The Securities and Exchange Commission, on September 26, 2019, adopted the expanded testing-the-waters relief it proposed in February. The JOBS Act permitted emerging growth companies (EGCs) to test the waters prior to or after filing a registration statement. The SEC’s new Rule 163B (the Rule) expands that permission to all issuers, including mutual funds and other investment companies. The new rule is a welcome change for companies that do not qualify as EGCs when considering an IPO.
The Adopting Release explains that the SEC adopted the Rule and related amendments largely as set forth in the Proposing Release, discussed in our earlier post. In essence, the SEC expanded the number of companies eligible to use testing-the-waters and left the rules for testing-the-waters the same as they were for EGCs. The Rule becomes effective 60 days after publication in the Federal Register.
Additional Clarity is Found in the Adopting Release
The Adopting Release includes some helpful discussion of a number of points raised by commenters that do not appear in the Rule as adopted:
- First, the anti-evasion provision in proposed Rule 163B(2)(b) could have created uncertainty and thus limited the utility of the Rule, and so the SEC adopted the Rule without that provision.
- Second, the Adopting Release clarifies the SEC’s statement in the Proposing Release that test-the-waters communications must not conflict with material information in the related registration statement. The SEC acknowledges that disclosures may be different, reflecting changes in circumstances or offering terms, and that its statement in the Proposing Release is guidance, not a condition to the availability of Rule 163B.
- Third, consistent with our earlier post, Private Offerings After Testing-the-Waters, the Adopting Release clarifies the steps a company can take to preserve its ability to conduct a private offering during or shortly after it tests the waters.
Practical Limits on Use Outside of IPOs
The SEC press release announcing the Rule describes the changes as applying to all public offerings (not just IPOs). However, the practical value of testing the waters by public companies post-IPO is often meaningfully reduced by the restrictions on selective sharing of material information with investors.
Regulation FD requires simultaneous disclosure of material information to the public, but disclosing a test-the-waters offer to the public exceeds the limits of Rule 163B, which only allows offers to qualified institutional buyers (QIBs) and institutional accredited investors (IAIs). Because news of a proposed offering will often be material to investors, a company would not be free to test the waters with QIBs and IAIs unless those potential investors are bound by a confidentiality agreement and cannot trade on the information. Many investors in public companies are unwilling to limit their ability to trade the securities they own, especially for long periods. While Regulation FD does not apply to non-US companies that qualify as foreign private issuers under the SEC rules, best practice is typically to limit selective disclosure just as though Regulation FD applies.
In some cases, such as when a well-known seasoned issuer (WKSI) does not have shelf registration statement on file, the Rule will help by allowing investment banks to assist in confidential pre-filing marketing. Under the WKSI rules, only the issuer can make those offers.
For issuers with an effective registration statement on Form S-3 or F-3, the Rule provides additional flexibility to the process of confidential pre-marketing of a shelf takedown. In confidential pre-marketing, a limited number of QIBs and IAIs are typically “wall-crossed”– that is they agree to treat information about the proposed deal confidentially — allowing the company and its investment bankers to explore investor appetite and deal terms with investors before publicly announcing a new offering. The Rule and related amendments eliminate the worry that test-the-waters materials might have to be filed as a prospectus.
The potential changes in offering practices, particularly for investment funds, remain to be seen. There may well be new developments as additional types of companies, newly eligible to test-the-waters, start to take advantage of that opportunity.