The Initial Public Offerings Law Review: USA
A long-time leader in the initial public offering (IPO) arena, the United States is home to the two largest stock exchanges by market capitalisation in the world, the New York Stock Exchange (NYSE) and the Nasdaq Stock Market (Nasdaq). Since the establishment of the first US exchange, the US offering process and regulatory landscape have changed dramatically, with the modern US IPO market regulated by both federal statutes and agency regulations, as well as the rules of the exchange on which a company is listed. Foremost among the governing statutes are the Securities Act of 1933, as amended (the Securities Act), which regulates offerings, and the Securities Exchange Act of 1934, as amended (the Exchange Act), which provides for market regulation once a company is public.
More recent regulation that has contributed to the evolution of the IPO market has come from the Sarbanes–Oxley Act of 2002 (SOX), the Jumpstart Our Business Startups Act of 2012 (the JOBS Act) and the Fixing America's Surface Transportation Act in 2015 (the FAST Act), which, despite its name, has been responsible for additional changes to the IPO landscape. The duty of administering, amending and interpreting federal securities laws is the responsibility of the US Securities and Exchange Commission (SEC), the agency that, among other things, reviews IPO registration statements and ensures regulatory compliance both during the IPO process and once companies are public. Over the past few years, the SEC has taken steps to develop the IPO market, by, for example, expanding access to various forms of disclosure relief to a wider class of IPO participants, and clarifying and streamlining the disclosures required by public companies, generally. These efforts, assisted by solid market conditions, have contributed to an IPO market that remained robust in 2019.
The US IPO market has been sensitive to local and global economic developments and geopolitical events. Despite the overall strength of the US economy in 2019, the US government shutdown, trade tensions, global economic conditions and Brexit represented hurdles for companies seeking to go public. After increasing year over year from 2015 through 2018, when 193 IPOs priced, the number of US IPOs decreased slightly to 184 in 2019.2 However, this decrease in number was offset by a significant increase in total US IPO proceeds, which rose from US$43.6 billion to US$60.1 billion. This represents an increase of more than 37 per cent and the highest valuation in the past five years.3 Much of this trend has been driven by the increasing proportion of 'unicorn' IPOs, or IPOs by issuers with valuations in excess of US$1 billion. Unicorns as a percentage of total deal value have risen from 16 per cent in 2017 to 38 per cent in 2019.4 In addition to the increasing importance of unicorns, 2019 saw a continuation of other recent trends, including an increase in IPOs by special purpose acquisition companies (SPACs), which accounted for 4 per cent of IPOs in 2013 and 30 per cent in 2019.5 Technology companies continued to lead in total IPO value at just under half of the total market proceeds in 2019 and together with the financial services, healthcare, energy and power and real estate sectors, had the greatest number of IPOs, both domestically and internationally.6
Going into 2020, economic volatility, uncertainty surrounding the impending US election, and the impact of the Coronavirus remain challenges that may depress IPO market performance. Additionally, some companies, and in particular, larger ones have struggled to achieve anticipated valuations both in the run up to going public and in the immediate aftermarket. This trend may affect issuers' eagerness to go public. However the first quarter of 2020 has been robust, and could lay the groundwork for another solid year for IPOs, provided that the backdrop of a favourable regulatory environment, positive corporate profitability metrics, and generally supportive economic and market conditions remains in place.
The decision to go public requires careful consideration by a company and its management. Issuers must be mindful that the US public company disclosure system may result in reduced confidentiality for the company and its management. Moreover, additional liability arises for the issuer, its directors and its management from being public in the United States. Further, the expense of complying with public company reporting obligations should not be underestimated. Despite these factors, going public in the United States is an exciting (and often long-anticipated) event for any company. The resulting liquidity for existing investors, as well as the visibility and prestige that comes from listing on US exchanges, is very attractive for many domestic and foreign companies. For almost every company, the path to going public in the United States involves an IPO. However, in select circumstances an alternative route may be available, such as a direct listing, where instead of raising funds by issuing new securities to the public, a company registers its privately held shares on behalf of its existing shareholders. A direct listing does not generate funds for the company, may not involve an underwriter, and is subject to a different registration and listing requirements than an IPO.7
Unless there is a compelling business reason, domestic issuers generally list in the United States rather than pursuing a primary (or dual) listing in another country. Foreign issuers, called foreign private issuers (FPIs),8 often opt to list solely in the United States as well. Some foreign companies already listed on an exchange in their home country also choose to list in the United States. For these companies, a US listing can provide several benefits, including increased visibility (which results in an expanded market for new products and services), an ability to use the US listing as currency for acquisitions and the creation of a more diverse investor base (which increases liquidity in the company's shares).
i Main stock exchanges
The primary stock exchanges in the United States are the NYSE and Nasdaq. Though each operate with their own independent standards for initial listing and continued listing compliance, many of these requirements are substantially similar across the two exchanges.
