Commonwealth of Pennsylvania

Pennsylvania Securities Commission

Robert M. Lam, Chairman

A. Richard Gerber, Esq., Commissioner

John A. Maher, Commissioner

M. Joanna Cummings, Secretary

Eliott Klein, Chief Counsel

G. Philip Rutledge, Deputy Chief Counsel

June 29, 1999

Jonathan G. Katz


U. S. Securities and Exchange Commission

450 Fifth Street, N.W.

Washington DC 20549

RE: The Regulation of Securities Offerings

Release No. 33-7606A

File No. S7-30-98

Dear Mr. Katz:

We appreciate the opportunity to respond to the request for comment on Securities and Exchange Commission (SEC) Release No. 33-7606A proposing to modernize and clarify the regulatory structure for offerings under the Securities Act of 1933 (1933 Act) and to enhance investor protection (Release).

The Pennsylvania Securities Commission (PSC) is an independent agency of the Commonwealth of Pennsylvania responsible for the administration and enforcement of the Pennsylvania Securities Act of 1972 (1972 Act). The PSC is mandated by the 1972 Act to provide investor protection and to promote legitimate capital formation.

PSC commends SEC for its efforts to modernize and clarify the federal regulatory structure for securities offerings and to improve the quantity, quality and timeliness of information provided to investors. PSC believes the Release, with some modification, would strike the proper balance between encouraging capital formation and providing investor protection.


A significant goal of the Release is to extend some of the advantages of a private offering to many registered offerings to make registration a more attractive alternative to companies seeking to raise capital. PSC shares SEC’s view that registration provides enhanced investor protections due to the higher quality of disclosure required in a registered offering, the absence of restrictions on the transferability of securities, and enhanced remedies for recovery of funds in the event disclosure is false or misleading. PSC supports the concept of minimizing impediments to registration to make it a more appealing option for issuers, so long as investor protection is not sacrificed.

PSC also supports SEC’s "inclusive" prospectus approach that would provide investors with access to all material information used by or on behalf of the issuer during the offering period, including the required material company and transaction disclosure, and would subject this information to the antifraud and civil liabilities provisions of the 1933 Act and the Securities Exchange Act of 1934 (1934 Act). PSC believes that the standards of accountability proposed in the Release strike a fair and appropriate balance for increased flexibility. PSC observes, however, that this is a finely-tuned balance and investors could be affected adversely if the final rule lessens the liability standards contained in the Release.

Offerings on Form B

Transactional Disclosure Standard. SEC has solicited comment on whether to adopt a standard for transactional disclosure that would require an issuer to include some of the items currently required and whatever other information the issuer, in its discretion, deems to be material. PSC encourages SEC to adopt this more flexible standard as disclosure tailored to a particular offering should result in a more relevant and informative document.

Free Writing Materials. SEC also has solicited comment on proposals addressing free writing materials. Specifically, SEC inquires as to whether it should require a registrant to indicate on the front cover page of the registration statement the date of the first offer in connection with the offering being registered and whether it should require free writing materials to be filed at the time of first use. In view of the significance of the offering period, PSC believes registrants should be required to state the date of first offer on the front cover page of the registration statement. Additionally, PSC believes free writing materials should be required to be filed at the time of first use to allow all investors access to those materials prior to making their investment decisions.


Reporting History Threshold. PSC’s comments relating to offerings eligible for registration on Form B reflect our concern that certain proposals may compromise important investor protection considerations in the attempt to simplify the registration system for certain issuers. The intent of the Release is that Form B would be available only to issuers that have a history of reporting under the 1934 Act. The proposed threshold is one-year of reporting history and the filing of at least one annual report. PSC urges SEC to establish a two-year reporting history threshold for issuers using Form B. PSC is concerned that a one-year reporting history may not provide investors with enough information with which to evaluate the investment. Additionally, a one-year requirement may not afford an issuer sufficient experience with the reporting process to achieve the filing of quality documents. PSC shares the view of the SEC Advisory Committee on the Capital Formation and Regulatory Processes, as stated in its 1986 report, that "[I]t often takes at least two years following an IPO for a company and its management to become fully comfortable with the disclosure obligations of a public company and to have all their mechanisms for gathering information in place and properly functioning."

