By: Cydney Posner

Who would have imagined that adoption of major Securities Act reform would be far from the most exciting item on the agenda for an SEC open meeting? At today's open meeting, the SEC adopted final rules that will significantly modify the registration, communications and offering processes under the Securities Act. Also adopted were amendments to Forms S-8 and 8-K intended to prohibit abuses by shell companies. Finally, the major fireworks were reserved for the adoption, on the eve of Chairman Donaldson's departure, of requirements that mutual funds have 75% independent boards and independent chairs, following consideration of the items on remand from the appeals court. That "emotions run extremely high on this issue," as Commissioner Goldschmid suggested, was surely an understatement. The SEC expressly assumed that further litigation on this topic would ensue, and the comments of the various commissioners will surely be fodder for additional litigation. See the newspaper articles copied below.

SECURITIES ACT REFORM

The SEC views the reform adopted today as the next step in a continuum of various reform efforts that have been undertaken since the adoption of the Act in 1933. Commissioners Glassman and Atkins both expressed the vain hope that this important action would not be overshadowed by the more "troublesome" item on the agenda. The Commissioners were unanimous in viewing the adoption of this reform proposal as the type of work that reflects the SEC at its best. The new rules eliminate a number of offering restrictions that have become out of date as a result of technological advances. In addition, the rules require that more timely investment information be provided to investors, but attempt to avoid unnecessary delays in the offering process. The rules also continue the SEC's efforts toward integration of disclosure and processes under the Securities Act and the Exchange Act. Alan Beller, who apparently was brought on board by Harvey Pitt specifically to shepherd Securities Act reform through the process, commented that the reform fulfills the essential goal of the Securities Act "to protect the public with the least possible interference with honest business."

In 1998, the SEC issued a voluminous proposal for Securities Act reform, known as the "aircraft carrier," which languished without approval. In this subsequent effort at Securities Act reform, the SEC has opted for "constructive, incremental adjustments" to existing regulations, preserving the perceived benefits of the existing system, but modernizing areas viewed to be outmoded. Nevertheless, the modifications are far-reaching. The new rules are premised on a landscape so changed in terms of technology, communications and globalization as to be unrecognizable to the drafters of the original Securities Act. In addition, the recent changes to the Exchange Act disclosure regime that provide more complete information to the capital markets on a nondiscriminatory and current basis have helped to lay the groundwork for reform.

The new rules relax the restrictions with regard to communications related to registered offerings, procedures in connection with registration and the capital formation process, and timely delivery of information to investors in varying degrees depending on the size of the issuer. Some issuers, such as penny stock and blank check companies and shell companies, would be prohibited from taking advantage of the new rules. The communication rules would also be inapplicable to investment companies and business development companies, as well as M&A transactions.

Two New Concepts Introduced

The new rules introduce two new concepts that permeate the new rules.

WKSIs. The first new concept establishes a new class of issuers, referred to as "well-known seasoned issuers" or "WKSIs" (pronounced "wiksies"), which include those issuers that have been reporting and are timely in their filings under the Exchange Act for one year and either:

  • have $700 million of worldwide public float or
  • have issued $1 billion in non-convertible securities (other than common equity) in registered offerings (for cash, not exchange) in the preceding three years and will register only non-convertible securities (other than equity) unless they also have $75 million in public float.
These thresholds were selected because companies that exceed those thresholds were presumed to have substantial analyst and media coverage and institutional holdings, which were perceived to provide the checks and balances necessary to enable loosening of regulatory restrictions. The SEC intends to monitor whether these thresholds may be lowered in the future.

Free-writing prospectus. The other new concept is that of the "free-writing prospectus," which consists of certain written communications, including electronic communications, that constitute an offer outside of the statutory prospectus. Free-writing prospectuses would not be part of the registration statement and, therefore, not subject to Section 11 liability, but would be subject to Section 12(a)(2) and antifraud provisions.

