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Securities Act of 1933 – Applicability and Requirements


The ’33 Act is a federal disclosure law covering the initial sale of securities to the public. Specifically, the ’33 Act makes it illegal to use the mail or any other means of interstate communication or transportation to sell securities without disclosing certain financial information to potential investors. Most notably, the issuer must register the issuance of securities with the SEC, unless the issuer is able to conduct the issuance pursuant to a registration exemption. Regardless, the ’33 Act covers all initial offers to sell securities and places detailed disclosure requirements on those issuing securities (issuees). These disclosures allow potential investors to make informed decisions about purchasing the issued securities.

Note: Failure to comply with the ’33 Act may lead to civil and criminal penalties. Often, however, violations of the ’33 Act may lead to court ordered relief such as injunctions against the violator or equitable remedies for those negatively affected by the issuance.

What is an “offer” to sell securities?

The ’33 Act specifically regulates any offer to sell securities. The term “offer” is defined very broadly under the ’33 Act as any attempt to solicit interest in buying shares. The definition of an offer to sell securities goes far beyond actually attempting to sell securities. As such, securities law regulates a much wider range of conduct than many people anticipate.

Note: Even if the communicator includes disclaimers or provisions stating that the information is not an offer and that the recipient cannot purchase securities at this time, the communication may still be considered an offer.

Example: Under this definition, direct mail or advertisement of any sort would constitute an offer. Posting information about a securities offering on a website would be considered a solicitation of offers. Further, any communication that discloses information about the decision to sell securities, depending upon the context, may be considered an offer.

Discussion: Why do you think an offer to sell securities is defined so broadly? Do you think it is appropriate or overly broad? Why?

Practice Question: ABC Corp is considering raising money for operations by selling bonds to the public. ABC Corp wants to gauge public interest, and posts an announcement on a popular investment website stating the ABC Corp will be selling bonds at the end of the year. Does this activity implicate the securities laws?

Who are the parties regulated in an offer to sell securities?

The ’33 Act regulates offers to sell securities by a number of individuals, including the issuer, underwriter, controlling party, or sales representative. The “issuer” is the individual or business organization offering a security for sale to the public. “Underwriters” are individuals participating in the original distribution of securities by selling such securities for the issue or by guaranteeing their sale. A “controlling party” is one who controls or is controlled by the issuer, such as a major stockholder of a corporation. A “sales representative” is anyone who contracts with a purchaser or who is a motivating influence that causes the purchase transaction to occur.

Discussion: Why do you think that the securities laws regulate the conduct of such a wide variety of sellers or securities? How does regulating the conduct of these individuals align with the objectives of the securities laws?

What are the primary disclosure documents required in a offer to sell securities?

The ’33 Act requires that an issuer of securities register with the SEC by filing a registration statement prior to any offer or sale of securities. Further, the issuer (or individual offering to sell securities) must provide a detailed disclosure document, known as a “prospectus”, to any potential investor prior to consummating a sale.

Registration Statement – Generally, it is illegal to sell securities to the public unless those securities are registered or there is an exemption from registration. The registration statement is the primary document that the entrepreneur must file with the SEC before undertaking a securities offering. The registration statement provides extremely detailed information about the business and the intended equity offering. The SEC reviews this information and makes it available to the public. Potential investors considering investing in the venture will use this information to make an informed decision. The investor can feel confident in the veracity of the information.

Note: There are several versions of the registration statement – the applicability of each depends upon the character and status of the business. The most common and recognized registration statement is the S-1, which applies to larger corporate entity forms that intend to offer securities to the public at large. The form S-1 contains instructions and references to dozens, if not hundreds, of applicable regulations that provide detailed information that must be included in the statement. While the actual requirements for registration are sufficient to fill a textbook, we simply make reference to them in order to illustrate the extensive requirements associated with registering the sale of a covered security.

Prospectus – Due to the volume of the disclosure included in the statement, it is somewhat difficult for a perspective investor to use the registration statement effectively to glean information about a particular investment opportunity. As such, the SEC requires that an issuer also prepare a “prospectus”, which is summary document containing fundamental information about the issuer, the security issuance, and the terms that apply. It provides the investor with sufficient facts (including financial information) to allow her to make an informed investment decision. At a bare minimum, it includes balance sheets and statements of operation by the investor. The issuer must provide this document to prospective investors prior to selling a security or accepting any investor funds. Like the registration statement, the information contained in the prospectus is subject to review and approval by the SEC.

