Congress Takes the FAST Lane to Important Securities Reforms
On December 4, 2015, the President signed the Fixing America's Surface Transportation Act, better known as the FAST Act, which had been approved by a bipartisan Congress. The FAST Act (also referred to in the media as the "Highway Bill") mainly addresses long-term funding needs for critical transportation projects, Amtrak, highway and boating safety and alternative fuel vehicles.1 However, the last part of the FAST Act, Division G, is comprised of a medley of unrelated but important amendments to financial services and securities laws.
On December 10, 2015, the Securities and Exchange Commission (SEC) issued an announcement entitled "Recently Enacted Transportation Law Includes a Number of Changes to the Federal Securities Laws." The SEC's announcement addresses the securities provisions of the FAST Act. The FAST Act's handful of securities provisions generally will make some important adjustments to existing laws—and most of them are effective already:
- Codify the increasingly important but heretofore unwritten "Section 4(a)(1 1/2)" resale exemption
- For Emerging Growth Companies (EGCs):
- Shorten the pre-filing wait period for confidential draft initial public offering (IPO) filings to 15 days
- Provide a grace period for change of EGC status
- Permit omission of certain historical financial statements
- Require the SEC to propose rules to permit so-called "forward incorporation by reference" in a Form S-1 registration statement
- Provide express permission to use a 10-K Summary Page
- Study how to simplify and modernize Regulation S-K
- Include savings and loan holding companies in the mandatory registration regime of Section 12(g) of the Securities and Exchange Act of 1934, as amended (Exchange Act)
As noted above, some of the items became effective immediately while others have a later effective date or must be addressed by the SEC in its rules. At the end of this article is a quick-reference table with the effective dates for each provision. The SEC's announcement provides insight on how it intends to treat the new securities provisions enacted by the FAST Act. The SEC will also consider providing additional guidance (most likely in the form of Compliance and Disclosure Interpretations (CDIs)) as questions are presented. On December 10, the SEC issued two FAST Act CDIs.2
New Resale Exemption—Section 4(a)(7)
This provision was one of the most talked-about provisions (at least for securities lawyers) of the FAST Act because it essentially codifies the so-called Section "4(a)(1 1/2)" exemption3, which is an unwritten, informal holder-to-holder resale exemption that developed as accepted practice over time. The "4(a)(1 1/2)" exemption facilitates private resales from institutional or accredited investors of restricted securities (securities not issued further to an effective registration statement or further to an exemption under Section 4(a)(1) of the Securities Act of 1933 (Securities Act)) in a transaction that does not involve any general solicitation.4 Investment banks occasionally would use 4(a)(1 1/2) to facilitate trades between or among clients directly (since under Section 4(a)(1) the bank, as an underwriter or broker-dealer, could not be a party), provided the buyer signed a letter agreeing to perform its own due diligence. It has also been used as a liquidity device for issuer management members who are constrained by the volume or informational restrictions of Rule 144.
Section 4(a)(7) of the Securities Act creates greater legal certainty for these transactions, providing a new, statutory, resale exemption so that any security holder—rather than issuers—may sell restricted securities as long as the following conditions are satisfied:
(1) the purchaser is an accredited investor (as defined in Regulation D of the Securities Act);
(2) there is no general solicitation;
(3) if the issuer is not a reporting company or exempt from reporting, then the seller must obtain and provide to the prospective purchaser certain information from the issuer, including a description of the issuer's business and its most recent balance sheet and two-year profit and loss or similar financial statements, all of which must be prepared in accordance with GAAP or IFRS (Company Information);
(4) the sale is not by the issuer or a subsidiary;
(5) neither the seller nor any person being paid in connection with the sale is a bad actor, as described in Regulation D;
(6) the issuer is neither in bankruptcy or receivership, nor is it a blank check, blind pool or shell company;
(7) the transaction does not involve an unsold allotment to, or participation by, a broker or dealer as an underwriter or a redistribution; and
(8) the class of securities has been outstanding for at least 90 days prior to the transaction.
A transfer of securities pursuant to Section 4(a)(7) will be deemed to be a transaction not involving a public offering nor a distribution, and the securities will be considered "restricted securities" pursuant to Rule 144 under the Securities Act. Furthermore, the securities will be deemed a "covered security" for purposes of Section 18(b)(4) of the Securities Act, also known as NSMIA, which means the transfer enjoys the benefit of federal preemption: no separate state registration, qualification or exemption is required for a sale pursuant to Section 4(a)(7).5
The SEC did not comment on Section 4(a)(7) other than to note that it does not require rulemaking.
We believe that the adoption of Section 4(a)(7) will affect a number of practices in connection with resales of securities. Like the informal Section 4(a)(1 1/2) exemption which it codifies, Section 4(a)(7) has no required holding period. As such, it could be used by security holders, especially if the sale involves restricted shares of a public company, to sell securities sooner than the six month holding period required by Rule 144.