The creation of the NYSE can be traced to the signing of the Buttonwood Agreement in May 1792.9 Also known as the 'Big Board', the NYSE is the largest stock exchange by market capitalisation in the world. Nasdaq, however, is a significantly younger exchange, having commenced operations in 1971. Nasdaq is known as the world's first electronic stock market. Unlike the NYSE, whose historic trading floor and official 'ringing of the bell' each day for opening and closing of trading hours is legendary, Nasdaq exists purely as an electronic platform with no physical trading space.
Both the NYSE and Nasdaq welcome domestic and foreign issuers as well as dual listings. Historically, Nasdaq was viewed as the go-to exchange for technology companies, with the NYSE operating as the primary exchange for 'brick-and-mortar' issuers. However, this has changed in recent years, with companies from all industries listing on both exchanges.
ii Overview of listing requirements
The NYSE and Nasdaq each maintain standards for initial listing and continued listing on their respective markets. Standards include financial thresholds and other quantitative benchmarks as well as requirements relating to corporate governance.
Over the years, the quantitative listing requirements for the NYSE and Nasdaq have become increasingly similar, such that the requirements themselves are not generally determinative of which exchange a company will select. Meeting the quantitative listing requirements is rarely a deciding factor for exchange selection. Similarly, the corporate governance requirements are substantially similar, due in large part to SOX, which considerably changed the governance requirements for US public companies. Even if a company meets all of the listing standards, each exchange reserves the right to deny listing to any company.
A US company seeking to list on the NYSE through an IPO must meet minimum distribution and size criteria, which include, among others, at least 400 round lot shareholders, a post-IPO market value of publicly held shares of US$40 million and a stock price of at least US$4. The company must also meet one of the exchange's two financial criteria: the earnings test or the global market capitalisation test. For IPO companies, the NYSE will accept the underwriters' representation that the offering will satisfy certain of the requirements once the IPO is consummated.10
A non-US company may qualify to list on the NYSE in one of two ways – under the standards for domestic issuers or under the alternate listing standards for FPIs. The FPI-specific listing standards are designed to attract major foreign companies with an existing, substantial market for the company's shares in its home jurisdiction. For example, under the minimum distribution and size criteria, the round lot shareholder requirement is 5,000 (versus 400 under the domestic standard), the market value of publicly held shares must be at least US$100 million, or US$60 million for companies qualifying under the affiliated company test (versus US$40 million under the domestic standard), and 2.5 million shares are required to be publicly held (versus 1.1 million under the domestic standard). To qualify under the alternate listing standards for FPIs, the company must also meet one of the financial tests: the earnings test, or one of the valuation or revenue tests (or qualify under the affiliated company test).
As a general matter, both the NYSE and Nasdaq permit an FPI to follow the governance rules of its home jurisdiction, subject to certain exceptions.
Nasdaq has three separate market tiers, the Nasdaq Global Select Market, the Nasdaq Global Market and the Nasdaq Capital Market. Similar to the NYSE, Nasdaq has liquidity requirements, including number of round lot holders, number of publicly held shares and market value of publicly held shares, as well as financial standards. For example, companies seeking to list on the Nasdaq Global Select Market must qualify under one of four tests: earnings, capitalisation with cash flow, capitalisation with revenue or assets with equity. To demonstrate the similarities between the requirements of Nasdaq and the NYSE, a company seeking to list on the Nasdaq Global Select Market would need 450 round lot holders (400 for NYSE), 1.25 million publicly held shares (1.1 million for NYSE) and a market value of publicly held shares of US$45 million (US$40 million for NYSE). The quantitative requirements for listing on the Nasdaq Global Market and the Nasdaq Capital Market become increasingly less demanding; however, the corporate governance requirements are the same across all three Nasdaq tiers.
The cost of listing on the NYSE and Nasdaq varies somewhat in approach. The NYSE calculates fees based on the exact number of shares listed, subject to a minimum and maximum fee, whereas Nasdaq bases its fee on a share range. For example, to list on the Nasdaq Global Select Market and the Nasdaq Global market, the cost for listing is as follows:
|Number of shares listed||Entry fee||Application fee*|
|Up to 30 million||US$150,000||US$25,000|
|30+ million to 40 million||US$170,000||US$25,000|
|40+ million to 50 million||US$210,000||US$25,000|
|50+ million to 60 million||US$250,000||US$25,000|
|60+ million to 70 million||US$290,000||US$25,000|
|More than 70 million||US$295,000||US$25,000|
* Application fees may be applied to the entry fee.
