REVISED August 6, 1999
July 30, 1999
Securities and Exchange Commission
450 Fifth Street N.W.
Mail Stop 6-9
Washington, D.C. 20549
E-mail address: firstname.lastname@example.org
Attention: Jonathan G. Katz, Secretary
Re: Securities Act Release No. 33-7606A
Exchange Act Release No. 34-40632A
Ladies and Gentlemen:
The Committee on Securities Regulation of the Business Law Section of the New York State Bar Association appreciates the opportunity to comment on Releases Nos. 33-7606A and 34-40632A, dated November 13, 1998 (the "Release").
The Committee on Securities Regulation (the "Committee") is composed of members of the New York Bar, a principal part of whose practice is in securities regulation. The Committee includes lawyers in private practice, in corporation law departments and in government agencies. A draft of this letter was circulated for comment among members of the Committee and the views expressed in this letter are generally consistent with those of the majority of the members who reviewed the letter in draft form. The views set forth in this letter, however, are those of the Committee and do not necessarily reflect the views of the organizations with which its members are associated, the New York State Bar Association, or its Business Law Section.
I. Conceptual Overview
We commend the Commission and the members of the Staff for their efforts in attempting to improve the current securities offering process and the disclosure system under the Securities Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act"). The Release reflects the results of an enormous undertaking that has resulted in what is colloquially referred to as the "Aircraft Carrier". The stated goal of the Release is "to make the registration system more workable for issuers and underwriters and more effective for investors in today's capital markets."
There have been many occasions over the past thirty years to reexamine the operation of the Federal securities laws in order to address changes in the offering and capital raising process. As noted in the Release, there had been a progression toward greater reliance on the efficient market theory and the public availability and integration of information under the Securities Act and the Exchange Act with a conceptual underpinning of incorporation by reference as one of the key ingredients of the Securities Act registration process. Beginning with the integrated disclosure recommendations of Milton Cohen, the report of former Commissioner Francis M. Wheat and the efforts of Professor Louis Loss, and culminating with the Report of the Advisory Committee on the Capital Formation and Regulatory Processes chaired by former Commissioner Steven M.H. Wallman (the "Advisory Committee"), the Securities Act regulatory process appeared to be moving in the direction of some form of "company registration". The Advisory Committee recommended the adoption of a company-based registration system, rather than a transaction-based system, which it viewed as the logical culmination of the improvements that had been made over the years, as exemplified most recently by "universal" shelf registration. The Advisory Committee also concluded that the transactional concepts underlying the registration process continued to "impose unnecessary cost and restrictions on issuer access to capital, as well as an impediment to full and timely disclosure to investors and markets."
The Release has addressed many of the problems identified in the Commission's 1996 Concept Release (Release No. 33-7314). By proposing a transaction-based system, however, we believe the Commission has abandoned some of the major improvements in the registration and disclosure processes since the adoption of integrated disclosure in 1982 and has failed to take advantage of the dramatic advances that technology has made in the dissemination of information and its impact upon the securities markets. We believe that the advantages of the proposed system are far outweighed by its disadvantages, particularly for seasoned issuers, as discussed below. Many of the changes proposed by the Release would, in our view, be so disruptive to the capital raising process that it would be preferable to continue utilizing the current registration system and correct the deficiencies identified by the Commission's Task Force on Disclosure Simplification rather than risk the adoption of a new and untested registration system that we believe to be seriously flawed. We also believe that the Commission should revisit the registration process with a view to adopting a conceptual approach closer to the one recommended by the Advisory Committee, building upon the benefits inherent in the current Form S-3/Rule 415 shelf registration process, notwithstanding that such a reexamination would likely require an effort comparable to that required to create the "Aircraft Carrier".
II. Prospectus Delivery Requirements
Proposed Rule 172. The preliminary prospectus delivery requirements of proposed Rule 172 would add substantial elements of delay and uncertainty to the registered offering process. The resulting loss of efficiency, and increased risk to market participants, would increase the relative attractiveness of unregistered offerings, in the Rule 144A market or offshore. We strongly oppose imposition of these new requirements.
As a purely conceptual matter, there is an undeniable logic to requiring delivery of information to investors prior to the investment decision. Eliminating the requirement to deliver a final prospectus makes sense from this perspective, and we support that aspect of the proposed changes to Rule 172. The preliminary prospectus delivery requirements, however, must be assessed in light of practical market realities _ both as to the likely impact of the proposed changes, and the actual need for additional delivery requirements.
Under current market practice there are substantial market segments in which most transactions are effected on a "real time" basis _ i.e., shelf registered securities are priced and sold immediately. Medium-term notes, underwritten offerings of other debt securities and secondary offerings of common stock are routinely sold in this manner on a registered basis. Proposed Rule 172, by requiring prior delivery of a preliminary prospectus, would introduce elements of delay into this process. Even if same-day delivery were permitted for large seasoned issuers (which would be clearer if the rule required delivery "before the time" of the investment decision, rather than "before the date"), the delay would necessarily reduce the efficiency of the registered offering process. The only questions that arise are whether the additional risk would be absorbed by issuers or by underwriters or other market intermediaries, or whether it would result in a shift toward unregistered offerings. The proposed Rule would have an even greater impact on the smaller or unseasoned issuers, which would be subject to three or seven day prior delivery requirements. We expect this change would have similarly harmful effects on the U.S. capital markets. And the extension of the 3/7 day requirements to MJDS offerings substantially undermines the utility of that system to Canadian issuers, without any justification offered. The Commission should not introduce changes of this importance into the capital raising process without very carefully analyzing their economic consequences. The Release does not demonstrate that such an analysis has been done.
Given the potential impact of these changes, the Commission should also undertake a more careful analysis of the practical need for them in the current marketplace. We believe that there is simply no demonstrated need for the additional steps that would be added to the capital raising process. First, in many offerings by seasoned issuers "off the shelf" _ including many medium-term note, investment grade debt, and secondary stock offerings _ there is simply no material information, other than the pricing terms, not included in the registration statement itself. Thus, no useful information can be conveyed by a term sheet. In addition, under current practice, issuers and underwriters often do circulate preliminary prospectus supplements, though not required, where it will facilitate the sales effort _ for example, where the issuer is not well known to investors in the targeted market, or where the terms of the securities are novel or complex. We also do not feel that the 3/7 day prior delivery requirements for smaller or unseasoned issuers are justified by any identifiable problems under current market practice. In our view, therefore, the Rule 172 delivery requirements are aimed at a problem that in large part does not exist, and address that problem through measures that could do substantial harm to the capital markets. We note that the integrated disclosure system and, more recently, the wide-spread electronic dissemination of the information that issuers file under the Exchange Act, have generally provided investors with up-to-date information on reporting issuers' business and financial position. To the extent actual needs for further information are identified, we suggest that the Commission explore ways to encourage use of generally available electronic media _ such as websites maintained by issuers _ rather than requiring additional physical delivery.
There are two other significant problems with proposed Rule 172. First, by apparently requiring prior delivery to each investor, the proposed Rule would seem to make it impossible to add prospective investors within the applicable three- or seven-day period. This could make it significantly more difficult to complete offerings in less favorable markets by adding new offerees, and could thus lead to more frequent downsizings of offerings. If the proposed Rule is adopted, the Commission should revise it to track the concept appearing in Rule 15c2-8, which requires delivery only to investors "reasonably expected to receive" confirmations.
Second, the requirement of proposed Rule 172(e) to deliver a document reflecting any "material change" at least 24 hours before pricing appears likely to introduce further delays to the offering process, again without real justification. Changes arising on the scheduled day of pricing would, under the proposed rule, result in an automatic postponement of the offering. We believe that this change is totally unjustified. The current market practice (which calls for communicating such changes to investors orally) functions well and, in any event, has not been shown to be deficient. Indeed, the proposed change may create a perverse incentive to withhold information, since the decision to communicate a change to investors might lead to an inference that the 24-hour requirement had been triggered.
Revised Rule 174. We oppose the change that would permit aftermarket delivery by adding a reference in the confirmation of sale. If the investor truly needs to receive this information, the confirmation is not a means well-calculated to communicate it. We feel the better view is that no special reference is needed.
