May 12, 1999
Mr. Jonathan G. Katz,
Securities and Exchange Commission,
450 Fifth Street, N.W., Stop 6-9,
Washington, D.C. 20549.
Re: The Regulation of Securities Offerings -- File No. S7-30-98
Dear Mr. Katz:
The Federal Regulation and Capital Markets Committees of the Securities
Industry Association ("SIA")(1) are pleased to submit this response to Release No. 33-7606A ("Release") on behalf of SIA.(2)
We firmly support fair and efficient capital markets and effective regulation designed to protect investors and to promote efficiency, competition and capital formation. We wish to commend the Commission on its initiatives to reexamine the regulation of securities offerings. As we stated in SIA's letter of November 13, 1996 at page 2 (File No. S7-19-96) in response to the Commission's 1996 Concept Release (No. 33-7314), continued review and vigilance to ensure that the system remains competitive and is as effective as possible are always in order.
We continue to believe that changes in the capital formation process, information technology and global financial markets have created the need to reform certain regulatory concepts and procedures. While we appreciate that the Commission has attempted to address some of these concerns, the proposals would do far more and constitute a radical -- and, we believe, seriously flawed -- restructuring of the registered offering process in this country.
The Commission is required to consider whether the proposals "will promote efficiency, competition, and capital formation." We strongly believe that the proposals would have precisely the opposite effect. The economic study accompanying this letter analyzes the inefficiency, increased market risks and increased costs of capital that would result from implementation of the proposals, and examines some of the harmful effects on the competitive position of the U.S. capital markets.
For the reasons discussed below, we believe the "aircraft carrier" should not be adopted.
The existing system has developed incrementally over the last three decades on the basis of an intellectual framework that evolved through careful study and discussion. Various reforms have made the registration process more flexible and efficient and have permitted quicker and less costly access to the capital markets. The radical restructuring contemplated by the current proposals would undercut these beneficial reforms. Although there is always room for improvement, the existing system is far better than the proposed "aircraft carrier".
We strongly support the proposals to relax the restrictions on research and oral communications, to permit effectiveness on demand and to limit physical delivery of final prospectuses. These proposals should be reproposed for comment and adopted in the context of the existing registration system and forms -- not as part of the new regulatory scheme described in the Release.
We do not support many of the other proposals because they are impractical and would constitute a major step backward. These proposals -- especially those regarding the delivery of preliminary prospectuses and term sheets, the "inclusive prospectus" concept and the filing of offering information and free writing -- would decrease efficiency, increase market risk, increase the cost of capital, discourage the registration of securities offerings, and harm the competitive position of the U.S. capital markets.
The Release cites no abuses that would justify the massive changes being proposed. We believe that any proposal for such a radical departure from established market practices that are working well should be based on substantial evidence of abuse or widespread investor demands for protection. We are aware of no such evidence or demands.
Shelf registration has worked well for over 15 years. By permitting virtually immediate access for seasoned issuers, shelf registration has been of central importance to the success of the U.S. public capital markets. It would be unwise to risk disruption of the shelf registration system in the absence of a compelling need for a specific change. Moreover, the U.S. capital markets are facing increasing competition from foreign markets. This is likely to be exacerbated by the recent introduction of the Euro. This is not the time to make U.S. capital markets less efficient and more costly.
Economic Study. It would appear that in connection with formulating the proposals the Commission has not studied the capital costs of delays. In view of the potentially serious negative consequences for the U.S. public capital markets, U.S. issuers and the securities industry, we have retained Dr. Edwin T. Burton, III, an economist,(3) to analyze the economic costs of delaying the offering process in the manner contemplated by the proposals. The analysis, which accompanies this letter, demonstrates that real and significant costs are borne by issuers and investors when delays are introduced into the offering process. The study estimates the costs of the delays that would be imposed by the preliminary prospectus and term sheet delivery and filing requirements. These costs would be substantial. Moreover, as indicated in the study, these estimates do not include various economic costs that cannot be measured or quantified, such as, for example, the substantial opportunity costs of transactions that are not completed as a result of the new regulatory regime.
In addition, the study concludes that the "aircraft carrier" proposals could have numerous other negative consequences, including, among others: substantially curtailed access of individual investors to IPOs and other offerings, a decline in the role of regional brokerage firms and smaller retail-oriented firms in the public offering process, fewer market makers for the stocks of medium-sized and smaller companies and fewer analysts covering these companies. The study also analyzes the importance of "immediacy" in today's capital markets and its impact on efficiency, innovation and the development of markets. In particular, it discusses the development and growth of the medium term note market and the potentially serious negative impact that the proposals could have on this important market.
The study analyzes the competitive position of U.S. capital markets and concludes that the increased costs imposed by the proposals would be likely to cause many issuers to move a substantial portion of their capital-raising activities offshore. The long-term adverse impact on U.S. capital markets could be enormous and, to some extent, irreversible.
We invite the Commission and its Staff to meet with Dr. Burton and us to discuss his analysis of the economic costs that the "aircraft carrier" would impose on the registered offering process.
In this letter, we shall first discuss the most troublesome proposals, including the delay and inefficiency that would result from the proposed preliminary prospectus and term sheet delivery requirements, the counterproductive effects of the proposed requirements to file "offering information" and "free writing", other problems with proposed Form B, the unwarranted destruction of a very useful and successful financing technique (Rule 144A offerings with follow-on registered exchange offers), the imposition of unjustified costs and burdens on many secondary offerings, and the undue complications resulting from the proposal to impose on dealers a 25-day prospectus delivery (or deemed delivery) obligation in all registered offerings. We shall then discuss the Commission's proposals regarding underwriters' due diligence and suggest certain changes. Next, we shall discuss the positive proposals set forth in the Release and urge that they be reproposed for comment in the context of the current registration system. We shall also discuss private placements and suggest certain reforms. Finally, we shall suggest ways to improve the quality of information available to the investing public.
The Commission should adapt its requirements to the realities of the technology and information age. For the purpose of protecting investors, availability and access are now an effective alternative to the physical delivery of information (whether by mail or e-mail). In terms of efficiency, competition and capital formation, they are far preferable. At this time, the Commission should redesign its rules to realize the full benefit of the major advances in information technology that have been achieved over the last decade, as well as the considerable time and expenditures that the Commission and thousands of issuers have invested in making all required information readily available to the public on the Internet. The Commission should also be forward-looking in recognizing that over the next few years the ever-increasing percentage of investors who have ready access to the Internet will escalate rapidly.
We continue to oppose regulatory "speed bumps" prior to offerings of securities. See our November 13, 1996 letter at page 17 (File No. S7-19-96). As we said then, such a requirement would create an artificial impediment for issuers that wish to access the capital market on a timely basis and would not provide a sufficient benefit to the public to justify the costs to issuers and the capital markets, which would be substantial. Moreover, the proposals are actually much worse than simple "speed bumps", because they would not only delay issuers' access to the U.S. public capital markets, but also severely constrict the universe of investors to whom an issuer could sell within any particular timeframe (and would impose additional "speed bumps" whenever an issuer wished to expand that universe).
Preliminary Prospectus and Term Sheet Delivery Requirements
Form A. We see no compelling reason why many issuers that are currently eligible for shelf registration on Form S-3 or F-3 should be demoted to proposed new Form A with its requirement to deliver preliminary prospectuses (together with, in the case of a seasoned issuer that incorporates by reference, its latest annual report on Form 10-K and quarterly report on Form 10-Q) at least three days before pricing. According to the Release, 1,427 issuers, or approximately 30% of the 4,824 issuers currently eligible for Form S-3 or F-3, would be relegated to Form A. The Release cites no abuses that would justify this proposed demotion.
