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Effective only since Dec. 1, 2005, recent reforms to the Securities Act of 1933-designed to modernize the securities-offering process-have begun to have an impact on securities distribution techniques. Before these rules took effect, the basic regulatory framework for securities distributions had changed little since 1933 despite enormous advances in communication technology and the size and sophistication of the securities markets. The new rules effect a number of significant changes, ranging from technical aspects of the registration process to fundamental issues of whether and when various offering participants have Securities Act liabilities. Two of these rule revisions have particular potential to alter some of the most basic securities-offering practices. The first is the permissible use of “free-writing” prospectuses, and the second is a new interpretive rule that moves up the time at which the adequacy of disclosure to investors is assessed for purposes of certain Securities Act liabilities. This article discusses both changes in more detail, makes some observations about their impact to date and offers some modest predictions about their future. Under the old rules, the “statutory” prospectus, which must comply with detailed requirements of the securities rules, was a revered document because it was the only tangible communication that could be used to sell securities. While “oral” offers were permissible, any other “written” communication used to sell a security was an illegal prospectus, which subjected the issuer and other offering participants to potential liability and rescission. As communication technology expanded, so did the definition of “written.” The Securities Act was amended in the mid-1950s specifically to provide that television communications were “written,” and the Securities and Exchange Commission (SEC) had consistently taken the position that so were e-mail and other forms of electronic communication. Due to these restrictions, the infamous “roadshow” became the accepted means of marketing any offering that required a significant sales process, and distributing securities was a labor-intensive process involving almost exclusively face-to-face and telephone communications. Under the revised rules, offering participants have much more flexibility. These rules introduce the “free-writing prospectus,” which means any nonoral communication. Their use is allowed so long as certain minimal conditions are met: generally, filing with the SEC and including a short, innocuous legend. These communications are, of course, still subject to the anti-fraud rules and must not contain material misstatements or omissions, but they are no longer strictly forbidden and there are no specific restrictions on their form or content. Under the old rules, the statutory final prospectus had another crucial function-in that it had to be delivered prior to or simultaneously with confirmation of the sale. Although this often presented a logistical problem, the issue had become less significant in recent years due to the ability to deliver the final prospectus electronically. The new rules eliminate the issue entirely by providing that access equals delivery of final prospectuses. Thus, the fact that a final prospectus is on file with the SEC is sufficient to satisfy the delivery requirement. While this relieves entirely the need to ensure final prospectus delivery, the second fundamental rule change-the change in the time at which the adequacy of disclosure is evaluated-takes back much of the benefit and more. Under the old rules and general practice, many disclosure issues were dealt with only in the final statutory prospectus. Marketing was often done with a preliminary prospectus that did not include final pricing terms and was often several weeks old. Confirmations of sale were delivered with an updated final prospectus, which included these terms and often also included new information (such as updated financial results) that had become available during the marketing process. Issuers, underwriters and their counsel (sometimes at the urging of the SEC staff) would consider whether these revisions and additional information were meaningful enough to merit “recirculation” of a prospectus. The conclusion was generally that they did not. While best practice had been to inform investors of key changes and developments-particularly negative ones-before confirming a sale, it was far from a universal procedure. Moving up disclosure time When the SEC proposed the new rules in November 2004, it set out a new interpretive position that the time for first evaluating the sufficiency of disclosure to an investor should be moved up to the time of the investor’s investment decision or commitment, rather than the date of delivery of the final prospectus. While the provision, embodied in new Rule 159 applies to all offerings, it has the most potential to affect those offerings that are completed rapidly and those that involve complex terms not available until shortly before the sale. Large, well-known issuers that routinely access the capital markets frequently accomplish offerings of equity or debt securities in “overnight” deals by a “take down” from a “shelf” registration statement under Rule 415. While the buyers in these offerings are almost exclusively sophisticated investors who demand to know sufficient deal particulars before placing orders, the fact is that under the old rules there was often no disclosure document even in existence, let alone delivered, before the investors committed themselves. In these situations the general practice was to provide the investors a final prospectus before closing that laid out the terms already described orally. If the investors did not object to the terms of that document (or perhaps even if they did), offering participants took the position that their liability was governed by the disclosure in that final document. While the SEC made it clear in adopting the new rules that it is not necessary for investors to receive a full statutory prospectus prior to an investment decision, the liability of offering participants is to be judged by the sufficiency of the overall disclosures, however communicated, at the time of the investor’s commitment to purchase. The SEC also made it clear that this disclosure obligation could be satisfied by a number of different means (e.g., a disclosure that the security terms would be the same as “for the transaction by XYZ company”). Free-writing prospectuses So what has happened in the weeks since the 1933 Act reform rules became effective? Offering participants have made extensive use of free-writing prospectuses. Many observers earlier questioned whether issuers and underwriters would actually