II. RECOMMENDATIONS OF THE ADVISORY COMMITTEE A. Reasons for the Recommendations and Anticipated Benefits 1. General Statement of Committee's Recommendation to Shift From a Transactional Registration System to a Company Registration System In the Committee's view, the U.S. capital markets are deep, liquid, efficient and reliable and, overall, the U.S. regulatory system for securities offerings works relatively well. While concluding that the system is not broken, the Committee believes that there is room for improvement. In the words of one member, "some fixing would make the system work even better."-[1]- The fact that the primary equity markets have not demonstrated any long-term upward trend as a source of capital since 1933, despite the fact that real Gross Domestic Product has tripled during that period,-[2]- amply justifies an inquiry into possible regulatory inefficiencies. In this regard, the Committee identified various uncertainties, complexities and anomalies in the current transactional system that unduly burden capital formation for issuers without providing significant ---------FOOTNOTES---------- -[1]- Transcript of May 8, 1995 Advisory Committee meeting at 155 (statement of Dr. Burton Malkiel). Indeed, as noted by one commenter, the "strength of our current capital markets serves as a testament to the existing securities legislation, related regulations, and interpretations." Documents for Advisory Committee Meeting, May 8, 1995, Tab I (Letter dated April 10, 1995 from Michael A. Conway, Senior Partner, KPMG Peat Marwick LLP to the Committee). -[2]- See Figures 1 and 2 in the Addendum to Appendix A of the Report. ==========================================START OF PAGE 2====== offsetting benefits to investors, and other anomalies that operate to deny needed investor protections. Although recognizing the past and ongoing efforts of the Commission to address these concerns through incremental regulatory reform, the Committee strongly believes that the time has come for a fundamental conceptual change in the scheme of regulation governing public offerings.-[3]- The Committee views a shift to company registration as the most logical culmination of the evolving recognition over the past thirty years by the Commission, commentators, the courts and market participants, of the need for reform. Specifically, it has long been recognized that a disclosure scheme dependent on infrequent, unpredictable and episodic offering transactions to provide continuous and current, high quality disclosure to investors and the public markets is not optimal. Stated differently, a regulatory structure that focuses on such transactions is neither efficient nor does it necessarily serve ---------FOOTNOTES---------- -[3]- A number of expert commentators similarly have called for fundamental reform of the current regulatory system. See, e.g., Roberta Karmel, Is Section 5 an Anachronism?, N.Y.L.J., December 21, 1995, at 3; John C. Coffee, Jr., Is the Securities Act of 1933 Obsolete? The SEC Increasingly Appears to Believe So But Has Not Yet Adopted a Consistent Policy to Replace It, Nat'l L. J., September 4, 1995, at B4; Gerald S. Backman and Stephen E. Kim, A Cure for Securities Act Metaphysics: Integrated Registration, INSIGHTS, May 1995, at 18; Joseph McLaughlin, 1933 Act's Registration Provisions: Is Time Ripe for Repealing Them?, Nat'l L. J., August 18, 1986, at 44. ==========================================START OF PAGE 3====== the public interest well, especially in light of the relative size -- 35 times larger -- of the equity trading markets (approximately $5.5 trillion dollars in 1995) as compared to the primary markets (approximately only $155 billion in 1995).-[4]- If the regulatory focus is shifted to a company registration model that would replace the transactional registration requirements, issuers would benefit from the elimination of the increasingly complex, but often ineffective, series of regulations and concepts fashioned over the years to preserve those transactional requirements. Eligible companies would have easier access to the capital markets with lower regulatory and transaction costs, enabling companies to tap the equity markets far more often than they do now. Equally as important, adoption of a company registration system would allow the Commission to eliminate those anomalies under the current system that function to deny investors the protections originally contemplated by the Securities Act, and to make the necessary adjustments to secondary market disclosure practices and due diligence responsibilities that would benefit investors and provide better continuous disclosures to the markets. The Committee recognized that the task of streamlining and simplifying the current regulatory system would be beneficial. Likewise, enhancing investor protection is always desirable. ---------FOOTNOTES---------- -[4]- See Figure 2 in the Addendum to Appendix A of the Report. ==========================================START OF PAGE 4====== Each of these goals could be accomplished easily at the expense of the other by dispensing with or adding burdens, restrictions, or liability. However, the Committee assumed the far more difficult task of crafting a system that both streamlines and simplifies the offering process, thereby lowering costs, while also enhancing investor protection and the integrity of corporate disclosures. The Committee believes that this company registration model, which would accomplish both goals, is superior to an approach that accomplishes only one. The Committee's approach represents a different concept in regulatory problem-solving -- crafting a whole model -- as opposed to effecting incremental changes to particular regulations. The recommendations of this Committee build upon the work of prior Commission committees and task forces,-[5]- and upon the work of Professor Louis Loss and other members of the American Law Institute in connection with its Federal Securities Code.-[6]- That the time has come to complete the transition to a company registration scheme is underscored by the fact that the ALI Code -- including its centerpiece proposal for ---------FOOTNOTES---------- -[5]- See, e.g., Report of the Advisory Committee on Corporate Disclosure to the Securities and Exchange Commission, 95th Cong., 1st Sess. (Comm. Print 1977) (the "1977 Advisory Committee Report"); Disclosure to Investors, A Reappraisal of Administrative Policies Under the 1933 and 1934 Acts, Report and Recommendations to the SEC from the Disclosure Policy Study (March 27, 1969) (the "Wheat Report"). -[6]- Federal Securities Code (Am. Law Inst.) (1980) (the "ALI Code"). ==========================================START OF PAGE 5====== company registration -- was endorsed by two separate Commissions in 1980 and 1982.-[7]- Experience in the intervening decade has only reinforced the advisability of modernizing the current system. The Committee urges the present Commission to complete the transition to a system of company registration, thereby freeing the markets of the costs, uncertainties and confusion engendered by the current transactional registration scheme. The Commission's ultimate goal should be the implementation of a system of company registration that totally replaces the current transactional registration concept for all reporting companies. In order to test most effectively the feasibility of the company registration model, however, the Committee recommends that the Commission establish a pilot program that would be open initially only to certain "seasoned" issuers on a voluntary basis. The Committee has suggested the general framework of the pilot system, recognizing that the Commission has the expertise to craft the details. As the Commission and issuers gain experience under the new system, it could be refined if necessary and then, with appropriate modifications, be made available to a broader class of issuers. Once the company registration system has sufficiently demonstrated its benefits during the pilot, ---------FOOTNOTES---------- -[7]- Statement Concerning Codification of the Federal Securities Laws, Securities Act Rel. 6377 (January 21, 1982); Statement Concerning Codification of the Federal Securities Laws, Securities Act Rel. 6242 (September 18, 1980). ==========================================START OF PAGE 6====== regulatory simplification could be completed through rulemaking and/or legislative changes, as necessary or appropriate. 2. Identified Problems of the Current Transactional System-[8]- The Committee identified uncertainties, complexities and anomalies in the current transactional registration system that increase costs of capital formation when a public trading market already exists for an issuer's securities and adequate information concerning the issuer is widely disseminated and followed in that market, without providing significant countervailing benefits to investors. These costs are both direct and indirect. a. Procedural Requirements of the Registration Process Statutory limitations and regulatory restrictions on solicitation activities prior to and during the registration process make it difficult for reporting companies to distinguish between permitted and prohibited market communications. Companies and other offering participants therefore have limited their ordinary-course market communications unnecessarily when contemplating or conducting a public offering. In the event of improper soliciting activities (called "gun-jumping"), the Commission may delay an offering, resulting in a possible loss of a temporary market opportunity. The ability of an issuer to ---------FOOTNOTES---------- -[8]- For a more in-depth discussion of the issues outlined in this section, see Appendix A to the Report. ==========================================START OF PAGE 7====== control the timing of its public offering, and therefore its ability to take advantage of a favorable market opportunity, also is affected by both the uncertainty of selection of its registration statement for Commission staff review and the length of the resultant delay if so selected. This uncertainty continues to impact even those companies eligible to register securities under the shelf registration system, who may wish to make immediate offerings, or "takedowns," after filing the shelf registration statement, but who must wait until any possible staff review of the registration statement is complete, before takedown is permitted. In addition, the mandatory nature of the prospectus delivery obligation in connection with a registered offering under the current system restricts the ability of the issuer to tailor the required document to suit the varying needs of prospective investors. Moreover, and perhaps more importantly, prospectus disclosure under the current system frequently is not even received by investors until after an investment decision is made. This anomaly defeats the primary purpose of mandated prospectus delivery -- that investors receive all information material to an investment decision before making that decision. Similarly, under the current system, the prospectus supplement is not required to be filed with the Commission until two days after it is delivered to investors in the primary offering. Although the purchasers may have received key pricing and other transactional information orally from participating ==========================================START OF PAGE 8====== broker-dealers at the time of takedown, the market frequently does not have the information contained in the prospectus supplement until days after completion of the shelf offering. Thus, investors trading in the secondary markets contemporaneously with a shelf offering do not have equal access to material information until after their trading decision is made, even though their investment decision takes place at the same time as the primary offering. Perhaps more importantly, one of the central tenets of the current shelf process -- namely the existence of an efficient market for the issuer's securities that helps establish the price for those securities -- is violated because the market does not have timely access to this prospectus supplement information. Consequently, to the extent the market is being relied upon to help set the price for the primary offering, it is being denied the full information it needs to do so. This disparity in the regulatory system exists because, under the current transactional registration system, the focus is on information given to purchasers in the offering, not the market. Under the company- focused approach, by contrast, there is a greater concern for the quality and timeliness of information available to the market and all investors. Further driving the need to reassess this process is the development of new technologies that are changing rapidly the way in which information is communicated and disseminated in our markets. Present and future changes in technology, particularly ==========================================START OF PAGE 9====== in light of the advent of T+3 clearance and settlement, electronic dissemination of offering documents, and the development of trading markets over the Internet, can only continue to challenge the current system. Finally, the registration process itself imposes direct expenses on an issuer in the form of legal, accounting, underwriting, printing and filing fees, as well as indirect costs