Permissible Communications

Existing rules prohibit all gun-jumping and restrict written communications after filing, as well as some post-offering communications, regardless of the accuracy of the information provided. Under the new rules, restrictions are relaxed to varying degrees for different classes of issuers, but liability standards will be applied to the information disclosed.

For WKSIs, all oral and written communications will be permitted at any time, including the use of a "free-writing prospectus," the use of which would be subject to compliance with certain conditions including, in many cases, filing with the SEC. For all reporting issuers, some asset-backed issuers and well-known non-reporting foreign private issuers, regularly released factual business and forward-looking information will be permitted at any time. For non-reporting issuers, factual business information that is regularly released and intended for use by persons other than in their capacity as investors will be permitted at any time. For communications occurring more than 30 days before filing of a registration statement, communications would be permitted so long as there is no reference to the offering. Following filing of the registration statement, all eligible issuers and other offering participants would be permitted to use a free-writing prospectus, subject to conditions. Ineligible issuers include those in bankruptcy and those that have violated the antifraud provisions of the securities laws.

Conditions for use of a "free-writing prospectus" include filing of:

  • any issuer free-writing prospectus,
  • all material information regarding the issuer or its securities provided by the issuer that is contained in another's free-writing prospectus,
  • any broadly disseminated underwriter or other offering participant's free-writing prospectus and
  • any description of final terms.
The filing condition does not apply to other underwriter free-writing prospectuses not used by the issuer. A filed registration statement is also a condition to use of a free-writing prospectus. For unseasoned or non-reporting issuers, a statutory prospectus must accompany or precede the free-writing prospectus if an issuer or offering participant prepares or pays for the free-writing prospectus. There are special provisions applicable to media publications that are issuer or underwriter free-writing prospectuses. Potential liability attaches to free-writing prospectuses, whether or not filed, under section 12(a)(2) and the anti-fraud provisions, but since they are not part of the registration statement, section 11 liability would not apply. In response to a question from Chairman Donaldson, Beller noted that the staff started with the view that current rules regarding media interactions were unduly restrictive. The new rules allow greater flexibility with little restriction on bona fide media communications, so long as a registrations statement is on file; however, issuers and underwriters must have responsibility for free-writing prospectuses where, for example, they provide interviews to the media. He noted that some counsel may continue to suggest that, so long as liability attaches, issuers and underwriters should play by the old rules, but the new rules allow them to make that judgment.

Graphic communications exclude communications that are live and in real-time to a live audience, regardless of the means of transmission. The SEC decided that the touchstone of the analysis should not be the means of communication, but rather the "characteristic of the origin of the communication and the characteristic of the reception of the communication," an archetypal Alan Beller phrase. Therefore, live videos of roadshows would be treated as oral communications. Electronic roadshows that are not live would be free-writing prospectuses. Electronic roadshows would not have to be filed for IPOs of common or convertible equity if the issuer makes one unrestricted version electronically available. Electronic roadshows for other offerings would not have to be filed.

The rules address cross-liability issues in connection with the use of free-writing prospectuses. In addition, Rule 134 was amended to expand the type of information allowed. The exemptions related to research reports were also modified. Conforming changes to Reg FD are also included as part of the reform package.

The final release confirms the new interpretation (contained in the proposing release) regarding antifraud provisions: under Sections 12(a)(2) and 17(a)(2), the existence of material misstatements and omissions would be assessed against the information available at the time the investor makes the investment decision. The SEC provides additional guidance with respect to the interplay of the antiwaiver provisions of the securities laws and contract provisions (for e.g., termination of an agreement to purchase without full disclosure or termination upon delivery of additional information and entering into a new agreement when in possession of the new information).

Prospectus Delivery

Under existing rules, a final prospectus, usually printed at great expense, must be delivered to the investor ...after the purchase has been made. Under the new rules, there would be no mandated method of prospectus delivery. Instead, the concept is that availability equals delivery, and SEC filing equals availability. The SEC has also kindly provided a cure provision for inadvertent failures to file. The rules include a requirement that purchasers be notified that they have made a purchase in the offering.

