On May 19, the SEC issued a release (the “Release”) proposing major changes in the regulation of securities public offerings,[1] one of four major disclosure-related rule proposals that it issued that month.[2]  Some of the Release’s proposed offering reforms, such as the modernization of Form S-1, are useful steps forward.  The Release, however, does not provide a sufficient basis for the changes involved in its three most central proposed reforms: (i) expanding the availability of ordinary shelf offerings; (ii) expanding the availability of “automatic” shelf offerings; and (iii) expanding the availability of the most relaxed rules concerning statements promoting an offering.  It is certainly possible that the SEC could, in a subsequent release, provide a sufficient basis for moving in the direction of one or more of these reforms, but we are doubtful that it will be possible to justify going as far as the Release proposes with regard to any of them.

The Three Central Proposals

1. Expansion of issuers qualified to conduct ordinary shelf offerings. Rule changes proposed in the Release would increase the number of issuers entitled to conduct offerings utilizing ordinary shelf registration by an SEC-estimated 60%. Ordinary shelf registration permits delayed or continuous offerings over time.[3]  This is in contrast to the traditional registration procedure, which can only be used for an offering of specified size planned for the period immediately following effectiveness.  An issuer that qualifies to use Form S-3 to register a public offering is generally entitled to use the ordinary shelf procedure.  Since its inception, Form S-3 and its associated prospectus permit an issuer, in answering required company information disclosures, to incorporate by reference information disclosed in its most recent Exchange Act periodic disclosure filings.[4]

Currently, an issuer is entitled to use an S-3 to publicly offer its shares, and hence to utilize the ordinary shelf procedure, if it (a) has been an Exchange Act reporting company for at least 12 months: (b) has complied with its Exchange Act disclosure requirements during that period (the “twelve-month seasoning requirement”); and (c) either (i) has a public float (the market capitalized value of its outstanding shares not held by affiliates) of $75 million, or (ii) is undertaking an offering small enough, when added to any prior offerings in the last twelve months, that the total is less than one-third its float.[5]

The proposed estimated 60% increase in the number of issuers qualifying for Form S-3, and hence entitled to use ordinary shelf registration, would be accomplished by eliminating, for any issuer having a class of equity listed on a national stock exchange, both the current twelve-month seasoning period requirement and the current minimum float or offering amount limitation. Hence, the change introduces the availability of shelf registration to both less seasoned and smaller issuers.  The SEC labels all the issuers that would so qualify to use Form S-3 under the proposed expanded rules as “Eligible Listed Issuers” (“ELIs”).

2. Tripling of issuers qualified to conduct “automatic” shelf offerings. Rule changes proposed in the Release would result in an SEC-estimated tripling of the number of issuers entitled to conduct offerings utilizing automatic shelf registration, a procedure by which an S-3 registration statement becomes effective immediately upon filing. The automatic shelf allows an issuer to offer an unlimited amount of securities at multiple points in time (albeit not to exceed three years) with payment of registration fees only when the securities are actually offered.[6]  Because the registration statements of issuers using the automatic shelf go effective upon filing, they are not subject to the review process customarily carried out by the SEC with all other registration statements, and the issuers do not receive comments from the staff as occurs with the so-called “letter of comment.”

Currently, use of the automatic shelf is confined to “Well-Known-Seasoned-Issuers” (“WKSIs”).[7]  These are issuers that not only qualify to use Form S-3 under existing requirements, but also have a float of at least $700 million.[8]  The proposed estimated tripling of the issuers entitled to use the automatic shelf would be accomplished by expanding the group to include any issuer entitled to use the S-3 as long as it has been a reporting company and listed on a national stock exchange for at least twelve months.   The float requirement for utilizing the automatic shelf has thus been entirely eliminated.  The SEC labels this subgroup of ELIs—ones that have been reporting companies for at least twelve months—as “Seasoned Eligible Listed Issuers” (“SELIs”).  Only SELIs can use the automatic shelf.

3. Expansion in the number of issuers entitled to the greatest relaxation of rules concerning release of statements promoting the offering. The Release proposes changes that would, based on SEC estimates, more than triple the number of issuers entitled to a full relaxation of the rules relating to statements that have the effect of promoting the offering.  Currently only a WKSIs can, during the thirty days prior to filing a registration statement, issue a “free writing prospectus.”[9] This is a statement that promotes the offering or otherwise excites interest in the issuer’s securities made outside the formal registration statement.  Because of this, whatever is said in such a statement is not “policed” by Section 11 liability that applies to items in the formal registration statement.  Under current regulations, during the waiting period between the filing of a registration statement and its effectiveness, only WKSIs and other firms that have been Exchange Act reporting companies for at least twelve months (and the underwriters and dealers involved in an offering by either such type of firm) are permitted to issue such a free writing prospectus[10]without the statement being preceded or accompanied by the red herring prospectus.[11]

The Release proposes to expand the range of issuers entitled to the free writing prospectus privileges heretofore enjoyed only by WKSIs. Under the proposal, this group would now include any issuer listed on a national stock exchange, i.e. any ELI.  In other words, neither a minimum float of $700 million (nor even of $75 million) nor at least twelve months of seasoning would be required any longer to enjoy these privileges.  Thus, a change now being proposed would, during the process of a registered offering, authorize the release to potential investors of information not policed by either staff review or Section 11 for a much larger portion of all issuers.

