On December 4, 2015, President Obama signed into law the Fixing America’s Surface Transportation Act, or FAST Act. The FAST Act includes several provisions intended to improve capital formation by smaller issuers and liquidity for their investors. These include a new exemption for resales of securities, as well as several provisions that modify existing provisions of the Jumpstart Our Business Startups Act, or JOBS Act, to further relax the requirements relating to EGC IPOs and registration statements filed by smaller reporting companies.
New Resale Exemption: Section 4(a)(7)
The FAST Act adds a new Section 4(a)(7) to the Securities Act of 1933 (the “Securities Act”), which is an exemption for resales of securities to accredited investors. Section 4(a)(7) was previously approved by the U.S. House of Representatives as the Reforming Access for Investments in Startup Enterprises Act of 2015, or RAISE Act, in October 2015 and discussed in our November 2015 client alert House Passes Act to Codify Section 4(a)(1½) Exemption for Resales of Restricted Securities. Overall, Section 4(a)(7) provides a statutory exemption from registration under the Securities Act for certain resales that previously had been exempt under the so-called “Section 4(a)(1½)” exemption that was developed informally. While there are benefits to the clarity that Section 4(a)(7) provides as a specifically codified exemption, Section 4(a)(7) is more limited than the Section 4(a)(1½) exemption in many respects and it subjects issuers and selling stockholders to informational requirements that the Section 4(a)(1½) exemption does not require.
Conditions for Section 4(a)(7) Resales. Resales under Section 4(a)(7) must satisfy the following conditions:
- Accredited Investors Only. Each purchaser must be an accredited investor as defined in Rule 501(a) of Regulation D. Rule 501(a) defines an accredited investor as any person who comes within, or who the issuer reasonably believes comes within, any one of several specified categories of persons at the time of the sale of the securities to that person. We believe Section 4(a)(7) should be interpreted to permit resales to a person who the seller (as opposed to the issuer) reasonably believes comes within the specified categories, although this has not been specifically addressed in the FAST Act or SEC interpretive guidance released to date.
- No General Solicitation or Advertising. Neither the seller nor any person acting on the seller’s behalf may offer or sell the securities by any form of general solicitation or general advertising.
- Outstanding Class Requirement. The securities must be of a class that has been authorized and outstanding for at least 90 days before the date of the transaction.
- Business Requirement. The issuer must be engaged in a business, and must not be in the organizational stage, bankruptcy or receivership, and must not be a blank check, blind pool or shell company that has no specific business plan or has indicated that its primary business plan is to engage in a merger, business combination or acquisition.
- Resale Transactions Only. The transaction must not involve the sale of a security by the issuer or a direct or indirect subsidiary of the issuer.
- Underwriter Prohibition. The securities must not be the whole or part of an unsold allotment to, or a subscription or participation by, a broker or dealer as an underwriter of the security or a redistribution.
- Bad Actor Prohibition. Neither the seller, nor any person who has been or will be paid, directly or indirectly, any remuneration or commission for participation in the offer or sale of the securities, is a “bad actor” under Rule 506(d)(1) of Regulation D or is subject to statutory disqualification under Section 3(a)(39) of the Securities Exchange Act of 1934 (the “Exchange Act”).
- Information Requirement. In the case of issuers that are not subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act or are exempt from reporting under Rule 12g3-2(b) of the Exchange Act, the seller and the purchaser must obtain from the issuer, upon request of the seller, and in all cases the seller must make available to a purchaser, certain information, which must be reasonably current in relation to the date of the resale, including:
- general information regarding the issuer (the issuer’s name and address, the names of its officers and directors, the name and address of the transfer agent or other person performing an equivalent role and a description of the nature of the issuer’s business and products or services), the security (the title and/or class, par or stated value and the number of shares outstanding) and the names of any persons registered as a broker, dealer or agent who will be paid or given, directly or indirectly, any commission or remuneration in connection with the offer or sale of the securities;
- the issuer’s most recent balance sheet and profit and loss statement and similar financial statements for the issuer’s two preceding fiscal years (or such lesser period as the issuer has been in operation), each prepared in accordance with U.S. GAAP, or in the case of a foreign private issuer, IFRS;
- the balance sheet shall be presumed reasonably current if it is as of a date less than 16 months before the date of the transaction, and the profit and loss statement shall be presumed reasonably current if it is for the 12 months preceding the date of the balance sheet; and
- if the balance sheet is not as of a date less than six months before the date of the transaction, the balance sheet must be accompanied by an additional profit and loss statement for the period from the date of the balance sheet to a date less than six months before the date of the transaction; and
- if the seller is a control person with respect to the issuer, (i) a brief statement regarding the nature of the seller’s affiliation and (ii) a statement certified by the seller that the seller has no reasonable grounds to believe that the issuer is in violation of securities laws or regulations.
