There Ain't No Such Thing As a Free Prospectus

The Shelf Offering Context

The advent of the free writing prospectus is particularly significant in the context of shelf offerings. Prior to the Securities Offering Reform, the base prospectus was first filed to register the shelf, which included preliminary information about the shelf and also incorporated by reference the issuer's recent Exchange Act reports. Next, prospectus supplements containing the offering details (and also incorporating any new reports) would typically be filed and then circulated to market a security just before it was taken down off of the shelf. A final prospectus had to be delivered at sale as part of the confirmation. All of these items, as part of the registration statement, carried ' 11 liability as well as ' 12(a)(2) liability.

Now, written offers are no longer limited to prospectus supplements and the preliminary prospectus, but can be made through free writing prospectuses. Furthermore, under the new 'access equals delivery' approach, a final prospectus no longer needs to be delivered at sale, but must be completely on file with the SEC (typically through adding prospectus supplements to the base prospectus) within two days after sale or a reasonable time thereafter. The net result is that the communication of offering terms to buyers can now be made through free writing prospectuses instead of just through filed prospectus supplements. And of course, any additional materials not normally appearing in a statutory prospectus can be included in a free writing prospectus.

While a free writing prospectus does not carry ' 11 liability, it would be a mistake to think that potential liability in a shelf offering has been decreased through the Securities Offering Reform. After all, prospectus supplements, which become part of the registration statement and therefore carry ' 11 liability, must still be filed after sale. And for ' 12(a)(2) purposes, the SEC has made clear that issuers are now liable for misstatements in free writings prospectuses (or other prospectuses) used by underwriters, even though they are not the direct seller. Furthermore, information that is conveyed to buyers after the contract of sale to provide a more complete picture, even if it is accompanied by an understanding that the buyer can back out of the offering at that point in light of the new information, is irrelevant when determining ' 12(a)(2) liability. The rule now is that only information conveyed before and at the contract of sale is considered.

What Can Issuers and Underwriters Do to Protect Themselves?

Issuers and underwriters carrying out a shelf offering (or, for that matter other offerings as well) should be aware of potential ' 12(a)(2) liability for misstatements in free writing prospectuses and act so as to minimize risk, as this could very well be the next big field of securities fraud litigation. As far as assessing whether a free writing prospectus is materially misleading, the Securities Offering Reform leaves unclear the extent to which other available information ' the registration statement, filed prospectus supplements, and Exchange Act reports incorporated by reference ' is considered to determine whether an omission has been made. Likewise, it does not address whether such other information is considered in the 'total mix' to determine whether a misleading statement or omission is material. The best bet for issuers and underwriters at this point is therefore to ensure that investors have in their hands before the contract of sale 'whether through free writing prospectuses, the base prospectus, prospectus supplements, incorporated reports, or some combination ' a complete and accurate picture of the offering. While prospectus supplements need not actually be filed until after the takedown, issuers and underwriters need to be sure that free writing prospectuses are not misleading by omitting important information.

Due diligence should of course be performed in preparing free writing prospectuses, but underwriters are in a particularly difficult situation in this respect. In high-speed shelf offerings, where investment banks compete at the last minute to serve as underwriters in connection with a specific shelf takedown which is then completed in a matter of days, there simply is not sufficient time for due diligence on their part. The underwriters who were sued in the WorldCom case (and eventually settled) experienced this very problem. See In re WorldCom, Inc. Securities Litigation, 346 F.Supp.2d 628, 677-71 (S.D.N.Y. 2004). Apart from conducting quarterly due diligence sessions to ensure that regular reports are accurate (which is only feasible if there is an ongoing relationship between the issuer and underwriter, and even then may prove to be impractical), there is little underwriters can do on this front. They may find a small bit of relief for ' 11 purposes in the ability to file a final prospectus supplement a few days after the takedown (marketing the security through free writing prospectuses instead), and using that time to conduct due diligence before completing the final prospectus.

On a positive note for underwriters, in the adopting release for the Securities Offering Reform, the SEC did offer two opinions (though not actual rules) related to ' 12(a)(2) liability. First, any practices or factors that are currently considered favorably under Rule 176 for assessing due diligence in ' 11 cases ' including the particular role of the underwriter and the availability of information to it ' should also be considered favorably in ' 12(a)(2) cases. It should be noted, however, that it is not yet clear how the Rule 176 considerations should or will be applied, and this issue has rarely been considered. In the WorldCom case, the court allowed the jury to consider whether the underwriters' actions were 'reasonable' under Rule 176. See In re WordlCom, Inc. Securities Litigation, 346 F.Supp.2d at 682. Second, the due diligence standard under ' 12(a)(2) is somewhat less demanding than under ' 11. See Section 1.V.C of the Securities Reform Release. Underwriters may therefore have a bit more breathing room when using free writing prospectuses, but the difficult situation very much remains.