Offerings to Existing Securities Holders. Form B also would be available for use by smaller issuers for registration of offerings to certain existing securities holders. PSC supports extension of the availability of Form B to these offerings provided that a two-year reporting history is required and the other limitations noted in the Release are adopted. PSC urges SEC, however, to consider expanding the restrictions on eligibility of these smaller issuers to file on Form B to include a minimum ownership requirement for shareholders receiving the securities and/or to extend the length of time a shareholder must have held the issuer’s stock to a period up to six months. A minimum ownership requirement would provide some assurance that investors have a reason to keep themselves informed about the company, while extending the length of time a shareholder must have held the issuer’s stock will ensure that investors have sufficient time to familiarize themselves with the issuer and increases the likelihood that any given offering is truly an offering to existing shareholders.

The extension of the availability for use of Form B to smaller reporting issuers that make offerings to existing shareholders pursuant to exercise of transferable warrants and options raises a number of concerns. The shareholder who exercises the warrant or option may not be the original shareholder and may not have the interest the original shareholder had to follow the issuer. Additionally, options and warrants have played a role in microcap stock fraud, and may be misused as a means of effecting indirect distributions of common stock to the public. For these reasons, PSC believes SEC should not permit use of Form B for exercises of options by dealers.

Non-convertible Investment Grade Securities. PSC does not support the proposal to permit offerings of non-convertible investment grade securities by issuers that have been reporting under the 1934 Act for one-year to be registered on Form B. SEC states in the release that the proposal is based on the belief that investors form their investment decision on the basis of interest rate and credit rating. However, as SEC notes in the Release, "A credit rating is one organization’s judgment about the likelihood of default. The judgment is not a guarantee of no risk." Additionally, the definition of investment grade securities encompasses securities rated AAA or Aaa to those rated BBB or Baa, and includes securities deemed to be of highest quality to those deemed to be medium grade. A rating of BBB or Baa is given to an obligation deemed by the rating agency to have adequate protection parameters; however, adverse economic conditions are more likely to have a negative impact on the issuer’s ability to pay the obligation. In light of the risks involved in investing in these securities, PSC believes investors should receive the mandated transactional disclosure required by Form A.

Additionally, PSC does not support permitting an issuer of a debt security rated investment grade to choose the effective date of the offering. PSC is particularly concerned about offerings of asset-backed securities. In these offerings, a trust is created to sell securities backed by a pool of receivables. The securities may attain an investment grade rating; however, the quality of receivables in the pool may differ and it is possible that a material portion of the receivables may carry a high risk that they will not be collected. The trust may market the offering as investment grade and fail to disclose that high risk receivables are included in the pool of assets.

Disqualifications. PSC supports the proposals relating to disqualification of specified issuers from use of Form B, including blank check companies, issuers offering penny stock, companies with significant liquidity problems, and companies that have violated, or whose officers, directors or general partners have violated, securities law antifraud provisions during the prior five years. Offerings undertaken by these issuers pose significant risks to public investors. We believe it is appropriate to subject these offerings to more stringent disclosure requirements and for SEC to exercise greater control over these offerings.

In addition to the disqualified issuers enumerated in the Release, issuers engaged in the business of extension of credit that continuously sell debt securities to the public have been problematic. PSC is aware of several companies that have engaged in activities that illustrate the need for SEC to review these offerings. These issuers have utilized financial statements that fraudulently overstated assets, revenues, and income to present an inflated financial condition. Further these issuers used proceeds from sales of their securities to repay earlier investors and to cover operating expenses. Based on the track record of issuers in this type of offering in creating investor protection concerns, we believe these issuers should be disqualified from using Form B and should be denied the benefits accorded to a Form A seasoned issuer.

We also believe it is important that issuers whose shares are more likely to be used in facilitating fraud in the microcap market be disqualified from using Form B. These issuers generally are small start up companies with little or no earnings and market capitalizations of less than $300 million. The securities tend to be low-priced and thinly traded on the NASDAQ Small Cap Market, the Over-the-Counter Bulletin Board or the pink sheets.

