Practical Implications of Proposed Testing the Waters for All Issuers under U.S. Securities Law

Jon Daly, Michael Hyatte, and David Ni are partners at Sidley Austin LLP. This post is based on a Sidley memorandum by Mr. Daly, Mr. Hyatte, Mr. Ni, David B. Lichtstein, Craig Chapman, and Eric Haueter.

On February 19, 2019, the Securities and Exchange Commission (SEC) approved a proposed rule that, if enacted, would permit all issuers to use “test-the-waters” communications (TTW communications). Currently, only “emerging growth companies”—a defined term generally describing most initial public offering (IPO) issuers and other new entrants to the SEC reporting system—are permitted to engage in TTW communications under the Securities Act of 1933 (Securities Act). This alert provides some background on TTW communications, discusses the new proposal and concludes with our views of the practical implications of the proposal.

Background: Testing the Waters and the JOBS Act

In April 2012, President Barack Obama signed the Jumpstart Our Business Startups Act (JOBS Act) into law. The JOBS Act’s stated objective was to facilitate capital formation, particularly for emerging growth companies (EGCs). The JOBS Act added Section 5(d) to the Securities Act to permit TTW communications for EGCs. Section 5(d) allows EGC issuers, and persons acting on their behalf, to test the waters by oral or written communication with potential investors both before and after the filing of an IPO registration statement. Under Section 5(d), TTW communications are solely permitted with potential investors who are “qualified institutional buyers” (QIBs) or institutional “accredited investors” (IAIs), as defined by applicable SEC rules. Apart from TTW communications, after the filing of a registration statement, written communication offering a security is forbidden by Section 5(b) unless such communication is a prospectus that meets SEC requirements or is exempt from those requirements.

Following the enactment of the JOBS Act, the vast majority of IPOs have involved EGCs, which accounted for 87% of IPOs between 2012 and 2017, according to a November 2016 report by Ernst & Young, LLP. A significant number of EGCs engage in TTW communications. Industry research and Sidley’s experience suggest that EGCs, especially those in the healthcare, technology, media, telecommunications and energy industries, and potential underwriters acting on behalf of EGCs find TTW communications very useful in their efforts to raise capital.

The Proposed Rule 163B: Eligible Issuers and Permitted Communications

Proposed Rule 163B under the Securities Act aims to “allow all issuers, including non-EGC issuers, 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.” The proposal would permit persons acting on behalf of the issuer, including prospective underwriters acting at the direction of an issuer, to effect TTW communications. The reasonable-belief requirement of Rule 163B applies equally to any person authorized to act on an issuer’s behalf, including underwriters. TTW communications made under the proposed rule are allowable so long as they are not intended to evade the requirements of Section 5 of the Securities Act.

Proposed Rule 163B and Section 5(d) differ in some significant respects. For example, the proposal would permit TTW communications if the party relying on the rule has a reasonable belief that all recipients of those communications are QIBs or IAIs, even if it turns out that they were not. It is not clear that the same result would follow under Section 5(d), which also requires that recipients be QIBs or IAIs but does not include a reasonable-belief qualification. The proposed rule would be the effective administrative repeal of Section 5(c) for offers to private equity funds, mutual funds or other “buy-side” institutions. Otherwise, the proposed rule largely mirrors Section 5(d). Rule 163B would be nonexclusive—issuers may rely on other Securities Act rules or exemptions, such as Section 5(d), Rule 163, Rule 164 or Rule 255 in holding exploratory communications with potential investors.

Under proposed Rule 163B, either the issuer or a party authorized to act on its behalf, such as an underwriter, may make TTW communications. The ability of a party authorized by the issuer to make TTW communications provides additional appeal over similar, existing rules. For example, Rule 163 under the Securities Act permits “well-known seasoned issuers” (WKSIs) as defined under Rule 405 to make oral and written offers before a registration statement is filed, subject to certain conditions. Rule 163 has proven to have virtually no practical use for WKSIs, however, because the SEC staff has construed the rule to be unavailable to underwriters acting on behalf of the issuer.

Other benefits of proposed Rule 163B are that unlike Rule 163, the proposed rule is available to all issuers (not just WKSIs) and does not require issuers to file TTW communications with the SEC or to include any legends in those communications. However, the absence of a filing requirement does not prevent the SEC staff from requesting written TTW communications as supplemental information, which is its practice for EGCs relying on Section 5(d).

TTW communications constitute offers within the meaning of Section 2(a)(3) of the Securities Act, which means that any misleading statements or omissions in the communications will be exposed to potential liability under Section 12(a)(2) of the Securities Act and Rule 10b-5 under the Securities Exchange Act of 1934 (Exchange Act).

Proposed Rule 163B and Regulation FD

In the proposing release for Rule 163B, the SEC noted that issuers subject to the reporting requirements of the Exchange Act should consider whether Regulation FD (for “fair disclosure”) applies to their TTW communications. Regulation FD prohibits reporting issuers from selectively disclosing material non-public information to certain market professionals and shareholders without simultaneous public disclosure unless the recipients of the communication have agreed to maintain the information in confidence.

Practical Implications for Issuers and Underwriters

If the proposal is adopted without significant change, we believe Rule 163B will have limited benefits in promoting public offerings.

The proposed rule’s benefit will be extremely limited for any issuer with an effective shelf registration statement. Under existing rules and practices, issuers with an effective shelf registration statement are already able to offer their securities in prelaunch marketing so long as any written communications qualify as prospectuses meeting SEC requirements or are exempt from those requirements. WKSIs with automatic shelf registration statements, which constitute a large portion of SEC reporting companies, have very few restraints on the timing of offers. EGCs can continue to rely on Section 5(d).

As noted earlier, Rule 163B would be non-exclusive. Issuers may rely on other Securities Act rules or exemptions, such as Section 5(d), Rule 163, Rule 164 or Rule 255, in communicating with potential investors and to achieve similar objectives. Likewise, there are no limitations on TTW-like communications in unregistered offerings, such as Rule 144A and Regulation S transactions, as these are not subject to the prohibition of Section 5(c).

The proposed rule may be beneficial in mergers deemed to be offers and sales of securities under Rule 145(a) of the Securities Act and requiring registration. The present position of the SEC staff is that communications made prior to the filing of the registration statement covering the merger are objectionable except for communications with directors, executives and holders of 5% or more of the merger counterparty’s securities. Proposed Rule 163B would open up a channel for an issuer to communicate with QIBs and IAIs before the filing of a registration statement covering the merger.

The proposed rule may also be popular with certain other classes of issuers, such as IPO candidates not meeting the EGC criteria or an issuer without an effective shelf registration statement covering the securities being offered. And even IPO candidates that do meet the EGC requirements may choose to rely on Rule 163B instead of Section 5(d) because of the greater protection provided by the proposed rule’s reasonable belief standard for determining whether potential investors qualify as QIBs or IAIs.

Next Steps

The public comment period for proposed Rule 163B ends on April 29, 2019. For additional information, see the SEC’s press release describing the proposal, available at, as well as the proposing release, available at

The complete publication is available here.

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