the world: it is followed by developed countries, and is the ideal to which emerging countries aspire. Under the knowledgeable and effective oversight of the Commission, regulation has successfully matched market realities and cost effectiveness, most notably through integrated disclosure and the shelf rule. These developments enabled us to combine enhanced transaction efficiency with fuller disclosure than the systems used in Europe in the early 1980s. As a result, we "took back" the Eurobond market for US issuers.
In the late 1980s, the Commission began initiatives with the International Organization of Securities Commissions ("IOSCO") and other foreign authorities to advocate adoption of a regulatory régime consonant with that extant in the US, of which the multi-jurisdictional disclosure system with Canada ("MJDS")8was the most ambitious. Now the Commission has proposed an entirely new régime, but it is questionable whether foreign regulators will continually revise their own régimes to harmonize with changes in US law.
Adoption of the Proposing Release would move us backward at a time when the United States' economy needs to be even more competitive, and would do so without a persuasive explanation to foreign regulators as to why they should give up the efficiencies of the current American model. This would have two effects: (1) the US would lose the benefits of efficiency and of "settled law"9 precisely at the time the Europeans are embarking on the new world of the Euro, thus forfeiting a competitive advantage, and (2) the rest of the world, which has previously sought to emulate the US model, will not switch to the over-regulated capital formation régime embodied in the Aircraft Carrier because of the demonstrated advantages of the current system. The result will be a breach in the uniform development of global securities offering practices and possible forfeiture of the success and leading role in global capital markets that the United States has enjoyed.
2. The Proposing Release strikes the wrong balance.
The Proposing Release strikes the wrong balance between investor protection on the one hand and the efficiency of capital formation on the other. While investor protection is primary, investors have an interest in a vibrant capital formation system.10 For example, a company can build the safest car in the world at a cost that results in sales of few, if any, of these cars and no decrease in highway fatalities. Similarly, what may be initially intended to be investor protective may not protect US investors in practice, if it creates new costs spent, that drives capital-raising offshore or to private markets. Similarly, increasing potential liability for informal communications may result in providing less information to investors or in driving communication into oral, and therefore less reliable, forms.
The delays to the offering process inherent in both proposed Form A and proposed Form B offerings would result in a less efficient system. A delay of 24 hours (much less seven or three days) can result in a significant change in the price of common stock or the interest rate for debt securities. Mismatching pricing and process results in inefficiencies that cause uncertainty and increase offering costs. Rather than follow an inefficient system, issuers and underwriters will (as they have in the past) find or create a more efficient market elsewhere.
3. The current registration system "ain't broke".
The Proposing Release represents an entirely new registration system that would replace one that has worked effectively for at least 15 years. The Proposing Release does not demonstrate any significant abuse or harm to investors that warrants an entirely new system nor does it describe any case law, administrative proceedings, Commission investigation or economic studies that support such action. While the communications aspects of the current system are in need of significant revision in light of changes in technology and practice, that deficiency alone does not mean the entire system is broken, nor do regulatory changes to modernize communications require wholesale replacement of the existing system. Thus, whatever is broken in the system can be fixed by mending, not ending, the current offering system.
4. In general, the proposals are not an improvement on the present régime, and in many cases are impractical.
Many aspects of the Proposing Release do not reflect an understanding of the process by which securities are offered and sold. From an intensified transactional approach in which each offering must be the subject of a separate registration statement, to requiring "free writing" and "offering information" to be filed, and requiring all investors to receive disclosure at a certain time, the proposals in the Proposing Release are impractical and do not reflect the timing constraints that vary greatly in securities offerings.
Disclosure policy is like a mobile in which pushing one piece affects all the other pieces of the mobile. The proposed transaction model, in which all offerings proceed on a schedule similar to that of an initial public offering ("IPO"), is not just a step back; it also does not accommodate the ever-increasing variety of issuers or diversity of offerings. One size does not fit all, and attempting to place all transactions into the same template does not work.
The types of offerings, which vary from tranches off a shelf to offerings of debt pursuant to Rule 144A11 under the Securities Act of 1933 ("Securities Act"),12 are practical responses by the marketplace to the needs of issuers and investors, including legal investment limits on investments in restricted securities by important categories of institutional investors. By eliminating Exxon Capital13exchange offers, the Proposing Release would seek to channel private offerings to institutional investors into registered public offerings, thereby limiting flexibility and increasing the offering costs. Traditional selling security holder registration statements, which are proposed to be eliminated, provide essential liquidity for venture capitalists, entrepreneurs, and shareholders of acquired companies. It is impractical to conclude that the regulatory framework of the Proposing Release can impose artificial mechanisms on all such offerings with the same efficiency and cost effectiveness as the current marketplace.
5. A cost-benefit analysis is essential.
The current integrated disclosure system, a recommendation of the Wheat Report,14 has evolved over 30 years by a process of incremental steps and experimentation. The Proposing Release would result in a fundamental change to the offering process, both public and private. There is no evidence of abuse in the current system that is so serious as to warrant the significant cost of adopting an entirely new system. Therefore, a cost-benefit analysis, including economic studies such as were conducted by the Commission in adopting the integrated disclosure system and the shelf rule, would seem to be essential.15
Instead of incremental revisions resolving issues of uncertainty, the proposals in the "Aircraft Carrier" would require greater resort than ever to legal counsel by issuers and underwriters, who in turn would require formal advice from the staff in order to provide proper legal advice to their clients.16 This arduous, expensive, and time-consuming process is antithetical to the needs of issuers for rapid access to capital markets.17The resulting market uncertainty, confusion, and costs would precipitate the flight of capital formation to other markets (with the prospect of accelerating the development of viable, Euro-denominated Eurobond markets), and would result in greater reliance on private placements.
6. The Proposing Release would unnecessarily expand and increase liability.
From our perspective, expanding liability is the least efficient way of regulating the marketplace. Yet, from requiring new certifications and signatures on periodic reports, to filing "free writing", to post-effective amendments (rather than supplements), the Proposing Release would increase and expand liability at every turn. In light of the absence of evidence of wide-scale abuse, and the success of the current system, it is puzzling that the Commission's effort to "modernize" the registration process should feature "increased and expanded liability" as a major component.
As noted in our six-prong analysis supra, the conceptual underpinnings of the "Aircraft Carrier" do not support the Commission's stated goal of "[making] the registration system more workable for issuers and underwriters and more effective for investors in today's capital markets."18 Our fundamental concerns with the proposals included in the "Aircraft Carrier" are as follows:
The "Walk-Through of a Form B Offering" illustrates some of the practical concerns we have with the Proposing Release.21
B. The sparse evidence of "selective disclosure" does not warrant the adoption of an entirely new system.
The Commission's focus on "selective disclosure" is of concern for three reasons. First, while one may speculate about the activities sought to be regulated,22 the term "selective disclosure" is not defined in the Proposing Release. The concept is vague and, therefore, the full scope of activities sought to be covered is unclear. Further, the Commission offers no real evidence that there is a problem in this area.
Second, the proposals apparently question the legitimacy of traditional methods of obtaining and disseminating information. The Committee believes that the proposed changes would have an adverse impact on the efficiency of our capital markets. The price discovery function performed by the markets is based upon information analyzed by market professionals.