The proposed requirements that a preliminary prospectus "must be sent to each investor in a manner reasonably designed to arrive" at least seven (or three) days before pricing(4) and that any updated information "must be set forth in a document sent to each investor in a manner reasonably designed to arrive" at least 24 hours before pricing would delay offerings and create increased risk in the capital-raising process. These requirements may require (1) issuers to accept a lower price or downsize or delay offerings (which may result in cancellation of a significant number of offerings) or (2) underwriters to assume the substantial market risk involved in positioning a portion of the offering (for which they are likely to seek compensation in the form of a lower purchase price and higher spread). The first alternative would clearly harm issuers, and it is likely that investors would lose as well. As discussed in the accompanying economic study, there is no reason to suppose that the after-market performance of IPOs cancelled as a result of these new regulatory delays would have been less advantageous for investors than the average IPO. The second alternative would clearly increase issuers' financing costs. Moreover, since positioning securities in offerings requires the commitment of substantial capital, growth of this practice in underwritten offerings could adversely affect the competitive position of regional and smaller underwriters.
Moreover, the proposed delivery requirements would thwart the current ability of an issuer to increase the size of an offering. If the proposals were adopted, in many cases an issuer would be able to increase the size of the offering only if it delayed the pricing (often by several days) so that additional preliminary prospectuses could be sent out the required number of days in advance of pricing. This delay would force the issuer to incur substantial market risks and would send inaccurate and unintended negative signals to the market.
The proposals, which do not take into account the practical realities of the marketplace and the effectiveness of the current system, would harm both issuers and investors, especially smaller investors. As indicated in our discussions with members of the Staff, the offering process is necessarily interactive and dynamic, and demand for a particular offering is determined over time -- building to a peak just before pricing, if everything goes right. Many factors affect this process. As just one example, since institutional customers set priorities among various investment opportunities in active primary markets, the road show schedule tends to influence when these customers will focus on a particular offering. In order to be able to "build a book" in the most efficient and effective manner, offering participants must have adequate flexibility in timing the launch, marketing and pricing of an offering, adjusting the scope of marketing efforts and customer contacts, inviting investment banks and dealers to join the underwriting syndicate and selling group, and making allocations of the offered securities. The need for flexibility is especially acute, because normally the most meaningful and important indications of interest are obtained late in the book-building process.
Usually the sales personnel of underwriters will identify those who might be interested in the securities before sending preliminary prospectuses to customers. The proposed delivery requirements would adversely affect investors who, due to temporary circumstances (vacation, business trip, illness, etc.), are not able to communicate with their brokers or sales representatives before the delivery deadline. Individuals are more likely than institutions to be affected by such circumstances and thus more likely to be excluded from an offering because a preliminary prospectus was not sent to them before the delivery deadline.
On the other hand, to the extent that underwriters wish to preserve some of the flexibility of the current system, they would have to send out preliminary prospectuses to a vast number of customers (typically at the issuer's expense) before attempting to determine whether the recipients have any interest in the securities. This would, of course, entail substantial unnecessary costs for issuers and could result in overwhelming customers with potentially unwanted preliminary prospectuses. Moreover, in oversubscribed offerings, this would also result in more disappointed customers. The business necessity of overselling, which would be artificially created by the proposed system, would strain customer relations and inconvenience investors. Investors' reactions to overselling are likely to be as unfavorable as travelers' reactions to overbooking by airlines. Indeed, the need to oversell an offering would greatly exceed the pressure to overbook a flight, since airlines are not subject to any constraints on sales to last-minute customers.
Any minimum delivery period necessarily closes the door arbitrarily on some investors. Given the realities of the offering process, the practical effect of such requirements would be to discourage offers to smaller customers and decrease allocations to the retail segment of the market. This is also likely to discourage the inclusion of regional and smaller investment banking firms in underwriting syndicates and selling groups, in view of the diminished role of such firms' customers.
The requirement to deliver a preliminary prospectus should continue to apply in initial public offerings to the extent currently required by Rule 15c2-8. If the Commission believes that the requirement should also apply in cases where abuses are perceived (for example, micro-cap stocks, partnership roll-ups and blank check offerings), it should propose to expand Rule 15c2-8 to cover specific classes of offerings. Such requirements should not be part of Regulation C, where violations may result in claims for rescission under Section 12(a)(1). Rather, as is currently the case, non-compliance should be subject to administrative sanctions under the Exchange Act.
The 48-hour period required by Rule 15c2-8 in IPOs should not be lengthened. As discussed above, any longer period would result in underwriters having to send out more copies of the preliminary prospectus, which would increase issuers' costs, could result in customers being inundated with unwanted documents and, in oversubscribed offerings, would result in more disappointed customers.
Form B. The term sheet delivery requirement would provide little or no practical benefits, and would slow down offerings (vis-à-vis current shelf procedures), create increased risk in the capital-raising process, and adversely affect the terms available to issuers and sellers.
Under current shelf procedures, an issuer can access the capital markets virtually instantaneously. The proposals would lengthen by hours the time required to come to market and would often delay the offering until the following business day. This could cripple shelf procedures and would frustrate issuers' financing plans.
The problem would be most acute for investment grade underwritten offerings and medium term notes. These are generally sold on trading desks based on rating, interest rate and maturity, just like secondary sales. A secondary market in which trades are not binding until the seller delivers a confirmation to the purchaser would be extremely inefficient if not unworkable. The practical results of requiring the delivery of term sheets in these types of primary offerings would be no better.
The proposed requirement would make "reverse inquiry" sales substantially less efficient. In a "reverse inquiry" sale, the purchaser (normally an institution) initiates the transaction by indicating the amount and type of investment it wishes to make and specifies its requirements as to credit rating, maturity, yield and other terms, and the broker-dealer then seeks out an issuer that meets the institutional investor's criteria and that may be interested in issuing securities with the desired terms. In some such sales the final terms of the securities are the result of an iterative process between the issuer and the institutional buyer. In any case, requiring the delivery of a term sheet in "reverse inquiry" sales seems especially inappropriate.
It is not clear whether the 24-hour requirement for updated information would apply to Form B offerings or whether an issuer would be permitted to reflect material developments in an incorporated Exchange Act document or amendment to the registration statement without triggering a special document delivery obligation. Under the existing system, offering participants can orally notify investors of such developments prior to sale without having to physically deliver anything. The ability to proceed on this practical basis should be preserved. Any document delivery obligation would cause more delays in many offerings, which would further increase the exposure of issuers and underwriters to market risk, and create an incentive to avoid disclosure of marginally material information.
In most offerings that would be registered on Form B, the receipt of a term sheet would provide no meaningful benefit to investors. In the case of offerings of shares of a publicly-traded class of capital stock, the terms of the stock will be straightforward and already known to the market (and set forth in Exchange Act documents on file with the Commission). In the case of most offerings of investment grade fixed-income securities, the securities are sold primarily on the basis of the issuer's credit rating and the yield and maturity of the securities, and the terms are straightforward and easily communicated orally. In most high-yield offerings, the securities are sold primarily to institutional investors, and often the terms are easily communicated orally by reference to recent precedents.
Generally, the only cases in which a term sheet may be helpful to investors are where the terms of the securities are novel or complex and not easily communicated orally. In such situations, however, marketing considerations normally dictate the use of written disclosures. The experience with shelf registration shows that issuers adapt to the needs of the market, for example, by using preliminary prospectus supplements where they are not legally required but are desired by investors.
For more than 65 years since the enactment of the Securities Act, term sheets prior to effectiveness have been prohibited. We believe that they should be permitted but not mandated as a pre-condition to sale and not required to be filed. We believe that voluntary use of term sheets should address most timing issues for investors. The Commission could monitor how this voluntary approach works in practice.
