Posts Tagged ‘initial public offering’

SME: SEC Publicity Regulations

Monday, April 9th, 2007

The subject matter:    SEC Publicity Regulations
The expert:                Jon Gavenman

Jon Gavenman practices law at the firm of Heller Ehrman.  His corporate practice emphasizes emerging company transactions.  Jon is also a member of the Corporate and Venture Law Groups. Heller Ehrman is a leader in providing innovative legal services to clients throughout the world. With approximately 700 attorneys and professionals in 13 cities nationwide and abroad, the firm was fifth on The American Lawyer’s "A-List" and is one of only nine firms to have made the prestigious list every year since its inception in 2003. Jon represents a wide range of emerging growth technology companies from start-ups to public companies, primarily in the areas of software, semiconductors, telecommunications and Internet services and digital media. His practice focuses on venture capital financings, strategic partnerships, mergers and acquisitions and public offerings, as well as on advising companies on general corporate and securities matters and the implications of proposed business transactions.  His clients have included Access360, Aspect Communications, Bowman Capital LP, Brio Software, CATS Software, Cirrus Logic, CrossWorlds Software, Fibex Systems, Goldman, Sachs & Co., Grouper Networks, Lam Research Corporation, Matrix Partners, META Group, Meta Software, OSA Technologies, Sequoia Capital, Spinner Networks, Unison Software and WebTV Networks. Many of Mr. Gavenman’s clients have gone public and/or been sold to companies including Microsoft, Cisco Systems, IBM and AOL.

Disclaimer: The views presented below have been prepared by lawyers at Heller Ehrman LLP for informational purposes only and are not legal advice. Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship.

Q & A

What is a "quiet period"?

In its most common securities law usage, in connection with a company’s initial public offering or IPO, the "quiet period" refers to the period in which a company is "in registration" – generally meaning that the company has affirmatively decided to undertake a public offering and sale of its securities. Because the company is trying to sell its securities to the public during this time period, the law requires that the company be careful ("quiet") about the kinds and timing of publicity it undertakes during the period. These limitations are based on the framework of the Securities Act of 1933, which prevents a company from trying to generate interest in its stock until it provides specified disclosure about the company and the offering in a document known as a "statutory prospectus."

Note that although the "quiet period" applies to all public offerings, the rules restricting communications outside the prospectus are strictest with respect to companies doing an IPO.

How long does a quiet period last?

A company is "in registration" from the time it reaches an understanding with an investment bank that the bank is to act as its managing underwriter for the IPO until 25 days following the commencement of the IPO and listing on an exchange. During this time period, a company should generally expect that its lawyers, as well as the lawyers for the underwriters of the IPO (and their lawyers) will want strict control over the company’s communications. That’s because both the content of the communications is relevant to the overall positioning of the company in its IPO process, and because improper statements could come back to delay or otherwise damage the process itself (which can impair the reputation of the underwriters as well).

During a quiet period, must all PR come to a stop?

As a general matter, not all PR has to stop during a quiet period. However, the securities laws distinguish three separate periods during an offering – the "pre-filing period" (the time between the organizational meeting to kick off the process or the company reaching an understanding with an investment bank that the bank is to act as its managing underwriter and the filing of the registration statement for the offering), the "waiting period" (the time between initial filing of the registration statement and the time at which the registration statement is declared effective by the SEC), and the "post-effective period" (the time between the declaration of effectiveness of the registration statement and the date 25 days from the date of the prospectus). Each of these sub-periods has slightly different rules that apply, and as mentioned above, all PR efforts need to be carefully reviewed to ensure they are compliant with Securities Act restrictions on communications where no prospectus is being provided with the communication, to ensure it is consistent with disclosures being made in the company’s offering prospectus, and to ensure it is not going to be construed as "hyping the market".

During the pre-filing period, all offers to sell, or solicitations of offers to buy, the company’s securities are prohibited. So is publicly disclosing the name of any potential underwriter. The SEC and courts have taken a broad view of what constitutes an offer to sell or solicitation of an offer to buy – and this is a subjective area (therefore dangerous). As a general matter, anything that may be viewed as designed to arouse public interest in the company or condition the market in anticipation of the offering may be deemed to constitute an offer. That said, there are two safe harbors that exist in this period.

