16th ANNUAL INSTITUTE FOR CORPORATE COUNSEL CURRENT DEVELOPMENTS IN SECURITIES LAW AND CORPORATE GOVERNANCE Norman S. Johnson, Commissioner * Los Angeles, California March 14, 1997 * The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its members or employees. The views expressed herein are those of Commissioner Johnson and do not necessarily reflect the views of the Commission or its staff. I am very pleased to have been invited to participate in this prestigious conference. I am particularly pleased to be back in Los Angeles. I served a tour of duty in the 1960's with the SEC's Los Angeles Branch Office, or the "Hollywood Office" - as it was called then -- when it was located at Hollywood Boulevard and Ivar. I grew up in California and I love it here. Nothing in Washington has changed that. A great deal, however, has changed in L.A. since then. This is also a time of dramatic change in our financial markets. The increasing globalization and institutionalization of the markets and the introduction of new technologies continue to alter the way the markets operate and how deals get done. These factors have led to the creation of many new products and services, such as electronic trading systems, where traditional market intermediaries are absent and investors deal directly with each other. Globalization and technology also are eroding national boundaries as effective regulatory concepts and barriers to competition. I cannot remember a time when the rate of change has been so rapid. Clearly, these changes present a unique challenge for the Commission. We must modify the way we regulate the offering process to recognize the changes that have occurred while not inhibiting the future evolution of the global markets. Some have suggested that developments in the financial markets have caused the current regulatory structure, which was drafted some 60 odd years ago, to become ancient and call for it to be discarded. In the short time we have today, I would like very briefly to share with you some of my preliminary thoughts concerning the Commissionžs ongoing project to reform regulation of the offering process. Internally, we call this the "Registration and Disclosure Reform Project." You perhaps know it better as "Company Registration." The need to reform the Securities Act and to develop new ways to meet our regulatory goals has been the focus of two recent studies initiated by Chairman Levitt. First, the Task Force on Disclosure Simplification examined all Commission regulations concerning capital formation with a view to simplifying the regulatory structure. The Task Force issued its report in March 1996 and called for elimination or modification of a quarter of our rules and half of our forms. The Advisory Committee on Capital Formation and Regulatory Processes, chaired by Commissioner Steven Wallman, studied alternative regulatory models for the offering process. In July 1996, the Wallman Committee recommended that the Commission implement a pilot program to test a Company Registration system. Under Company Registration, larger companies would have the opportunity to file a single registration for all future offerings. It would become effective upon filing and be supplemented by the issuer's 1934 Act reports and by traditional prospectus information regarding the transaction that would be filed under Form 8-K or Rule 424. Issuers would not pay the registration fees until the outset of the offering. Also in July 1996, the Commission issued a concept release soliciting comment on the Company Registration model and many other ideas aimed at modernizing the current registration and disclosure systems. The concept release discussed key issues relating to the capital formation process, and asked what changes should be made to our regulations consistent with our investor protection mandate. In the midst of this activity, Congress changed the rules of the game by passing the National Securities Markets Improvement Act. Among the many significant changes to the securities laws, the Act gave the Commission, for the first time, broad exemptive authority under the Securities Act. This new authority greatly expands our horizons for possible regulatory changes. Many of the roughly 50 commenters on the concept release made interesting and thoughtful suggestions for change. Others merely proffered a wish list of deregulatory revisions. It is difficult, if not impossible, to say that there is a consensus of views among those who wrote letters. The lack of consensus is even more apparent when you factor in the views of many others who have communicated with the Commission outside the formal letter process. A minority of the commenters advocated a complete overhaul of the registration and reporting structure. More appeared to feel that discarding a system that works fairly well for most issuers would be inadvisable. They felt the current system would work quite well if several discrete changes were made. Most of the commenters who wrote letters liked the Company Registration concept, although there was no agreement on how or whether it should be implemented. We are proceeding expeditiously on this most important project and are discussing and debating many ideas. Current thinking is that the Commission will consider a package of proposals before the end of May, perhaps sooner. I have not yet finalized my thinking, but I do have some preliminary thoughts and observations about the Registration and Disclosure Reform project I would like to share with you. First, I have practiced securities law for 30 years. Over that period I have helped numerous companies navigate through the securities laws in search of much needed capital. Notwithstanding my longstanding association with the current system, I do not hold the Securities Act sacrosanct, and I fully endorse our ongoing top-to-bottom review. I am not persuaded, however, that the current system needs to be jettisoned at this time. I believe our capital formation system does most things very well. We do have the deepest, richest, most liquid and transparent markets in the world. We should be careful not to rush to change for the sake of change. At the same time, there clearly is significant room for improvement in our current system of regulation without compromising investor protection. One important factor that we must recognize as we consider modification of the Securities Act is that immense amounts of information are now available to investors from a multitude of sources. The Internet, on line resources, fax transmissions and even satellite transmissions now supplement traditional media sources. Also, information is now available from all around the globe in an instant. The reality of these changes in the availability and flow of information needs to be taken into account in terms of how we regulate communications between issuers and investors. We are examining whether the statutory focus on the prospectus as the sole means of written communication during an offering remains a viable concept, particularly in light of the myriad methods of communication available today. Perhaps the time is right to reduce restrictions on the flow of information to investors