In addition to the increased costs arising from delay and greater uncertainty and risks in particular offerings, the time and costs involved in developing, implementing and operating the new delivery systems required by the proposals would be substantial. These new systems would have to be significantly different from existing prospectus delivery systems, which are now part of firms' back office confirmation processes. The proposed requirements would require extensive front office systems and additional interface systems between front and back offices.
Finally, it is not clear how offering participants are expected to comply with the proposed new delivery requirements in connection with transactions on an exchange or Nasdaq (as, for example, in the case of many registered secondary offerings). In these transactions, the seller does not know the identity of the buyer. It is thus not practicable to require advance delivery of a term sheet or preliminary prospectus, and any such requirement would serve no purpose. It is also not clear how offering participants could comply with the proposed requirements in connection with transactions with investment managers and others acting on behalf of various accounts and sub-accounts, where normally the seller does not know prior to sale the particular accounts to be designated as purchasers.
These proposals would completely rewrite the requirements of the offering process, turn back the clock and even impose obligations not known at any time since the enactment of the Securities Act. The ultimate consequences to the efficiency of our capital-raising process are unpredictable. These requirements would impair issuers' access to capital and would slow the pace and increase the cost of raising capital in registered offerings in this country. This would adversely affect the competitiveness of U.S. markets as compared to other markets, especially the European market - just when that market is gathering strength as a result of its consolidation through the introduction of the Euro.
Filing Requirements and "Inclusive Prospectus" Concept
The proposed expansion of what is required to be included in a registration statement and the requirement to file "offering information" (as part of the registration statement and thus subject to Section 11) and "free writing" (not as part of the registration statement, but subject to Section 12(a)(2) if the writing constitutes an offer) are antithetical to encouraging the registration of offerings and freer flow of information. Furthermore, whether or not information deemed to be a "prospectus" is required to be filed, we believe the "inclusive prospectus" approach is fundamentally unsound and constitutes regulatory overreaching.
Post-effective free writing has been permitted since the enactment of the Securities Act over 65 years ago. Such free writing has never been subject to filing requirements.
The proposed filing requirements and "inclusive prospectus" concept would unfairly expose offering participants to liability for the conduct of others (issuer for underwriters, underwriters for issuer, underwriters for each other). First, offering information prepared and used by one offering participant would subject all offering participants to potential Section 11 liability. This would be unfair to all other participants. Moreover, issuers, which do not have a "due diligence" defense under Section 11, would not want to be liable for offering information prepared by underwriters.
Furthermore, the potential consequences of a failure to file either offering information or free writing are unclear. Would such a failure result in a violation of Section 5? By the issuer? By the person who failed to produce the information? By all other underwriters, too? The possibility of a rescission remedy under Section 12(a)(1) could give unfair advantages to litigants.
Information prepared by an offering participant for its customers should not expose that participant (much less any other participants) to liability to persons for whom the information was not prepared. The filing requirement would discourage investor-specific information and would force offering participants to modify or eliminate the presentation of such information.
Information traditionally presented at road shows has not been, and should not be, required to be filed. While the Commission may desire to make road show information available to investors generally, we believe that the proposals would have the opposite effect, reducing the information made available and restricting certain information to oral communications with selected institutional investors.
The Commission does not require public disclosure of forecasts and projections by issuers, and it should not attempt to impose such a requirement indirectly on issuers -- much less on outside analysts. Any such requirement would create a regulatory incentive for limiting forecasts and projections to oral communications to a very limited number of selected institutional investors.
The filing requirement also could force the disclosure of proprietary information, for example, where in connection with an offering an underwriter provided offering information describing an innovative structure that was abandoned or modified before the issuer filed its registration statement relating to the offering.
The requirement to file "offering information" and "free writing" would slow down offerings and create increased market risk in the capital-raising process. Under the existing shelf system, underwriters may sell securities whenever they are ready and then document the transaction. Under the proposed registration scheme, broad-based searches within issuers, underwriters and others may be required to identify all "offering information" and "free writing" that must be filed with the Commission, and everything to be included in the registration statement (except, according to the Commission Staff, price-related information) must be complete, prior to effectiveness and sale.
Even the handling of price-related information under the new system would be cumbersome. It appears that price-related information would have to be included by post-effective amendment rather than Rule 424 prospectus.
It is unclear whether price-related information would have to be included in the term sheet in Form B offerings. The Staff has said that it would alleviate this concern by making clear that such information need not be included.
Except for the purchase price, it would not be feasible to include price-related information in confirmations. Expanding confirmations to include additional information would require substantial and costly alterations to the design and operation of the confirmation process.
Application of the filing requirement to "offering information" and "free writing" used subsequent to 15 days before the "first offer" is unworkable in view of the number of participants involved and the ambiguity inherent in the "first offer" concept. If this requirement were adopted, an issuer would have to obtain and review all written communications relating to the issuer which were sent by each prospective underwriter in the recent past. This identification, retrieval and review process would be cumbersome and time-consuming, and these practical considerations would be likely to encourage issuers to limit the number of underwriters who may be invited to participate in a registered offering. This result could adversely affect the competitive position of regional and smaller investment banking firms vis-à-vis firms with larger customer bases.
The nebulous concept of "first offer" would be very difficult to apply in a system in which oral offers are permitted before the filing of a registration statement. What contacts with a customer constitute an "offer"? What facts and circumstances would an issuer or underwriter have to investigate to determine when the "first offer" was made?
Moreover, the line between "offering information" and "free writing" is extremely murky, which would make the filing requirements very difficult to apply in practice. Since these issues involve exposure to potential liability, counsel would need to devote substantial time to assisting offering participants in each step of the review process and in determining each document's status under the filing requirements. This could substantially increase legal costs.
The potential for inadvertent technical violations of Section 5 could create a field day for litigants.
All these problems would lead offering participants to prohibit or severely restrict "offering information" and "free writing" by contract. This would perpetuate a regulatory-based disparity in the scope of information available inside and outside the United States.
Contrary to the Commission's intention, the net effect would be to discourage the availability of additional information in registered offerings.(5)
In view of these serious problems, the Commission should not adopt proposed Forms A and B. The positive initiatives in the Release should be reproposed for comment in the context of the current registration system and forms.
If the Commission nevertheless proceeds with the Form A and Form B approach, the following additional problems would have to be corrected. Our comments on these additional problems, however, are not intended to suggest that we would support adoption of Form A and Form B in any modified form.
Disqualification Provisions. The proposed disqualification of an issuer or an underwriter for past violations is draconian and unnecessary.
This entirely new eligibility requirement for short-form registration would require issuers to obtain representations from all prospective underwriters and require underwriters to satisfy themselves that neither the registrant, any executive officer or director nor any other underwriter is disqualified. This could slow down the offering process if underwriters are added at the last minute or effectively eliminate the ability to add offering participants at that stage. Moreover, we see no logic or fairness in having the behavior of an underwriter affect an issuer's eligibility to register its securities on a short-form registration statement. Shelf takedowns under Rule 415 have worked well without this requirement, and we do not see why this impediment should be considered appropriate now.
Possible disqualification from Form B offerings could subject issuers and underwriters to undue pressure to settle enforcement proceedings. The Division of Enforcement already has sufficient means to deal with violations by underwriters.
The consequences of using Form B when not eligible are unclear. If after the fact a single disqualified underwriter is found to have been mistakenly included, would the entire offering be subject to rescission under Section 12(a)(1)?