Note: The prospectus delivery requirements generally do not apply to persons other than issuers (and their affiliates), underwriters or dealers. An individual purchaser of a security is generally exempt from providing this document in sales to a subsequent purchaser.

Discussion: Why do you think the SEC requires both an issuer to file a registration statement and prospectus prior to offering securities for sale? Why do you think the SEC requires the issuer to provide the prospectus to perspective purchasers of securities? Do you think this method of disclosure is effective? Why or why not?

Practice Question: What are the disclosure documents required under the Securities Act of 1933 and how are they used?

What is an issuer allowed to do during each stage of the registration process?

A company offering its shares for sales to public for the first time (an initial public offerings) must register with the SEC or perfect an exemption from registration. If the company must register, the ability to advertise or offer to sell securities to the public follows a process that is linked to the filing of the registration statement. Generally, companies must follow the following framework and timeline:

Pre-filing Period – This refers to the period leading up to making the regulatory filings required by the SEC. During this period, the issuer cannot make offers to sell or take offers to buy securities. The issuer may, however, engage underwriters about the planned issuance. The underwriters may make commitments regarding the underwriting process for the securities, but no securities are actually sold during this period.

Waiting Period – This period refers to the post-SEC filing period during which an issuer can undertake limited efforts to market or sell the securities. The waiting period generally lasts for 20 days following the filing, if not extended. During this period, the SEC is charged with evaluating the registration statement and investigating the information contained therein. The SEC is looking for disclosures that may be incomplete or confusing to investors. The issuer may use this period to solicit offers to purchase securities, but no sales can take place until the registration is complete. The issuer will generally put out advertisements, known as “tombstone ads”, to garner interest in the offering. The ads generally identify the securities being offered, the broker, provide access to prospectus information, and state an offer price.

Note: Nearly all registrations filings extend beyond the standard 20-day period. This gives the SEC more time to evaluate the issuance. Companies are rightfully woeful to proceed with the sale of securities if the SEC has not properly evaluated the offering disclosures. Issuing securities with noncompliant disclosures can subject the company to civil and criminal liability.

Post-Effective Period – This is the period following registration. At this point, the registration and plan for issuing securities is officially approved. Unless the SEC gives notice that the registration and plan is defective, the approval is automatic. The issuer is now free to sell securities.

As stated above, the ability of an issuer to undertake activity in promoting, offering, or selling securities varies somewhat based upon the status of the issuer.

Discussion: Why do you think the securities laws prohibit the offer to sell securities to varying degrees based upon the stage of filing of the registration statement? Should there be any restrictions that remain in place following the post-effective date?

Practice Question: ABC Corp is in the process of registering with the SEC to sell company shares to the public. Rachel, a large investor, approaches ABC Corp immediately following the filing of the registration statement. Rachel wants to get ahead of other investors and purchase a large quantity of shares. What are ABC Corp’s options and limitations in this situation?

How are issuers of securities classified for purposes of the registration and offering process?

The rules applicable to an issuing company during the above time periods depend upon the issuer’s classification. The classifications are as follows:

Non-reporting Issuer – This refers to a company that is not subject to any SEC reporting requirements at the time of the issuance. This includes non-public companies below a certain capitalization ($75 million).

Note: Most companies seek to maintain a non-reporting status as long as possible. Many companies will maintain their private status until they reach this reporting threshold. Once the threshold is reached, the company is required to undertake the extensive reporting similar to that of a public company. At this point, the companies often decide to become public companies to open this funding channel.

Unseasoned Issuer – This is a company subject to SEC public reporting requirements, but it has either not been subject to the reporting requirements for 12 consecutive months or does not meet the $75 million public float requirement.

Seasoned Issuer – A seasoned issuer is a reporting company that has greater than $75 million in public float, but less than $700 million and at least one year of timely reporting.

Well-Known Seasoned Issuer (WKSI) – This is an issuer with worldwide stock float of $700M or outstanding debt of $1billion that has been issued within the past 3 years.

Each classification relates to the capitalization of the company or status as a company compelled to report to the SEC. The purpose behind classifying companies in this manner regards the ability of the company to offer for sale or solicit offers to purchase securities during the pre-filing and waiting periods.

Discussion: How do you feel about classifying companies and providing different rights to offer for sale or solicit purchasers of securities based upon the capitalization and reporting history of the company? Should there be other considerations that affect the extent of regulation? Why or why not?

