United States: SEC Proposes To Expand "Test-The-Waters" Accommodation

On February 19, 2019, the SEC proposed a rule and related amendments under the Securities Act of 1933, as amended (the "Securities Act"), that would permit issuers to engage in oral or written communications with potential investors that are, or are reasonably believed to be, qualified institutional buyers ("QIBs") or institutional accredited investors, either prior to or following the filing of a registration statement, to determine whether such investors have an interest in a contemplated securities offering registered under the Securities Act.: 1  This rulemaking would expand the "test-the-waters" accommodation to all issuers. 

In a press release announcing the Commission's action, Chairman Jay Clayton stated, "Extending the test-the-waters reform to a broader range of issuers is designed to enhance their ability to conduct successful public securities offerings and lower their cost of capital, and ultimately to provide investors with more opportunities to invest in public companies . . . . The proposed rules would allow companies to more effectively consult with investors and better identify information that is important to them in advance of a public offering."


Section 5(c) of the Securities Act prohibits written or oral communications about a proposed securities offering prior to filing a registration statement with the SEC, absent an exemption. A violation of these restrictions is generally referred to as "gun-jumping." Further, Section 5(b)(1) of the Securities Act generally prohibits an issuer from using a prospectus that does not meet the requirements of Section 10 of the Securities Act after filing a registration statement.

In 2012, the Jumpstart Our Business Startups Act ("JOBS Act") was enacted, which amended Section 5 of the Securities Act to provide an EGC, or any other person that the EGC authorizes to act on its behalf, with the flexibility to engage in oral or written communications with QIBs or institutional accredited investors in order to engage their interest in a proposed registered securities offering either prior to or following the filing of a Securities Act registration statement, subject to the requirement that no security may be sold unless accompanied or preceded by a prospectus meeting the requirements of Section 10(a) of the Securities Act.

Further, as part of the SEC's Securities Offering Reform rulemaking in 2005, the Commission had adopted Securities Act Rule 163, which provides an exemption from the restrictions in Section 5(c) for pre-filing communications by well-known seasoned issuers, without any limitations as to the types of investor that can be solicited, subject to certain filing and legend requirements. 

Similarly, in amendments to Regulation A that were adopted in 2015, the Commission adopted Rule 255, which allows eligible issuers conducting an offering exempt from registration under Regulation A to engage in test-the-waters communications with potential investors, without any limitations as to the type of investors that can be solicited, subject to certain disclaimer and filing requirements.

Recent legislative efforts have also sought to expand the test-the-waters accommodation to issuers that are not EGCs; however, to date, none of these proposed statutory amendments have been enacted.: 2

Proposed Rule 163B

If adopted, proposed Rule 163B under the Securities Act would permit an issuer, and any person authorized to act on the issuer's behalf (including underwriters), to engage in oral and written test-the-waters communications with QIBs and institutional accredited investors, by providing an exemption from Section 5(b)(1) and Section 5(c) of the Securities Act for such communications.: 3 Under the proposed rule, these exempt communications would not need to be filed with the SEC, nor would they need to include any specified legends.

Information in Test-the-Waters Communications

The SEC does not propose any specific limitation on the information that can be included in test-the-waters communications.  The Commission notes that information contained in a test-the-waters communication may not conflict with information in the related registration statement. Consistent with the practice of SEC's staff when reviewing offerings conducted by EGCs, the Commission or its staff could request that an issuer furnish the staff with any test-the-waters communication used in connection with an offering.

The Commission notes that Section 12(a)(2) of the Securities Act provides purchasers of an issuer's securities in a registered offering private rights of action for materially deficient disclosure in oral communications and prospectuses, and imposes liability on sellers for offers or sales by means of an oral communication or prospectus that includes an untrue statement of material fact or omits to state a material fact that makes the statements made, in light of the circumstances on which they were made, not misleading. Oral and written communications under proposed Rule 163B would be subject to liability under Section 12(a)(2), both before and after a registration statement has been filed. In addition, such communications would be subject to the anti-fraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

Exclusion from the Definition of "Free-writing Prospectus"

The Commission proposes to amend Rule 405 under the Securities Act to exclude a written communication used in reliance on the proposed Rule 163B from the definition of "free writing prospectus." Further, the Commission proposes that communications made under the proposed rule would not be required to be filed pursuant to the prospectus filing requirements of the Securities Act and the Investment Company Act of 1940.

