May 12, 1997
VIA E-MAIL at firstname.lastname@example.org
and Via Ordinary Mail
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
Mail Stop 6-9
450 Fifth Street, N.W.
Washington, DC 20549
Re: Comments on Proposed Rule Changes for Delayed Pricing for Certain Registrants
Release Number 33-7393 (the "Proposing Release")
SEC file no. S7-9-97
Dear Mr. Katz:
This letter is written in response to the Commissions recent solicitation for comments on the above proposed changes. Each major item in the proposal will be addressed separately. Following my experience in the Division of Corporation Finance, I have been an active securities lawyer for more than ten years and have concentrated my practice on IPOs and private financings of smaller high growth companies. Therefore, I think my comments are particularly relevant to the proposals and come from a perspective of significant practical experience in the small business corporate finance field.
As a general matter, I am very supportive of the Commissions efforts in this area and in other areas to facilitate capital raising by small business issuers. Consistent with its goal of investor protection, there is room for much improvement to the current regulatory structure that would benefitsmall business capital formation. I think these proposals are a terrific starting point.
Reporting Requirements. This is a sensible starting point for eligibility purposes. I agree with the proposal as drafted and think that a twelve (12) month reporting period is a logical starting point at this stage, although as the Commission gains experience, this time period might be worth reevaluation. I dont believe that expanded Rule 430A should initially be available in the IPO context, although this may be another point for examination after the Commission has had some practical experience administering the proposed Rule.
Qualitative Conditions. I believe timely reporting under the Securities Exchange Act of 1934 ("Exchange Act") is a sensible and reasonable qualitative condition to the use of expanded Rule 430A for all the same policy reasons that the Commission employs such qualitative conditions for eligibility in the S-2 and S-3 contexts. I support this condition unequivocally. With respect to the other qualitative conditions (dividend/sinking fund/preferred stock payments and indebtedness defaults), I am uncertain. Especially in light of the fact that use of expanded Rule 430A would not permit the use of abbreviated disclosure or incorporation by reference as currently employed in the S-2 and S-3 disclosure schemes, I question the logic of these qualitative conditions. Nevertheless, as a matter of policy, the Commission may believe that these additional qualitative factors would be sensible to permit use of the Rule only by issuers who are in sound financial condition. If this were the Commissions logic for imposing the qualitative conditions, I dont think they should be included, since it is not uncommon for small business issuers to be looking to the capital markets as a vehicle to reduce overall leverage and provide an equity capital base for future growth. Again, from a policy perspective, inclusion of these other qualitative conditions may be unduly restrictive in light of the universe of companies who are sought to be the primary beneficiaries of expanded Rule 430A, and in my opinion I would prefer these additional qualitative conditions be excluded.
Bad Boy Provisions. The use of "Bad Boy" disqualifiers in the expanded Rule 430A context is in my opinion, unnecessary. The logical underpinning for use of the "Bad Boy" disqualifiers in exempt transactions is the fact that there is no regulator in a position to insure proper disclosure of violations in the offering documents (therefore, no "disclosure police" mechanism to protect investors). Therefore, in the exempt transaction context, the only bullet-proof mechanism is to preclude use of an exemption. In the context of expanded Rule 430A, this protection appears unnecessary, provided that any violation of the Federal Securities Laws has been properly and completely disclosed in the offering document. This approach is more consistent with theCommissions traditional non-merit full disclosure philosophy. Similarly, it appears inappropriate to punish the issuer community by denying the use of expanded Rule 430A in circumstances where an underwriter has involvement with an unrelated registrant whose registration statement was the subject of a proceeding or examination under Section 8 of the Securities Act, etc. It appears unnecessary to punish one issuer for the sins of another or, for that matter, to punish an issuer for the sins of its underwriter. With respect to the solicitation of comments for a managing underwriter that is subject to a permanent injunction, the question seems unclear. If the injunction relates to an underwriters participation in an underwriting, it would appear to be the Commissions responsibility to monitor the activities of that underwriter. It is in my opinion an unfair burden to place that type of burden on the issuer community, especially the small business issuers who have the least resources, the least leverage and are the least sophisticated in corporate finance matters.
Going Concern. I see absolutely no reason why use of expanded Rule 430A should be denied to an issuer whose financial statements contain a going concern qualification from the issuers accountants, provided the registration statement in the Risk Factor section and elsewhere as appropriate, properly discloses the existence of this qualification.
Foreign Issuers. As a matter of policy, I support the Commissions additional condition attached to the eligibility to use expanded Rule 430A in the foreign private issuer context. The obligation to deliver current information is absolutely necessary to the sensible use of expanded Rule 430A given the small market capitalizations of the companies expected to benefit from its use. I believe the conditions outlined in the Proposing Release are practical and sensible in this regard.
