Recent SEC Adoptions: “Test-the-Waters” Communications
By The Securities and Capital Markets Practice Group
On September 25, 2019, the Securities and Exchange Commission (“SEC”) adopted Rule 163B under the Securities Act of 1933, as amended (the “Securities Act”), which expands to all issuers the accommodation to “test-the-waters” (“TTW”) in connection with proposed registered securities offerings, which was created by the Jumpstart Our Business Startups Act (the “JOBS Act”) for emerging growth companies (“EGCs”). Rule 163B will become effective 60 days after publication in the Federal Register. The benefits and implications of Rule 163B are discussed below.
Summary of Rule 163B
TTW communications refer to oral or written communications with potential investors conducted for the purpose of determining investor interest in a proposed registered securities offering. These communications may occur prior to or following the filing of a registration statement with the SEC. Previously, under Section 5(d) of the Securities Act only an EGC,
After Congress passed the JOBS Act in 2012, which amended the Securities Act to permit TTW, EGCs began relying on the TTW provision to gauge market interest in their potential registered offerings, and investment banks developed procedures around underwriting transactions that involved TTW communications. The SEC noted that between 2012 and 2018, approximately 37 percent of EGC IPOs used the TTW provision, and about 68 percent of EGC IPO underwriting agreements had provisions specifically authorizing underwriters to conduct TTW on behalf of EGC issuers.
Now that the SEC has adopted Rule 163B, all issuers, regardless of size or reporting status, or any person authorized to act on an issuer’s behalf, including authorized underwriters, will be allowed to engage in these communications with those that are, or that they reasonably believe are, QIBs or IAIs.
Important Considerations in the Application of Rule 163B
Issuers and those authorized to communicate on their behalf intending to rely on Rule 163B should keep in mind the following considerations:
I. Offers are Subject to Liability under the Securities Act for False or Misleading Statements
The SEC highlighted that even though Rule 163B communications are exempt from Sections 5(b)(1) and 5(c) of the Securities Act, Rule 163B communications are still considered “offers”—meaning that the communication is intended to determine interest in a proposed registered offering. As a result, such communications are still subject to Section 12(a)(2) liability, as well as the anti-fraud rules of the federal securities laws. Therefore, all such communications with prospective investors must not conflict with material information contained in the related registration statement, whether previously filed or subsequently filed. The SEC also emphasized that statements made in both oral and written TTW communications must not include any material misstatements or omissions at the time the statements are made.
II. Test-the-Waters Communications Do Not Need to Be Filed with the SEC, but Should Be Consistent with Related Registration Statements
The SEC noted that TTW communications in compliance with Rule 163B are voluntary in nature, meaning that issuers are not required to include a legend or file such communications with the SEC. As a result, record keeping, reporting, and other compliance requirements should not be materially affected by the adoption of Rule 163B. However, issuers should be mindful of TTW communications that trigger a public disclosure obligation or require updates to the related registration statements.
It is good practice to update any TTW materials to accurately reflect continuing operations and material changes that may occur during the period between the communication and the registration statement filing, in order to ensure conformity with the related registration statement. However, there may be situations in which information in the registration statement on file differs from previously used TTW communications that would not be cause for concern. For instance, the SEC considered the possibility that an issuer may change its capital raising strategy or offering terms, which could result in changes to the registration statement, but stated that such changes usually do not affect material information about the issuer itself. Overall, material information about the issuer and its business should be consistent during the period between the communications and the registration statement filing.
III. Reporting Issuers Subject to Regulation FD Must Consider Those Obligations As Well
Regulation FD prohibits a reporting issuer from selectively disclosing material nonpublic information (“MNPI”) to certain securities market professionals or shareholders without making concurrent public disclosures of such information. Issuers who are subject to Regulation FD need to consider whether any information contained in a TTW communication would trigger a public disclosure obligation under Regulation FD—the mere fact that an issuer is considering a public offering could itself be MNPI.
For example, reporting issuers who disclose MNPI in TTW communications with QIBs or IAIs, may also be required to disclose such information publicly unless an exemption from Regulation FD is available. One of the most common of these exceptions used in the wall-crossing context is subjecting the recipient to a confidentiality obligation; similarly, the use of confidentiality arrangements in connection with TTW communications should help issuers avoid the need to publicly disclose such communications. This can be particularly important where the proposed offering itself constitutes MNPI.
IV. Abandoning a Registered Offering After Testing the Waters and Conducting a Private Placement Instead
In adopting Rule 163B, the SEC considered public comments expressing concerns that TTW communications could be viewed as a general solicitation that could disqualify an issuer from immediately completing certain types of private placements in lieu of a registered offering and recommended that the SEC take the position that such communications made in reliance on Rule 163B will not itself constitute a general solicitation. Alternatively, commentators expressed concerns regarding issuers simultaneously considering both private and public offerings. The SEC declined to adopt a bright line rule, and instead took the position that whether a TTW communication would constitute general solicitation depends on the facts and circumstances regarding the manner in which the communication is conducted.
Where an issuer wishes to pursue a private placement in lieu of a registered offering immediately after engaging in TTW communications, and that private placement exemption would prohibit general solicitations, then the issuer should consider whether the TTW communication was conducted in such a way as to constitute a general solicitation.