III. Form B Registration Statement
1. Delayed Primary Shelf Offerings
One of the most efficient and cost effective features of the current S-3/ Rule 415 registration process is the delayed shelf offering, particularly for investment grade debt and preferred equity securities. Thus far, at least, there has been only limited use of delayed shelf offerings for the issuance of common stock. The key ingredient of the current process is the Rule 424(b) prospectus supplement which obviates the need for amendments to the registration statement and, in reliance upon incorporation by reference of company information, facilitates rapid take-downs from the shelf. This can also be accomplished without the delivery of a term sheet to prospective investors prior to receiving commitments or the need for officers and directors to review and sign post-effective amendments to the registration statement before filing with the SEC.
The proposal in the Release would effectively eliminate delayed offerings as they are known today because of the requirements to (1) prepare and deliver a term sheet or other preliminary prospectus before receiving commitments, (2) file post-effective amendments to the registration statement to update transactional information, (3) file post-effective amendments to incorporate by reference forward information not previously filed or disclosed during each offering period (meaning each takedown off the shelf), and (4) file a post-effective amendment to include pricing and related information in the final prospectus.
We believe there is a continued need for delayed shelf registration for issuers using Form B if the current speed, efficiency and economic benefits of the capital raising process are to be retained for large seasoned issuers, particularly in sales of investment grade debt and preferred equity securities.
2. QIB-only Offerings.
We support the proposal to permit seasoned issuers who do not satisfy the Form B size requirements to utilize Form B for sales to QIBs. However, we do not believe that parties satisfying the QIB size requirements should be excluded unless there is evidence of abuse or potential harm to investors.
We believe that dealers purchasing for resale to QIBs and investment advisors purchasing for the accounts of QIBs should be permitted to participate. The exclusion of dealers would effectively preclude the use of Form B for underwritten offerings to QIBs. We also do not believe that there should be a different definition for purposes of Rule 144A than for Form B offerings.
We also believe that reinstituting the "presumptive underwriter" concept to the Form B registration process would seriously undermine any potential benefits sought to be achieved. The inclusion of a requirement that the securities "come to rest" with the QIBs would seriously limit the transferability and liquidity of the investment and, ultimately, could result in significantly increased costs to issuers.
As we discuss later under "Proposed Elimination of Exxon Capital," we do not believe that the inclusion of QIB-only offerings on Form B should serve as the basis for eliminating the Exxon Capital exchange offer procedure. On the other hand, if Exxon Capital were to be eliminated, not only would a viable QIB-only offering process be needed for seasoned issuers but a mechanism should also be established to permit first time registrants of high yield debt and non-convertible preferred securities for sale solely to QIBs to enter the registration process without the delays inherent in the use of proposed Form A. This could be done, for example, by providing automatic effectiveness on Form A for offerings structured to ensure that sales will be limited to the institutional market.
3. Form B Disqualification
We disagree with the proposal to disqualify some of the enumerated categories of issuers and underwriters from the use of Form B. Since many of the same factors would apply to the permitted use of incorporation by reference and expedited effectiveness for Form A registration, our objections would be the same.
One set of provisions would cover specified violations by the issuer, executive officers and directors as well as underwriters (Form B General Instructions IB6(g) and (h) and Form A General Instructions II B7 and 8). These requirements would add unnecessary confusion to the offering process and would impose undue burdens upon both issuers and underwriters in relation to the activities of the other. Further, the potential liability of issuers and underwriters resulting from the discovery of the disqualification after the completion of the offering would seriously jeopardize the entire offering process.
We also have serious reservations concerning the proposal that would preclude the use of Form B and ineligibility to incorporate by reference and rely on automatic effectiveness on Form A by issuers having unresolved disputes with the Staff in connection with their Exchange Act filings (Form B General Instruction IB6(i) and Form A General Instruction II B10). This requirement should not be adopted because it could impede the speed and efficiency of short form registration and gives too much leverage to the Commission Staff in reviewing Exchange Act filings.
Similarly, although we understand the rationale for eliminating the availability of Rule 401(g) for Form B registration statements because they become effective automatically, we believe the Commission should reconsider the potential consequences of this proposal. To the extent that a Section 5 violation results, should the liability be borne by all participants in the offering process or only those that were the source of the disqualification? Similarly, should liability be the same regardless of the magnitude or timing of the violation? We believe some attempt should be made to limit the consequences of the use of the wrong form in cases where there was a good faith attempt to comply or the violation was immaterial.
4. Secondary Offerings
We disagree with the proposals in the Release that would require offerings by selling securityholders on Form B to qualify under the same size requirements as offerings by an issuer, at least in offerings by non-affiliates. We do not believe the Commission has demonstrated that abuses of the short form registration process by non-affiliates have resulted in sufficient injury to investors to warrant the elimination of this practice. Even if abuses were to exist, we believe that a six month or comparable holding period would be sufficient to eliminate any ability of issuers to utilize secondary offerings as indirect primary distributions. We wish to point out, however, that in its present form, Form B would not be usable for secondary at-the-market offerings, even for issuers meeting the size of issuer eligibility requirements. Both the restrictions on forward incorporation by reference and the requirements for the delivery of a term sheet or prospectus prior to sale would restrict the use of Form B to underwritten secondary offerings. We do not believe that a major change of this type should be adopted without clear and convincing evidence of abuse and significant harm to investors.
Whether or not the Commission makes a distinction between affiliates and non-affiliates for this purpose, we would recommend the adoption of the definition of "affiliate" proposed by the Wallman Commission. For this purpose an affiliate would include only a holder of 20% or more of the voting power, a holder of 10% or more of the voting power with at least one director representative on the board, the chief executive officer, inside directors and the director representatives of an affiliate.
5. Review of Form B Registration Statements
We believe that many of the potential benefits of short form registration on Form B would be lost if there was a policy to screen Form B registration statements for post-effective review. This practice could result in even more serious consequences because of the elimination of the availability of Rule 401(g) for Form B registration statements, as discussed above. As we suggested, even if such a practice were to be followed we believe that the Commission should give consideration to clearer guidelines of the consequences. An effort should be made to avoid the imposition of significant liability where there is a good faith attempt to satisfy the eligibility and other requirements of the form.
6. Non-Convertible Investment Grade Securities
We concur in the Commission's conclusion to permit registration on Form B for offerings of non-convertible investment grade debt and preferred equity securities by seasoned issuers who do not meet the size eligibility requirements. Since securities of this type generally are purchased on the basis of the issuer's credit rating, we believe there is adequate investor protection by combining seasoning with an investment grade rating.
7. Filing Offering Information and Free Writing
The Release would require issuers to file with the Commission "offering information" and "free writing" materials used after the commencement of the 15 day period prior to the "first offer". The failure adequately to define the term "first offer" is one of the major deficiencies in the Release and should be rectified. We also are concerned about the potential liability for issuers and underwriters for the failure to file all materials disclosed "by or on behalf of the issuer". This result is unduly harsh and could have unforeseen consequences. We do not believe it is appropriate to expect an issuer to control all information distributed by every member of the underwriting syndicate. No underwriter should be expected to control all information distributed by the other members of the syndicate. The need to conduct a "retroactive" market sweep of all information utilized during the offering period also raises serious concerns for issuers and underwriters.
From a liability standpoint, we have the same concerns in this area as we did with potential violations of Section 5 resulting from the possible use of the wrong form of registration statement and potential rescission rights for purchasers.
We also note that the goal of expanded communications through the use of "inclusive" disclosure may be defeated if the liability concerns are perceived as being unnecessarily severe. We believe that imposing Section 11 liability on offering information and Section 12(a)(2) liability on free writing may discourage the distribution of information. Moreover, under circumstances in which offering information contained in a communication constituting free writing was not previously filed as part of the registration statement, the entire document, including the free writing portion, would be subject to the broader liability provisions of Section 11 and Section 12 (a)(2).
We believe the Commission should reconsider the liability provisions in the proposals in an effort to limit the exposure of most communications, excluding clearly defined core "offering information", to Section 10(b) of the Exchange Act. We believe that this core information should be limited to the description of the securities and the plan of distribution in addition to any other information constituting part of the registration statement.