The traditional means23 of obtaining and disseminating information include:
(a) Issuer communications with research analysts employed by broker/dealers; analysts employed by Moody's, Standard & Poor's, and similar entities; and institutional investors; and
(b) Broker/dealers communications through research analysts' conference calls with the sales force research and with institutional investors; and publication and dissemination of proprietary research reports to clients.
When the Commission considered the three-tier registration system under the Securities Act for purposes of its integrated disclosure system, it explicitly recognized the value provided by research analysts employed by full-service broker-dealers.24 In essence, the Commission acknowledged that not all investors (or potential investors) have comparable analytical skills, time, or interest to assimilate great quantities of market data, issuer information, industry data, economic trends and data, and political and strategic information, but took the view that the market price of securities would reflect this information for all investors as a result of the activities of research analysts and other market professionals.
The Commission has stated its belief that "small investors" are the last to realize the benefits of "the filtering and dissemination function customarily performed by research analysts."25 However, it is not apparent that investors generally - including small investors - suffer any discernible harm from the traditional means of disseminating information, given the impact of the "Internet, instant television analysis and the explosion of electronic means of moving money."26 We believe that, in fact, today small investors have more relevant information available more quickly than ever before in history.
If the activities of any of the key players in the disclosure cycle (issuers and their affiliates, research analysts, or institutional investors) violate prohibitions on insider trading, the Commission and any aggrieved investor already have available more than adequate remedies and penalties (administrative, civil, and criminal).27 Moreover, the rules of the National Association of Securities Dealers, Inc. ("NASD"), a major self-regulatory organization ("SRO"), prohibit broker/dealers from "front-running" research.28 Finally, all registered broker/dealers are required to have reasonable policies, procedures, and internal controls to monitor and regulate the flow of proprietary or inside information ("Chinese Walls") between the firms' investment bank and proprietary trading, brokerage, and research functions.
Third, any alleged "abuses" associated with "selective disclosure" are not sufficient to justify the sweeping changes proposed by the "Aircraft Carrier". While we are not aware of significant abuses, and the Commission has presented no evidence they exist, if the Commission perceives problems to exist,29 it could use its existing powers under current law to bring enforcement actions. We believe enforcement action when abuses exist would be fully justified to protect not only investors, but also the fundamental integrity of our capital markets. Moreover, we believe that enforcement actions would offer a far more effective remedy (and deterrent) than a rulemaking proceeding that, at best, duplicates existing authority and, at worst, impedes information flows and capital formation.
C. Our capital markets have benefited from intelligent, rational administration of federal securities laws.
One of the enduring strengths of US capital markets for over years has been intelligent, rational administration of federal securities laws. Working cooperatively with the private securities bar and representatives of the securities industry, the Commission has used its formal and informal rulemaking powers to adapt requirements of the Securities Act, the Trust Indenture Act of 1939,30 and the Securities Exchange Act of 1934 ("Exchange Act")31 to evolving trends in capital formation, innovations in technology and telecommunications, and increasing competition in global capital markets.
The Securities Act provides the necessary framework for "full and fair disclosure" of the material terms of securities offerings, and proscribes fraud in the offer and sale of securities. Congress, however, expressly recognized that not all securities or offerings of securities are required to be registered under the Securities Act. Thus, in addition to various exempted securities32and transactions,33 the Securities Act exempts non-public offerings34 made to sophisticated investors who have no need for the protections afforded by a registered public offering.35For that reason, Congress left to the discretion of the issuer (and the business judgment of management) whether to make public offerings or private placements of its securities.
Congress did not attempt to legislate every particular of securities offerings (which would be impractical), but granted ample authority to the Commission,36 as an independent regulatory agency, to adopt rules and regulations consistent with the purposes fairly intended by the statute.37 The Wheat Report is the genesis of the Commission's modern approach to disclosure regulation, viz., prior to adoption, proposed modifications would be tested and evaluated at each stage of development. In this manner, the Securities Act has retained its vitality notwithstanding unforeseeable changes in financial markets, capital-raising processes, technology, and telecommunications in the years since 1933.
The Committee is well aware that the Commission's use of this authority has generally served equity and debt capital markets exceedingly well.38 The integrated disclosure system, shelf registration, EDGAR, the Commission's Internet site, and the creation of "safe harbors" for institutional resales, offshore offerings,39and research activities40 are products of the Commission's intelligent, rational administration of federal securities laws. The "fundamental reforms" envisioned by the Committee in 1996 would have been built on the current integrated disclosure system (and its "crown jewel", shelf registration) and reconciled Commission lore and statutory metaphysics with modern techniques of capital formation and communication practices.41
D. Regulation can accommodate innovations in capital formation without compromising investor protection or the public interest.
As members of the private securities bar, we remain committed to ensuring that rules and regulations promulgated under federal securities laws continue to be responsive to innovations in the capital markets without unduly burdening capital formation. We support regulation that is consistent with the Commission's mandate to act in the public interest and for the protection of investors.
The close of the second millennium has been a time of rapid technological development accompanied by an accelerated pace of innovative capital formation techniques. Issues associated with these developments are often complex. In order to maintain the preeminence of domestic capital markets, we recommend that the Commission avail itself of the resources and expertise of the securities industry and the private securities bar in its continuing review of disclosure policy.
We would be pleased to assist the Commission in this on-going review of disclosure policy. This could take the form of a regularly-convened Capital Formation Working Group ("Working Group") and be composed of representatives of each of the ABA (counsel to issuers, underwriters and investors), the Council of Institutional Investors, the American Society of Corporate Secretaries, the Business Roundtable, the Securities Industry Association and the Bond Market Association, and other professionals with recognized expertise in these matters (e.g., accountants, economists and academicians).42
Due to its composition, the Working Group would offer the Commission a balanced perspective (market-oriented and theoretical). The Working Group could also prepare model rules, regulations and forms, thereby offering the Commission specific approaches for its consideration in connection with matters identified in the Regulatory Flexibility Act Agenda. This would be similar to the Commission's request for views on a regulatory framework for offerings of asset-backed securities (see infra). The Working Group would be similar to the Commission's long-standing commitment to small business initiatives. In order to ensure a broad spectrum of public awareness, we recommend that the Commission consider convening sessions of the Working Group in various geographical regions of the United States.
E. Irrespective of the ultimate fate of the "Aircraft Carrier" proposals, the Commission should make adequate provision for offerings of Asset-Backed Securities.
We appreciate the Commission's request for views concerning a regulatory framework for asset-backed securities ("ABS")43 in the context of the régime described in the Proposing Release.44 We believe that it is extremely important that the Commission not engage in a fundamental revision to the registration process without making adequate provision for ABS.45 Given the idiosyncrasies of registration and reporting for ABS offerings and issuers, respectively, and the enormous size of the ABS market,46 we believe this is a propitious time for the Commission to formally promulgate rules, regulations, and forms for ABS irrespective of the ultimate fate of the "Aircraft Carrier". For example, there is widespread recognition that disclosure items applicable to ABS differ from those material to securities of operating companies.
In summary, we believe that the Commission should (1) adopt reasonable rules related to term sheets and computational materials and (2) codify current interpretive positions concerning Exchange Act reporting.47 Finally, the Commission should assure that disclosure policies are communicated broadly to the industry at-large rather than on a selective basis in the context of comments on particular filings during the staff review process.
