On September 26, 2019, the U.S. Securities and Exchange Commission (SEC) announced that it had voted to adopt new Rule 163B, extending the "test the waters" accommodations previously available only to emerging growth companies (EGCs) to all issuers. The new rule will be effective 60 days after it is published in the Federal Register.

Background

Since the implementation of the JOBS Act in 2012, EGCs have been able to avail themselves of Section 5(d) of the Securities Act, an exemption to the gun-jumping prohibitions in Section 5 of the Securities Act, including Section 5(c), prohibiting any written or oral offers prior to the filing of a registration statement and Section 5(b)(1), limiting written offers to a statutory prospectus that meets the requirements of Section 10 of the Securities Act.

In utilizing this exemption, EGCs and any person authorized to act on their behalf (including underwriters) have been permitted to gauge market interest in a potential securities offering by engaging in "test the waters" communications with potential investors that are, or are reasonably believed to be, qualified institutional buyers (QIBs) or institutional accredited investors (IAIs).

In February 2019, the SEC proposed to adopt Rule 163B, extending "test the waters" accommodations to all issuers that are contemplating a securities offering. In addition to leveling the playing field for all issuers, the SEC believed that its proposed rule would, among other things, "provide increased flexibility to issuers with respect to their communications about contemplated registered securities offerings, as well as a cost-effective means for evaluating market interest before incurring the costs associated with such an offering." Its proposal was consistent with the Division of Corporation Finance's continuing efforts to improve capital formation, including its announcement in 2017 that it would accept voluntary draft registration statements from all issuers for nonpublic review, extending to all issuers what was previously only available to EGCs.

This expansion should benefit larger companies, often with more complicated businesses, enabling them to talk more freely with potential investors and to learn about what investors may expect.

"Test the Waters" for All Issuers

The SEC adopted Rule 163B in substantially the form proposed. In its adopting release, the SEC noted that it believes that "these communications could result in a more efficient and potentially lower-cost and lower-risk capital raising process for issuers" and "enhance the ability of issuers to conduct successful registered offerings." The key highlights of this new rule include the following:

• Scope of Eligible Issuers. Rule 163B will be available to all issuers, including EGCs, non-EGCs, well-known seasoned issuers (WKSIs), and investment companies (including registered investment companies and business development companies).
• Investor Status. Issuers, and persons authorized to act on their behalf, will be permitted to engage in both written and oral communications with potential investors that are, or that the issuer reasonably believes to be, QIBs and IAIs. The SEC did not propose, nor did it adopt, specific steps that issuers must take to verify investor status; rather, the SEC noted that issuers may continue to rely on their existing methods to verify investor status in other contexts, acknowledging that Rule 144A(d)(1) sets forth non-exclusive means to determine QIB status.
• No Legending Requirement. Communications under Rule 163B will not be required to include legends.
• No Filing Requirement. Communications under Rule 163B will not be required to be filed with the SEC. However, consistent with the current practice of the staff of the Division of Corporation Finance with respect to EGCs, the SEC noted that the staff anticipates that it will request copies of these materials for review in connection with securities offerings.
• Offers. Communications under Rule 163B will be deemed "offers" under Section 2(a)(3) of the Securities Act, thereby subjecting them to Section 12(a)(2) of the Securities Act and other antifraud provisions of the federal securities laws, including Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 of the Exchange Act.
• Consistent with Registration Statement. Communications under Rule 163B must not conflict with material information in the related registration statement, regardless of whether the communications are made before or after the filing of the initial registration statement. In adopting the final rule, the SEC acknowledged the concern expressed by some commenters that requiring consistency between pre-filing test the waters communications and registration statements could be challenging, particularly if the issuer's offering strategy or messaging changed in response to investor feedback. The SEC recognized that disclosures may change but, citing staff's prior experience in reviewing EGC test the waters materials, noted that even where an issuer may change its offering terms or messaging based on its testing the waters communications, the material terms about the issuer itself, e.g., financial condition, management information, and business operations, typically remain consistent.
• Free Writing Prospectuses. The SEC adopted amendments to Rule 405 of the Securities Act to both clarify that Section 5(d) written communications were not free writing prospectuses, and that new Rule 163B written communications would not be considered free writing prospectuses.
• Non-Exclusivity. Rule 163B will be non-exclusive, meaning that issuers will be able to rely concurrently on other Securities Act communications rules or exemptions.
• Regulation Fair Disclosure (FD). The SEC noted that issuers that were subject to Regulation FD would need to consider whether its test the waters communications may trigger obligations under Regulation FD and, if so, whether an exception may apply or the potential investors will be required to enter into confidentiality agreements.

While the SEC adopted the final rule in substantially the same form it was proposed, it was persuaded by commenters to remove the so-called "anti-evasion" language, i.e., that the rule would not be available for any communication that, while in technical compliance with the rule, is part of a plan or scheme to evade the requirements of Section 5 of the Securities Act. Several commenters found it unclear how this proviso could apply to exempt, permissible communications, and expressed concern that this proviso could introduce uncertainty that may risk limiting the utility of this new rule.

What to Do Now

The final rule will become effective 60 days after publication in the Federal Register, at which time all issuers will be able to engage in test the waters communications, subject to the limitations set forth in the rule.