The first safe harbor exempts communications that do not reference a registered securities offering, provided that the company takes reasonable steps within its control to prevent further distribution of the information during the 30-day period immediately prior to the filing of the registration statement. For example, interviews given to a reporter more than 30 days prior to the filing of a registration statement should be okay; UNLESS the article is published within the 30 day window prior to filing (in which case, snap – the company is not within the safe harbor). So a company needs to be very careful about interviews where it doesn’t have a good view of the publication timing AND the timing of the filing of the registration statement – lots of variables can cause the timing of either of those events to shift, so it’s dangerous territory.

The second safe harbor exempts ongoing communication of regularly released factual business information. This safe harbor was designed to codify SEC interpretive positions going back to the 1950s regarding normal course product advertising, discussions with vendors and employees, and the public release of business or financial developments. Again, a very fact-intensive analysis must be undertaken to decide if this safe harbor can apply, as the harbor requires that the company have previously released the same type of information in the past, the timing, manner and form of the release must be consistent with the company’s past practices, and the release must be intended for use by persons, such as customers or suppliers, other than in their capacities as investors or potential investors in the company’s securities. In addition, the release may not be used in the marketing activities of the registered offering.

Note that just because one of the above safe harbors does not technically apply, a communication may still not be an illegal "offer" within the meaning of the Securities Act. But that analysis, as discussed, must be undertaken very carefully, and many constituents in an offering process (company counsel, underwriters, underwriters’ counsel) will want to have input in reaching the conclusion, preferably PRIOR to the communication being made.

The "waiting period" and "post-effective period" each also have their own particular restrictions on publicity, mainly pertaining to what kinds of limited offering notices and "free writing prospectuses" can be disseminated during those periods. Those topics are quite detailed and beyond the scope of this discussion, except to note that the restrictions on non-prospectus communications are strictest with respect to companies doing an IPO, and there are very few restrictions for large corporations that have been public for a while ("well-known seasoned issuers") That said, as a general matter, publicity tends to be restrained during the "quiet period" as a whole, based on the notion that taking a conservative position on "hyping the market" and not running afoul of the restrictions that exist during the period will tend to enhance (or at least not tend to decrease) the chances of a successfully completed offering (which, after all, is the primary objective during this window of time).

What does "hyping the market" refer to?

"Hyping the market", "conditioning the market for the offering", or "gun jumping", all refer to the activity prohibited by the U.S. securities laws discussed above, i.e., attempts to generate public interest in a new issuance of securities by a means other than the statutory prospectus. (Note that the term "gun jumping" can also be used to refer generally to other securities law violations deemed to be a violation of Section 5 of the Securities Act). This discussion is focused only on the publicity issues, where a company (or its underwriters or agents) engages in publicity that excites or conditions the market for the sale of the company’s securities at an unduly early stage, and/or uses written materials in the offering process that do not comply with the extensive prospectus requirements of the U.S. securities laws.

This kind of activity can take many forms, including sending particular non-prospectus communications to prospective investors in advance of a prospectus, or (perhaps more publicly notable) having company personnel (or underwriters or agents) being quoted in magazines or newspapers with respect to the company (either generally or specifically with reference to the company’s securities offering). And the issue can pop up despite the fact that the company’s personnel may have given an interview months before and the interview gets published during the offering period (while the company is in registration). So a great deal of care has to be taken, in advance, to control the levels and timing of company publicity in and around offerings.

The result of this activity can also range: In some cases, underwriters responsible for "gun jumping" can be forced to withdraw from an offering (having detrimental effects both on the underwriter and, potentially, the offering itself). In other cases, the SEC may require detailed disclosures about the publicity and risk factors associated with the publicity, including that the company conducting the offering might be required to repurchase the shares being sold in the offering because of the potential securities law violation. The company may be required to incorporate the "gun jumping" disclosure into its prospectus, which raises the potential for company liability. Additionally, companies may be forced to delay their offerings, in light of these kinds of potential violations, for substantial periods of time to allow for a "cooling off" period (a time period that allows the "hyped" market to "un-hype" following the offending publicity). Those kinds of disclosures and/or delays can also obviously be very detrimental to completing an offering, especially in a volatile stock market period.

Does the law require a quiet period before every quarterly earnings announcement from public companies?

This is a difficult question to answer with a clear bright-line rule. The general answer here is "no", but for the reasons discussed below one has to think about this question very carefully. The question often results from confusing "quiet period" and "quarterly blackout period". If one only thinks about "quiet period" applying during an offering, one would almost certainly conclude that if there is no offering, there is no quiet period restriction, and thus no requirement for any sort of "blackout period" period prior to quarterly earnings announcements.

