SEC Allows ‘Test-the-Waters’ Communications for All Issuers
We previously discussed the Securities and Exchange Commission’s (the SEC) proposed Rule 163B under the Securities Act of 1933, as amended (the Securities Act), and proposed amendments to Rule 405 promulgated under the Securities Act (the Proposed Rule) to expand “test-the-waters” communications to all issuers.
The SEC received approximately 20 comment letters in response to the Proposed Rule. The commenters broadly supported the Proposed Rule and endorsed the SEC’s efforts. On September 26, 2019, the SEC adopted Rule 163B under the Securities Act, largely as proposed, to permit all issuers to engage in “test-the-waters” communications to gauge market interest in contemplated registered offerings.
Summary of Rule 163B
We discussed the following aspects of the Proposed Rule in our previous client alert. In the final rule, the SEC adopted the following aspects of Rule 163B as proposed.
All issuers, including non-reporting issuers, emerging growth companies (EGCs), non-EGCs, well-known seasoned issuers, and investment companies (including registered investment companies and business development companies) are eligible to rely on Rule 163B.
Intended Recipients of “Test-the-Waters” Communications
Under Rule 163B, issuers are allowed to engage in test-the-waters communications with qualified institutional buyers (QIBs) or institutional accredited investors (IAIs) either prior to or following the filing date of a registration statement related to a securities offering.
Reasonable Belief Requirement
Rule 163B requires the issuer to have a reasonable belief that a potential investor is a QIB or an IAI. Unlike Rule 506(c) of Regulation D, which imposes a burden on issuers to verify investor status, Rule 163B requires only the issuer to establish a reasonable belief with respect to the potential investor’s status based on the particular facts and circumstances. Not surprisingly, the SEC did not specify the steps that an issuer could or must take to establish a reasonable belief that the intended recipients of “test-the-waters” communications are QIBs or IAIs. The SEC instead concluded that issuers continue to rely on the methods they currently use to establish a reasonable belief regarding an investor’s status as a QIB or accredited investor pursuant to Rule 144A and Rule 501(a) of Regulation D, respectively. The SEC also reiterated that such methods will be dependent on the facts and circumstances of the proposed securities offering.
“Test-the-Waters” Communications are “offers”
According to the SEC, the “test-the-waters” communications, while exempt from the gun-jumping provisions of Section 5, would nonetheless still be considered “offers,” as defined in Section 2(a)(3) of the Securities Act, and would therefore be subject to Section 12(a)(2) liability, in addition to the anti-fraud provisions of the federal securities laws. Also, information provided in a “test-the-waters” communication under Rule 163B must not conflict with material information in the related registration statement. Further, issuers subject to Regulation FD would need to consider whether any information in the “test-the-waters” communication would trigger any obligations under Regulation FD, or whether an exception to Regulation FD would apply.
Legend or Filing Requirement
An issuer contemplating a registered securities offering may solicit interest from QIBs and IAIs without legending or filing “test-the-waters” communications that comply with Rule 163B. Although an issuer is not required to file the “test-the-waters” communications with the SEC, as is currently the practice of the SEC when reviewing offerings conducted by EGCs, the SEC or its staff could request that an issuer furnish the staff any “test-the-waters” communication used in connection with an offering.
Rule 163B would not act as an exclusive election and an issuer could rely on other Securities Act communications rules or exemptions when determining how, when, and what to communicate with respect to a contemplated securities offering. If the same issuer decides to claim the availability of another exemption or communication rule with respect to those communications, the conditions of the other exemption or rule relied upon must be satisfied.
Moreover, to address certain issues raised by commenters in connection with the anti-evasion language and free writing prospectus, the SEC made the following two modifications to the Proposed Rule when adopting Rule 163B:
Eliminating the anti-evasion provision
The Proposed Rule included an anti-evasion provision in proposed Rule 163B(a)(2), which, according to the commenters, caused confusion or uncertainty and would limit the utility of the Proposed Rule. The SEC decided to remove proposed Rule 163B(a)(2) to avoid such confusion.
Revising the definition of free writing prospectus in Rule 405
The SEC amended the definition of “free writing prospectus” in Rule 405 to clarify that a written communication used in reliance on Rule 163B would not constitute a free writing prospectus.
Investment Company Implications
The SEC, in its Proposed Rule release, recognized that investment companies are less likely to use Rule 163B than other issuers because investment companies commonly file a single registration statement under both the Investment Company Act of 1940, as amended (the 1940 Act), and the Securities Act to take advantage of certain efficiencies. The SEC received comments from the Investment Company Institute requesting that the SEC allow investment companies to rely on Rule 163B to engage in pre-filing communications prior to registering under the 1940 Act. However, the SEC declined to provide a new exemption under the 1940 Act to allow investment companies to avoid registration under Section 8 of the 1940 Act while it engages in communications under Rule 163B.
New Rule 163B will become effective 60 days after publication in the Federal Register.
Copyright © 2019 by Ballard Spahr LLP.
(No claim to original U.S. government material.)
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, including electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the author and publisher.
This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.