Any good compliance officer or securities lawyer knows to expect the unexpected when it comes to the unrelated matters that so often get spliced into Congressional legislation. That was certainly the case with the December passage of the Fixing America’s Surface Transportation (FAST) Act, five-year spending plan for improving the nation’s transportation infrastructure.
Tucked into the bill are a variety of decidedly non-transportation-related requirements for the Securities and Exchange Commission regarding its ongoing review of its disclosure regime’s effectiveness, emerging growth companies, and unregistered securities offerings.
“There were a number of proposals that have been floating around since the JOBS Act,” says Joshua Wechsler, a partner with law firm Fried Frank. “There has been talk of a JOBS Act 2.0, and these were probably JOBS Act 1.5 because they don’t go as far as some of the things that were talked about.”
Of particular note are new requirements intended to prod along the SEC’s disclosure review process—an effort to streamline filings, reduce duplication, and slice away puffery—initially mandated by the JOBS Act.
The FAST Act requires the SEC, in consultation with its Investor Advisory Committee and the Advisory Committee on Small and Emerging Companies, to conduct a study of Regulation S-K’s regime for public company disclosure requirements, report to Congress on that study within 360 days, and issue proposed rules within another 360 days.
“There were a number of proposals that have been floating around since the JOBS Act. There has been talk of a JOBS Act 2.0, and these were probably JOBS Act 1.5 because they don’t go as far as some of the things that were talked about.”
Joshua Wechsler, Partner, Fried Frank
Those recommendations should elaborate on plans to modernize and simplify Regulation S-K, packaging information that is material to investors in a way that is more cost-effective and less burdensome for issuers. The intent is to eliminate “boilerplate or static requirements,” discourage duplication and repetition, and cut down on the immaterial information that often clutters 10-K and other filings.
A related inclusion requires the SEC to issue regulations to permit issuers to submit a 10-K summary page, provided that its information is cross-referenced to relevant portions of the 10-K through hyperlinks or other means.
In the original JOBS Act, enacted in 2012, the SEC was given 180 days to prepare an initial review of Regulation S-K; it was finally released 18 months later, well past the mandated deadline. Although the Commission and staff have pledged progress on the S-K review (and related Regulation S-X and industry guide reviews), members of Congress may have felt another kick was needed to keep the project on track.
The original S-K report presented two divergent approaches for rationalization and reform, explains Matt Kaplan, a partner with law firm Debevoise & Plimpton. One potential approach was an “incremental and targeted review and revision; the other was a wholesale rethink. Beyond that, “the report did not actually include specific action items or further to-do(s),” he says. Nevertheless, the SEC has been soliciting solicit comments on various aspects of disclosure effectiveness reform as well as on a modernization of its EDGAR filing system and the liability concerns that some believe may have slowed company-initiated disclosure refinements.
WHAT WAS INCLUDED
The following, as published by the Securities and Exchange Commission, is a list of its requirements under the FAST Act:
Filing Requirement for Public Filing Prior to Public Offering
The JOBS Act allows “emerging growth companies” (EGCs) to submit for confidential, non-public staff review a draft registration statement for an initial public offering. Section 6(e) of the Securities Act previously required the issuer to publicly file the registration statement and all previously submitted drafts no later than 21 days before the date on which the issuer conducts a road show. Section 71001 of the FAST Act shortens that period to 15 days. This provision became effective upon enactment. EGCs with initial public offerings pending before the FAST Act became law or at any time thereafter may take advantage of the provision. Consistent with the Division’s JOBS Act interpretations of Section 6(e), 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 for Change of Status of Emerging Growth Companies
The FAST Act also amends Section 6(e)(1) to provide that an issuer that qualifies as an EGC at the time it initiates the registration process, either by submitting a draft registration statement or by filing it publicly, but which subsequently ceases to be an EGC, will continue to be treated as an EGC until the earlier of the date on which the issuer “consummates its initial public offering . . . or the end of the 1-year period beginning on the date the company ceases to be an emerging growth company.” This provision became effective upon enactment. In the Division’s view, EGCs with registration statements pending at the time of enactment may rely on the provision.
Simplified Disclosure Requirements for Emerging Growth Companies
Amends Section 102 of the JOBS Act to allow an issuer that is an EGC to “omit financial information for historical periods otherwise required by Regulation S-X” if it “reasonably believes [the omitted information] will not be required to be included in the [filing] at the time of the contemplated offering,” so long as the issuer amends the registration statement prior to distributing a preliminary prospectus to include all financial information required at the time of the amendment. The provision will become effective 30 days after the date of enactment. The provision further directs the Commission to amend the instructions to Forms S-1 and F-1 to reflect this statutory change. The Division will not object if EGCs apply this provision immediately.
Summary Page for Form 10-K
Requires the Commission to issue rules that permit issuers to include a summary page in their annual reports filed on Form 10-K. Currently, an issuer is not prohibited from including a summary in an annual report on Form 10-K provided the summary fairly represents the material information in the report. The FAST Act imposes an additional requirement that each item in the summary must include a cross-reference to material contained in the Form 10-K. Rulemaking will be required to implement this provision.
