In mid-May, Salomon Brothers invited journalists to a briefing by Impress Metal, a newly-formed European canning business created through a management buyout led by equity investor, Doughty Hanson.
The briefing was scheduled for the River Room of the Savoy Hotel at 12.30pm on May 16. There was considerable interest. The single B-rated company was due to sell a Dm200 million Eurobond the following week, the third in a recent series of high-yield European corporate bond issues. Like its predecessors, the deal carried a 144A option for sale in the US.
No sooner had journalists put the date in their diaries than they received a follow-up letter. Everything said at the press conference was to be embargoed. Nothing could be published before the following Tuesday May 20, the launch day for the bond. Worse followed. On the morning of the planned news conference, Salomon Brothers’ public relations department telephoned reporters to tell them, with many apologies, that the event had been cancelled.
Fortunately, journalists with a sudden hole in their diaries had another interesting engagement that day. The administration of the City of Moscow was celebrating its 850th anniversary at a conference hosted by Sachs Associates and Bloomberg on new opportunities in finance, investment and trade.
Journalists hoped they would hear more at the conference about a three-year dollar Eurobond issue with 144A option for the City of Moscow, due to be sold later in the month. They knew that Nomura and CS First Boston were conducting roadshows. But at the conference, delegates were careful to avoid talking about the forthcoming deal. One speaker from Renaissance Capital even apologized for not being able to talk much about Moscow and offered to talk instead about the City of St Petersburg.
Meanwhile, officials and lead managers, who had been enthusing about their latest credit research reports compiled using freshly-available information from the City of Moscow, apologized that, after checking with their compliance officers, these could not be handed out. Journalists were bemused.
De-briefing
This January, an American bank invited a handful of journalists to a London briefing on what was billed as a potentially trend-setting deal for a European sovereign borrower. Notes on the complicated deal were handed out on arrival, and as journalists pored over them, a library hush descended on the conference room. Five minutes later there was a whispering among the lead manager’s staff near the doorway. The head of public relations walked around the table and, quietly but firmly, took back the papers she had just handed out.
The link between these stories is the limitation the American Securities and Exchange Commission (SEC) imposes on publicity before any new sale of securities. In most countries it is precisely when an issuer is preparing a large bond or equity deal that journalists want to write about it, to explain the issuer and the deal. In the US, as soon as an issuer reaches an agreement with a lead manager or syndicate to sell securities, the flow of news concerning issuer and deal, via research reports and press briefings, is severely limited.
The SEC enforces rules established under the Securities Act of 1933 and the Securities and Exchange Act of 1934. These were introduced with the trauma of the 1929 stock market crash still fresh in legislators’ minds. The regulations aim to ensure the provision of reliable information about a company to enable investors to decide whether or not to buy newly-issued securities. Issuers and underwriters may only use a proper prospectus, with comprehensive financial information, risk factors and details of key executives included, to sell public securities. Particular emphasis is placed on any documents, or other written words, that might be seen as being used to sell securities. The law is based on an assumption, which makes many journalists smile, that the written word is inherently more authoritative than anything merely spoken.
The rules prevent an issuer from starting to market an offer through the media before it files its prospectus with the SEC for approval – so-called gun-jumping. From the moment a company reaches a preliminary agreement with a lead underwriter on a proposed financing, it is considered to be in registration. It is prevented from using any form of publicity to condition the market: that is, to arouse public interest in the company or its securities in a way designed to promote the new issue. Any such publicity may be construed as an offer to sell securities using something other than a proper prospectus. That precludes not only paid advertising to promote the company (advertising for a company’s products is still allowed) but also on-the-record and even non-attributable interviews with company management about the company.
SEC employees monitor publicity closely, according to Meredith Cross, deputy director in the commission’s corporate finance division, but she stresses there is no need for paranoia. What they are really looking for, Cross says, are cases of “clear-cut market conditioning before the offer is filed”. For a company to leak a strong earnings projection two weeks before filing to sell a new issue would be unwise.
Arguing over implications
So far, so sensible, it might seem. But the legislation has spawned libraries full of related documents, as issuers’ and underwriters’ lawyers have argued over its implications.
