SEC Expands “Testing-the-Waters” Accommodation to All Issuers, Regardless of EGC Status
The Securities and Exchange Commission (SEC) has adopted Rule 163B (“Rule 163B”) under the Securities Act of 1933 (the “Securities Act”), which expands the availability of “testing-the-waters” communications to all issuers. Testing-the-waters communications are solicitations by an issuer (or person authorized to act on an issuer’s behalf) of nonbinding indications of interest from certain investors before or after the issuer files a registration statement with the SEC. Prior to the enactment of the rule, testing-the-waters communications were available only to issuers that qualified as “emerging growth companies” (EGCs) under the Jumpstart Our Business Startups Act (JOBS Act). This expansion provides all issuers easier access to public capital markets by allowing issuers of any size to gauge market interest prior to initiating a registered public offering. The rule will become effective on December 3, 2019. View the SEC release here.
Background of Testing-the-Waters Communications
Testing-the-waters communications originated with the JOBS Act, passed by Congress in 2012 in part to encourage capital formation by smaller companies. In addition to a number of other reforms, the JOBS Act allowed EGCs (generally, issuers with less than $1.07 billion in annual revenues) to engage in communications with certain investors prior to or following the filing of a registration statement in order to assess investor interest in a potential registered offering. Permitted testing-the-waters communications were limited to investors that are, or are reasonably believed to be, qualified institutional buyers as defined by Rule 144A (QIBs) or institutions that are accredited investors as defined by Regulation D (IAIs). Prior to the passage of the JOBS Act, such communications would have violated the “gun-jumping” restrictions of Section 5 of the Securities Act, which prohibits the making of oral or written offers prior to the filing of a registration statement with the SEC, as well as, generally, the use of written offering materials other than the prospectus.
The New Rule
Under Rule 163B, any issuer (or any person authorized to act on behalf of the issuer, including an underwriter) may engage in oral or written communications with certain investors (as further detailed below) to determine whether such investors might have an interest in a potential registered securities offering before or after filing a registration statement with the SEC. Specifically, Rule 163B provides that:
All issuers, regardless of size or reporting status, may engage in testing-the-waters communications. All issuers, including non-EGCs, well-known seasoned issuers, and non-reporting issuers, may engage in testing-the-waters communications.
The rule encompasses only communications with QIBs and IAIs. Testing-the-waters communications may be made only with potential investors that are, or are reasonably believed to be, QIBs or IAIs. Issuers need not take steps to verify the investor’s status as a QIB or IAI if the issuer reasonably believes the investor to be a QIB or IAI. Issuers should take reasonable steps to prevent the communications from being shared with non-QIBs and non-IAIs.
Testing-the-waters communications are not required to be filed with the SEC or legended. Communications made in reliance on the rule are not required to be filed with the SEC or to comply with SEC legend requirements.
Testing-the-waters communications are classified as “offers” under the Securities Act. Any communication made in reliance on the rule will be deemed an “offer” under the Securities Act.
Rule 163B is expected to ease the burden on issuers seeking to gauge preliminary market interest in potential registered offerings and may spur activity in the public capital markets. Issuers seeking to take advantage of the flexibility provided by the new rule should keep the following in mind:
Certain liability provisions still apply. Because testing-the-waters communications are deemed “offers” under the Securities Act, testing-the-waters communications remain subject to liability under the anti-fraud provisions of the federal securities laws, and to liability under Section 12(a)(2) of the Securities Act. Accordingly, issuers should ensure that testing-the-waters communications do not include any material misstatements or omissions.
Regulation FD obligations may still be triggered. If any testing-the-waters communications contain material nonpublic information (MNPI), already-public issuers subject to Regulation FD should comply with Regulation FD by either (i) publicly disclosing the MNPI simultaneously or (ii) entering into confidentiality agreements with the potential investors receiving the MNPI.
Testing-the-waters communications could constitute a general solicitation, thereby precluding the availability of a subsequent private placement exemption. In its adopting release, the SEC noted that testing-the-waters communications do not automatically preclude, and may be disseminated in a manner that preserves, the availability of private placement exemptions to registration. However, the SEC warned that if an issuer undertakes a private placement offering immediately subsequent to making any testing-the-waters communications, the issuer should consider whether the testing-the-waters communications were conducted in a manner that could constitute a general solicitation, such that a private placement exemption is no longer available.
Testing-the-waters communications are not immune from SEC review. When reviewing EGC registration statements, the SEC staff has typically requested that the company submit supplementally to the SEC copies of all testing-the-waters communications, and this practice is likely to continue with respect to non-EGCs using the new rule. Therefore, issuers should seek to achieve consistency between disclosures in testing-the-waters communications and those in a related registration statement.