Practice Question: What are the different classifications of issuers of securities?

What is an issuer allowed to do during the “Pre-Filing Period” (and the exceptions)?

During the pre-filing period, no offers to sell or offers to buy securities are permitted. There is a limited exception to this rule under SEC Rule 135, which allows for the announcement of an upcoming offer. The issuer can have discussions with underwriters or with an underwriting syndicate. This allows the company to undertake the procedural arrangements and financing of the offering. In any event, the communications or announcement of the upcoming offer cannot have the purpose or effect of “conditioning of the market”. That is, it cannot cause a market reaction for the pending IPO that is commensurate with the effect of an actual offering. This is a poorly defined standard, which does not provide a great deal of guidance to issuers. There are some other notable exceptions to the general prohibition against offers to sell during the pre-filing period that are worthy of note.

Emerging Market Company Exception – The JOBS act makes an exception and eliminates the “conditioning the market” restriction for “emerging market companies”. So, if a company meets the criteria to be an emerging market company, the announcement of the upcoming issuance faces few limitations aside from waiting to consummate the sale until the post-effective period.

Section 5(b) Exception – This provision allows oral or written communication with qualified institutional buyers (QIBs) and accredited investors that are institutions, prior to filing of the registration statement. This is a limited exception that allows issuers with connections with potential purchasers who have the knowledge and sophistication that warrants a lower level of protection under the securities laws.

Public Company Exception – Public filers can (must) continue their periodic disclosure (quarterly and annual reports) and Rule 168 permits forward-looking information. This means that a public company that is planning to issue more securities on the market must disclose this intended action to the market and existing shareholders. The prohibition against conditioning the market is trumped by the need for full disclosure.

Free-Writing Prospectus Exception – Under Rule 163, WKSIs can use a “free-writing prospectus” during the pre-filing period, so long as it is filed with SEC prior to distribution. Per Rule 405, a free-writing prospectus is a written communication (including electronic/graphic) that constitutes an “offer to sell” that does not fall under a statutorily defined format (such as preliminary prospectus defined in section 10(b) or Rule 430 “red herring” prospectus).

There are other limited exceptions to the ability to make offers of securities at the pre-filing stage; however, these are the most commonly recognized.

Discussion: What do you think is the reason for restricting the sale of securities prior to filing a registration statement? Do you think that requiring the filing of a registration statement achieves the underlying objectives? Why or why not? Why do you think the securities law allows for these exceptions?

Practice Question: What are the limitations on an issuer of securities prior to filing a registration statement? What are the primary exemptions from these limitations?

What are the limitations on an issuer during the “Post-Filing Waiting Period”?

During the post-registration, waiting period, special rules apply to the general dissemination of information about the issuance. Generally, oral discussions or offers to buy the securities are unregulated. This allows investment banks to carry on a “road show”, which is a concerted effort by the bank to build a book of subscribers for the security issuance. Written offers to sell (or other solicitations) must be accompanied by a prospectus that meets statutory standards for disclosure. Anyone submitting a written request to purchase must receive a prospectus that has been reviewed and approved by the SEC. No actual sales can occur until the registration statement “goes effective” for any issuer.

Note: One notable exception under Rules 164 and 433, seasoned issuers and WKSI can use a free-writing prospectus, so long as it contains information on where to get the statutory prospectus. Unseasoned issuers and non-reporting issuers (IPO filers) can use free writing so long as accompanied by statutorily approved prospectus.

Discussion: Why do you think the securities laws closely regulate written disseminations of information during the post-filing period? Why do you think these are treated differently than oral communications? Should there be a free-writing prospectus exception for certain issuers? Why or why not?

Practice Question: ABC Corp is a well-known, seasoned issuer. It has made the registration statement with the SEC and is awaiting approval. Jamie is an investor and approaches ABC Corp (through its representative) with a written request to purchase a large block of shares. If ABC Corp chooses to respond to Jamie’s inquiry with any information about the issuance, what are its obligations and limitations?

What is an issuer allowed to do during the “Post-Effective Period”?

During the Post-Effective Period, the issuer can begin selling securities. The issuer must still deliver a statutorily prescribed prospectus to offerees. Additional rules benefiting WKSIs exist during this stage that allow for an automatic “shelf registration”. Shelf registration is the pre-registration of securities that will not be issued until a later date. This can be useful when the business plans for multiple stages of funding over a period of time.