Interaction with Regulation FD

The Commission notes in the proposing release that issuers subject to Regulation FD would need to consider whether any information in a test-the-waters communication would trigger any obligations under Regulation FD, or whether an exception to Regulation FD would apply. This is because Regulation FD only provides a limited exception for communications in connection with certain registered securities offerings if the disclosure is made by: (i) a registration statement filed under the Securities Act; (ii) a free writing prospectus used after filing a registration statement for the offering or a communication falling within the exception to the definition of prospectus contained in clause (a) of section 2(a)(10) of the Securities Act; (iii) any other Section 10(b) prospectus; (iv) a notice permitted by Rule 135 under the Securities Act; (v) a communication permitted by Rule 134 under the Securities Act; (vi) or an oral communication made in connection with the registered securities offering after filing the registration statement. 

Given the potential application of Regulation FD, the Commission notes that an issuer may want to consider obtaining a confidentiality agreement from any potential investor engaged under proposed Rule 163B in order to rely on the exclusion under Rule 100(b)(2) of Regulation FD for a selective disclosure that was made to a person who owes a duty of trust or confidence to the issuer or to a person who expressly agrees to maintain the disclosed information in confidence.

Eligible Issuers and Authorized Persons

Any issuer, or person authorized to act on behalf of the issuer, would be able to rely on proposed Rule 163B to engage in exempt oral or written communications with potential investors that are, or that the issuer or person authorized to act on behalf of the issuer reasonably believes are, QIBs or institutional accredited investors. The Commission notes that this would include non-reporting issuers, EGCs, non-EGCs, WKSIs, and investment companies (including registered investment companies and business development companies).

Reasonable Belief Standard

Under proposed Rule 163B, any potential investor solicited must meet, or issuers must reasonably believe that the potential investor meets, the requirements of the rule.  This approach would not require issuers to verify investor status, as required under Rule 506(c) of Regulation D. As a result, the Commission notes that, under proposed Rule 163B, an issuer could reasonably believe that a potential investor is a QIB or an institutional accredited investor, even though the investor may have provided false information or documentation to the issuer. The Commission believes that, in those circumstances, the issuer should not be subject to a violation of Section 5 of the Securities Act, so long as the issuer established a reasonable belief with respect to the potential investor's status based on the particular facts and circumstances. The Commission is not proposing to specify the steps an issuer could or must take to establish a reasonable belief that the intended recipients of test-the-waters communications are QIBs or institutional accredited investors. The Commission believes that issuers should continue to rely on the methods they currently use to establish a reasonable belief regarding an investor's status as a QIB pursuant to Rules 144A under the Securities Act, or as an accredited investor pursuant to Rule 501(a) of Regulation D.   

A Non-Exclusive Exemption

Proposed Rule 163B would be non-exclusive; therefore, attempted compliance with proposed

Rule 163B would not act as an exclusive election, and an issuer could rely on other Securities

Act communications rules or exemptions.  For example, an issuer could rely on Section 5(d) of the Securities Act, Rule 163 under the Securities Act, Rule 164 under the Securities Act, or Rule 255 of Regulation A.  


Proposed Rule 163B is representative of the SEC's recent efforts to further increase access to the public capital markets by providing flexibility to issuers with respect to their communications and a cost-effective means for evaluating investor interest in a proposed public offering. This flexibility would allow companies to more closely align the transaction terms and other information available to investors to respond to the most important concerns of institutional investors, thereby potentially providing a more efficient and effective capital-raising process. 


1 Solicitations of Interest Prior to a Registered Public Offering, SEC Release No. 33-10607 (February 19, 2019), available here. https://www.sec.gov/rules/proposed/2019/33-10607.pdf

2 See H.R. 3903 "Encouraging Public Offerings Act of 2017;" S. 2347 "Encouraging Public Offerings Act of 2018;" and the House amendment passed on July 17, 2018 to S. 488 "Encouraging Employee Ownership Act."

3 A QIB is defined in Rule 144A of the Securities Act as a specified institution that, acting for its own account or the accounts of other QIBs, in the aggregate, owns and invests on a discretionary basis at least $100 million in securities of unaffiliated issuers. Banks and other specified financial institutions must also have a net worth of at least $25 million. A registered broker-dealer qualifies as a QIB if, in the aggregate, it owns and invests on a discretionary basis at least $10 million in securities of issuers that are not affiliated with the broker-dealer. Institutional accredited investors include any institutional investor that is also an accredited investor, as defined in paragraph (a) of Rule 501 of Regulation D. Specifically, for the purposes of proposed Rule 163B, an institutional accredited investor would be an institution that meets the criteria of Rule 501(a)(1), (a)(2), (a)(3), (a)(7), or (a)(8).

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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