This letter responds to the request of the Securities and Exchange Commission (the "Commission") in Release No. 33-7393 (the "Release") for comments on the Commission's proposed amendments to Rule 430A under the Securities Act of 1933, as amended (the "Securities Act") to permit delayed pricing after the effectiveness of registration statements by certain smaller reporting companies not eligible to use Form S-3 for primary offerings.
This letter has been prepared by members of the Task Force on Small Business Issuers (the "Task Force") of the Committee on Federal Regulation of Securities (the "Committee") of the Section of Business Law (the "Section") of the American Bar Association. A draft of this letter has been circulated for comment among members of the Task Force and the Chairs and Vice Chairs of the Committee and subcommittees and task forces of the Committee, and the officers and certain other members of the Section. A substantial majority of those who have reviewed the letter in draft form have approved the views expressed. This letter, however, does not represent the official position of the American Bar Association, the Section or the Committee, nor does it necessarily reflect the views of all of the individuals who have reviewed it.
The Task Force supports the proposal to amend Rule 430A to permit the deferral of pricing and certain other information in registration statements of qualified issuers. Qualified issuers would be those with at least one year of reporting history under the Securities Exchange Act of 1934 (the "Exchange Act") that are not eligible to use Form S-3 for primary offerings. We believe the proposed amendments will provide additional flexibility for small business issuers and expand their capital raising opportunities. We commend the Commission for developing an approach that benefits seasoned smaller issuers while providing the investor protection mechanisms needed where there may not be as well-developed an efficient market. The Commission's proposal
clearly distinguishes the ability of smaller issuers to use delayed pricing from the availability of shelf registration for larger, seasoned issuers.
Benefits of the Proposal
. Larger seasoned issuers with a market float of $75 million or more are able to use Form S-3 for primary offerings. This permits them to take down securities from the shelf on a continuous basis, to rely on incorporation by reference, to effect an immediate distribution with a prospectus supplement without SEC staff review and to update and complete the information using a prospectus supplement (with the lesser liability standards of Section 12(2) rather than Section 11 applicable in some cases to the prospectus supplement). If the eligible S-3 issuer chooses to use the universal shelf procedure, it can register a dollar amount of securities, provide a general description of the types of securities to be offered and leave determination of the specific securities and specific terms until the time of takedown. The availability of this shelf procedure with its attendant benefits is premised in part on the efficient market theory which relies on the existence of a large enough market float to ensure sufficient market interest and analyst following.
Smaller issuers, even if they are seasoned reporting companies, do not have this flexibility and are at a disadvantage in raising capital. The proposal would move in the direction of providing added flexibility for smaller seasoned issuers by permitting delayed pricing, with use of a prospectus supplement, beyond the current 15 day period following effectiveness. It would not, however, go so far as to create a shelf registration system for small issuers, as some have critically suggested. For example, the proposal would not allow incorporation by reference, it would require full prospectus delivery and it would add a 48 hour speed bump from prospectus delivery to confirmation similar to that imposed on initial public offerings by Exchange Act Rule It also would provide for prior staff review by requiring filing of a post-effective amendment to include annual audited financial statements and financial statements for fundamentally material acquisitions, as well as post-effective amendments required by Item 512(a) of Regulations S-K or S-B. In addition, the prospectus supplement would be deemed part of the registration statement and therefore subject to Section 11 liability. These aspects of the proposal provide appropriate investor protection mechanisms that distinguish the delayed pricing proposal from shelf registration, as well as from the "company registration" proposal of the Advisory Committee on the Capital Formation and Regulatory Processes (see SEC Release No. 33-7314 (July 25, 1996) on "Securities Act Concepts and Their Effects on Capital Formation"). This distinction in treatment recognizes the smaller size of these issuers and therefore the reduced reliability of reliance on the efficient market theory. Accordingly, we disagree with those who have criticized the proposal as providing shelf registration availability for issuers who do not merit it or, alternatively, of providing the benefits of company registration commencing with issuers at the wrong end of the spectrum and without the corresponding disclosure enhancements upon which the company registration proposal is premised. In short, those who have criticized the deferred pricing proposal on this basis fail to give adequate recognition to the investor protection provisions that remain in place under the proposal and that therefore differentiate it from shelf registration or company registration.
