Free writing.

• Author: Thel, Steve
• Position: Of securities prospectuses under the Securities Act of 1933

1. INTRODUCTION II. PROSPECTUSES, FREE WRITING, AND FREE WRITING PROSPECTUSES A. Prospectuses B. Free Writing C. Free Writing Prospectuses III. FREE WRITING AND SECTION 12(a)(2) A. Free Writing Is Exemptfrom Section 12(a) (2) B. Congress Was Wise to Exempt Free Writingtom Section 12(a) (2) IV. FREE WRITING PROSPECTUSES AND SECTION 12(a)(2) A. Free Writing Prospectuses are Not Exempt from Section 12(a) (2) B. Free Writing About Free Writing Prospectuses 1. Issuer Liability 2. Section 10(b) C. Free Writing Prospectuses Should Be Exempttom Section 12(a) (2) If They Are Not Broadly Disseminated Before a Final Section 10(a) Prospectus Is Available V. CONCLUSION I. INTRODUCTION

   In 2005 the Securities and Exchange Commission (SEC) effectively ended most restrictions on the use of written offering materials in public distributions of securities. Previously, the only written offering materials that could be used in such distributions were terse announcements and dense statutory prospectuses that constituted the bulk of the registration statements that issuers had to file with the SEC. These restrictions did not depend on the accuracy of the information in the communications, so other written communications could not be used even if completely accurate. Less formal written offering material, known as free writing, could be distributed at the end of the offering process, but even then only to investors who had previously been sent a copy of the final statutory prospectus.

   Under the Commission's new regime, all sorts of written material may be distributed much earlier in the offering process, and participants in most public offerings are relieved of any obligation to deliver statutory prospectuses. The SEC adopted its new rules to simplify the offering process and to eliminate delays in the dissemination of information to investors. (1) To accomplish these ends, it created a new disclosure device--modeled on free writing--which it calls the free writing prospectus. Participants in a public offering may now, from a very early date, widely disseminate free writing prospectuses--containing almost any kind of information in whatever form they choose--and often without any requirement that they deliver a statutory prospectus at all.

   Although these reforms eliminated the prohibition on distributing informal written offering materials before a registration statement becomes effective, few market participants are using free writing prospectuses that differ substantially from communications they were using before the reforms were adopted. This is not because they do not know about the new regime. On the contrary, the securities industry and its lawyers were keenly interested in the SEC's reform agenda. From the time the reforms were first floated, however, they warned that reform would have limited traction if security buyers were permitted to rescind their purchases under section 12(a)(2) (2) of the Securities Act of 1933 (3) in the event the newly permitted communications contained false statements. Nonetheless, the Commission insisted that such liability would attach, and in fact acted to make issuers liable under section 12(a)(2) for some misleading free writing prospectuses used by other market participants. Not surprisingly, the specter of liability for inadvertent and third party misrepresentations has kept security sellers from using the newly permitted free writing prospectuses widely. Since the reforms were adopted, the techniques of disclosure have changed, but the content of disclosure has remained largely the same. Indeed, the greatest practical change resulting from the reforms is an almost universal practice of offering participants agreeing among themselves to restrict the use of free writing prospectuses by any of them. Accordingly, the reforms have fallen short of their stated goals of facilitating communication, simplifying the registration process, and reducing the cost of raising capital.

   In this Article, I argue that free writing prospectuses containing false statements should not be subject to liability under section 12(a)(2) unless they are widely distributed before a final statutory prospectus is available. Outside that context, such liability serves no good end, but simply complicates the offering process, impedes the flow of information, harms market participants, including innocent investors, and burdens the capital formation process generally. These conclusions do not depend on any particularly controversial view of market efficiency or morality, but follow from the very premises that led the SEC to permit free writing prospectuses in the first place. Moreover,

   Congress recognized as much in 1933.