II. REGISTRATION AND DISCLOSURE POLICY
A. The shelf registration process and current registration forms are superior to the proposed regulatory structure.
The proposals would generally interpose regulatory delay into a capital-raising process that is noted for its efficiency.48 In markets increasingly characterized by volatility (daily and intra-day), delay introduces substantial risk and is inimical to capital formation.49 Indeed, when it considered adoption of shelf registration, the Commission thoroughly examined the impact of interposing regulatory delay in the rule, but ultimately rejected it as costly and unwarranted.50The Proposing Release does not specify abuses that justify this timing regression in regulation of our markets.
1. Proposed forms for Securities Act registration should not be adopted.
a. Proposed Form A.51
Proposed Form A, which is designated for domestic and foreign issuers, would be available to register offerings by unseasoned issuers and issuers that do not satisfy the minimum $1 million average daily trading volume or $250 million public float requirement for registration on Proposed Form B. Concurrent Exchange Act registration pursuant to paragraphs (b) or (g) of Section 1252 could also be effected on the proposed form. The proposals do not make substantive changes to the current disclosure requirements; rather, the principal changes are (1) how that information is delivered, and (2) when Form A registration statements become effective. These changes, however, are significant.
i. A 7 or 3 calendar day preliminary prospectus delivery requirement would seriously impede the underwritten distribution process and place many offerings in jeopardy.
As proposed, a preliminary prospectus would have to be delivered to each investor at least seven calendar days before pricing in the case of unseasoned issuers and three calendar days before pricing in the case of seasoned Form A issuers. If there are material changes, the information must be delivered at least 24 hours before pricing. A failure to satisfy these requirements would be a violation of Section 5 of the Securities Act.
These advance prospectus delivery requirements are impractical and would interfere with the successful completion of many underwritten offerings under Form A. While the objective of providing investors with the prospectus in a timely fashion before they make their investment decision is sound, the proposed approach is unworkable and is likely to result in excluding retail investors from offerings rather than affording them protection.
The underwriting process is an iterative one in which the pricing and sizing of an offering evolve as new investors come in to participate. It is all designed to culminate with the pricing of the offering to achieve maximum efficiency. It is not possible, and indeed would be counter-productive, to call a halt to the process for seven or three calendar days to allow newly identified investors to catch up. The markets are too volatile and the requirement for certainty in capital-raising is too important to permit this. The staff has recognized the need for speed and flexibility in the registered offering process in the recent Wit Capital no-action letter.53
If an offering is oversold, it might theoretically be possible to complete it with only investors lined up seven or three calendar days before. But even in that case, it would prevent newly identified investors, who are more likely to be retail customers, from participating. In many cases, the offering is not oversold in advance and the book is being compiled up to the time of pricing and even after. These offerings would have to be downsized, delayed or abandoned in a weak market or if the underwriters' book changed shortly before pricing.
The Securities Act from its inception has recognized that advance prospectus delivery to each investor cannot realistically be mandated. The statute requires that the prospectus accompany or precede the confirmation. The Commission administratively has sought to ensure adequate dissemination of the preliminary prospectus through Rule 460 under the Securities Act54 and Rule 15c2-8 under the Exchange Act.55 This approach has worked well but it is applied on an overall basis rather than with respect to each investor as proposed by the "Aircraft Carrier". There is no evidence that a change in approach is required. Quite the contrary, the availability of preliminary prospectuses electronically on the Commission's website through EDGAR, and frequently on issuer and underwriter websites makes it more likely that the preliminary prospectus will be readily available to an investor.
ii. Issuers should be permitted to incorporate by reference or deliver company information.56
As proposed, "seasoned"57 issuers could incorporate by reference company information. The Commission has noted that of the Securities Act registration forms filed in 1996, only 105 were filed on Forms S-2 and F-2.58 We suspect that in many of these filings the issuer did not elect to deliver company information through separate incorporated documents.59 We also suspect that this situation is unlikely to change if the rule proposals are adopted.
Smaller issuers may, for marketing purposes, still elect to include company information in the prospectus. Any estimates about cost savings would be wholly speculative. Nonetheless, we believe that the "incorporation/delivery" method can be a useful alternative to including all the company information in the prospectus and should be retained.
Form A may be more costly for smaller issuers in at least one respect. Currently, rather than delivering incorporated documents, issuers eligible to use Form S-2 may provide abbreviated company information that focuses on the information most important to investors. It permits the issuer to omit information (e.g., executive compensation tables) that is arguably less important to an investor's decision to purchase the issuer's securities. The Committee believes that it would be a mistake for the Commission to abandon this approach. We suspect that, if asked, investors would say that they rarely review this "back of the book" information. In any event, should they want to see it, it is easily available from various sources, including the Commission's Internet site. Under the Commission's proposals, issuers that do not want to deliver incorporated documents but prefer to include all required information in the prospectus would have to provide the entire range of company information prescribed by Form A.
If the Commission elects to retain "Form S-2 type" disclosure for seasoned issuers, it would make sense to have the required business description refer to Item 101 of Regulation S-K ("S-K Item 101"),60 rather than the abbreviated disclosure required by Rule 14a-3 under the Exchange Act.61 The remaining disclosure items prescribed in Form S-2 could be imported into Form A as well. In this way, the Commission could be certain that investors were provided with more comprehensive information about the issuer. This level of disclosure would be consonant with the requirements of Form 10-K under the Exchange Act,62 which an issuer can elect to deliver with the prospectus.
We think that the alternative of providing the glossy annual report to shareholders and quarterly reports, instead of Form 10-K and Form 10-Q under the Exchange Act,63 provides a reduced measure of disclosure and ought not to be continued. In our experience, the business descriptions in glossy annual reports run the gamut from quite thorough to very brief. The requirement in Rule 14a-3 to provide a "brief description of the business" does not provide the same depth and quality of disclosure as that required by S-K Item 101. If the Commission reasonably concludes that seasoned issuers need to accompany the statutory prospectus64 with a business description, the disclosure prescribed by S-K Item 101 is preferable.
iii. Issuer's ability to time effectiveness of registration statement is illusory.
The Commission proposes to permit an issuer to control the timing of effectiveness if (a) its public float is at least $75 million, or (b) the Form 10-K incorporated into the Form A registration statement has recently been fully reviewed by the staff, and all outstanding comments have been resolved.65 As proposed, the issuer's registration statement may be subject to a post-effective review. However, the Proposing Release does not describe the consequences to the issuer, underwriters, or other offering participants if this review is negative. For example, would the offering be deemed to violate Section 5?
A public float test of $75 million is appropriate. In response to the Commission's request for comment, we see no reason to make the level higher or lower.
The "recently reviewed" alternative may be helpful, although it will depend to a great extent on whether the staff will accommodate an issuer's request to review its Form 10-K. The timeliness in completing this review will also be an important factor. It may force issuers, underwriters and their respective counsel to new heights of prognostication, speculating whether the statistical chance of a "no review" decision is greater than the almost certain pain that a requested staff review of the Form 10-K would likely inflict. Many issuers may, on balance, decide to "run for luck." If so, the "recently reviewed" alternative (at least in a voluntary setting) may be mere window-dressing. For those issuers whose Forms 10-K are selected for review, and who satisfactorily resolve the staff's comments in a timely fashion, it may be the equivalent of an inoculation, warding off the review flu for at least the ensuing nine months or so.
