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Securities Regulation and Corporate Governance > Posts > SEC Proposes Long-Awaited Expansion of “Test-the-Waters” to All Issuers - Use With Caution
SEC Proposes Long-Awaited Expansion of “Test-the-Waters” to All Issuers - Use With Caution

On February 19, 2019, the Securities and Exchange Commission (the “SEC") proposed a new rule that would allow all issuers to engage in “testing the waters." Specifically, the SEC proposed an exemption (the “Proposed Rule") to certain provisions of Section 5 of the Securities Act of 1933 (the “Securities Act") commonly referred to as “gun-jumping" provisions. This exemption would permit any issuer or authorized person (e.g., an underwriter) to engage in oral or written communications with potential investors that the issuer reasonably believes are qualified institutional buyers (“QIBs") or institutional accredited investors (“IAIs").  Currently, this exemption to the gun-jumping provisions is only available to emerging growth companies (“EGCs").  The SEC believes that the Proposed Rule may “help issuers better assess the demand for and valuation of their securities," which may in turn “enhance the ability of issuers to conduct successful offerings and lower their cost of capital."  This goal is consistent with the SEC's overall effort to increase the number of public companies and reduce the regulatory burden of capital raising.

The SEC'S press release announcing the Proposed Rule is available here, and the proposing release is available here.

EGCs have been permitted to provide information through test-the-waters communications since adoption of the JOBS Act in 2012, which dramatically changed the way in which IPOs and certain other securities offerings are conducted.  The Proposed Rule would expand this option to all issuers, including larger companies planning an IPO or seasoned public companies that do not have a shelf registration statement on file, and would also extend to investment companies (including registered investment companies and business development companies). It may be particularly attractive to issuers who are interested in assessing market interest for their securities prior to creating any market disruption by publicly filing a registration statement that could signal a coming offering or investing considerable resources into conducting a formal roadshow against an uncertain market backdrop. 

If approved, the Proposed Rule would permit all issuers to provide information to QIBs and IAIs (but only QIBs and IAIs).  The Proposed Rule would not require that the issuer file such information or communication with the SEC or include any special legend on the communication, although the SEC often asks to see these materials as discussed below.  The SEC believes such measures are not necessary because the communications are limited to QIBs and IAIs, who are presumed to be sophisticated investors who do not need additional protections. Such a limited communication will not be deemed a free writing prospectus under Rule 405 of the Securities Act.

However, these test-the-waters communications will still be subject to certain limitations and issuers should use them with diligence. First, the SEC specified that test-the-waters communications are “offers" as defined in Section 2(a)(3) of the Securities Act and therefore subject to liability under Section 12(a)(2), as well as the anti-fraud rules (e.g., Rule 10b-5). Second, information provided in any test-the-waters communication under the Proposed Rule must not conflict with material information in a related registration statement.  As is the current practice, the staff of the SEC could request copies of test-the-waters communications in connection with its review of a registration statement. Third, for public companies using test-the-waters, the related communication will still be subject to Regulation FD's requirement that material nonpublic information be publicly disclosed or shared only on a confidential basis.  For these public companies using private communications in test-the-waters exercises, the SEC did endorse a wall-cross approach (subject to possible need for cleansing), similar to current practice in confidential marketed offerings (CMPOs).

Once the Proposed Rule is published in the Federal Register, the SEC will accept comments from the public for sixty days.  The SEC has expressed interest in receiving comments addressing, among other things: (a) the expected benefits to issuers, including assessing demand for securities and capital cost reduction; (b) whether written communications under the Proposed Rule should be filed with a registration statement; (c) the need for legends; (d) whether Regulation FD should have a specific exception for some communications; (e) whether some issuers should be excluded (e.g, ineligible issuers, non-reporting issuers, and blank check issuers); and (f) other investors, if any, to whom the exemption should apply.

Special appreciation to Eric Haitz, associate in the Houston office, for his assistance with this post.

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