Key Differences Between Section 4(a)(7) and Existing Resale Exemptions. Section 4(a)(7) provides a non-exclusive resale exemption that will supplement Rule 144, Rule 144A, and the Section 4(a)(1½) exemption. Although we expect that the practical benefits and limitations of the Section 4(a)(7) exemption will depend on how market practices develop, the following discussion highlights several key differences between Section 4(a)(7), Rule 144 and the Section 4(a)(1 ½) exemption:
- No Holding Period. Unlike Rule 144, which requires a six month holding period for resales of restricted securities of a reporting company by a non-affiliate and a one year holding period for all other resales, Section 4(a)(7) has no holding period requirement, although the class of securities must have been authorized and issued for at least 90 days before the date of the resale transaction. Similar to Section 4(a)(7), the Section 4(a)(1½) exemption has no holding period requirement and, in addition, the Section 4(a)(1½) exemption is not limited to classes of securities that have been authorized and issued for at least 90 days.
- “Restricted” Status. Unlike securities resold by non-affiliates under Rule 144, which are freely transferrable by non-affiliates of the issuer, securities resold under Section 4(a)(7) remain restricted securities in the purchaser’s hands, so further resales will require an exemption from the registration provisions of the Securities Act. This is similar to the Section 4(a)(1½) exemption and, in both cases, may affect the pricing of securities resold under these exemptions in comparison to securities resold under Rule 144.
- Resales by Affiliates. The volume limits and manner of sale restrictions on resales by affiliates under Rule 144 do not apply to resales under Section 4(a)(7), and resales under Section 4(a)(7) will not count toward the volume limits of Rule 144. This is similar to the treatment of resales made pursuant to the existing Section 4(a)(1½) exemption.
- Accredited Investor Requirement. Section 4(a)(7) is only available for resales to accredited investors, as defined in Rule 501(a) of Regulation D. In contrast, Rule 144 has no such requirement. In this respect, Section 4(a)(7) is substantially similar to the Section 4(a)(1½) exemption, although the Section 4(a)(1½) exemption is not strictly limited to accredited investors.
- Information Requirements. In contrast to Section 4(a)(7), securities may be sold under the Section 4(a)(1½) exemption (and, for resales by non-affiliates following a one-year holding period, under Rule 144) without meeting any specific informational requirements relating to the issuer or the security. This is a significant difference, which may make Section 4(a)(7) significantly less attractive to sellers than the existing Section 4(a)(1½) exemption. It remains to be seen whether market conventions for transaction documents will evolve to require that non-reporting issuers agree to provide information that satisfies the conditions of Section 4(a)(7) to purchasers of securities in private placements in order to facilitate their resales of these securities.
- Blue Sky Preemption. Section 4(a)(7) provides that securities resold in reliance on that exemption will be “covered securities” under Section 18(b)(4)(D) of the Securities Act, which preempts state “blue sky” securities registration requirements. This may be a significant benefit for resales of securities that are not exchange-listed or otherwise subject to preemption under Section 18(b), and is a significant difference from existing resale exemptions.
Relaxing IPO Requirements for Emerging Growth Companies
Reduced Waiting Period Prior to Initial Public Offering Roadshow. Under the JOBS Act, an EGC is permitted to confidentially submit a draft registration statement for SEC review, provided that the draft registration statement (and all amendments) are publicly filed with the SEC no later than 21 calendar days before the EGC commences its IPO “roadshow.”
