Tuesday, April 19, 2011

Corporate Secretaries Society Suggests to SEC an Alternative to Credit Ratings for Form S-3 Criteria

An SEC proposal to eliminate the use of investment grade credit ratings as a criterion for Form S-3 eligibility and replace it with a requirement that a company have issued at least $1 billion of non-equity, non-convertible securities in transactions registered under the Securities Act for cash during the past three years is a standard that many issuers currently satisfying the investment grade criteria may not be able to meet, emphasized the Society of Corporate Secretaries and Governance Professionals. In a letter to the SEC, the Society said that the proposed standard is well above what is necessary to ensure a wide following in the market place and is substantially in excess of the thresholds in other criteria for Form S-3 eligibility. For example, currently issuers with only $75 million of public equity float are eligible for unlimited use of Form S-3, and even smaller reporting companies with less than $75 million of public equity float can use Form S-3 in certain circumstances.

The proposal was issued in response to the requirement in Section 939A of the Dodd Frank Act that federal agencies modify regulations to remove any reference to, or requirement of reliance on, credit ratings, and to substitute a standard of credit worthiness as the agency determines to be appropriate. The Society believes that the SEC’s proposal does not set forth an appropriate alternative standard for Form S-3 eligibility within the spirit of Section 939A because it would result in the loss of eligibility by issuers of debt securities that are in fact well known and widely followed in the marketplace. The Society requests that the Commission adopt alternate criteria that are designed to replace, as closely as possible, the existing pool of eligible issuers.

The Commission should permit the use of Form S-3 by majority-owned subsidiaries of well known seasoned issuers that have $1 billion in assets or $1 billion in outstanding debt securities so long as they otherwise meet the registrant requirements of General Instruction I.A. of Form S-3. The Society believes that debt issuers meeting these criteria would be widely followed in the market and therefore should continue to be eligible to use Form S-3.

In the Society’s view, these alternate criteria arc consistent with the legislative history of Dodd-Frank, which does not indicate that Congress intended to change the types of issuers and offerings that could rely on the SEC's forms. In addition, neither Congress nor the Commission has found that issuers using investment grade credit ratings as the criterion for eligibility to use Form S-3 pose any particular risk to investors or were associated with abuses in the markets.

While the SEC recognizes that certain issuers may lose eligibility to use Form S-3 under the proposal, noted the Society, the proposing Release underestimates the effect of the change. The loss of eligibility to use Form S-3 would present significant problems for issuers that arc currently eligible. The use of Form S-1 to register debt offerings would significantly increase the cost and time to prepare for the offering and afford issuers less flexibility in the amount of debt to be issued and the timing of the issuance. Moreover, issuing debt in exempt offerings is often an unattractive alternative, said the Society, since such offerings will likely result in additional costs for issuers, such as higher coupon rates and costs associated with registration rights. Companies choosing this option also would be disadvantaged in that securities issued in exempt offerings would not be counted toward their future eligibility to use Form S-3 under the Commission's proposed issuance test.

The Society also urged that a company a majority of whose common equity is held by a well-known seasoned issuer that has either $1 billion in assets or $1 billion in 1933 Act-registered debt outstanding should be eligible to use Form S-3, provided that it otherwise meets the registrant requirements of General Instruction I.A. of Form S-3. The Society posited that subsidiaries with either $1 billion in assets or $1 billion in debt outstanding are large enough to ensure that the issuer would be subject to the level of market coverage and analysis cited in the proposing Release as a proper substitute for an investment grade security rating as a criterion to permit the use of Form S-3. This level of outstanding debt or assets would ensure that the issuer attracts significant analyst and investor attention.

In this regard, the Society urged that the debt securities that would be counted to satisfy the $1 billion threshold under this test include not only debt securities issued in primary registered offerings for cash, but also those issued in exempt offerings such as Rule 144A offerings and those issued in registered exchange offers. It is appropriate to include all such debt securities, said the Society, because a substantial portion of the market for debt securities consists of institutional investors that purchase debt securities in both Rule 144A offerings as well as registered offerings.