SEC Proposes to Expand “Test-the-Waters” Modernization Reform to All Issuers

March 08, 2019

On February 19, 2019, the U.S. Securities and Exchange Commission (the “SEC”) proposed new rule 163B under the Securities Act of 1933, as amended (the “Securities Act”), which would permit all issuers, not just Emerging Growth Companies (“EGCs”), to engage in “test-the-waters” communications with potential investors that are, or are reasonably believed to be, qualified institutional buyers (“QIBs”) and institutional accredited investors (“IAIs”) in order to determine whether such investors might have an interest in a contemplated registered securities offering. These communications would be exempt from restrictions imposed by Section 5 of the Securities Act on written and oral offers prior to, or following, filing a registration statement and would be limited to QIBs and IAIs.


In 2012, Congress passed the Jumpstart Our Business Startups Act (the “JOBS Act”), which created Section 5(d) of the Securities Act. Section 5(d) permits any EGC and any person acting on such EGC’s behalf to engage in oral and written communications with potential investors that are QIBs and IAIs before or after filing a registration statement in order to gauge such investors’ interest in a contemplated securities offering. 

The proposed new rule should be understood in the context of other actions taken by the SEC’s Division of Corporation Finance to extend EGC reforms to all issuers. For example, in 2017, the Division of Corporation Finance took action to permit all issuers, not just EGCs, to initially submit certain filings in draft, non-public format.

The SEC intends that the proposed expanded “test-the-waters” rule and related amendments provide "all issuers with appropriate flexibility in determining when to proceed with a registered public offering while maintaining investor protections” and “a cost-effective means for evaluating market interest before incurring the costs associated with such an offering."1 SEC Chairman Jay Clayton observed, “[e]xtending 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."

Proposed Securities Act Rule 163B


The proposed rule would permit any issuer, or any person authorized to act on its behalf, including an underwriter, to engage in oral or written communications with potential investors that are, or are reasonably believed to be, QIBs or IAIs, either prior to, or following, filing a registration statement, in order to determine whether such investors might have an interest in a contemplated registered securities offering. All issuers, including non-reporting issuers, EGCs, non-EGCs, well-known seasoned issuers (“WKSIs”) and investment companies (including registered investment companies and business development companies (“BDCs”)) would be eligible to rely on the proposed rule. 

Non-Exclusivity of the Proposed Rule

The proposed rule would be non-exclusive; accordingly, an issuer could rely on other Securities Act communications rules or exemptions when determining how, when and what to communicate related to a contemplated securities offering. The following table summarizes some of the existing provisions that issuers may rely on in addition to, or in lieu of, the proposed rule:

View the chart here.

No Filing or Legending Requirements

Test-the-waters communications that comply with the proposed rule would not need to be filed with the SEC nor would they be required to include any specified legends. The test-the-waters communications would be limited to investors that are, or are reasonably believed to be, QIBs or IAIs. Sophisticated institutional investors such as QIBs and IAIs are generally considered to be competent to assess investment opportunities and, therefore, are not in need of the additional safeguards provided by filing or legending requirements.

While test-the-waters communications would be exempt from Section 5, such communications would still be considered “offers” as defined in Section 2(a)(3) of the Securities Act3 and would, therefore, be subject to Section 12(a)(2) liability in addition to the anti-fraud provisions of the federal securities laws4.

No Conflict with Registration Statement

Test-the-waters communications must not conflict with material information in the related registration statement. As is the current practice of the SEC staff when reviewing offerings conducted by EGCs, the SEC staff may request that an issuer furnish the staff with any test-the-waters communications used in connection with an offering.

Disclosure Obligations Under Regulation FD

Issuers subject to Regulation FD would need to consider whether any information in a test-the-waters communication would trigger disclosure obligations under Regulation FD or whether an exemption under Regulation FD would apply. Regulation FD requires public disclosure of any material non-public information that has been selectively disclosed to certain securities market professionals or shareholders if the issuer has a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) or is required to file reports under Section 15(d) of the Exchange Act. Accordingly, communications made under the proposed rule that also include material non-public information could be subject to Rule 100(a) of Regulation FD unless an exclusion applies under Rule 100(b)(2) of Regulation FD. For example, Regulation FD does not generally apply if the selective disclosure 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. Therefore, to avoid the application of Regulation FD, an issuer could consider obtaining confidentiality agreements from any potential investor engaged under the proposed rule.5

No Verification Requirements

In order to avoid imposing undue burden on issuers, issuers are not required to verify any investor’s status as a QIB or IAI. Instead, under the proposed rule, any potential investor solicited must meet, or issuers must reasonably believe that such potential investor meets, the requirements of the rule. The SEC has declined to propose specific steps an issuer could or must take in order to establish a reasonable belief that the intended recipient of test-the-waters communications are QIBs or IAIs. Such approach is intended to provide issuers with flexibility to use methods that are both cost-effective and appropriate in light of the facts and circumstances of each contemplated offering and each potential investor.

Considerations for Use by Investment Companies

Investors that are, or are considering becoming, registered investment companies or BDCs (together, “funds”) would also be eligible to engage in test-the-waters communications under the proposed rule. Fund communications contemplated by proposed rule 163B would generally be considered “sales literature” and subject to their own rules under the Securities Act and the Investment Company Act of 1940, as amended (the “Investment Company Act”).6 Compliance with these rules is generally required so that certain communications are not deemed to be an offer made in violation of Section 5 of the Securities Act. 