Section 71001 of the FAST Act, which became effective upon enactment, shortens the required period between the public filing of an IPO registration statement that was previously filed with the SEC for confidential review and the commencement of the IPO roadshow from 21 calendar days to 15 calendar days. This will permit EGCs to conduct a roadshow beginning 15 calendar days following the public filing of the registration statement, which will allow EGCs faster access to capital and more control over the timing of their IPOs. The Division of Corporation Finance has stated that EGCs with initial public offerings pending before the FAST Act became law or at any time thereafter may take advantage of the provision. The Division has further stated that, consistent with its interpretations of Section 6(e) of the JOBS Act, if an EGC does not conduct a road show, the non-public drafts must be filed at least 15 days before the effectiveness of the registration statement.
Grace Period to Retain EGC Status. Section 71002 of the FAST Act establishes a grace period under which an issuer that qualifies as an EGC at the filing of its confidential or publicly filed registration statement but subsequently loses EGC status prior to the completion of its IPO will continue to be treated as an EGC through the earlier of (i) the date on which the EGC consummates its IPO or (ii) the end of the one year period beginning on the date the issuer loses its EGC status.
Under prior SEC interpretive guidance, an issuer that ceased to qualify as an EGC during the confidential review phase of its IPO – for example, because total annual revenues for a fiscal year that ended after the confidential filing of the registration statement exceed $1 billion – was required to file the registration statement publicly and amend the registration statement to comply with rules and regulations applicable to non-EGCs. Section 71002, which became effective upon enactment, allows EGCs to go public without the risk of incurring the additional costs and burdens of updating a previously-filed registration statement, as long as the IPO is completed prior to the end of the one year grace period. The Division of Corporation Finance has stated that EGCs with registration statements pending at the time of the enactment of the FAST Act may rely on this provision.
Simplified Disclosure Requirements for EGCs. Beginning 30 days after enactment of the FAST Act (January 3, 2016), Section 71003 permits an EGC to omit certain historical financial information from pre-effective filings of an IPO registration statement on Form S-1 or Form F-1. Section 71003 requires that:
- the EGC must reasonably believe that the omitted financial information relates to a period that will not need to be included in the registration statement at the time of the contemplated offering; and
- prior to distribution of a preliminary prospectus to potential investors, the EGC must amend the registration statement to include all financial information required by Regulation S-X as of the date of the amendment.
This provision eliminates the time burdens, as well as the auditor and legal fees, associated with preparing and filing financial statements for periods that ultimately will not be required in the IPO prospectus. The Division of Corporation Finance has stated that it will not object if EGCs apply this provision immediately. Section 71003 requires the SEC to revise Form S-1 and Form F-1 to reflect these changes not later than January 3, 2016, but expressly provides that issuers may rely on Section 71003 beginning on that date even if the SEC has not yet amended its Form S-1 and Form F-1 registration statement forms.
The Division issued two Compliance and Disclosure Interpretations on December 10, 2015. The first states that although Section 71003 permits an issuer to omit financial information that “relates to a historical period that the issuer reasonably believes will not be required to be included . . . at the time of the contemplated offering,” this does not permit an issuer to omit interim financial information that will be included within required financial statements covering a longer interim or annual period at the time of the offering, even though the shorter period will not be presented separately. For example, if a calendar year-end EGC submits or files a registration statement in December 2015 and reasonably expects to commence its offering in April 2016 when financial statements for 2014 and 2015 will be required, the issuer may omit its 2013 annual financial statements from the December filing. However, the issuer may not omit its nine-month 2014 and 2015 interim financial statements because those statements include financial information that relates to annual financial statements that will be required at the time of the offering in April 2016.
The second interpretation clarifies that an EGC may omit not only its own financial statements but also financial statements of other entities from its filing if it reasonably believes that those financial statements will not be required at the time of the offering. For example, an issuer could omit financial statements of an acquired business that would be required by Rule 3-05 of Regulation S-X if the issuer reasonably believes that those financial statements will not be required at the time of the offering.