IV. Form A Registration Statement
Proposed Form A would be available to register offerings by unseasoned issuers and issuers that do not satisfy the size test for registration on proposed Form B. While the Release maintains the current disclosure obligations and registration process for unseasoned issuers, it proposes changing the obligation and process for seasoned issuers in two important respects - (i) incorporation by reference and delivery of information and (ii) timing of effectiveness of the registration statement. While we believe that certain aspects of both major issues are meritorious, we believe that such items as proposed have significant flaws.
1. Incorporation by Reference and Delivery of Information
The analog for the proposed form of disclosure for seasoned issuers is the Form S-2. Although the Commission states in its proposal that only 102 issuers used Form S-2 in 1996, the proposed decrease in the seasoning test from three years to two years together with the substantial increase in the size test from Form S-3 to Form B will significantly increase the number of seasoned issues that would be required to use Form A. We believe that the incorporation by reference and delivery provisions for seasoned Form A issuers should not be adopted as proposed.
Our primary concern raised by the proposal is the level of required information which an issuer must include in the registration statement if it elects not to deliver its incorporated Exchange Act reports together with its prospectus. The proposal would require issuers to include full Form S-1 disclosure in the prospectus if it elects not to deliver the Exchange Act reports in lieu of abbreviated company information presently required under Form S-2. Our experience with Form S-2 offerings has been that most issuers provide the required information in the prospectus rather than by incorporating by reference and delivery of the incorporated documents. We have found that this is preferred by underwriters for presentation and marketing reasons as well as for investor ease of use. We do not believe that this practice will change if the proposal is enacted. Consequently, issuers that elect to include this information in the prospectus would be required to include full Form S-1 disclosure. We strongly urge that the Commission retain the current approach of Form S-2 with respect to inclusion of information. We believe that this information (risk factors, the financial statements, selected financial information, management's discussion and analysis, and the description of the business) is significantly more important to the investor than the management-related information which Form S-2 permits to be excluded. With the ease of access to an issuer's Exchange Act reports via the Internet, we do not believe that maintaining the present inclusion requirements will be detrimental to investors.
We do agree, however, with the Commission's requiring the more comprehensive business description from Item 101 of Regulation S-K rather than including the abbreviated disclosure required by Rule 14a-3 under the Exchange Act. Our experience has shown that the low standard of Rule 14a-3 has not resulted in the presentation of meaningful company information.
2. Timing of Form A Offerings
We agree with the Commission's proposal to allow certain seasoned issuers eligible for use of Form A to control the timing of the effectiveness of a registration statement. We believe that this proposal is an important step in improving the flexibility of the securities laws and allowing issuers to quickly access today's fast-moving capital markets while removing the uncertainty of timing resulting from the review process. While the achievement of the stated goals of this particular proposal should be beneficial to issuers, it is important that the parameters for controlling the timing of effectiveness be carefully considered because the elimination of pre-effective Commission review could adversely affect the quality of disclosure and, thereby, decrease investor protection. The need to carefully craft this proposal and decrease the potential for abuses is even more vital for Form A-eligible issuers than for the larger, and theoretically more widely-followed, Form B-eligible issuers.
In that regard, several aspects of this proposal need to be considered. First, with respect to the eligibility criteria for issuers ($75 million public float or Commission review of its latest incorporated annual report), the Commission may also want to consider establishing some minimum public float criteria for issuers qualifying under the latter criteria (i.e. $40 - $50 million) to ensure that the ability to control timing is entrusted to issuers with a sufficient level of market following. For issuers who qualify by virtue of their annual report having been reviewed by the Commission, it appears to be reasonable to allow the issuer to rely on the reviewed annual report until the time its next annual report is required to be filed as long as it is required to provide disclosure of any material changes either in other periodic reports incorporated by reference in the registration statement or by way of disclosure in the registration statement itself. In order for this eligibility criterion of Commission review to be anything other than subject to happenstance, it would be advisable for the Commission to establish some mechanism for issuers to request Commission review of their annual reports. The Commission can relieve the potential burden on itself of a potential overload of these requests by limiting the ability to request Commission review to only those issuers who are otherwise eligible for use of Form A (i.e. current in their Exchange Act filings, timely filings for the last 12 months, etc.). While some commentators may suggest that the "recently reviewed" alternative results added complexity to the regulatory framework, we believe that the benefit of improved disclosure outweighs the complexity.
One potential drawback to creating a process whereby Exchange Act reports are reviewed is the possibility that with the filing of multiple amendments to Exchange Act reports, issuers will create confusion for their shareholders and possibly subject themselves to a greater threat of liability from shareholders who claim they were adversely affected by inadequate disclosure which the Commission review requires an issuer to amend. However, if an issuer elects to subject itself to Commission review in anticipation of a registered offering, an issuer can decide for itself whether the benefits of being able to control the timing of effectiveness for a subsequently filed registration statement outweigh the risks arising from Commission comments on and amendments to the issuer's Exchange Act reports. In addition, without this pre-filing review process, a Form A-eligible issuer that incorporates Exchange Act reports in its registration statement would still be subject to Commission review of those Exchange Act reports. Therefore, without this advance review process, an issuer who is registering securities would be subject to the risks of amending its Exchange Act reports, but would not receive the benefits of controlling the timing of effectiveness of registration statements.
We do not concur with two proposals relating to issuer eligibility to control the timing of effectiveness. We do not believe that requiring the filing of the underwriters' confirmation of the issuer's decision as to the timing of effectiveness is necessary. Our experience with underwritten offerings has been that the underwriters work closely with the issuer in planning and determining the timing of an offering. Indeed, in practice, the effective date is frequently driven more by the underwriters than by the issuer. We have serious reservations, however, with respect to the Commission's proposal to conduct post-filing "red-flag" screenings. We believe that this practice would lead to significant issues of potential liability impacting the entire offering process.
As an alternative to restricting the timing of effectiveness to securities which have already been registered under the Exchange Act, we would propose that the Commission establish a pre-clearance process requiring the issuer to deliver a term sheet of the proposed securities. The Commission could then determine whether to review the eventual registration statement or allow the Form A issuer to control the timing of the registration statement without Commission review. This pre-clearance process would require less Commission intervention than a full review of the registration statement, but also safeguard the investing public from inadequate disclosure of complex securities by less-seasoned issuers.
V. Communications During the Offering Process
1. Research. In general, we support the proposed expansion of the coverage of Rules 137, 138 and 139 as likely to increase the flow of useful information to the marketplace. However, we believe that these rules should continue to provide that covered research will not be treated as a "prospectus". The prospect of Section 12(a)(2) liability would be a substantial disincentive to publishing during the pendency of a registered offering, which in turn would undercut the expansion of the Rules' coverage. We also view the requirement that the research be stickered to reflect the broker-dealer's role in the registered offering as providing little or no benefit to investors (who will generally be aware of the dual roles) while creating substantial practical problems (as broker-dealers' roles may be uncertain for long periods or change on short notice).
2. Issuer Communications. Proposed Rule 167 would add useful certainty in Form A offerings by providing a 30-day bright-line safe harbor. The proposed Rule would be much less useful in Form B offerings since the safe harbor is defined by reference to the "offering period" concept, which in turn is based on the impossibly ambiguous "first offer" concept in Form B. We suggest that some clearer and more objective standard be used instead.
We believe that proposed Rule 168 is too narrowly drawn to be of much practical utility, and that proposed Rule 169 does little but codify current practice with respect to factual business communications. However, we would not oppose adoption of either proposed Rule.
We support proposed Rule 165, which would permit free writing once a registration statement is filed. We expect, however, that the filing requirements of the proposed Rule would severely reduce the extent to which issuers would in fact rely on it.