Resolution of Staff Comments on Exchange Act Reports. The proposed requirement that all Commission staff comments on the issuer's Exchange Act reports be resolved is draconian and unnecessary. It would effectively eliminate the benefits of effectiveness on demand for Form B registrants.
Under existing shelf procedures, the registrant and its underwriters can assess the materiality of any outstanding Staff comments on incorporated documents and proceed if they judge the issue to be not material (which involves taking into account both possible market disappointment and potential liability in the event of future change) and are willing to run the risk of Staff dissatisfaction. Under the new procedure, issuers would be (or would perceive themselves to be) at the mercy of the Staff in connection with each offering, whether the subject of a new registration statement or a post-effective amendment to a shelf registration statement. This could subject issuers to capricious and arbitrary delays.(6)
This unfair position would be especially burdensome for frequent issuers and issuers that need to maintain a continuously effective registration statement (for example, a market-making or MTN shelf). Here again, shelf takedowns under Rule 415 have worked well without this requirement, and we see no reason to make this change.
No Presumption as to Correct Form. The proposed elimination of the presumption under Rule 401(g) regarding the availability of Form B is troubling because the consequences of using the wrong form are unclear. A violation of Section 5 would clearly be too onerous since rescission based on use of the "wrong" form would be excessive and unfair. If the presumption is eliminated, the Commission should clarify the consequences and limit them to the participant that caused the ineligibility.
Certification Requirements. The proposed requirement that all signers of a registration statement certify compliance with the securities term sheet delivery requirement is not workable. The registrant, signing officers and directors would not be able to satisfy themselves that this is true, because delivery is to be made by the underwriters at times subsequent to the filing of the registration statement or amendment.
The proposed requirement that signers (including a majority of directors) certify that they have read the registration statement or amendment is unworkable. In many if not most cases, the registration statement or amendment is finalized at counsel's office or at the printer late at night. Powers of attorney to sign the document are no solution. It would serve no purpose if all it means is that an attorney-in-fact read the document for the relevant directors and officers. The proposed requirement would be a major burden for frequent issuers. The logistical difficulties of having all signers read, and certify that they have read, the registration statement before filing would create significant delays for seasoned issuers that wish to seize favorable market opportunities. The Release does not cite any abuses or other problems that would be addressed by this new requirement. This burden would increase costs but provide no real benefit since it is not likely to affect the quality of disclosure in any meaningful way.
The proposed requirement that signers (including a majority of directors) certify that they know of no material misstatements or materially misleading statements is unworkable. How would the signers get to read offering information (especially offering information prepared by underwriters) included in the filing or filed by post-effective amendment?
It is also unclear how this would affect the liability of the directors who sign the registration statement vis-à-vis those who do not. It could create unnecessary new difficulties for issuers in determining which individuals to ask to sign and persuading them to do so.
Size Requirements. We see no compelling reason to impose the $1 million average U.S. daily trading volume requirement on issuers having a public float of at least $75 million but less than $250 million. In the absence of any abuses cited in the Release, requiring 30% of all issuers currently eligible for Form S-3 or F-3 henceforth to use Form A would be an unnecessary step backward. The substantial costs to issuers demoted by the proposal would far outweigh any supposed benefit to investors. If the Commission believes such issuers' registration statements should be subject to possible Staff review, it should simply exclude such issuers from effectiveness on demand, rather than demoting them to Form A.
Reporting History. We support the proposed requirement that the issuer have filed at least one annual report under the Exchange Act. We would support a proposal to amend Form S-3 to include such a requirement.
The one-year reporting requirement, however, should be dropped. This requirement seems unnecessary when the issuer is required to have filed at least one annual report under the Exchange Act. We see no purpose in requiring the filing of a specified number of quarterly reports, which are narrower in scope and not intended to provide comprehensive information regarding the issuer. Once the issuer has timely filed a complete annual report, the public information filed by the issuer under the Exchange Act should be sufficient to permit incorporation by reference and a more streamlined offering process.
The requirement in Forms S-3 and F-3 that an issuer be current in its Exchange Act reporting during the 12 calendar months and any portion of a month immediately preceding the filing of the registration statement should be amended to require that the issuer be current during such period or, if shorter, since the issuer became subject to the Exchange Act's reporting requirements.
Underwriters' Concurrence. The requirement to file the underwriters' concurrence in the issuer's request for effectiveness is a formality and unnecessary nuisance. It does nothing to protect underwriters or investors and should be dropped. A prospective underwriter can always protect itself from Section 11 liability by not participating in an offering.
Offerings to QIBs. The proposed "conduit" concept in offerings by small issuers to QIBs would render Form B useless for such offerings. Purchasers need to know whether they can freely resell the securities or not. The "conduit" concept would effectively retract, or even reverse, the interpretive position set forth in the American Council of Life Insurance letter (May 10, 1983), reinstate the mischievous "presumptive underwriter" theory and create substantial uncertainty as to when and under what circumstances a QIB may resell the securities to non-QIBs.
Even if the "conduit" concept is withdrawn, a Form B offering to QIBs would not be a viable alternative to an Exxon Capital transaction for issuers that do not satisfy the reporting history requirement.
Market-Making Registration Statements. As proposed, Form B would not be available for market-making transactions involving securities acquired from another affiliate of the issuer (directly or indirectly) in market-making transactions. This is unduly restrictive. For example, where the issuer has both U.S. and non-U.S. broker-dealer subsidiaries engaged in market-making, there is no reason to restrict resales of securities transferred between these subsidiaries.
Incidentally, market-making sales are another example of registered sales where it would be impossible to comply with the proposed requirement to deliver a term sheet prior to purchasers' investment decisions -- much less a preliminary prospectus three days prior to sale.
The Release cites no abuses in Exxon Capital transactions, and we see no compelling reason to prohibit this very useful and successful capital-raising technique.
These transactions have benefitted investors that are regulated by legal investment laws and have provided these and other investors with greater liquidity while avoiding the burdens of traditional "evergreen" registered resales. The cost savings to investors have been substantial. Moreover, shelf registration of resales is unattractive to investors because it subjects them to prospectus liability, requires disclosure of their names and allocations, and does not change the restricted status of the securities until they are sold pursuant to the registration statement.
Non-convertible Debt and Investment Grade Preferred Stock. The proposed rescission of the Exxon Capital interpretation is designed to drive U.S. issuers to register offerings on Form B. Given the problems inherent in using Form B, as well as the unworkable "conduit" concept proposed for small issuers selling to QIBs, however, the proposed rescission is likely to have the opposite effect. More offerings may be made in the Rule 144A market but at higher issuance costs, or in non-U.S. markets.
On the other hand, in cases where an issuer is otherwise eligible to use Form B, the proposal to permit effectiveness on demand would render the repeal of Exxon Capital unnecessary as an incentive to register. In such cases, we expect that many Form B issuers would forego doing a private placement and then an Exxon Capital registered exchange offer, and would instead do a registered offering at the outset. However, even where effectiveness on demand is available, issuers and the market should be allowed to decide which technique to use.
Equity Securities of Non-reporting Foreign Issuers. It is unclear whether the Commission intends to preserve the Vitro line of letters as an incentive for non-reporting foreign issuers to use Rule 144A as a "stepping stone" to the U.S. market and then make a registered exchange offer, thereby becoming subject to the ongoing reporting requirements of the Exchange Act. We believe that this incentive has been very useful and should be retained. This technique has lowered ongoing administrative costs for issuers and provided greater liquidity for U.S. investors.
We see no reason to eliminate the ability of smaller seasoned issuers to register secondary resales on a short-form registration statement. The proposals would unduly curtail the availability of secondary shelf sales of common stock, which have been available for over 40 years.