Discussion: Why do you think the securities laws are less restrictive on communications by issuers following the post-effective period? Should there be any continued regulation (beyond the requirement to provide purchasers with a prospectus) following the post-effective date?

What is an “Emerging Growth Company” and why is it important?

An emerging growth company (EGC) is any company that meets the following requirements:

• the company has less that $1billion or more of total gross revenue in a consecutive 12-month period;

• is within 5 years of its original IPO;

• the company cannot have issued more than $1 billion in non-convertible bonds within the last 3 years, and

• the company does not qualify as a “large accelerated filer”, meaning a public float of over $700 million.

Status as an emerging growth company provides a number of benefits to the company with regard to security laws and regulation.

Confidentiality – An EGC may make confidential submission to SEC of a preliminary prospectus prior to the public filing with SEC. This gives the SEC an opportunity to review the prospectus and maintains confidentiality about the securities issuance.

Note: Eventually this draft and all amendments must be filed public with the SEC at least 21 days prior to underwriters commencing a road show.

Unregulated Communications – An EGC may have unregulated oral or written communications with qualified institutional buyers and accredited investors. This effectively allows the EGC to “test the waters” before the preliminary prospectus is filed with SEC.

Note: This is a big difference from non-EGC companies that must file the preliminary prospectus with the SEC before discussions/selling efforts could begin.

Audited Financial Statements – The EGC must produce 2 years of audited financial statements with the registration statement.

Note: Non-EGC companies are required to submit 3 years of audited statements.

Security Analyst Reports – Securities analysts will be permitted to freely publish research reports about companies about to issue securities.

Note: Securities analysts generally do not have access to information from non-public company. Disclosing this information to the public could be seen as conditioning the market for the issuance, which is prohibited for non-EGC companies. This benefit is so broad as to allows companies participating in underwriting process to publish an analyst report.

Accounting Standards – Exemption from new or revised accounting standards.

Note: This can reduce the cost of updating disclosures of financial documents based upon new or revised accounting procedures.

Auditor Exemptions – The EGC is exempt from compliance with PCAOB rules requiring mandatory rotation of external firms auditing the company. Further, the company executives are not required to produce an auditor attestation of internal controls under section 404(b) of SOX of 2002.

Note: Smaller companies generally do not have the funds or resources to rotate auditing firms or verify compliance with SOX.

Executive Compensation Rights – EGC companies are exempt from many requirements to disclose executive compensation. Also, EGC companies are exempt from “say-on-pay” vote requirements placed on non-EGC companies by securities laws. Say-on-pay rights allow shareholders to vote to approve the compensation of executives of the business.

Given the benefits associated with EGC status, companies are apt to monitor their growth and plan for the effects of losing EGC status.

Discussion: Why do you think Congress established the category of Emerging Growth Company and provided the above-referenced benefits? Can you think of any other factors that should be considered in categorizing a company as an EGC? Which of the state exemptions do you see as the greatest benefit to EGCs?

Practice Question: What are the requirements to qualify as an emerging growth company? What advantages does this designation provide to the company?

What type of information must an issuer disclose?

Securities laws intend to protect individuals from financial loss due to a lack of understanding of the risk associated with an investment or intentional fraudulent activity by an issuer. As such, the SEC requires that anyone offering to sell securities disclose certain “material” information about the venture to prospective purchasers. The disclosure requirements vary with the type of investor and the amount and context of the security offering. Courts have held that “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”

Note: The “total mix” is inherently fact specific. It also raises questions about who is the reasonable investor.

Discussion: Why do you think the law focuses on the disclosure of only material information? How do you feel about the subjective determination of what information is material?

Practice Question: What standard will a court apply in determining whether an issuer of securities has complied with its duty of disclosure?

What laws govern the mechanics of disclosure of information in a securities offering?

Regulation S-K is an SEC promulgated regulation that applies to new issuances under the ’33 Act and subsequent sale or transfer of securities under the ’34 Act. This regulates the specific types of information that an issuer must disclose to the public. The primary disclosure statement in an IPO is the registration statement (Forms S-1 and S-3 for Securities Act (33 Act)). Publicly-traded companies are subject to Schedule 14A (requiring disclosure of proxy statements). Public companies are also subject to continued reporting by filing form 10-K, 10-Q, 8-K for ’34 Act.

Note: The disclosure requirements are often extensive and difficult for companies to manage.

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