In addition to being attractive to unscrupulous brokerage firms who engage in fraudulent trading activities, companies with these characteristics are susceptible to fraudulent financial reporting. According to Fraudulent Financial Reporting: 1987-1997, An Analysis of U.S. Public Companies (Fraudulent Financial Reporting: 1987-1997), companies committing fraud were relatively small with assets and revenues of less than $100 million preceding the fraud, and most did not trade on the New York and American Stock Exchanges. The report also indicated that the majority of companies committing financial statement fraud had an inadequate internal control environment with boards of directors dominated by insiders or outside directors with special ties to the company or management and either had no audit committee or an inexperienced audit committee that met infrequently.

We realize that many micro-cap stocks are not utilized in the facilitation of micro-cap fraud and the vast majority of small companies do not prepare fraudulent financial statements. This makes it difficult to craft a disqualification standard for micro-cap securities. One source of guidance SEC should consider is S.1189, the Microcap Fraud Prevention Act of 1999 (S.1189). S.1189 would amend Section 15(b)(6) of the 1934 Act to broaden the current penny stock bar to include non-covered securities. S.1189 also would amend Section 21(d) the 1934 Act to grant courts authority to prohibit certain persons from participating in offerings of "non-covered securities." For both purposes, a "non-covered security" is defined as "any security other than those described in paragraphs (1) and (2) of section 18(b) of the 1933 Act.

Offerings on Form A

Incorporation by Reference. PSC supports SEC’s efforts to reduce the registration burden on smaller seasoned issuers by proposing to permit an issuer that has been subject to 1934 Act reporting requirements for 24 months, has filed all reports due in the preceding 24-month period, has been timely in filing its reports for the past 12 months, and has filed at least two annual reports to incorporate company information by reference into Form A. The Release would require a company using Form A to deliver an incorporated annual report and its latest incorporated quarterly report with the prospectus. A company would be required to describe, in the prospectus, any material change in its affairs that it did not disclose in a 1934 Act report delivered to investors.

PSC shares the view expressed by SEC that investor protection should not be compromised by implementation of the proposals. Reports filed under the 1934 Act generally are viewed as a reliable source of information because they are subject to the regulatory and anti-fraud provisions of the federal securities laws and to review by SEC staff. A company would be required to deliver incorporated reports with the prospectus. Also, a company would describe in the prospectus any material change in its affairs that it did not disclose in a 1934 Act report delivered to investors.

The Release solicits comment on whether the seasoning test for incorporation by reference should be shortened to require reporting under the 1934 Act for 12 months and the filing of one annual report. PSC strongly believes that the seasoning test should not be reduced below the 24 months currently proposed for the reasons enumerated above in discussing Form B.

SEC also seeks comment on whether incorporation of information by reference increases the analytical burden on investors, who would have to review multiple documents disclosing material information. PSC believes that the analytical burden on investors would be increased and encourages SEC to limit incorporation by reference to the most recent annual report and require all subsequent information to be included in the prospectus.

Timing of Offering. PSC supports the concept of permitting a seasoned issuer that uses Form A in connection with an offering of securities to designate the effective date of the offering, so long as investor protection is not compromised. PSC considers the requirement that a company’s 1934 Act annual report incorporated into Form A be subject to a full review by SEC and amended in accordance with staff comments to be an important investor protection provision. Additionally, PSC believes the proposed requirement for delivery of the preliminary prospectus at least three days prior to pricing or signing of the subscription agreement is essential to the preservation of investor protection. PSC argues that it would not be appropriate to permit a Form A issuer to choose the effective date of the offering, absent a requirement that investors be given a period of time to review the preliminary prospectus.

Offerings by Small Business Issuers

Definition of Small Business Issuer. PSC supports revising the definition of small business issuer to raise the revenue level to $50 million and eliminate the public float test.

PSC agrees with SEC that a small business issuer that uses the less extensive Regulation A narrative disclosure requirements in its latest annual report on Form 10-KSB should not be permitted to incorporate 1934 Act reports by reference. We share SEC’s belief that an issuer should have experience reporting under a comprehensive disclosure regime before it is permitted to utilize incorporation by reference. PSC supports extension of the prohibition on incorporation by reference to a transitional small business issuer registering securities on Form SB-1 as the less extensive disclosure requirements of Regulation A may not ensure that investors have access to sufficient information on which to base an investment decision.

