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SEC Proposes Testing the Waters Communications for All Issuers

Client Updates

On February 19, the Securities and Exchange Commission (the “Commission”) issued a proposed rule to allow all issuers – not just emerging growth companies – to use testing the waters communications in their public offering process.  If adopted, this rule would result in earlier communications with potential investors by non-emerging growth companies in public offerings to assist in gauging market interest, developing relationships with potential investors and book-building.

In 2012, Congress passed the Jumpstart Our Business Startups Act (the “JOBS Act”), a key feature of which allows emerging growth companies (“EGCs”) to assess the interest of qualified institutional buyers (“QIBs”) and institutional accredited investors (“IAIs”) in connection with contemplated securities offerings. This communication is commonly referred to as “testing the waters.”

On February 19, the Commission proposed new Rule 163B, which would extend to “any issuer [not just an EGC] or person authorized to act on behalf of any issuer, including an underwriter” the ability “to engage in test-the-waters communications with potential investors that are, or that the issuer reasonably believes to be, QIBs or IAIs, either prior to or following the date of filing of a registration statement related to such offering.” Under the proposed rule, such communications need not be filed with the Commission or include any specified legends.

As in current testing the waters communications by EGCs, the information contained in communications under proposed Rule 163B must not conflict with material information in the related registration statement, so companies must be thoughtful in the information they present in such communications to ensure discrepancies do not arise later in the offering process. To avoid issues, we generally recommend that issuers wait until a draft registration statement has been reviewed by counsel before preparing separate written testing-the-waters materials in order to minimize the risk of conflicting statements.  The new rule is not the exclusive means for an issuer to communicate about a registered securities offering. Testing the waters communications also remain subject to Section 12(a)(2) liability and the anti-fraud provisions of federal securities laws.

In support of the proposed rule, the Commission stated that “pre-filing solicitations pursuant to Section 5(d) have not been a significant cause for concern with respect to investor protection” in part because QIBs and IAIs are considered financially sophisticated investors with little need for such protections. The Commission cited many benefits for both issuers and investors related to the proposed new rule including leveling the playing field in capital raising efforts, increasing registered offerings in the United States and encouraging capital markets participation, as well as promoting investment opportunities, market transparency and resiliency.

The proposed new Rule 163B will be open for public comment on a number of topics after publication in the Federal Register. The Commission’s release is available here.

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