Investment Companies. I agree in part with the Commissions proposal that investment companies be excluded from the use of expanded Rule 430A; however, my view extends only with respect to open ended investment companies. On the other hand, I believe business development companies ("BDCs") which are closed-end and are quite similar to industrial companies in that regard (i.e., fixed number of shares outstanding, issuer does not act as its own liquidity mechanism and/or re-marketing agent) could benefit from the ability to use expanded Rule 430A. The one concern that may exist, however, is the fact that a subsequent offering at a price less than current net asset value would require stockholder approval of the BDCs stockholders prior to being effected. In this regard, the benefits of expanded Rule 430A may not be practically available. I have been involved in subsequent public offerings of BDCs that were hampered by this provision. I believe the Commission should permit the use of expanded Rule 430A for business development companies, but not for open-ended investment companies.
Blank Check and Penny Stock Issuers. I wholeheartedly support the Proposing Release in this regard. Prevention of these types of issuers from using the expanded Rule 430A is a laudable goal which will facilitate capital raising for those companies who have articulated their business objectives. Clearly, blank check companies ought not to be permitted to use the expanded Rule. There may, however, be legitimate circumstances where an issuer has been delisted from the Small Cap market (especially in light of recent dramatic increases in the quantitative inclusion criteria for NASDAQ) and such issuer is unable, due to lack of underwriter support, to maintain a stock price to exclude the issuer from the definition of a penny stock issuer. In these circumstances, it may be unfairly prejudicial to preclude penny stock issuers from the ability to use expanded Rule 430A. Perhaps a sensible middle ground is to initially exclude them from eligibility under the Rule and accumulate some empirical information and then reevaluate the operation of the Rule. While I concur with the Commissions view that there have been substantial abuses in the penny stock arena, many of these abuses have been driven by broker-dealer sales practice abuse, rather than abuse on the issuer side.
In my personal experience, I have seen numerous examples of completely "innocent" issuers being preyed upon by unscrupulous members of the broker-dealer community. The emphasis, therefore, in my opinion should be on greater levels of broker-dealer examination and surveillance in the sales practice area to eliminate the root of the problem, rather than penalizing the issuer community for broker-dealer misconduct.
Since the purpose of the Private Securities Reform Act of 1995 is to create a statutory safe harbor from liability for certain statements, and is therefore a liability limiting device, I believe it serves clearly different policy goals than those sought to be achieved by expanded Rule 430A. In my view, expanded 430A is not intended to limit liability in any way, rather it is intended to provide a mechanism to permit greater flexibility by issuers to tap the securities markets. Since the other registrant requirements of expanded Rule 430A require current public information and delivery of updated disclosure to investors, I believe extending the PSLRA disqualification provisions to the Rule 430A context is inappropriate.
EDGAR. I am clearly a supporter of the Commissions condition to require the use of EDGAR. The benefits of the use of EDGAR greatly outweigh the costs by several orders of magnitude, even in the context of the small business issuer community, especially in light of technological developments with todays computers. Surely, it is not too much for the Commission to require that eligibility to use expanded Rule 430A be conditioned upon all filings being made (or refiled in the case of earlier paper filings) on EDGAR. The same is true for any necessary financial data schedules. Similarly, I strongly support the Commissions proposals regarding the continuinghardship exemption under Rule 202(a) of Regulation S-T. In order to support the principle enunciated in expanded Rule 430A, it is absolutely essential that companies have relevant information in the EDGAR database, and therefore companies which have previously relied on a continuing hardship exemption should be ineligible. The application of this requirement both at the time of registration statement filing and at the time of offer and sale is completely reasonable under the circumstances and should remain intact as proposed. I believe these EDGAR related conditions are desirable although not "necessary" to permit delayed pricing as discussed in the proposing release. I believe expansion of the continuing hardship exemption condition in the Rule 202(d) context is unnecessary, provided the electronic conforming copy was indeed filed via EDGAR.
Perhaps it would be appropriate for the Commission to require all electronic conforming copies filed in connection with the Rule 202(d) hardship exemption to be on file in electronic form at least six (6) months prior to the time a registrant is eligible to file a registration statement with the intended use of expanded Rule 430A.