due to the effects of market overhang and short-selling and related activities on the market price of an issuer's securities traded in the secondary markets. Under a company registration system that allows "just-in-time" financing techniques, these costs should be reduced. ==========================================START OF PAGE 10====== b. Technical Distinctions and Concepts Designed to Protect the Integrity of the Transactional Registration Paradigm While originally devised to prevent evasion of the transactional registration requirements, the technical distinctions and concepts developed by regulation and/or interpretation over the years -- such as "restricted" securities, integration of offerings and limitations on general solicitations -- have added a significant degree of confusion and uncertainty, as well as constraints and costs, to the capital formation process. These concepts and requirements increasingly have been condemned as "metaphysics,"-[9]- and are among the reasons why issuers often offer securities in the private and offshore markets. Public companies that today wish to avoid the disadvantages of the current registration scheme currently bear the burden of an illiquidity discount in private placements of securities or the additional logistical burdens of an overseas offering. In the case of seasoned companies, these restrictive concepts have limited practical or economic substance in terms of investor protection. Given that they drive seasoned companies to markets where there are in fact little or no Securities Act investor protections, these concepts are increasingly difficult to defend on a legal, economic or investor protection basis. ---------FOOTNOTES---------- -[9]- See, e.g., Stanley Keller, Basic Securities Act Concepts Revisited, INSIGHTS, May 1995, at 5; Gerald S. Backman and Stephen E. Kim, A Cure for Securities Act Metaphysics: Integrated Registration, INSIGHTS, May 1995, at 18. ==========================================START OF PAGE 11====== c. Changes in the Markets and Offering Processes, and the Effect on Investor Protection While the public, private and offshore markets are still treated as technically distinct and separate markets under the Securities Act, the traditional boundaries between and among such markets have increasingly become blurred and distorted by technological advances and evolving trading practices. The Committee questions whether the regulatory distinctions drawn between and among these markets should, or can, be maintained for seasoned issuers. Through the use of such strategies as hedging techniques, equity forwards, and equity swaps, and so-called "A/B exchange offers" and "PIPE" transactions-[10]- that the Committee believes promote form over substance, the vital investor protection concepts underpinning the Securities Act are losing their effectiveness. Simply put, through these techniques, issuers in essence can engage in public offerings without providing investors with the benefits and remedies of the Securities Act at the time of the investment decision. The nature of our securities markets has changed dramatically over the last sixty years. The rate of change has been even more striking in the last two decades. In the Committee's view, the statutory schemes first enacted in 1933 and ---------FOOTNOTES---------- -[10]- For an explanation of these devices and additional information regarding the blurring of public, private, domestic and offshore markets and the consequent effects on investor protection, see Appendix A to the Report at p. 38-45. ==========================================START OF PAGE 12====== 1934 were well adapted to the markets of the time.-[11]- Sixty years ago, the secondary trading markets for equity were far smaller and less active than they are today -- only a few times the size of the primary markets, as opposed to 35 times today -- and there were few mechanisms for the general public to make investments other than through the direct purchase of corporate shares in primary offerings. Since then, trends such as the growth in the secondary trading markets for equity relative to the primary issuance market, the general shift of retail investor participation from the primary markets to the secondary markets, and the increasing institutionalization of the markets for both debt and equity, have called into question whether the current statutory provisions of the Securities Act continue to protect investors as efficiently and effectively as possible. In addition, ---------FOOTNOTES---------- -[11]- For example, during the 1930s and 1940s, on average, the number of registration statements declared effective on a yearly basis was approximately 400 as compared to over 8,000 today (including all registration forms). Annual Report of the Securities and Exchange Commission for the fiscal years 1935 through 1950; Division of Corporation Finance data. In the past, companies tapped the equity markets only when necessary because costs were extremely high. Prospectuses, even for the most seasoned issuers, were fully stand-alone documents presenting an entire picture of a company, without incorporation by reference to other disclosure documents. Offerings frequently took months to complete, and the process for seasoned issuers was not very different from the process for an initial public offering. Moreover, the SEC Commissioners themselves would actually meet to review the few registration statements that were submitted each week and provide written comments on the disclosure presented in the registration statement. ==========================================START OF PAGE 13====== evolutionary changes in the rules governing the offering process made by the Commission over time to facilitate issuer access to the markets, including the increased reliance on Exchange Act reports to satisfy many core Securities Act disclosure requirements, the adoption of shelf registration for primary offerings and the timing of prospectus delivery, may be impairing the ability of issuers' boards of directors, underwriters and independent accounting firms to perform their traditional Securities Act "due diligence." 3. Company Registration as the Logical Conclusion of Evolutionary Change in the Regulatory Process Past initiatives demonstrate that, while also enhancing investor protection, cost savings can be anticipated from a transition to a company registration system. In this regard, the Committee does not write on a blank slate. Almost thirty years ago, Milton Cohen described the need for a dramatic transformation in focus and thinking regarding the regulatory structure of the federal securities laws, when he wrote: [i]t is my thesis that the combined disclosure requirements of [the Securities Act and the Exchange Act] would have been quite different if the [Acts] had been enacted in opposite order, or had been enacted as a single, integrated statute -- that is, if the starting point had been a statutory scheme of continuous disclosures covering issuers of actively traded securities and the question of special disclosures in connection with public offerings had then been faced in this setting. Accordingly, it is my plea that there now be created a new coordinated disclosure system having as its basis the continuous disclosure system of the [Exchange] Act and treating ==========================================START OF PAGE 14====== "[Securities] Act" disclosure needs on this foundation.-[12]- Further suggestions regarding the integration of the disclosure and regulatory schemes of the Securities Act and Exchange Act -- actions moving towards a company registration model -- were raised in the 1969 Wheat Report,-[13]- the 1977 recommendations of the SEC's Advisory Committee on Corporate Disclosure,-[14]- and the ALI Code.-[15]- As a result, the integrated disclosure system and the shelf registration process were implemented by the Commission in the early 1980s, and have now firmly taken hold and demonstrated their benefits. Moreover, with the adoption of Rule 144A in 1990, the Commission began the development of a limited institutional trading market in certain restricted securities, thereby permitting greater liquidity and a lower illiquidity discount, and consequently reducing the regulatory costs imposed by resale restrictions on these securities. Similar to public offerings, Rule 144A placements generally are conducted with the assistance of investment banking firms. In addition, Rule 144A placements often involve the use of detailed offering circulars making ---------FOOTNOTES---------- -[12]- Milton H. Cohen, "Truth in Securities" Revisited, 79 Harv. L. Rev. 1340, 1341 - 1342 (1966). -[13]- Wheat Report, supra n.5. -[14]- 1977 Advisory Committee Report, supra n.5. -[15]- ALI Code, supra n.6. ==========================================START OF PAGE 15====== extensive disclosures regarding the offering as well as the company and its financial condition. This is the case even though there are no explicit Commission-mandated disclosure requirements applicable in a Rule 144A placement.-[16]- Due to the innovative ideas of integrated disclosure (including incorporation by reference), short-form shelf registration and Rule 144A, offerings today can be conducted on a more cost-efficient basis than under the traditional model for underwritten public offerings: Under the current selective review system, the majority of registration statements relating to public offerings by seasoned issuers are not reviewed by the Commission's staff prior to effectiveness. Moreover, in the case of primary shelf offerings, the information contained in prospectus supplements is never required to be pre-reviewed by the staff prior to the takedown of securities from the shelf. A shelf registration statement need not describe in advance a specific contemplated offering. Since 1992, issuers have been able to complete an offering under a universal shelf registration statement that simultaneously registers an unspecified amount of each enumerated type of security registered, subject only to the unallocated total dollar amount of securities being registered and a presumed two-year limit on the amount reasonably expected to be offered. The traditional methods of prospectus delivery are not necessary in connection with all public offerings. Today, in the case of offerings by seasoned issuers, much of the crucial company-related information is incorporated by reference from the company's filed reports, rather than physically delivered to investors as part of the prospectus. The success of the Rule 144A institutional market evidences that an active primary issuance market can ---------FOOTNOTES---------- -[16]- Of course, the general antifraud provisions of the federal securities laws still apply. ==========================================START OF PAGE 16====== develop, with procedures and disclosure documents delivered to investors that better suit their needs, in the absence of a mandated Securities Act transactional registration process, and disclosure delivery requirements. That the Commission already has travelled so far from the original transactional disclosure model does not imply, however, that there is nothing more to be done to enhance investor protection and facilitate capital formation. It should be noted that, at each phase in the development of the current system, this country's securities markets were functioning well and were the deepest, most liquid and largest of any in the world. With each transition to a new phase, the markets improved. The favorable experience with these reforms illustrates that issuers, under the proper conditions, can be freed from many of the constraints of the transactional registration process not only without undermining the Securities Act's investor protection goals but also, if appropriately and thoughtfully done, by better satisfying them. The overall success of the current integrated disclosure and shelf offering systems, and the Rule 144A market, provides the Commission with a solid foundation for making additional improvements to facilitate issuer access to the U.S. public markets consistent with these goals. 