If, as suggested in the Release, certain issuers or underwriters have been abusing the process by calling "secondaries" what are really primary offerings, then these abuses should be addressed directly by interpretation and enforcement.
The negative effects of the proposal would be particularly harmful to venture capital investors. This would increase the cost of capital for issuers that obtain financing from venture capitalists. The suggestion in the Release that issuers could register offerings to venture capitalists on Form B and avoid having to register resales disregards the fact that private sales of securities to venture capitalists are frequently made well before the issuer is ready to register securities and thereby become subject to the ongoing reporting requirements of the Exchange Act.
Further, in many acquisitions by a publicly-traded company, the acquiring company issues common stock to the stockholders of the business being acquired subject to an agreement to register the stock for resale. In cases where the acquiring company is a smaller seasoned issuer, the proposals would make such acquisitions less attractive by substantially decreasing the degree of liquidity available for secondary sales. This would adversely affect such stockholders and would increase the costs to such issuers of making acquisitions by issuing common stock.
The proposals provide no relief for practical logistics in registered secondaries. The Commission should permit the use of a universal shelf registration statement for secondary sales without naming the selling security holder until the takedown, and then only if the amount to be sold by the selling security holder is above a specified threshold amount (for example, 2% of the outstanding securities of the class).
We do not support the proposal to require dealers to deliver prospectuses for 25 days after all offerings, not just IPOs. It is unclear whether the registrant or underwriters would be required to ensure that the prospectus is updated during this period. Currently there is no such duty to update in the case of any registration statement filed by an issuer that is already reporting under the Exchange Act. Would the registrant be required to file Exchange Act reports by post-effective amendments during the offering period and under Rule 424 thereafter? Further issues would arise concerning who would be subject to potential liability for prospectuses deemed to have been delivered in connection with secondary trading. Would this include the issuer? The selling dealer, whether or not it was a participant in the offering? Would offering participants need to attempt to obtain an agreement by issuers to update the prospectus during this period even though the offering has been completed?
Although in most cases the prospectus delivery requirement would be deemed to be satisfied by the inclusion of a legend in confirmations of sale, dealers would be required to deliver prospectuses upon request. This would be burdensome for dealers, especially those that did not participate in the offering. The prospectus is readily available to after-market purchasers via the Commission's EDGAR system, and availability and access are sufficient for their protection. The Commission should not be expanding the number of situations in which physical delivery would be required.
Underwriters' Due Diligence. We recognize and appreciate that the Commission has attempted to address in a helpful way the securities industry's concerns arising from the fact that the liability provisions of the Securities Act have not kept pace with the realities of the underwriters' role in offerings registered on short-form registration statements.
We support the proposed extension of Rule 176 to Section 12(a)(2) and agree with the Commission that "any practices or factors that would be considered favorably under Section 11 also should be considered as favorably under the reasonable care standard of Section 12(a)(2)." We also agree with the Commission's observation that "Section 11 requires a more diligent investigation than Section 12(a)(2)".
Subject to the comments below, we support the proposed addition of paragraph (i) to Rule 176. We see no reason, however, to exclude offerings of investment grade debt securities from the benefits of the new guidance, which we believe should apply to offerings of any type of security. We are not aware of specific due diligence practices that are performed only with regard to investment grade debt offerings. Moreover, in view of the relative risks involved, we believe that any practices or factors that would be considered favorably in connection with an offering of equity or non-investment grade debt securities should be considered at least as favorably in connection with an offering of investment grade debt securities.
We believe that the new guidance should not be limited to offerings that are marketed and priced in fewer than five days. There should be no time limit, because the factors included in the guidance are just as relevant to other offerings. Moreover, limiting the benefits of Rule 176(i) in this manner would create an unjustified regulatory bias in favor of marketing and pricing offerings quickly.
While we agree with the Commission's observation that "in limited and controlled circumstances, cooperation between analysts and underwriters can be useful" in expediting the due diligence process, we do not believe that the new guidance in Rule 176 should include consulting with an analyst who has been covering the issuer. Including this as a factor would exacerbate the competitive disadvantage of investment bankers that have no such analyst. In addition, as the Commission recognizes, among firms that have such analysts, practices vary with respect to their role in the due diligence process. The Release indicates that the Commission also recognizes "the wisdom of maintaining legitimate [information barriers] between [a firm's] analysts and [its underwriting personnel]." The weighing of the advantages and disadvantages of bringing an analyst "over the wall" in connection with a specific offering involves countervailing practical considerations and should be left to the individual firms that must live with the consequences of their decisions.
We believe that having an independent professional review an issuer's annual report would not be workable in practice. It would be too costly, and it is not clear who would be available to perform such service.
Subject to the foregoing, we believe that the factors to be included in Rule 176, except those set forth in proposed subparagraphs (i)(3)(i) and (i)(3)(ii), should apply to all offerings, and that all factors, including those in subparagraphs (i)(3)(i) and (i)(3)(ii), should apply in all shelf-registered offerings. In addition, Rule 176 should expressly provide that what constitutes "reasonable investigation" or "reasonable care" in the context of offerings on short-form registration statements is substantially less than in other registered transactions such as initial public offerings.
For the reasons indicated in SIA's letter of November 13, 1996 at pages 17-19 (File No. S7-19-96), we continue to believe that the Commission should provide a safe harbor for underwriters who meet certain conditions in connection with registration statements on Forms S-3, F-3, F-7 and F-9. Specifically, we believe that an underwriter's compliance with the guidance to be included in Rule 176 should provide a safe harbor in connection with registration statements on such Forms, especially in connection with takedowns under shelf registration statements. We believe that the availability of such a safe harbor will not significantly lessen the incentive of investment bankers to conduct a reasonable investigation in connection with offerings on such Forms. First, an investment banker's incentives to conduct reasonable investigations in registered offerings underwritten by it include substantial business, reputational and risk-management concerns that go beyond liability issues under Section 11 or 12(a)(2). Experience with unregistered offerings under Rule 144A during the last nine years bears this out: in general, the scope of disclosure demanded by the market in Rule 144A offerings is substantially the same as that required in registered offerings, and underwriters conduct "due diligence" investigations even in the absence of liability under Section 11 or 12(a)(2) -- and even after the Gustafson decision in 1995. Second, the guidance in Rule 176 is neither so specific nor so limiting as to obviate an underwriter's need and incentive to conduct a reasonable investigation. For example, the broad concepts and objective standards in proposed subparagraph (i)(3)(i)(B) ("a reasonable inquiry into any fact or circumstance that would have caused a reasonable person to question whether the registration statement contains" a material misstatement or omission) belie any notion that the guidance would provide underwriters with a "finite list of steps" or simple checklist.
We continue to believe that it is fundamentally unfair for underwriters to still be held responsible as gatekeepers even though they no longer control the gates. A safe harbor would not eliminate this unfairness but would at least ameliorate it.
Indemnification. We continue to believe that the Commission should expressly confirm that indemnification of underwriters is not contrary to public policy. We believe that, as a matter of simple fairness, this position should apply to all registration statements, but in any case should at least apply to registration statements on Form S-3, F-3, F-7 or F-9.
Integration of Registered and Unregistered Offerings
We support greater clarity in the application of the integration doctrine in analyzing whether offers and sales should be considered part of the same "offering". The list of five factors to be considered in determining whether offers and sales should be "integrated", as described 37 years ago in Release No. 33-4552 (1962) and repeated in the Note to Rule 502(a) of Regulation D, does not effectively address the realities of today's securities markets or issuers' current financial practices, unnecessarily restricts the ability of issuers to raise capital and should be withdrawn.
