Guide to new SEC rules

Posted by Joseph Himy

Recent SEC Updates

The U.S. Securities and Exchange Commission (SEC) was established in 1934 as the first federal regulator of the securities markets. Its purpose? To protect investors, monitor corporate takeover, and maintain fair and transparent securities markets. With so much on the line, the SEC must constantly review and update its rules to reflect the current needs of investors and the zeitgeist of the times.

In the past month, the SEC announced two updates: The expansion of the “test-the-waters” accommodation and new rules for ETFs. Both updates are designed to make things easier for investors.

Expansion of the “Test-the-Waters” Accommodation

On September 26, the SEC announced a new rule that extends its “test-the-waters” accommodation. Previously, the accommodation was only available to emerging growth companies (ECGs), but under the new rule, it will be available to all issuers who wish to engage in raising funds through a public offering or other registered securities.

There is one catch to the “test-the-waters” accommodation however, and that is that only qualified institutional buyers (QIBs) and institutional accredited investors (IAIs) as defined in Rule 501 of Regulation D will be allowed to receive “test-the-waters” communications. QIBs are typically accredited investors who act:

  1. For their own account or the accounts of others
  2. On a discretionary basis
  3. For at least $100 million in securities or non-affiliate issuers

However, the “catch” is not part of the new rule; it was in the original as well.

What Exactly is the “Test-the-Waters” Accommodation?

The “test-the-waters” accommodation is part of the Jumpstart Our Business Startups (JOBS) Act, which was passed by Congress in 2012. Section 5(d) of the JOBS Act permits EGCs to communicate with potential investors before or after the filing of a registration statement with the SEC. The purpose is to gauge interest from investors.

The JOBS Act essentially upended an outdated rule from 1933 that prohibited issuers from discussing potential securities offering with investors prior to the filing of a registration statement. The JOBS Act was created to be more relevant to today’s market, and the recent amendment, which allows non-ECGs to communicate with potential investors, goes one step further. The expanded accommodation will provide flexibility in determining whether to pursue a public offering, encourage more issuers to enter public equity markets, and maintain appropriate investor protections.

The ETF Rule

While the expansion of “test-the-waters” was announced, the SEC announced a new rule surrounding exchange-traded funds (ETFs). The new rule is an attempt to modernize the regulation of ETFs, which are hybrid investment products that are traded like stocks but are not actually stocks. They can include stocks, commodities, or bonds, and certain large institutions can also perform direct transactions with the fund. Originally, ETFs were not allowed in the U.S., but since 1992 the SEC issued more than 300 exemptive orders allowing ETFs to act.

In a span of 25 years, ETFs have grown into a multi-trillion-dollar industry and are favored by investors due to their low costs, tax efficiency, and similarities to stocks.

The SEC’s new rule is an attempt to streamline the process of allowing ETFs to function. Rather than each individual ETF requesting exemptive relief, the new rule provides a clear framework for many ETFs in operation today (some 2000) so that they can skip the application. The amended rule will make it easier for ETF issuers to bring new innovations and strategies to the market. The new rule also offers customized creation/redemption baskets for different types of ETFs. The custom baskets will create a potential for tax benefits and make it easier for companies and investors to understand transaction costs associated with those funds.

When Do the New Rules Go into Effect?

Both the “test-the-waters” expansion and the ETF rule will become effective 60 days after publication in the Federal Register. Given the dynamic nature of the investment market, there will undoubtedly be more new rules, updates, and amendments soon.

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