“Believe me there exists case law, enforcement proceedings and interpretative letters over the question of whether simply paper-clipping a business card to a prospectus, or adding a covering letter saying ‘Dear Bob, I like this deal, take a look at the accompanying prospectus’, constitute inappropriate offers for sale using something other than the actual prospectus,” says the head of European compliance at one American investment bank.
As with many common-law statutes, only so many clearly defined rules are spelled out in black and white. The writers’ intention was to establish broad principles, not to proscribe or prescribe issuers’ and underwriters’ actions in exhaustive detail. Sensible judgements still have to be made. For example, it soon became clear that casting a blanket of silence over an issuer’s affairs for several months prior to a new issue might have disastrous consequences for holders of its existing securities. These could, with justice, claim that they have the right to be promptly informed of key business developments which might affect the value of their investments.
In 1971, the SEC published guidelines saying that companies should, even when in registration, continue to make announcements to the press on factual financial and business developments. (A quaint echo of American industry in the early 1970s can be heard in the SEC’s suggested list of examples of such developments: receipt of a contract, settlement of a strike, and the opening of a plant.) Issuers should also, the guidelines instructed, “answer unsolicited telephone inquiries from stockholders, financial analysts, the press and others concerning factual information”. But the SEC insisted that issuers and their lead banks should be careful not to offer projections or forecasts of sales and earnings, or the value of forthcoming securities, nor should they initiate publicity designed to sell the new offer.
That leaves a fair amount open to interpretation. Most obviously, a forthcoming financing can itself be a major news event, especially if proceeds are earmarked for a significant investment or re-capitalization. It is a difficult distinction to draw: is an issuer releasing news designed to keep existing investors up-to-date or to condition the market to buy new securities?
Over the decades, market practices have developed and evolved. “Something considered unacceptable five years ago, might be acceptable today,” says Alan Klein, partner at Simpson Thacher & Bartlett. At the margin, the rules are fluid. For example, the Securities Act introduced tombstones as a means of telling investors across America which local brokerage to contact if they wanted to buy securities. In line with that intention, tombstones originally appeared in advance of deals, and listed basic terms and huge syndicates. In later years, this might have been interpreted as conditioning the market, and tombstones now appear only after deals are completed.
Most issuers and underwriters are clear on the basics for public, fully registered deals sold in the US. It’s all right to issue a press release before a prospectus becomes effective, saying that the issuer is filing with the SEC to issue a certain type of security and raise a certain amount for whatever purpose. But it is not permissible at this stage to suggest that these securities will be a great investment, nor even to say who the lead underwriter is, because that might count as conditioning the market (by encouraging investors to contact the firm and place orders). Similarly, once it is clear a company intends to launch a deal, managers of that company are not allowed to give interviews to the press (even before initially filing with the SEC). Paid corporate advertising campaigns are way beyond the pale.
To an American lawyer in London, the publicity that precedes new offers outside the US, especially large equity initial public offerings, is jaw-dropping. Back home, the research analysts of underwriters and syndicate members are reined in well before a deal is launched. (SEC guidelines suggest they can continue to comment on a firm for which they are about to distribute new securities, as long as these comments appear in country or industry research pieces, in no greater length or detail than that previously devoted to the issuer in such reports.)
Analysts cannot upgrade their previous forecasts and they certainly cannot suddenly produce large company-specific reports to sell a new issue. Outside the US, securities firms regularly produce such reports in the run-up to new deals.
But it’s the advertising that veterans of the US market find most odd. Klein felt a certain culture shock when he watched a recent television advertisement exhorting savers who have deposited their money with the Norwich Union to subscribe for shares in its forthcoming offer. “It would never happen in the US. It’s just a fundamentally different concept than in the UK.” He adds: “It may be common practice here for a company, before an offer, to give background or even on-the-record interviews to the financial press which lead, all of a sudden, to big pieces on the prospects for the issuer. But that would be extremely inadvisable for a company if its deal includes a US-registered public offer, especially if the newspaper has circulation in the US.”
Klein explains: “The ethos in the US is not simply to say whatever it takes to persuade investors to part with their money, but to say only what’s factually accurate and to put it all in the prospectus.”