We support the proposed liberalization of oral offers. It would make a great deal more sense to liberalize oral offers without regard to whether the ultimate transaction is a public or private sale. This approach would eliminate needless legal uncertainties for issuers and other market participants without in any way lessening the protection of any investor who purchases securities.
We recommend that the Commission permit all oral offers by or on behalf of an issuer that is eligible to use Form S-3 or F-3 or Schedule B, without regard to whether the ultimate sale is registered or is exempt from or not subject to the registration requirements of the Securities Act. Although we do not recommend extending this liberalization to other issuers at this time, such an extension may be appropriate after the markets and the Commission have gained experience with this reform.
We support the broader Section 5 safe harbors for research. While we support the proposed extension of the safe harbors to Rule 144A and Regulation S offerings, we believe that the safe harbors should also be expressly available in all exempt offerings, including Regulation D offerings and other private placements.
We do not support the proposed inclusion of research permitted under Rules 138 and 139 in the definition of "prospectus". The chilling effect of subjecting such research to potential liability under Section 12(a)(2) would be contrary to encouraging the freer flow of information and thus counterproductive. We believe that, in the case of bona fide research, administrative sanctions and civil liability under the antifraud provisions are clearly sufficient for the protection of investors.
The proposed requirement that the research report disclose the dealer's participation in an offering would not work in practice. Research may already be in circulation when the issuer decides to commence an offering or the underwriter is invited or decides to participate. In addition, the issuer and underwriter may have been discussing a possible offering, but the issuer has not yet decided to proceed and thus has not announced an offering. These practical difficulties would unduly frustrate and impede the free flow of research. Accordingly, we urge that this requirement not be included as a condition to the safe harbor.
The Commission should clarify that research need not be filed, whether or not it satisfies a safe harbor. Research is proprietary non-issuer information.
Press Coverage. We support the elimination of restrictions on bona fide press activities. For the reasons discussed in our November 13, 1996 letter at pages 11-12 (File No. S7-19-96), we believe that, insofar as the requirements of Section 5 of the Securities Act are concerned, the Commission should eliminate restrictions on bona fide press activities, wherever conducted, and that the safe harbors for offshore press activities should also cover press activities in the United States for both foreign and domestic issuers and should extend to offerings made primarily or exclusively in the United States.
We also continue to believe that the Commission should remind market participants, the press and other media of the existing prohibitions of "touting", particularly Section 17(b) of the Securities Act. This reminder should, of course, expressly apply to "chat room" operators and others on the Internet.
Term Sheets. Free writing consisting of a description of the terms of the securities and the plan of distribution should be permitted but not mandated. Some SIA members believe that more writings should also be permitted without limitation.
Regardless of the permitted scope of free writing, there is a consensus that, for the reasons outlined earlier, the filing of free writing should not be required.
Effectiveness on Demand
We applaud the Commission's proposal to permit effectiveness on demand for many seasoned issuers. We believe that eliminating the uncertainty and potential marketing delays resulting from the Commission's current policy of staff review would reduce some of the existing pressure to issue securities in exempt transactions or in markets outside the United States. Accordingly, we support effectiveness on demand for all offerings of securities of seasoned issuers, except in cases where abuses are perceived (for example, micro-cap stocks, partnership roll-ups and blank check offerings).
Within the context of the current registration forms, effectiveness on demand would not eliminate all disincentives to register an offering, but it would at least eliminate a significant one and, we believe, would be helpful. Within the context of proposed Forms A and B, the magnitude and severity of the disincentives to register created by the delivery and filing requirements would far outweigh -- and, in most cases, effectively nullify -- any incentive (or, more precisely, non-disincentive) provided by effectiveness on demand.
Finally, we wish to emphasize that effectiveness on demand would not constitute a practical substitute for shelf registration. The logistics of preparing and filing a registration statement (including, for example, filing a written consent of the issuer's independent accountants following completion of their updating procedures, obtaining the signatures of officers and directors, and preparing and filing various exhibits) are more cumbersome and time-consuming than the logistics of doing a takedown under an effective shelf registration statement. In most cases effectiveness on demand would simply not provide the immediacy currently available under the existing shelf registration system. We firmly believe that preserving the immediacy of shelf registration is crucial to continuing success of the U.S. capital markets. Accordingly, we believe that effectiveness on demand should be adopted as an independent improvement -- not as an occasion to impose new burdens on, or otherwise curtail the flexibility of, the shelf registration process.
We believe that elimination of the need to deliver final prospectuses with confirmations of sale is an important step forward in terms of efficiency in the clearance and settlement process. We applaud the Commission's proposal in this regard. As indicated in SIA's letter of November 13, 1996 at page 20 (File No. S7-19-96), the existing requirement for physical delivery of a prospectus prior to or simultaneously with written confirmation of registered sales imposes substantial expenses and unrealistic burdens in the context of T+3 settlement. The Commission's proposed revision would relieve costly bottlenecks and thereby facilitate the settlement process.
This strengthening of the clearance and settlement process would be especially important if registered transactions were to settle on a T+1 basis. We note, however, that a decision generally to require that secondary trading settle on a T+1 basis would not necessitate T+1 settlement for registered offerings, which involve more documentation and frequently involve various third parties (for example, counsel, auditors and indenture trustee or fiscal agent).
Although the Release suggests that the proposal would allow offering participants to save the cost of delivering final prospectuses, we doubt whether any such savings would be substantial. Rather, we expect that in most cases final prospectuses will be delivered after sale to customers for their files. We expect that most customers will want this.
We strongly believe that decoupling the delivery of final prospectuses from the settlement process clearly does not require or justify coupling investment decisions to the delivery of preliminary prospectuses or term sheets earlier in the offering process. Moreover, coupling investment decisions to the prior delivery of preliminary prospectuses or term sheets would create substantial market and credit risks which would offset any future reduction of credit risks achieved by shortening the clearance and settlement process.
The increased flexibility in switching from a private to public offering and vice versa is helpful but of less importance than certain other issues relating to private placements.
Investors, issuers and the United States are well served by having both public and private capital markets that are fair and efficient. The proposals, however, do not address any of the practical concerns regarding private placements.
When adopting Rule 144A in 1990, the Commission characterized the "initially limited form" of the Rule being adopted as "the first step toward achieving a more liquid and efficient institutional resale market for unregistered securities" and stated its intentions "to monitor the evolution of this market and to revisit the Rule with a view to making any appropriate changes."
The Commission has carried out its intention to monitor the development and evolution of the Rule 144A market. As a result, the Commission is aware that the adoption of Rule 144A in 1990 has allowed for significant improvements in the efficiency and liquidity of the U.S. private placement market, and that these improvements have provided substantial benefits for both issuers and sophisticated investors. Furthermore, Rule 144A has greatly enhanced the competitive position of the United States in the global securities markets. Foreign issuers have sold billions of dollars of securities to QIBs in offerings where, in the absence of Rule 144A, they might very well have excluded U.S. investors altogether. We believe that the development and growth of the Rule 144A market have not had any adverse effect on the public market.
Now that Rule 144A has been in successful operation for nine years, the Commission should extend the important reform of the U.S. private placement market which it began in 1990. The Rule 144A market should be expanded to a wider range of qualified buyers, and certain unnecessary restrictions should be eliminated. These changes will strengthen the Rule 144A market by enhancing its liquidity and efficiency and should provide issuers with greater flexibility to raise capital on an unregistered basis at reduced costs and with less regulatory delay, and in a manner consistent with the protection of investors.