Unfortunately, non-accredited purchasers cannot use Section 4(a)(7), so unlike Rule 144, the securities may not be sold to just anyone. Plus, the seller will most likely require the purchaser to represent that it qualifies as an accredited investor.
Also, like informal Section 4(a)(1 1/2), new Section 4(a)(7) has advantages over Rule 144 for affiliates, as Section 4(a)(7) does not require Rule 144's pre-sale filing with the SEC nor does it impose any volume limitation. On the other hand, although a reseller may not have a waiting period nor be required to make filings with the SEC under Section 4(a)(7), unlike Rule 144, Section 4(a)(7) securities will continue to be restricted in the hands of the purchaser.
With regard to private companies, investors in negotiated purchases of restricted securities may start requiring those companies to covenant to provide Section 4(a)(7) Company Information (including financial statements) when requested to facilitate resales, which may well prompt those companies to resist or require confidentiality covenants from the parties to the transfer.6 Law firms, in turn, may start issuing Section 4(a)(7) resale opinions, with far more comfort than the previously issued Section 4(a)(1 1/2) opinions, with a likely caveat regarding the sufficiency or accuracy of any Company Information. Section 4(a)(7) also can be applied to securities in private funds, accredited crowdfunding and Regulation A resales among accredited investors. With respect to Regulation A, Section 4(a)(7) resolves a glitch in Title IV of the JOBS Act (known as Regulation A+) for at least accredited investors, as Title IV and subsequent rulemaking contained no resale exemption from registration.7
Emerging Growth Companies
Shorter Waiting Period. Previously, an EGC could confidentially file, for SEC review, a draft IPO registration statement as long as it publicly filed it 21 days before its IPO "road show." The FAST Act amended, effective immediately, Section 6(e)(1) of the Securities Act by shortening the period to publicly file a draft IPO registration statement prior to the commencement of a road show from 21 days to 15 days. The SEC has clarified that EGCs with filings pending prior to enactment of the FAST Act may also rely on this provision.
Grace Period. The FAST Act amended Section 6(e)(1) of the Securities Act so that if an issuer that previously qualified as an EGC at the time it initially filed its registration statement, either confidentially or publicly, no longer qualifies as an EGC, it will continue to be treated as an EGC until the earlier of (1) the date on which it completes its IPO, or (2) the end of the one-year period beginning on the date the company ceases to be an EGC. This provision is also effective immediately, and the SEC has stated that issuers with pending filings at the time of enactment may rely on this provision.
Permitted Omission of Certain Financial Statements. The FAST Act amended the JOBS Act by permitting EGCs to omit financial information for historical periods that the issuer reasonably believes will not be required in the registration statement at the time of the IPO, as long as, prior to distributing the preliminary prospectus, it is amended to include all required financial information. This affords relief with respect to prior period audited financial statements, including financial statements of an acquired business, however, the SEC clarified in its FAST Act CDIs that interim periods may not be excluded.
This financial statements provision has the practical impact of allowing an IPO filer near its fiscal year-end to omit the audited financial statements of its previous year(s) and instead only include financial statements from the most recently completed fiscal year (plus reviewed financial statements for any interim period). This could be helpful for issuers who have a legacy auditing firm in that earliest year, by eliminating the need for a review and consent by the legacy auditing firm.
Although the SEC is required, no later than 30 days after enactment of the FAST Act, to revise Form S-1 to include this provision, the SEC has stated that it will not object if EGCs apply this provision immediately.
Form S-1 Forward Incorporation by Reference
The FAST Act requires the SEC to amend registration statement Form S-1 to permit forward incorporation by reference. Currently, based on the Securities Act Reform adopted in 2005, Form S-1 permits a company to incorporate SEC filings made prior to the effective date of the Form S-1, shortening the length and complexity of the Form S-1 because it can incorporate filings that were already made, rather than having to actually include them in the registration statement.
It remains to be seen the extent of relief that will be afforded by the SEC in this area. Extending the benefit to allow issuers to incorporate filings made after the effective date of the registration statement—which is the meaning of forward incorporation—could provide a great benefit to issuers that register shares for resale but do not qualify for Form S-3 because, for example, they are not listed or quoted on a national securities exchange. Currently, these issuers must undergo the cumbersome process of updating the Form S-1 by filing prospectus supplements to the original Form S-1 and also filing post-effective amendments (which are subject to review by the SEC) to the original Form S-1 for each annual report. Using forward incorporation by reference, these reports will be automatically incorporated by reference without any further filings.
It will be interesting to see how this provision of the FAST Act relates to the existing statutory provisions regarding the use of Form S-3 for shelf and other continuous offerings. Currently, an issuer must satisfy several hurdles regarding market capitalization and other similar thresholds to qualify for the use of a Form S-3 shelf registration statement. It is unclear if the effect of this provision of the FAST Act would effectively limit or change any of these existing rules.
In the implementation of this provision, the SEC may include conditions to permit forward incorporation by reference that are similar to Form S-3, such as timely filing of Exchange Act reports. The SEC did not make any such indication in its announcement, but merely noted that it will require rulemaking.