Most importantly, issuers and underwriters should be sure to consult with counsel when using a free writing prospectus to ensure that liability is avoided.

Take Advantage of the Free Writing Prospectus

Issuers and underwriters can also take advantage of free writing prospectuses by using them to help avoid ' 12(a)(2) liability. In shelf offerings, potential buyers are often conveyed rapidly-changing information in pieces, resulting in buyers having outdated information in their hands and a mosaic of potentially confusing prospectus supplements and post-effective amendments. A free writing prospectus can be used to clearly convey to buyers the current state of affairs for the offering prior to contract of sale, helping to avoid potential ' 12(a)(2) liability due to previously conveyed information in a fast-paced shelf offering.

And of course, the potential of free writing prospectuses to effectively market a shelf takedown in ways that would have been inappropriate in a statutory prospectus should not be overlooked amidst the potential liability. As long as the free writing prospectus does not mislead or conflict with the registration statement, any information can be included, opening the door to a new breed of creative marketing and offering tactics in registered public offerings.

Ralph C. Ferrara is a partner at Dewey & LeBoeuf LLP and former General Counsel of the United States Securities and Exchange Commission. Anthony Ford is a third-year student at New York University Law School and served as a Summer Associate with Dewey & LeBoeuf during the summer of 2007.

The Securities & Exchange Commission's Securities Offering Reform dramatically changed the landscape of registered public offerings. Issuers and underwriters would do well to take advantage of these changes while staying aware of potential fraud liability. See Final Rule: Securities Offering Reform, Release Nos. 33-8591 and 34-52056, 70 Fed. Reg. 44,722, available at www.sec.gov/rules/final/33-8591.pdf. Previously, written offers could only be made after a registration statement had been filed and only in the form of a statutory prospectus. Now, written offers can be made in much freer form through a 'free writing prospectus.' Through this new free writing prospectus, some issuers can even make offers regardless of whether a registration statement has been filed.

A free writing prospectus ' which is any written offer outside of the statutory prospectus ' can take many forms: printed materials, e-mails, Internet Web sites, radio or television broadcasts, faxes, and even widely distributed voice mails. It can contain any information, including information not contained in the registration statement as long as there is no conflict. A free writing prospectus usually needs to be filed with the SEC by the issuer, but not by underwriters unless it is likely to be broadly disseminated. Furthermore, it must contain a legend advising the potential investor to read the registration statement and indicating how it can be obtained. While many issuers still need to have a registration statement on file to use free writing prospectuses, well-known seasoned issuers can now make written offers even before filing through free writing prospectuses.

The free writing prospectus has the advantage of carrying less potential liability than the usual statutory prospectus. Much of recent securities fraud litigation has been under ' 11 and ' 12(a)(2) of the Securities Act of 1933, two sections that often overlap, but are distinct. Great news ' but: ' 11 establishes liability for misstatements in a registration statement, which include the final prospectus and Exchange Act reports that are incorporated by reference. A free writing prospectus, since it is not considered part of the registration statement, does not carry ' 11 liability. Section 12(a)(2) establishes liability for misstatements in a 'prospectus.' And, like a statutory prospectus or final prospectus, a free writing prospectus still carries ' 12(a)(2) liability. Issuers and underwriters using free writing prospectuses should be well aware of this point.

The Shelf Offering Context

The advent of the free writing prospectus is particularly significant in the context of shelf offerings. Prior to the Securities Offering Reform, the base prospectus was first filed to register the shelf, which included preliminary information about the shelf and also incorporated by reference the issuer's recent Exchange Act reports. Next, prospectus supplements containing the offering details (and also incorporating any new reports) would typically be filed and then circulated to market a security just before it was taken down off of the shelf. A final prospectus had to be delivered at sale as part of the confirmation. All of these items, as part of the registration statement, carried ' 11 liability as well as ' 12(a)(2) liability.

Now, written offers are no longer limited to prospectus supplements and the preliminary prospectus, but can be made through free writing prospectuses. Furthermore, under the new 'access equals delivery' approach, a final prospectus no longer needs to be delivered at sale, but must be completely on file with the SEC (typically through adding prospectus supplements to the base prospectus) within two days after sale or a reasonable time thereafter. The net result is that the communication of offering terms to buyers can now be made through free writing prospectuses instead of just through filed prospectus supplements. And of course, any additional materials not normally appearing in a statutory prospectus can be included in a free writing prospectus.