On the NYSE, fees for an IPO are US$0.004 per share, including a US$25,000 application fee, plus a US$50,000 special one-time fee. Including the special one-time fee, listing on the NYSE is subject to a minimum of US$150,000 and maximum of US$295,000.
iii Overview of law and regulations
IPOs in the United States are governed by federal rules and regulations with oversight by the SEC. The main rules and regulations are contained in the Securities Act and the Exchange Act.
By way of background, the Securities Act was passed in response to the 1929 US stock market crash. It was designed to prevent fraud and misrepresentation in connection with public securities offerings, by requiring that investors receive adequate and accurate information to make their investment decisions. The system is disclosure-based, meaning that a judgement is not made by the SEC on the quality of the IPO company or the securities being offered. Market regulation, however, comes through the Exchange Act, which, among other things, created the SEC. The Exchange Act requires periodic reporting by companies with registered securities (i.e., generally, companies that have made a Securities Act-registered public offering; companies with a security registered on a national exchange; or companies with total assets exceeding US$10 million and a class of equity security held of record by more than 2,000 persons or 500 persons who are not accredited investors).11 Over the years, the SEC has sought to harmonise the Securities Act and the Exchange Act, by providing for integrated disclosure between their forms.
Arguably, the next most significant piece of legislation was in 2002 with the passing of SOX, which came in response to significant US accounting scandals. The main goals of SOX were to strengthen financial disclosures, deter fraud, and heighten corporate responsibility and accountability through various measures, including through increased executive liability. Though not monumentally influential on the actual IPO process, SOX did have a tremendous effect on the governance requirements for companies post IPO.
The most recent significant changes came with the passing of the JOBS Act in April 2012. It created a new category of issuers called emerging growth companies (EGCs), which, generally, are companies with less than US$1.07 billion in annual gross revenues in their most recently completed fiscal year. EGCs are entirely exempt from certain, or subject to reduced, regulatory requirements for a limited period.
The benefits afforded to EGCs pursuant to the JOBS Act include allowing them to provide reduced financial information in SEC filings, including IPO registration statements, relaxing restrictions around analyst communications and carving out certain areas for reduced compliance or exceptions. Certain accommodations that were initially available only to EGCs, including the ability to submit draft registration statements confidentially to the SEC for review prior to making them publicly available and the ability to 'test the water'12 with potential qualified investors to determine investor appetite in an offering, have since been made available to all issuers, by virtue of the FAST Act.
Also integral to the IPO process is the Financial Industry Regulatory Authority (FINRA), an independent non-governmental agency that aims to provide investor protection through the regulation of broker-dealers. During the IPO process, the underwriters must file information with FINRA in connection with the initial submission of the registration statement to the SEC and every amendment thereafter.
The offering process
i General overview of the IPO process
A typical US IPO takes approximately 16 to 20 weeks, assuming that no significant issues arise that delay or complicate the process. Adequate planning and preparation are crucial to the IPO process as delays are often caused by disclosure or financial statement issues that could have been addressed in the early offering stages.
The IPO process can be divided into four distinct phases:
- preparation and analysis (the pre-filing phase);
- filing and SEC review (the phase between filing the registration statement with the SEC and responding to, and clearing comments from, the SEC);
- marketing the IPO; and
- pricing and closing the offering.
The IPO team, also known as the 'working group', consists of several key parties, including the company, company counsel, the underwriters, underwriters' counsel and the company's accountants. The roles of each are described in more detail below.
During the pre-filing phase, even before the first meeting of the full working group, a company works with its outside counsel to prepare for the IPO. Preparatory tasks include reviewing the company's current corporate and capital structure, as well as analysing its organisational documents (such as its charter and by-laws) to ensure that the company is best positioned for life as a public company. In-house and outside counsel also will examine the company's existing corporate governance structure and begin to address any changes that may be needed prior to the IPO. In many instances, a company's private governance practices are not suitable for a public company and changes are often required for SOX compliance, including the creation of new board committees. Additionally, committee charters and other corporate policies may need to be drafted or modified. The underwriters will provide guidance on the governance structure from the perspective of marketing the deal, and may suggest additional corporate changes for marketing reasons. During this phase of the IPO process, a company may also need to prepare new equity compensation plans and employment agreements (or amend current ones), and address other general corporate housekeeping matters. The company's in-house finance team and outside auditors should begin preparing the financial statements that will be required in the registration statement. It is important that the company's auditors are involved early in the IPO process as accounting issues are a common source of SEC comments and potential delay. Also at this time, companies should begin to seek any required approvals for the IPO and begin to develop a plan for public reporting after the IPO.
