Episode #19: Recent SEC Rule Changes Affecting Companies and Investors (David Baxter)

Joel Simon: August was a busy month for the SEC. They adopted two sets of rules, both of which changed some long-standing guidelines and practices that industry professionals have been trying to get updated for quite some time. In a nutshell, what are these two changes and just how important are they?

Baxter: That’s right, Joel. There were two particular sets of rule amendments that were adopted by the SEC in August that apply to a lot of our client base, including public companies and investors. The first amends the definition of accredited investor, which results in an expanded universe of who can invest in most private offerings. The second involves amendments to simplify and clarify some of the SEC’s disclosure requirements for public companies and Regulation S-K regarding a company’s business, legal proceedings and risk factors. I think the accredited investor change is the more meaningful of the two since it expands the investor universe in the most popular form of capital raising that we currently have in the United States. The changes to Regulation S-K were generally positive or mutual to public companies and not as important in the grand scheme of things.

Simon: Both of these changes sound like pretty positive developments, both for investors and companies. Let’s start with the changes to the accredited investor definition. I know that’s a definition that’s been static for a long time. What’s changed, and why is it significant?

Baxter: Well, what changed is that the SEC added more categories of people and entities who qualify as accredited investors. This is important to private placements which have supplanted registered offerings as a principal form of capital raising in the United States. Most private placements are done pursuant to Rule 506 of Regulation D under the Securities Act of 1933, and since regulatory requirements are greater for private placements that include investors who are not accredited investors, most of these private placements are sold only to accredited investors. So the definition of accredited investor is very important to how private placements work.

Simon: So tell us who was missing from the long-standing definition but has now been added and why, and what impact will this have on transaction documents?

Baxter: You bet. There are four main types of people and entities who have been added. First, entities of family offices with investments or assets under management over $5 million; second, many investment advisors; third, a knowledgeable employee of a private fund; and fourth, any individual with a professional certification, designation or credential from an SEC-approved accreditor. The SEC has initially approved accreditations to be the Series 7, Series 65, and Series 82 licenses, and you can see more detail on all these changes to the accredited investor definition in our September 9 client alert. One of the main impacts of these changes is that people who oversee or participate in investments by private funds can now qualify as accredited investors. Previously, those employees, assuming they had less than $5 million of assets, were often restricted from investing in the private fund because the fund itself often wants to qualify as an accredited investor by having all its owners be accredited investors. Separately, securities professionals who often know about as much as anyone about an investment opportunity can also now invest as accredited investors. As to the impact this will have on transaction documentation—issuers, investors and advisors, including counsel, really need to look to documentation on existing and new investments to check that the requirements for being considered an accredited investor are satisfied. Often, documents will reference only Rule 501(a) 1, 2, 3 and 7, but most of these new amendments have been effectuated through different sub-classes of Rule 501. In particular, folks will want to examine investor questionnaires and subscription documents for new deals where the accredited investor requirements are spelled out, as well as transfer restrictions in existing deals.

Simon: It’s really amazing that the accredited investor definition stayed the way it was for so long because it seems like all of the new categories that were added have been around for quite a while now. I guess it took the government a long time to catch up to market realities. Let’s pivot now to the disclosure changes. I think I read in your client alert that the rules affected by these changes date back to 1973. That’s a long time ago even for an old guy like me. I wasn’t even in high school yet. What were these changes all about?

Baxter: Well, I wasn’t even on planet Earth yet, so you’re one up on me, Joel. For these, the SEC has tried to simplify disclosure requirements concerning descriptions of a company’s business, legal proceedings and risk factors. There are several changes that we highlighted in our August 31 client alert, but let me focus on five of the key changes. First, the business description can now be hyperlinked to one prior filing with just the material updates disclosed in the new filing. In practice, since you can only hyperlink to one prior filing, companies will likely decide to provide the full description in annual reports. Second, the SEC now requires a description of the company’s human capital resources to the extent material and a description of the impact of all governmental regulations on the company. Third, the required description of legal proceedings can now be hyperlinked to disclosure elsewhere in the filing such as the MDNA or the financial statement notes. Fourth, companies with more than 15 pages of risk factors must now include summary risk factor disclosure. That summary disclosure has been pretty commonplace in IPO filings anyway, so really this impacts 10-Ks and fall on prospectuses. Companies preparing a registration statement in the coming months should also be cognizant of this requirement about risk factor summaries. And fifth, risk factors must now be grouped under headings with general risk factors in the final section captioned “general risk factors.” Many companies have already done this sort of grouping in IPO filings.

Simon: How long will it take these changes to go into effect, Dave?

Baxter: The Regulation S-K changes become effective 30 days after publication in the Federal Register, and the accredited investor changes become effective 60 days after publication in the Federal Register. Now these rules were all adopted by the SEC on August 26. In non-COVID times, it was typical for rules to be published in the Federal Register about a week or two later after adoption, but during COVID we’ve seen a marked delay in Federal Register publication of SEC rulemaking, so it could be several months before these rules are even published. At this point, I’d say it’s becoming unlikely that the S-K changes will be published in time to impact third quarter filings for calendar year companies, so this will likely become a 10-K issue for calendar year companies.

Simon: In the last couple of minutes that we have, Dave, can you tell us how the debt capital markets have been faring during the pandemic? From what I’ve been reading, it seems that for the past few months they have almost been insulated from it. Is that accurate?

Baxter: Yeah, even more so to the other side. It’s been a record-breaking year for debt capital markets, so if anything COVID has had a positive effect on capital raising, at least for investment-grade companies. The prior record of $1.4 trillion of investment-grade issuances had been set in 2017. That’s already been beat, and we still have three months to go in 2020. Yeah, it’s really something. Investors have really piled into a market that’s been backed up by the fed and in the environment of historically low interest rates, so our capital markets practice has been as busy as ever.

Simon: Dave, thank you so much for that enlightening discussion on these long overdue changes to SEC rules applicable to securities offerings and also that brief market update. It’s been great chatting with you today.

Baxter: Likewise, Joel. It’s been a real pleasure. Thanks very much for inviting me to join you on today’s podcast.