Klein takes a more conservative view than many lawyers in the securities industry by suggesting that a well-written preliminary prospectus should provide material sufficient for any reporter to write a decent article about an issuer. He dismisses the notion that these are too lengthy or too dry to get to the nub of an investment story: “When people draft these documents, they spend hours and hours over the first three paragraphs of the summary section, because they know that’s their best chance to grab investors’ attention.”
Pink-herring prospectus
According to Klein, if a reporter obtains a preliminary or pink-herring prospectus and lifts from it for a story, well and good. But seeking an interview with the company is edging into questionable territory. “The only reason for a reporter to sit down with the company is to get more information than is actually in the prospectus.”
That begs the question: why do issuers bother with roadshows? Roadshows, at which company managers deliver spoken presentations to large gatherings of institutional investors (or address select fund managers individually and less formally) are regarded as the essential means by which issuers market deals subject to US law. The importance of roadshows suggests that fund managers need something more than a plainly written prospectus on which to base their investment decisions.
The fact that these presentations are spoken not written, provides limited relief from the strictest interpretations of the Securities Act. Most lawyers advise issuers to stick closely to the facts contained in the prospectus; some discourage slides (and particularly photocopies of slides) being distributed to the audience. Many lawyers say that, after warning clients against any extravagant projections not contained in the prospectus, they prefer to stay away from roadshows. That is because they allow for a greater degree of puffery, as managers talk about their vision for the business and their company’s position against competitors in the same markets.
Writers of the Securities Act of 1933 could never have predicted how, over the years, the US capital markets and foreign capital markets would become so closely linked. In today’s global bond markets, an issuer might well begin marketing bonds with no firm idea of where they will eventually be placed. The strongest bid might come from America, Europe or Asia.
Publicity restrictions
The SEC’s restrictions on publicity have clearly not been so onerous as to prevent an ever-growing number of foreign issuers from selling securities in the US, through US-targeted and global offers. The SEC has been a standard-bearer for securities regulators, particularly in matters of how much and what sort of information issuers should publicly disclose and how often. One reason why European investors have been enthusiastic buyers of recent high-yield corporate Eurobonds, is that the European issuers have signed up to US standards of disclosure.
At the same time, the SEC has done a great deal to encourage foreign issuers to raise capital in America, on some occasions waiving its usual requirements. If SEC reporting requirements demand an emerging market issuer to publish three years’ worth of financial accounts audited to US standards before selling bonds, for example, and the issuer can provide only two years’ worth, but is clearly willing and able fully to meet future reporting requirements, the SEC might well permit it to go ahead. On public fully-registered deals, foreign issuers are allowed to submit filings confidentially to the SEC for its comments, protecting themselves from inadvertently disclosing too much information to competitors. This is an accommodation that American issuers do not enjoy.
The rule 144A procedures were designed partly with the idea of opening access to the US capital markets to foreign issuers. The 144A rules allow certain foreign issuers to sell securities in the US to institutional investors as private placements, without submitting to the more rigorous reporting and disclosure requirements of fully-registered transactions. Many global bond deals now include 144A eligibility.
But the fundamental differences between American and foreign attitudes to publicity still create difficulty and confusion. The rules governing publicity on 144A deals are even stricter than on fully-registered deals, following the logic that, if a deal is truly private, there should be no need for any publicity. “It’s even difficult putting out a press release saying you intend to do a 144A deal,” says Klein. “Issuers tend not to. There is even SEC concern about announcing deals on the day of pricing or closing, because distribution might not quite be complete and it might be taken as a widespread offer for sale.”
This can soon lead to problems for an issuer conducting a broadly-placed international bond with distribution in the US under 144A, especially if its local stock exchange requires it to publicize new fund-raising. Certainly, existing equity investors would seem to have a natural right to know about up-coming convertible bonds, which international issuers commonly sold using 144A in the mid-1990s. To reconcile conflicting regulatory requirements, an issuer might release details of a deal, but only in its local, national press.
A further complexity is that 144A deals can only be sold to qualified institutional buyers (QIBs). A conservative lawyer would warn that any publicity in a widely-read newspaper or journal could be construed as a general solicitation of potential buyers, including those other than QIBs, and therefore an improper offer for sale. So, if during a global bond offer, a European issuer decides to brief the local press in Europe, as it would with a normal local offering, many lawyers would advise against briefing journalists from publications with any significant circulation in the US. Lawyers will even offer learned opinions on whether a journal’s distribution in America constitutes general circulation. So in London The Times is acceptable, but the Financial Times, and for that matter Euromoney, are off-limits.