   As noted above, Congress--not the SEC--created the concept of free writing when it permitted those selling securities to distribute statutory free writing after a registration statement became effective. A limiting clause in section 12(a)(2)--one that has seldom been noted and, when noted has generally been misunderstood--exempts statutory free writing from the section. As this Article shows, exempting free writing that contains false statements from section 12(a)(2) led to the broad dissemination of accurate information in the far more powerful form of the statutory prospectus. The same exemption should be extended to most free writing prospectuses.

   Part II of this Article analyzes the treatment of written offering materials under the registration provisions of the Securities Act, with particular attention to traditional free writing and the new free writing prospectuses. Part III examines the application of section 12(a)(2) to free writing. Misrepresentations made in the public offer or sale of securities are actionable under section 12(a)(2) except when they are contained in free writing. (4) Although this loophole is generally taken to be a drafting error, it is in fact an extremely effective mechanism for accomplishing the goals of the Securities Act. The Securities Act's mandatory disclosure scheme has one great weakness. Although the Act requires security issuers to file elaborate statutory prospectuses with the SEC, it does not require them or anyone else to provide those prospectuses to prospective investors. The free writing loophole addressed this problem. By permitting written offering material to be used without fear of section 12(a)(2) liability, but only if it is accompanied or preceded by a final prospectus containing the information in an effective registration statement, the Act created a powerful and necessary incentive for offering participants to distribute statutory prospectuses voluntarily. Paradoxically, privileging false statements in free writing was the key to achieving widespread distribution of the Securities Act's central information document.

   Part IV extends the analysis to the new free writing prospectuses, which are subject to section 12(a)(2) liability. It criticizes the SEC's ham-handed attempt to extend section 12(a)(2) liability to issuers that sell through underwriters, and questions the SEC's authority to permit the use of free writing prospectuses in the manner in which it did. After showing that the SEC could have permitted the use of free writing prospectuses--albeit by an approach the Commission chose not to take--it then addresses the SEC's decision to subject free writing prospectuses to section 12(a)(2) liability. While the justification for exempting free writing from section 12(a)(2) does not apply perfectly to free writing prospectuses, the very changes in market structure and communications practices that led the Commission to permit the use of free writing prospectuses also indicate that free writing prospectuses that are not widely disseminated before a final statutory prospectus is available should be exempt from section 12(a)(2) as well.

   The Article concludes with a reappraisal of Gustafson v. Alloyd Co., (5) in which the Supreme Court held that section 12(a)(2) applies only in public offerings.' Gustafson is the most important authority on section 12(a)(2), and by all accounts the worst securities law opinion ever written. While the Supreme Court's analysis cannot be defended, the

   regulatory structure it created may be more consistent with the structure and evident purpose of the Securities Act than has generally been recognized.

2. PROSPECTUSES, FREE WRITING, AND FREE WRITING PROSPECTUSES

   1. Prospectuses

      The Securities Act is built around section 5, (7) which makes it unlawful to offer a security for sale in interstate commerce until the issuer has filed a registration statement containing extensive information about the security being offered, its issuer and the terms of the offering, and also makes it unlawful to sell a security until the registration statement becomes effective. (8) Thus, absent an exemption from section 5, no offer of securities, written or otherwise, may be made until the issuer has filed a registration statement for those securities. The Securities Act defines the term "offer" quite broadly to include any attempt to dispose of a security for value, (9) so until a registration statement is filed section 5 prohibits people who are planning to distribute securities to the public from making almost any statement, written or oral, relating to those securities.

      After a registration statement is filed, written and oral communications are subject to substantially different regulation. Oral offers may be made without restriction, but written offers are problematic because the filing of a registration statement triggers restrictions on the use of prospectuses. With a few important exceptions discussed below, (10) any written offer (as broadly defined) is a prospectus. (11) Section 5(b)(1) of the Securities Act makes it unlawful to use jurisdictional means to transmit a prospectus after a registration statement has been filed unless that prospectus meets the requirements of section 10 of the Act. (12) Given the Act's broad...