A Small Entity Compliance Guide[1]

Introduction

On September 26, 2019, the Securities and Exchange Commission voted to adopt Securities Act Rule 163B, which extends to all issuers a “test-the-waters” accommodation previously available to emerging growth companies or “EGCs.”  Under the new rule, all issuers and those authorized to act on their behalf are allowed to gauge market interest in a possible initial public offering or other registered securities offering through discussions with certain institutional investors prior to, or following, the filing of a registration statement.

The rule is intended to provide issuers a cost-effective means for evaluating market interest in a potential registered offering before incurring the costs associated with such an offering.  At the same time, the rule is designed to maintain investor protections by limiting the investors with whom issuers, or persons authorized to act on their behalf, may test the waters to qualified institutional buyers (“QIBs”) or institutional accredited investors (“IAIs”).

Background

The Jumpstart Our Business Startups Act of 2012[2] added Securities Act Section 5(d), permitting EGCs, and persons authorized to act on their behalf, to engage in oral or written communications with potential investors that are QIBs or IAIs before or after filing a registration statement to gauge such investors’ interest in a contemplated securities offering.  The new rule extends this “test-the-waters” accommodation to non-EGCs, thereby encouraging more issuers to consider entering our public equity markets. 

Who is affected by the new rule?

The new rule affects all issuers contemplating a registered securities offering, including:

• Reporting and non-reporting issuers;
• EGCs;
• Non-EGCs;
• Well-known seasoned issuers (“WKSIs”); and
• Investment companies, including registered investment companies and business development companies.

What are the provisions of Rule 163B?

Under the new rule, any issuer, or person authorized to act on behalf of the issuer (including an underwriter), may engage in exempt oral or written communications with potential investors that are, or are reasonably believed to be, QIBs or IAIs to determine whether such investors might have an interest in a contemplated registered securities offering.  These test-the-waters communications may occur either prior to or following the date of filing of a registration statement with respect to such registered offering.[3]  The rule is non-exclusive and issuers may rely concurrently on other Securities Act communications rules or exemptions when determining how, when, and what to communicate related to a contemplated securities offering.

Under the rule:

• Rule 163B communications are offers exempt from certain provisions of Securities Act Section 5 but are subject to liability.  Rule 163B communications are exempt from the prohibitions of Section 5(c) (which prohibits any written or oral offers prior to the filing of a registration statement) and Section 5(b)(1) (which limits written offers, once an issuer has filed a registration statement, to a “statutory prospectus” that conforms to the information requirements of Securities Act Section 10).  Such communications would nonetheless still be considered “offers” as defined in Section 2(a)(3) of the Securities Act  and would therefore be subject to Securities Act Section 12(a)(2) liability both before and after a registration statement has been filed.  The anti-fraud provisions of the federal securities laws also apply. 
• Test-the-waters communications need not be filed but they should not contain material misstatements.  Rule 163B does not require issuers to file test-the-waters communications or to include legends or disclaimers.  Statements made in the test-the-waters materials must not contain material misstatements or omissions at the time the statements are made. 
• Issuers subject to Regulation FD must consider its application.  Issuers subject to Regulation FD[4] will need to consider whether any information in a test-the-waters communication would trigger disclosure obligations under Regulation FD or whether an exemption would apply.  For example, reporting issuers that selectively disclose material nonpublic information while testing the waters with QIBs or IAIs may be required under Regulation FD to disclose such information publicly.  However, issuers subject to Regulation FD may choose to avail themselves of one of the exceptions under Regulation FD, such as the exception involving confidentiality agreements.
• Issuers must establish a reasonable belief regarding investor status.  Rule 163B requires that the solicited investor is, or is reasonably believed to be, a QIB or IAI.  However, the rule does not specify steps an issuer or person acting on the issuer’s behalf must take to establish that reasonable belief or otherwise require the issuer to verify investor status.  This approach is intended to provide flexibility to use methods that are cost-effective but appropriate in light of the facts and circumstances of each contemplated offering and each potential investor.  This approach is also consistent with the methods employed by issuers and their representatives pursuant to other Securities Act rules, such as Rule 506(b) or the Rule 144A safe harbor, both of which require a reasonable belief as to investor status.
• Registered investment companies and business development companies are eligible to rely on Rule 163B.  Issuers that are, or are considering becoming, registered investment companies or business development companies (together, “funds”) are eligible to engage in test-the-waters communications under the rule.  Funds and their advisers may have an interest in engaging in test-the-waters communications to help assess market demand for a fund—for example, for a particular investment strategy or fee structure—before incurring the full costs of a registered offering.  The new rule does not provide an exemption from registration or other requirements under the Investment Company Act of 1940. 

Refer to the release for a complete description of all amendments.

What are the compliance dates of the rules?

The new rule will be effective on December 3, 2019.

Other Resources

The adopting release for the new rule can be found on the SEC’s website at https://www.sec.gov/rules/final/2019/33-10699.pdf.

Contacting the SEC Staff

The SEC’s Division of Corporation Finance is happy to assist small companies and others with questions regarding the amendments.  You may contact the Division for this purpose at (202) 551-3400 or at https://www.sec.gov/forms/corp_fin_interpretive.

Questions on other SEC regulatory matters concerning smaller reporting companies may be directed to the Division’s Office of Small Business Policy at (202) 551-3460.

The SEC’s Division of Investment Management’s Chief Counsel’s Office is also available to assist small entities and others with questions regarding the amendments with respect to investment companies.  You can contact the Office for this purpose at (202) 551-6825 or IMOCC@sec.gov.