4. The Benefits of the Company Registration System as Compared to the Current Transactional Regulatory System The reforms that would be instituted under the proposed company registration system are part of this ongoing evolutionary process. Transactions under company registration would not ==========================================START OF PAGE 17====== differ significantly from transactions under the current universal shelf system, in the sense that the issuer in advance of an offering need only describe its financing plans in general terms, and would not be subject to a separate registration process and staff review when it wishes to proceed to market. There will, however, be significant advantages for the issuer and its shareholders over the current shelf system because the company registration system essentially will make the Form C-1 the equivalent of a shelf registration statement that is applicable on a continuous basis for all future offerings. The various elements of company registration that will effect this change include the pay-as-you-go fee system, the elimination of the need to register a specified amount of securities in advance (which should alleviate the concerns regarding equity market overhang that persist notwithstanding the adoption of the unallocated or "universal" shelf procedure), as well as the extension of the streamlined offering process to most acquisitions. Smaller, more frequent, offerings likewise will be facilitated by the simplicity and ease of the company registration system. In addition, elimination of current restrictions on at-the-market equity offerings will eliminate the lingering confusion surrounding this concept. Moreover, issuers should realize significant cost savings as a result of the more flexible prospectus delivery requirements, while maintaining, and even enhancing, the nature and amount of disclosure on file with the Commission and hence disclosed to the ==========================================START OF PAGE 18====== markets at the time of sale. Finally, the full company registration system eliminates the unnecessary application of resale restrictions on most directors and officers. Company registration also would offer issuers and investors significant advantages over Rule 144A: all the speed and predictability of a Rule 144A offering; no illiquidity discount, which generally now attaches to restricted (unregistered) securities; offering not limited to a prescribed class of qualified institutional buyers; offered securities not limited by fungibility restrictions; satisfaction of investor demand for registered securities; investors afforded the Securities Act protections of a registered transaction; and avoidance of uncertainties arising from potential integration with non-144A offerings. Unlike the current shelf rule and even Rule 144A, full implementation of a company registration model would simplify the complex regulatory quilt of rules and doctrines that has been patched together in an effort to preserve the transactional focus of the existing regulatory scheme and its core registration requirement. Thus, the need to superimpose legal distinctions on economically indistinct markets would be eliminated. At the same time, and as important, company registration would provide an opportunity to buttress the fundamental investor protections that have come under increasing stress as the markets have experimented with more efficient offering methods, some of ==========================================START OF PAGE 19====== which are outside the scope of the Securities Act altogether. As efforts have been made to accommodate demands for more flexibility under the current system, and as issuers and other sellers of securities have found mechanisms to utilize exemptions and jurisdictional limitations under the current system because they find its requirements too burdensome, the core protections of the current system have begun to erode.-[17]- By contrast, with a rationalized, streamlined and cost effective regulatory process in place, the incentive for issuers to utilize jurisdictional or other means to escape the Securities Act should be substantially diminished. Concomitantly, the opportunity is presented to reinstate and provide for better investor protections. At base, by reducing unnecessary costs of complying with the registration requirements of the Securities Act, the Committee expects that more issuers will register more offerings, thereby extending the benefits of the Securities Act to more investors. Company registration also will further the longstanding Commission goal of improving the quality and reliability of information disseminated by public corporations on an ongoing basis to a level comparable to that traditionally provided in primary offerings.-[18]- Disclosure will be required on an ---------FOOTNOTES---------- -[17]- See p. 36-54 of Appendix A to the Report for more detail. -[18]- As Milton Cohen observed in 1985, "[d]isclosures for [Exchange] Act purposes still tend to be taken less seriously, and to be of lower quality, than (continued...) ==========================================START OF PAGE 20====== Exchange Act Form 8-K of transactional information and material developments at the time of virtually all equity offerings. This requirement also will ensure full availability to investors of Securities Act (as well as Rule 10b-5) remedies for material deficiencies in that information, facilitate the due diligence efforts of underwriters and other participants in the offering, and provide material information regarding the issuer and the transaction to the markets earlier than under the current system. Reordering and rationalizing the various gatekeeping or monitoring functions to provide greater oversight of the issuer's disclosures on an ongoing basis will be accomplished through the provision of more detailed and explicit guidance regarding the due diligence and reasonable care defenses of certain gatekeepers under Sections 11 and 12(a)(2) of the Securities Act. Such guidance should encourage companies to adopt interim reviews of financial information by outside auditors, a disclosure committee of the board to perform continuous oversight of the disclosure process, and various other measures. In addition, the flexibility company registration provides to issuers to tailor offering materials to the needs of ---------FOOTNOTES---------- -[18]-(...continued) those historically provided, and still aspired to, under the [Securities] Act despite the advent in 1982 of incorporation by reference of Exchange Act reports into Securities Act registration statements." Milton H. Cohen, The Integrated Disclosure System -- Unfinished Business, 40 Bus. Law. 987, 992 (1985). ==========================================START OF PAGE 21====== investors, including putting them in plain English, will result in those documents being more readable and more informative, just as "profile prospectuses" in the mutual fund industry are more readable. Thus, company registration complements well, and furthers, the potential application of the Commission's "plain English" initiative. The Committee recognizes that there may be costs associated with an issuer's opting into the pilot, particularly in connection with the adoption of the recommended disclosure enhancements discussed below. In the Committee's view, however, issuers should embrace both the mandatory and voluntary disclosure enhancements because they reflect better practices, should help reduce the potential for litigation based on material misstatements or omissions, and will, in the long run, result in lower costs to the issuer when it proceeds to market. Because participation in a company registration system would be voluntary during the pilot, companies would be free to make their own judgments whether the benefits of more efficient and less costly access to capital pursuant to the company registration system outweigh any attendant costs. B. Key Elements of the Recommendations The following is a summary of the basic recommended features of the company registration system and pilot, as well as the Disclosure Committee proposal. A full description of the specific elements of the pilot is provided in Appendix B and in the Term Sheet. ==========================================START OF PAGE 22====== 1. The Offering Process. The basic principle of a company registration system is that the regulatory process is company- based, rather than transaction-based. Once meeting eligibility standards, companies would register with the Commission. To become company-registered, an eligible company would file a Form C-1 registration statement, much like the current process for registering a class of securities under the Exchange Act, and also disclose its plans to sell securities from time to time in the indefinite future on a company-registered basis. Much like today, companies also would file Exchange Act reports, which would automatically be incorporated into the Form C-1, and the information in the company's public file would then form the primary basis for decisions by the investing public with respect to a registered company's securities. Only a nominal registration fee would be paid when the company is first registered. The issuer would pay a full registration fee at the time of sale based on the amount of securities to be sold. In effect, this process would create a "pay-as-you-go" system somewhat similar to that now available to open-end investment companies registered under the Investment Company Act of 1940. Under a full company registration system, once a company is registered and filing periodic and current reports, most routine sales and resales of the company's securities would be consummated immediately without any additional Commission staff review prior to the sale of the security, just as is the case ==========================================START OF PAGE 23====== today for takedowns from a shelf, and would be based primarily upon the information contained in the company's updated Exchange Act disclosure file. All subsequent sales of covered securities by registered companies and their affiliates (outside Rule 144) would be deemed to be covered by the registration statement, and thus would be registered for purposes of the Securities Act. All purchasers of securities from the issuer or its affiliates, regardless of the nature of the transaction, thus would receive freely tradeable securities, as well as the benefit of all statutory remedies that now attach to information disseminated in connection with a registered offering of securities. Therefore, investor protection would be enhanced and extended to a broader class of transactions, while the need for concepts such as gun- jumping and restricted securities would be eliminated. At the time of each offering, the issuer would file with the Commission material information relating to both the specific offering, as well any material updates to the filed company- related information that has not already been disclosed in its filings at the time of the transaction. In the case of non- convertible debt and de minimis equity offerings, that information could be filed by the issuer with the Commission on a Form 8-K or, a prospectus supplement, and the registration fee for the specific offering would be paid. In the case of an equity offering over a de minimis threshold (e.g., more than three percent of the public float of the security in any three business day period), this information must be filed on a Form 8- ==========================================START OF PAGE 24====== K, rather than merely in a prospectus supplement, on a date no later than the date of the first sale. This Form 8-K transactional filing, which is not required today for takedowns from a shelf registration, will ensure that this important information is incorporated into the registration statement and thus within the coverage of Section 11 liability, and facilitate the due diligence inquiries of underwriters and other gatekeepers, thereby improving the quality of the disclosure made to investors in both the primary and secondary trading markets. The Committee also recommends that, during the pilot, this Form 8-K filing requirement be applied to all non-de minimis equity offerings utilizing the current shelf registration process. In further distinction to the current system, where a Form 8-K is required to be filed or is voluntarily filed for the purposes of the incorporation by reference method of prospectus delivery (as discussed more fully below), any information that is material company-related disclosure (including, where necessary, an updated Management's Discussion and Analysis) that is not yet in the public file would be required to be filed some period of time before the sale (which could be, for example, the same day as, or one to three business days before, the transaction, depending on the issuer and the information) to provide an adequate opportunity for the market to absorb the information. (The transactional information, however, normally need not be filed until the day of sale.) The company registration system thereby corrects a clear infirmity in the current system, ==========================================START OF PAGE 25====== especially where transactions with purchasers are priced on the basis of the current market price of the issuer's securities. The filing requirements regarding an auditor's consent to the use of its report in connection with the issuer's financial statements would remain unchanged from those followed today with respect to primary shelf offerings.-[19]- Thus, company registration would enhance the timeliness, quality, and level of information about companies and their offerings that currently is made available to investors and the markets through Commission filings. At the same time, as noted below, company registration would afford companies offering their securities to the public the flexibility to tailor the disclosure documents actually delivered to investors to the nature of the transaction and the demands of the offering participants. 