Registrations and Shelf Offerings

For WKSIs, shelf registrations would become effective automatically. WKSIs would be permitted to register unspecified classes of securities, without allocation and with no distinction between primary and secondary shares, and could pay in advance or "as-you-go." The rules also permit WKSIs to omit more information from a base prospectus than previously permitted and to add additional classes of securities after effectiveness.

For all shelf offerings, prospectus supplements would be deemed to be part of the registration statement. For liability purposes, a new effective date would be triggered with each filing for a takedown off of the shelf for underwriters and issuers, but not for officers, directors or experts, such as auditors. (The effort here was apparently to avoid "speed bumps" in the offering process.) The rules also identify the type of information that may be omitted from the base prospectus in a shelf at effectiveness and included later, essentially codifying current practice while providing more direction. The SEC has eliminated the rule that limits issuers to registering under Rule 415 only the number of shares intended to be sold within two years and instead requires that the shelf be updated with a new registration statement every three years. The rules also eliminate restrictions on at-the-market equity offerings for primary shelf-eligible issuers, permit immediate shelf takedowns (the end of the "48-hour" rule) and would allow changes to the plan of distribution through filing of a supplement. Primary shelf-eligible issuers would be allowed to add the names of selling shareholders by supplement, so long as the securities were already outstanding.

The rules also require that risk factors be included, as applicable, in Forms 10-K. Voluntary filers must also disclose their status as such. The rules permit incorporation by reference into Form S-1 by reporting issuers and eliminate the rarely used Forms S-2 and F-2. Accelerated filers and WKSIs would be required to disclose in their Forms 10-K material, unresolved written Staff comments that were issued more than 180 days before end of the fiscal year to which the filing relates.

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SHELL COMPANIES

The SEC also adopted final rules amending Form S-8, Form 8-K and Form 20-F, as well as new definitions of the terms "shell company" and "succession." These rules were characterized by Marty Dunn as a "palette cleanser" and a "lime sorbet" in advance of the heavy dinner expected to be served on the rest of the agenda. The rules limit the use of Form S-8 by shell companies, which typically do not have any employees, and require that, when a company becomes a shell company or ceases to be a shell company, the company must file, within four business days, a Form 8-K or Form 20-F containing the information that would be required in a registration statement. The rules are designed to ensure that investors in shell companies that acquire operations or assets have access on a timely basis to the same kind of information as is available to investors in public companies with continuing operations. The SEC stated that the rules as adopted do address concerns raised by comments that shell companies do have some legitimate uses and that the restrictions should not unduly limit those uses.

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MUTUAL FUND GOVERNANCE

In a very heated session, the SEC also considered the matters remanded to it by the U.S. Court of Appeals for the D.C. Circuit on June 21, 2005, in its decision in Chamber of Commerce v. SEC regarding the SEC’s investment company governance rules adopted in August 2004. The remanded matters were the costs of complying with the 75% independent director condition and the independent chairman condition as well as consideration of an alternative to the independent chairman condition, promoted by commissioners Glassman and Atkins, that involved only disclosure of whether the fund has an independent chair. The rules were again approved by a vote of three to two.

The Commissioners that favored the rule stressed that the court had held that the SEC was within its authority under the Investment Company Act to impose governance requirements, an area typically reserved to the states, and that the SEC's rationale was reasonable. In addition, the court had not vacated the rules, only remanded them for further consideration of specific matters. They also emphasized the importance of expeditiously addressing the egregious and unethical conduct that inspired the SEC to take action in the first place and the concern that the rules would be in limbo until a new chair was approved and able to familiarize himself with the voluminous 1.5-year record. The staff were now able to provide the estimates required and otherwise comply fully with the court order because they had worked on a concentrated basis and followed the detailed directions from the court as to the information required. In addition, several Commissioners noted, by comparison, the volume of new rules adopted by the SEC on a compressed schedule to comply with SOX. Commissioner Goldschmid lamented the "crocodile tears" shed over the procedures used here and noted that if the procedures were inadequate, the court would certainly so advise the SEC in the litigation that was certain to come.