Expand the Qualified Buyer Market. Expanding the universe of investors covered by Rule 144A will substantially enhance the efficiency and liquidity of that market for the benefit of all its participants, without in any way reducing the investor protections for those who need the benefits of registration under the Securities Act. The Commission should (1) reduce the minimum required size portfolio for non-broker-dealers from $100 million of securities to $25 million of investments (which should include securities, cash, money-market instruments, commodity futures and other similar financial assets) and (2) expand the type of buyer to include any person, i.e., any entity or individual, in order to increase the number of sophisticated buyers who may purchase Rule 144A securities and allow issuers greater access to capital. Requiring all non-broker-dealers to have investments of at least $25 million would still assure that only those investors who are sophisticated with respect to investments would be qualified to purchase under Rule 144A. This is amply demonstrated by the less stringent definition of "qualified purchaser" in the National Securities Markets Improvement Act of 1996 ("1996 Act"), which identifies those investors Congress considers to be sophisticated enough to purchase securities in unregistered offerings of unregulated investment vehicles.
In addition, whatever the level of the threshold, it is unnecessary and illogical to exclude any individuals who meet that threshold in their own right. We recognize that, in theory, an individual having a portfolio that large can already participate in the Rule 144A market by forming a corporation or other institution to hold his or her securities. We see, however, no reason why such individuals should be put to the time and expense of taking that approach. While forming an entity may be relatively straightforward for some, for others implementing such approach might force them to incur unnecessary tax, legal and administrative costs. In any event, the form of ownership is irrelevant to the key issue, namely, the investor's sophistication and ability to make investment decisions without Securities Act registration. Accordingly, we believe that qualified buyers should include any person, i.e., any entity (however formed) or individual that satisfies the investments threshold. We note that under the 1996 Act "qualified purchaser" includes both individuals and institutions, and that the $5 million investments threshold for individuals is substantially lower than the $25 million threshold for institutions. Indeed, some SIA members believe that the thresholds for qualified buyers under Rule 144A should be the same as those in the definition of "qualified purchaser" enacted by Congress.
Rule 144A also should be amended to expressly acknowledge that sellers may rely on a qualified buyer's or intermediary's certification as to the qualified status of the accounts for which the buyer is acting. Requiring anything more is simply not practical in today's highly competitive securities markets. Most qualified buyers acting for the accounts of other qualified buyers are extremely reluctant to identify these accounts to the seller, and often refuse to do so. This amendment would increase the efficiency of the Rule 144A market by relieving sellers of a paperwork burden that is impractical and unnecessary for the protection of investors and by placing the responsibility for determining qualified status appropriately on the person best positioned to make such determination.
Amend Rule 144A to Delete References to Offers. The availability of Rule 144A should be determined with reference to those who actually purchase the securities rather than to the identity of all offerees. This approach is taken in Regulation D, even though the thresholds for "accredited investor" under Regulation D are much lower than those proposed above for qualified buyers under Rule 144A. We see no justification for a more stringent approach in Rule 144A.
In addition, deleting the reference to offers would clarify the permissibility of public dissemination of quotations in trading systems for restricted securities (for example, Autex, Reuters, Bloomberg and Instinet). This would enhance the liquidity and efficiency of the Rule 144A market and eliminate an unnecessary restraint on the flow of information in the present world of electronic communications. It also might make possible the revival of SITUS and revitalize the PORTAL Market.
In the Rule 144A context, it is difficult to see any harm to offerees who do not purchase any securities. Restricting eligibility for the exemption by reference to actual buyers rather than offerees is all that is necessary for the protection of investors, as was recognized by the Commission in adopting Regulation D in 1982.
Narrow the Definition of "Fungible Securities". Assuming the Commission wishes to continue to exclude exchange-listed and Nasdaq securities from Rule 144A, then only securities that actually are fungible with exchange-listed or Nasdaq securities should be excluded. For example, not only convertible securities and warrants that meet the 10% minimum premium requirement, but also those that are not convertible or exercisable until at least six months after issuance, should be considered to be non-fungible with the underlying common stock based upon traditional market dynamics (in each case, even if the issuer has the option to redeem the convertible security or warrant and deliver shares of common stock in payment of the redemption price, so long as the security or warrant may not be so redeemed until at least six months after issuance). In this context, the Commission should explicitly permit mandatorily convertible or exchangeable securities to qualify as non-fungible securities. The Commission should also make clear that cash-settled securities are non-fungible even if the amount payable is tied to the value of exchange-listed or Nasdaq securities.
Eliminate, or Narrow the Definitions of, "General Solicitation" and "Directed Selling Efforts". The Commission should amend Regulation D and Regulation S to make clear that "general solicitation" and "directed selling efforts" do not include the dissemination of any written materials permitted under various safe harbors, including those proposed to be amended, and to expressly permit press activities within the expanded safe harbor recommended under "Positive Proposals--Free Writing--Press Coverage" above.
If and to the extent that there are substantive restrictions on the dissemination of offering materials relating to an unregistered offering, the Commission should expressly provide that the issuer or broker-dealer may rely on reasonable "gateway" procedures in connection with the dissemination of offering material by electronic or other means (for example, by requiring that any person seeking access must affirm its status as a qualified buyer). Also, in addition to permitting publication of research that satisfies a safe harbor, there should be formal acknowledgment that accessibility of research reports on electronic data bases is not considered to be publication or re-publication of the research, i.e., where a research report was previously included in an electronic database (for example, on an Internet site), it is permissible to leave the research in the database during the offering, whether or not the research report is within a safe harbor.
Adopt a Non-Exclusive Safe Harbor from the Definition of "Control". As indicated in SIA's letter dated May 21, 1997 at pages 2-4 (File Nos. S7-07-97 and S7-08-97), we support the creation of a "bright-line" safe harbor that would eliminate from the definition of "control", as used in the last sentence of Section 2(a)(11), persons who are clearly not in a position of control with respect to an issuer. We believe that a bright-line safe harbor would be especially useful in terms of convenience and simplicity. However, we believe that it is critical that if a person falls outside the proposed safe harbor, whether that person would be deemed to control the issuer should be determined based on all of the facts and circumstances, and that the Commission make clear and explicit in the Rule (as it did, for example, in the case of Rule 10b-18) that no presumption arises that such a person is a "controlling" person for purposes of Section 2(a)(11) or an "affiliate" for purposes of Rule 144(k).
Limiting the definition of "affiliate" in Rule 144 would not be adequate. It would simply limit the scope of those who may rely on the Rule for sales of control securities, without affecting who is an underwriter within the meaning of Section 2(a)(11). This anomalous result should be avoided by having the limitation apply to Section 2(a)(11) as well as Rule 144.
For the reasons discussed in SIA's May 21, 1997 letter at pages 2-4, we support the creation of a nonexclusive safe harbor based on the definition proposed by the Advisory Committee on the Capital Formation and Regulatory Processes. The Advisory Committee recommended the adoption of a definition that would include only (1) the company's chief executive officer, (2) the company's inside directors, (3) holders of at least 20% of company's voting power, and (4) holders of at least 10% of the company's voting power with at least one board representative. We urge the Commission to adopt a safe harbor definition that reflects the standards proposed by the Advisory Committee. In particular, we urge that any safe harbor from the definition of "controlling" person exclude a holder of less than 20% of the voting power of an issuer unless such holder is a member of, or has the right to elect a member of, the issuer's board of directors. We also agree that a holder of 20% or more of the voting power of an issuer, with or without board representation, should not be allowed to rely on the definitional safe harbor. As noted above, however, we believe that it is important for the Commission to make clear that no presumption of control status would attach to persons falling outside the definitional safe harbor and such persons could, in seeking to rely on Section 4(1) or 4(3) or Rule 144(k), continue to determine control status based on an analysis of all the relevant facts and circumstances.