2. Prospectus Delivery Requirement. In routine offerings, issuers would have greater flexibility with respect to the delivery of both the company-related and transactional information mandated in a public offering. This flexibility regarding the delivery of information to investors is in contrast to the filing of disclosure documents with the Commission: those filed documents will be subject to the same Securities Act content requirements but, in many instances, will be filed on an accelerated basis. Rather than imposing formal, full-fledged delivery requirements in connection with all issuances of ---------FOOTNOTES---------- -[19]- See p. 24-28 of Appendix B to the Report. ==========================================START OF PAGE 26====== securities to the public, the appropriate style and level of company and transactional disclosure that physically would be delivered to investors would be determined in most offerings by considerations relating to informational demands of participants in the particular offering, thereby facilitating more useful and more readable ("plain English") disclosure. Specifically, in routine offerings under company registration, where physical delivery of a traditional prospectus would not be mandated because the requisite information has been filed on a Form 8-K and may be incorporated by reference and constructively delivered, issuers and underwriters would be free to decide whether to use some form of a formal prospectus and what information to disclose in that prospectus if used.-[20]- The Committee expects that the information that actually is delivered to investors in the form of a term sheet, selling materials or a more formal prospectus, would be the information that the issuer deems most relevant and material to the investment decision. Because all mandated company and transactional disclosure must be filed with the Commission and made part of the registration statement, strict liability will attach to this information. To the extent an issuer elects to ---------FOOTNOTES---------- -[20]- Just as under the current system, to the extent that disclosure made in any delivered document might be rendered misleading by the omission of information contained only in documents filed with the Commission, such as the transactional Form 8- K, the delivered documents must include such information. See p. 17-18 to Appendix B of the Report. ==========================================START OF PAGE 27====== use selling material without delivering a statutory prospectus, those materials that ordinarily would not be filed at all and would have only Rule 10b-5 liability, will now be filed and have Section 12(a)(2) liability. As is the case with the takedown prospectus supplement under today's shelf procedures, there would be no prior Commission staff review of any disclosure document prior to the sale of the securities (although the Commission staff may choose to review such a document, as it might any other, in conjunction with a review of the company's disclosure file).-[21]- In those circumstances where the company registration system would continue to mandate formal prospectus delivery, physical delivery of the formal prospectus must be provided to non- accredited investors in sufficient time to influence the investment decision.-[22]- This is in sharp contrast to the current system, where, as noted above, the disclosure ---------FOOTNOTES---------- -[21]- Even in the absence of Commission staff review at the time of the offering, issuers and underwriters still must comply with all other applicable regulatory requirements, e.g., state Blue Sky requirements, exchange and Nasdaq listing requirements, and NASD review of underwriter compensation. -[22]- In these non-routine equity transactions, the prospectus received by the non-accredited investors prior to the sale would be similar to the preliminary prospectus mandated in initial public offerings (cf. Rule 15c2-8 under the Exchange Act [17 CFR 240.15c2-8]) and also routinely disseminated in non-shelf repeat equity offerings where the price-related and other current information often would not be incorporated into the document prior to sale. ==========================================START OF PAGE 28====== document frequently is received by investors at the time of the confirmation of sale -- often days after the investment decision has been made. For purposes of the pilot, the different levels of transactions requiring varying levels of prospectus delivery essentially fall into three tiers. The Commission may wish to consider whether the second tier (Nonroutine Transactions) is necessary and whether it is practicable to require delivery of prospectus information prior to the sale, or whether the system could be simplified by extending the procedure for Routine Transactions to this second tier. ù Routine Transactions (e.g., all offerings of all covered securities, except offerings of voting equity amounting to 20% or more of the existing public float of the security;-[23]- similar limitations on "routine" issuances for other types of securities could possibly be adopted as well)(This category established for prospectus delivery purposes encompasses the de minimis equity and other types of offerings that are exempt from the mandatory Form 8-K filing requirement.) The issuer could continue to use traditional prospectus delivery. In the alternative, the issuer may incorporate by reference any publicly filed information into a document serving as the prospectus, such as the confirmation of sale or selling materials. Issuers would file transactional and updating disclosure with the Commission on a Form 8-K and incorporate this information as well as any other ---------FOOTNOTES---------- -[23]- Based on data from 1992-1994, approximately 70% of all firm commitment common equity offerings would be deemed routine under this threshold. See Figure 6 in the Addendum to Appendix A of the Report. ==========================================START OF PAGE 29====== necessary information in other filed reports.-[24]- Much like under shelf registration today, the disclosure incorporated by reference need not be repeated in the document serving as the prospectus. All mandated disclosure, including transactional disclosure, may be incorporated by reference from Exchange Act reports, a more flexible standard than under the current shelf registration system where transactional disclosure may not be incorporated by reference and must actually be delivered (albeit frequently after the investment decision has already been made). If the issuer wishes to use selling materials without having delivered a formal prospectus, the issuer would simply incorporate by reference into those selling materials the transactional disclosure and any material company-related updating disclosure (i.e., the disclosure currently required under shelf registration to be delivered in a formal prospectus) as well as all of the Exchange Act reports on file. The selling materials then would be treated as the statutory prospectus, including for liability purposes. This new flexibility to use abbreviated selling materials without incurring the obligation to deliver physically a full statutory prospectus will facilitate the development of summary prospectuses and plain-English disclosure documents. ù Non-routine Transactions (e.g., offerings of voting equity amounting to 20% or more of existing public float of the security) The current requirement under shelf registration that transactional information (and any material updating company disclosure not already on file with the Commission) actually be delivered to investors in a formal prospectus (as opposed to incorporated by reference from filed documents) would be retained. Where this more traditional ---------FOOTNOTES---------- -[24]- With respect to the filing requirement, unless the transaction is de minimis, the Form 8-K would be required to be on file in any equity offering regardless of whether the information is incorporated into a document serving as a prospectus. ==========================================START OF PAGE 30====== prospectus is mandated to be delivered to the investor, delivery should be required to be made to investors prior to sale. ø Traditional prospectus delivery may be useful in transactions that would alter significantly the information previously disseminated to the markets and that likely would be accompanied by significant selling efforts. Physical delivery of a prospectus would not be required for accredited investor purchasers. ù Extraordinary Transactions (securities transactions that fundamentally change the nature of the company (e.g., offerings of voting equity amounting to 40% or more of the existing public float of the security)) Traditional prospectus delivery would be mandated as in non-routine transactions. The opportunity for Commission review of the prospectus prior to its use would be retained for this category of transactions. Physical delivery of a prospectus would not be required for accredited investor purchasers. ==========================================START OF PAGE 31====== Company Registration Pilot Matrix--refer to link ==========================================START OF PAGE 32====== 3. Scope. Participation in the company registration pilot would be voluntary and would be limited to a senior class of seasoned issuers, i.e., issuers with a $75 million public float, two years of reporting history, and a class of securities listed on a national securities exchange or traded on the National Market System of the Nasdaq Stock Market. Thus, the current Securities Act transactional system, including specifically, where applicable, Commission staff review of transactional documents prior to the offering, would be retained for all other issuers including for those engaging in initial public offerings. Foreign issuers could participate if they adopt the reporting requirements applicable to domestic companies and otherwise meet the eligibility criteria, including adopting the disclosure enhancements described below. The Committee recommends, however, that the Commission consider whether accommodations should be made for foreign issuers similar to those that permit such issuers to use the shelf today. The extent to which smaller, less seasoned companies could benefit from the system will depend on experience with the pilot and, if otherwise deemed appropriate based on such experience, may require mandating such additional protections as traditional prospectus delivery, greater advance notice for prospective investors of company and transaction information before any offering, or the retention of the potential for staff review of ==========================================START OF PAGE 33====== annual financial information before its use in connection with an offering. A company may opt out of the pilot by withdrawing its Form C-1, but would not be eligible to opt back into the company registration system for a period of two years. For purposes of the pilot, noncompliance with the issuer eligibility conditions or any of the mandatory disclosure enhancements in any material respect would result in the loss of eligibility to make offerings pursuant to the Form C-1 for a two-year period. Moreover, an issuer would have to be current in its reporting obligations at the time of each offering. Under full company registration, all issuances of any covered security by a registered company or its affiliates, including those issuances made for acquisitions, would be afforded the same legal status and carry the same protections as securities registered under the Securities Act today. Accordingly, all securities sold by a registered company would be freely tradeable. Thus, a principal benefit of the comprehensive nature of company registration is that distinctions currently existing between public and nonpublic offerings (with the resultant formalities and restrictive concepts such as gun- jumping and integration) would be eliminated. For example, securities sold overseas by a registered company would be deemed registered to the extent of any flowback of those securities into the United States, providing investors in the United States the ==========================================START OF PAGE 34====== same protections they would have had if the securities had been sold initially in this country. In addition, by thus eliminating the risk of unregistered distributions through the use of conduits, the system also eliminates any need for restrictions on resales by affiliates and statutory underwriters. Consequently, only the Chief Executive Officer and inside directors, as well as holders of 20% of the voting power, or 10% of the voting power with at least one director representative on the board, need be subject to affiliate resale restrictions. Similarly, the statutory underwriter concept would apply only to persons engaged in the business of a broker-dealer (whether or not so registered) who participate in a distribution of securities by a registered company or its affiliates under the Form C-1. At their option, under the pilot, participating companies may elect to continue to conduct offerings not registered under the Securities Act (such as private placements and other transactional exemptions, and offshore offerings under Regulation S) for all types of securities, i.e., "modified company registration." Although the Committee was aware that the addition of a modified company registration option would add complexity, the Committee was concerned that, at this initial stage and until issuers become comfortable with the company registration concept, the loss of the ability to conduct exempt private placement and offshore offerings could be a deterrent to ==========================================START OF PAGE 35====== the voluntary use of the company registration system.