The issues that deserve to be addressed about the proposal are whether it will in practice prove to be useful and whether it will further erode the ability of gatekeepers to meet their diligence responsibilities. We address each of these in turn.
. There are a number of situations in which the availability of delayed pricing will afford significant benefits to smaller seasoned issuers. The following are some examples:
The proposal would give an issuer the flexibility to process its registration statement through to effectiveness and then defer the actual offering until market conditions and other factors are advantageous. Although this may not be of great importance in the case of most traditional underwritten equity offerings with an extensive road show, there will be other situations, such as a direct offering without an extensive road show, when the ability to have greater control over the timing of the offering will be beneficial.
The proposal would also benefit a company that goes effective but then sees the market drift away from the offering. The current 15 day period under Rule 430A may not be long enough to permit a market rebound or a restructuring of the offering. The amended rule would afford a company more time within which to remedy the situation.
Under the proposal a directed registered offering to a limited number of institutional investors could be effected quickly, thereby combining the benefits of the speed of a private offering with the liquidity of a registered offering. This technique could be used to replace so-called "PIPE" transactions, which combine a private offering with a more burdensome resale registration, and which nevertheless involve a liquidity discount. Similarly, amended Rule 430A would obviate the need to use the AB Exchange Offer technique to effect a prompt private offering followed by a registered exchange. Accordingly, through use of delayed pricing, smaller seasoned issuers would be able to obtain better pricing for their securities and avoid the discount inherent in private or offshore offerings.
The proposed amendment to Rule 430A might also permit smaller seasoned issuers to use debt financing techniques now available only to primary S-3 issuers. For example, under the proposal an eligible company could implement a medium term note program, utilizing a series of takedowns as financing needs and market conditions dictate. It would also make it easier to engage in one or a series of high yield debt issues. Accordingly, the proposal would increase the financing flexibility of smaller seasoned issuers and give them a broader range of capital raising alternatives, with resulting savings.
Underwriter Gatekeeping Function
. A legitimate concern is whether the ability of underwriters to meet their diligence responsibilities will be eroded, with a consequent reduction in the quality of disclosure, because of the increased flexibility afforded issuers in going to market. While we acknowledge this concern, a reduction in the quality of underwriter diligence is a product of the existing shelf registration process and is less likely to be a factor under the Rule 430A proposal. Unlike larger primary S-3 eligible issuers, the companies that would use the amended Rule 430A will not have the market leverage to require underwriters who are prepared to fulfill their responsibilities to forego the necessary diligence review. Not only are underwriters more likely to be able to insist on the requisite procedures but the proposal itself builds in a 48 hour speed bump, together with the requirement for delivery of disclosure material. We believe that the proposal strikes the right balance and should allow underwriters to fulfill then gatekeeper role.
We also do not believe that the quality of disclosure will be compromised by the ability of issuers to combine documents to form the required prospectus. The proposed rule recognizes that the traditional prospectus booklet may not be the only method, and may not even be the best method, for providing meaningful disclosure. In the current era, with the dramatic changes in information technology, including electronic communication, information is readily accessible and is provided from a variety of sources, particularly for reporting public companies, whether large or small. The use of current Exchange Act reports as part of the disclosure package may provide even better disclosure because of their stand-alone nature and focus on current developments. In our view, the ability to physically deliver current Exchange Act reports under the proposed rule is a fair substitute for incorporation by reference under a traditional shelf registration and will save smaller issuers the considerable expense of reprinting the prospectus.
