SEC Replaces Credit Ratings with New Wide Market Following Test for Shelf Registration Statement Eligibility
The Securities and Exchange Commission (SEC) recently adopted amendments to its short-form registration statements on Forms S-3 and F-3 to replace credit ratings with new eligibility criteria focused on wide market following for the use of the registration statements in offerings of non-convertible securities (other than common equity). The SEC also adopted amendments to Rules 134, 138, 139 and 168 under the Securities Act to remove credit rating references or to incorporate the new eligibility criteria for short-form registration statements on Forms S-3 and F-3. The amendments become effective on September 2, 2011.
In 2008, the SEC had proposed similar amendments that were not adopted. However, Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) requires the SEC to remove from its rules any reference to credit ratings and to substitute a standard of creditworthiness as the SEC determines to be appropriate.
The amendments to Forms S-3 and F-3 provide additional eligibility criteria to those originally proposed by the SEC in February 2011 to preserve the use of short-form registration statements for issuers with a wide market following. The amendments also include a temporary "grandfathering" provision that will permit eligible issuers to file new short-form registration statements so long as any offerings pursuant to the registration statements have a final prospectus filed by September 2, 2014. Despite the SEC’s efforts to preserve the use of short-form registration statements for widely followed issuers, the amendments may cause some issuers to lose Form S-3 and F-3 eligibility after the expiration of the "grandfathering" period.
New Eligibility Criteria for Short-Form Registration Statements
Background. An issuer is eligible to use Form S-3 to register securities if it satisfies the form’s registrant requirements and registers securities pursuant to one of the form’s transaction requirements. One of the existing transaction requirements permits issuers to register primary offerings of non-convertible securities for cash if they were rated at the time of sale as "investment grade" by at least one nationally recognized statistical rating organization.
New Eligibility Criteria. Effective September 2, 2011, the amendments will replace the investment grade transaction requirement of General Instruction I.B.2 of Form S-3 with new eligibility criteria focused on wide market following. At that time, a primary offering of non-convertible securities (other than common equity) for cash will be eligible to be registered on Form S-3 pursuant to General Instruction I.B.2 if an issuer satisfies one of the following criteria:
- the issuer has issued (as of a date within 60 days prior to the filing of the registration statement) at least $1 billion in non-convertible securities (other than common equity) in primary offerings for cash (not exchange) registered under the Securities Act of 1933 (Securities Act) over the prior three years;
- the issuer has outstanding (as of a date within 60 days prior to the filing of the registration statement) at least $750 million of non-convertible securities (other than common equity) that were issued in primary offerings for cash (not exchange) registered under the Securities Act;
- the issuer is a wholly-owned subsidiary of a well-known seasoned issuer (WKSI); or
- the issuer is a majority-owned operating partnership of a real estate investment trust (REIT) that qualifies as a WKSI.
To be eligible to use Form S-3, issuers will still be required to satisfy the form’s other eligibility requirements, which did not change as a result of the amendments.
In calculating the $1 billion and $750 million thresholds, issuers may generally include the principal amount of any non-convertible debt and the greater of liquidation preference or par value of any non-convertible preferred stock that were issued in primary registered offerings for cash. Non-convertible securities (other than common equity) issued in registered exchange offers and private placement transactions (for example, Securities Act Section 4(2), Rule 144A and Regulation D and S offerings) would not count toward the thresholdsbecause an issuer will need to calculate the threshold amounts in accordance with the standards used to determine whether an issuer is a WKSI.
Temporary "Grandfather" Provision. To ease the transition to the new eligibility criteria and allow affected companies adequate time to adjust, the SEC adopted a temporary "grandfather" provision. Under this provision, an issuer that does not satisfy any of the new criteria will remain eligible to register on Form S-3 primary offerings of non-convertible securities (other than common equity) for cash if it discloses in the registration statement that it has a "reasonable belief" that it would have been eligible to register the securities offerings pursuant to the investment grade transaction requirement, discloses the basis for that belief in the registration statement and files the final prospectus for any offering on or before September 2, 2014. Factors that indicate a "reasonable belief" of eligibility to rely on the "grandfather" provision will include, but not be limited to:
- an investment grade credit rating;
- a previous investment grade credit rating on a security issued in an offering similar to the one being registered that has not been downgraded or put on a watch-list since its issuance; or
- a previous assignment of a preliminary investment grade rating.
The SEC recently indicated that issuers relying on the "grandfather" provision would generally not need to obtain a consent from the relevant rating agencies when disclosing the basis for the reasonable belief in the registration statement. However, unless and until the SEC issues an official interpretation on the matter, issuers should confirm with the SEC before filing a registration statement containing reasonable belief disclosure without obtaining the relevant rating agency's consent.
Form F-3 Amendments. The SEC adopted identical amendments to the short-form registration statement on Form F-3, which is used by foreign private issuers.
Impact of New Eligibility Criteria
In response to comments on the SEC’s proposed amendments, the final amendments reflect changes from the proposals that are designed to minimize the number of issuers that would be denied the ability to use short-form registration statements under the new eligibility criteria, particularly utility companies, REITs and insurance company issuers of certain insurance contracts. The SEC indicated that the legislative history for Dodd-Frank Section 939A did not indicate that Congress intended to change the types of issuers and offerings that could rely on the SEC’s forms, but rather sought to "reduce reliance on credit ratings." Despite these efforts, the amendments may cause some issuers that have relied (or could rely) on the investment grade transaction requirement to lose Form S-3 eligibility after the expiration of the "grandfathering" period.