-[25]- Therefore, to permit a meaningful test of the company registration concepts during the pilot stage, the Committee believes that issuers should be afforded the option of continuing to conduct nonregistered offerings, while still availing themselves of most of the benefits of the system. Companies could choose either to waive transactional exemptions, or determine to preserve the option to exclude those transactions from the company registration system by using the modified version of this system. Under either approach, however, companies could choose to exclude straight debt securities. If a company chooses to conduct an exempt offering, the securities issued outside the Form C-1 would remain subject to the current concepts of restricted securities, and the resale restrictions and registration requirements applicable to current affiliates and statutory underwriters would remain. Exempt offerings, however, would not be subject to integration with offerings made pursuant to the company registration statement. The benefits resulting from registration, including the issuance of freely tradeable securities in what otherwise would have been a private transaction resulting in restricted securities, should outweigh any additional costs imposed by registering the securities under the system. Illiquidity ---------FOOTNOTES---------- -[25]- Transcript of May 8, 1995 Advisory Committee Meeting at 177 (statements of Professor Coffee). ==========================================START OF PAGE 36====== discounts typically imposed by the market on non-registered securities should be eliminated for all securities issued under the company registration system. As noted, these discounts can range up to 20 percent for equity, compared to 0 basis points market discount for shelf registered equity offerings (5 percent total underwriter spread and fees).-[26]- Also, issuers would ultimately benefit by the reduction or elimination of the costs and uncertainties that today result from complex interpretive concepts and the concomitant need to monitor transactions in restricted securities. 4. Disclosure Enhancements. In the Committee's view, enhancing the quality and reliability of secondary market reports is an integral part of an effective company registration system, because these reports are the cornerstone of the offering disclosures by company-registered issuers. While the Committee does not consider the quality and reliability of the current secondary market disclosure system to be so deficient as to compromise investor protection, the Committee does find that there is room for improvement.-[27]- With registered companies having almost immediate access to the capital markets, new measures are necessary and appropriate to provide assurance regarding the integrity of the disclosure disseminated by those companies on an ongoing basis. For these reasons, the Committee ---------FOOTNOTES---------- -[26]- See p. 37 and Table 1 of Appendix A to the Report. -[27]- See p. 45-49 of Appendix A to the Report. ==========================================START OF PAGE 37====== believes that secondary market disclosures must be improved and enhanced. The Committee recommends that any company registration system adopted by the Commission include a series of procedural disclosure enhancements as part of opting into company registration and remaining in the system. The purpose of these disclosure enhancements is to ensure that those individuals and entities best equipped to guard the integrity of the disclosure provided in the company's filed reports focus increased attention on these disclosures: Top Management Certifications Certification to the Commission (not a filed document) would be required of two of any of the following four officers, attesting that they have reviewed the Form 10-K, the Form 10-Qs and any Form 8-Ks reporting mandated events, but not for voluntarily filed Form 8-Ks, and that they are not aware of any misleading disclosures or omissions: the chief executive officer, chief operating officer, chief financial officer, or chief accounting officer. The attestation would be required upon the filing of each such document with the Commission. Management Report to Audit Committee A report prepared by management and addressed and submitted to the board of directors' audit committee (or its equivalent or the disclosure committee, if adopted and different from the audit committee) describing procedures followed to ensure the integrity of periodic and current reports and procedures instituted to avoid potential insider trading abuses (e.g., any requirement that company insiders clear trades with the issuer's general counsel).-[28]- This report would be ---------FOOTNOTES---------- -[28]- The recommendation that the Report cover procedures to prevent insider trading was suggested to complement the elimination of Form 144 filings by those affiliates (officers and directors) who no longer would be subject to resale restrictions. Those filings were believed to serve as a mechanism to help police improper insider trading. ==========================================START OF PAGE 38====== made public as an exhibit to the Form 10-K; the report need not be resubmitted on a yearly basis if the described procedures are unchanged. Form 8-K Enhancements Expansion of current reporting obligations on Form 8-K under the Exchange Act to mandate disclosure of additional material developments: ø Material modifications to the rights of security holders (current Item 2 of Form 10- Q); ø Resignation or removal of any of the top five executive officers; ø Defaults of senior securities (current Item 3 of Form 10-Q); ø Sales of a significant percentage of the company's outstanding stock (whether in the form of common shares or convertible securities or equity equivalents); ø Issuer advised by independent auditor that reliance on audit report included in previous filings is no longer permissible because of auditor concerns over its report, or issuer seeks to have a different auditor reaudit a period covered by a filed audit report. For the above items that are required now to be filed on a Form 10-Q, the information therefore would be provided on a current, rather than a quarterly, basis. Moreover, the period within which a Form 8-K must be filed following any mandatory event specified in that form would be accelerated from 15 calendar days to 5 business days. Risk Factors Risk factor analysis disclosure requirements to the extent currently required in an issuer's Securities Act filings would be added to the Form 10-K. Voluntary Measures Voluntary measures would be encouraged by the opportunity for various gatekeepers to make the due diligence process more efficient, and would consist of: auditor review of interim financial information either consistent with SAS No. 71 or a more detailed interim audit procedure; auditor review of events subsequent to the date of the audited financial statements that may bear materially on those statements ==========================================START OF PAGE 39====== pursuant to SAS No. 37; opinion letters by auditors pursuant to SAS No. 72 and by issuer's counsel that are provided to underwriters and outside directors in connection with offerings; and the establishment of a "disclosure committee" of outside directors (which could be the existing audit committee). 5. Liability While the Committee evaluated alternative liability schemes in its consideration of the company registration system, the Committee has determined that the company registration model should maintain the current Securities Act liability scheme at least during the pilot stage. The Committee believes that the continued application of the current liability scheme will ensure the maintenance of familiar investor protection concepts during the transition from a transactional- based system to a company-based system. In fact, investor protection would be enhanced under the pilot program. Notably, under the current shelf system, companies deliver transactional information in a traditional prospectus supplement that, although filed with the Commission, is not deemed filed as part of the registration statement. As a consequence, investors are denied the core protections of Section 11 of the Securities Act with respect to this information.-[29]- By contrast, the pilot would expand the scope of the Section 11 protections to these disclosures through its requirement of a Form 8-K filing for non-de minimis equity ---------FOOTNOTES---------- -[29]- See Elimination of Pricing Amendments and Revision of Prospectus Filing Procedures, Securities Act Rel. 6672 ( Oct. 27, 1986)[51 FR 39868 (November 3, 1986)]. ==========================================START OF PAGE 40====== offerings. For companies that fully opt into the system, liability also would be expanded to cover transactions that are not now subject to Section 11 liability, such as the flowback of overseas offerings, private placements and other transactions currently deemed "exempt" offerings. In addition, sales literature that today only receives the protection of Rule 10b-5 would, under many circumstances, receive the enhanced protection of Section 12(a)(2) of the Securities Act. 6. Due Diligence In reaching its conclusion to retain the current Securities Act liability structure, the Committee weighed concerns regarding the due diligence responsibilities of various gatekeepers stemming from the expedited nature of the current shelf registration process, and recognized that company registration could further expedite the offering process. Although the current system expects outside parties to act as gatekeepers in the offering process, in practice and for a variety of reasons, such roles are not necessarily being fulfilled in the manner anticipated when the Securities Act was adopted.-[30]- From the outset, the Committee sought to buttress and strengthen the gatekeepers' roles in protecting investors not only in the context of episodic, transaction- specific oversight, but also, and with increased emphasis, in the context of ongoing oversight by those persons in the best ---------FOOTNOTES---------- -[30]- See ABA Committee on Federal Regulation of Securities, Report of Task Force on Sellers' Due Diligence and Similar Defenses Under the Federal Securities Laws, 48 Bus. Law. 1185 (May 1993). ==========================================START OF PAGE 41====== position to monitor the integrity and accuracy of company disclosures. Separately, proponents of the proposed Form 8-K filing requirement at the time of the transaction asserted that such a filing would help serve to focus and facilitate the due diligence inquiries of underwriters. As part of the adoption of company registration, the Committee recommends that the Commission provide interpretive guidance to gatekeepers as to more effective methods of satisfying the "reasonable investigation" and "reasonable care" standards, respectively, of Sections 11 and 12(a)(2) of the Securities Act. In this regard, the Committee recommends expanding the factors (currently enumerated in Securities Act Rule 176) that may be taken into account by gatekeepers or monitors in determining their appropriate due diligence investigation, to refer specifically to compliance with the mandatory and voluntary procedures outlined in the disclosure enhancements. To the extent that the addition of disclosure enhancements, including voluntary enhancements such as SAS No. 71 reviews by independent auditors, increases the attention paid to the disclosure by those having the best opportunity to monitor the issuer on an ongoing basis, other participants in the gatekeeping process could take such efforts into account when deciding the appropriate level of due diligence needed to be performed in order to satisfy their own statutory duties, and in determining how best to satisfy those duties. ==========================================START OF PAGE 42====== The underwriter thus would continue its pivotal role in ensuring the adequacy of disclosure at the time of the offering by drawing upon all available sources of information concerning the company and assessing the scope of the ongoing reviews conducted by the other gatekeepers in evaluating the appropriate due diligence the underwriters should perform. In this fashion, the Committee has recognized both the practical demands of market participants and the need to maintain the integrity of the disclosure system. If the proposals to enhance and rationalize the due diligence process on an ongoing basis are implemented, the gatekeeping function ultimately should be more effective in protecting investors and in ensuring the integrity of corporate disclosure disseminated to the markets, not only in the context of episodic public offerings, but with respect to continuous secondary market trading as well. This principle is consistent with one of the primary motivating factors underlying a shift towards a company registration model: namely, the tremendous movement during the last few decades in investor transactions from the primary issuance markets to the secondary trading markets. Since only four to six percent of exchange and Nasdaq traded issuers make public offerings of equity in a given year,-[31]- strengthening the gatekeeping function available on a continuous basis provides greatly enhanced protection to investors overall. ---------FOOTNOTES---------- -[31]- See Figure 4 in the Addendum to Appendix A of the Report. ==========================================START OF PAGE 43====== The Committee also urges the Commission to continue exploring means to make the current liability structure more effective and more fair for gatekeepers in light of modern offering practices and techniques. After the Commission gains experience with the company registration offering process under the pilot, the Committee recommends that the Commission revisit the possibility (and the advisability) of providing more concrete guidance to various gatekeepers as to when they may be deemed to have satisfied their respective due diligence obligations. 