The WSJ is reporting that “people familiar with the matter”—every reporter’s favorite source—say that the SEC is “weighing” expanding “test the waters” beyond just EGCs. You might recall that, in 2012, the JOBS Act allowed IPO candidates that were EGCs to take preliminary steps to determine the potential level of investor interest before committing to the expensive and time-consuming prospectus drafting and SEC review process. That flexibility, together with the new confidential IPO filing process—which allowed EGCs to start the SEC review process on a confidential basis so that sensitive information would not be disclosed if they ultimately determined not to move forward with the offering—was intended to promote and facilitate access to the public capital markets. Since that time, however, the IPO market has not exactly taken off like a rocket, and the hand-wringing over the lack of interest in going public has continued. In June 2017, Corp Fin extended the confidential filing process, permitting non-EGCs to submit confidential draft registration statement for IPOs and for most offerings made in the first year after going public. Will testing the waters be the next step?
The number of public companies has declined by about 50% since the mid-1990s. The article reports that close to 40% of eligible EGCs conducting IPOs took advantage of testing the waters in 2015, but the percentage fell to less than 25% in 2016. Although, according to the article, the SEC does not “view testing the waters as a panacea for the diminished appeal of going public,” some regulators do seem to believe it will encourage companies to go public: at the San Diego Securities Conference in January, the article reports, Corp Fin Director William Hinman argued that “[i]f we can be successful in reducing the burdens associated with joining the public capital markets, we think we will get companies to join us at an earlier stage.” However, many commentators view the issue of the decline in IPOs as more complex than just the volume of red tape. Among the factors commonly cited for the decline are the availability of capital in the private markets, the greater maturity expected of IPO candidates, more opportunities for liquidity for investors and employees through secondary trading in the private markets, changes to the Exchange Act registration threshold that permit companies to stay private longer and concerns regarding hedge-fund activists with short-term views, among other reasons. (See this PubCo post and this PubCo post.)
The testing-the waters provisions in the JOBS Act significantly relaxed “gun-jumping” restrictions by permitting an EGC, and any person acting on its behalf, to engage in pre-filing communications with qualified institutional buyers and institutional accredited investors. This relaxation of the gun-jumping rules allows companies to reduce risk by gauging in advance investor interest in a potential offering. (See this Cooley Alert.) Prior to the JOBS Act, only WKSIs could engage in similar testing-the-waters communications. “Test-the-waters” communications can be oral or written, made before or after filing a registration statement, in connection with an IPO or any other registered offering. However, the only permitted communications are those made to determine whether the specified investors might have an interest in a contemplated securities offering. A 2017 Treasury report also recommended expanding this provision of the JOBS Act to allow all companies, not just EGCs, to “test the waters.” (See this PubCo post.)
What’s more, those same people familiar with the matter told the WSJ that the SEC was also looking at exempting smaller companies from SOX 404(b), the requirement to have an auditor attestation and report on management’s assessment of internal control over financial reporting. The auditor attestation requirement has recently been much maligned as time-consuming and expensive for smaller companies, diverting capital from other more important uses such as R&D. However, many see value in these controls audits. According to a GAO study, companies exempt from controls audits had more restatements. In addition, another study showed that companies that had controls audits had higher valuation premiums and lower cost of debt. See this PubCo post.