Offerings Under Regulation D, Rule 504

PSC supports the proposed revision to Regulation D, Rule 504 (Rule 504) that would provide that the status of an issuer as a reporting company does not prevent it from relying on Rule 504 for the issuance of securities underlying convertible securities and warrants that it previously offered in compliance with Rule 504 at a time when it was not a reporting company. The proposed change would assist an issuer in raising capital without compromising investor protection.


Bright-Line Communications Safe Harbor. The proposed safe harbor would permit an issuer to communicate freely at any time before the 30-day period before the filing of the registration statement. The issuer, underwriter and participating dealers would be required to "take all reasonable steps" within their control to prevent further distribution or republication of the communication during those periods in which free communication is not permitted.

We are concerned that the requirement to "take all reasonable steps" to prevent further distribution or publication of communications during the 30 days immediately preceding the date of filing the registration statement may be problematic for an issuer who must make a determination as to what actions would be considered to be reasonable steps. We encourage SEC to enumerate those actions it would consider to be reasonable in an effort to provide issuers with a safe harbor from liability.

Communications During the Waiting Period. We support the proposal to permit unlimited use of free-writing materials during the waiting period, so long as companies are required to file the information with the SEC. The filing requirement will enhance investor access to the information.

Research Reports. We do not support expansion of the safe-harbor provided by Rule 139 to permit a broker or dealer participating in the distribution of securities to publish a focused research report so long as the issuer has been a reporting company for one year, nor do we support elimination of the requirement that focused research reports be distributed with "reasonable regularity" in the normal course of business. As Professors Loss and Seligman have noted, the SEC, in amending Rule 139 in 1984, "did not address the possibility that participating underwriters or dealers might employ research reports in an attempt to ‘condition the market.’" Professors Loss and Seligman also noted that it is "far from self-evident" that a "widespread market following" of issuers eligible for current Rule 139 ‘greatly lessens the potential for the abuses Section 5 was intended to prevent.’"

These concerns would be exacerbated by expanding the safe harbor provided by Rule 139. We recommend that the "reasonable regularity" requirement be retained, that eligibility be restricted to companies with a two-year history of reporting under the 1934 Act, that the broker or dealer be required to have a history of following the company for a specified number of years, and that all focused reports be filed with SEC.

Prospectus Delivery Requirements

Delivery of Preliminary Prospectus Information. PSC strongly supports the proposals intended to ensure that relevant disclosure is delivered to investors before they make their investment decision. The intended purpose of disclosure, to assist an investor in making an informed investment decision, can be achieved only if the prospectus is delivered prior to the time an investment decision is made.

Form B Offerings. With respect to the alternative proposals for delivery of transactional information to investors, PSC prefers the alternative that would mandate delivery of a term sheet that includes the items proposed in the Release as well as material transactional disclosure. We believe that an investor is more likely to read a term sheet.

We strongly believe the term sheet should be drafted in Plain English. The term sheet should provide a clear, concise summary of material information relating to the particular offering that would assist an investor in making an informed investment decision. We strongly suggest that the transactional information set forth in the term sheet should include a description of the intended use of proceeds, and a listing of the major risks of investing in the issuer.

We believe that it is crucial that an investor receive the term sheet at a time when the term sheet will have an impact on the investment decision. The proposals would require the term sheet be sent in a manner reasonably designed to arrive before the date an investor makes a binding investment decision. PSC urges SEC to adopt a specific time for receipt of the term sheet to allow an investor an opportunity to study the term sheet and the issuer’s 1934 Act reports prior to making an investment decision. An appropriate time period would be three calendar days before pricing or execution of a subscription agreement. Additionally, Form B issuers should be required to provide to investors, at least 24 hours before pricing or signing of the subscription agreement, any and all material changes to information included within the term sheet or 1934 Act reports regarding the company or a transaction.

Offerings by Small or Unseasoned Issuers. PSC strongly supports the SEC proposal to require delivery of a Section 10 prospectus for all filings of Forms A, SB-1, SB-2, F-7, F-9 and F-10 (not involving a business combination) and certain Schedule B offerings. Companies utilizing these forms to register offerings generally are new and there is little or no information available about them. Thus, the prospectus is a significant source of information about these companies and their offerings.

