Amendments to US 'Normal Course' Research Exemptions
Just as in context of what are now commonly known as Rule 144A/Regulation S offerings, which are not made public in the US but instead are extended only to certain US qualified institutional buyers, prohibitions on ‘general solicitations’ and ‘directed selling efforts’ effectively forbid the public distribution of research reports in advance of or during such offerings. These restrictions are often problematic for investment banks in the context of international offerings of securities by non-US companies that have publicly traded securities and are covered by the bank’s research analyst. This is particularly the case in the context of undocumented offerings (such as placings and accelerated book builds) and other follow-on offerings, which often closely follow results announcements that prompt research analysts to issue update or ‘flash’ notes on the issuer. The problem is exacerbated by the increased use by investment banks of websites and email as the primary method of distribution of research, which make it more difficult, if not impossible, to ‘ring-fence’ the US adequately and thus prevent the distribution of problematic research in the country.
As part of its far-reaching Securities Offering Reform that was adopted in 2005 this year and took effect on 1 December 2005, the US Securities and Exchange Commission (SEC) made a number of amendments to the principal exemptions (Rules 139 and 138 ) available for the distribution of research reports in the context of international offerings by non-US issuers. These amendments should ameliorate this problem in a number of important respects. In particular, as more fully discussed below, the amended exemptions:
Before the effectiveness of the amendments, Rule 139 created separate limited exemptions for issuer-specific and industry-specific reports. Issuer-specific reports were permitted if, among other requirements, either the issuer met a $75m minimum public float requirement or the offering involved non-convertible investment-grade securities. In order to take advantage of the exemption, the issuer must either:
Industry-specific reports were permitted, provided that the issuer was a reporting company in the US (or was a foreign private issuer that satisfied the second of these requirements) and provided that the analysis of the issuer was not given greater prominence than the other companies in the report, and any recommendations or opinions expressed in the report were no more favourable than in previous reports. For both issuer-specific and industry-specific reports, the research had to appear in a publication distributed with ‘reasonable regularity in the normal course’ of the investment bank’s business.
The amended Rule 139 retains the distinction between issuer-specific reports and industry-specific reports. Significantly, the amended rule extends the exemption for both types of research to foreign private issuers that have a $700m worldwide public float, even if their equity securities have not traded on a designated offshore exchange for the required 12 months. Additionally, in light of the stricter requirements on analyst independence that have been adopted in recent years, the SEC has removed the requirement that the analyst recommendation be ‘no more favourable’ than in the previous report on the issuer. Lastly, for both types of reports, the requirement that the report appear in a publication distributed with ‘reasonable regularity’ – often a source of debate – has been eliminated. Under the amended rules, in the case of issuer-specific research, the investment bank must publish research in the regular course of its business and such publication may not represent the initiation of publication of research reports about such issuer. In the case of industry-specific research, the investment bank must publish research in the regular course of its business and, at the time of publication of the research, must be including similar information about the issuer or its securities in similar reports.
Rule 138 creates a related safe harbour that allows an investment bank participating in an offering of common stock or similar securities to issue research in relation to the issuer’s fixed income securities, and vice versa, if the investment bank publishes such research in the regular course of its business. Whereas the former Rule 138 required that reporting issuers meet certain technical criteria, it has now been expanded to include all reporting issuers that are current in their periodic reports. The old Rule 138 also applied to foreign private issuers meeting the same requirements as those set out in Rule 139, and the amendments now extend the safe harbour to foreign private issuers meeting the $700m worldwide float requirement. The new Rule 138 will also require that the investment bank has previously published research on the type of securities that is the focus of the report.
In addition to these changes, the amendments also once and for all codify a position the SEC expressed in 1998, when it indicated that existing Rules 138 and 139, which by their terms apply only to registered (that is, public) offerings, apply to Regulation S offerings as well. While not explicit, most practitioners believed that a similar view was reasonable in connection with Rule 144A offerings. Specifically, the new amendments make clear that the publication of research reports meeting the requirements of Rules 138 or 139 will not be considered ‘general solicitation’ or ‘general advertising’ in the context of Rule 144A, nor will it be considered ‘directed selling efforts’ in violation of Regulation S.
These amendments to Rules 138 and 139 are part of the SEC’s broader project to eliminate unnecessary and outmoded restrictions on communications with the market and should help clarify when research can be issued in the context of international offerings made under Rule 144A and Regulation S.