More importantly, the Form A on-demand effectiveness régime carries with it the requirement for a seasoned issuer to deliver a preliminary prospectus to each purchaser three days before pricing. This requirement is wholly incompatible with the quick market access of today's shelf system.
iv. Definition of "seasoned" issuer should not be complex.
The Commission has requested comment on several issues relating to the proposed definition of seasoned issuer. As proposed, there would be two ways for an issuer to become seasoned:
It has been reporting under the Exchange Act for at least 24 months and has filed at least two annual reports; or
It has been reporting for at least 24 months and has a public float of $75 million or more, regardless of the number of annual reports filed.
Given the complexity of the proposals, we are guided by one maxim: Simpler is better.
In our view, a three-year reporting history for smaller issuers is too long and one year is too short. Why add an extra layer of complexity by requiring issuers with less than $75 million in public float to have filed at least two annual reports? Two annual reports would admittedly ensure that the issuer's independent auditors had performed two audits after the IPO; however, we have serious doubts that this distinction would matter much in practice. Besides, an issuer would just have to wait a few extra months, depending on when in its annual reporting cycle it had become a public company.
We suggest that the Commission simply define "seasoned" as any issuer with a 24-month reporting history under the Exchange Act. Two years of reporting history also ought to be sufficient to allow issuers to be permitted to incorporate by reference,66 without further qualifications.
v. Specific comments on the text of the proposed form.
(A) Should include definition of "seasoned issuer".
We believe that the term "seasoned issuer" should be defined in the form or in the rules, and not solely in the Proposing Release.
(B) "General Instructions" to the form should be revised.
General Instruction II.B.4(b) refers to a registrant that has "caused any material delinquency with respect to preferred stock . . . ." What does this mean? What if the issuer did not "cause" the delinquency but one nonetheless exists?
In General Instruction VI.A., foreign registrants are instructed to "reconcile [their] financial statements. . . ." Would a foreign registrant understand what that means? We presume it means to reconcile financial statements to generally accepted accounting principles prevailing in the United States ("US GAAP"), but it would help to state explicitly "reconcile the financial statements to US GAAP" and cross-reference to the relevant provision of Regulation S-X if that is the intent.
General Instruction VIII.A.1 would be clearer if the instruction read that the Form would be effective automatically "upon filing or upon a specified date designated by the registrant, as specified on the front page of the Form . . . ."
General Instruction X.D states that issuers are to file at least one complete signed copy of the Form with each exchange or market. These filings are now deemed to be made via EDGAR, and paper copies need not be filed. The instruction should be revised to conform to the Commission's electronic filing rules.
(C) The proposed certifications on the signature page should not be adopted.
Under proposed Form A, a majority of the issuer's board of directors and each signatory to the registration statement (and amendments thereto) would have to certify that they have read the filing. In general, we believe these requirements are impractical and do no reflect the manner in which registration statements and amendments thereto are prepared and filed with the Commission.67 Accordingly, the Committee believes that a "certification" requirement should not be adopted.
i. Shelf registration is without question one of the Commission's most successful regulatory innovations, and has operated without abuse since 1982.
The Commission heralded proposed Form B as a major advance in capital formation on the theory that it would offer issuers quick market access while providing investors with more information on a more timely basis. The benefits, however, are illusory. Unlike the highly successful shelf rule, the Commission's proposals would obstruct market access by issuers and selling securityholders. The proposed free communications rules would not result in greater flows of information to investors, but would have a chilling effect on issuers, underwriters and broker/dealers, which presently provide much of the information investors now receive.
The Form B proposals ignore the way the public capital markets in the US currently operate. Ready access to capital markets already exists in the form of shelf offerings pursuant to Rule 415 for issuers eligible to use Forms S-3 or F-3. For example, in 1998, over $50 billion in equity (including convertible and preferred) and $350 billion in debt (excluding asset-backed)68 were raised under a shelf registration system that has operated without identified abuse since 1982. The Commission's proposals will disrupt this significant and highly efficient market by delaying issuer access by at least one to two days. That delay undoubtedly has a real cost (and associated risk). We note, however, that the Commission has not analyzed or quantified the cost of that delay.69
The proposed structure of Form B offerings would also adversely impact how transactions are marketed. We expect issuers and underwriters to prohibit all written disclosures except those fully vetted by the legal and business representatives of the issuer and lead-managing underwriter, because of the onerous cross-liabilities the proposals would impose on offering participants for those written disclosures.70We expect the statutory prospectus and registration statement generally to become the only permitted disclosure documents. In other words, investors would receive no additional information, and potentially less. Road show71 information would still be available only to institutional attendees. We predict that information presented at the road show would be reduced to ensure that it would be deemed only "oral" and thus not subject to filing under the new régime.
ii. Proposed Form B is fundamentally flawed and would disrupt capital formation.
(A) Current sell, then document process should continue to be permitted.
The Form B proposals would require all offering information to be on file with the Commission at the time of the first oral commitment by an investor (other than pricing-related information pursuant to Rule 430A under the Securities Act72, and would require Rule 430A information to be on file by the time written confirmations73 are sent to investors. While in the abstract this approach may seem innocuous, it disregards 17 years of shelf practice and would in our view likely disrupt the current multi-billion dollar corporate capital formation process. The proposals in effect demolish today's shelf registration system. However, the Proposing Release does not identify any abuses that would justify such a disruptive and costly change.
Under the current system, issuers and underwriters are accustomed to pricing and selling an offering, then documenting via completion of the prospectus supplement within one or two business days, as required by Rule 424 under the Securities Act.74 This instant market access allows them to minimize exposure to market volatility and risk.
The pre-sale documentation requirements of the proposals would almost always cause some delay between the desired time of pricing and the time of sale to investors, while security-related information is documented. This delay would almost always be at least several hours, and seems likely to be at least a day or more. As noted in Appendix I, "Walk-Through of a Form B Offering", when Form B proposals are compared to typical offerings of investment-grade securities under the current shelf rule, investment-grade debt securities would probably have a one-day "speed bump," and equity offerings would either have a similar "speed bump", or the issuer would be forced to downsize the offering and risk a lower price.
While we cannot predict how the market exposure risk (which varies widely in daily and intra-day trading) would be allocated among issuers, underwriters and investors, it is obvious to us that the delay would introduce a real and new economic cost to capital formation in the United States. The Proposing Release does not address this allocation of risk. In view of the prominence and importance of US public markets to the corporate capital-raising process, we urge the Commission to conduct a serious economic study of the likely impact of the proposals on the costs of US capital formation.
The ability to postpone filing Rule 430A "pricing-related information" until confirmations are mailed would provide only partial relief. The scope of matters that are not finalized until pricing a security is much broader than the limited Rule 430A information, and can encompass the majority of transaction-related information - from covenants and redemption provisions in debt securities, to anti-dilution adjustments in convertible securities, to pro forma financial information. The Committee believes that maintaining the current post-sale documentation approach for all transaction-related information is the only way the proposals would avoid this adverse market impact on domestic capital formation.
