SEC Proposal to Permit Non-Emerging Growth Companies to “Test the Waters”


On February 19, 2019, the Securities and Exchange Commission (“SEC”) voted to propose an expansion of a reform implemented by the Jumpstart Our Business Startups Act (“JOBS Act”), where emerging growth companies (“EGCs”) have been permitted to gauge investor interest in a possible initial public offering (“IPO”) by allowing discussions with particular investors prior to filing a registration statement.[1]  According to SEC Chairman Jay Clayton, “[e]xtending the test-the-waters reform to a broader range of issuers is designed to enhance their ability to conduct successful public securities offerings and lower their cost of capital, and ultimately to provide investors with more opportunities to invest in public companies . . ..I have seen first-hand how the modernization reforms of the JOBS Act have helped companies and investors.  The proposed rules would allow companies to more effectively consult with investors and better identify information that is important to them in advance of a public offering.”[2]  The SEC proposal would add Rule 163B to the Securities Act of 1933 (“33 Act”).[3]


Historical Background

Prior to the enactment of the ’33 Act, federal regulation of the securities industry was essentially non-existent.[4]  During that time, companies and brokers routinely offered stock to the public without providing any relevant disclosures or by providing highly misleading or fraudulent information.[5]  The lack of regulation led to the catastrophe of the Great Depression, where the Dow Jones from its peak in 1929 to the bottom in 1932, lost close to 90% of its value.[6]  The American public felt the economic squeeze, as unemployment exceeded 20% at its peak.[7]

The federal government reacted decisively in the face of this catastrophe. Congress, at the insistence of President Franklin Delano Roosevelt, held hearings that shed light on the fraudulent behavior and wild speculation leading to the crash.[8]  Subsequently, Congress enacted the ’33 Act, which has disclosure as its unifying theme and allowed investors to get the information they needed to make educated decisions about buying and selling securities.[9]  Under Section 5 of the ’33 Act, companies who want to offer securities to the general public must file a registration statement with the SEC.[10]   To offer securities, the registration statement must be filed and it must be “effective” (i.e., approved by the SEC) before the issuer can sell securities.[11]


Registration Statement

A registration statement is a disclosure document that is intended to give investors enough material information about a company to make a properly informed investment decision.[12]  While this disclosure system has protected the American public from fraudulent practices, critics thought that the cost and effort of registration discouraged capital formation, especially for smaller issuers. Thus, in 2012, Congress passed Section 5(d) the “JOBS Act”[13], which allows certain companies to test the waters by soliciting investor interest prior to filing a registration. In the four years since the enactment of the JOBS Act, hundreds of private companies have gone public and EGCs have dominated the IPO market by accounting for 87% of the IPOs.[14]


Proposed Rule 163B

Now, the SEC is proposing to allow non-EGCs to test the waters via Rule 163B. William Hinman, SEC Director of the Division of Corporation Finance, believes that “making the U.S. public market more attractive for companies to go public – and stay public – will ultimately benefit investors and our markets through increased transparency, liquidity, and investment opportunities.”[15]  This reasoning is consistent with one of the fundamental missions of the SEC, which is capital formation.[16]  Thus, Rule 163B under the ’33 Act would “permit issuers to engage in oral or written communications with potential investors that are, or are reasonably believed to be, qualified institutional buyers or institutional accredited investors, either prior to or following the filing of a registration statement, to determine whether such investors might have an interest in a contemplated registered securities offering.”[17]

Issuers would benefit from Rule 163B through lower informational costs and investors would gain additional information from the issuer.  According to a Treasury Department report, allowing non-EGCs to test the waters will reduce the risks associated with an IPO by providing the company with better information on investor interest prior to the significant expenditures associated with the registration process.[18]  Investors would benefit from the early disclosure about the security.[19]  However, investors are at risk “[i]f issuers with a traded class of securities test the waters in conjunction with a potential follow-on offering, [and]solicited investors might potentially use the resulting information advantage to realize trading profits at a cost to investors that were not solicited.”[20]

Rule 163B is now available for public comment.  Investors, issuers, and all other interested parties will be able to voice their concerns for a limited period.  All public comments on this proposal are due April 29, 2019.

[1] See Press Release, Sec. & Exch. Comm’n, SEC Proposes to Expand “Test-the-Waters” Modernization Reform to All Issuers (Feb. 19, 2019),

[2] Id.

[3] Id.

[4] See Securities law history, Legal Information Institute,

[5] Id.

[6] Leslie Kramer, What Caused the Stock Market Crash of 1929?, Investopedia (Mar. 22, 2019),

[7] Richard H. Pellis & Christina D. Romer, Great Depression, Encyclopedia Britannica,

[8] Legal Information Institute, supra note 4.

[9] Id.

[10] See 15 U.S.C. §77e(a).

[11] See Small Business, Sec. & Exch. Comm’n, Going Public (last accessed Mar. 23, 2019),

[12] See Going Public, Sec. & Exch. Comm’n, What is a Registration Statement (last accessed Mar. 23, 2019),

[13] Public Law 112-106, 126 Stat. 306 (2012).

[14] Ernst & Young, Update on Emerging Growth Companies and The JOBS Act, at 1 (Nov. 2016),

[15] William Hinman, Dir., Div. Corp. Fin., Sec. & Exch. Comm’n, Keynote Address at the PLI’s Seventeenth Annual Institute on Securities Regulation on Europe (Feb. 1, 2018),

[16] Sec. & Exch.Comm’n, The Role of the SEC (last accessed Mar. 28, 2019),

[17] Solicitation of Interest Prior to a Registered Public Offering, Release No. 33-10607, File No. S7-01-19 at 1 (proposed Feb. 19, 2019) (to be codified at 17 C.F.R. Part 230),

[18] See U.S. Dep’t of the Treasury, A Financial System That Creates Economic Opportunity: Capital Markets, at 30

[19] See Solicitation of Interest Prior to a Registered Public Offering, supra note 17, at 48.

[20] Sec. & Exch.Comm’n, supra note 17, at 50.


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Fordham Journal of Corporate & Financial Law