Discussion

We start with a consideration of the automatic shelf and ordinary shelf registration expansions proposed in the Release.  We should make clear at the outset that we are supportive of these procedures when made available to the appropriate types of issuers.  These procedures reduce delay and compliance costs for issuers and allow them to obtain the services of underwriters at more competitively priced fees. However, these benefits should only be available to issuers where it is reasonable to believe that their use will not threaten the level of investor protection and capital allocation efficiency that is associated with the traditional standard registration process. Adoption of the current rules drawing the lines between the issuers that are and are not entitled to utilize each of these procedures occurred only after extensive study and discussion as to their effects on investor protection and efficient capital allocation.  Although it is possible that new learning or changes in circumstances could now justify expanding the sets of issuers entitled to use one or both procedures, the Release does not provide anything like the empirical and theoretical base that the SEC provided in the rulemaking that has led to the current set of protocols.  This is of particular importance given how sweeping are the SEC’s proposed changes.

Because a shelf registered offering only occurs when there is already public secondary market trading in the issuer’s securities, a key question for allowing an issuer to use either of these procedures is the quality of the pricing of securities already trading in that secondary market: in essence how accurately does this price reflect information potentially available about the firm and its future cash flows. This concern was invoked by the SEC when it first adopted the ordinary shelf pursuant to Rule 415 in the early 1980s,[12] and again when it introduced the automatic shelf available for WKSIs in the 2005 Offering Reforms.[13]  The reason for focusing on the quality of secondary trading market pricing is that any newly offered securities cannot be priced higher than the price at which the already outstanding securities of the same class can be obtained on an exchange.  Thus, when secondary market pricing is of sufficiently high quality, the price at which the new securities are being offered provides the purchaser with a significant measure of protection from overpaying (contingent on the information potentially available at the time) even if she does not look at any SEC disclosure documents.  Such high-quality pricing also provides a reasonable assurance that capital is being allocated efficiently, i.e., that, as best can be ascertained given what is known by anyone at the time, capital is going to the firms that can make the best use of it.

The construction of the current rules relating to the automatic shelf reflects these ideas. For example, when the SEC created the procedure in 2005 as part of that year’s offering reforms, it found that firms meeting the WKSI $700 million float test had an average of twelve analysts following them.  Such analyst coverage suggests a high level of market efficiency, meaning that any information about an issuer disclosed in its existing Exchange Act filings will be well analyzed for its implications and quickly reflected in the issuer’s secondary market trading price.  This kind of analyst following also suggests the existence of a number of independent fact finders who are looking for information beyond what is revealed in the issuer’s Exchange Act filings.  Their discoveries will also be reflected in share prices, making these prices that much more accurate as predictors of a firm’s future cash flows.  The Release lacks serious analysis of this kind and stands in stark contrast to earlier reform efforts by the SEC.

The required twelve-month seasoning period as a reporting company serves a similar role.  It gives analysts time to gain an understanding of a company new to being publicly traded.  It also creates a test period during which the issuer can demonstrate a pattern of properly complying with its periodic Exchange Act disclosure obligations. The Release sheds little light on the effects of relaxing this historical requirement.

The construction of the current rules on the use of the ordinary shelf reflects these ideas as well.  Like the automatic shelf, use of ordinary shelf registration is currently confined to issuers that have had at least twelve months as public companies, thereby providing the same benefits noted just above.  The $75 million float requirement is enough to suggest there would likely be market trading based on many of the disclosures in an issuer’s Exchange Act filings, though, unlike the automatic shelf’s $700 million float test, a $75 million float by itself is probably not a sure indicator of a high level of market efficiency.[14]  The lower float’s weaker assurance of pricing quality, however, is compensated, at least in part, by the more restricted way that the ordinary shelf procedure works. Unlike the automatic shelf, the registration statement for an ordinary shelf offering does not go effective immediately upon filing.  During the waiting period between filing and effectiveness, the registration statement is subject to SEC staff review. Staff comment letters commonly elicit decision-useful information. Also, if there is an underwriter involved when the registration statement is filed, the time between filing and effectiveness allows the underwriter to engage in more meaningful due diligence without holding up the offering.