That raises the question of the Italian company issuing a press release in Italian in Milan which is picked up by Bloomberg, translated into English and appears on the wires in America within minutes. Is the wily issuer hoping for this to happen, in a sneaky attempt to condition the US market with a general solicitation? Or is it genuinely trying to meet its obligations to inform the national media of its fund-raising plans?
It is, of course, all quite ridiculous. As soon as the local press reports on a deal, the US-based or US-circulated press cannot be stopped from repeating what the local press is reporting. The issuer and its underwriters cannot control this, or be charged with breaking the rules. The news gets out anyway. So how exactly does that help or protect American investors?
“There is an element in all this of the theatre of the absurd, of which many on the commission staff are perfectly well aware,” says George White, partner at Sullivan & Cromwell. Absurd perhaps, but the SEC has real teeth. It can, if it feels the rules have been flouted, force an issuer to delay a deal which can be embarrassing (or worse, if the proceeds are urgently needed – say to fund an acquisition). “But they do not apply these rules in an unreasonable way,” adds a reassuring William Plapinger, partner at Sullivan & Cromwell. “Generally, it’s only the really egregious cases which concern them. They have come to an understanding of foreign markets and foreign regulators.”
Maybe so. But issuers, underwriters and lawyers still treat the SEC with respect bordering on fear. But several bankers have told Euromoney of similar experiences. The story goes like this. The banker works for a bank known to be leading a global deal for an issuer. A journalist contacts the banker and asks when the deal will be launched and, without really thinking, he or she replies, ‘next week’ or ‘next month’. This appears in print in a journal circulated in America. The banker is immediately contacted by the issuer’s lawyers or the bank’s own compliance department and scolded for an imprudent action which may threaten the deal, in that there is a danger of the SEC seeing the report as an attempt to condition the market by soliciting investors to contact the underwriter in that specified week to buy securities.
Does this mean that simply giving the approximate launch date for a deal is a problem? Not, surprisingly enough, according to senior members of the SEC staff. Cross at the SEC finds the idea of the commission delaying a deal for such an indiscretion, “highly unlikely”. She adds: “It seems some lawyers are more conservative in advising their clients than the SEC staff would be.” But she also says that the SEC uses the Internet and all the available electronic media services to monitor publicity about forthcoming offers. The SEC can respond to abuses of the regulations in one of two ways: delay approving the deal until it feels that the impact of the unauthorized publicity has faded; or require the issue to print the projection in its official prospectus, so that it really has to stand by it.
She says that none of this happens often, and the SEC only takes such punitive action “in the worst cases, where clearly there has been an effort to condition the market and it will be hard to ensure that investors focus on what’s in the prospectus, rather than what’s been in the press”.
In less serious cases, says Cross: “We try to be understanding and practical. We might approach the issuer over some publicity and ask, ‘what was your plan here?’ If we do make an issuer wait, it’s rarely for more than a few days.” There are more subtle methods of enforcement. Cross says: “Instead of delay, we may ask that the prospectus include the information that has been in the press reports.” An issuer must stand firmly behind its prospectus. If it contains inaccurate information, the issuer risks being sued by investors.
In special circumstances, the SEC has proved flexible. For the privatization of Deutsche Telekom, it provided two no-action letters, which allowed the issuer and its advisers to conduct an unprecedented corporate identity media campaign in the US. This took place well before the actual offer and White at Sullivan & Cromwell, who dealt with the SEC, warns other issuers against misreading this as a general relaxation of the rules. “The SEC recognized that the Deutsche Telekom offer was of such size and importance that the deal itself was a major news event in the home market and in the US. Even then, standard restrictions on publicity still had to be observed in the three months leading up to the offer, the period when any publicity is most likely to influence investment decisions.”
Though all concerned portray the publicity allowed for Deutsche Telekom as a one-off, it inevitably raises the question in what other circumstances the rules might be relaxed. “We have not faced such a huge deal here in the US,” says Cross, “but if something like the US postal service were ever to be privatized, expecting everyone to be quiet about it in the run-up would be somewhat unrealistic.”