. We have the following specific suggestions regarding the Rule 430A proposal:
1. We support the Commission's proposal to tie the eligibility for use of delayed pricing on the issuer's Exchange Act reports actually being on file without a requirement that they be filed timely. This recognizes that the availability of delayed pricing is not based on the efficient market theory and that, therefore, the timeliness of the filings is not as important as it would be for S-3 issuers. In addition, tying eligibility to actual filing would eliminate questions surrounding whether filings were timely. Accordingly, the amended rule as proposed would increase the availability of the delayed pricing procedure for smaller reporting issuers.
At the same time, we recognize that a requirement for timely filing can be justified as imposing a desirable discipline on the process, filtering out questionable cases and being consistent with the objectives of investor protection. Although we do not generally favor qualitative standards for eligibility to use the new procedure, we would understand if the Commission concluded that a timely filing requirement were necessary.
2. The adopting release should make clear that registrations subject to delayed pricing under amended Rule 430A are treated like shelf registrations for purposes of integration and the application of Regulation M.
Under current staff positions, a shelf registration is not treated as a current offering and therefore is not integrated with other offerings for purposes of determining whether there is "general solicitation" until there is a take down from the shelf. Registration statements subject to delayed pricing under Rule 430A should be afforded the same treatment.
Under Regulation M, a distribution does not occur until securities subject to a shelf registration are taken down from the shelf and priced. Distributions of securities subject to delayed pricing under Rule 430A should be treated the same way in order to maximize the usefulness of the proposed rule. We believe that the safeguards under Regulation M once the distribution commences address the concerns over potential market manipulation. Since the shelf position has been taken by interpretation, we believe that delayed pricing under Rule 430A can be handled the same way without an amendment to Regulation M.
3. In addition to the omission of pricing information and the identity of the managing underwriter, if any, the amended rule also should permit omission of the following:
The identity of selling shareholders. The identity of selling shareholders, except possibly in the case of affiliates, is generally not material to investors. Furthermore, the decision of shareholders whether to include their shares in the registration statement is often dependent on the final pricing of the offering.
The detailed terms of the security. It is important to permit flexibility in defining the terms of the security being offered in order to maximize the usefulness of the proposed rule. While information in advance about the general nature of the proposed security may be desirable, the detailed terms of the securities are only important to investors at the time the securities are actually offered. Many of these terms will be dependent on market conditions at the time of offering. Accordingly, we suggest requiring inclusion in the registration statement at the time it becomes effective of only such information regarding the terms of the security as is then reasonably available. In this connection, it should be permissible to file the trust indenture for a debt offering by post-effective amendment which becomes effective automatically when filed.
4. We recommend that the proposed rule be streamlined to permit the filing of the company's Form 10-K to automatically constitute the required post-effective amendment under the proposed rule without the need for an actual post-effective amendment to be filed. This would be consistent with existing shelf registration procedure but unlike shelf registration it would not represent full incorporation by reference since the Form 10-K would have to be physically delivered to investors. If notice to the staff to facilitate review is considered significant, issuers could be required to notify the staff of the Form 10-K filing or send them a courtesy copy, or, alternatively, to note on the cover page of the filing that the filing is also a post-effective amendment. Our recommendation also would apply to other post-effective amendments where a Form 8-K is filed.
5. The adopting release should confirm that the staff interpretation in
Lamar Advertising Company
(Nov. 18, 1996) regarding the availability of Form S-3 for a reporting issuer that voluntarily filed Exchange Act reports during the prior twelve months would also apply to delayed pricing under amended Rule 430A.
* * *
We hope that the Commission will find these comments helpful. Members of the Task Force are available at the Commission's convenience to discuss further any aspect of these comments.
John M. Liftin
Chair, Committee on Federal
Regulation of Securities
Jean E. Harris
Richard M. Leisner
Co-Chairs, Task Force on
Small Business Issuers
cc: The Hon. Arthur Levitt, Chairman
The Hon. Steven M.H. Wallman, Commissioner
The Hon. Isaac C. Hunt, Jr., Commissioner
The Hon. Norman S. Johnson, Commissioner
Brian J. Lane, Director,
Division of Corporation Finance
Barbara C. Jacobs, Office of Small Business, Division of