As noted, the Release proposes to entirely eliminate the float requirements for both the automatic and ordinary shelf offerings, which currently are $700 million and $75 million respectively.[15] For ordinary shelf offerings, the Release proposes to eliminate the twelve-month seasoning period as well.  The Release makes no serious attempt to show that the large number of additional issuers that would become entitled to use each of these procedures would have the same quality of share pricing as that of the issuers currently so entitled.  Indeed, many might not even come close. Rather, the SEC’s primary rationale for both expansions is simply that internet access to EDGAR and issuer webpages is wider than ever.  The idea is that because of this ready access, a potential investor can easily inform herself of an issuer’s Exchange Act disclosures that are then available. In reality, though, for most anyone likely to be an investor, they already had such access back in 2005 when the current rules were adopted.

Interestingly, the Release’s rationale makes little sense even on its own terms. This rationale is equally applicable to issuers that are not listed on a national stock exchange but are nevertheless reporting companies because of ownership, and asset considerations. Yet the Release does not extend the expansions of the sets of issuers entitled to use automatic and ordinary shelf offerings to these issuers.  If simple availability of information is not sufficient to allow unlisted issuers to use shelf procedures, the SEC has not explained why it is sufficient when it comes to listed issuers.

More crucially, the Release’s easy-information-availability rationale ignores the idea that unless trading prices reflect available information about a firm with sufficient accuracy, an offering’s potential investors will not be protected from overpaying without needing to inform themselves by reference to the issuer’s Exchange Act filings. Where the quality of an issuer’s security’s secondary market pricing is not assured to be of this quality, investor protection and efficient allocation of capital are better served by requiring offerings to be conducted in the standard fashion, i.e., more akin to the way that a previously non-reporting company’s IPO is conducted.  Put another way, efficient secondary market pricing is a much more powerful and socially efficient means to protect new investors in new offerings than is the mere availability of Exchange Act filings.  Without evidence of efficient secondary market pricing, the burden of showing that mere availability of Exchange Act filings would alone suffice to protect investors and allow for the efficient allocation of capital should be heavy, and it is not met by the Release or the studies it reviews.  And the fact that a wider range of content is easily available to investors today than was the case when the current rules were adopted provides little comfort if there is no assurance that trading prices reliably reflect what the securities laws provide: a central source of information superintended by a transparent set of disclosure rules and policed by reasonable liability standards.

It is certainly possible that the range of firms entitled to use each of these procedures should be expanded from the current number, [16] most likely through a discrete expansion of the automatic shelf.  To do so, however, the SEC would need to show that the criteria adopted assure that the securities of the additional qualifying issuers are trading in highly efficient markets and that the issuers are subject to meaningful analyst scrutiny, something the Release fails to do.[17] With regard to the highly expanded range of issuers entitled to utilize the automatic shelf, the SEC needs to show that consequent loss of staff review of these additional issuers’ registration statements would not result in a loss of meaningful information reaching the market and potential investors in time to affect their offerings.[18]

Enhancing capital formation, the stated goal of the Release, can only be achieved when a reform’s savings do not come at the expense of investor protection and efficient capital allocation.  If the savings come at the expense of investor protection, that will eventually lead to a decline in investor confidence and a consequent reduction in capital formation.  And if they result in more money going to fund unworthwhile real investments, the whole point of promoting capital formation—the wealth it generates in the future—is lost.

We are very much of the same view when it comes to the Release’s proposal to extend the current WKSI-only relaxations on free writing statements that are outside the formal registration statement but nonetheless have the same effect of promoting an offering.  A primary concern ever since adoption of the Securities Act has been to prevent issuers from selling securities at an inflated price through use of an optimistic sales pitch that lacks full disclosure.  The rules that make up the traditional registration process are designed to accomplish just this.  Key to this result is the registration statement the content of which is defined by disclosure guides promulgated by the SEC the responses to which are subject to rigorous Section 11 liability imposed on the issuer and a list of other key actors in the distribution of the security. Where the secondary market pricing of an issuer’s securities is of sufficiently high quality, this concern is much abated.   Hence the current rules relating to WKSIs in this regard make sense.  Again, if the set of issuers entitled to privileges currently confined to WKSIs is to be expanded to include additional issuers, the SEC should show that the criteria adopted assure that the securities of the additional qualifying issuers are trading in highly efficient markets and that the issuers are subject to meaningful analyst scrutiny.

Our bottom line is, slow down and get things right.  Barreling ahead without a firmer basis for the proposed changes is particularly concerning when its potential effect on the overall public company disclosure environment is added to that of May’s other dramatic SEC proposals: giving issuers the option to report only semi-annually, and reducing what must be provided in periodic Exchange Act filings for a wide swath of publicly traded issuers. It is difficult for the public to—and we have not had the time ourselves to try to—anticipate how the various pending proposals might interact in unpredictable ways, reducing yet further any confidence that anyone should have that the proposals will in fact accomplish the SEC’s own stated goals in proposing them.

