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Recent SEC Adoptions: “Test-the-Waters” Communications

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. [1]

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,[2] and any person authorized to act on its behalf, were allowed to engage in oral or written communications with potential investors that are either qualified institutional buyers (“QIBs”) or institutional accredited investors (“IAIs”).[3]

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.[4] Issuers who are considering an IPO (and not only EGCs), and reporting issuers who plan on conducting other registered offerings likely will find great benefit from Rule 163B.[5]

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.[6] Whether the TTW communication constitutes a general solicitation should be taken into consideration depending on the private placement exemption pursued.[7]


[1]   To view the full text of the SEC’s adopting release, please see Solicitations of Interest Prior to a Registered Public Offering, SEC Release No. 33-10699, available at https://www.sec.gov/rules/final/2019/33-10699.pdf (Sept. 26, 2019).

[2]   An EGC is an issuer with less than $1.07 billion in annual revenue and, as of December 8, 2011, had not sold common equity securities under a registration statement.

[3]  Now, all issuers are allowed to rely on the exemptions provided by Rule 163B, including non-reporting issuers, emerging growth companies (“EGCs”), non-EGCs, well-known seasoned investors (“WKSIs”), investment companies (including registered investment companies) and business development companies.

[4]  In order to engage in test-the-waters communications, an issuer must, at minimum, have a reasonable belief that a potential investor is a QIB or an IAI. Since the SEC did not provide any specific instruction as to how to establish a reasonable belief that a potential investor is a qualified institutional buyer (“QIB”) or an institutional accredited investor (“IAI”), issuers have the flexibility to engage in their own cost-effective methods to determine the status of all potential investors prior to engaging in communications with such investors.

[5]  In addition to test-the-waters, or TTW, communications in connection with IPOs, the adoption of Rule 163B will also allow all issuers, as well as underwriters acting on behalf of an issuer, to TTW in all registered follow-on offerings, even if the issuer does not have a registration statement on file or is not a WKSI. Currently, Rule 163 under the Securities Act only permits WKSIs, and those acting on their behalf, to make offers to sell securities before a registration statement is filed with the SEC, while Section 5(c) of the Securities Act permits any issuer to make an offer to sell securities once a registration statement is on file. However, unlike new Rule 163B, Rule 163 specifies that it may not be relied upon by an offering participant that is an underwriter or dealer. Due to the limitations of Rule 163, in Paul Hastings’ experience, Rule 163 has provided limited utility to WKSIs. The adoption of Rule 163B will allow underwriters to participate directly in “wall-crossing”, which is a process by which reporting companies enter into confidentiality agreements with potential institutional investors to gauge interest in potential securities offerings prior to a traditional marketing process, in a process that allows confidential communication while still complying with a reporting issuer’s obligations under Regulation FD. In theory, the SECs adoption of Rule 163B will allow all reporting issuers, regardless of their reporting status, to use this process to confidentially gauge market interest in their proposed offerings prior to publicly disclosing such offering. However, since wall-crossing typically includes restricting the potential investor from trading in the issuer’s securities until the deal is announced, where a non-WKSI does not have a registration statement on file or in confidential review at the time of the TTW communications, it remains to be seen whether investors would be willing to be restricted for a significant period of time to allow the issuer to prepare and file a registration statement, which may minimize the effectiveness of TTW in these cases.

[6]  The Securities Act and its rules do not explicitly define general solicitation but recent SEC guidance has helped to identify what factors that would make a communication a general solicitation. Such factors include an analysis of the issuer’s preexisting relationship with potential investors as well as the means of contact. For instance, if an issuer does not have sufficient information to evaluate, and indeed never undertakes an evaluation of a potential investor’s financial circumstances and sophistication, then approaching such potential investors via private phone call, email, or social media message could be considered general solicitation. In addition, cold-calling, cold e-mailing, and cold social media messaging potential investors about an offering could be considered general solicitation. Posting information about an offering on the publicly available Internet, an unrestricted public website, newspaper, or television advertisement is likely to be viewed as general solicitation. Even if the materials posted can only be accessed by entering various information, the action is still likely to be viewed as general solicitation. Issuers are more likely to be found to be engaging in general solicitation if they contact potential investors i) through impersonal means or in a non-selective manner, or ii) who lack financial experience and sophistication. Note that use of informal investor networks to connect with potential investors is not considered a general solicitation.

[7]  Rule 502(c) bans the use of general solicitation in Rule 506(b) offerings (i.e., those offerings in which issuers sell to an unlimited number of accredited investors and up to 35 non-accredited investors). If an issuer is relying on Rule 506(b) as a safe harbor from the registration requirements of the Securities Act for its securities offering, the issuer cannot engage in general solicitation. However, not all private placement exemptions require that an issuer refrain from general solicitation. General solicitation is permitted in connection with Rule 144A or Rule 506(c) offerings, for instance, and therefore issuers who use test-the-waters communications may want to structure their concurrent or replacement offerings to comply with those safe harbors to avoid worrying about general solicitation considerations.


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