PSC also strongly supports the proposed seven calendar day prospectus delivery requirement for offerings by unseasoned Form A issuers and small business issuers. As noted in the Release, where a company is not well-known, it is important that investors have sufficient time to read and analyze the disclosure and, if necessary, to seek further information. Seven calender days should provide sufficient time for an investor to study the company’s disclosure in order to make an informed investment decision.

We agree with SEC that a seven-day delivery period may not be necessary for an offering by a more seasoned issuer that has a history of filing periodic reports under the 1934 Act. We do not agree with SEC, however, that the test for seasoning should be whether the issuer’s initial public offering took place one year or more before the effective date of the registration statement for the current offering of securities. We also do not think that a minimum one-year reporting history provides investors with sufficient information to make an educated investment decision. We urge SEC to employ the definition of Form A seasoned issuer found in Section II of the General Instructions of Proposed Form A; i.e., an issuer that has been reporting under the 1934 Act for at least 24 months, has timely filed its Exchange Act reports over the previous year and meets the $75 million float test or has filed at least two annual reports.

If SEC would adopt the definition of Form A seasoned issuer found in Section II of the General Instructions of Proposed Form A, PSC would support the SEC proposal to shorten the delivery period to three calendar days for seasoned Form A issuers. In the event SEC adopts the proposed test for seasoning that the issuer’s initial public offering took place one year or more before the effective date of the registration statement for the current offering of securities, PSC believes that a seven-day prospectus delivery period is appropriate.

Proposed Rule 172(e) would provide that, if not previously disclosed by any other means to investors, material changes in information reflected in the previously delivered prospectus must be set forth in a document sent to each investor reasonably designed to arrive at least 24 hours before the securities are priced or the investor signs the subscription agreement. PSC supports the 24-hour delivery requirement.

Under Rule 172(e), as proposed, an issuer would be permitted to have brokers orally inform investors of material changes to information in the previously delivered prospectus. Through use of technology there are numerous means by which an issuer can communicate with potential investors in a short period of time (e.g., e-mail, faxes). Therefore, PSC does not support the proposal to transfer the issuer’s obligation to deliver updated information to investors to a broker in the form of oral disclosure.

Delivery of Final Prospectuses. In light of the proposals to refocus the prospectus delivery requirements on a point in time before an investor makes an investment decision, PSC agrees with SEC that it is appropriate to create an exemption from the 1933 Act requirement to deliver a final prospectus where a prospectus meeting the requirements of Section 10 is on file with SEC, and investors are informed, at a time at or before they receive their confirmation of sale, where they can promptly obtain the final prospectus. PSC supports requiring an issuer to provide a prospectus upon request and free of charge.

Aftermarket Prospectus Delivery. PSC supports proposed revisions to Rule 174 that would permit a dealer to satisfy its aftermarket prospectus delivery requirement by filing its final prospectus with SEC and notifying each investor, before or at the same time the investor receives a confirmation, where it may acquire, free of charge from the issuer, final prospectus information. The purpose of requiring physical delivery of a prospectus is to provide investors with information prior to making an investment decision. Since investors in the aftermarket make their investment decisions prior to receipt of the final prospectus, physical delivery of the prospectus is not necessary to provide suitable investor protection.


PSC supports the expansion and clarification of the integration safe harbor to address circumstances under which (1) a completed unregistered private offering would not be integrated with a subsequent registered offering, (2) an unregistered private offering that has been abandoned may be followed by a registered offering, and (3) an issuer may abandon a registered offering and undertake an unregistered private offering. Like SEC, staff of PSC encounters questions regarding integration on a regular basis. The Release should assist in addressing these issues.

Safe Harbor to Switch From a Registered to a Private Offering. Creation of a safe harbor for issuers that wish to abandon a registered offering and undertake a private offering would appear to be especially beneficial to small issuers. In our experience, many small issuers have no choice but to undertake a registered offering, because without the aid of general solicitation, the issuer has no access to potential investors. It is not unusual, however, for an issuer to register its securities and then encounter little public interest in purchasing the securities. The issuer is forced to abandon the offering without obtaining the needed capital. Many of these issuers cannot afford to wait six months to proceed with a private offering.

The flexibility to abandon a public offering and proceed with a private offering to persons eligible to buy under the private offering exemption, even if they expressed interest in the offering as a result of public offers in the registered offering, would provide significant regulatory relief for these issuers. So long as the conditions set forth in the Release are included within Rule 152, we believe that investor protection would not be compromised.