from outside the traditional prospectus. One approach might be to permit free writing after a registration statement has been filed or after a form of summary prospectus has been delivered to investors. This approach would permit the distribution of sales materials and road show materials, perhaps with the corresponding requirement that such materials be filed with the Commission. I also share Chairman Levitt's view that disclosure that doesn't get into the hands of investors until after they make their investment decision is not meaningful disclosure. At the same time, too much disclosure can be less meaningful than briefer, more tailored disclosure. Investors might be better served by mandating the delivery of essential information prior to making an investment decision with additional, detailed information available to them. I am intrigued by the concept of mandating the delivery of a summary or preliminary prospectus early in the offering process, perhaps with the content and timing of delivery dependent on such factors as the size and market following of the issuer and the nature of the offering. Such a system would recognize the availability of company disclosure under the 1934 Act for larger, well-seasoned issuers and at the same time take into account the fact that certain offering-specific information should always be furnished before an investment decision is made. For example, under such a system, a large, seasoned issuer offering rated debt securities might provide virtually only a term sheet to investors immediately prior to purchase. On the other hand, a small, lightly traded, unseasoned reporting issuer offering preferred stock might be required to provide a traditional preliminary prospectus substantially prior to the investment decision. A system as I have just described necessarily places greater reliance on the availability of 1934 Act disclosure. There is a widespread belief, however, that 1934 Act disclosure is not equal in quality to traditional Securities Act prospectus disclosure. Regardless of whether we move to a Company Registration or other model or make adjustments to the current system, the quality and reliability of Exchange Act disclosure must be enhanced or assured. If reporting issuers are to be given more rapid access to the markets, with a concomitant reduction of traditional prospectus due diligence, it is appropriate to take steps to assure the high quality and integrity of the periodic disclosures by these companies. Moreover, since Exchange Act disclosure serves to inform secondary trading participants, there is reason to enhance its quality even under the system as it exists today. There are a number of interesting ideas on the table to accomplish that goal. These include mandating auditor review of interim financial information; requiring the disclosure of risk factors in Form 10-K with updates in Form 10-Q; eliminating the list of reportable events in Form 8-K and simply calling for the disclosure of all material events therein; and shortening the time periods for filing Form 10-Q and 8-K reports. In addition, the Wallman Committee recommended requiring top management certifications and a one-time report to the audit committee describing disclosure practices the issuer follows to assure integrity of the reports. Some also have suggested mandating a disclosure audit of the type performed by underwriters on a periodic rather than transactional basis. I believe that a package of disclosure enhancements, likely including some of the ideas I have mentioned, is necessary and will be proposed. Be assured, however, that we will continue to be mindful of the need to balance issuer costs against the benefits of any proposed change. Before I close, let me mention one additional area that we should address in any reform of the current system. That is the body of technical distinctions and concepts developed to prevent evasion of the Securities Act transactional registration requirements, known commonly as "Metaphysics." These concepts, such as "gun jumping" and "integration," although originating from valid statutory concepts, have been interpreted in such a way as to add a degree of uncertainty, and therefore additional cost, to the capital formation process. The Commission largely created this uncertainty and we should take the responsibility for resolving it. For instance, the Commission should give clear guidance on when offers begun privately can be changed into registered offerings, and vice versa. In addition, with respect to gun jumping or improper soliciting activities prior to or during the registration process, we are concerned that there may be such uncertainty regarding what communications are permitted that legitimate communications to the markets have been chilled. The Commission should provide guidance by rule on what type of communications can occur and when. One suggestion is to shorten the quiet period to a specified time immediately prior to filing the registration statement. If combined with the proposal I mentioned earlier to permit free writing after filing the registration statement, substantial areas of confusion could be eliminated while not deregulating so far that the registration system becomes a formalism that brings cost to issuers with little corresponding benefit to investors. I certainly remember from my own practice the difficulties and contortions that result from "Metaphysics"; I assure you that any Securities Act reform package will address these concerns. I am sure many of you are wondering, "But what does he think about Company Registration?" As I mentioned earlier, I do not feel the current system needs to be jettisoned at this time. That does not necessarily mean I would not support proposing full company registration as an addition to the current system for companies wishing to opt in. Although I am still considering this option, it does appear that experience under a voluntary system could provide a basis for judging the need for further Commission action. I know that my musings about our Securities Act Reform Project don't give you a firm, specific idea about what the new system of regulation will look like. I don't think anyone can give you that at this time. Indeed, my own preliminary thoughts that I have just described are subject to change. As we progress on this most important project, I can assure you that my analysis will be guided by three primary principles. First, that we not lose sight of our overriding goal of investor protection; second, that the concepts underlying a new system of regulation need to match the reality you face in the markets; and third, that we must avoid the classic Washington affliction of making the system overly complicated in our pursuit of modernization and simplification. Clearly, I find these are exciting times to be at the SEC. The staff who are working very hard on this project and have to deal with four Commissioners who frequently have differing views might be more likely reminded of the old Chinese curse, "May you live in interesting times!" I appreciate the opportunity to speak with you today and would be interested in hearing your perspective on these issues. Thank you.