In late September, the Securities and Exchange Commission (SEC) approved a new rule that extends a “test the waters” accommodation to all issuers. Under the new Securities Act Rule 163B, all issuers will be allowed to gauge market interest in a possible initial public offering or other registered securities offering through discussions with certain institutional investors prior to, or following, the filing of a registration statement.
“The final rule benefits from the staff’s experience with the test-the-waters accommodation that has been available to EGCs since the Jumpstart Our Business Startups Act (JOBS Act),” SEC Chairman Jay Clayton said in a press statement. “Investors and companies alike will benefit from test-the-waters communications, including increasing the likelihood of successful public securities offerings.”
The Securities Act generally restricts communications by issuers contemplating a registered securities offering during various phases of the offering process. In addition, Section 5(c) of the Securities Act generally prohibits issuers or other persons from offering securities prior to the filing of a registration statement. Once a registration statement has been filed, Section 5(b)(1) generally requires issuers to use a prospectus that complies with Securities Act Section 10 for any written offers of securities.
In 2012, the Jumpstart Our Business Startups Act (JOBS Act) relaxed the rules for certain companies. The JOBS Act specifically mandated Section 5(d) of the Securities Act, which allows an emerging growth company (EGC) and any person acting on its behalf to engage in oral or written communications with potential investors that are qualified institutional buyers (QIBs) and institutional accredited investors (IAIs) before or after filing a registration statement to gauge such investors’ interest in a contemplated securities offering. The most recent confirmation of the rationale for the “test the waters” accommodation is the withdrawal by WeWork’s parent, the WeCompany, of its IPO filing, having misjudged the market for its proposed multi-billion-dollar IPO.
Rule 163B extends the "test-the-waters" provision to non-EGCs. Specifically, the new exemption allows any issuer or person authorized to act on behalf of an issuer, including an underwriter, either prior to or following the filing of a registration statement, to engage in oral or written communications with potential investors that are, or that the issuer reasonably believes are, QIBs or IAIs, to determine whether such investors might have an interest in the contemplated offering.
Test-the-waters communications that comply with the new rule don’t need to be filed with the SEC and are not required to include any specified legends. However, as the SEC highlights, “testing the waters” communications are still considered “offers” as defined in Section 2(a)(3) of the Securities Act and, thus, subject to Section 12(a)(2) liability in addition to the anti-fraud provisions of the federal securities laws. Further, information provided in a test-the-waters communication under Rule 163B must not conflict with material information in the related registration statement.
Issuers subject to Regulation FD must also consider whether any non-public information in the test-the-waters communication would trigger any obligations under Regulation FD, or whether an exception to Regulation FD would apply. Regulation FD generally does not apply if the selective disclosure was made to a person who owes a duty of trust or confidence to the issuer or to a person who expressly agrees to maintain the disclosed information in confidence.
Benefits of Testing the Water
The ability to “test the water” has proven to be very popular because it allows businesses to assess investor interest before having to commit the time and expense necessary to carry out a contemplated securities offering. As the SEC notes in its Final Rule, the option to test the waters can benefit the issuers affected by the new Rule 163B in several ways:
- In the case of issuers that decide after testing the waters not to proceed with a registered securities offering, testing the waters before a public registration statement filing decreases the risk of premature public disclosure of sensitive or proprietary information about the issuer to competitors (to the extent that the communications are not subject to Regulation FD).
- In the case of issuers that decide after testing the waters not to proceed with a registered securities offering, testing the waters before the registration statement filing can save such issuers some or all of the cost of preparing and publicly filing a registration statement.
- Testing the waters, particularly before the registration statement filing, can reduce the risk of miscalculating market interest in the offering and having to withdraw the offering, thus reducing potential reputational costs associated with a failed offering.
- Testing the waters, particularly before the registration statement filing, can help issuers gauge investor demand for purposes of determining offering size and other terms, potentially resulting in a more efficient offering process and a higher likelihood of selling the offered amount more quickly.
Taking Advantage of the New Rule
Rule 163B will become effective 60 days after publication in the Federal Register. If you have questions about how “testing the waters” may benefit your business, we encourage you to contact a member of the Scarinci Hollenbeck Business Law Group.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.