February 20, 2019

SEC Proposes Universal Access to “Testing-the-Waters” Exemption

The Securities and Exchange Commission (SEC) has announced a proposal to expand the current exemption for “testing-the-waters” communications — currently limited to emerging growth companies (EGCs) — to all companies, including investment companies. Proposed Rule 163B will permit prospective issuers, regardless of size, to engage in discussions with qualified institutional buyers (QIBs) or institutional accredited investors (IAIs) to assess investor interest before the company commits the time and expenses necessary for a potential securities offering.

The JOBS Act added Section 5(d) to the Securities Act of 1933, permitting an EGC and persons authorized to act on its behalf, including underwriters, to engage in oral or written communications with potential investors that are, or that the company reasonably believes to be, QIBs or IAIs under SEC rules to determine whether these investors might be interested in a contemplated securities offering. Section 5(d) permits these communications both before and after the company files a registration statement.

Because Section 5(d) only applies to companies that qualify as EGCs, many companies are currently excluded from taking advantage of this exemption for testing-the-waters communications. These companies include:

  • Potential initial public offering (IPO) candidates with more than $1 billion in annual revenues;
  • Companies that have ceased to qualify as EGCs due to an increase in annual revenues to more than $1 billion, an equity market capitalization of $700 million or more, the expiration of the five-year period following the company’s IPO, or otherwise; and
  • All companies that were already public before the JOBS Act was enacted.

Proposed Rule 163B will extend this exemption to all issuers. Like the exemption for EGCs under Section 5(d) (but in contrast to somewhat similar relief available to well-known seasoned issuers (WKSIs) and eligible issuers engaged in a Regulation A offering under existing Rule 163 and Rule 255, respectively), proposed Rule 163B will not require testing-the-waters communications to be filed with the SEC or to include any specified legends.

Taken as a whole, the exemption that would be provided by proposed Rule 163B and the exemptions already provided by Section 5(d), Rule 163, and Rule 255, as well as the exemption for free-writing prospectuses under Rule 164, will substantially reduce the risks of mistimed communications about proposed offerings, often referred to as “gun jumping” violations, which can result in significant costs and delays. Summarizing its rationale for proposing Rule 163B, the SEC states in the adopting release:

We believe that, by allowing more issuers to engage with certain sophisticated institutional investors while in the process of preparing for a contemplated registered securities offering, the proposed rule could help issuers to better assess the demand for and valuation of their securities and to discern which terms and structural components of the offering may be most important to investors. This in turn could enhance the ability of issuers to conduct successful offerings and lower their cost of capital. 

Proposed Rule 163B would be nonexclusive, so attempted compliance with the rule would not preclude a company from relying on other rules or exemptions that are conditioned on the timing, manner, or content of communications relating to a contemplated securities offering.

The proposed rule will be subject to public comments for a period of 60 days following publication in the Federal Register.