Key Takeaways
- On May 19, the U.S. Securities and Exchange Commission (SEC) announced two proposals that serve as the largest potential change in more than two decades to expand disclosure accommodations and streamline filer reporting categories and the public capital markets registered offering framework.
- Per the proposal on filer status changes, public filers would be bifurcated into Large Accelerated Filers (LAFs) and Non-Accelerated Filers (NAFs).
- The public float threshold for LAFs would be increased from $700 million to $2 billion and be measured over two years, as of the end of the second fiscal quarter of each year.
- The majority of public filers would be reclassified as NAFs and would gain access to accommodations previously reserved for Emerging Growth Companies (EGCs), including streamlined and reduced financial statement preparation and executive compensation disclosure as well as exemptions from auditor attestations to internal control over financial reporting (ICFR) and shareholder advisory votes.
- Per the proposal on registered offering reform, many more issuers would be eligible to file shelf and short-form registration statements with the goal of providing greater access to the public capital markets.
- The proposed changes would replace the current well-known seasoned issuer (WKSI) status for domestic issuers and instead provide for two new categories, Eligible Listed Issuers (ELI) and Seasoned Eligible Listed Issuers (SELI), with tiered benefits tied to each status.
- If the proposed changes are adopted, the preemption of state securities law would apply to all registered offerings, not solely those registered offerings for securities that are listed or approved for listing on a national securities exchange.
Overview
The SEC announced on May 19 two sets of proposals that would serve as the largest reform in more than two decades of the filer status system and the registered offering framework. In one proposal, the SEC seeks to streamline filer statuses for reporting companies by bifurcating filers into two principal categories: LAF and NAF. The proposed rules would consolidate the current multitiered system, effectively eliminating Accelerated Filer (AF) and Smaller Reporting Company (SRC) categories and extending certain existing SRC and EGC accommodations and scaled disclosures to all NAFs. Reporting companies that qualify as LAFs under the new thresholds would continue to comply with non-scaled disclosure, but all other filers would have their reporting obligations pared back considerably. The SEC further proposed to extend deadlines for filing periodic reports for the smallest NAFs, creating a new subcategory of “small NAFs.” In the other proposal, the SEC would amend a package of rules to allow for further access by issuers to the shelf registration and short-form registration statements on Form S-3, allow for further use of incorporation by reference on Form S-1 and replace the WKSI definition that has afforded qualifying companies access to streamlined offering processes.
Large Accelerated Filer Public Float Updates
Under the existing system, registrants become LAFs once they meet several criteria, including having a public float of at least $700 million and qualifying above the revenue-based test for SRCs. Under the proposed reforms, the SEC would raise the public float threshold from $700 million to $2 billion and remove the other criteria, except to require that the company has been a reporting company for at least the preceding 60 consecutive months (which would be an increase from the current requirement of 12 months). The SEC explained that this target for public float was proposed in order to capture an approximate percentage of total market float comparable to the figure used when the SEC first adopted LAF filer status in 2005. The percentage of public companies subject to LAF status would be reduced from 35.4% to approximately 20%, and total public float subject to LAF status would be pared back from 98.8% to 93.5%, which is closer to the 95% target espoused by the SEC when the LAF designation was originally adopted.
The SEC has further proposed revising the public float calculation to provide a more stable measurement that would be unaffected by short bursts of price volatility. Rather than using the closing price on the last business day of the second fiscal quarter, the public float would be calculated by multiplying the number of shares held by non-affiliates on the last day of the second fiscal quarter by the average price over the last 10 trading days of the second fiscal quarter. The revised threshold would also use a two-year lookback period for qualifying for LAF status, meaning that a company would only transition into or out of such status based on whether the public float was above or below the $2 billion threshold in each of the past two years.
Apart from updating the qualification criteria, the SEC is not proposing any other changes to the LAF reporting requirements.
Non-Accelerated Filer Amendments
Under the existing framework, a public company that does not qualify as an LAF is either categorized as an AF with a public float of $75 million up to $700 million or an NAF with a public float of less than $75 million. Overlapping with these filer designations, a public company may also qualify as an SRC if public float is below $250 million (or revenue is under $100 million) and as an EGC for up to five years following its initial public equity offering (if the company stays below certain revenue and debt thresholds). SRC and EGC status and each tier below LAF provide certain filing accommodations.
Under the proposed framework, every company that does not qualify as an LAF would fall into the NAF category, effectively removing the tiered public float subcategories and broadening access to filing accommodations to a significantly greater number of public companies. Removing AF and lowering the LAF threshold will effectively reclassify the majority of public filers as NAFs. The proposed rules also provide a gradual on-ramp for newly public companies as, regardless of public float, a public company will qualify as an NAF for at least the first five years following the company’s initial public offering.
Among other things, the significant changes to NAF reporting obligations would include the following:
- Article 8 of Regulation S-X for financial statements. NAFs would be able to prepare financial statements using Article 8 of Regulation S-X, which is only available to SRCs under the existing framework. NAFs would only provide two years (rather than three) of audited financial statements and corresponding MD&A disclosure.