While a free writing prospectus does not carry ' 11 liability, it would be a mistake to think that potential liability in a shelf offering has been decreased through the Securities Offering Reform. After all, prospectus supplements, which become part of the registration statement and therefore carry ' 11 liability, must still be filed after sale. And for ' 12(a)(2) purposes, the SEC has made clear that issuers are now liable for misstatements in free writings prospectuses (or other prospectuses) used by underwriters, even though they are not the direct seller. Furthermore, information that is conveyed to buyers after the contract of sale to provide a more complete picture, even if it is accompanied by an understanding that the buyer can back out of the offering at that point in light of the new information, is irrelevant when determining ' 12(a)(2) liability. The rule now is that only information conveyed before and at the contract of sale is considered.

What Can Issuers and Underwriters Do to Protect Themselves?

Issuers and underwriters carrying out a shelf offering (or, for that matter other offerings as well) should be aware of potential ' 12(a)(2) liability for misstatements in free writing prospectuses and act so as to minimize risk, as this could very well be the next big field of securities fraud litigation. As far as assessing whether a free writing prospectus is materially misleading, the Securities Offering Reform leaves unclear the extent to which other available information ' the registration statement, filed prospectus supplements, and Exchange Act reports incorporated by reference ' is considered to determine whether an omission has been made. Likewise, it does not address whether such other information is considered in the 'total mix' to determine whether a misleading statement or omission is material. The best bet for issuers and underwriters at this point is therefore to ensure that investors have in their hands before the contract of sale 'whether through free writing prospectuses, the base prospectus, prospectus supplements, incorporated reports, or some combination ' a complete and accurate picture of the offering. While prospectus supplements need not actually be filed until after the takedown, issuers and underwriters need to be sure that free writing prospectuses are not misleading by omitting important information.

Due diligence should of course be performed in preparing free writing prospectuses, but underwriters are in a particularly difficult situation in this respect. In high-speed shelf offerings, where investment banks compete at the last minute to serve as underwriters in connection with a specific shelf takedown which is then completed in a matter of days, there simply is not sufficient time for due diligence on their part. The underwriters who were sued in the WorldCom case (and eventually settled) experienced this very problem. See In re WorldCom, Inc. Securities Litigation, 346 F.Supp.2d 628, 677-71 (S.D.N.Y. 2004). Apart from conducting quarterly due diligence sessions to ensure that regular reports are accurate (which is only feasible if there is an ongoing relationship between the issuer and underwriter, and even then may prove to be impractical), there is little underwriters can do on this front. They may find a small bit of relief for ' 11 purposes in the ability to file a final prospectus supplement a few days after the takedown (marketing the security through free writing prospectuses instead), and using that time to conduct due diligence before completing the final prospectus.

On a positive note for underwriters, in the adopting release for the Securities Offering Reform, the SEC did offer two opinions (though not actual rules) related to ' 12(a)(2) liability. First, any practices or factors that are currently considered favorably under Rule 176 for assessing due diligence in ' 11 cases ' including the particular role of the underwriter and the availability of information to it ' should also be considered favorably in ' 12(a)(2) cases. It should be noted, however, that it is not yet clear how the Rule 176 considerations should or will be applied, and this issue has rarely been considered. In the WorldCom case, the court allowed the jury to consider whether the underwriters' actions were 'reasonable' under Rule 176. See In re WordlCom, Inc. Securities Litigation, 346 F.Supp.2d at 682. Second, the due diligence standard under ' 12(a)(2) is somewhat less demanding than under ' 11. See Section 1.V.C of the Securities Reform Release. Underwriters may therefore have a bit more breathing room when using free writing prospectuses, but the difficult situation very much remains.

Most importantly, issuers and underwriters should be sure to consult with counsel when using a free writing prospectus to ensure that liability is avoided.

Take Advantage of the Free Writing Prospectus

Issuers and underwriters can also take advantage of free writing prospectuses by using them to help avoid ' 12(a)(2) liability. In shelf offerings, potential buyers are often conveyed rapidly-changing information in pieces, resulting in buyers having outdated information in their hands and a mosaic of potentially confusing prospectus supplements and post-effective amendments. A free writing prospectus can be used to clearly convey to buyers the current state of affairs for the offering prior to contract of sale, helping to avoid potential ' 12(a)(2) liability due to previously conveyed information in a fast-paced shelf offering.

And of course, the potential of free writing prospectuses to effectively market a shelf takedown in ways that would have been inappropriate in a statutory prospectus should not be overlooked amidst the potential liability. As long as the free writing prospectus does not mislead or conflict with the registration statement, any information can be included, opening the door to a new breed of creative marketing and offering tactics in registered public offerings.

Ralph C. Ferrara is a partner at Dewey & LeBoeuf LLP and former General Counsel of the United States Securities and Exchange Commission. Anthony Ford is a third-year student at New York University Law School and served as a Summer Associate with Dewey & LeBoeuf during the summer of 2007.