United States: Securities Offering Reform: Communications Proposal

On November 3, 2004, the Securities and Exchange Commission proposed new rules (http://www.sec.gov/rules/proposed/33-8501.pdf) that would significantly modify and advance the registration, communications and offering framework of the Securities Act of 1933. The proposals would enhance the disclosure requirements under that Act and the Securities Exchange Act of 1934 — which have both undergone significant changes since the enactment of the Sarbanes-Oxley Act of 2002 — and continue the SEC’s long-term effort to integrate the disclosure requirements, as well as other offering processes, under both of these Acts. The release is subject to a 75-day comment period, which expires on January 31, 2005, and the SEC is seeking comment on virtually all of the topics covered in its proposals.

This Client Alert is one of three separate Client Alerts summarizing the SEC's principal proposals that are described in our overview Client Alert entitled "Securities Offering Reform: A Takeoff from the Aircraft Carrier". Specifically, this Client Alert covers the proposal to formalize and liberalize communications that can be used by or on behalf of companies in connection with their offerings, other than by means of the customary statutory prospectus, including the use of "free writing prospectuses," with the most flexibility afforded to a new category of issuers that have reporting histories and are presumptively the most widely followed in the marketplace — which the SEC calls "well-known seasoned issuers." A well-known seasoned issuer — or so-called "WKSI" — is generally a company eligible to file a registration statement for an offering of debt or equity securities on Form S-3 or Form F-3 that either has a market capitalization held by non-affiliates of at least $700 million or has issued at least $1 billion of registered debt over the past three years and registers only debt securities. (For a more complete definition of WKSI and other categories of issuers, see our overview Client Alert.)

Because of the technical nature of the proposed reforms — which took the SEC nearly 400 pages to summarize and promulgate — we have also prepared separate articles for the other two principal proposals covered by the SEC’s release:

• our Client Alert entitled "Securities Offering Reform: Shelf Registration Proposal" covers the proposal to simplify the shelf registration process, including automatic effectiveness of registration statements for WKSIs that will permit them to issue securities without any potential delay arising from SEC staff review
• our Client Alert entitled "Securities Offering Reform: Prospectus Delivery Proposal" covers the proposal to adopt an "access equals delivery" model that will minimize the requirements to deliver a hard copy of a final prospectus, as well as to clarify that investors should have all the information necessary to make their investment decision at the time of sale; that Client Alert also covers other topics in the SEC’s proposal, including a requirement to include risk factor disclosure in annual reports on Form 10-K and update them in quarterly reports on Form 10-Q

Moreover, the SEC's proposals modify and clarify the principal liability provisions of the Securities Act, which have varying standards of liability associated with untrue statements of or omissions to state material facts in connection with an issuer’s offering of its securities. These liability standards are discussed as applicable in the context of each of our Client Alerts.

The Securities Act currently restricts the types of communications that issuers, underwriters and other offering participants subject to the Securities Act may use during a registered public offering. Before a registration statement is filed, all offers, whether oral or written, are prohibited; the term "offer" has been interpreted very broadly for these purposes and includes any communication that would have the effect of conditioning the market for a securities offering. Between the filing of a registration statement and its effectiveness, subject to limited exceptions, offers made in writing (including by e-mail or Internet) are limited to a "statutory prospectus" that conforms to specified SEC-information requirements. After a registration statement is declared effective, offering participants must continue to make any written offers through a statutory prospectus, but they may use additional written offering materials if a final prospectus that meets the Securities Act’s requirements precedes or accompanies those materials. Violations of these restrictions are commonly referred to as "gun-jumping".

In 1998, the SEC proposed new rules under the Securities Act, which became known as the "Aircraft Carrier" proposals (Release No. 33-7606A), that were intended to modernize the securities offering process. Those proposals, which constituted the SEC’s first attempt at a broad relaxation of the gun-jumping provisions, were favored by a majority of commentators at the time, but the Aircraft Carrier proposals were sunk because of their far-reaching approach that called for an entirely new securities offering regime. The rules now being proposed by the SEC, while similar in spirit to many of the Aircraft Carrier proposals, instead constitute incremental changes that work within the existing securities offering regime to reflect the substantial changes in recent years in communications methods and technology and in disclosure obligations and processes outside the offering process.