VI. Underwriter Liability
The Commission has proposed (1) making clear that Rule 176 addresses the reasonable care standard of Section 12(a)(2) as well as the reasonable investigation standard of Section 11, and (2) identifying six due diligence practices against which a court could evaluate the due diligence efforts of an underwriter in the context of an "expedited offering" (as defined). The Commission, describing these practices as "guidance," states that "courts should view these practices as positive factors when evaluating an underwriter's due diligence defense". The Commission explicitly states, however, that these factors should not be considered an "exhaustive list" nor that the absence of any one or more of these practices (save one described below) should be considered "definitive" in reaching a conclusion about the adequacy of the underwriter's investigation. The Commission explicitly rejects the notion of a "safe harbor" from underwriter liability, citing the need for investor protection and the impossibility of a single, finite list of procedures which would be appropriate in every case. Finally, the Commission solicits comment on certain other due diligence practices and proposed practices.
Our committee is in agreement with the Commission that Rule 176 should be applicable to standards under Section 12(a)(2) as well as Section 11.
Our committee does not see why the Commission has limited the availability of the proposed "guidance" to offerings of equity and non-investment grade debt marketed and completed in fewer than five days. The distinction is particularly curious given the stated non-exclusive, non-mandatory nature of the proposed practices. We believe there are instances of investment grade debt offerings where such guidance could be relevant and useful, and we believe there are instances of transactions marketed and completed in time periods substantially longer than five days where such guidance could be relevant and useful. The current proposal has confused our Committee, and may therefore confuse courts considering the actions of underwriters in light of the proposed guidance, as to whether these practices are truly "guidance," or whether the Commission intends something more or less by them. We believe that principles of fairness and efficiency dictate that the intended nature of the proposed "guidance" be made explicit, if it is to be useful in guiding the future conduct of underwriters and courts evaluating underwriters' due diligence efforts.
With respect to the proposed practices themselves, our committee has the following comments (references are to subparagraphs of proposed new paragraph (i) to Rule 176):
In proposed subparagraphs (2) and (3)(i), the Commission suggests that failure by an underwriter to review all documents incorporated by reference in a registration statement establishes "definitively" (and presumably negatively) whether the underwriter has met the standards of Section 11 or 12(a)(2). We believe some expedited offerings are conducted on such a compressed timeframe that review of all incorporated documents may simply not be feasible. Some practitioners asked to give "10b-5" disclosure letters in this context are currently unwilling to do so unless incorporated documents are excluded from the scope of such letters. We therefore question whether the absence of this factor should in fact be "definitive" with respect to all offerings, regardless of other circumstances.
In proposed subparagraph (3)(iii), the Commission identifies the practice of receiving a SAS 72 comfort letter as a positive factor. Our committee suggests that in some circumstances an "agreed procedures letter" under SAS 35 may also be a positive factor, even in circumstances where a SAS 72 letter may be available.
In proposed subparagraph (3)(vi), the Commission identifies the "practice" of consulting a research analyst who has followed the issuer or the issuer's industry and who has published a report in the 12 months preceding the offering, as a further positive factor in establishing the underwriter's due diligence. While we agree with the Commission that under "limited and controlled circumstances" cooperation between analysts and underwriting units of investment banks can be useful and appropriate, this is not typically the case outside the realm of initial public offerings. We do not believe that this practice is currently "standard" (with the possible exception of IPO's). We further believe that the Commission's concept of a "one way" wall between analysts and underwriting units may be difficult to implement. Recognizing that research analysts are viewed as "outside" the Chinese Wall at an investment bank, we note that "consulting" a research analyst in the context of a non-IPO may have the effect of "tainting" the analyst with material non-public information with the result of "freezing" the analyst with respect to the issuer. This result would seriously inhibit the analyst's utility to the investment bank and to the analyst's investor clients who might otherwise benefit from the analyst's research product. Thus, we do not believe that this factor should be included in the list of circumstances under proposed Rule 176.
We considered the additional proposals of the Commission, beyond the six identified practices, relating to quarterly accounting reviews under SAS 71 and to accountants' examination/review of an issuer's management's discussion and analysis disclosure. While each of these procedures may be helpful in the due diligence process respecting some issuers and some situations, neither of these procedures would be so broadly indicated as to warrant inclusion in the proposed changes to Rule 176. Similarly, we considered the proposal relating to receipt of a favorable report from a so-called "independent qualified professional". In the first place, we are dubious as to whether such a professional would be available at a reasonable cost, given the professional liability involved. Secondly, we do not believe such a role would introduce a new or different skill set into the mix of lawyers, accountants and financial experts already involved in due diligence reviews. For these reasons, we do not believe these practices should be included in any revision to Rule 176.
VII. Proposed Elimination of Exxon Capital.
The Commission is proposing the repeal of the Exxon Capital line of no-action letters upon adoption of the proposals contained in the Release. These letters have formed the foundation of a marketplace for the sale of securities (particularly high-yield debt securities) followed by registered exchange offers of identical securities that give the investors the benefits of free marketability. This marketplace has become efficient and cost-effective and generally has been limited to sophisticated institutional investors who do not require the protection of registration. Moreover, there is no evidence that the existing Rule 144A/Exxon Capital exchange offer process has harmed investors, notwithstanding the fact that Securities Act registration occurs after the initial sale of the securities under Rule 144A. Even if the new registration process proposed in the Release is adopted, we do not believe that it would be appropriate as a matter of policy to rescind Exxon Capital.
The Commission objects to the large volume of offerings utilizing the Exxon Capital exchange offer procedure. The Commission also objects to the fact that purchasers of securities in the Rule 144A transaction who receive registered securities in the exchange offer no longer have underwriter liability when the securities are thereafter sold by the initial investors. Unlike the case in which securities are sold in a private placement and are resold pursuant to resale registration rights, the initial purchasers who participate in the exchange offer receive freely-tradable securities. What this analysis ignores, however, is that the market for the securities that are principally sold under the exchange offer procedure, namely high-yield debt securities, are traded in a market that is entirely institutional in nature and is serviced by investment banking firms who are able to provide an effective and efficient gatekeeper function. Thus, the content and quality of disclosure in offering documents in Rule 144A offerings, and the due diligence performed by the investment banks underwriting these offerings, are comparable in most respects to registered public offerings. Further, since issuers are subject, or become subject, to the periodic reporting requirements of the Exchange Act following the registered exchange offer, subsequent trading in the securities has the benefit of Exchange Act reports, as well as the information contained in the filed prospectus pursuant to which the exchange offer was made.
The Commission suggests that, by permitting offerings of securities to QIBs on Form B under the Release, the speed and flexibility of the current system can be replaced. Unfortunately, the proposed Form B offering to QIBs would be limited to seasoned issuers. Those issuers who could not qualify for Form B would be relegated to the use of private placements followed by shelf registration, a process that had significant limitations even where shelf registration for resales on Form S-3 was available. One of the major disadvantages of shelf registration in this context was that the securities remained "restricted securities" and did not afford sufficient liquidity to institutional buyers such as insurance companies that are limited by regulatory constraints on their ability to hold unregistered securities. This situation would be further exacerbated because the proposals in the Release would effectively eliminate the existing procedure for at-the-market resale shelf-registration. In those situations in which high-yield debt securities are being sold by private companies to finance acquisitions, the delays and uncertainties associated with registration on Form A would likely force issuers to rely on far more costly sources of financing, such as bridge loans and bank financings.
In those cases in which the issuer could qualify for the use of Form B there would continue to be a variety of problems under the new proposals. The Release suggests that eligibility for registration on Form B would be lost retroactively if the securities did not "come to rest" in the hands of the QIBs. If eligibility were lost, the removal of Form B from the protection of Rule 401(g) would result in liability under Section 5. Further, the use of Form B would preclude Rule 144A offerings that could also be accompanied by side-by-side offerings to a limited number of institutional accredited investors that do not qualify as QIBs (although this practice has admittedly been limited as a result of the implications under Regulation M).
The elimination of Exxon Capital not only would disrupt what has become an efficient and cost-effective market for high-yield debt securities by U.S. issuers, but would also reduce the attractiveness of the U.S. capital markets for foreign issuers who are able to utilize the process for sales of equity securities. This would serve as another basis for foreign issuers to avoid the U.S. markets. Large U.S. investors, on the other hand, are likely to continue to invest in foreign private issuers by continuing off-shore investment programs at a higher cost with less disclosure of the type typical in the United States. U.S. issuers as well, particularly those who are ineligible to use Form B, also may be forced to look off shore in order to raise capital in the most efficient and cost-effective manner.
