During the post-budget discussions, a number of industry leaders and financial analysts endorsed the proposed Securities Act, 2012 which is expected to be proclaimed before the end of the year on the notion that it will facilitate financial innovation and increase the efficiency of raising capital in the market.
I however suspect its proponents have not carefully read the draft legislation and, in particular, the proposed filing and approval processes.
Let me at the onset state that the Securities Bill, 2012 represents a significant improvement over the draft dated August 02, 2012 which was published on the Commission’s website.
The new legislation will, inter alia, increase the SEC’s regulatory and enforcement powers as it relates to the conduct of inspections and investigations; provide greater transparency through increased disclosure by market participants; and facilitate increased cooperation and sharing of information among local and foreign regulators.
The Bill also introduces a Securities Industry Tribunal which will improve standards of procedural fairness as all ‘material actions’ of the SEC will be subject to review. These improvements will ultimately redound to the benefit of the industry.
Let us, however, examine the following matters to determine the extent to which the new legislation will positively impact on the initial filing and disclosure regime and its effect on capital market transactions.
Issuers of securities and market intermediaries have from the inception of the SEC in 1997 complained about the excessive length of time it takes to receive approvals from the SEC before taking securities products to market.
Some have questioned the need for prior registration of securities in circumstances such as limited offerings to sophisticated purchasers who have access to the information contained in registration statements filed with the TTSEC.
Financial institutions have questioned the utility of the registration statement in respect of limited offerings of certificates of participation where the underlying instrument does not constitute an offer to the public. The legislation has proven to be a challenge for issuers wishing to engage in a debt issuance program which provides the flexibility and opportunity to take advantage of favourable changes in market conditions over an extended period of time.
Filing requirements under the SIA
Let us first consider the filing requirements under the current Securities Industry Act, 1995 (“the SIA”). The SIA imposes a dual filing requirement which requires issuers to file a registration statement in respect of the securities they propose to offer to the public as well as to file a prospectus with the SEC when they propose to make a distribution of securities. Issuers making an offer to the public for the first time must also register as a reporting issuer by filing a registration statement. The dual filing requirement under the SIA in respect of an offer to the public and a distribution of securities is similar to the disclosure regime in the United States but differs from Canada and the Bahamas; the Bahamas Securities Industry Act, 2011 being the most recent securities legislation in the region.
The securities legislation in the two jurisdictions (Canada and Bahamas) require issuers (subject to enumerated exemptions) to file a prospectus prior to a distribution of securities but not a registration statement pursuant to an offer of securities to the public. The two jurisdictions also do not require reporting/public issuers to apply for registration by filing a registration statement to become a reporting/public issuer. The issuer becomes a reporting/public issuer as a consequence of filing a prospectus and issue of a receipt by the regulator. The reporting/public issuer then becomes obligated to make continuous disclosures.
Registration and offers to the public
Registration involves the filing of separate registration statements in respect of the issuer and the securities. The registration process entails a review of the disclosures made in the registration statements and accompanying documents that have been submitted by the issuer. If the regulator determines that the disclosures satisfy the standards set out in the legislation, approval to issue the securities is granted by registering the issuer and securities. Registration of issuers is a one-time event and thereafter only subsequent issues of securities are required to be registered. Depending on the complexity of the transaction or the concerns arising from the submission, the approval process can cause delays in the issuance of securities.
The obligation to register securities with the SEC under the SIA turns on the definition of the term ‘offer to the public’. Section 3 of the SIA defines an offer to the public as follows:
“An offer to the public, in relation to any security, means any offer to the public at large or to any section of the public, whether selected as clients of persons issuing the prospectus or in any other manner by way of advertisement or other form of solicitation, but does not include an offer by an offeror who is not a registered issuer under this Act where the offer is made to fewer than thirty-five persons and the offer can be regarded as not being calculated to result directly or indirectly in the securities becoming available for subscription or purchase by persons other than those receiving the offer or invitation, or otherwise as being a matter of domestic concern of the persons making and receiving it;”
Simply stated, the term ‘offer to the public’ is an offer of securities to thirty-five or more persons. The definition is extended to include an offer by a reporting issuer to fewer than thirty-five persons. Thus for example, financial institutions that are registered as reporting issuers must register any offering of securities, notwithstanding it is a limited offering to sophisticated purchasers.