The Form B proposals would also undermine forward incorporation by reference, a cornerstone of the current delayed shelf process. Requiring the listing of all previously filed Exchange Act incorporated documents at the time of each takedown would prohibit forward incorporation by reference. What must an issuer do if it files an incorporated document after a takedown but before the offering is fully sold (i.e., before the end of the offering period)? Incorporation is automatic in today's system, and correctly so based on the efficient market theory which supports shelf registration and (presumably) the Form B proposals.
The Commission must also recognize that a significant change in the registration process, as proposed, that has adverse economic consequences could drive some issuers and underwriters to the unregistered market. The proposal's likely increase in capital-raising costs could narrow the pricing advantage of the public markets versus the Rule 144A market for fixed income securities. With the recent introduction of the Euro currency, the European capital markets can be expected to become more attractive for US issuers as well, through improved liquidity and a broader investor base.
We are not aware of any widespread or systemic problem with the current shelf system, and the Commission has not identified any such problem in the Proposing Release. Where the security is relatively straightforward, an oral description of terms to investors suffices. For more complex or novel securities, in our experience investors can be relied upon to require circulation of a preliminary prospectus or term sheet (if permitted) as part of the marketing process.
The Committee urges the Commission to reconsider implementing such a potentially disruptive change to the US capital formation process as would be caused by the "document-before-sale" proposal.
(B) Term sheet delivery requirement should be eliminated.
Preparation and delivery of a term sheet before the investor makes an investment decision would unduly delay the offering process and provide no corresponding benefits.75The problem would be most acute for investment grade underwritten debt and medium term note ("MTN") programs, which are often sold from trading desks in the same manner as secondary market sales of similar securities (i.e., on the basis of credit quality rating, interest rate and maturity). The term sheet delivery requirement would also be a problem for offerings of common stock that do not require a significant selling effort. For issuers of the high standing of those eligible for proposed Form B, the requisite information would either be readily available through previously filed information or else readily communicated orally. When used with potential institutional investors to develop the terms of a deal, the term sheet will necessarily vary from the final terms of the deal. Further, it seems inappropriate to subject the issuer or the underwriters to liability under Section 11 because indicative term sheets were required to be filed as part of the registration statement.
Preparing, filing and delivering of a term sheet would in most cases be an unnecessary impediment. In cases where the novelty or complexity of the offered security warrants a written summary, customary market pressures should be more than adequate to ensure investors receive whatever additional information they require.
If a term sheet delivery requirement of some sort is to be kept, it should be limited to complex or novel securities. What would be in a term sheet for common stock? Why would a term sheet be needed for traditional investment grade debt? Further, the proposed Form B certification of compliance with that requirement should not be adopted. The Form B cover sheet contains a certification by the signers of the registration statement of compliance with the term sheet delivery requirements. Obviously, this is not within their control (or even their knowledge) because delivery would be made by underwriters, after the filing of the term sheet. The certification would serve no purpose and would undermine the analytical integrity of the registration process.
iii. Form B's eligibility requirements should be revised.
(A)Disqualification under so-called "bad boy" provisions76 should not be adopted.
The proposals introduce "bad boy" disqualification, a new and problematic concept, to "short-form" registration. Under these provisions, proposed Form B would be unavailable if the issuer, its executive officers or directors or its underwriters have been previously held to have committed specified securities fraud or been enjoined from future violations. To comply with this requirement, an issuer would have to verify the status of its underwriters, and the underwriters would have to verify the status of the issuer and its executive officers and directors, as well as each other. In the world of "on-demand" registration, this verification may be difficult or impossible to complete in the required time frame. Offering participants can be added at the last minute, and time can generally be extremely tight. In practice, this requirement would make the notion of "on-demand" effectiveness of the registration statement illusory.
Contractual cross-representations and cross-indemnifications would not be an adequate substitute for due diligence in this area, given the potential downside risk if a disqualification were found to have existed after-the-fact. The penalty for proceeding on proposed Form B when not eligible would appear to be that the entire offering violates Section 5 of the Securities Act, for which the remedy is rescission under Section 12(a)(1) of the Securities Act.77 We can envision an entire new industry of plaintiffs' lawyers focused on discovering latent Form B disqualifications.
Form B issuers are already expected to have high standing, based on their market prominence, which should offer sufficient safeguards against whatever unspecified abuse is of concern to the Commission. The Committee is not aware of any problems with today's shelf system that would justify a requirement as extreme as the Form B disqualification provisions, and we believe they should not be adopted.
(B) The existence of unresolved comments in connection with staff review of Exchange Act filings should not block financings.
The Commission proposes to make Form B "on-demand" registration unavailable if the staff has given the issuer comments on an incorporated Exchange Act report that have not been resolved to the satisfaction of the staff. Under the current shelf system, in such a situation the issuer and underwriters would assess the materiality of the affected disclosure comments and make a considered judgment to proceed or not to proceed with a takedown from an already-effective shelf. Given the potential liability if important disclosures were subsequently changed, these decisions would be weighed quite seriously and would err in the direction of awaiting resolution of the staff's comments. This balance, in our view, already provides adequate safeguards against unreasonable offering activity in the face of disclosure comments by the staff.
Many staff comments, initially phrased as requests for disclosure changes, are ultimately resolved through supplemental explanation to the staff. Instead, under the Commission's proposals, the mere issuance of a staff comment letter "blacks out" the issuer from conducting an offering unless it capitulates immediately on all points, irrespective of the validity of the comments or materiality of the disclosure sought. Furthermore, the "black out" would continue during any dispute between the issuer and the staff, even on immaterial matters. The time required to resolve these comments could be several months. This aspect of the proposals would give the Commission staff an unwarranted "choke-hold" over issuers. It could also drive issuers into the Rule 144A or foreign unregistered markets in cases where they would otherwise be comfortable with a public shelf takedown but would now be blocked from doing so because of unresolved comments. We believe this proposal is too extreme and should not be adopted.
(C) Penalty for filing on the incorrect form should be clarified and eased.
The Commission proposes to make paragraph (g) of Rule 401 under the Securities Act78 unavailable for offerings filed on Form B. Currently, the rule deems the registration statement to have been filed on the correct form unless the staff objects before effectiveness. While we understand that application of the rule to an automatically-effective form may raise conceptual concerns, a more practical approach is called for than the one proposed. Given the potential liability to participants if an offering were retroactively deemed to have violated Section 5, it is essential that a bright-line standard exist. This is even more necessary to the extent the Commission determines to adopt "disqualification provisions" in proposed Form B.
Rule 401(g) currently serves the purpose of being such a bright-line standard. The inability of the staff to review a registration statement prior to an offering has already existed for every takedown under the current shelf registration system since 1982. What are the abuses that justify the proposed change? We are not aware of any abuses or other problems with this approach, and believe no change is warranted.
If Rule 401(g) is nonetheless amended as proposed, the Commission should at a minimum clarify that the penalty for inadvertently proceeding on Form B is limited to Commission administrative remedies against the non-qualifying issuer, and that no private remedies are available or implied. In other words, the rule should be clear that the Form B filing becomes effective as specified therein, even if the offering is ultimately found not to have been eligible for Form B for some reason.
(D) Financial eligibility criteria should not be changed.