For the moment the SEC staff are defending a regulatory line when some of them must privately wonder whether that line is worth defending at all. Overseas securities regulators have taken a very different attitude to pre-offering publicity, apparently with no dire consequences for investors.
The SEC has taken two important first steps towards rewriting the rules. Last October, it proposed an amendment that would grant foreign issuers and underwriters a safe harbour in certain circumstances. If the amendment is passed, issuers and underwriters will be able to invite reporters from media with US circulation to overseas press conferences regarding the offer of securities with some distribution in the US, without fear of breaching the Securities Act. Issuers and underwriters in such circumstances would not be deemed to have made either an improper offer for sale nor a general solicitation of investors in the US. The amendment follows the lobbying of congress by some US-based media which claimed they were being unfairly excluded from such press conferences.
Reporters excluded
The SEC has said previously that it would allow such press activity provided it was not intended to induce American investors to purchase securities. Proving what behaviour a press conference is intended to induce is very difficult and lawyers have continued to advise issuing clients to exclude reporters with circulation in the US. The proposed changes would drop this qualification of intent and only revisit the rules if abusive practices resulted.
The proposals seem encouraging. But they raise tricky questions. The SEC is requiring that such press conferences take place offshore. What about US-based reporters calling into conference calls, or attending overseas events and then calling back to the issuer or underwriter from America with follow-up questions? The commission is limiting the new rules to deals with some distribution offshore. But can it specify a minimum amount to be placed overseas, or should it allow the new rules to apply to yankee bonds entirely placed in America? If it does that, should it give similar rein to US issuers of securities? For the moment, it is proposing the amendment for foreign issuers only.
Over time, new technology, such as the Internet, will chip away at the SEC’s control, and it knows it. Earlier this year, it approved a joint venture between Microsoft and NBC television network to broadcast (some would say narrowcast) issuers’ roadshows on its private financial network. Although individual investors will not be able to see these broadcasts (viewers will be restricted to broker dealers and investment advisers) from the SEC’s perspective it seems that the information genie is nearly out of the bottle.
The change is an instructive example of the contradictory nature of American securities regulation. If small investors are excluded from the hype of roadshows, are they truly being protected or are those who attend roadshows getting privileged information? There are other contradictions. Issuers are supposed to file timely information but to keep quiet about their funding. They are supposed to keep an open door to analysts, investors and the press, but not to say anything material, nor reveal information not already public, before an offer. They are not supposed to offer projections, but investment decisions are at heart about prospective earnings, and securities markets discount expectations of issuers’ future performance.
It is hard to deregulate the flow of information just a bit. Eventually, the SEC will have to confront the two great myths on which its rules on publicity are based: the myth of a great mass of American retail investors ready to be taken advantage of by unscrupulous issuers; and the myth of a compliant press that will be suckered into touting every new issue of securities that comes along. “It doesn’t seem to faze the commission that these myths do not reflect reality,” says Saul Cohen, partner at US law firm Proskauer Rose. “The American population consists of a high proportion of college-educated potential investors who are already bombarded with information on investments, economics, and interest rates. It’s not just The Wall Street Journal: there are two daily television channels full of all this.”
To be fair the SEC does sense the intrusion of reality. It has for some time been entertaining the possibility of a more radical overhaul of securities regulation. Last July the commission issued its so-called “concepts release on securities regulation and capital formation”. Among other things, this explores the idea that public American companies regularly disclosing financial information might be considered to be in full-time registration.
That would do away with the whole notion of quiet pre-offer periods for a huge number of American issuers. Firm rule proposals will follow in a few months and the SEC is still not sure whether to proceed with the offshore press rules separately.
A complete overhaul of securities regulation may eventually follow the concepts release. Until then, the commission is sticking to its guns, partly out of a sense of pride, partly out of a sense of history. Says Cross: “Many of us realize that the system may need modernizing, given the explosion in communication, the Internet, the growth in cross-border offers and the very different overseas practices. But there is a reluctance to throw out a system which has provided good discipline and protected investors for so long. It’s not something you abandon lightly.”