7. Disclosure Committee In the course of its deliberations on the company registration model, the Committee considered a separate proposal to expand the role of the outside directors in ensuring the integrity of corporate disclosures.-[32]- Although not a necessary part of the company registration model developed by the Committee, the Committee strongly recommends that the Commission endorse (but not require) a new procedure whereby outside directors use the issuer's audit committee (or a separate ---------FOOTNOTES---------- -[32]- According to Professor Coffee, this concept would incorporate "the traditional reliance defense under state corporation law. Under such a rule, other outside directors could rely on a committee of directors --- tentatively called the 'disclosure committee' -- which would review the company's interim [Exchange] Act filings, such as its Form 10-K and Form 10-Q's, and consider the need for additional disclosures to cover material developments." John C. Coffee, Jr., An 'Evergreen' Company Registration Approach Would Modernize the 1933 Act, Nat'l L. J., Sept. 11, 1995, at B4. ==========================================START OF PAGE 44====== committee of one or more outside directors to be known as a "disclosure committee") to conduct an investigation of the issuer's disclosures. The Committee believes that this proposal has merit whether or not company registration is pursued by the Commission. The disclosure committee could conduct this investigation, just as a board of directors may appoint a committee to engage in other types of specialized inquiries, so long as (a) the delegating directors reasonably believe that the member(s) of the disclosure committee are sufficiently knowledgeable and capable of discharging due diligence obligations on behalf of the outside directors (if necessary, with the assistance of their professional advisers) and are provided with adequate resources to conduct the requisite investigation -- that is, the delegation must be reasonable; (b) the delegating directors maintain appropriate oversight of the disclosure committee (which would entail requiring the disclosure committee to report periodically to the Board on the procedures followed to ensure the integrity of the disclosure) and reasonably believe that the disclosure committee's procedures are adequate and were being performed; and (c) the delegating directors reasonably believe that the disclosure is not materially false or misleading. Although the reasonableness of a delegating director's reliance on the disclosure committee, as well as the director's belief in the accuracy of the disclosure based solely upon the establishment of and procedures for investigation by the ==========================================START OF PAGE 45====== disclosure committee, will depend on the facts and circumstances of each offering, the Committee believes that this practice generally will permit a delegating director to satisfy its obligations under both federal and state law.-[33]- In addressing the liability of outside directors under Section 11, the legislative history to the Securities Act states that "reliance by the fiduciary, if his reliance is reasonable in the light of all the circumstances, is a full discharge of his responsibilities."-[34]- The requirements that the delegation be reasonable and that the committee members ---------FOOTNOTES---------- -[33]- Under state law, where each director has a fiduciary duty with respect to the corporation, directors may create committees to ensure the proper functioning and discharge of their fiduciary obligations. See, e.g., 8 Del. C.  141(e) (Del. 1994); 15 Pa.C.S.A. 1712(a)(3) (Penn. 1995); American Law Institute, Principles of Corporate Governance 4.03 (1994). The legislative history of Section 11 of the Securities Act, including the 1934 amendment to the Act which deleted the original fiduciary standard and substituted a "prudent man" standard, does not suggest that Congress intended a more strict standard to apply under federal law. H.R. Rep. No. 1838, 73d Cong., 2nd Sess. 41 (1934). See James M. Landis, The Legislative History of the Securities Act of 1933, 28 Geo. Wash. L. Rev. 29, 47-48 (1959) (stating the drafter's belief that "a goodly measure of delegation was justifiable, particularly insofar as corporate directors are concerned"). -[34]- H.R. No. 152, 73d Cong., 1st Sess. at 26 (1933). See also Circumstances Affecting the Determination of What Constitutes Reasonable Investigation and Reasonable Grounds for Belief Under Section 11 of the Securities Act; Treatment of Information Incorporated by Reference Into Registration Statements, Securities Act Rel. 6335 (August 6, 1981) n. 106 [46 FR at 42022 (August 18, 1981)]. ==========================================START OF PAGE 46====== periodically report on the procedures followed in conducting the investigation,-[35]- should result in more meaningful oversight of the issuer's disclosures by its outside directors. The creation of such a voluntary committee would be consistent with current corporate governance trends emphasizing the need for outside directors to exercise continual diligence in monitoring the performance of management and ensuring the candor and completeness of company disclosures to the marketplace.-[36]- Moreover, the Commission recently underscored the critical role of corporate directors in ---------FOOTNOTES---------- -[35]- Cf. The Obligations of Underwriters, Brokers and Dealers in Distributing and Trading Securities Particularly of New High Risk Ventures, Securities Act Rel. No. 5275 (July 26, 1972) [37 FR 16011 (Aug. 19, 1972)] at text accompanying n. 29 (discussing relative responsibilities of the managing versus participating underwriters: "Thus, although the participant may delegate the performance of the investigation, he must take some steps to assure the accuracy of the statements in the registration statement. To do this, he at least should assure himself that the manager made a reasonable investigation"). -[36]- See, e.g., J. Lorsch, Empowering the Board, Harv. Bus. Rev., Jan.-Feb. 1995, at 107, 113 ("[a]udit committees made up of outside directors in all public companies ensure that financial reports are accurate, that accounting rules are followed, and that assets are not misappropriated"); F. Lippman, What Should the Audit Committee Do? 3 Corp. Gov. Adv. 22 (March/April 1995); I. Millstein, The Evolution of the Certifying Board, 48 Bus. Law. 1485 (1993). ==========================================START OF PAGE 47====== safeguarding the accuracy and integrity of a registrant's periodic reports and other public statements.-[37]- This governance mechanism would benefit investors in a variety of ways. First, it would ensure more continuous oversight of the disclosure preparation process and, over time, improve the quality and integrity of periodic and secondary market reporting and disclosure generally. Second, it will provide a focus at the board level for due diligence in the context of primary offerings by issuers, thereby ensuring greater involvement by outside directors as one set of monitors. Third, it will provide a practical means for greater outside director involvement with the due diligence activities of other gatekeepers, such as underwriters. Thus, the Committee hopes that many registered companies -- regardless of whether they are permitted to or elect to participate in the company registration system -- would choose to implement this measure as a natural extension of present "best practices" that promote investor confidence in the adequacy of corporate disclosures. The result would be an increased focus by the board on its existing statutory obligations, and additional ---------FOOTNOTES---------- -[37]- See Report of Investigation in the Matter of the Cooper Companies, Inc. as it Relates to the Conduct of Cooper's Board of Directors, Exchange Act Rel. 35082 (December 12, 1994). See also Report of Investigation in the Matter of National Telephone Co., Inc. Relating to Activities of the Outside Directors, Exchange Act Rel. 14380 (January 16, 1978). ==========================================START OF PAGE 48====== review by a qualified committee-[38]- of outside directors, while allowing the outside directors an appropriate mechanism to fulfill their Securities Act responsibilities. III. CONCLUSION The Committee believes that company registration is superior to incremental liberalization of the current offering process. Short of implementing company registration, the Commission could continue its approach of implementing incremental changes to improve seasoned issuer access to the markets, particularly through further liberalization of the shelf procedure. As noted in the description of the offering process under the company registration model, much of the suggested company registration pilot can be implemented primarily by modifying and liberalizing the shelf concept. Similarly, the Commission could take discrete steps to allow issuers to meet market demands within the framework of the current registration scheme, such as the elimination of the nonfungibility requirement of Rule 144A, the broadening of the eligibility requirements for purchasers in the Rule 144A market, the minimization of the resale limitations on restricted securities, the allowance of greater flexibility under the gun-jumping doctrine to permit "testing of the waters," and ---------FOOTNOTES---------- -[38]- Establishment of disclosure committees might also lead to the appointment of disclosure specialists (such as lawyers, accountants or bankers) to the board so that they may serve as members of the disclosure committee, just as directors are often selected based upon their qualifications to serve on audit committees. ==========================================START OF PAGE 49====== the implementation of more flexible regulatory interpretations such as those permitting A/B exchange offers. Indeed, the Committee is pleased that, since the time the Committee began its deliberations and commenced its observations on the shortcomings of the current system, the Commission has made significant proposals, and the staff has rendered interpretations, to begin to take some of these steps. The Commission's Task Force on Disclosure Simplification followed the work of the Committee and has recommended the measures crafted by the Committee to streamline further the shelf offering process.-[39]- The Task Force, however, did not make any specific recommendations for Securities Act disclosure enhancements or other measures to ensure adequate investor protections in the context of a streamlined offering process; instead it urges the Commission in implementing the streamlining recommendations to take the steps necessary to ensure quality disclosure and investor protection and points to the Committee's efforts in that regard.-[40]- ---------FOOTNOTES---------- -[39]- Report of the Task Force on Disclosure Simplification to the Securities and Exchange Commission (March 5, 1996), at 34, 38-40 (the "Task Force Report"). -[40]- As noted in the Task Force Report: The recommendations for seasoned issuers set forth under the [Task Force Report's] "Shelf Offerings" caption, as well as certain other items in this Report, are substantially identical to the streamlining concepts of the "company registration" framework developed by the Advisory Committee. Although the Task Force was not designed to overlap with the work of the (continued...) ==========================================START OF PAGE 50====== Nevertheless, continued incremental liberalization of the offering process alone would not achieve all of the benefits sought by the Committee. While such steps would benefit issuers (including those who by choice or by reason of ineligibility remain outside the company registration system), such steps ---------FOOTNOTES---------- -[40]-(...continued) Advisory Committee, the Task Force members have followed the work of the . . . Committee. The Task Force recommends almost all of the streamlining elements of company registration [e.g., eliminate restrictions on at-the-market offerings, permit an issuer to add additional securities without having to file a new registration statement, narrow the definition of affiliate, allow prospectus delivery by means of full incorporation by reference into a confirmation, and establish a pay-as-you-go fee system]. Given its original purpose, the Task Force only has sought to identify and recommend ways to streamline the regulatory process and thus only has looked at the suggestions individually. Were the Commission to reach the next step of putting the pieces together into a comprehensive package, the Task Force recommends that the Commission consider reasonably expected investor protections consequences of any particular package. The Task Force notes that the Advisory Committee has devoted significant time to deliberations on these issues