Stipulation in the US Securities Act: A crazy law
What is the most nonsensical law covering the financial markets?
Many would argue that it is the stipulations in the US Securities Act which restrict an issuer and its underwriters of US public bonds or equities from marketing the deal, or publicizing it any way except via the official prospectus.
Consider the following. The Republic of Ruritania agrees at a cabinet meeting in April 1997 to launch sometime over the coming two years a global bond issue, with a 114A private placement in the US. The issue is finally registered with the Securities and Exchange Commission (SEC) in October 1998. The SEC responds a month later, requesting substantial rewriting of the prospectus, which takes a further month. After a two-month roadshow and preparatory period, the issue is launched in March 1999.
Ruritania's US counsel reminds the finance minister that, during this entire two-year period, the country cannot be seen to be marketing its bonds. To be doubly sure that this rule is not breached, it advises, finance ministry officials should not answer questions on the economy or its prospects from journalists or analysts. This might be construed as a marketing effort.
The counsel becomes even stricter when the roadshow begins. In Hong Kong and London, the finance minister makes an hour-long presentation with slides and a print-out. He answers questions fully. When the roadshow moves to New York, however, slides are shown but fund managers have to make copious notes because a printed copy of the slides may not be distributed.
Some managers, used to this practice, have already had colleagues from London fax over the print-out distributed at the roadshow there. In answering questions, the minister is told by advisers to restrict his answers strictly to factual points; in practice he may do no more than parrot what is in the prospectus.
As the roadshow progresses, the financial press starts to report a row between the joint bookrunners. The two banks are in disagreement over how fees are to be split. This worries potential investors who fear buying paper from a lead manager which may not support the issue in the secondary market.
The issuer puts out a statement in London and Ruritania, clarifying how the fees will be split. This calms investors' fears. But, after advice from lawyers, Ruritania agrees not to make the statement available to the US media, or to publications such as Euromoney or the Financial Times which have circulation in the US. As a result, many US money managers do not hear about the clarification and boycott the deal. Those that ring the lead managers for explanation are told that the banks cannot comment for legal reasons.
This is an extreme example perhaps. But the law and, more particularly, the paranoid way in which lawyers interpret the law has an enormous, detrimental, influence on the behaviour of issuers and underwriters.
The principle of the law is not unreasonable. It aims to protect naive retail investors from issuers that try to sell securities by making exaggerated claims. But surely the law goes too far. Is it so unreasonable that an issuer advertise an issue in the press or on television? In many European countries, mass advertising campaigns brought individual investors almost always happily to buy privatization stocks. Is it so unreasonable that an issuer or its advisers should answer queries or criticism of a deal? Is it so unreasonable that journalists are properly briefed about an issuer so that they can write about its deal's prospects in an informed way?
The consequence of the rules as they stand is that very often US investors are less well informed about a borrower than are their non-US counterparts. Surely this was not the intention of the drafters of the securities legislation, or of the SEC.
The law itself may be stupid, but the way law firms interpret it is even more so. One can but suspect that they need to justify their existence (and high fees) by making the law appear as daunting as possible; they therefore interfere at every opportunity to insist that the issuer obeys their instructions. Their excessive caution also arises from fear of being taken to court if they are wrong: no-one was ever sued for advising an issuer not to make a comment.
A close reading of the detailed rules the SEC has released to clarify how it implements the law suggests that its interpretation is not as draconian as the lawyers would make out. The SEC allows issuers to continue, after the registration of an issue, to make announcements to the press with respect to factual or financial developments, for example, the opening of a new factory. It allows them to answer unsolicited telephone calls from investors and the media concerning factual information. It even requests that they observe an "open door" policy to analysts and others with a legitimate interest in the issuer's affairs.
Ultimately, if the law or at least the way it is in practice observed is not changed, the US capital markets will suffer. International borrowers have rushed to tap the US market in recent years because American investors have become big buyers of foreign paper. They have done so in spite of, not because of, the over-burdensome character of the US regulatory and legal system.