We reiterate that, in our view, the securities markets for corporate debt in the United States, particularly offerings of high-yield debt securities to institutional investors, has been one of the highlights of the development of the capital markets under the current Securities Act regime. Even if all our concerns do not prove to be warranted, we believe the Commission should seriously reexamine this aspect of the proposals in the Release before risking such a dramatic change in the Rule 144A marketplace.
VIII. Integration of Registered and Unregistered Offerings.
We appreciate the Commission's efforts to revise Rule 152 to expand and clarify the safe harbor from the integration of certain public and private offerings. Because the rationale for integration has been questioned over the years and its application has been uncertain, any change that adds certainty is to be welcomed. Furthermore, there is nothing inherently in contravention of the objectives of the Securities Act if an issuer engages in successive private and public offerings, provided that there is a good exempt offering. This is especially true today where generally the same information about an issuer will be available to investors in a private offering as in a public offering, particularly in the case of a reporting company. Accordingly, the rule should favor permitting private and public offerings unless there is some compelling need for integration in order to preserve the registration objectives of the Securities Act.
In our comments below, we suggest some clarifications and modifications that add certainty and increase issuer flexibility in raising capital without lessening meaningful investor protection.
1. Safe Harbor/Grandfathering
The adoption of rule modifications and new rules should make clear that: (1) existing interpretations and no-action letters regarding types of transactions not expressly addressed in the adopted rules continue to apply; and (2) failure to satisfy the requirements of the rules does not preclude other grounds for concluding that the integration doctrine does not apply.
The adoption of the rules should also provide that any agreements or arrangements in existence or under negotiation at the time of adoption will continue to have the benefit of the applicable rules, no-action letters and interpretations as they existed immediately prior to such adoption. Otherwise the rules as proposed could affect registration rights of investors as well as increase the cost and burden to issuers of providing such rights, negotiated based on the rules and interpretations as they existed at the time.
2. Completed Private Offering _ Subsequent Issuer Public Offering
Proposed revisions to Rule 152 would provide that if a private offering is completed before the registration statement for the public offering is filed, the two offerings would not be integrated, irrespective of the length of time between the two offerings. An offering would be completed if all purchasers: (1) have fully paid the purchase price for the securities in the private offering; (2) are unconditionally obligated to pay for the securities; or (3) have conditional obligations to purchase securities where the condition is not within the direct or indirect control of the purchaser. Finally, the purchase price in the private offering must be fixed and not contingent upon market prices around the time of the registered offering.
We believe the proposal for completed private offerings should be considered in conjunction with the proposal for abandoned private offerings. As proposed, there is a gap between a completed offering, which appears to require that all the securities offered have been purchased, and an abandoned offering which would require for Form A issuers that no securities have been sold. How should a private offering in which some but not all of the offered securities have been sold be treated?
In fact, there is no reason to treat abandoned private offerings any differently than completed or partially completed private offerings. In each case, integration should not apply if the registered offering is filed after the private offering is over or has been discontinued and securities purchased, if any, have been paid for or the purchaser is obligated to pay for such securities subject only to conditions not under the purchaser's control.
As long as the original private offering satisfies the applicable requirements for exemption from Section 5, the offering by definition will be limited in nature and restricted as to offerees. As a result, the prior private offering should not present gun jumping concerns. In addition, investors will have the benefit of registration and the associated disclosure, with respect to any securities offered in the private offering that are subsequently included in the registered offering.
Although proposed Rule 152 does not expressly state so, the Commission in the Release indicates that the integration doctrine would not apply to private placements abandoned by a Form B issuer because there would be no filing required before sale and thus no gun jumping issue.* The safe harbor of proposed Rule 152 by its terms applies only to private placements abandoned by Form A issuers.
The result is that, for Form B issuers, integration would not apply to private placements whether abandoned or completed. The proposal should clarify that partially completed private offerings also are entitled to the safe harbor.
Rule 152(b) would, on the other hand, impose several complicated and burdensome requirements on Form A issuers to come within the safe harbor for abandoned private offerings. These requirements add a lot of paperwork, complexity and possible additional liability for the issuer without any increase in information about the issuer. There is no need for any of these requirements in order to achieve the registration objectives of the Securities Act (see below under "Abandoned Private Offering-Subsequent Issuer Public Offering"), and they should be eliminated.
Rule 152 should simply provide that private offerings will not be integrated with public offerings (for all issuers, Form A and Form B) filed after completion or partial completion and discontinuance of the private offering.
The provision in Rule 152 for determining completion should be modified as suggested below. The only other condition needed is that the issuer not take any actions inconsistent with discontinuance such as accepting subsequent offers to purchase or continuing to communicate the private offer.
Finally, the safe harbor should apply where the purchase price is contingent upon the market price if the purchaser is obligated to purchase a specified or determinable amount of securities by some determinable date. There does not appear to be any opportunity for abuse in such a case even if the purchase price is not fixed.
3. Convertible Securities or Warrants
Proposed Rule 152 would be expanded to protect the offering of the securities underlying convertible securities and warrants from integration with the registered offering. The offering of the underlying securities would be considered completed when the offering of the convertible securities or warrants is completed. We fully support this proposal.
4. Abandoned Private Offering - Subsequent Issuer Public Offering
We agree with the Commission's position that, for Form B issuers, an abandoned private offering will not be integrated with a subsequent registered offering. As discussed above under "Completed Private Offering", we believe that Form A issuers should have the same treatment.
Proposed Rule 152 would provide a safe harbor from integration for Form A issuers if: (1) all offerees are notified of the abandonment; (2) no securities were sold in the private offering; (3) there was no general advertisement or solicitation; (4) in a situation where any offeree is non-accredited, there is a 30-day cooling off period after the offerees are notified of the abandonment before the registration statement is filed; and (5) either (a) any selling material used in the private offering is filed with the registration statement; or (b) the issuer informs all offerees in the private offering that the prospectus supersedes any selling material used in the private offering and any indications of interest are rescinded.
We find several problems with these requirements. The tracking and notification of private offerees would be burdensome and time consuming without providing any material benefit to investors. These requirements should be eliminated completely. In any event, there should be a "reasonable efforts" standard.
Further, it is unclear as to whom the Commission is attempting to afford protection and why. Those private offering offerees who participate in the subsequent public offering would be afforded complete protection by virtue of their receipt of a prospectus in the public offering. They would necessarily know from the public offering material that: (1) the private offering had been abandoned; (2) the prospectus supersedes any previous selling document; and (3) prior indications of interest would no longer be applicable.
In any event, the most that would be needed would be to make such disclosure in the public offering prospectus. That is a disclosure requirement that should be addressed in Form A; it is not an integration issue. Those private offerees who do not participate in the public offering do not require further protection in the first place. With respect to "gun jumping", the limited and restricted nature of the exemptions from Section 5 registration should eliminate any concern. For the same reason, no cooling off period is necessary.
Finally, filing selling materials from the private offering with the registration statement would serve no relevant purpose, other than to ascribe liability where none exists. Issuers should not have to relinquish the limitation on statutory liability for private offering materials determined by the Supreme Court in Gustafson v. Alloyd, 513 U.S. 561(1995) in order to gain safe harbor protection.
5. Completed Offerings - Resale Transactions
Proposed Rule 152 would permit an issuer to register the resale of securities that were originally sold by the issuer in a completed private offering as defined above. Thus, the securities do not have to be paid for and the securities do not have to be issued when the registration statement for the resale is filed. Payment may be made following filing or effectiveness of the registration statement for the resale, and may be conditioned upon effectiveness of the registration statement, assuming the purchasers have no control over that condition. Resales by affiliates of the issuer (as defined by Rule 144) or a broker-dealer that had purchased directly from the issuer or an affiliate are expressly excluded from the safe harbor.
This proposal raises several questions. Even though it is considered as a safe harbor, the proposed Rule as written creates a negative implication that registration of resale transactions by affiliates or broker-dealers purchasing from the issuer or an affiliate would be prohibited by the integration doctrine. Does the Commission mean to suggest that resales by affiliates or broker-dealers may never be registered by the issuer, or is there some waiting period before such resales may be registered? Does the Commission intend to encourage such resales to be made through exemptive offerings such as Rule 144 transactions?
