SEC Adopts Rule Allowing All Issuers to "Test the Waters"

October 08, 2019

The Securities and Exchange Commission (SEC) on September 26, 2019 voted to adopt a new rule that extends the "test-the-waters" accommodation under the Securities Act of 1933 (Securities Act) to all issuers. The new Rule 163B permits all issuers to engage in oral or written communications with the potential investors that are, or are reasonably believed to be, qualified institutional buyers (QIBs) or institutional accredited investors (IAIs). The new accommodation extends to persons authorized to act on behalf of issuers, including underwriters, and permits communications prior to and after the filing of a registration statement with the SEC. Rule 163B will become effective 60 days after publication in the Federal Register. 

Like other recent SEC rulemaking, the new rule arises from the Jumpstart Our Business Startups Act (JOBS Act) with the goal of easing the disclosure regime for public companies.2 The JOBS Act added Section 5(d) to the Securities Act, which permitted emerging growth companies to “test the waters” with QIBs and IAIs for potential offerings. With Rule 163B, the SEC expands this flexibility to other issuers in order to broadly permit issuers to assess the interest in and valuation of their securities prior to making a registered offering, in the hope of ultimately encouraging more issuers to engage in registered offerings in the U.S. markets. In this regard, Rule 163B also expands the test-the-waters audience provided for in Section 5(d) to allow a potential issuer to communicate not only with persons that are QIBs or IAIs, but also with persons that are “reasonably believed” by the issuer to be QIBs or IAIs. 

Under the new rule, all issuers will be eligible to engage in test-the-waters communications with QIBs and IAIs under Rule 163B, including fund issuers that are registered investment companies or business development companies (BDCs). However, Rule 163B does not provide for a corresponding exemption from the registration requirements under Section 8 of the Investment Company Act of 1940 (1940 Act). This could limit the utility of Rule 163B with respect to pre-filing communications for funds that intend (as is common practice) to file a single registration statement under both the Securities Act and the 1940 Act. The SEC suggested that it may consider a corresponding exemption under the 1940 Act in the future; in any event, this concern will not limit the utility of Rule 163B for funds that preliminarily engage in offerings that are otherwise exempt under the 1940 Act, such as certain registered closed-end funds and BDCs. The SEC recognized that Rule 163B, as a general matter, would not specifically benefit funds that conduct offerings qualifying for an exemption from Section 5 of the Securities Act, such as private funds that conduct non-public offerings pursuant to Section 4(a)(2) and Rule 506 thereunder. 

Under Rule 163B, test-the-waters communications do not require any legends. Furthermore, such communications are exempt from SEC filing requirements. The SEC is also amending Rule 405 of the Securities Act to exempt test-the-waters communications from being considered “free writing” prospectuses. 

The SEC cautioned that Regulation FD (which applies to exchange-listed public companies including closed-end funds and BDCs) continues to apply to any test-the-waters communications for public companies, absent an exemption from Regulation FD. Test-the-waters communications are also still deemed offers under the Securities Act and may not contain material misstatements or omissions. Rule 163B is a non-exclusive safe harbor under the Securities Act, and issuers may continue to take advantage of other exemptions from “gun jumping” rules in the Securities Act, such as the exemption from Section 5(c) of the Securities Act provided by Rule 163 to well-known seasoned issuers.

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