The two opponents of the reform, Commissioners Glassman and Atkins, focused primarily on the procedural aspects of the action taken. Commissioner Glassman disagreed with the "rush" to take action in the "strongest possible terms," and accused the Chairman of "elevating form over substance once again." Commissioner Atkins decried the "race to beat the clock" Both tried to make their case by discussing in detail the accelerated timetable involved and urging that it was not possible to review the record or to prepare the information required that quickly. Commissioner Glassman also noted some conduct she perceived to be fishy: the Sunshine Act requires that the duty officer sign off on the notice of meeting and agenda. In this instance, she was the duty officer at that time; however, she was not asked to sign off on the notice and agenda and instead the Chairman signed off, an "unprecedented" event. The real reason for the rush, she argued was the fear that the rule would not be implemented in the Chairman's absence. In addition, she argued that the economic information provided was just "back of the envelope" calculations and an "assembly of false statements" and "flawed analyses." There was also an interesting moment when she inquired of the SEC's General Counsel as to the meaning of footnote 15 in the release, which directs the staff to respond to expected litigation. Prezioso said only that the meaning was self-evident and refused to say more. However, he did argue that the Chairman did not "order" this result, but instead acted only after review of the staff report. Commissioner Atkins suggested that the "ink was not even dry when the dye was cast for this predetermined result," and that it provided a "fitting capstone for this flawed rulemaking process." He also commented that the release "perpetuated the cavalier attitude" taken toward this rule and that the actions today "showed profound disrespect for the rule of law." He also appeared to suggest that the rule was not really in effect until there was proper compliance with the APA and that this action did not accomplish that. He finished by characterizing today as one of "the saddest days in the Commission's 70-year history."

The meeting ended with Commissioner Glassman, in an exercise of damming with faint praise, after noting that they had had their conflicts, thanking the chairman for his service

New York Times
SEC to Vote on Mutual Fund Rule
By THE ASSOCIATED PRESS
Published: June 29, 2005
Filed at 1:17 a.m. ET

WASHINGTON (AP) -- Stepping into controversy, a divided Securities and Exchange Commission is voting on a rule that could reshape the mutual fund industry a day before the agency's chairman resigns.

A federal appeals court ruled last Tuesday that the SEC must re-examine the rule mandating that chairmen of mutual funds be independent from the companies managing the funds. The five-member SEC adopted the rule in a 3-2 vote a year ago, with proponents -- SEC Chairman William Donaldson and the panel's two Democrats -- saying it was needed to protect investors from abuses in the wake of a fund industry scandal.

Now, in a hastily arranged public meeting before Donaldson steps down, the five-member panel is addressing the court's order by examining the costs that mutual funds would incur to comply with the rule and considering alternatives to the requirement of independent fund chairmen. With the SEC commissioners unlikely to change their positions from before, the rule would be affirmed.

The timing of Wednesday's meeting has caused an uproar, with President Bush planning to name Rep. Christopher Cox of California, a free-market conservative, as Donaldson's replacement. Business interests and the mutual fund industry, Republican lawmakers and former SEC officials have protested, accusing Donaldson of trying to ram through the rule in an eleventh-hour maneuver.

The U.S. Chamber of Commerce, which brought the suit against the SEC that put the mutual fund rule before the U.S. Court of Appeals for the District of Columbia Circuit, threatened on Tuesday to sue the agency again.

The SEC action ''is a dangerous attempt to circumvent our legal and regulatory system,'' Chamber President Thomas Donohue said at a news conference. The group ''has every intention to return to the court and sue the SEC.''

Separately, Paul Atkins, one of the two Republican SEC commissioners who voted against the rule, told reporters, ''I think we're in contempt of the court if we do it, frankly.''