As a starting point for its proposed communications reform, the SEC has proposed a rule making clear that all electronic communications, including Internet communications, e-mails and other electronic and web-based communications (except for most telephone communications), are graphic and, therefore, written communications for purposes of the Securities Act. The overall effect of the SEC’s communications proposal, however, is intended by the SEC to enhance the ability of offering participants to make written offers outside the statutory prospectus, or a "free-writing prospectus." Varying levels of restrictions and conditions to the use of these free writing prospectuses would apply depending on the category of issuer, with WKSIs having the most flexibility on the theory that those issuers’ communications would have the least potential for conditioning the market for a securities offering.

The communications proposal generally provides the following:

• two separate exemptions — or so-called "safe harbors" — from the gun-jumping provisions for ongoing communications for:

• two separate safe harbors from the gun-jumping provisions for communications that occur prior to the filing of a registration statement, but are not covered by the safe harbors described above, for:

• expansion of written communications currently permitted about an offering after the filing of a registration statement (proposed amendments to Rule 134)
• permitted use by eligible issuers and other offering participants (such as underwriters) of free writing prospectuses after the filing of a registration statement, subject to certain conditions (including, in certain cases, filing with the SEC) (proposed Rules 164 and 433)
• expansion of existing safe harbors for research reports (proposed amendments to Rules 137, 138 and 139)

While the proposed rules generally would be applicable to offerings of asset-backed securities, many of the proposed rules would not be applicable to blank check companies, penny stock companies and shell companies. In addition, the proposed rules would not be available to investment companies or business combination transactions, as those communications are regulated separately.

The proposed rules would adopt two safe harbors from the gun-jumping provisions for ongoing communications, which would largely codify current SEC positions and market practice.

The first safe harbor, applicable to reporting issuers, would permit a reporting issuer’s continued dissemination at any time (including around the time of a registered offering) of factual business and forward-looking information regularly released in the ordinary course, such as earnings guidance. This safe harbor would not include information about the registered offering itself or information released as "part of the offering activities" in a registered offering, which would be limited to the registration statement, existing safe harbors or exemptions or the use of a permissible free writing prospectus. The release of information would have to be consistent in timing, manner and form with the issuer’s similar past releases of such information, and the issuer would have to have a track record of releasing this type of information, without, however, requiring a minimum time period. An underwriter would not be able to rely on this safe harbor in connection with its marketing activities to potential investors (instead, the underwriter could rely on the use of a permissible free writing prospectus).

The second safe harbor, applicable to non-reporting issuers, would be substantially similar to the safe harbor for reporting issuers, except that this safe harbor would not cover forward-looking information or information released to investors or potential investors. In addition, the information would have to be released by the same non-reporting issuer employees responsible historically for providing this information. In light of the risk of conditioning the market for the issuer’s securities, the SEC is not proposing a safe harbor for forward-looking information for non-reporting issuers because of the lack of such information about these issuers in the marketplace.

The SEC is proposing a bright-line time period for all eligible issuers (but not underwriters), ending 30 days prior to filing a registration statement, during which they may communicate in any manner (oral or written) without violating the gun-jumping provisions. The communications covered by this exemption could not reference a securities offering, and the issuer would have to take reasonable steps within its control to prevent further distribution or publication of the information during the 30 days prior to filing. The SEC has indicated that an issuer would not be expected to control the republication or accessing of previously published press releases; however, if an issuer gave an interview to the press prior to the 30-day period but the interview was published during the 30-day period, the issuer would not be able to rely on this exemption. It is also unclear whether information posted by an issuer to its website (other than identifiable historical information) prior to the 30-day period that remains available during the 30-day period would affect the availability of this exemption.