Post-Effective Amendments. I like the Commissions proposals in this regard, since issuers relying on expanded Rule 430A are not likely to be widely followed and incorporation by reference under the S-3 model would not in my mind provide any meaningful level of investor protection. Perhaps the appropriate time period ought to be less than ninety (90) days after the close of the companys fiscal year. This approach would hopefully permit staff review of such a post-effective amendment so that there would be no gap period on the timing of delivery of updated disclosure. While this may impose an additional burden compared to the current system, it appears a fair price to pay for the expected benefits of the Rule. Perhaps a provision could be employed that provides for automatic effectiveness after the lapse of fourteen (14) days following filing. While this would impose an additional burden on timely staff review of such post-effective amendments, it would also provide issuers some reasonable degree of certainly that if they filed with enough advance time, they would be assured of the ability to continue their offering as of a definite date. A collateral benefit to mandating the filing of post-effective amendments will be that the quality of disclosure should be improved since there will be greater involvement of legal and accounting professionals. I also believe that in situations where the issuer intends to file its Form 10-K or 10-KSB prior to its due date, the post-effective amendment should be filed at the same time.
Similarly, the requirement to file a post-effective amendment in connection with significant probable business acquisitions under Rule 3-05 of Regulation S-X and item 310(c) of RegulationS-B is an appropriate circumstance since these transactions can dramatically affect the financial condition of the issuer. It is unclear what the Commissions position is with respect to the timing of the filing of a post-effective amendment under these circumstances compared to the time period specified in the Form 8-K context as referenced in footnote 56 of the Proposing Release. This is an area that may need some clarification, since it appears the Commission is proposing a burden which exceeds that required in the 8-K context (prompt filing of Form 8-K following consummation of the transaction, followed by sixty (60) day follow-up period for amended 8-K to provide financial information). See Form 8-K Item 7(a)(4).
With respect to pending acquisitions below the fifty-percent (50%) threshold levels, the proposals appear to be sensibly drafted. Since companies eligible to use expanded Rule 430A do not have an expanded market following, this approach seems workable and sensible. Similarly, the requirement to file post-effective amendments under the circumstances outlined in Item 512(a) of Regulation S-K and Regulation S-B also seem fair under the circumstances. On balance, these provisions would appear to provide both full and timely disclosure of relevant information.
Naming of Underwriter. While the importance of underwriters in an offering cannot be understated, the requirement to file a post-effective amendment simply to identify an underwriter or to indicate that a managing underwriter has been selected, is onerous and unnecessary. Underwriters will be effective in conducting diligence of an issuer before securities are sold simply because they are in control of the selling process. In the event that underwriters conduct of due diligence results in suggested changes to the content of the prospectus which would amount to a "fundamental change", a post-effective amendment filing would be triggered under the Item 512 undertaking procedure. Absent unusual circumstances of this sort, a prospectus supplement, at most, would seem to be warranted. With respect to the form of underwriting agreement, requiring it to be filed in a Form 8-K might be sensible. Filing a form of underwriting agreement in an automatically effective post-effective amendment seems to accomplish no apparent regulatory purpose. Either the underwriting agreement should be filed at a time when contents of its disclosure can be examined by the staff, or an 8-K approach should be sufficient. This raises the question then of whether an 8-K filing is even appropriate under the circumstances.
The Proposing Release seems to express concern that the provisions of expanded Rule 430A may make it difficult for underwriters of issuers eligible to use the proposed Rule to conduct their due diligence in an adequate manner. It has been my experience that in the small business issuermarket, Gatekeepers have practically all the transactional leverage. Therefore, it seems extremely unlikely that an issuer eligible reap the benefits of expanded Rule 430A could "force" an underwriter into an expedited, and perhaps truncated diligence process. The practical reality is that if these were the circumstances faced by the underwriter, they simply would refuse to participate in the selling efforts and the issuer would have to either accept the underwriters timetable and permit the diligence to be performed in accordance with the underwriters standards, or forego using that underwriter. I believe the concerns expressed in the Proposing Release are simply inapposite in the context of the small business issuer community. I do not believe that the Commission should attempt to alter the traditional role of due diligence in the offering process, and if this means small business issuers have slightly less rapid access to the capital markets, so be it. This force will potentially have the effect of creating closer relationships between a particular issuer and an underwriter (to take advantage of "knowing the company") which, should benefit all parties concerned.
Type of Security Offered
I believe expanded Rule 430A ought to be permitted to be used in contexts involving the sale of preferred stock or debt securities, provided, however, that in such instances material terms and conditions, covenants and other provisions be adequately disclosed. Perhaps, an approach the Commission should consider is whether or not to permit the use of the Rule only for securities which are listed on a national securities exchange or quoted on a qualifiying inter-dealer quotation system, or are equivalents of these, such as a convertible preferred stock or convertible debt, but excluding non-convertible preferreds and straight debt where such securities are not listed or quoted.
Information Delivery Issues
As a general matter, I wholeheartedly concur with the spirit of the Proposing Release that requires an issuer to deliver updated company-related information to accompany a prospectus for offerings under expanded Rule 430A. This information delivery requirement should also be expanded to cover all Forms 8-K filed since effectiveness of the registration statement. Absent this information delivery condition, it is difficult to conjure a scheme that provides meaningful investor protection. I also support the option to permit an issuer to integrate all relevant Exchange Act information into a single supplement rather than delivering a handful of Exchange Act reports. Likewise, providing an option for electronic delivery as referenced in footnote 67 of the Proposing Release is a logical extension of the views of the Commission expressed in the releases referenced in that footnote.