The Form B proposals would add a $1 million average daily trading volume test ("ADTV") for issuers having under $250 million in market capitalization. This test would be applied solely to US trading volume. The Commission estimates that 30 percent of the 4,824 issuers eligible for Forms S-3 and F-3 in 1997 would have been forced into the Form A régime.79 While some of these issuers would theoretically be eligible for automatic effectiveness and incorporation by reference, the other requirements of Form A procedures would either block this approach or make it much slower and more cumbersome than proposed Form A.80
The Committee notes that the Commission's analysis was based on 1997 data. Subsequent increases in general stock market price levels have no doubt pushed many of those issuers above $250 million in market capitalization. However, these increases have also created more Form S-3 and Form F-3 eligible issuers at the $75 million level, many of which would likely be ineligible for Form B due to the $1 million trading volume test. We are not aware of any abuses arising as a result of the $75 million level. Accordingly, we believe the financial eligibility standards for proposed Form B should remain as they currently are for Forms S-3 and F-3. At the very least, if the eligibility standards are raised, issuers who are now S-3 or F-3 eligible should be grandfathered.
(E) Secondary offerings should be permitted on Form B.
The Form B proposals would eliminate short-form registration for secondary offerings on Form B if the issuer is not eligible for a primary offering on that Form. Form S-16 permitted short-form registration of secondary offerings from its initial adoption in 1970. When Form S-3 was adopted to replace Form S-16 in 1982, it also was available for secondary offerings without regard to the minimum public float requirement for primary offerings. As originally proposed, Form S-3 would have applied the same public float requirement to both primary and secondary offerings, similar to what the Commission now proposes for Form B.
The adopting release for Form S-3 noted that commenters had urged the Commission to make Form S-3 available for secondary offerings, as they had been under predecessor Form S-16, without regard to public float. In reconsidering its proposal and making the requested change in the final version of the form, the Commission stated it had concluded that "most secondary offerings are more in the nature of ordinary market transactions than primary offerings by the registrant, and, thus, that Exchange Act reports may be relied upon to provide the marketplace the information needed respecting the registrant."81 Accordingly, the Commission eliminated the public float requirement for secondary offerings by non-affiliates on Form S-3.
Given this long-standing practice, the current proposals should permit delayed secondary offerings on proposed Form B to continue for all issuers having the requisite reporting history, even where the market capitalization or trading volume tests are not satisfied. Moreover, the Commission should continue to permit prospectus delivery obligations to be satisfied by delivery to a national securities exchange pursuant to Rule 153 under the Securities Act.82
In the Proposing Release, the Commission dismisses commenters' 1982 concerns on the original Form S-3 proposal as not relevant to the Form B proposal. The Commission asserts that venture capital financing and resale concerns can be addressed under the Form B proposals by an issuer's conducting venture capital financing on a registered basis on Form B to existing investors and qualified institutional buyers ("QIBs")83, which remain eligible offerings on proposed Form B after the seasoning requirements are met even where the trading volume/public float test cannot be met.
This assertion discounts the potential significance to the resale process of non-QIBs (who are not already investors). Narrowing the resale market essentially to institutions would presumably adversely affect the pricing and thereby raise the "costs" of venture capital formation. Similarly, resale registration is an important component of acquisitions done for "speed and efficiency" as private offerings. Therefore, we believe resale registration should be permitted on proposed Form B once the issuer has been a public reporting company for 12 months. In the absence of resale registration, there will be a loss of liquidity which will increase the costs of non-institutional private offerings and private acquisitions.
iv. Specific comments on the text of the proposed form.
(A) The proposed certifications on the signature page should not be adopted.
Form B would require the signers of the registration statement (including a majority of the issuer's directors) to certify they have read the registration statement. The same certification applies to every amendment. As a practical matter, the signers can be expected only to have read a draft of the original registration statement before filing.
They cannot be expected to gather at the financial printer and read pages as changes are made in the pre-dawn hours. They will not read multiple printer's proofs having only incremental changes as a document nears final form. They will not be able to read "offering information" prepared by underwriters and others, then filed immediately before first use in the fast-paced environment of "on-demand" registration. They will not have an opportunity to read last-minute amendments filed to reflect deal pricing. They will not read exhibits.
Including a certification requirement that the Commission knows cannot be observed is unreasonable and disrespectful to the signers. Moreover, this requirement could create additional liability, and would, in our view, undermine the analytical integrity of the registration process.
The proposed certification would require that the signer certify to his knowledge that the document contains no material misstatements or material omissions. How does this certification affect the relative liability of signers versus directors who do not sign? How will the signers conduct their own due diligence in a fast-paced offering process? If they do not, what does the certification mean? Disparate liability for signing and non-signing directors would create disincentives for signing the registration statement and would undermine the public policy served by the liability provisions in the Securities Act. Hence, we believe the proposed certification should not be adopted.
(B) Forward incorporation by reference should be permitted on Form B.
Item 3(b) appears to prohibit incorporation by reference into the registration statement and prospectus of any Exchange Act document filed after the time of delivery of the term sheet prescribed by proposed Rule 172(a) under the Securities Act (which must occur before an investor makes a binding investment decision).
We believe that Item 3(b) should be deleted. First, the term sheet delivery time would be different for each investor. Yet, whether or not an Exchange Act report is incorporated in the registration statement must be answered the same for all investors as of any given date.
Second, the principle of efficient markets, on which the current shelf system is based, is predicated on public dissemination of the information in Exchange Act filings. There is no reason why that should cease being true after delivery of any term sheet.
Third, the requirement creates a disincentive for early delivery of the term sheet. If the term sheet cuts off incorporation by reference, issuers would seek to delay delivery by underwriters and other offering participants until the last possible moment. This result is contrary to the interests of investors.
Fourth, the term sheet requirement emphasizes terms of the proposed offering, whereas incorporated Exchange Act documents are most likely to address information concerning the issuer.
Fifth, prohibiting incorporation by reference would not ensure that the investor physically receives information disclosed after delivery of a term sheet. Presumably, an issuer would file the information as a post-effective amendment and continue with the offering to other investors. We believe that an issuer's liability for its registration statement and prospectus would be the same whether the material is incorporated by reference or physically included in the registration statement and prospectus. If the Commission wishes to emphasize or clarify that forward-incorporated documents are also subject to Section 11 liability, we believe a specific rule to that effect would be a more direct and less problematic way to address the concern.
Thus, the prohibition on incorporating Exchange Act documents filed after term sheet delivery should be eliminated.
(C) Interim incorporated reports cannot be new registration statements.
The proposals would revise the undertaking in Item 512(b) of Regulation S-K84 to provide that the filing of a Form 10-Q or Form 8-K under the Exchange Act85 would be deemed to be the filing of a "new registration statement." While indisputably such a filing is a part of the registration statement, it is not a comprehensive document, and the Committee believes that it would be inappropriate to treat it as such.
Perhaps the intention of the undertaking is to provide that the Form 10-K should be considered a new registration statement as of the date of the Form 10-Q or 8-K filing (as modified by that filing). This approach is also flawed, because the Form 10-Q or 8-K filing would not comprehensively update the Form 10-K. The Committee believes the only approach that works analytically is the one in the current undertaking: that the Form 10-K filing is deemed the filing of a new registration statement.
We assume the Commission's goal in changing the undertaking was to subject the interim report to Section 11 liability and to extend the statute of limitations for purposes of liability under Section 11 to run from the most recently filed Exchange Act periodic report, rather than from the Form 10-K filing, if those dates are more recent than the effective date of the registration statement. The Committee suggests that this be addressed directly, if in fact any change is needed. In this connection, we note that many Form B offerings may be made through stand-alone, "on-demand" filings rather than through supplements to a previously effective shelf registration statement.