Clarify Holding Period Under Rule 144. The utility of Rule 144 would be enhanced by an amendment providing that in calculating its holding period, a holder of "restricted securities" may assume that they have not been owned by an affiliate of the issuer unless the holder has actual knowledge to the contrary. This would help clarify when securities in DTC, Euroclear and CEDEL are no longer restricted and would reduce the administrative burdens of participants in the restricted securities markets without reducing meaningful investor protections.
In the Release the Commission indicates that "the next step in our ongoing process will be to revisit the quantity and quality of required disclosure" in both Exchange Act periodic reports and Securities Act registration statements. We support this initiative as more fully described below.
We continue to believe that one of the most effective ways for the Commission to improve the quality of disclosure in periodic reports is to provide more specific guidance to a greater number of issuers. While we strongly support Staff review of Exchange Act reports, the initial impact of such review is necessarily limited to the issuers that receive specific comments from the Staff. It is, of course, neither appropriate nor realistic for the Staff to review all issuers all the time. Thus, without more, the benefits of Staff review are necessarily realized by only a very limited portion of the market and are often disseminated in a manner which is, of necessity, both indirect and random to some extent. To maximize the benefits of Staff review and to assist more issuers in improving the quality and usefulness of their disclosures, the Commission should publish, after notice and public comment, specific guidance for various categories of issuers and businesses as to what is expected of them in complying with the disclosure requirements of the Federal securities laws and the regulations thereunder.
These guidelines could be developed on the basis of the Staff's experience in reviewing some issuers in specific businesses. We believe that this approach has been successfully utilized by the Commission in the past. For example, we believe the Releases regarding the content of "Management's Discussion and Analysis of Financial Condition and Results of Operations" and various Staff Accounting Bulletins and Staff Legal Bulletins have had a beneficial impact on the quality of disclosures made by many companies. We strongly urge the Commission to utilize this approach more often and with respect to more subjects. We believe that such disclosure guidelines should be proposed for public comment before being issued in final form, in order to help ensure that the guidelines achieve an appropriate balance between the costs and burdens on issuers and the benefits to investors and the U.S. capital markets.
In the Release the Commission correctly observes that "investors will receive [the] benefits of registration only if the Commission continues to make the registration system flexible enough to be a viable alternative in the capital markets of today and the future."
The proposals regarding research, oral offers, integration and effectiveness on demand and eliminating the physical delivery of final prospectuses satisfy this criterion and should be reproposed for comment and adopted in the context of the existing registration system and forms.
Other proposals, especially those regarding the delivery of preliminary prospectuses and term sheets, the "inclusive prospectus" concept and the filing of offering information and free writing, do not satisfy this criterion and should not be adopted. These proposals would decrease efficiency, increase market risk, increase the cost of capital and discourage the registration of securities offerings. They would harm the competitive position of the U.S. capital markets, at a time when the United States is facing increasing competition from foreign markets, especially Europe. The recent introduction of the Euro is likely to intensify this competition.
The Committees appreciate very much this opportunity to present our views. Should you have any questions, please feel free to communicate with Brad Gans at 212-816-0661, Lee Spencer at 212-214-2034 or Patricia Maher at 212-667-9068. Also, we very much appreciate the opportunities that the Committees and representatives of member firms have had to discuss with members of the Staff various important issues raised by the "aircraft carrier" proposals. We hope that there will be an ongoing dialogue. We would be happy to arrange a meeting between the Staff and Dr. Burton and members of the Federal Regulation and Capital Markets Committees or their Aircraft Carrier Subcommittee to explain our views more thoroughly.
Very truly yours,
Lee B. Spencer, Jr., Chairman
SIA Federal Regulation Committee
Patricia A. Maher, Chairman
SIA Capital Markets Committee
Bradley J. Gans, Chairman
SIA Aircraft Carrier Subcommittee(7)
cc: The Honorable Arthur Levitt, Chairman
The Honorable Norman S. Johnson, Commissioner
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Paul R. Carey, Commissioner
The Honorable Laura S. Unger, Commissioner
Harvey J. Goldschmid, General Counsel, Office of General Counsel
Brian J. Lane, Director, Division of Corporation Finance
Anita T. Klein, Senior Special Counsel, Division of Corporation Finance
Annette L. Nazareth, Director, Division of Market Regulation
Paul F. Roye, Director, Division of Investment Management
1. SIA brings together the shared interests of more than 740 securities firms to accomplish common goals. SIA member-firms (including investment banks, broker- dealers and mutual fund companies) are active in all U.S. and foreign markets and in all phases of corporate and public finance. The U.S. securities industry manages the accounts of more than 50 million investors directly and tens of millions of investors indirectly through corporate, thrift and pension plans. The industry generates more than $300 billion of revenues yearly in the U.S. economy and employs more than 600,000 individuals. (More information about SIA is available on its home page: http://www.sia.com.)
2. The Federal Regulation and Capital Markets Committees received comments and suggestions from various other SIA committees, and this response has received the approval of SIA's Board of Directors.
3. Dr. Burton has extensive experience both in academia and in the financial industry. Currently he is Professor of Economics at the University of Virginia and is Chairman of the Board of Trustees of the Virginia Retirement System.
4. This could in effect require underwriters to mail preliminary prospectuses at least 10 (or six) days before pricing. Many customers are not equipped to receive documents electronically, and using overnight delivery services would be prohibitively expensive.
Measuring the deadline for the delivery of a preliminary prospectus from the pricing of the securities does not work. This would seem to mean that an investor who did not receive a preliminary prospectus the required number of days before pricing could never purchase in the offering -- even if the investor was in possession of the preliminary prospectus for at least the same number of days before committing to purchase the securities. In this regard we note that the 48-hour period in Rule 15c2-8 is measured from the date a confirmation is mailed, which is more sensible.
5. We believe that the substantial differences between business combinations and securities distributions, particularly syndicated distributions, warrant different resolutions of the filing requirement issue.
In the case of transactions subject to Regulation MA, the Commission could reasonably conclude that the entire marketplace needs access to written information about the transaction provided by the subject companies because of the immediate, and frequently substantial, impact of news on the trading price of securities. Due to the time periods involved in tender offers and proxy solicitations, the principals have time to make filings without delaying the transaction. The principals can carefully prepare and control the written materials as to which they are exposed to potential liability. They are accustomed to filing many of these materials already. (See SIA's letter of May 12, 1999 at pages 3-5 (File No. S7-28-98).)
In the case of securities distributions, especially shelf takedowns, time is of the essence. There is no time to find out what an issuer, underwriter or salesperson may have sent out, collect it, EDGARize it and transmit it to the Commission. In the case of offerings involving large syndicates, especially heavily retail offerings, the task and the delay are multiplied. Issuers and underwriters would be exposed to liability for documents they had no role in preparing and no opportunity to review before use. The likely result would be exclusion of underwriters (either because this is the easiest course of action or because of what they may have sent out) and prohibition of subsequent dissemination of written materials.
6. This risk would be exacerbated to the extent that "Plain English" rules are extended to Exchange Act reports.
7. This letter was prepared on behalf of the Federal Regulation and Capital Markets Committees by their Aircraft Carrier Subcommittee, consisting of representatives of the following member firms:
ABN AMRO Incorporated
Barclays Capital Inc.
BT Alex. Brown Incorporated
Caledonian Investment Partners LLC
Credit Suisse First Boston Corporation
Goldman, Sachs & Co.
Lehman Brothers Inc.
Merrill Lynch & Co., Inc.
J.P. Morgan Securities Inc.
Morgan Stanley Dean Witter
Nomura Securities International, Inc.
Piper Jaffray Inc.
Prudential Securities Incorporated
Salomon Smith Barney
D.E. Shaw & Co.
T D Securities (USA) Inc.