The stated reason for excluding affiliates and broker-dealers is uncertainty as to whether the transaction is truly a resale transaction or a primary offering by the issuer. Because the resale offering would be registered under the Securities Act, with the same statutory liability for the issuer as for a primary offering, it is hard to see what the advantage would be for investors in precluding a registered resale by affiliates.
Another reason given is that some issuers who do not qualify to use the short form registration statement on Form S-3 for primary offerings are permitted to use Form S-3 to register secondary offerings. These issuers could then use a sale to an affiliate with a subsequent resale as a conduit to register a primary offering under simplified Form S-3, assuming an affiliate was willing to undertake the statutory individual liability to which it would be subject as part of such a scheme. However, this issue does not, in any event, exist under the Aircraft Carrier proposals which eliminate the distinction between primary offerings and secondary offerings when determining whether an issuer may use Form B.
It appears that the proposal may be intended to permit PIPE (private investment, public equity) transactions in which investors agree to purchase securities in a private offering subject to a condition that a registration statement covering the resale become effective. In such a case, there is a legitimate question as to whether the transaction is truly a primary offering, and the exclusion of resales by affiliates or broker-dealers purchasing from an issuer or affiliate appears to be justified. If the Commission's intention is to permit certain registered resales of PIPEs, the Rule should expressly provide that it is only addressing PIPE transactions and does not intend to preclude registration of resales by affiliates in other types of transactions.
6. Lock-Up Agreements
Newly Proposed Rule 159 codifies the SEC's current position that registration of offers and sales are permitted under certain circumstances where lock-up agreements have been signed, specifically when: (1) the lock-up agreements involve only executive officers, directors, affiliates, founders and their family members and holders of 5% or more of the voting equity securities of the company being acquired; (2) the persons signing the agreements own less than 100% of the voting equity securities of the company being acquired; and (3) votes will be solicited from shareholders of the company being acquired who have not signed the agreements and who would be ineligible to purchase in a private offering under Sections 4(2) or 4(6) or Rule 506.
We support Proposed Rule 159 and urge its expansion to cover lock-up agreements in connection with tender offers. We believe that the objectives served by its application to mergers would be equally served by including tender offers, and that there would be no practical or protective disadvantage to do so.
7. Abandoned Public Offering - Subsequent Private Offering
Proposed Rule 152 would permit switching from a public offering to an unregistered private offering if: (1) a registration statement has been filed and the issuer withdraws it under Proposed Rule 477 (which permits automatic withdrawal upon application) or, where no registration statement has been filed, the issuer (Form B issuer) notifies all offerees in the public offering that it is abandoning the public offering; (2) no securities were sold in the public offering; and (3)(i) where the issuer first offers the securities in the private offering more than 30 days after abandonment or withdrawal, the issuer notifies each purchaser in the private offering that the offering is not registered, the securities are restricted, and investors do not have the protections of Section 11 of the Securities Act; and (ii) where the issuer first offers the securities in the private offering 30 or fewer days after abandonment or withdrawal of the public offering, the issuer and any underwriter agree to accept liability for material misstatements or omissions in the offering documents used in the private offering under the standards of Section 11 and Section 12(a)(2) of the Securities Act.
Certain aspects of the proposed rule are burdensome and would be difficult to implement and do not add to investor protection. For example, it would be almost impossible for a Form B issuer to determine who all the offerees may be in order to give notice of abandonment of the public offering. In any event, similar notification is required in the private offering materials. Also, as discussed above, we believe that parties should not have to voluntarily accept Section 11 and Section 12(a)(2) liability for private offering documents in order to be entitled to safe harbor protection. In addition, it is difficult to envision how such a provision would work. This appears to contemplate a contractual obligation to apply a statutory liability scheme, with many unanswered questions as to how it would be implemented. The proposed Rule also talks about statutory liability for underwriters, although there should be no "underwriters" in a private offering.
We recognize that the Commission has a legitimate concern about a private offering immediately following the abandonment of a public offering. We believe that the best solution would be a mandatory 30-day waiting period following abandonment or withdrawal of the public offering, which would eliminate any need for imposing statutory liability. In addition, we see no need for the condition that no securities were sold in the public offering.
In sum, we believe the following conditions should be sufficient to qualify for the safe harbor and would provide adequate protection for investors:
1. Any filed registration statement is withdrawn under proposed Rule 477;
2. The private offering material provides notice to each purchaser that the offer is not registered;
3. The securities are restricted and cannot be resold without registration or an exemption; and
4. The purchasers do not have protection under Section 11 or Section 12(a)(2).
8. Definition of Private Offering
We fully support the Commission's proposal to expand the private offerings covered by Rule 152 to include offerings under the Section 4(6) exemption and to specify in the text of the Rule that it applies to the Rule 506 exemption. We also would support including Rule 505 offerings in the safe harbor. The limitations and restrictions of the Rule should be sufficient to protect against abuse.
9. Proposed Changes to Rule 477
The proposed change to Rule 477 of Regulation C would allow registration statements to be withdrawn automatically upon filing the request, thereby expediting the use of Proposed Rule 152 in switching from a registered public offering to a private offering. We fully support the proposed changes to Rule 477.
IX. Multijurisdictional Disclosure System ("MJDS")
In our view, one of the most significant proposed changes to the MJDS (in addition to the indirect impact of proposed Rule 172 discussed above), and the one that we will direct our comments to, is the proposal to revise the current US $75 million public float test. For the reasons outlined below, we believe that the SEC should reconsider the changes to the MJDS public float requirement.
Presently, a Canadian "foreign private issuer" is eligible to use the MJDS for Form F-10 equity securities offerings if it has a 12 month reporting history in Canada and a public float of equity securities of at least US $75 million. The MJDS also imposes a public float requirement for various other offerings. The Aircraft Carrier proposes to replace the public float test with two alternative tests: (1) a public float of US $75 million or more and an ADTV of equity securities of US $1 million or more; or (2) a public float of US $250 million or more.
The SEC's stated rationale for this change is that Form B and MJDS eligibility requirements should be the same. That is, in both cases issuers should be selected on the basis of having a demonstrated market following and securities for which there is an efficient market.
However, this rationale fails to recognize a number of fundamental principles and objectives of the MJDS.
From a practical perspective, we question whether sufficient consideration has been given to the degree that the proposed changes will reduce the number of Canadian issuers eligible to use the MJDS and therefore reduce US investor access to securities of Canadian issuers. On this point, we are aware of a study conducted by the Investment Dealers Association (the "IDA", a Canadian self-regulatory body) that reviewed MJDS offerings by Canadian issuers since 1996 and found that: (1) approximately 40% of the issuers would not meet the revised eligibility and (2) only one issuer would meet the US $1 million ADTV requirement.
This drop-off in MJDS eligibility should concern the SEC given that the MJDS was intended to be a bold initiative reflecting the inter-relationship of U.S. and Canadian capital markets and the geographical proximity of the two countries. Significantly increasing the MJDS eligibility requirements is inimical to the objectives of the MJDS which the SEC set out at the time the MJDS was adopted (SEC Release No. 33-6902, at p.1) that the MJDS was "intended to facilitate cross-border offerings of securities ... and ... remove unnecessary impediments to transnational capital formation."
In addition, setting a much higher public float threshold is a drastic change in the direction of the SEC's reform measures which, to date, have generally relaxed the MJDS eligibility requirements to make MJDS more readily available to Canadian issuers. In 1993, the SEC adopted the following amendments to the MJDS: (1) Form F-9 and F-10 were amended to eliminate the market capitalization requirement (of Cdn. $180,000,000 and Cdn. $360,000,000, respectively) and to adopt a public float requirement of US $75 million - Form 40-F was similarly amended; and, (2) the 36-month reporting history requirement in Forms F-9 and F-10 and 40-F was reduced to 12 months. In 1993 the SEC also extended the "sunset" U.S. GAAP reconciliation requirement. At that time, the SEC stated (Release No. 33-7025, at p.1) that "[T]hese amendments are being adopted in light of the Commission's experience with the multijurisdictional disclosure system and should continue to facilitate transnational capital formation".