as it assembled its complete [company registration] model and has added, what the Advisory Committee intends to be, significant investor protections. * * * * * The Task Force believes that the Commission, in its consideration of these recommendations [to streamline the existing shelf offering process] and any alternatives that may be suggested, should take steps to ensure that the quality of disclosure provided to investors be at least of the same quality as that provided to investors today. The Task Force notes that improving the quality of disclosures in periodic reports is an area being considered by the Advisory Committee. Id. at 34. ==========================================START OF PAGE 51====== should be balanced with increased protections for investors. Moreover, as noted in this Report, there are investor protection concerns in the current system that should be addressed before further streamlining proceeds. In addition, without a shift in the underlying regulatory philosophy, new "metaphysics" would continually be constructed to preserve the Securities Act's current transactional registration requirement. In the Committee's view, these concepts and requirements will continue to cause confusion, add substantial costs to the capital formation process, and drive issuers to alternative markets where investors will not be able to avail themselves of the protections of the Securities Act. The Committee believes that the cumulative effect of the evolutionary changes in the markets since the 1930s now requires a reassessment of the conceptual underpinnings of the regulatory process, as opposed to continued incremental changes. Company registration is consistent with the evolutionary approach of incremental liberalization, but it is also, unmistakably, a new departure. Unlike incrementalism, it says with finality that registration should not take precedence over periodic disclosure for companies that are already traded. It recognizes and addresses what was not yet apparent in the early 1930s: the economic importance of traded companies raising additional capital by issuing securities. Thus company registration is far more than a cost-reduction and efficiency reform. It is a new beginning for the registration process, and it is overdue. The ==========================================START OF PAGE 52====== shift to a company registration system thus would change the way we think about the regulation of the capital formation process and foster a fresh approach to addressing the various problems. This more comprehensive conceptual approach would address both the interests of seasoned issuers in today's fast-moving markets, and the implications of those changes in the markets and offering processes for investors, underwriters, and other participants. The company registration pilot described in this Report continues the process of using the Commission's existing rulemaking authority to effect appropriate reforms, rather than recommending major legislative changes. The Committee decided at the outset, at the urging of Chairman Levitt and Commissioner Wallman, to promote primarily those modifications that could be accomplished, at least initially, through rulemaking as opposed to legislation. The benefit of this approach is that it provides greater flexibility for Commission experimentation and timely regulatory adjustments as dictated by experience with the pilot. While some of the complexity and various aspects of the pilot are necessary in order to fit within the current regulatory scheme and would be unnecessary under a legislatively implemented system, experience gained under the pilot will provide a firm foundation for determining what legislative changes and/or rulemaking changes, if any, would be appropriate to simplify further the regulatory process and complete the long-awaited transition to a company registration system. ==========================================START OF PAGE 53====== IV. SEPARATE STATEMENT OF JOHN C. COFFEE, JR., EDWARD F. GREENE, AND LAWRENCE W. SONSINI We write separately, not to criticize the Advisory Committee's Report (with which we fully concur), but to voice our concerns that additional steps must be taken by the SEC to fully realize the Report's goals and to stress the need for any specific reforms adopted based on this Report to be consistent with the integrated approach taken by this Report, which seeks to pursue both deregulation and qualitative improvement in our disclosure system. Achieving one without the other will not be an advance. Essentially, we advance two basic contentions: (1) The transition from the transaction-oriented disclosure system of the past to the company registration system envisioned herein must be accompanied by a corresponding transition in liability rules. Otherwise, there is a fundamental incongruence between what can realistically be expected of the independent "gatekeepers" (outside directors, accountants, underwriters and others) who monitor the corporation's disclosures and their statutory responsibilities under the Securities Act of 1933. In particular, we are skeptical that practitioners will recommend, or that corporations will adopt, some of the reforms that this Report proposes (such as, in particular, the disclosure committee) without further guidance from the Commission. In particular, some form of safe harbor must be developed that protects disinterested persons who undertake ==========================================START OF PAGE 54====== due diligence efforts under company registration from thereby effectively incurring insurer-like liability for the accuracy of all factual information incorporated into the registration statement. (2) The incentives to opt into a company registration system are uncertain and limited. Some companies may prefer to rely on the existing shelf registration system. In our judgment, it is unwise to have two parallel systems, one carrying the obligation to file a mandatory Form 8-K at the time of a substantial equity issuance plus requirements for certification by top management and the preparation of a senior management report; and the other, not. Any disparity between company registration and shelf registration that requires mandatory filings, certifications, and reports under the former (but not the latter) will create an unfortunate and powerful incentive for issuers to opt to remain within the existing shelf registration system. Thus, we would urge the Commission to adopt similar requirements with respect to the existing shelf registration system. More generally, our concern is that pressures may develop for the Commission to adopt selectively the deregulatory proposals from this Report while quietly ignoring the disclosure enhancements and supplemental filing obligations that this Report also envisions. The proposals in this Report are part of a balanced and integrated package, which should not be implemented on a piecemeal basis. ==========================================START OF PAGE 55====== 1. Due Diligence Under Company Registration Model and the Problem of Liability. We share the view clearly stated in this Report that company registration has not made, and should not make, obsolete the efforts of the corporation's independent "gatekeepers" (i.e., its outside directors, accountants, and underwriters) to verify and monitor the accuracy of the corporation's disclosures. No less than our colleagues on the committee, we believe such due diligence efforts play a critical role in assuring the integrity of our disclosure system. But the advent of company registration (as the culmination of a shelf registration system that has efficiently evolved over time so as to assure issuers increasingly rapid market access) does require that we rethink how due diligence is undertaken and the level of liability that can be fairly attached to it. In the past, concern has been expressed that the rapid pace and time constraints associated with shelf registration makes due diligence infeasible.-[1]- Although the available evidence remains largely anecdotal, we recognize that such a tendency may exist and could accelerate under a company registration system. The Report directly addresses this problem by recommending a mandatory Form 8-K filing at the time of any substantial equity issuance (i.e., greater than 3% of outstanding shares). As ---------FOOTNOTES---------- -[1]- Compare Merritt Fox, Shelf Registration, Integrated Disclosure, and Underwriter Due Diligence: An Economic Analysis, 70 Va. L. Rev. 1005 (1984) and David Green, Due Diligence Under Rule 415 Is the Insurance Worth the Premium?, 38 Emory L.J. 793 (1989). ==========================================START OF PAGE 56====== strong proponents of such a requirement, we believe that one of its most important virtues is that it may provide a focal point for due diligence.-[2]- Because a Form 8-K carries Section 11 liability (unlike a prospectus supplement), we expect that participating underwriters, the company's senior management, and its accountants would meet to discuss and review the contents of the proposed Form 8-K and recent developments during the current quarter.-[3]- The existence of a mandatory filing requirement may strengthen (perhaps only marginally) the position of the underwriters in their negotiations with management over the conduct of due diligence.-[4]- On balance, we believe ---------FOOTNOTES---------- -[2]- Such due diligence would chiefly focus on whether material developments had occurred since the date of the corporation's last filing under the 1934 Act's continuous disclosure system. We do not mean to imply that verification of prior filings would necessarily be undertaken at such issuance. -[3]- Indeed, some recent decisions suggest that the failure to implement such a review for late- breaking developments may subject the corporation and its directors to liability under 11 because the registration statement and prospectus may as a result contain material omissions. See Shaw v. Digital Equipment Corp., 83 F.3d 1194 (1st Cir. 1996) (where offering under a shelf registration statement occurred near end of quarter, the failure to disclose downturn during current quarter that was below analyst forecasts could constitute a material omission for purposes of 11 of the Securities Act of 1933). -[4]- In discussions we have had both within the Advisory Committee and with underwriters and others, this proposal has been described as the "Form 8-K speed bump." This may mischaracterize it. Like a speed bump, it does require the issuer to focus and pay attention to this filing obligation, but it does not require any necessary (continued...) ==========================================START OF PAGE 57====== that such a requirement will better protect the interests of investors at relatively low cost to issuers. But here difficulties surface that motivate us to write separately. To the extent that company registration is adopted (or that any significant step is taken toward simplifying the existing system of shelf registration), corporate issuers may come to make more frequent use of the debt and equity markets.-[5]- Issuers seeking to make frequent use of company registration (or the existing shelf registration system) face a problem, because repetitive debt or equity offerings co- exist uneasily at best with the statutory structure of the Securities Act of 1933. By regularly tapping the capital markets through repetitive offerings, the corporation exposes its directors to an increased risk of 11 liability under circumstances that make effective compliance with their statutory "due diligence" defenses infeasible. Although we have no doubt that the board should familiarize itself with the contents of the registration statement in the context of a major public offering, there is not the same opportunity for factual verification and searching questioning in the context of smaller, repetitive ---------FOOTNOTES---------- -[4]-(...continued) braking in the issuance process. -[5]- If it occurs, such an evolution toward smaller, more frequent offerings could efficiently reduce the cost of capital to corporate issuers and might even parallel the "just-in-time" supply systems that American issuers have begun to copy from their Japanese originators. ==========================================START OF PAGE 58====== offerings. Nor is it necessarily efficient to consume the board's limited time in this fashion. The dilemma then is that either (1) board members are over-exposed to liability because they cannot establish their due diligence defenses within these compressed time frames, or (2) the corporation must forgo repetitive offerings because of the legal risks to its directors. Neither option is attractive; nor is this choice necessary. This example illustrates a more general point: "company registration" represents a movement away from a transaction- oriented system of disclosure. But the liability rules of the Securities Act of 1933 remain transaction-oriented. As a result, a mismatch arises, which, we submit, requires that the liability provisions of the federal securities laws also be re-assessed. Of course, such an undertaking invites some controversy, but it is today a feasible project now that the Private Securities Litigation Reform Act of 1995 has given the Commission broad exemptive authority under both the Securities Act of 1933 and the Securities Exchange Act of 1934.