Safe Harbor to Switch From a Private to a Registered Offering. PSC supports the safe harbor provision that would permit an issuer to abandon a private offering and undertake a registered offering on a form other than Form B. PSC believes, however, that in order for persons offered securities in the private offering to be treated the same as offerees and purchasers in the public offering, SEC should require an issuer to both file the private selling materials with the registration statement, and inform offerees that the prospectus delivered in the registered offering supersedes any selling materials used in the private offering.


If the proposals contained in the Release are adopted, investor reliance on 1934 Act filings will increase. PSC agrees that, in light of the increased reliance on the reports, it is appropriate to adopt provisions to enhance the quality and timeliness of information included in these reports.

We support SEC’s efforts to "even the flow of disclosure" to provide small investors with access to information that currently may be available only to large institutional investors. We also support inclusion of risk factor disclosure in 1934 Act reports. As stated in the Release, risk disclosure would be equally valuable whether investors are purchasing securities in a registered offering or trading in the secondary market.

Additionally, we support the proposal to accelerate the filing dates for disclosure of annual and quarterly financial results in order to ensure uniform and balanced disclosure by public companies. Acceleration of the filing dates also would alleviate the situation under the current time lines where information included in reports may be stale by the time the report is filed.

We are in accord with the proposal to treat the financial statement and MD&A disclosure in Forms 10-Q and 10-QSB as filed. According to Fraudulent Financial Reporting: 1987-1997, of the approximately 200 financial statement fraud cases reviewed, the average fraud period extended over 23.7 months, and involved both annual and quarterly financial statements. The report also found that fraud often begins with the misstatement of interim financial statements. Treating this information as filed, resulting in the attachment of liability under Section 18 of the 1933 Act, may serve to deter fraudulent financial reporting.

We agree with SEC that requiring the principal executive officers and a majority of the members of the board of directors to sign periodic reports should increase the quality of filings under both the 1933 Act and the 1934 Act. We support introduction of Plain English into the 1934 Act filing system as the changes contemplated by the Release will increase the need for investors to read 1934 Act reports, and understand them.


The Release requests comment on proposed revisions to SEC staff review policy. Under the policy, SEC staff would continue to review all registration statements filed in connection with an initial public offering (IPO), and would review Form A registration statements filed by certain repeat issuers. Form B registration statements and Form A registration statements filed by seasoned issuers that would be able to choose an effective date would not be reviewed.

A Form A seasoned issuer that wishes to determine the date of effectiveness of its offerings would have to have its 1934 Act annual report that would be incorporated into Form A fully reviewed by the SEC. The 1934 Act reports of a Form B issuer would be subject to selective review.

PSC is delighted that SEC is committed to reviewing all registration statements filed in connection with an initial public offering. This is a critical investor protection function. PSC believes that no issuer of securities should be completely free from SEC review of its disclosure. PSC believes that the registration statements of Form A issuers should be reviewed regardless of whether the registration statement is filed in connection with an IPO or a repeat offering. With respect to Form A seasoned issuers that can choose the effective date of their offerings, we believe SEC staff should review not only the annual report to be incorporated by reference, but also Forms 10-Q subsequently filed. We commented earlier in this letter that only the most recent annual report of a Form A seasoned issuer should be incorporated by reference and subsequent information should be included in the prospectus. Review of the Forms 10-Q would ensure that information updating the Form 10-K would be subject to SEC review.

The Release provides that a Form B issuer must incorporate by reference its latest annual report filed under the 1934 Act and any reports filed since the end of the fiscal year covered by its latest annual report. We believe that all reports incorporated by reference should be reviewed by SEC.

PSC appreciates the opportunity to communicate its views on this important regulatory initiative. If SEC staff have any questions or require additional information, please do not hesitate to call Lynn Naefach, Counsel, Division of Corporation Finance at (717) 787-5401.

Very truly yours

/s/Robert M. Lam

Robert M. Lam



cc: A. Richard Gerber, Commissioner

John A. Maher, Commissioner

Deborah R. Bortner, Chair, NASAA Corporation Finance Section

Karen M. O’Brien, General Counsel, NASAA