The proposals also fail to recognize that the MJDS is based on the principle of "mutual recognition" - a principle which arguably justifies a lower eligibility standard for MJDS issuers than Form B issuers.
Under the Release, Form B registration statements would become effective at the issuer's discretion - the SEC staff would not review these registration statements before the offering or take action to make the registration effective. By contrast, the SEC "non-review" policy with respect to MJDS registration statements is based on a policy of "mutual reliance". MJDS registration statements are subject to customary Canadian securities regulatory review practice. An MJDS registration statement is not made effective automatically upon filing with the SEC where no contemporaneous offering is being made in Canada and where preliminary materials are being filed. In the case of offerings not made contemporaneously in Canada, MJDS registration statements are made effective only after the Canadian securities regulator has completed its review. Of note, issuers using the MJDS continue to be subject to provisions imposing civil or criminal liability for fraud in each jurisdiction where the securities are offered.
The importance of mutual recognition was noted in SEC Release No. 33-6879 at p.3 which states:
While the multijurisdictional disclosure effort is based on the concept of mutual recognition, Canada was chosen as the first partner for the United States in part because of the similarities between the U.S. and Canadian investor protection mandates and disclosure requirements. The existence of a well-developed, sophisticated and reliable system for administering Canadian disclosure requirements was critical, given the Commission's reliance on Canadian definitions, procedures, application of disclosure standards, and day to day administration of those standards.
Finally, we question whether the SEC has given sufficient consideration to the possibility that the measurement of ADTV (based only on U.S. trading markets rather than world-wide ADTV) is unduly restrictive. It is widely acknowledged that the U.S. and Canadian trading markets for securities of interlisted Canadian issuers is highly integrated. As discussed above, there is a significant risk that many Canadian issuers will not be MJDS eligible under the new proposals. Further analysis of U.S./Canadian trading and pricing relationships may be needed so as not to disqualify Canadian issuers that on a combined U.S./Canadian trading market basis have a sufficient degree of pricing efficiency. If one accepts the results of the IDA's study referred to above, we find it hard to justify measuring ADTV in such a way that the required ADTV can be met by only one Canadian issuer.
In summary, the Release overlooks the goals of the MJDS and is a step backward from the SEC's views stated in a speech by SEC Chairman Breeden in May 1991 when the MJDS was introduced:
Canada's securities markets are among the most developed in the world. The MJDS was developed initially with Canada due to Canada's developed capital markets and strong regulatory tradition. While specific disclosure requirements of the U.S. and Canada differ in detail, the regulatory systems share the common purpose of ensuring that investors are given information adequate to make an informed investment decision. I might add that it is not entirely irrelevant that we also have a very strong and long tradition of working together on issues of mutual concern between the Commission and our colleagues from Canada. . . The MJDS considered today is an initial step in what I hope would be the eventually mutual recognition of the entire disclosure systems of our respective countries. I think it is important, as we begin the process, that we take the very large and significant step we are taking today, and that we then work hard on identifying areas in which we can improve the system as we go forward.
X. Exchange Act Disclosure
We support the concept of enhancing the quality and timeliness of information contained in Exchange Act filings where the quality is questionable or can be improved without unreasonable effort or expense and where the information is not already timely disseminated. We do not believe that the Commission has made a persuasive case that, except in certain limited instances, the quality of Exchange Act filings needs improvement or that the timeliness of these filings requires major changes.
The purpose of many of the Commission's proposals (for example, applying Section 18 liability, filing management reports to audit committees, requiring directors to sign Form 10-Q's and requiring certifications by signatories) seems to be to require Exchange Act filings to be made with greater attention by issuers to their liability for any omissions or misstatements. We generally believe that issuers take their Exchange Act obligations very seriously and, on the whole, make every effort to ensure timely, complete and accurate information in those filings. We also generally believe that the Commission and investors already have adequate remedies to protect against those relatively few cases of delinquent, inaccurate or incomplete information in Exchange Act filings.
Many of the Commission's proposals (for example, requiring disclosure of financial information on Form 8-K, accelerating due dates of Forms 10-Q and 10-K and expanding disclosure requirements of Form 8-K) seem based on the perception that there is something wrong with the current practice of disseminating information through press releases and conference calls with analysts, at least without making contemporaneous disclosure of that same information in Exchange Act filings. We generally believe that investors have current access to press releases and the reports which result from analysts' conference calls, and that requiring the same disclosure in an Exchange Act filing is not required to "level the playing field" as between large and small investors. EDGAR is a convenient site for obtaining much information concerning an issuer. But investors, large and small, use many other sources to obtain information (some of which are faster and easier to use than EDGAR), and we do not believe that any significant benefit will accrue from attempting to centralize that source of information through EDGAR, especially if a result, intended or otherwise, is to lessen the dissemination of information through the current means. More basically, we question the Commission's assumption that there is an "uneven playing field" between large and small investors which needs to be leveled. Large and small investors have different interests, time available and financial skills, and we do not believe the Commission has demonstrated that any material abuses result from press releases and analysts' calls where the same information is not included in contemporaneously filed Exchange Act documents. In many cases, smaller investors need the thoughtful and knowledgeable analysis which they can obtain only in analysts' reports based on the analysts' conference calls. The filtering of the information disclosed in analysts' conference calls through meaningful independent interpretation in fact helps, in our view, to create an efficient market.
We support the Commission initiatives which remind issuers to consider whether the disclosure of information to analysts or a select group of investors may constitute a violation of the Exchange Act unless the information is also promptly made available to all shareholders.
1. Annual and Quarterly Reports
a. Risk Factor Disclosure.
We support requiring risk factor disclosure in annual and quarterly reports, and we support requiring that the disclosure be drafted in plain English. We believe that the required disclosure now contained in Item 503 of Regulation S-K is adequate for these purposes, and need not be expanded at this time for Exchange Act filings.
b. Due Dates for Annual Reports of Foreign Private Issuers.
We do not support this proposal to reduce the due date for Form 20-F from six months to five months. We believe that the Commission should move slowly in changing the requirements for foreign private issuers, especially where burdens are being imposed without a significant benefit to U.S. investors. Adding regulatory burdens for foreign issuers will only increase the likelihood that foreign issuers will avoid extending their securities offerings into the United States.
c. Treating Quarterly Information as "Filed".
We do not believe that applying Section 18 remedies to financial statements and/or MD&A disclosure would cause registrants to alter the disclosure they currently make in quarterly reports. As noted above, we believe that issuers take their Exchange Act obligations seriously and make reasonable efforts to ensure complete and accurate information in those filings. Nor do we believe that providing Section 18 remedies will benefit investors in any material way since cases alleging Section 18 violations are seldom brought and are seemingly never successful. Moreover, we believe liability under Section 10(b) provides adequate protection to investors.
d. Request for Comment on Management Report to Audit Committee.
We oppose requiring filing a management report to the audit committee of the board of directors, and do not believe that filing such a report will enhance the quality of Exchange Act disclosure. We do not agree with the Advisory Committee's conclusion that the report would not specify a particular set of procedures or require an assessment of the adequacy of the procedures. To the contrary, we believe that the procedures will quickly result in boilerplate disclosure and that there will be an implicit assumption of adequacy. As a result, the report will provide potential plaintiffs with an additional claim, related solely to procedures, when there are already adequate substantive causes of action for an omission or misstatement.
2. Interim Reports on Form 8-K
a. Timely Disclosure of Annual and Quarterly Results of Domestic Corporations.
(i) Form 8-K Requirement for Item 301 Information.