The sophisticated purchasers are usually institutions that have access to relevant information about the issuer and the securities and, therefore, do not require the protection provided by the disclosures made in the registration statement. The requirement for prior registration in such instances is inimical to the efficiency of capital market transactions as it delays the transaction and introduces an unnecessary administrative burden.
Distributions and the Prospectus
A distribution typically involves a primary offering of securities from an issuer’s treasury. Offerings of these securities are sometimes made to persons who cannot “fend for themselves”. In many instances, the issuer possesses information which is not known to potential investors and, therefore, such information has to be initially disclosed to investors in a prospectus and thereafter through a process of continuous disclosures. Exemptions to the prospectus requirement are granted in situations where the prospective investor has access to the same information which would have been provided in the prospectus or do not need the ‘protection’ afforded by a prospectus. Thus for example, under the SIA a distribution under specified conditions to fewer than fifty sophisticated purchasers does not require the filing of a prospectus.
The Securities Bill at paragraph (b) of the definition of ‘reporting issuer’ states “‘reporting issuer’ means an issuer . . . that has filed a prospectus and obtained a receipt for it under this Act”. The issue of a receipt for a prospectus is the determiner as to whether the issuer becomes a reporting issuer. There must be full, true and plain disclosure of all material facts relating to the securities being offered before a receipt is issued. The Commission does not pronounce on the merits of the disclosures made in the prospectus. The Commission may however refuse to issue a receipt for reasons enumerated in the Bill. It is expected that the Commission would issue a receipt for the prospectus within a reasonable time after the date of the filing of the prospectusviii but the process of review can take a considerable length of time if the staff has concerns about the information submitted. This can delay the offering and increase the cost of capital.
One of the substantial changes which the consultants, Stikeman Elliott LLP, recommended and addressed in the draft legislation presented in 2004 was the elimination of the concept ‘offer to the public’.
The report and draft legislation followed a series of public consultations with market participants including issuers and market intermediaries over a period of eighteen months.
The definition of ‘offer to the public’ in the SIA was deemed to be susceptible to interpretational difficulties and the meaning of the term ‘to the public’, the subject of a significant amount of litigation in the more developed securities markets. Along with the elimination of this term was the removal of the obligation to register as a reporting issuer prior to an offer being made and the exclusion of the requirement to register the securities prior to an offering. The Consultants, however, recommended that a registration statement be filed with the SEC after a distribution of securities.
The system of post-distribution registration (but note the requirement to file a prospectus for some distributions) allows the SEC to collect information to conduct its regulatory functions without stymieing the market as information regarding the securities issued in the market is made available to the SEC in a timely manner. Transparency is also maintained as the information filed with the SEC is available for public inspection.
Quietly without fanfare and as far back as December 2005 the SEC clawed back in the registration requirement in respect of both issuers and securities prior to a listing or a distribution of securities. The requirement for prior registration is irrespective of whether a prospectus is required to be filed. The effect of this change is that there is a duplication of filings for listings and distributions requiring a prospectus.
The Securities Bill, 2012 provides under clause 61(1) that a person who proposes to make a distribution, must register with the Commission as a reporting issuer and file a distribution statement (essentially a registration statement) in the prescribed form within the prescribed time and pay the prescribed fee. Clause 62(1) of the Bill provides: no security shall be distributed or listed with any self-regulatory organization unless it is registered with the Commission. Clause 62(4) goes on to state that a distribution statement shall be deemed effective only as to the securities specified therein [as] proposed to be offered. Clause 62(4) has significant implications for the efficiency in doing business with the SEC and conducting capital market transactions.
