Securities Offerings Reform
by Stuart A. Ober, CFE, AIFA ®
he Practising Law Institute's ("PLI") "Securities Offerings 2006: Operating Under the New Rules" conference on April 6 and 7, 2006 held in New York City covered the latest developments in securities offerings from the viewpoint of counsel representing issues, underwriters and plaintiffs. The program offered an in-depth review of the changes brought about by the Securities Act Reform Rules ("Reforms") that went into effect on December 1, 2005. The following is largely taken directly from the section of the PLI text submitted by William J. Whelan, III, of Cravath, Swaine and Moore LLP. The full text of the Final Release, SEC Rel. No. 33-8591, may be accessed at http://sec.gov/rules/final/33-8591.pdf.
As part of the Reforms, the SEC has divided all issuers into four categories based on market capitalization (or historical registered debt issuance in certain instances) and reporting history. This analysis describes the SEC's reform as they apply, in particular, to "well-known seasoned issuers" ("WKSIs"), which are those companies (domestic and foreign) that are the largest, most widely-held and most widely-followed by the analyst and institutional investor communities.
The so-called WKSIs received the greatest benefits of the reforms, which include:
Shelf registration statements that will go into effect automatically upon filing, without SEC review;
The ability to have effective shelf registration statements just a few pages in length, with omitted information (such as the description of the securities, plan of distribution and any selling security holders) added at the time of the offering;
An optional, new "pay-as-you-go" fee structure that will allow registration fees to be paid upon shelf take-downs if the issuer chooses; and
The ability to communicate in writing about an offering, with potential investors at any time, even before filing, under the new "free writing prospectus" rules, separately from the statutory prospectus. A free writing prospectus is any written communication used in the offer or sale of securities covered by a registration statement that constitutes an "offer" and is made by means other than a statutory prospectus. It may take a traditional paper format or fall under any of the graphic communications (e-mails, Internet postings, blast voicemails, etc.). It includes media communication that constitutes offers. There are no content restrictions for free writing prospectuses other than the legend requirement. Information in a free writing prospectus may go beyond - but may not "conflict with" - the information in the prospectus that is part of the registration statement.
There are important changes to the liability regimes under Section 11 and Section 12(a)(2) of the Securities Act of 1933 ("1933 Act"), including liability determination under Section 12(a)(2) based on information conveyed to the investor at the time of sale. This shifting liability standard will pose new challenges for all issuers, including WKSIs, which must be met as issuers adjust their practices to avail themselves of the new rules.
Section 11 Liability
The new Rule 430B makes clear that information contained in a prospectus supplement is part of the registration statement for Section 11 purposes. Information in a prospectus supplement used in a shelf take-down will be deemed part of the registration statement as of the earlier of the date it is first used (i.e., the date the prospectus is available to the managing underwriter, syndicate member, or any prospective purchaser).
Section 12(a)(2) Liability
The changes to the liability regime under this section relate to two concepts:
1. that liability attaches to the information conveyed at the time the investor makes its investment decision and is not limited by subsequent disclosure information, and
2.the issuer is a "seller" with respect to the end purchasers of its securities in an underwritten offering.
These changes have repercussions throughout the offering process including the timing for execution of sales, use of free writing prospectuses, the due diligence procedures of underwriters and other offering participants that have an available due diligence defense, and the letters and opinions expected of offering counsel and the issuer's auditors.
Under Section 12(a)(2), sellers have liability to purchasers for offers or sales by means of a prospectus or oral communications that include a material omission or an untrue statement of material fact. The SEC has expressed its view that with regard to Section 12 and Section 17(a)(2), the time at which an investor has entered into a contract of sale is one appropriate time to apply those liability standards, and for purposes of that liability analysis, information conveyed to the investor only after the time of sale should not be taken into account.
Thus, disclosure that is added or amended only in the final prospectus would not protect the issuer and underwriters under the above sections of the 1933 Act if investors make their investment decision before they receive the final prospectus.
Because any misstatements or omissions that exist at the time of sale cannot be cured by a subsequently provided disclosure, the SEC also provided guidance on how an issuer or other offering participants could attempt to terminate an existing contract of sale and enter into a new one premised on additional or corrected information. In that case, the investor must be provided:
1. Adequate disclosure of the contractual arrangement;
2. Adequate disclosure of its rights under the existing contract that is being terminated;
3. Adequate disclosure of the new information the seller seeks to convey; and
4. A meaningful ability to choose whether to terminate the first contract and whether to enter into a new one.
There is an expectation that underwriters and other offering participants will seek to have investors "re-up" their sales contracts to account for subsequent information if the information conveyed at the time of sale was inadequate.
Issuer as "Seller"
Section 12(a)(2) creates liability for material misstatements and omissions made by the "seller" of the securities. The SEC has adopted new Rule 159A that provides that an issuer in a primary offering of securities (but not in the aftermarket) is considered to offer or sell the securities to the investors in the initial distribution of the securities. Thus, the issuer is the seller for the purposes of Section 12(a)(2) as to any communications made by the issuer.
New 1934 Act Reporting Requirements
The SEC reforms will require WKSIs to include in their reports the risk factors on Form 10-K and disclosure on unresolved SEC staff comments on their prior 1934 Act reports.
Conclusion
Effective December 1, 2005, WKSI securities offerings will change dramatically. Use of free writing prospectuses will develop. Underwriting procedures and arrangements will be modified. Electronic road shows will expand. Communications and procedures surrounding the time of sale will change. Due diligence procedures will be reviewed. WKSIs will transition to automatic shelf registration statements.
The text of "Securities Offerings 2006: Operating Under the New Rules" is available from Practising Law Institute, 810 Seventh Avenue, New York, NY 10019-5818, at http://www.pli.edu or call (800) 260-4PLI or (212) 824-5710.
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Stuart A. Ober is president of Securities Investigations, Inc., a firm specializing in due diligence and investment consulting and analysis (845 679-2300 or ober@stuartober.com).
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