Given the fluidity of the time of filing of a registration statement, issuers therefore should keep in mind that any communication made prior to the filing of a registration statement (not otherwise covered by the ongoing communications safe harbors) could mandate a 30-day waiting period prior to any such filing. Since many eligible reporting issuers will be Form S-3 eligible and likely have a shelf registration statement on file, whether or not effective, the practical use for this pre-filing safe harbor is probably limited since these issuers will be entitled to use the proposed permissible free writing prospectus provisions without violating the gun-jumping provisions.

For WKSIs (but not underwriters), the SEC is proposing an exemption that would allow these issuers to make unrestricted oral or written offers at any time before the filing of a registration statement without violating the gun-jumping provisions. A written offer made under the proposed exemption would be a free writing prospectus, would be required to meet the conditions relating to the use of such a prospectus and would be required to be filed by the issuer after the filing of a registration statement. In addition, such a free writing prospectus would be subject to all the attendant liabilities associated with a prospectus under the Securities Act (whether or not a statutory prospectus), including Section 12(a)(2) of the Securities Act, as discussed below. In light of the SEC’s proposed "automatic shelf registration" process for WKSIs, however, it may be rare for these issuers to take advantage of the ability to make written offers without a registration statement on file.

The SEC’s proposals would expand the amount and types of permitted written offering-related communications that may be made by offering participants after the registration statement is filed. The two principal components of the proposals are the expansion of permitted information under Rule 134 and the permitted use of a free writing prospectus in connection with a registered offering.

The proposed rules would expand the information permitted to be communicated under existing Rule 134, which originally was enacted to provide issuers with a means to locate persons that might be interested in receiving a prospectus, and provides a safe harbor from the gun-jumping provisions for limited public notices about an offering made after an issuer files its registration statement, customarily by way of press release to the market. The proposed amendments to existing Rule 134 would expand the scope of permissible factual information about the offering itself, including the details of road shows, and would permit the disclosure of the security ratings reasonably expected to be assigned. The proposed amendments to Rule 134, however, would not permit the use of a detailed term sheet for the securities being offered, which instead would be covered by a free writing prospectus.

The most significant aspect of the SEC’s proposed rules is the concept of a "free writing prospectus," which would be defined as any written offer of a registered security except for statutory prospectuses and written offers otherwise permitted or exempted by the Securities Act under existing rules or the new proposed rules (including the safe harbors and exemptions discussed above and offers made after a final prospectus has been sent or given). As discussed below, in certain instances, the permissible use of a free writing prospectus will be conditioned on its filing with the SEC. However, any written communication constituting an offer of a security could be a free writing prospectus, irrespective of whether filing is required. In this regard, as is currently the case, whether a particular written communication is an offer for purposes of the Securities Act would be determined based on the particular facts and circumstances. As discussed below in greater detail, all free writing prospectuses will be subject to liability under Section 12(a)(2) of the Securities Act.

As proposed, a free writing prospectus (or the information contained in a free writing prospectus) would have to be filed with the SEC by the following persons in the following circumstances:

• where a free writing prospectus is prepared by or on behalf of the issuer and used by any person (known as an "issuer free writing prospectus"), it must be filed by the issuer on or before the date of first use
• where a free writing prospectus is prepared by any offering participant (other than the issuer) and contains material information about the issuer or its securities that has been provided by or on behalf of the issuer (known as "issuer information") that is not already contained or incorporated by reference in the registration statement or a previously filed free writing prospectus, it must be filed by the issuer on or before the date of first use
• where a free writing prospectus is prepared by any person and contains only a description of the final terms of the issuer’s securities, it must be filed by the issuer no later than two days after the later of (i) the date such terms become final or (ii) the date of first use (but filing of a prospectus supplement under existing Rule 424 would not satisfy this requirement)
• where an offering participant (other than the issuer) has prepared and distributed a free writing prospectus in a manner reasonably designed by that offering participant to lead to its broad unrestricted dissemination, it must be filed by that offering participant

In addition to the filing conditions, the SEC proposal also includes eligibility, legend and record retention conditions for the permitted use of free writing prospectuses, including the following:

• a WKSI could use a free writing prospectus at any time
• a seasoned issuer (or an offering participant with respect to a WKSI) could use a free writing prospectus after the filing of a registration statement containing a statutory prospectus (which would include a preliminary prospectus or a base prospectus in a shelf offering) — physical delivery of the statutory prospectus would not be required, but instead the recipient could be notified through a required legend of where to access or hyperlink to the statutory prospectus
• an issuer that is not a seasoned issuer (or an offering participant with respect to an issuer that is not a seasoned issuer) could use a free writing prospectus after the filing of a registration statement containing a statutory prospectus (which would include a preliminary prospectus that, in the context of an initial public offering, would require a price range for the securities) — the statutory prospectus generally would have to be provided on or prior to the first use of the free writing prospectus, which could be satisfied in many instances by a hyperlink from an electronic free writing prospectus (including an electronic road show) to the statutory prospectus
• a legend, which is the only line-item disclosure requirement in a free writing prospectus, must be used, and it must include a toll-free number at which investors can request copies of the prospectus (which may add costs for some issuers and offering participants)
• any unintentional failure to file a free writing prospectus may be cured if a good faith and reasonable effort was made to comply with the filing condition and the free writing prospectus was filed as soon as practicable after the discovery of the failure to file
• issuers and other offering participants must retain for three years any free writing prospectuses they have used from the date of the initial bona fide offering of the securities — issuers will want to consider making this record retention requirement (and the associated filing requirements) part of their disclosure controls and procedures

As a practical matter, the ability to use free writing prospectuses in the context of an initial public offering may be limited because the proposed rules require a statutory preliminary prospectus to be on file before any free writing prospectuses may be used. Since the SEC states that a preliminary prospectus for an initial public offering that does not contain an estimated price range does not satisfy the requirements for a statutory preliminary prospectus, and since the price range in recent years generally has not been added until close to the time that an issuer is ready to commence its road show, there may be a limited time period during which free writing prospectuses may be used in an initial public offering.

Under the free writing prospectus regime proposed by the SEC, in most cases, filing would not be required for free writing prospectuses prepared by underwriters or dealers. Information prepared by underwriters (including proprietary information) on the basis of, but, importantly, not containing, issuer information would usually not need to be filed. However, underwriter written communications that meet the "broad unrestricted dissemination" standard set forth in the proposal would require filing by the underwriters. The SEC has stated that situations in which the broad unrestricted dissemination standard would apply include where an underwriter includes the free writing prospectus on an unrestricted website, hyperlinks from an unrestricted website to information that would be a free writing prospectus, releases or gives a copy of a free writing prospectus to the media or sends out a press release regarding the issuer or the offering that would be a free writing prospectus. Conversely, the broad unrestricted dissemination standard would not apply where the underwriter provides a website with access restricted to customers or sends a communication (including e-mail) to its customers (no matter how large the number). Underwriters in any event will want to consider the logistical issues that may arise from these proposed rules, such as the need to obtain EDGAR filing codes to file a free writing prospectus with the SEC.

Under existing interpretations of the gun-jumping provisions and SEC staff practice, information about an issuer or an offering furnished by the issuer or its representative that is published by the media is deemed by the SEC to be an impermissible written offer. The SEC staff has required issuers to delay offerings and either to disavow the statements or to include them in a revised prospectus and thus have those statements become subject to liability under Section 11 and Section 12 of the Securities Act.

Under the proposed rules, where any offering participant has provided information to the media about an issuer or an offering that would constitute an offer (whether orally or in writing) and that information is published or broadcast in any form (including the publication of information obtained at an electronic road show with a limited audience or a live road show to which the media were invited), that publication or broadcast generally would be considered a free writing prospectus that must be filed with the SEC.

If any offering participant prepared, paid or gave consideration for the publication, the free writing prospectus must be filed by the issuer at the time of publication or broadcast, in which case a statutory prospectus would have to precede or accompany this communication in the case of a non-reporting issuer, and a statutory prospectus would have to be on file with the SEC in the case of a seasoned issuer. If no such consideration was given, the free writing prospectus must be filed by the issuer within one business day after the first publication or broadcast, with the additional requirements that a registration statement be on file and a statutory prospectus be available.