Donaldson defended the move, saying in newspaper interviews published Tuesday that delaying action on the fund rule could seriously damage investors.

''This rule is a cornerstone of the mutual fund reform package the (SEC) passed in the wake of severe malfeasance just a year and a half ago,'' Donaldson spokesman Matt Well said in a telephone interview. ''The chairman believes very strongly that the cost of inaction at this important juncture carries an undue risk to over 90 million mutual fund investors.''

The SEC has spent 18 months debating the rule, and Donaldson ''believes it's our principled responsibility to act in the best interests of investors,'' Well said.

The SEC staff's research on the potential costs of the rule has been compiled in a new study, being presented at the meeting, that concludes the costs would be minimal.

If independence for mutual fund chairmen is required, some industry experts say the new independent chairmen would replace chairmen who are more well versed in fund operations and therefore they would have to hire additional staff to assist them.

The rule, which is scheduled to take effect next year, could shake up the $8 trillion mutual fund industry to which some 95 million Americans entrust their savings. The boards of 80 percent of U.S. funds -- or about 3,700 funds -- would have to replace their chairmen, according to SEC officials.

The rule also requires that at least 75 percent of the directors on mutual fund boards be independent, up from the current mandatory minimum of 50 percent.

On a far more harmonious issue, the SEC also was voting to ease restrictions on executives' comments in the weeks before their company goes public in a stock sale. The change will loosen restraints on the so-called quiet period preceding IPOs, part of a broader plan to ease regulation of new stock offerings.

New York Times
S.E.C. Chief Defends Timing Of Fund Vote
June 28, 2005

William H. Donaldson yesterday defended his decision to put a proposed rule regarding the independence of mutual fund boards up for a vote the day before he steps down as chairman of the Securities and Exchange Commission.

He said the commission had spent a year debating the merits of the rule, which would require greater independence among the directors of mutual funds. He expressed trepidation that the newly constituted commission could kill the measure.

''There are those who have thwarted this from the beginning who are saying I am trying to ram something through,'' Mr. Donaldson said in an interview. ''There's nothing further from the truth. We've spent a year on this and we have the principled responsibility to act in the interest of investors.''

His call for a new vote has drawn opposition from Congress, former commissioners, industry groups and some fellow commissioners, who have asserted that he should not force a vote in his last week.

Last summer, the S.E.C. voted 3 to 2 to require 75 percent of a mutual fund's directors, including the chairman, to be independent of the fund company's management. Mr. Donaldson and the two Democrats on the commission voted for the rule.

The United States Chamber of Commerce sued the commission, saying it did not have the authority to impose such a rule. The chamber also accused the S.E.C. of violating administrative procedures in not considering an alternative, a disclosure requirement, and not adequately contemplating the costs of putting the rule into effect.

Last week, the Federal Court of Appeals for the District of Columbia Circuit ruled that the commission had acted within its authority.

But the court agreed with the chamber that the S.E.C. had failed to adequately consider the costs of putting such a rule into effect and that it had failed to consider an alternative proposal to simply require a fund to disclose whether at least three-quarters of its directors and its chairman were independent.

In response, Mr. Donaldson scheduled a vote for the commission's meeting tomorrow, the day before he is expected to leave the commission. Representative Christopher Cox, Republican of California, has been nominated to succeed Mr. Donaldson but not confirmed.

Mr. Donaldson expressed concern about leaving the question to a future commission.

''The inefficiency and delay of throwing this to a total new group carries with it undue risks to investors,'' he said. ''There are 90 million people who own mutual funds who are entitled to have the confidence that the directors who represent them and the chairman are independent people.''

Mr. Donaldson's opponents have accused him of ignoring the court's order to analyze the costs and benefits of the requirements.

His supporters have said the court's request can be easily addressed using the research and comment gathered before the original vote.

The debate almost ensures that Mr. Donaldson's final meeting will include a heated debate, an appropriate conclusion to a tenure in which Mr. Donaldson, a Republican, was frequently at odds with the other Republican commissioners.