Clause 62(4) of the Bill which is also contained in section 65(4) of the SIA can be traced to the last sentence of section 6(a) of the US Securities Act of 1933 (in force). In its formative years, the United States Securities and Exchange Commission (US SEC) adopted a strict interpretation of the legislation and required issuers to file a registration statement prior to each issue of securities. This ensured that the information contained in the registration statement is current and available to prospective purchasers when the securities are being offered. The US SEC held the view that it was misleading to register more securities than the registrant presently intended to offer and only securities intended to be sold immediately could be registered.
The prior registration of securities proved to be challenging in certain situations and in response to the demands of the market, the US SEC began to relax its strict interpretation of the subsection and shelf registration under Rule 415 was introduced. Rule 415 expressly authorized a more liberal interpretation of subsection 6(a) in defined circumstances. One obvious weakness presented by shelf registration is the unavailability of current information. Shelf registrants are, therefore, required to give an undertaking to file amendments to the registration statement with the US SEC when there are fundamental changes.
Unlike the US Securities Act, the Securities Bill, 2012 does not provide for shelf registration. The absence of shelf registration in the Bill will impede financing arrangements which are structured to take advantage of favourable changes in the market. The shelf registration concept which is akin to the concept of authorized capital under the previous Companies Ordinance would allow issuers to pre-register a defined amount of securities for issuance over a predefined period. This allows issuers to have multiple issues of securities with varying terms and conditions under a single registration without the administrative burden of having to seek the approval of the SEC prior to each offering. This reduces the issuer’s cost of capital. The shelf registration system reduces the time and administrative resources which would have been spent in registering the securities and permits issuers to take advantage of ‘market windows’.
The policy regarding the registration requirement for issuers and securities prior to a distribution of securities should be reviewed. In respect of distributions requiring the filing of a prospectus, the requirement in the Securities Bill, 2012 for the filing of a registration statement by a first time issuer and the filing of a distribution statement in respect of securities should be eliminated as it is superfluous and amounts to a duplication of effort with no additional benefits to the Commission nor the issuer. The issuer by definition (paragraph (b) of the definition) becomes a reporting issuer when pursuant to clause 73(1) a prospectus has been filed and a receipt has been obtained for it. The distribution of securities can proceed and the issuer becomes a reporting issuer when the receipt has been issued by the Commission.
In respect of prospectus exempt distributions, the SEC should consider adopting the procedure observed in the Bahamas where an issuer in a prospectus exempt transaction is required to file information concerning the exempt transaction no later than a stated number of days prior to the first sale of securities. This gives the regulator adequate time to review the documents submitted without delaying the transaction and at the same time allow sufficient time to take mitigating action, in the event there are any concerns regarding the distribution. The issuer would also be required to file a report with the Commission within a stated number of days after any subsequent sale of securities.
Issuers should also be required to give an undertaking to submit to the SEC information regarding any major or substantial changes concerning the issuer or securities while the securities remain outstanding. This process ensures that there is regulatory oversight and at the same time reduces the regulatory burden in the case of ‘non-public’ entities. The issuer is also able to proceed with its offering without having to wait on the approval of the SEC.
Should the policy of prior registration of issuers and securities in respect of distributions be maintained by the SEC, at a minimum there should be some compromise by the inclusion of shelf registration in the regulatory regime. The inclusion of shelf registration can be easily accomplished by inserting in the By-laws criteria similar to those contained in Rule 415 of the US Securities Act, 1933 which would permit issuers to issue securities on a continuous or delayed basis.
As a condition, securities registered under a shelf registration should only be registered in an amount which, at the time the distribution statement becomes effective, is reasonably expected to be offered and sold within two years from the initial effective date of registration. Issuers should also be required to give an undertaking to submit to the SEC information regarding any major or substantial change concerning the issuer or securities subsequent to the shelf registration.
Annette C. Borel is a local lawyer who has an LL.M. from Georgetown University Law Centre in securities and financial regulation