ENDNOTES

[1] Registered Offering Reform, Sec. Act Rel. 11,418 (2026) (proposal).

[2] The other three proposals are SEC proposal on semiannual reporting, Sec. Act Rel. 11,414 (2026) (proposal) {see Shadow SEC Statement No. 8); Enhancement of Emerging Growth Company Accommodations and Simplifications of Filer Status for Reporting Companies, Sec. Act Rel. 11,419 (2026) (proposal) (Filer Status Proposal)(see Shadow SEC Statement No. 9); Rescission of Climate Related Disclosure Rules, Sec.Act Rel. 11,421 (2026) (proposed withdrawal of 2024 climate control rules)(see Shadow SEC Statement No. 10).

[3] Securities Act Rule 415(a).

[4] Incorporation by reference is now made available for issuers not eligible to use Form S-3 provided the registrant has filed a current Form 10-K with the SEC.

[5] See Form S-3 General Instruction I.A Business development companies and closed end mutual funds that meet these qualifications are entitled instead to use a short-form N-2 and are similarly entitled to utilize the ordinary shelf procedure.

[6] Business development companies and closed end mutual funds that are entitled to use a short-form N-2 and meet these qualifications are similarly entitled to utilize the ordinary shelf procedure.

[7] Form S-3 General Instructions I.D.

[8] Securities Act 405. As an alternative to meeting this float test, to qualify as a WKSI, the issuer can instead have issued at least $1 billion aggregate principal amount of non-convertible debt securities offered in registered public offerings over the preceding three years.

[9] Securities Act Rule 163.

[10] Securities Act Rule 163 for WKSIs and Securities Act Rule 164 for other issuers.

[11] Currently, a firm that is not already Exchange Act registered or is so registered but for less than twelve months (and underwriters and dealers involved in its offering) can issue a free writing prospectus during the waiting period, but only if receipt by the investor is preceded or accompanied by the statutory red herring prospectus.

[12] See SEC Release No. 33-6499 (Nov. 17, 1983).

[13] See  SEC Release No. 33-8591 (July 19, 2005).

[14] The alternative to the $75 million float requirement—the offering amount, combined with all other public sales in the last twelve months, not exceeding a third of the issuer’s float—is no indicator of market efficiency at all, but it does at least suggest that the funds raised are not going to entirely transform the nature of the firm from that reflected in the current trading price.

[15] The limit on offering amount alternative to the $75 million float requirement is also eliminated.

[16] It should be noted that simply by the effects of inflation, the range of firms qualifying to engage in an ordinary shelf offering has already been expanded substantially since the $75 million float requirement was adopted in 1992. In 1992 dollars, $75 million today would be about $31 million.  The similar comparison for the automatic shelf’s $700 million float test is that it would have been equivalent to about $410 million back in 2005 when the $700 million threshold was established.

[17] One way that the SEC could show the market efficiency for the shares of issuers to it proposes to add to those entitled to use either of these procedures is to take a random sample of them and see what portion would meet the so-called Cammer tests of market efficiency used by courts in connection with determining the availability of the  fraud-on-the-market presumption in Rule 10b-5 civil liability damages suits.  Cammer v. Bloom, 711 F. Supp 1264, 1286-87 (D.N.J. 1989).  In addition to the number of analysts following these issuers and the public float, other factors mentioned in the case include the average weekly trading volume and event studies suggesting that significant instances of unexpected news led to price changes in the predicted direction very quickly that thereafter follow a random walk.  Although not mentioned in Cammer, market capitalization would be another factor since the trading strategies that rapidly translate news into price changes are more profitable, and therefore more likely to be worth the effort, for issuers with a larger capitalization.  Yet another would be to study bid-ask spreads.  Purchases are always at the offer and sales at the bid, and, at any one time the offer is always higher than the bid.  These strategies that transfer news or discoveries into price require both a purchase and a sale, and so the narrower the offer is typically above the bid, again the more profitable the strategy and so the more of it that goes on with the resulting higher quality secondary market pricing.  See Krogman v. Sterrit, 202 F.R.D. 467, 474-478 (N.D. Tex. 2001) for mention of using market capitalization and bid-ask spreads as factors.

[18] At a minimum, the SEC needs to review a sample of recent registrations statements by issuers of the type that would be added to the group entitled to use the automatic shelf.  The purpose of this review would be to see how many of the registration statements prompted staff comments during this review process and to assess the importance of the additional disclosures resulting from these comments.

This post comes to us from the Shadow SEC, whose members are professors John Coates at Harvard Law School, John C. Coffee, Jr. at Columbia Law School, James D. Cox at Duke University School of Law, Merritt B. Fox at Columbia Law School, and Joel Seligman at Washington University School of Law.