The SEC’s quiet period rules do not suffer from a constitutional defect under the US Supreme Court’s First Amendment test announced in a 2001 ruling, said SEC Chair Chair Mary Schapiro in response to a question from House Oversight Committee Chair Darrell Issa (R-CA) as part of a letter from the oversight chair containing a number of questions on the reform of the IPO regulatory regime.
Chairman Issa asked the SEC Chair to reconcile the quiet period rules with the Supreme Court’s decision in Lorillard Tobacco Co. v. Reilly, 533 US 525 (2001), where the Court used a four-part test to determine if commercial speech fell within First Amendment protection: 1) whether the expression is protected by the First Amendment; 2) whether the government interest is substantial; 3) whether the regulation directly advances the government interest; and 4) whether it is not more extensive than necessary to serve the government’s interest.
According to Chairman Schapiro, communications regarding registered securities offerings are neither inherently unlawful nor inherently misleading. Moreover, there is no doubt that the government interest is substantial. The primary purpose of the Securities Act is to protect investors by requiring the publication of material information thought necessary to allow them to make informed investment decisions concerning public offerings of securities. Congress intended for Section 5 of the 1933 Act to protect the public from fraudulent statements made by issuers or underwriters who, in their efforts to persuade investors to participate in a financing, might fail to disclose material information. Section 5 ensures that investors have access to the disclosures of the material business and financial facts of the issuer provided in registration statements and prospectuses.
According to Chairman Schapiro, a restriction on commercial speech directly advances a substantial government interest if it will alleviate the harms that the government seeks to prevent to a material degree. The quiet period rules restrict the communications that encourage investors to form a premature opinion of value without benefit of the full set of facts contained in a prospectus. The premise of the rules is that if investors could receive glossy promotional literature from the issuer they might pay little attention to the dull and formalistic prospectus.
In Chairman Schapiro’s view, the quiet period rules thus protect investors by forcing the company to market its securities principally by means of the disclosure document prepared in accordance with SEC rules and subject to prior review by SEC staff. Also, requiring a company to use a registration statement and prospectus as the means to market its securities offering to potential investors subjects those efforts to Securities Act liabilities.
The limitation is narrowly tailored to be not more extensive than necessary. The limitations on communications during the quiet period are of finite duration, said the SEC Chair, thus ensuring that the impact on speech is limited.
Chairman Schapiro pledged that the SEC will continue to consider the First Amendment interests implicated by the quiet period rules, but those interests must be assessed in light of the Securities Act provisions requiring investors who receive offers for securities to also receive the information that accompanies registration, as well as protection from misleading communications.