The Committee believes that the proposal to report selected financial information on Form 8-K when financial information is released in a press release prior to the filing of a Form 10-Q or 10-K is misguided and based on incorrect factual assumptions. Although technological developments may have simplified the process of preparing financial data and periodic reports, the disclosure requirements have become more complicated and more detailed and the process of gathering the necessary data in an expanding world-wide market economy has become more difficult and time-consuming. As a result, although hundreds of companies may issue press releases before the due dates of their annual and quarterly reports, hundreds, if not thousands, of public companies do not and can not. Even though many of these companies have completed the preparation of their core financial data before the due dates of their Exchange Act filings, in many of these cases full Item 301 information is not available at that time. Finally, investors who do want to follow a particular company can easily access that company's press releases. The Committee believes investors who wish to be kept apprised of current developments with respect to registrants have the ability and resources to access press release information on a real time basis, and do not necessarily rely on the Wall Street Journal or The New York Times for publication of that information. To base burdensome and expensive regulatory proposals on a fact such as "not all investors subscribe to the publications that supply press release information" is wrong. We believe that all interested investors are or can be informed of a company's financial results at or about the same time under the current regulatory framework. We are very concerned that in an effort to ensure uniform and even disclosure, where no strong case has been made that non-uniform or non-even disclosure is a significant problem, the result will inevitably be a significant delay in the release by registrants of any financial information. This is especially troubling in adversely affecting the ability of a company to "alert" the market that revenues or income will be materially lower (or higher) than that anticipated by analysts. We think the public interest is better served by continuing to permit registrants to issue financial information when it is available, recognizing that the accuracy and completeness of that disclosure will be actively enforced by the plaintiff's bar and the Commission. We believe that any requirement to include full Item 301 information at this early stage would be costly and also result in significant delay for many hundreds of registrants. The Commission states that it believes that "all investors and the market would benefit from being able to review selected financial data earlier than they can today." While no one could argue with that statement, the cost of accelerating disclosure is far too high, especially if the result is, as we are confident would be the case, the delay in the release of financial information.
(ii) Solicitation of Comments on Whether to Accelerate Due Dates.
The experience of members of the Committee is that many registrants, especially smaller ones and companies with widespread international operations, have great difficulty in meeting the 90- and 45-day requirements for their annual and quarterly Exchange Act filings. We do not support any shortening of the due dates of those reports. Our experience is that many of those companies that do have their financial information ready earlier release that information either in the form of a press release or an Exchange Act filing at that earlier date so that there has been public dissemination of the financial information when it becomes available. Basing shorter due dates on the ability of the largest and most efficient registrants to meet these dates would be costly and extremely burdensome on the hundreds of registrants that have great difficulty today in meeting the 90- and 45-day requirements.
b. Other Reporting Events.
(i) Material Modifications to the Rights of Security Holders.
We agree with the move of this information from Form 10-Q or Form 10-QSB to Form 8-K, and with a reduction to five business days for its filing where the modification was not subject to vote by security holders and thus already the subject of an Exchange Act filing. Requiring a filing in five calendar days is not, in our view, a requirement that can be easily met by thousands of smaller and less sophisticated registrants.
(ii) Departure of CEO, CFO, COO or President.
We believe that the departure of a CEO or CFO will generally be viewed as a material event and should be disclosed in a Form 8-K. We believe that a registrant should be able to make its own determination whether the departure of its COO or president may also be deemed to be a significant event. We do not believe that any interest is served (other than investor curiosity) by setting forth the reasons for the departure of a senior officer. Those reasons are often personal and usually have no impact on the value of a registrant's securities. We do believe, however, that, as is the case for a director, disclosure be required if the CEO or CFO wishes to set forth the reasons for his or her departure, with an opportunity for the registrant to comment on the CEO's or CFO's statement. We would support a reduction to five business days for the filing of a Form 8-K, but one business day is, in our view, inadequate time to carefully prepare and make this filing.
(iii) Material Defaults on Senior Securities.
We agree that if a covenant default is material, it should be reported on a current basis on Form 8-K, rather than waiting for a quarterly report on Form 10-Q. However, when a registrant is in the process of negotiating a waiver or amendment which will waive or cure a default, and in good faith believes that the waiver or amendment will be forthcoming, no disclosure should be required during those negotiations. We also would support a reduction to five business days for the filing of a Form 8-K, but one business day is, in our view, inadequate time, especially when management's attention may be on saving the company.
(iv) Reliance on Prior Audit.
The Committee agrees that Form 8-K disclosure should be required if an independent auditor notifies a registrant that it may no longer rely on the audit report. However, we do not agree that a notification that the auditor will not consent to the use of a prior audit report is automatically disclosable unless it is based upon an inconsistency in the audit report or is based on an issue of management integrity. The Committee also does not believe that disclosure should be required when an auditor decides to re-audit a prior audit period. Such a re-audit may be undertaken for many reasons and not necessarily for reasons which relate to the accuracy of material financial information. We also would support a reduction to five business days for the filing of a Form 8-K, but one business day is, in our view, inadequate time for preparing and filing the Form.
(v) Name Changes.
The Committee agrees with the proposal to include a change in name in a Form 8-K. However, name changes resulting from a business combination which were subject to stockholder votes, and thus are already a matter for Exchange Act filings, probably should be excluded from this requirement.
(vi) Due Dates for Reporting Events.
The Committee objects to a system with multiple due dates for Form 8-K filings as confusing and likely to result in inadvertent late filings. We believe that most of the information which would be reported on a Form 8-K will already be reported by means of a current press release. Registrants are under significant pressure by analysts and institutional investors to report material information promptly, and run the risk of significant litigation for failing to promptly make public available material information. We do not believe that changing the due dates for Form 8-K will result in investors learning of this material information at an earlier time.
a. Exchange Act Reports and Registration Statements.
The Commission's proposals under this section seem to be based on its view that Securities Act filings have a higher quality of disclosure than Exchange Act filings and on anecdotal statements that officers and directors sign blank signature pages without reviewing the documents to which they will be attached. We believe that any difference between the quality of disclosure in a Securities Act filing and an Exchange Act filing relates to the participation of investment banking firms, auditors and their counsel in the Securities Act filings, which are not present in the case of Exchange Act filings. As noted above, we believe that issuers take their Exchange Act obligations seriously and attempt to assure complete and accurate information.
Whether or not an officer or director signs a blank signature page, he or she has liability as a result of that signature. We do not believe that adding formalistic requirements will result in a higher degree of completeness or correctness of the substantive information contained in an Exchange Act filing. Nor do we believe that a case has been made that Exchange Act filings are not in the overwhelming number of cases complete and correct. And even when Exchange Act filings contain omissions or inaccurate information, we do not believe a case has been made that a director would recognize the omission or inaccuracy even after a careful scrutiny of the document. Directors are entitled to rely on the accounting staffs of the registrant and its outside auditors and most cases of omissions or inaccuracies in Form 10-Q's are in the financial statements where such reliance was otherwise appropriate. We are particularly concerned that requiring additional signatures to quarterly Exchange Act filings will be unduly burdensome to many registrants.
b. Securities Act Filings.
The Committee does not believe that requiring the certification proposed will cause any behavior modification by the required signatories. The Securities Act liability already imposed on these signatories is and should be an appropriate and adequate incentive to ensure the accuracy of the documents.
4. Form 6-K Submissions.
The Committee supports these proposed changes and does not believe that they will be perceived as adding additional cost or burden to foreign private issuers.
5. Solicitation of Comment Regarding Plain English in Exchange Act Reports.
The Committee believes that the staff has an adequate basis, under the "clear, concise and understandable" requirement of Rule 421(b), to ensure that Exchange Act disclosure is in fact clear, concise and understandable. The additional plain English requirements do not, in our view, seem necessary to accomplish this purpose. Notwithstanding the Commission's belief that cost is not a significant factor in drafting in plain English, the Committee believes that the cost burden to registrants is and would be significant.
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We hope that the Commission will find these comments helpful. The undersigned would be available at the Commission's convenience to discuss further any aspect of these comments.
COMMITTEE ON SECURITIES REGULATION
By: Guy P. Lander
Guy P. Lander
Chairman of the Committee
Gerald S. Backman, Chairman
Stephen M. Davis
Robert E. Buckholz
Travis F. Epes, Jr.
Michael J. Holliday
Edward H. Cohen
Kenneth G. Ottenbriet
cc: Hon. Arthur Levitt, Chairman, Securities Exchange Commission
Hon. Paul R. Carey, Commissioner
Hon. Isaac C. Hunt, Jr., Commissioner
Hon. Laura Simone Unger, Commissioner
Brian J. Lane Director, Division of Corporation Finance