Timing of Information Delivery. Use of a 48-hour delivery rule similar to that used for IPOs seems to strike a fair balance between the needs of issuer flexibility and investor protection. I believe that while this information delivery obligation clearly places a burden on issuers, it is a burden that rests more fairly on the issuer community than on the investment community in general. Any flexibility reductions in my mind are justified by the benefits of the availability of the new approach of expanded Rule 430A. That being said, however, I believe 48 hours is an appropriate time standard, and going to a five or ten business day period seems excessive, especially in light of the current requirements under Rule 15c2-8.
Voluntary Forms 8-K, Etc. I dont believe voluntary Form 8-K filings need to be delivered to potential investors. Similarly, companies should not be given the option to deliver quarterly reports rather than the Form 10-Q report unless the Commission were to propose a rule indicating what information in the form could be omitted from the report and still be considered to substantially comply with the disclosure burden. In either case, however, all Exchange Act filings should be incorporated by reference into the registration statement to impose Securities Act liability on such statements.
I think the Commissions views requiring a description of all material changes, as referenced in footnote 71 of the Proposing Release is most interesting and ought to be part of the expanded Rule.
Additional or Alternative Conditions
Requiring the filing of a supplemented prospectus within a certain period of time after the effectiveness of the registration statement does not seem to serve any legitimate purpose. The requirement should be triggered upon the taking of securities down from the shelf, not merely the lapse of a measured amount of time.
I dont agree with a mandated time period to lapse between the filing of an Exchange Act report and the offering of securities. This is based upon the protections afforded by the 48-hour delivery requirement prior to confirmation. In the absence of this prior delivery requirement, I can understand the potential benefits of permitting the market to absorb new Exchange Act information. If the Commission is genuinely concerned about this issue, perhaps it can solve the problem by lengthening the duration of the pre-delivery period from 48-hours to a longer period, such as five business days. I do not see the logic of a mandated delay between issuer notification, i.e. "intent to offer", as a pre-condition to the Rule. I believe the problems of enforcement of a mandated timeperiod coupled with the uncertainty and lack of uniformity that can come from the need for constant staff interpretation makes this approach unworkable and, frankly, unnecessary. Again, if the Commission is concerned about the markets ability to absorb issuer specific information, perhaps it ought to consider a different objective condition such as market capitalization or trading volume in determining eligibility for use of the expanded Rule, although this is not an approach I think is warranted.
I do not believe the Rule as proposed should be limited to a single delayed offering or should contain any other limits on the number of takedowns. With respect to the Commissions views regarding Regulation M, I concur that compliance with the full applicable restricted period of Regulation M prior to pricing is appropriate and I also believe that an express amendment to Rules 101 and 102 of Regulation M to incorporate this position would be worthwhile. In the context of proposed expanded Rule 430A, I believe Rule 105 of Regulation M should not exclude offerings made in reliance on expanded Rule 430A since most takedowns of securities in reliance of the expanded Rule will likely be considered distributions under the definition. Therefore, the contemplated revision to Rule 105 as referenced in the Proposing Release would seem to be appropriate.
With respect to issuer flexibility to use either old or expanded Rule 430A, I believe the approach upon effectiveness of "choose one or the other" is good.
As referenced in footnote 21 in the Proposing Release, I believe the ability to use expanded Rule 430A could be used sensibly for self-underwritten offerings. I have been involved in several instances where sound companies have experienced problems with an underwriters ability to complete a transaction having nothing to do with the merits of the issuer. The ability to use expanded Rule 430A would be of great assistance to provide issuer flexibility in this regard.
The views expressed in the Proposing Release are a welcome sign of fresh thinking from the Commission in an area where much improvement and flexibility is needed. In general, the provisions and conditions of expanded Rule 430A strike a reasonable balance between issuer flexibility and investor protection. The Commissions efforts to improve access by small business issuers to the capital markets are greatly appreciated and have long-term implications with respectto job creation, development of new technologies, global competitiveness and strength in the overall domestic economy. I am most grateful that the Commission is devoting considerable resources and focusing its thoughts on improving this sector, rather than only focusing on the large cap sector. Improvements in capital access in the small business issuer marketplace will affect a vast number of issuers and therefore the aggregate impact of positive change is truly immense.
As always, I thank you for the opportunity to express my views. Should any issues in this letter require clarification or if you wish to discuss them further, I would be most pleased to hear from you.
Very truly yours,
bef Gerard S. DiFiore