Rhymes With Dixie: ‘WKSI’ Proposal Flying Off The Shelf

When the SEC tried to overhaul the 1933 Securities Act five years ago, critics charged that the proposed reforms went too far and would undermine investor protection. The massive 1998 proposal—now known as the “aircraft carrier” reform initiatives—eventually sank under its own weight, leaving the procedures for securities offerings stuck in a 70-year-old time warp.

But late last year, the Commission launched a second attempt at reforming the securities offering process, and the proposed rule is so sleek it may not only float, but fly.

A Subtle Shift

Building on the shelf registration rules promulgated 20 years ago, the SEC proposes to create a new class of "well-known seasoned issuer," or WKSI (rhymes with Dixie).

To qualify as a WKSI, an issuer's equity market capitalization must exceed $700 million, or it must have raised at least $1 billion of debt through registered offerings in the past three years. According to a recent study by the Office of Economic Analysis, 30 percent of issuers would qualify as WKSIs. Those issuers account for approximately 95 percent of U.S. equity market capitalization, and 87 percent of the debt raised through registered offerings between 1997 and 2003.

"This represents a huge portion of the U.S. market," says Jeffrey Rubin, a partner at Hogan & Hartson. "The SEC is basically taking the view that they are going to regulate disclosure by these WKSIs on a '34 Act basis rather than a '33 Act basis." The Securities Act of 1933 addressed the disclosure of information about new securities, and the Securities Exchange Act of 1934 extended those principles to the secondary market.

The subtle shift described by Rubin is an important one, as it represents a further integration of the two laws, thereby streamlining the registration process and eliminating potentially time-consuming and expensive steps. In fact, experts note that the new proposal ostensibly completes the integration of disclosure that began when the SEC permitted incorporation of '34 Act filings by reference in '33 Act registration statements in order to facilitate shelf offerings.

Delaney

For example, notes Pillsbury Winthrop partner Jeffrey Delaney, issuers now have to include risk factors in 10-Ks and 10-Qs, not just in 1933 Act filings. "Risk factors were the one remaining piece of substantive company disclosure that had no hook into the '34 Act," he says. "For these WKSIs, and maybe even for public companies generally, it's all about the regular disclosures they make to the market."

Evolutionary Changes

In the SEC’s proposed rule, the Commission noted that Milton Cohen—a legendary securities expert and SEC veteran who died in November 2004—had argued as long ago as 1966 that “a new coordinated disclosure system” that integrated the two Acts would ensure more simple and continuous disclosure. In fact, Cohen went so far as to state that the U.S. securities laws reflected a historical anomaly: If the 1934 Securities and Exchange Act, which regulates the secondary market, had passed Congress first, it would have contained most of the disclosure requirements in the 1933 Act except for those describing the securities being offered.

Eckland

Todd Eckland, another partner in the New York office of Pillsbury Winthrop, sees the changes as incremental, not revolutionary. “Unlike the ‘aircraft carrier,’ these proposals are working within the existing parameters of the securities laws," he says. "It's a recognition that for a WKSI the procedural aspects of the '33 Act are outdated, although obviously the liability provisions are very important."

Lee

A WKSI will be able to use a stripped-down universal shelf registration statement for debt, equity or other securities that will be effective automatically unless the SEC has notified the issuer its periodic filings are under review. That removes a potential delay under the current rules. "Today, when you file a shelf registration, you may or may not get reviewed by the SEC staff," says Sey-Hyo Lee, a partner at Chadbourne & Parke. "If they do review you, that can stretch on for an extended period of time. With the automatic effectiveness, you avoid that whole process."

Fewer ‘Gotchas’

Automatic registration will also remove stumbling blocks that issuers often encounter. According to Rubin, for example, there are still a number of “gotchas” that limit the ability of companies to issue any amount of securities at any time. "If I have only $1 billion available on the universal shelf and I want to raise $1.5 billion,” he says, “I really am stuck filing a new registration statement.”

The new rules will permit issuers to add securities to an existing shelf and sell them at once. Rubin explains that if an issuer offers securities not covered by the registration statement, or names a new guarantor, it has to make additional filings—but in the future those filings will be automatically effective.

Secondary offerings will be easier, too. The shelf registration need no longer distinguish between primary and secondary offerings, and issuers can identify selling security holders in a prospectus supplement, rather than a post-effective amendment subject to possible SEC review.

Access to the capital markets is already near-instantaneous if a company has an effective universal shelf registration statement in place; however, most do not. Instead, those companies often issue debt as a private placement under Rule 144A followed by an exchange offer for registered securities. That way, the issuer has the money in hand before the SEC decides whether to review the exchange offer registration statement.

Delaney at Pillsbury Winthrop expects the proposed rules will eliminate most 144A offerings for WKSIs. "If you know you are not under review at the moment, you have no reason to do a 144A with an exchange offer any more," he says. "You can just go ahead without worrying that when the SEC sees the registration statement it could say, 'Stop!'"

Eckland believes the SEC wants to discourage 144A offerings. "The proposal is trying to encourage issuers to use the registration process and to make it easy to do so," he says. "But they also sign up for all the liability that has historically been part of the statute."

Louder Quiet Periods

In a nod to modern technology, the SEC also proposes to relax rules governing communications during an offering. Today, issuers must observe a "quiet period," during which they cannot say anything beyond information that the statutory prospectus contains. But under the proposal, WKSIs would be able to publish "free-writing prospectuses," which would include any written offer of a registered security, excluding statutory prospectuses or other permitted documents.

And because free-writing prospectuses will still be subject to liability for incomplete disclosure—as well as existing anti-fraud provisions—there is concern that the proposal will create disclosure violations.

"I have this vision of flyers going out to 10 million customers saying, 'Boy, do I have a security for you,'" says Delaney. "The question then becomes do you really want to do that? What liability do you have associated with that, and then—more importantly—if an underwriter does this, what level of liability does the issuer have?"

In addition, under the proposal, information provided to certain members of the media by WKSIs would be considered a free-writing prospectus, and would need to be filed with the SEC. Such a precedent was set last year, when Playboy Magazine published an interview with the founders of Google shortly before the company’s IPO. Among the remedies required by the Commission: Google was forced to resubmit its offering documents with the text of the interview included.

While complexities abound, issuers and their advisers will likely welcome the proposals. "The release is dealing with most if not all of the things that we as practitioners have tried to get around over the years on shelves," says Delaney.

The proposals may also prove more palatable to investors than the “aircraft carrier” release. That’s partially because the integrity and timeliness of public company disclosure has improved since 1999, thanks to new standards from the SEC, the Public Company Accounting Oversight Board, and the Financial Accounting Standards Board. "You see securities disclosure now that simply wasn't on the landscape 10 years ago," says Rubin at Hogan & Hartson. "Changes in the level of SEC scrutiny of '33 Act offerings can be done against the backdrop of enhanced investor protection. That simply wouldn't have been possible a few years ago."