use free-writing prospectuses. Their use, however, has been substantial and expanding. More than 370 free-writing prospectuses were filed under Rule 433 on Form FWP in December; in January, more than 470; and in February, some 680. It should also be noted that not all free-writing prospectuses are required to be filed, so the number used might well be higher. The overwhelming majority of these filings consist of term sheets and similar disclosure documents used for offerings of securities taken down from shelf registrations, often in very rapidly completed transactions. These documents are either preliminary-describing a proposed offering and being used to elicit interest and educate investors-or final-setting forth the final pricing terms and other details of the offered securities for use in making the contract of sale. In some instances, the free-writing prospectus is a substantially abbreviated document when compared to the later-filed final prospectus. In other cases, the free-writing prospectus is the functional equivalent of a standard prospectus, complete with a traditional table of contents and sometimes running several hundred pages. These uses of the free-writing prospectus mechanism seem compelling. It is significantly more efficient and timely for sellers of complex securities to employ an abbreviated term sheet to provide information about an offering and to use commonly understood “shorthand” descriptions of terms rather than the more technical, voluminous and often boilerplate disclosures contained in the final prospectus. And these documents allow offering participants to prove that investors have been given, before or at the time of their commitment, the level of disclosure necessary under new Rule 159. Other situations Free-writing prospectuses have not, however, been restricted to use by large seasoned issuers in fast-paced transactions to rapidly convey offering terms. They have also been used in other situations to achieve either disclosure or marketing objectives. Some disclosure examples include: to notify potential initial public offering (IPO) investors of a change in the expected offering price range and other developments (see Pixelplus Co. Ltd. FWP filed on Jan. 20, 2005, and Spansion Inc. FWP filed on Dec. 15, 2005); to inform investors in the issuer-directed component of an offering of special procedures applicable to them (see Dealer Track Holdings Inc. FWP filed on Dec. 12, 2005); to provide updated earnings guidance (see EMS Technologies Inc. FWP filed on Jan. 26, 2006); and to provide updated financial information (see Martec Inc. FWP filed on Jan. 24, 2006). Marketing-related examples include: to provide a summary document circulated separately from the standard preliminary prospectus in a common equity offering (see Parker Drilling Co. FWP filed on Jan. 17, 2006, and Somaxon Pharmaceuticals Inc. FWP filed on Dec. 15, 2005); to present slides used by management at an industry conference (see Xoma Ltd. FWP filed on Jan. 10, 2006) and to present favorable media coverage about the company (see Johnson Controls Inc. FWP filed on Jan. 9, 2006). The Chipotle IPO example Another particularly interesting use of the free-writing prospectus demonstrates that Wall Street is taking advantage of the marketing potential of the new rules. In January, Chipotle Mexican Grill Inc.’s extremely successful IPO used a special Web page as a free-writing prospectus to aid marketing efforts. The Web page allowed users to access numerous of the company’s print, radio and TV ads. See FWP filed on Jan. 17, 2006; see also www.chipotleipo.com. Under the prior rules, the print ads could have, of course, appeared in the prospectus, as could transcriptions of the radio and TV ads (which is, of course, less compelling and informative than seeing or hearing them as they were intended). The radio and TV spots could also have been displayed at the roadshow. However, the new free-writing prospectus rules allowed a more compelling approach. Based on the early experience and the creative forces at work in the securities industry, it seems likely that free-writing prospectuses will be used in more creative ways. Because of the labor-intensive nature of securities distributions, it has generally been necessary to have a significant sales force to effectively market securities offerings. Perhaps that can change, allowing smaller investment banks to take advantage of the new rules, marketing offerings with broad sponsored advertising to a retail audience and minimizing the need for a large sales force. For “seasoned” issuers-based on their reporting history and size-a securities offering could even be marketed on television so long as a transcription of the advertisement is filed as a free-writing prospectus. Of course, more seasoned and well-known issuers are less likely to benefit from such broad-based advertising directed to small investors, but innovative ways to obtain exposure could be particularly helpful in the case of an IPO. Internet as marketing tool A free-writing prospectus used in connection with an IPO (or other offering of an unseasoned issuer) must be accompanied or preceded by the statutory prospectus. This means that television is not a viable alternative because it is impossible to prove that all those who saw the ad received the prospectus. In this regard, the Internet could be a very powerful marketing tool. The rules allow the “accompanied or preceded” test to be satisfied with respect to an electronic communication if that communication contains a hyperlink to a prospectus. For example, a biotechnology company involved in an IPO could pay for sponsored advertising on the finance pages of popular Web sites or, more pointedly, pay for an advertisement that popped up whenever a user searched for a stock quote on specified biotech companies or searched for certain key words. So long as the ad included a link to a prospectus, any manner of marketing materials, including video presentations, animations and testimonials, could be displayed for marketing purposes. Securities offering documents have always had two somewhat contradictory purposes: to market securities and to establish the adequacy of disclosure. While it is too early to tell how far and how quickly the marketing envelope will be pushed with the use of the free-writing prospectuses, changes seem inevitable. On the other hand, as a means to improve the timeliness and quality of disclosure, the free-writing prospectus is changing the standards. Thomas J. Murphy is a partner in the Chicago office of McDermott, Will & Emery. He is partner-in-charge of the Chicago corporate practice, head of the firm’s securities practice group and co-head of its corporate responsibility practice group.

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