- No auditor attestation of ICFR. NAFs would not need to obtain an auditor’s attestation on the effectiveness of ICFR under Section 404(b) of the Sarbanes-Oxley Act.
- Scaled executive compensation disclosure. NAFs would only be required to provide compensation disclosure for three (instead of five) named executive officers and two years (instead of three years) of summary compensation table disclosure. NAFs would further be exempt from providing Compensation Discussion and Analysis disclosure, pay versus performance disclosure, pay ratio disclosure, several compensation-related tables and disclosure regarding risks of compensation policies and practices.
- Exemption from risk factors disclosure. NAFs would not be required to provide risk factors disclosure in Forms 10-K and 10-Q.
- More limited disclosure under other items of Regulation S-K. NAFs would be permitted to provide a more limited description of business (Item 101) and omit performance graph disclosure (Item 201(e)) (except for investment companies), quantitative and qualitative disclosures about market risk (Item 305), and policies and procedures for review and approval of related-party transactions (Item 404(b)).
- Exemption from shareholder advisory votes. NAFs would be exempt from the requirements to conduct nonbinding, advisory votes on say-on-pay, frequency of say-on-pay, and golden parachute compensation.
- Delayed accounting standards adoption. Consistent with the current reporting accommodations available to EGCs, NAFs may defer compliance with certain new or revised accounting standards issued by the Financial Accounting Standards Board for a period of five years following the NAF’s initial registration with the SEC.
- Material unresolved SEC staff comments. NAFs would be required to disclose in their Form 10-K the substance of material unresolved SEC staff comments received at least 180 days before fiscal year-end. This new obligation previously applied only to LAFs and AFs and, as proposed, would now be applied to all registrants. As the concurrent offering reform proposal makes Form S-3 and shelf offering eligibility available to significantly more issuers, the SEC reasons that investors in issuers conducting offerings should be made aware of any material unresolved comments incorporated by reference from the issuer’s Form 10-K or Form 20-F. As proposed, the rule only creates a disclosure obligation and does not preclude use of Form S-3 while material unresolved comments are outstanding.
- Extended filing deadlines for “small NAF” subcategory of filer. NAFs with total assets of $35 million or less for the two most recent fiscal years would have an extra 30 days, or 120 days total, after fiscal year-end to file Form 10-K and an extra five days, or 50 days total, after fiscal quarter-end to file Form 10-Q.
Changes in S-3 Eligibility
Under the second proposal regarding amendments to the registered offering rules, the most immediate benefits would be felt by newly public companies and companies with small public floats, which will be eligible to place an unlimited amount of securities on a shelf registration statement on Form S-3 while using the pay-as-you-go fee model previously restricted to WKSIs. Currently, to be eligible to use Form S-3 to register the primary sale of an unlimited amount of securities, an issuer must (i) be “seasoned,” meaning the issuer has reported for 12 full calendar months pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act) and (ii) have a public float of at least $75 million. Both requirements, as well as the transaction requirements and lack of certain defaults, would be eliminated by the proposed rule changes. This change would also eliminate the so-called baby shelf restrictions under which issuers with less than $75 million in public float could only issue a capped amount within a 12-month period.
Per the proposed rules, issuers would no longer need to have 12 months of Exchange Act reporting prior to using Form S-3 but would still need to be current on their Exchange Act reporting since the time they went public in order to conduct an offering on Form S-3. Such timeliness determination would also be amended to allow issuers to be considered timely if (i) only one late filing is made during the past 12 months and (ii) such delinquent filing is rectified within seven calendar days of the original due date.
While many filers would gain access to Form S-3, the proposed rules would also expand the scope of “ineligible issuers” that are prohibited from using Form S-3, including adding a category of “BSP issuers,” which would be defined under Rule 405. BSP issuers include blank-check companies, shell companies (other than a business-combination-related shell company or a former special purpose acquisition company (SPAC) that is not a shell company at the time of filing) and penny stock issuers. Companies that within the prior three years have been subject to disclosure-related criminal convictions, anti-fraud-related decrees and orders, and Section 8 or 8A proceedings would be prevented from using Form S-3 as ineligible issuers. The SEC reasons that adding a disqualifying provision to Form S-3 would be appropriate to protect investors against these categories of issuers that pose a greater risk of noncompliance with disclosure requirements.
The SEC believes that these changes would increase the number of issuers able to register an unlimited number of securities on Form S-3 by more than 60%.
Elimination of WKSI Definition and Substitution of Two New Categories
Certain portions of the registered offering reform proposals would replace the WKSI status that allows for broad privileges in the registration process, such as allowing issuers to file automatically effective shelf registration statements, with the new categories of ELI and SELI. Under current rules, WKSIs need to have a public float of at least $700 million or have issued at least $1 billion in nonconvertible securities in primary registered offerings in the past three years, have been a reporting company for at least 12 months, be up to date on all filings, not have defaulted on any debt or long-term leases, and not be classified as an ineligible issuer as discussed above.