-[6]- ---------FOOTNOTES---------- -[6]- See Section 27A(g) of the Securities Act of 1933, 15 U.S.C. 77z-2(g), and Section 21E(g) of the Securities Exchange Act of 1934, 15 U.S.C. 78u- 5(g). We are, of course, aware that the Commission has not yet spoken to the scope of its exemptive authority under these sections. We believe, however, that courts would defer to any "reasonable" construction of these provisions advanced by the Commission. See Chevron U.S.A. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). The pending Securities Investment Promotion Act of 1996 would also greatly enhance the Commission's exemptive authority in even clearer statutory language. ==========================================START OF PAGE 59====== How might the liability provisions of the Securities Act of 1933 be modified? Less we be misunderstood, we stress at the outset that we do not seek to abolish liability under 11 or 12. Although there are multiple forces that drive our disclosure system, the risk of liability is one of the most significant, and it motivates independent gatekeepers to test and, if necessary, challenge the issuer's proposed disclosure. The proposed Form 8- K requirement (which we support) at least technically increases the risk of 11 liability for both board members and underwriters.-[7]- In seeking to strike the proper balance, we believe the proper starting point is to define a realistic role for gatekeepers that is sensitive to both the time constraints imposed on issuers and underwriters by the marketplace and the character of the modern board of directors. When the Securities Act of 1933 was drafted, both were very different. Corporate boards were then insider-dominated with few truly independent directors, and as a result it was natural to assume that board members would be familiar with all material pending corporate developments. The modern board is now predominantly composed of outside directors, who are not necessarily familiar on a daily basis with all material information concerning their corporation ---------FOOTNOTES---------- -[7]- On the other hand, fulfillment of this duty may serve to protect directors and underwriters from liability for material omissions relating to developments subsequent to the issuer's last Form 10-Q. See Shaw v. Digital Equipment Corp., supra n.3. ==========================================START OF PAGE 60====== and who have other commitments and business obligations that preclude them from devoting unlimited time to the corporations they serve as outside directors. Correspondingly, where once a public offering of debt or equity securities was a long, drawn- out process which permitted ample time for conducting a due diligence review, it can now occur from conception to consummation under shelf registration within the space of a single day. As a result, the full board of directors, dispersed in the typical case across the country and subject to their own time constraints, often cannot undertake a meaningful due diligence review, at least not within the compressed time frames that the equity marketplace imposes. What then can be done without sacrificing the idea of independent gatekeepers? The modern board necessarily functions through specialization and delegation. Thus, one of us has recommended (and the Advisory Committee has accepted) the idea of a disclosure committee in which the "due diligence" gatekeeping function would be largely centralized. Such a committee, which would in all likelihood be a subcommittee of the audit committee, would meet with the underwriters, senior management, and the outside accountants to review the corporation's disclosures and its proposed Form 8-K. Directors not on this committee would be entitled to rely on the efforts of such a committee (at least provided that their reliance was reasonable and they did not have any objective reason to doubt its performance and did not ==========================================START OF PAGE 61====== otherwise lack confidence in the accuracy of the corporation's disclosures or financial statements). Even if the logic of our proposal is sound, movement toward it will not come automatically. Rather, the Commission must hold out positive incentives to encourage its adoption. Here, the Report stops short of addressing these necessary incentives. One such incentive would be a clear right on the part of the other directors to rely on such a committee, much as directors may do under the common law or statutory provisions in most states. Even more importantly, however, the SEC would need to face and address the liability of the disclosure committee members, themselves. Easy as it is to say that the rest of the board can rely upon the disclosure committee, this policy will not work if outside directors are unwilling to staff such a committee for fear of enhanced liability. As a practical matter, we doubt that practitioners will counsel directors to adopt such a committee or to serve on it -- absent clearer SEC guidance.-[8]- Such SEC guidance could take a variety of forms: safe harbors, a burden shifting rule, or some fuller specification of what the committee should do. For example, when the disclosure committee has engaged in a specified review of the corporation's financial ---------FOOTNOTES---------- -[8]- Indeed, the early commentary on a publicly circulated draft of this Report has focused on exactly this problem. See Roberta S. Karmel, Deregulation: Real or Alleged, N.Y.L.J., June 20, 1996, at 3, 7 (noting that "there would be no diminution in 11 liability under the Securities Act . . ." under the Advisory Committee Report). ==========================================START OF PAGE 62====== statements and '34 Act filings, the Commission might exercise its exemptive authority to shift the burden of proof under 11 to the plaintiff to prove that this investigation was inadequate. Such a change would not wholly absolve committee members from liability, but it would require the plaintiffs to prove by clear and convincing evidence that the investigation that they did conduct was unreasonable under the circumstances. Beyond this change, a more general principle might also be recognized: the diligence that is due should be proportionate to the size and character of the offering. Today, the leading precedents that guide practitioners -- Feit v. Leasco Data Processing Equip. Corp.,-[9]- and Escott v. Bar Chris Construction Corp.-[10]- -- deal with major offerings by high-risk companies. These cases are clearly correct on their facts, but they do not address the nature of the investigation that should be required by outside directors or underwriters in proportionately smaller offerings by established companies with rapid access to the market under a company registration system in order to establish a "reasonable investigation" defense under 11. Here again, SEC guidance is necessary if the board and the underwriters are to play a meaningful role as a gatekeeper in the disclosure process. ---------FOOTNOTES---------- -[9]- 332 F. Supp. 544 (E.D.N.Y. 1971). -[10]- 283 F. Supp. 643 (S.D.N.Y. 1968). ==========================================START OF PAGE 63====== We, of course, recognize that a single Advisory Committee cannot address every issue, and this committee was not selected to address legal issues. Nonetheless, the Report concludes without proposing ways to update the liability rules under the federal securities laws to mesh with its proposed new disclosure system. As a result, the paradigm shift that this Report envisions is incompletely articulated. Gatekeeper liability makes sense only when the gatekeeper is placed in a position to take effective preventive action. Strategies such as the disclosure committee may enable a board committee to play a meaningful gatekeeper role in the disclosure process. But, to induce the corporation to form such a committee or outside directors to staff it, some relief from the "in terrorem" liabilities of 11 is necessary. In the last analysis, a choice must be made between (1) abandoning the idea of a gatekeeper role for the outside director (as some have argued)-[11]- and (2) focusing the liability provisions of the federal securities laws so they encourage the performance of clearly specified responsibilities, but expose the board to no greater liability than is necessary. That choice has not yet been made and now falls to the Commission. (2) Adopting Company Registration Via the Backdoor. We are concerned that the recommendations of the Advisory Committee could be adopted in a selective, piecemeal fashion that ---------FOOTNOTES---------- -[11]- See, e.g., Green, supra n.1. ==========================================START OF PAGE 64====== yields greater deregulation but little or no qualitative improvement in our disclosure system. If there were to be significant deregulation of the existing shelf registration system without the concomitant adoption of mandatory disclosure enhancements or the proposed Form 8-K filing obligation, this would be the net result. Even if company registration is adopted as a voluntary opt- in system, there may be inadequate incentives for issuers to elect it. Inevitably, issuers will compare company registration with shelf registration. Here, one of the principal attractions of company registration over shelf registration is that it gives the issuer greater flexibility by permitting the issuer in effect to register and sell all its outstanding shares without substantive restrictions. In contrast, Rule 415 permits a shelf registration statement in the case of an "at the market offering of equity securities" to register no more that "10% of the aggregate market value of the registrant's outstanding voting stock held by non-affiliates of the registrant."-[12]- Although this limitation seems significant at first glance, the staff's interpretation of this provision has minimized its actual impact. For example, we have been informed by the staff that it does not read the 10% ceiling on shelf registration to apply to a fixed commitment underwriting, even when the offering is done at the last closing price of the issuer's stock on a stock exchange. ---------FOOTNOTES---------- -[12]- See Rule 415(a)(4)(ii), 17 C.F.R. 230.415(a)(4)(ii). ==========================================START OF PAGE 65====== In such a case, we were told, the offering will not be deemed an "at the market" offering. As a result, the relative incentive to opt into a voluntary company registration system dissipates to the extent this ceiling on shelf registration is relaxed. Indeed, while an offering under company registration will sometimes be subject to staff review (if it is in excess of a specified percentage of the company's outstanding shares), no such review will occur under the current system if the offering is properly structured and the company has filed an unallocated shelf registration statement.-[13]- We point to this example not to protest it, but simply to illustrate how weak the incentives may be to elect into a voluntary company registration system, especially in light of the growing use of unallocated shelf registration statements. In contrast, the regulatory requirements associated with company registration are real. Chief among these are the mandatory Form 8-K filing obligation, the certification requirement, and the senior management report. Although the Form 8-K filing may serve to promote a current review of developments subsequent to the corporate issuer's last filing under the Securities Exchange Act of 1934's periodic disclosure system (and ---------FOOTNOTES---------- -[13]- If the Commission adopts its proposed rule to make reporting of probable and material acquisitions the same under the Securities Act of 1933 and the Securities Exchange Act of 1934, an unallocated shelf registration statement will seemingly give more predictable market access than would be available under company registration. ==========================================START OF PAGE 66====== this could reduce corporate liability), it is undeniable that many issuers will view this requirement (and the other new mandatory features associated with company registration) as increased burdens, particularly because any periodic report that is incorporated by reference into the registration statement will carry 11 liability. In contrast, a prospectus supplement does not carry 11 liability (nor will it create 12(2) liability for the corporation's directors because they are not in privity with the buyers). Hence, this disparity between the legal status of a Form 8-K filing and a prospectus supplement may cause corporate counsel to prefer shelf registration to company registration. We see only one answer to this problem: level the playing field by extending the new requirements to shelf registration as well.-[14]- In our judgment, these requirements are justified because they should enhance the quality of disclosure to the secondary market. We realize that this proposal will not be popular in some quarters. Still, unless it is implemented, the prospect is remote in our judgment that many issuers will adopt company registration. ---------FOOTNOTES---------- -[14]- We recognize that the Advisory Committee Report does recommend that the Form 8-K filing obligation be extended to shelf registration as well as to company registration, but we are concerned that, unless highlighted, this recommendation may receive inadequate attention.