SEC Expands "Test-the-Waters" Communications For All Companies

Capital Markets Alert | October.04.2019

On September 26, 2019, the Securities and Exchange Commission (SEC) adopted Rule 163B permitting all companies to use test-the-waters (TTW) communications. This change will enable all companies to take advantage of practices common to initial public offerings of emerging growth companies (EGCs).

What Are TTW Communications?


Under Section 5(d) of the Securities Act of 1933 (Securities Act), EGCs and persons authorized to act on their behalf may test the waters by oral or written communications with potential investors before and after the filing of a registration statement. This enables EGCs a means to evaluate market interest in a contemplated registered offering and obtain valuable investor feedback. Under Section 5(d), after verifying investor status, TTW communications are permitted with qualified institutional buyers (QIBs) and institutional accredited investors (IAIs).

What Changes with Rule 163B?


Rule 163B will expand TTW communications to all companies, or persons authorized to act on their behalf, and will permit TTW communications with any potential investor reasonably believed to be a QIB or IAI before and after the filing of a registration statement. Rule 163B affords broader protection than Section 5(d) by providing a reasonable belief standard for determining an investor’s status as a QIB or IAI. Rule 163B is also non-exclusive. Companies may rely on other rules or exemptions, such as Section 5(d), Rule 163 or Rule 164, in communicating with potential investors.

Rule 163B is otherwise consistent with Section 5(d). In particular, TTW communications will still constitute “offers” within the meaning of Section 2(a)(3) of the Securities Act, and any misleading statements or omissions in the communications will still be subject to Section 12(a)(2) liability and to the anti-fraud provisions of the federal securities laws. Accordingly, we expect the existing “playbook” for TTW communications will not change. For example, companies will still maintain consistency between TTW communications and the registration statement. In addition, companies and their authorized persons will continue to take reasonable steps to prevent TTW communications from being shared with non-QIBs and non-IAIs (e.g. collecting written materials back from investors after the meeting). Also, we expect that the SEC will continue to request companies furnish written TTW communications during its review even though there are no filing or legending requirements under Rule 163B.

Rule 163B will become effective 60 days after publication in the Federal Register.

Top 5 Takeaways for Companies


1. Rule 163B “Levels the Playing Field” for Pre-Public Companies.


With companies these days staying private longer, a growing number of private companies (e.g. those with annual revenues in excess of $1.07 billion) do not qualify as EGCs as they look ahead to an initial public offering or direct listing. Under Rule 163B, these companies will be able to gather valuable information from QIBs and IAIs during the confidential phase of the offering process.  

2. All Reporting Companies Will Be Able to Engage in Pre-Filing Communications.


Rule 163B will enable companies and their authorized underwriters to engage in discussions with potential investors to gauge market interest in a contemplated registered offering prior to filing a registration statement. Before this change, many reporting companies could not engage in such discussions without first filing a shelf registration statement. Companies will still need to comply with reporting company disclosure obligations, such as Regulation FD, but this change is a vast improvement to the offering process because it will help reporting companies assess market interest and terms before publicly disclosing their intentions, reducing execution risks and the drawbacks of premature disclosure.

3. Be Careful Conducting Concurrent or Subsequent Private Placements.


While Rule 163B will not prevent companies from pursuing a private placement concurrently with or in lieu of a registered offering after engaging in TTW communications, the SEC reminds companies that do so to consider whether the TTW communications constitute general solicitation, taking into account all the facts and circumstances. Practically speaking, if there is doubt in this regard, companies may rely on a private offering exemption that allows for general solicitation (e.g. Rule 506(c)) or limit participation to investors solicited through some other means (e.g. a substantive, preexisting relationship exists between the investors and the issuer) that would otherwise not foreclose the availability of an exemption.

4. Investor Verification Requirements Clarified.


Companies will not be required to take prescribed specific steps to verify investor status under Rule 163B. The SEC believes that companies should continue to rely on the methods that they currently use to establish a reasonable belief with respect to an investor’s status as a QIB or IAI pursuant to Rule 144A and Rule 501(a).

5. No Filing or Legending Requirements.


Like existing TTW communications, TTW communications under Rule 163B will not need to be filed with the SEC. Nor will such communications be required to include any specified legends. In connection with initial public offerings or direct listings, pre-public companies should expect the SEC to continue to seek copies of any written TTW communications in connection with its review of their registration statements.