The proposed rule would allow funds to communicate with QIBs and IAIs prior to, or following, filing a registration statement about a contemplated offering without complying with the requirements of the Investment Company Act or Rules 4827 or 34b-18, as well as certain filing, disclosure and legending requirements. The proposed rule also contains related amendments that would exclude funds’ test-the-waters communications conducted under the proposed rule from the filing requirements of Rule 497 under the Securities Act9 and of Section 24(b) of the Investment Company Act10 and the rules thereunder. 

However, the SEC has observed that funds’ use of test-the-waters communications under the proposed rule, as well as the associated benefits, may be more limited for than for other issuers, in particular in  relation to pre-filing communications. The SEC asserts that it is common practice for a fund that is contemplating a registered offering at the time of its organization to simultaneously file a registration statement under both the Investment Company Act and the Securities Act for the purposes of efficiency.11 Accordingly, the SEC observes that if funds continue to prefer to file a single registration statement under the Investment Company Act and the Securities Act, funds may be less likely to use the proposed rule for pre-filing communications than other issuers.12

Comment Period

Interested stakeholders may submit comments to the SEC on the rulemaking proposal during the 60-day public comment period.   


1) “Fact Sheet: Solicitations of Interest Prior to a Registered Public Offering”. SEC (19 February 2019). Available here. 

2) Regulation A is an exemption from the registration for public offerings, allowing companies to offer and sell their securities without having to register the offering with the SEC. Companies relying on a Regulation A exemption can offer and sell their securities to the public under two different tiers that have two different requirements—Tier 1 and Tier 2. Under Tier 1, an issuer can raise up to US$20 million in any 12-month period, including no more than US$6 million on behalf of selling security holders that are affiliates of the issuer. In addition to qualification by SEC staff, companies offering securities pursuant to Tier 1 of Regulation A will also need to file and have their offering statements qualified by the state securities regulators in the states in which the issuer plans to sell its securities. Under Tier 2, an issuer can raise up to US$50 million in any 12-month period, including no more than US$15 million on behalf of selling security holders that are affiliates of the issuer. Under Tier 2, the offering statement does not have to be qualified by a state securities regulator, and the issuer is subject to ongoing reporting requirements in the form of an annual report on Form 1-K, a semiannual report on Form 1-SA and a current report on Form 1-U. Companies offering securities under Tier 1 do not have ongoing reporting requirements other than a final report on Form 1-Z on the status of the offering. Under both Tier 1 and Tier 2, the issuer must file an offering statement under Form 1-A with the SEC. 

3) Securities Act Section 2(a)(3) defines “offer” as any attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value. The term “offer” has been interpreted broadly and goes beyond the common law concept of an offer. See Diskin v. Lomasney & Co., 452 F.2d 871 (2d. Cir. 1971); SEC v. Cavanaugh, 1 F. Supp. 2d 337 (S.D.N.Y. 1998).

4) 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. Liability under Section 12(a)(2) would attach to test-the-waters oral and written communications under the proposed rule, both before and after a registration statement has been filed. Communications under the proposed rule would also be subject to the anti-fraud provisions of Securities Act Section 17(a) and Exchange Act Section 10(b) and Rule 10b-5 thereunder.

5) See Regulation FD Rule 100(b)(2)(ii). If the issuer determines not to proceed with the offering and the filing of a registration statement at such time, the issuer may choose to disclose information regarding the communications publicly in order to release the potential investors from the terms of such confidentiality agreement.

6) However, BDCs that are EGCs can currently engage in the communications that proposed Rule 163B contemplates pursuant to Section 5(d) of the Securities Act.

7) Rule 482 establishes requirements for advertisements or other sales materials with respect to the securities of registered investment companies and BDCs. The rule does not apply to certain specified communications, including advertisements exempted from the definition of “prospectus” under Section 2(a)(10 of the Securities Act.

8) Rule 32b-1 provides that any advertisement, pamphlet, circular, form letter or other sales literature (“sales literature”) addressed to or intended for distribution to prospective investors that is required to be filed with the SEC by Section 24(b) of the Investment Company Act will have omitted to state a fact necessary in order to make the statements made therein not materially misleading unless it includes certain specified information.

9) Rule 497 requires investment companies to file every form of prospectus given to any person prior to the effective date of the registration statement that varies from the form of prospectus included in its registration statement. 

10) Section 24(b) of the Investment Company Act generally requires filing of any sales literature that a registered open-end company, registered unit investment trust or registered face-amount certificate company, or an underwriter of any such fund, intends to distribute to prospective investors in connection with a public offering of the fund’s securities. 

11) The SEC points out that registered investment companies are generally able to use the same form and provide much of the same information to register under the Investment Company Act and to register a securities offering under the Securities Act. The SEC further observes that simultaneously filing under both the Investment Companies Act and the Securities Act allows a fund to make fewer filings with the SEC.

12) The SEC asserts that, since a BDC is not required to register under the Investment Company Act, it may be more likely to use the proposed rule to engage in pre-filing communication when it is contemplating a registered offering close to the date of its organization.

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