Forward Incorporation Permitted in Form S-1 Registration Statements Filed by Smaller Reporting Companies
Section 84001 of the FAST Act requires the SEC to revise Form S-1 within 45 days after enactment (January 18, 2016) to permit smaller reporting companies (generally, issuers having a public float of less than $75 million) to incorporate by reference Exchange Act reports filed after the effective date of a Form S-1 registration statement. Before the FAST Act, only short-form registration statements on Form S-3 and Form F-3 permitted issuers to incorporate their Exchange Act reports filed after the effective date of the registration statement by reference; Form S-1 permitted issuers to incorporate by reference only Exchange Act reports filed prior to effectiveness. As a result, issuers previously could only update Form S-1 registration statements by filing post-effective amendments that would be potentially subject to SEC review before becoming effective.
When the SEC rulemaking that the FAST Act requires has become effective, smaller reporting companies will be able to eliminate the additional costs and delays of manual updates to "shelf" registration statements on Form S-1 for resale transactions and continuous offerings that commence promptly after effectiveness and continue for a period in excess of 30 days after effectiveness. Section 84001 does not change the current requirement that issuers must conduct delayed offerings under Securities Act Rule 415(a)(1)(x) using Form S-3 or Form F-3.
Because Section 84001 requires rulemaking by the SEC to implement its provisions and does not contain the self-executing provisions of Section 71003, issuers must wait for final SEC rules to become effective before relying on Section 84001.
Regulation S-K Improvement and Simplification and Form 10-K Summary Page
Improvement of Regulation S-K. Sections 72002 and 72003 require the SEC to take several actions to simplify and modernize Regulation S-K. These include:
- Within 180 days after enactment (June 1, 2016), the SEC must revise Regulation S-K (1) to further scale or eliminate requirements of Regulation S-K to reduce the burden on EGCs, smaller reporting companies, accelerated filers and “other smaller filers” while still providing all material information to investors and (2) to eliminate, for all issuers, provisions of Regulation S-K that are duplicative, overlapping, outdated or unnecessary. These requirements do not apply to provisions of Regulation S-K for which the SEC determines that further study is necessary to determine their efficacy.
- The SEC, in consultation with the Investor Advisory Committee and the Advisory Committee on Small and Emerging Companies, must conduct a study of Regulation S-K (1) to determine how best to modernize and simplify the requirements of Regulation S-K and reduce the costs and burdens on issuers while providing all material information, (2) to emphasize “a company by company approach” that allows relevant and material information to be disclosed “without boilerplate language or static requirements” while preserving completeness and comparability of information across public companies, and (3) to evaluate methods of information delivery and presentation and explore methods for discouraging repetition and disclosure of immaterial information.
- Not later than 360 days after enactment (November 28, 2016), the SEC must deliver to Congress a report containing the findings and determinations of the SEC study, as well as specific and detailed recommendations on (1) how to modernize and simplify Regulation S-K to reduce costs and burdens on companies while still providing all material information and (2) ways to improve the readability and navigability of disclosure documents and discourage repetition and disclosure of immaterial information. The SEC will have an additional 360 days after it delivers this report to Congress to propose rules to implement the recommendations of this report.
Given the lack of specifically mandated changes and the fact that the SEC is already engaged in a study of Regulation S-K, it is unclear what, if any, benefits will emerge as a result of these requirements.
Form 10-K Summary Page. Section 72001 of the FAST Act requires the SEC to issue regulations to permit issuers to submit a summary page as part of annual reports on Form 10-K not later than 180 days after the date of enactment (June 1, 2016). The summary page must include a cross-reference (by electronic link or otherwise) to the material contained in the Form 10-K to which the item relates.
Associate Courtney Hetrick contributed to the production of this alert.
Daniel P. AdamsPartner
Gregg L. KatzPartner
Michael J. MinahanPartner
John O. NewellCounsel
Edwin M. O'ConnorPartnerCo-Chair, Capital Markets
Ettore A. SantucciPartnerCo-Chair of Debt Capital Markets, Co-Chair of REITs and Real Estate M&A