By John Filar Atwood
The Council of Institutional Investors (CII) has written to the SEC to express its support for a March 2023 rulemaking petition that requests a holding period for unregistered shares after the effectiveness of an IPO registration statement. The need for the holding period came into sharp focus, the association said, after the Supreme Court’s decision in Slack Technologies LLC v. Pirani to narrow the traceability requirement imposed on plaintiffs in Section 11 cases.
The rulemaking petition asks the Commission to amend Rule 144 to limit sales of unregistered securities after the effectiveness of a registration statement. CII noted that it recommends the adoption of a holding period after the effective date as a means of balancing the interests of issuers and early investors in being able to sell unregistered shares against the interests of public shareholders in having an effective remedy under Section 11.
In its letter, CII said that it supports this recommendation although it did not have a specific length in mind for the proposed holding period. In CII’s view, the rulemaking petition provides a starting point for that discussion by proposing a holding period that would be the later of 90 days after the effectiveness of the registration statement, or the filing of the next Form 10-Q or Form 10-K after that date.
Section 11. CII noted that Section 11 provides protection for investors in new publicly traded companies by creating liability for companies, their directors, underwriters and advisers if there is any misrepresentation or omission of any material information in a registration statement. However, Section 11 requires that the securities purchased by the investor must be “traceable” to the specific registration statement claimed to be false or misleading.
Traceability has historically not been a problem in Section 11 cases, CII stated, because underwriters generally required a lockup period of 180 days for insiders and early investors after the effectiveness of a registration statement. The lockup prevented insiders and early investors from selling unregistered shares that they had acquired before the public offering.
The problem arose because while the lockup was standard industry practice, it was not a requirement. Consequently, investor protections eroded over the past ten years, CII said, because 1) underwriters became increasingly willing to waive lockup periods and allow the sale of unregistered shares alongside shares registered during an IPO, and 2) companies began going public through direct listings of shares (as Slack Technologies did), thereby allowing insiders and early investors to sell their pre-existing, unregistered shares alongside shares offered pursuant to a registration statement.
These developments plus the Slack ruling mean that the investor protections in Section 11 have been significantly undermined, CII stated, and the SEC needs to update the regulatory framework to address the problem.
Legal authority. CII emphasized in its letter that the Commission clearly has the legal authority to implement the change. CII supported the rulemaking petition’s argument that the agency has at various times amended timing considerations in light of market developments in securities-offering practices.
CII further argued that former SEC Chairman Jay Clayton and former SEC Commissioner Joseph Grundfest filed a brief as amici curiae in Slack in which they agreed that the Commission has the authority to create the holding period. CII also cited the Slack oral argument in which Justice Brett Kavanaugh noted the company’s view that “we should leave it to the SEC and/or Congress, rather than ourselves, kind of departing from that longstanding body of law.”
CII pointed out that it has long urged the SEC to address the issue comprehensively by adopting “proxy plumbing” regulations, the concept release for which is now 13 years old. The changes outlined therein included traceability matters of the sort currently at issue, and CII said that it continues to believe that an update of those rules would be the best way forward.