This requirement to file media publications and broadcasts should raise a number of concerns to issuers and other offering participants. Delay in an offering without prospectus liability for the statements in media publications would no longer be the case, because media publications and broadcasts now would be subject at all times to Section 12(a)(2) liability without the consequent offering delays. As highlighted by the Google article that was published in Playboy shortly before Google’s initial public offering, under the SEC’s proposals, an issuer will need to consider its ability to grant interviews and have other interactions with the media in the course of a registered offering in light of the attendant liabilities for material misstatements and omissions if the interview is considered an offer of securities. In addition, given the filing requirement, an issuer will need to determine the manner in which it will be able to monitor publications and broadcasts of interviews and obtain appropriate electronic copies or transcripts for filing purposes, or even record interviews. Issuers should be sensitive particularly to information provided to the media by underwriters that could give rise to filing requirements as well as related liability issues.

The proposed free writing prospectus rules raise a panoply of issues with respect to electronic road shows, which, to date, have been conducted in reliance on a series of SEC no-action letters. Under the proposed rules, the SEC would clarify that electronic road shows are written communications that also would be considered free writing prospectuses subject to filing unless certain conditions are satisfied. Live road shows otherwise would continue to be considered oral communications. It is unclear whether slides or PowerPoint presentations used but not distributed at live road shows would be considered free writing prospectuses. Multiple versions of an electronic road show would be permitted, although each would be a separate free writing prospectus.

An electronic road show (or its script) would not be subject to filing except for material issuer information not previously included or incorporated by reference in the registration statement or a free writing prospectus related to the offering, provided the issuer makes at least one version of a "bona fide electronic road show" (which would be a version of the road show that covers the same general areas but need not address all of the same subjects or provide the same information as other versions) readily available electronically to any potential investor at the same time as the electronic road show and files any issuer free writing prospectus or material issuer information used at an electronic road show (other than the road show itself). Although the SEC proposal does not require that road shows be made available to unrestricted audiences, the proposals likely will encourage broader availability of road shows to all investors (whether institutional or retail), especially when the conditions to avoid filing are taken into account.

The SEC’s proposals would make clear that an offer of an issuer’s securities that is contained on an issuer’s website or hyperlinked from the issuer’s website would be a free writing prospectus. Thus, if a hyperlink was included within a written communication used to offer the issuer’s securities (such as a free writing prospectus), the hyperlinked information would be considered part of that written communication. The SEC has stated that issuers in registration should be able to segregate historical information properly identified as such on their websites into an archival section so that it remains accessible to the public but will not be presumed to be reissued or republished for these purposes or considered a current offer, provided that the information is not incorporated or otherwise included in a prospectus or used, identified, updated or modified in connection with the offering or otherwise. Issuers therefore should take great care in using hyperlinks and maintaining their websites. While we believe most ordinary course, factual business information on an issuer’s website should not be considered an offer and, in any event, would likely fall into the proposed safe harbor, the SEC’s proposals would likely cover material such as investor conference presentations, webcasts and similar information that is often posted on issuers’ websites primarily for Regulation FD purposes. Issuers should consider dating all of the information on their websites to provide a further demonstration that archived information was previously published and, therefore, would not be considered a free writing prospectus.

A free writing prospectus would not be considered part of a registration statement (unless the issuer elected to file it as part of a registration statement) and therefore would not be subject to liability under Section 11 of the Securities Act. Regardless of whether a free writing prospectus is filed, however, any person using a free writing prospectus would be subject to liability under Section 12(a)(2) of the Securities Act and the anti-fraud provisions of the federal securities laws, as all free writing prospectuses would have the same statutory liability as oral offers and statutory prospectuses. Written communications not constituting offers and, therefore, not prospectuses within the meaning of the Securities Act, including certain of the communications safe harbors proposed by the SEC discussed above, would not be subject to disclosure liability applicable to prospectuses under Section 12(a)(2) of the Securities Act. These written communications would, however, be subject to liability under the anti-fraud provisions of the federal securities laws, including Section 10(b) of, and Rule 10b-5 under, the Securities Exchange Act of 1934. It is clear from the proposing release that the SEC’s faith in the investor protection provided by the liability provisions of Section 12(a)(2) of the Securities Act and the anti-fraud provisions of the federal securities laws is a key factor underlying the proposal to permit "free writing" beyond the statutory prospectus and not requiring any particular information to be included (other than a legend), as is the case with statutory prospectuses.