Opposition to a vote tomorrow by the S.E.C. has been widespread. Eight senators, all Republicans, wrote a letter to the S.E.C. last Wednesday, the day after the court ruling. They urged the commission to ''defer final action on this controversial and complex matter until the commission's new chairman is in office and the full commission can make a deliberate decision.''

The Chamber of Commerce has threatened further legal action.

''If the commission forges ahead and promulgates a rule on Wednesday, we will be back in court,'' said Stephen Bokat of the National Chamber Litigation Center, the legal arm of the Chamber of Commerce. ''We will challenge the failure of the commission to adequately respond to the court's remand.''

Since the court's decision last week, the S.E.C. staff has given the commissioners a 28-page response on the issues of cost and disclosure. The report details the cost of requiring an independent chairman; various ways to achieve a board that is three-quarters independent (the cost of letting two insiders go or adding three directors, for example); and further consideration of the disclosure option rather than the rule, said one person who had seen the study.

USA TODAY
SEC chief makes final push for rule
By Greg Farrell

William Donaldson, the Securities and Exchange Commission chairman who is stepping down Thursday, is determined to go out fighting.

Over the objections of several former commissioners and his Senate overseers, Donaldson is pressing ahead with plans to re-approve a controversial rule adopted in 2004 that would force mutual funds to hire independent chairmen. The rule was nullified last week when a federal appeals court said the SEC violated the Administrative Procedure Act by not addressing the question of how much the rule would cost mutual fund companies.

Donaldson, who championed the rule throughout his 28-month tenure as SEC chair, has decided that the appeals court judgment wasn't rebuking the SEC or its ability to force reforms on the mutual fund industry. Instead, he felt the court wanted him to address technicalities that had been ignored when the rule was adopted after a contentious 3-2 vote.

But his decision to schedule a final vote for Wednesday, while he still has a fragile coalition of three votes in support, has drawn criticism. Donaldson, a Republican, approved the rule last year with the support of the two Democrats on the commission, Harvey Goldschmid and Roel Campos.

The U.S. Chamber of Commerce, which filed the lawsuit that led to the appeals court decision, criticized Donaldson's move. "It's an outrageous and obviously politically motivated move," says Stephen Bokat, a Chamber lawyer. "I have more respect for the Court of Appeals than Chairman Donaldson does. They remand things because they want a substantive review done, and that's not what the commission's doing."

Eight Republican members of the Senate banking committee wrote, urging Donaldson to leave the matter to his successor. In a highly unusual move, three former SEC commissioners, including former chairman Harvey Pitt, also wrote, warning Donaldson that the appearance of political opportunism would undermine the SEC's credibility. The hastily scheduled vote "makes a mockery of the rule of law," Pitt wrote. "Worse, it breeds and encourages disrespect for the agency's actions —not just this action, but all of them."

Joseph Grundfest, who served on the SEC from 1985 to 1990 and now teaches at Stanford Law School, wrote, "The long-run implications of such conduct can only be corrosive and unfortunate." Another former commissioner, Bevis Longstreth, wrote, "Such a course of action could easily be construed as an expression of contempt for the rule of law and the judicial process."

In an interview Monday, Donaldson defended himself. "The court did not vacate our rule. The SEC did not exceed its authority." He said the SEC had delved into this matter extensively for more than two years and had all the data required to satisfy the appeals court.

"We feel there is an imperative here to answer the court," he said. "The concept of punting to a new commission and a new chairman is not only inefficient but unfair. The delay in doing that presents an intolerable risk to the 90 million investors out there who have been waiting to make sure they have independent directors representing them."

Ann Yerger, executive director of the Council for Institutional Investors, praised Donaldson's move. "This is the commission that has wrestled with the scandals in the mutual fund industry and crafted a series of reforms," she said. "It's appropriate for this commission to take this rule across the finish line."

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