Improvement of Regulation S-K
Requires the Commission to revise Regulation S-K to further scale or eliminate requirements relating to EGCs, accelerated filers, smaller reporting companies and other smaller issuers, and eliminate duplicative, overlapping, outdated or unnecessary provisions of Regulation S-K. The required revisions would not apply to provisions for which the Commission determines that further study is necessary to determine their efficacy.
Study on Modernization and Simplification of Regulation S-K
The statute requires the Commission to carry out a study of the requirements of Regulation S-K to determine how best to modernize and simplify disclosure requirements, emphasizing a company by company approach without boilerplate or static requirements, and evaluate methods of information delivery and presentation that discourage repetition and disclosure of immaterial information. The Commission is required to consult with the Investor Advisory Committee and the Advisory Committee on Small and Emerging Companies and issue a report of findings and recommendations to Congress.
The statute adds a new exemption to Section 4 of the Securities Act for secondary sales of securities that are purchased by an accredited investor, among other requirements. This new exemption became effective upon enactment and does not require Commission rulemaking.
Forward Incorporation by Reference for Form S-1
Requires the Commission to amend Form S-1 to allow smaller reporting companies to incorporate by reference in a registration statement on that form any documents that the company files after the effective date of the registration statement. This provision will require Commission rulemaking.
Registration Threshold for Savings and Loan Holding Companies
The FAST Act amends Section 12(g) of the Exchange Act so that savings and loan holding companies are treated in a similar manner to banks and bank holding companies for the purposes of registration, termination of registration or suspension of their Exchange Act reporting obligations. This provision became effective upon enactment.
“With a formal request for comment on Regulation S-X on record, we understand that the SEC is working on other concept releases,” Kaplan says. The mandated S-K report and associated action items in the FAST Act were, perhaps, a bit surprising to see because it is clear that the SEC is already diligently focused on it. “On the other hand, one does not preclude the other and it is probably fair to say that this was Congress’ way of telling the SEC that they wanted a more formalized process with respect to S-K,” Kaplan says. “Congress may be focused on ensuring that a reduced and rationalized disclosure reform produces disclosure that is more comprehensible to investors at all points on the spectrum, versus technical revisions to Regulation S-K and S-X, and that’s why they are focused on it.”
The call for a summary page may foreshadow additional changes to how companies file with the SEC. There is plenty of discussion in securities circles about ways to improve EDGAR, including a “file cabinet” approach that better categorizes the erratic stream of content and periodic reports, relying on cross-referencing and hyperlinks to guide investor searches. With specialized data tagging, investors could also benefit from instant updates to key information sources.
But first things first: Before companies will be willing to craft a summary page, SEC rulemaking will need to define what “submitted” means in a legal context and what liability concerns may exist.
Beyond disclosure reform, the FAST Act included requirements that further the JOBS Act’s initiatives to make it easier for emerging growth companies to raise capital. Rather than the current 21-day limitation, investor roadshows may now begin 15 days after the confidential filing of an IPO registration statement with the SEC is made public. Also, an issuer designated an emerging growth company at the time it submitted a confidential registration statement or a public registration will continue to benefit from that status until it moves forward with an IPO or one year after it ceases to be an EGC.
The shortening of the investor roadshow blackout period is welcomed, Kaplan says, explaining that “the 21-day speed bump may have been a little too long.”
Additional disclosure leeway for EGCs comes in a clarification of how far back audited financial statements must be disclosed. Under the JOBS Act, EGCs and smaller reporting companies are only required to file two years of audited financial statements in the registration statement at the time it is declared effective. That posed a problem that was not anticipated.
“Let’s say you are starting to work on one right now, you are ready to file a registration statement, but it is before you have your 2015 financial statements prepared. You are in a situation where you need to prepare 2013 and 2014 financial statements, even though you know that by the time you finish the IPO process, roadshow, and SEC review, it is probably going to be months later. By that time, you will include the 2015 audited statements,” says Thomas Friedmann, a partner at law firm Dechert. Being able to omit 2013 financials could save considerable time and money.
Another welcome change in the FAST Act pertains to secondary offerings. The SEC is directed to enact changes related to the so-called Section 4(1_) exemption for the private re-selling of pre-IPO, restricted securities. A new Section 4(a)(7), required of the SEC by the legislation, preempts state blue sky registration requirements and provides an exemption for resale transactions provided that purchasers meet accredited investor guidelines; the seller doesn’t use general solicitation or advertising; the transaction is not conducted by the issuer or a subsidiary of the issuer; and neither the seller nor any person receiving a commission in connection with the transaction would be disqualified as a bad actor under Regulation D.
“There have been efforts to develop secondary trading markets that permit people who ended up holding sizable positions in unlisted, unregistered securities to trade those securities,” Friedmann says. “One of the things that has always been difficult about getting those platforms up and running is uncertainty about the exemptions you are selling under. This clarified it.”
The change should help smaller companies and startups attract capital and retain employees because they and investors know there are better liquidity options. “There is a significant chance of increased secondary trading,” says Stuart Gelfond, a partner with Fried Frank. “The goal of all these rules is to improve the U.S. as a great place to raise capital. At times the blue sky laws can make that more complex and cumbersome, especially if you are selling in a lot of places. Investors will know that their resale ability, particularly in larger transactions, will be easier.”