If issuers or underwriters wish to use free writing prospectuses in connection with a public offering, they will need to consider the liability ramifications, including the following:

• how issuers will manage their potential liability with respect to free writing prospectuses prepared and distributed by underwriters
• how underwriters will manage their potential liability with respect to free writing prospectuses used by issuers before the underwriters are engaged in an offering
• how underwriters will reconcile the tension between the liberal use of free writing prospectuses to advance the marketing of an offering vis-à-vis the potential liabilities for such use
• how issuers and underwriters will establish appropriate internal disclosure controls and procedures with respect to the use of free writing prospectuses, including with respect to the broad unrestricted dissemination standard applicable to underwriters
• how engagement letters and underwriting agreements (and possibly opinions delivered under these agreements) should be revised to include appropriate representations and indemnification provisions to address some of these concerns

The proposed rules would make incremental amendments to Rule 137, Rule 138 and Rule 139 with respect to research reports.

• Rule 137, which provides that a non-offering participant broker or dealer that publishes or distributes research will not be considered an underwriter, would be expanded to apply to securities of any issuer rather than solely to securities of those issuers that are required to file SEC reports
• Rule 138, which provides that a broker or dealer participating in a distribution of one type of the issuer’s securities may publish or distribute research confined to another type of the issuer’s securities, would be expanded to cover research reports on all reporting issuers that are current in their SEC periodic reports (rather than only seasoned issuers), and would require that the broker or dealer must have previously published or distributed research reports of the types of securities that are the subject of the reports in the regular course of its business
• Rule 139, which provides that a broker or dealer participating in a distribution of securities of a seasoned issuer may publish research concerning the issuer or any class of its securities if that research is in a publication distributed with reasonable regularity in the normal course of its business, would be amended to eliminate the requirement that the report be published with reasonable regularity, provided that the broker or dealer must, at the time of use, have published or distributed research reports about the issuer or its securities, though there is no minimum time period or requirement that the same securities be covered — the SEC believes that the most important element of the "reasonable regularity" requirement is that the report initiating coverage of an issuer should not benefit from the Rule 139 exemption
• Rule 139, which provides that a broker or dealer participating in a distribution of securities of a reporting issuer may publish research complying with certain restrictions on the nature of the publication and the opinion or recommendation, would be amended to remove the prohibition on a broker or dealer making a more favorable recommendation than the one made in its last publication
• research reports meeting the conditions of Rules 138 and 139 would not be considered offers or general solicitation or general advertising in connection with Rule 144A offerings, nor would they constitute directed selling efforts or be inconsistent with the offshore transaction requirements of Regulation S

Contact Pillsbury Winthrop For More Details

Our securities practice team works together with our securities litigation team and white collar defense and corporate investigation team to monitor developments in the federal securities laws and at the SEC, the NYSE and Nasdaq. As indicated above, the SEC is seeking comment on virtually all of the topics covered in its proposals and the comment period expires on January 31, 2005. While we expect that the proposals will receive meaningful public comment, we also expect that the SEC will adopt final rules that reflect many of the more significant proposals included in the SEC's release. We will issue additional Client Alerts addressing significant developments affecting the proposals as they occur.

If you wish either to obtain a more detailed explanation of the proposals and their ramifications or develop a new comprehensive and adaptive strategy to meet the changing landscape, please contact the Pillsbury Winthrop securities attorney with whom you work or one of the co-leaders of the Pillsbury Winthrop securities practice team, Stanton D. Wong in San Francisco or Todd W. Eckland in New York

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.