The amendments will only adversely impact an issuer if it currently relies on the investment grade transaction requirement for Form S-3 eligibility and is unable to satisfy one of the new criteria or one of the other Form S-3 transaction requirements. For example, an issuer could still register on Form S-3 primary offerings of non-convertible securities if it:
- satisfies the form’s registrant requirements and has a public float of $75 million;
- satisfies the form’s registrant requirements and (1) has a class of common equity securities listed and registered on a national securities exchange, (2) is not, and has not been in the previous 12 months, a shell company and (3) does not sell more than one-third of its public float in primary offerings over any period of 12 calendar months; or
- is a majority-owned subsidiary and can satisfy one of the requirements found in General Instruction I.C. of Form S-3, including that its parent satisfies the form’s registrant requirements and the applicable transaction requirement and provides a full and unconditional guarantee of the non-convertible securities (other than common equity) being registered.
Loss of Form S-3 eligibility would force an issuer to either register its securities on a long-form registration statement on Form S-1 or conduct a private placement. Due to the time involved in the preparation and SEC review of a Form S-1, we expect issuers that lose Form S-3 eligibility as a result of the amendments will likely rely on private placements for debt and preferred stock offerings. Use of private placements will make it difficult for issuers to ever gain Form S-3 eligibility under the new eligibility criteria because non-convertible debt and preferred stock issued in private placements are excluded from the threshold calculations.
Impact of New Eligibility Criteria on Specific Types of Issuers
Master Limited Partnerships (MLPs). We do not expect the amendments will impact non-convertible debt offerings by MLP subsidiaries as they will generally be able to rely on the new eligibility criteria for wholly-owned subsidiaries of a WKSI or, as they have previously done, on the transaction requirement for majority-owned subsidiaries whose parents fully and unconditionally guarantee the registered debt.
Issuers of Asset-Backed Securities. The amendments will not impact offerings of investment grade asset-backed securities registered on Form S-3. Asset-backed issuers must continue to look to General Instruction I.B.5 of Form S-3 for their investment grade offerings, which includes an investment grade eligibility standard, until such time as new shelf eligibility requirements for asset-backed issuers are adopted that do not make reference to credit ratings. The SEC has proposed (and re-proposed on July 26, 2011) new shelf eligibility requirements for asset-backed issuers that do not make reference to credit ratings as part of its overhaul of Regulation AB.
Securities Act Rules 138, 139 and 168. These rules provide that certain broker-dealer and issuer communications are not deemed to be an offer for sale or offer to sell a security within the meaning of Securities Act Sections 2(a)(10) and 5(c) when the communications relate to an offering of non-convertible investment grade securities. Each of these rules was amended to replace the references to non-convertible investment grade securities with the new eligibility criteria set forth in the Form S-3 amendments. As a result, to ensure reliance on the safe harbors provided by Rules 138 and 139, firms that publish research reports will need to determine an issuer’s eligibility to use Form S-3 or F-3 instead of relying on a published credit rating.
Securities Act Rule 134(a)(17). This rule creates a safe harbor for the disclosure of credit ratings assigned, or reasonably expected to be assigned, by rating agencies in certain communications (for example, "tombstone" ads or press releases announcing offerings) so that the communications are not deemed to be a prospectus or free writing prospectus. The amendments eliminate this safe harbor. Removal of the safe harbor will not, by itself, result in a communication that includes credit ratings being deemed to be a prospectus or free writing prospectus. However, issuers that want to include credit rating information in their communications would need to determine whether the information constitutes a prospectus in light of all of the circumstances of the communication.
We do not expect the removal of the safe harbor will have an impact on communications relating to non-convertible debt offerings. Eligible issuers will continue to be able to disclose a credit rating in a term sheet filed with the SEC as a free writing prospectus. While Dodd-Frank’s repeal of Securities Act Rule 436(g) prevents the disclosure of credit ratings in a registration statement or prospectus (and any incorporated documents) without the consent of the rating agency, as the SEC has explained in a compliance and disclosure interpretation, an issuer free writing prospectus that complies with Rule 433 would not be a registration statement or prospectus for purposes of Rule 436, so the consent of the rating agency would not be required for the inclusion of credit ratings in the free writing prospectus.
Issuers that have relied or intended to rely on the Form S-3 investment grade transaction requirement should consider taking the following actions in response to the amendments.
- Review the new eligibility criteria, including the temporary "grandfather" provision, to determine whether they expect to remain eligible to use Form S-3, including whether steps can be taken to issue registered non-convertible securities over the next three years to satisfy the new criteria. Issuers that seek to rely on the "grandfather" provision must carefully consider the matter to ensure that the "reasonable belief" disclosure is accurate as they will be responsible for the disclosure under the Securities Act.
- If they are unable to satisfy any of the new eligibility criteria, evaluate whether they can satisfy one of Form S-3’s other transaction requirements in order to maintain Form S-3 eligibility.
- If they are faced with loss of Form S-3 eligibility, they should contact the Staff of the SEC’s Division of Corporation Finance to request relief from compliance with the amendments. Based on the language in the SEC’s adopting release and recent public statements, the Staff may be amenable to such requests.
- If they are unable to satisfy one of Form S-3’s other transaction requirements and the SEC will not grant their request for relief, evaluate the impact of the loss of Form S-3 eligibility on future financings including the impact on an offering’s timing and the issuer’s cost of capital.