SEC Proposes to Expand Obama-Era ‘Test-the-Waters’ Modernization to All Businesses

Proposition would allow businesses to solicit institutional investor interest before filing an IPO.

A significant reform included in the 2012 “Jumpstart Our Business Startups Act,” allowing companies with annual revenues under $1 billion to solicit investor feedback before IPOs, could be expanded to all companies regardless of size in the near future, according to a recent statement from the Securities and Exchange Commission (SEC).

The SEC voted to propose an expansion of the allowance, coined the “Test-the-Waters” modernization reform, this week and the proposal is now headed toward a 60-day public comment period before it goes before the commission for approval.

“Extending the test-the-waters reform to a broader range of issuers is designed to enhance their ability to conduct successful public securities offerings and lower their cost of capital, and ultimately to provide investors with more opportunities to invest in public companies,” said SEC Chairman Jay Clayton. “I have seen first-hand how the modernization reforms of the JOBS Act have helped companies and investors. The proposed rules would allow companies to more effectively consult with investors and better identify information that is important to them in advance of a public offering.”

The allowance was limited to “Emerging Growth Companies” since it passed seven years ago, and companies surpassing the $1 billion annual revenue mark were not allowed to consult with investors before their IPOs.

The vote follows a 2017 extension which extended the ability to initially submit certain filings in draft, non-public form.

The proposition states that the rule “could improve the likelihood of successfully raising capital in a registered offering,” and could “reduce the risk of having to withdraw a publicly filed registration statement and can also tailor offering size and other terms included in the initial filing more closely to market interest.”

Other benefits are included, such as if a company, after “testing the waters”, decides not to register an IPO, it could avoid exposing its financial statement and other proprietary information, as well as avoiding reputational damage from withdrawing public securities after an IPO.

The rule harbors potentially adverse effects on investors if the test-the-waters communications contain incomplete or misleading information and if solicited investors improperly rely on such communication rather than on the filed offering materials.

The SEC expects these effects to be mitigated through the “general applicability of anti-fraud provisions of the federal securities laws.”

The SEC collected $3.95 billion in enforced penalties and assets that were returned to its investors in fiscal 2018, up 4.2% from the previous year’s $3.79 billion.

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