ELI status would apply to issuers that (i) meet the newly proposed requirements to use Form S-3 and (ii) list on a national securities exchange at least one class of common equity securities. SELIs would be those issuers that have additionally been an Exchange Act reporting company for at least 12 months, maintaining in some form the “seasoning” requirement for current WKSIs. The SEC believes the new SELI category could cover approximately 74% of reporting issuers, which is about twice the amount that qualify as WKSIs under current rules.
Under the package of amendments, ELIs would be eligible to use all the same accommodations provided to WKSIs except for the ability to file automatic shelf registration statements. These include the ability to (i) utilize pay-as-you-go filing fees regarding shelf registration statements, (ii) omit additional information from the base prospectus in a shelf registration statement (allowing for future flexibility at the time of filing the prospectus supplement), and (iii) provide certain communications both before and after filing of the registration statement that are currently restricted to WKSIs, including prefiling communications under Rule 163 and broadened flexibility in using free writing prospectuses under Rule 433. SELIs would additionally be able to file automatically effective shelf registration statements.
Expansion of Incorporation by Reference in Form S-1
The proposed registered offering rules amendments would also allow for expanded use of incorporation by reference on Form S-1. Specifically, issuers would be eligible to incorporate previous Exchange Act filings by reference, even if the issuer had not filed a Form 10-K for the most recently completed fiscal year. Currently, an issuer must file such Form 10-K prior to utilizing this backward incorporation by reference. Further, the proposed amendments would allow all issuers to forward incorporate by reference their future Exchange Act filings. Such forward incorporation by reference on Form S-1 is currently restricted to those issuers that are an SRC. Per the SEC estimate, up to 106% more issuers would be eligible to forward incorporate due to this change.
Further Preemption of State Securities Laws, Sometimes Called Blue Sky Laws
Under current Section 18(b)(1) of the Securities Act, state securities law requirements are preempted for “covered securities,” including securities sold to a “qualified purchaser,” but the rule currently limits preemption to registered offerings of securities that are listed or approved for listing on a national securities exchange. The newly proposed amendments would extend this preemption for all registered offerings through the definition of “qualified purchaser” under Section 18(b)(3) of the Securities Act to include any purchaser to whom securities are offered or sold pursuant to a registered offering, regardless of whether the offered securities are listed on a national securities exchange. The SEC reasons that the proposed amendment would lower the cost of a registered offering of securities that are not listed on a national securities exchange.
Parallel Accommodations for Business Development Companies and Closed-End Funds
Further amendments would allow for essentially parallel access to short-form registration statements on Form N-2 for business development companies (BDCs) and registered closed-end funds (CEFs). Similar to the expansion of WKSI-like capabilities to a broader swath of operating companies, further proposed language would extend certain registration and communication capabilities to BDCs and registered CEFs that meet the expanded criteria for use of Form N-2.
Preparing for the Proposed Transition
Companies with public floats of between $700 million and $2 billion would transition to NAF status and benefit from the reduced reporting obligations described above. Regardless of public float size, companies that are still within five years of the date they went public would also benefit from NAF status and the streamlined reporting requirements. Current NAFs, SRCs and EGCs would continue to benefit from existing accommodations, and NAFs that have lost their EGC status would regain the EGC accommodations.
The proposed reforms to the securities offering process would eliminate many barriers to or constraints on fundraising, including through broader access to use of Form S-3 and shelf and at-the-market offerings, expanded opportunities for offering communications and elimination of the baby shelf restrictions.
As such, companies should track both sets of proposals together as they are advanced through the rule adoption process and consider how this might change processes for preparing filings and opportunities for capital raising.
Further, SEC Chairman Paul Atkins indicated in a recent speech that he has directed SEC staff to begin preparing recommendations to spark growth in the initial public offerings space. Atkins discussed reforming the communications and “testing the waters” rules in connection with initial public offerings to permit more registrants to solicit feedback from institutional investors prior to pursuing initial public offerings. Rule changes to make the initial public offering process less burdensome, coupled with the proposed reduced burdens for maintaining reporting company status and raising subsequent capital, could make being a public company significantly more attractive.
Conclusion
The public comment period for both proposals will remain open until 60 days after publication of the proposing releases in the Federal Register (July 20 for the filer status rules and July 25 for the offering reform rules), and comments may be submitted through the SEC’s online public comment portal.
The SEC’s proposals would result in one of the most significant shifts in the reporting regime and the registered offering process in decades. Public companies should begin evaluating how the proposed amendments could ease their reporting burden and affect their plans for interacting with the public markets and their next capital raises, and private companies considering an initial public offering should stay tuned for further updates from the SEC.
Please feel free to contact any of our experienced professionals if you have questions about this alert or would like to discuss the proposed rule and its possible impact.
BakerHostetler’s Capital Markets and Securities team is composed of attorneys with extensive experience in SEC rules and regulations, public disclosure requirements, and a wide range of capital markets transactions. The team advises public and private companies on financing growth and acquisitions and managing balance sheets through tailored equity and debt offerings aligned with their business needs.