(D) After-market prospectus constructive delivery creates an update problem in all offerings.
The proposed revisions to Rule 174 under the Securities Act86 would create a prospectus "delivery" requirement for dealers after all offerings, not just IPOs. While the proposed revision avoids the mechanical burden of physical delivery through constructive delivery by reference to Commission filings, it does not address the question of updates during the 25-day period. If in fact the prospectus is deemed delivered throughout the 25-day period after the offering, then the issuer will be justifiably concerned about its liability under Section 12(a)(2) of the Securities Act87 (as will any dealer that could be a seller) if any event occurs that would warrant a revision or addition to the disclosures. Furthermore, because any such update would most likely have to be reflected after the "offering period," incorporation by reference would not be available under Item 3(c) of proposed Form B or under Item 3(b) for the reasons noted above. This leaves the unattractive prospect of a post-effective amendment, and the attendant disruption of after-market trading.
Certainly, this result is unintended. The Commission indicates the rationale for the proposed amendment to Rule 174 is the decision in Gustafson v. Alloyd Co., Inc.,88 which some lower courts have subsequently interpreted to mean that after-market investors do not have standing to assert Section 12(a)(2) claims. We suggest that the Commission address its concern through a request that the Congress amend the statute, rather than by creating confusion in the prospectus delivery rules.
i. The Commission should adopt an omnibus Form M-A instead of proposed Form C.
Proposed Form C would be prescribed for business combinations and exchange offers and supersede current Forms S-4 and F-4.89 Proposed Form SB-3 would be available for specified small business issuers. A special committee of the Committee has examined the proposed registration régime in the context of the Regulation of Takeovers and Security Holder Communications,90which was proposed concurrently with the "Aircraft Carrier".
In their view, the Commission's goal to integrate disclosure obligations (and thereby reduce filing obligations) could be accomplished with greater efficiency if the Commission were to adopt one form applicable to any transaction involving an exchange offer, merger, or other business combination ("Form M-A") and prescribe related disclosure requirements in one regulation ("Regulation M-A").91 Thus, if Proposed Form M-A were adopted as an omnibus Securities Act registration statement for exchange offers, mergers, and business combinations, there would not be a need to adopt proposed Form C or proposed Form SB-3 for offers registered under the Securities Act.92
The Committee concurs in this view, and encourages the Commission to adopt an omnibus Form M-A, irrespective of the ultimate resolution of proposals included in the "Aircraft Carrier".
2. The metaphysics of integration of private and public offerings.
a. Integration initiatives are a welcome response to a complex issue.
We applaud the Commission's efforts to provide greater clarity to issuers and their counsel on the circumstances under which ostensibly separate private and public offerings of securities would be deemed the same offering for purposes of satisfying the registration requirements of the Securities Act. In addition to clarifying its views of "integration", the proposals include safe harbors applicable to (1) integration of public and private offerings, and (2) voting commitments in connection with mergers and similar transactions (i.e., "lock-up agreements"). In addition to our comments on the Commission's proposal, we recommend an alternative for the Commission's consideration, which we believe would address the integration issues in a more systemic way.
The Committee notes that proposed Form B would provide a larger, seasoned issuer with the ability to commence a private offering or "test the waters" to determine what type of offering to pursue without forestalling its ability to complete the offering as a public offering. In our view, this type of structural solution to the dilemma posed by integration issues is highly desirable. Similarly, an issuer using either proposed Form B or proposed Form A could use the proposed safe harbor to abandon a public offering and complete it privately.
Although the proposals do not provide guidance on "traditional" integration issues, we urge the Commission and the staff to further develop integration principles that enhance certainty and provide greater flexibility to issuers. Subject to our specific comments below, we believe that the proposed safe harbors would provide useful relief for issuers, particularly those ineligible for Proposed Form B, without compromising important investor safeguards for that class of investor for whom the registration provisions of the Securities Act were enacted. Moreover, the Committee believes that integration issues are of such a magnitude that the Commission should immediately adopt relief, irrespective of the ultimate resolution of other proposals included in the "Aircraft Carrier".
The Committee believes that the Commission should also clarify that the proposed integration safe harbor operates independently of the proposed communications safe harbor. For example, it appears that the proposal contemplates that an issuer using proposed Form A would be able to avail itself of the communications safe harbor prior to the 30-day period before filing in order to convert a private offering to a registered offering, without reference to the integration safe harbor. We believe that the Commission should clarify that this is the case, because communications that are not "offers" do not raise the "gun-jumping" concerns underlying the integration issue. Finally, we believe that the Commission should emphasize that the communications safe harbor in its proposed amendments to Rule 15293 is non-exclusive; accordingly, any failure to satisfy the requirements of a safe harbor would not necessarily result in integration. The Committee's comments on the integration proposals are noted infra.
i. Completed private offering.
Subject to our suggestion below for a more comprehensive approach, we concur that an offering will be deemed complete when the purchase price has been fully paid or, in situations in which there has not yet been full payment, when the transaction cannot be renegotiated and the purchaser is unconditionally obligated to pay for the securities. We agree that the revised rule should make it clear that conditions that are not directly or indirectly within the control of the purchaser will not negate the availability of the safe habor. There is uncertainty, however, as to the conditions that are permissible.
We believe it would be helpful for the Commission to provide guidance on the type of conditions that are permissible because they are not deemed to be within the purchaser's control. For example, customary closing conditions for which there are objective standards (e.g., "material adverse change"), or which the purchaser cannot assert without causing a breach of contract or a violation of law, would not be within its control. On the other hand, conditions that vest the purchaser with discretion, such as satisfactory completion of due diligence, would be within the purchaser's control. Furthermore, we note that the staff supplemental telephone interpretations state that a condition relating to market price (e.g., a collar) is unacceptable.94 Since market price is a non-discretionary, objective condition that is not within the control of a purchaser (except perhaps by manipulation, which would be illegal or a breach of a duty of good faith and fair dealing), this interpretation would seem to be incorrect.
We question the need for the blanket exclusion of "affiliates" and "dealers" from the resale safe harbor for completed offerings. It is not unusual, for example, that an existing investor or senior management would participate in a financing for which resale registration rights were granted, either on an immediate PIPE95 basis or on a deferred demand or piggyback basis. Any concern that these persons may be acting as "conduits" (i.e., as "underwriters") could be dealt with on a case-by-case basis with reference to the use of the form available for a "primary offering" (and other consequences stemming from characterization as a primary offering). Rather, the focus should remain on the scope of protection for investors in a registered resale. Thus, the safe harbor for resales should neither be denied across the board, nor have any bearing on the validity of the private offering.
Similarly, we do not see the need to deny a private offering completed status because the purchase price is not fixed but rather may be tied to the market price. While we understand the staff's concern that equity lines may constitute delayed offerings, in our view this concern goes to whether the resale is in substance a primary offering. This factor should have no bearing on to the validity of the private offering exemption. Nonetheless, the Commission should clarify that this condition would not apply to a business combination. In this regard, we note that the number of shares to be issued in a business combination is often determined by a formula based on current market price. Moreover, because these transactions are not for capital-raising purposes, they should not be viewed as constituting delayed primary offerings.