10-K Summary Page
The FAST Act requires the SEC no later than 180 days after enactment to issue rules that permit issuers to include a summary page in their annual reports on Form 10-K as long as each item includes a cross-reference to the material contained in the form. The SEC notes that currently an issuer is not prohibited from including such a summary provided the summary fairly represents the material information in the report. The SEC stated that it will provide rulemaking to implement this provision.
Regulation S-K Improvement, Modernization & Simplification
The FAST Act requires the SEC to revise within 180 days the Securities Act's complex Regulation S-K disclosure rules to further scale back or eliminate requirements for EGCs, accelerated filers, smaller reporting companies and other small issuers and, for all issuers, to eliminate provisions that are duplicative, overlapping, outdated or unnecessary. However, this requirement does not apply to provisions as to which the SEC determines further study is necessary to determine the efficacy of the current provision.
Accordingly, to implement this mandate, the SEC is also required to study Regulation S-K, consulting with the Investor Advisory Committee and the Advisory Committee on Small and Emerging Companies, to determine how best to modernize and simplify its requirements but still provide all material information and to evaluate methods of delivery and presentation, discouraging repetition and disclosure of immaterial information. The SEC is required to issue a report within 360 days and, not later than 360 days after the report, release proposed rules implementing the recommendations. In its announcement, the SEC reported on these provisions of the FAST Act but did not provide any comment. However, on September 23, 2015, the Advisory Committee on Small and Emerging Companies provided Recommendations about Expanding Simplified Disclosure for Smaller Issuers, which includes providing the same disclosure exemptions for smaller reporting companies that are provided to EGCs. Based on the requirements of the FAST Act, the SEC's report and proposed rules, which are required to be issued in December 2017 at the latest, may very well cover many more disclosure requirements.
Inclusion of Savings and Loan Holding Companies in Section 12(g) Regime
Last on the list is the amendment, effective immediately, to Section 12(g) of the Exchange Act adding savings and loan holding companies to its mandatory registration, termination and suspension regime. Savings and loan holding companies were not specifically included in Section 12(g). As such, the registration, termination and suspension thresholds of Section 12(g) adopted in 2012 pursuant to the JOBS Act did not apply to savings and loan companies, causing disparate treatment as compared to banks, savings associations and bank holding companies. In its announcement, the SEC noted that it is evaluating the effect of this provision on its 2014 proposed rule release: Changes to Exchange Act Registration Requirements to Implement Title V and Title VI of the JOBS Act (Release No. 33-9693).
Fast Act: Adopted December 4, 2015
Table of Enactment Dates and Deadlines
|FAST Act Section
||EGCs confidential filings wait period
||EGCs with IPOs pending before the FAST Act became law or at any time thereafter may take advantage of the provision
||Grace Period for Change of Status of EGCs
||EGCs with registration statements pending at the time of enactment may rely on the provision
||Omission of certain historical financial information for EGCs
||January 3, 2016 (30 days after the date of enactment)
||The SEC will not object if EGCs apply this provision immediately
||10-K Summary Page
||An issuer is currently not prohibited from including a summary in an annual report on Form 10-K provided the summary fairly represents the material information
Requires SEC rulemaking
||Regulation S-K improvements
||Study on Modernization and Simplification of Regulation S-K
||Report due in 180 days
Proposed Rules are due 180 days after report
||Section 4(a)(7) Resale Exemption
||No SEC rulemaking required
||Form S-1 Forward Incorporation by Reference
||Requires SEC rulemaking
||Added savings and loan companies for Section 12(g) purposes
||The SEC is evaluating the effect of this provision on the SEC's current rule proposal issued on December 30, 2014 (Release No. 33-9693)
1The complete text of the FAST Act can be found by following this link: https://www.gpo.gov/fdsys/pkg/BILLS-114hr22enr/pdf/BILLS-114hr22enr.pdf.
2The complete text of the CDIs can be found by following this link: http://www.sec.gov/divisions/corpfin/guidance/fast-act-interps.htm.
3So called because it contains elements of Section 4(a)(1) of the Securities Act (the exemption from registration for transactions not involving an issuer, underwriter or broker-dealer) and Section 4(a)(2) (the exemption from registration for issuers not involving a public offering).
4The Section 4(a)(1 1/2) approach has not been eliminated, but the statutory version in Section 4(a)(7) will likely prove more popular and useful.
5Note that NSMIA does not preempt notice filings, and state law may require filing of a notice and payment of a fee.
6It remains to be seen where any potential liability would lie if for whatever reason the Company Information proved to be materially incorrect, inaccurate or misleading.
7This raises an interesting question of whether a freely-tradable security can become "restricted" by virtue of being sold in a Section 4(a)(7) transaction, which is generally the case when an affiliate privately sells securities. See alsoSEC CDI, Securities Act Rules, Q. 129.02 (January 26, 2009).