However, the law in this area, around quarterly earnings announcements for public companies, has much more to do with other anti-fraud oriented securities laws than "quiet period" rules we’ve discussed above; and it’s a very fact-intensive area. The basic issue presented to a company is this: As a company comes to the end of a quarter, it gets increasing visibility on its results for that quarter, arguably the single most material piece of information about the company at that particular moment in its stock trading life (each quarter). And most companies are not prepared to announce their results for a period of time following the end of a given quarter, as they need to close their books for the quarter, ensure the proper reviews have occurred with respect to same, and then prepare the public announcement of those results. As a result, during that preparation time, there can be a lot of market anxiety about how the company performed during the most recent quarter. Many companies therefore impose a "quarterly blackout period" on PR activities (as well as stock trading by company board members and executives), as they do not want to make announcements during that period, prior to their earnings release, based on a legitimate fear that the market may react strongly to the non-earnings announcement (up OR down), and then days later when the earnings release comes out (which is very likely to cause the stock price to move up or down), the stock may move the opposite direction. And someone may then accuse management of trying to manipulate the stock price for selfish reasons. The classic illustration of that situation is as follows:

Company X has a bad quarter ended March 31. During early April, Company X puts out lots of announcements that are very bullish on the company’s products, management team successes, and maybe even general trends (arguably, though doubtfully, true as to the future, despite the bad March quarter). Company X’s stock price moves up on the announcements – and many company employees (even assume non-executives who don’t know about the bad quarter) decide to sell stock in light of the movement. A week later, the Company announces the bad results for the March quarter and the stock gets whacked.

Clearly, someone might suggest that the Company was trying to manipulate its stock price prior to announcing the bad news (the quarter’s results). That someone could be a regulatory agency, or a securities lawyer that believes the company was committing securities fraud. Often, a lawsuit or regulatory agency investigation follows.

So companies have to decide very carefully whether they want to set a practice of allowing "normal course" announcements (and if so, the process around such announcements) during that end of quarter period. And note that there is no magical set of dates defining that period – it is an intensely fact-based analysis depending on the company and its industry. It can and frequently does start prior to the end of a quarter, and it usually runs through the date of the company’s earnings release, plus one or two days). Alternatively, companies may decide to "go dark" during that period (meaning, talk to no one in the analyst community, stop press activities that may be viewed as "market moving" or analyst oriented, and the like).

Companies are all over the map on this point. Many "go dark" completely. Many only issue product-related announcements to trade publications (as opposed to financial analysts), presumably concluding the announcements are ordinary course and not material to the company in the aggregate sense (and therefore unlikely to affect the company’s stock price). Some certainly do nothing to limit their press and just take their chances (that is not at all recommended). A company needs to weigh the content of the announcements it will allow very carefully. And additional complexity exists when third parties make announcements relating to the company during that period (for example, a vendor or other third party announces that Company X has done a deal with it – and the announcement is going to run during that "quarterly blackout period"). It’s a difficult question to answer with a general rule.

What’s a good resource to learn more about the SEC’s publicity rules?

An outstanding securities lawyer or law firm of course. 😉 Less flippantly, you could do legal research on the SEC’s website – using terms like "gun jump" or "Section 5 violation" – or you could look for companies that have been subjected to cooling off periods and try to piece together the rules that they broke to get to that point – but to be honest that’s the long way around in this area. This is a dangerous area to attempt self-help, in large part because of the very broad (and non-obvious) definitions of terms such as "offer," "sale," and "prospectus." Finally, Securities Act Release No. 5180 (Aug. 6, 1971) [36 FR 16506] (Aug. 21, 1971) and the rules promulgated under the Securities Act of 1933 are pretty important resources for lawyers advising companies doing public securities offerings; Regulation FD contains the critical rules restricting communications once a company has gone public.

Disclaimer: The views presented above have been prepared by lawyers at Heller Ehrman LLP for informational purposes only and are not legal advice. Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship. Readers should not act upon this information without seeking professional counsel. The information contained in this MoPR Blog post is provided only as general information which may or may not reflect the most current legal developments. This information is not provided in the course of an attorney-client relationship and is not intended to constitute legal advice or to substitute for obtaining legal advice from an attorney licensed in your state. This blog post may be considered advertising under applicable laws and ethical rules. Heller Ehrman LLP does not wish to represent anyone desiring representation based upon viewing this blog post in a state where the MoPR Blog fails to comply with all laws and ethical rules of that state.

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