The proscription on re-negotiation should be revised to clarify its application to re-negotiation only of a material term of the investment. The Committee notes that there may be many contractual terms, some of which are not material to the investment, that may need to be renegotiated (e.g., exclusion from exercising board visitation rights when a matter involving the investor is being considered). In our view, overly broad application of this proscription would result in the loss of completed status for many private offerings that merit being considered completed.
We recommend that the proposal be expanded to provide that formation transactions (e.g., private acquisitions) are within the ambit of protection under proposed Rule 152(a)(4) for modification of an issuer's capital structure in connection with an IPO. This would be consistent with existing staff positions. In this connection, it is unclear whether the provisions of proposed Rule 152(a)(2) also apply in the situation described under 152(a)(4), with respect to offerings which do not raise capital for the issuer, or described under 152(a)(4) is self-contained and stands alone. We believe the intent was that if a transaction met subsection (a)(4), it need not fit within subsection (a)(2). We agree with this approach and request that the Commission clarify this intent. We note, however, that subsection (a)(4)(iii), which provides that the private offering must not be a roll-up transaction under rule 901(c) of Regulation S-K, it is unworkable because it is circuitous. A private offering becomes a roll-up transaction if the private offering is integrated into the registered offering. Therefore, it is not possible to determine whether it will be a roll-up transaction unless you first know whether the private placement will be integrated. It should be sufficient that there is a bona fide private placement and such private placement is deemed "completed" within the other parameters of subsection (a)(4) of revised Rule 152.
ii. Abandoned private offering.
The Committee questions the need to require notification of all offerees that the private offering has been abandoned. Adoption of this provision would reintroduce the concept of "offerees," which was correctly abandoned with the adoption of Regulation D. This requirement would not only require keeping track of all offerees, but also of determining who in fact is an offeree. This disclosure would be relevant only for purchasers in the subsequent public offering, and would be obvious to such purchasers from their participation in the transaction. Similarly, purchasers in the after-market will know that a public market has been created since they will be purchasing securities in the secondary market. Because of the difficulty of ascertaining who is an offeree, if the Commission nevertheless retained the notification requirement, we recommend making clear that giving the notice is not an admission that a person is an "offeree" and that a good faith effort, not perfect execution, is all that would be required.
The problem of tracking offerees is made worse by tying the "cooling-off period" to the nature of the offerees. We believe that the prohibition on general solicitation should provide ample protection against improper gun-jumping activity. Nevertheless, if the Commission were to require a cooling-off period, we recommend that it be a period of 30 days from the last offer to an ineligible person, unless the issuer can show that the private offering was directed solely to eligible persons or that the public offering is limited to eligible persons.
Rather than requiring filing of private offering selling material or the need to inform offerees, the requirement should only be to inform purchasers in the public offering who were offerees in the private offering that the prospectus included in the registration statement supersedes the offering material used in the private placement, and that any indications of willingness to purchase are deemed rescinded. In practice, issuers would include this notice in the prospectus delivered as part of the public offering.
iii. Abandoned public offering.
We do not believe that a compelling reason exists to integrate an abandoned public offering with a subsequent private offering in order to protect investors. Since the public offering was registered, there is little prospect of harm to investors from this activity. Any subsequent private offering would still have to meet the requirements for an exemption, the most significant of which is the nature of the purchasers and their ability (acting alone or with their respective purchaser representatives) to fend for themselves. Liability concerns could be addressed by disclosure of the differences between a public and private offering (i.e., the restricted nature of securities and the absence of Section 1196 or 12(a)(2) liability), unless all purchasers were "accredited" or otherwise "sophisticated" investors.
We note that the safe harbor would be available irrespective of marketing activity as part of the public offering and would not be limited to quiet filings as proposed by the SEC Task Force on Disclosure Simplification. We believe this is the correct approach. However, we believe that the Commission should formally withdraw the presumptive general solicitation interpretation,97 in favor of a focus on actual marketing activity. In this regard, we note that the mere filing of a registration statement is no more "general solicitation" than a third-party listing of private offerings. It would be most unlikely that an issuer would file a registration statement in order to solicit investors for a private placement.
If the focus were directed toward actual marketing activity, there would be no reason to require an issuer to withdraw the registration statement. For example, an issuer may desire to preserve its ability to resume a public offering after completion of the private offering. In this case, it would be able to use the filing fee already paid. Any required "cooling-off" period would commence after the last marketing activity.
The Committee does not support any requirement to notify all offerees of the abandonment of a public offering. As noted in "Abandoned private offering" supra, reintroducing the concept of tracking "offerees" would be an anachronism that would not provide any meaningful protection to investors. Furthermore, in the public offering context, it would be totally impractical to expect that an issuer would be able to identify all offerees. Rather, when a private placement follows an abandoned public offering, the issuer should only be required to inform potential investors in the private placement of the restricted nature of the securities and that the issuer and any other offering participant are not subject to liability applicable to an offering made pursuant to an effective Securities Act registration statement, specifying the particular abandoned public offering.
As proposed, an issuer that sells privately, even solely to a large mutual fund or an existing institutional investor, within the 30-day period would have to accept Section 11 liability. We do not favor using the proposed safe harbor in a way that would have the practical effect of reversing the holding of Gustafson,98 which would be the effect of requiring a contractual undertaking of liability under Section 11 or Section 12(a)(2), in order to finance prior to the expiration of a 30-day "cooling-off" period. Instead, it would be preferable to impose a 30-day "cooling-off" period before private sales could be made to non-accredited investors, coupled with disclosure to all purchasers in the private offering of the liability consequences of the switch from a public to private offering.
Each underwriter would have to agree to Section 11 or Section 12(a)(2) liability for a private offering that commences within 30 days after notification of abandonment or withdrawal of a particular public offering. The Proposing Release refers to any underwriter involved in the private offering, which is an odd reference since - by definition - there is no "distribution". Presumably, the reference is meant to cover any "placement agent". If this provision were adopted, this should be clarified. As proposed, it is unclear who is intended to be covered by the term "underwriter". The Committee notes that it would not always be the case that an underwriter in the public offering would be involved in the subsequent private offering.
Moreover, the general reference to Section 11 or Section 12(a)(2) liability raises a further question. Does it mean the liability the issuer or underwriter would have had if the offering had been registered, subject to all the defenses and procedural protections? We request that the Commission clarify this provision if it is adopted.
The proposed safe harbor only addresses abandoned public offerings - it does not deal with pending or completed public offerings. We propose that the safe harbor be available for pending and completed public offerings. Just as Rule 152 applies whether a private offering is completed or abandoned, we see no reason that the rule should not apply in the case of an abandoned or completed public offering. With respect to a pending public offering, at the very least the Commission should recognize and codify the Black Box99 interpretation, thereby permitting certain private offering activity during a pending public offering. The Proposing Release, however, is silent on this important issue.
The Commission is correct to expand the coverage of Rule 152 to offerings under Section 4(6) and to clarify that the rule would apply to offerings under Rule 506. We believe the relief afforded by Rule 152 should also be extended to Rule 505 offerings.
Often there is little substantive difference between the conduct of a Rule 506 and Rule 505 offering, other than the $5 million offering limi