Preparation of the registration statement typically begins with an initial organisational meeting attended by the full working group, followed by drafts of the registration statement being circulated among the group. The registration statement describes the company and its business; provides risk factors regarding the company, its business and the offering; and includes financial and other information, including the use of proceeds from the offering, company capitalisation, management's discussion and analysis (MD&A) of the company's financial condition and results of operation, and certain relationships and related-party transactions. For domestic companies, the registration statement is generally filed with the SEC under cover of Form S-1 (or Form S-11 in the case of a real estate investment trust), whereas FPIs generally use Form F-1. Contained within the registration statement is the prospectus, which is the stand-alone document provided to investors. The exhibits to the registration statement – which are delineated in the applicable form, as well as other information, such as the expenses of the offering and certain undertakings by the company – are not circulated to prospective investors as part of the prospectus and can be found in filings with the SEC.13 At a certain point in the drafting phase, the registration statement is sent to the financial printer, which will then run any changes to the document on its system and ultimately file the document with the SEC through its Electronic Data Gathering, Analysis and Retrieval system.
Concurrent with the drafting of the registration statement, legal due diligence is conducted by the company's counsel and underwriters' counsel. During legal due diligence, counsel examines various books, records and agreements as well as other material documents of the company to assist the working group to ensure that the registration statement is accurate and not misleading. As explained in subsection ii, due diligence provides a defence for certain liability participants against liability for claims of false and misleading statements under Sections 11 and 12 of the Securities Act. It also provides counsel with a basis for delivering certain legal opinions and negative assurance letters to the underwriters at the closing of the offering. Business due diligence is also conducted by the underwriters to ensure that the company's business and operations are as it purports them to be.
Also at this time, the underwriting agreement, comfort letter and other transactional documentation are negotiated. The underwriting agreement is the main contract that binds the underwriters and the company for the sale of the securities. Through the underwriting agreement, the securities are purchased by the underwriters from the company and are then resold to the public by the underwriters. The agreement contains the pricing terms, various representations and warranties, and provides for indemnities and closing conditions. Though negotiation of the underwriting agreement begins early in the IPO process, it is not actually signed until near the end when the offering is priced. The comfort letter is delivered by the company's auditors to address the accuracy of the financial data included in the prospectus. All financial data in the prospectus should be supported or confirmed as part of the underwriters' due diligence. Any factual information in the prospectus that is not 'comforted' by the auditors must be backed up by the company.
Before filing the registration statement with the SEC, the company's board of directors (and potentially the company's shareholders) will approve the filing and other corporate activities associated with the offering. Additionally, the stock exchange will be determined and the exchange listing process will begin.
After the registration statement is filed with the SEC, it typically takes up to 30 days to receive SEC comments. During the period between filing the registration statement and receiving the first round of SEC comments, preparation continues to position the issuer for life as a public company. This includes continuing to establish certain corporate governance policies and practices, writing charters and required governance documentation, and continuing to advance the stock exchange listing application.
When comments are received from the SEC, they arrive in the form of a letter. The company, underwriters, counsel and accountants respond by filing an amendment to the registration statement to address the SEC comments. The company also writes a response letter to the SEC. Typically, there are several rounds of back and forth between the company and the SEC before it will allow the registration statement to 'go effective'. During this time, FINRA also reviews the underwriting arrangements.
During the marketing phase, the underwriters and the company conduct a roadshow, which is typically a two- to three-week period of investor meetings across the United States, and often in Europe and other jurisdictions. Prior to the roadshow, the deal team will print red herrings or 'reds', which are glossy copies of the preliminary prospectus. These will be handed out during the investor meetings. The books are called 'reds' owing to the red banner that appears at the top and the left margin of the preliminary prospectus, stating that the information is not complete and may be changed, and that the document is not an offer to sell the securities. Over the course of the roadshow, the underwriters will collect non-binding indications of interest from potential investors. The roadshow is separate from any testing-the-water activities that may already have been conducted by or on behalf of an eligible issuer.
When the roadshow is complete, the underwriters will look to price the deal based on the demand for the securities. As securities only may be sold once the registration statement is declared effective by the SEC, clearance from the SEC and FINRA must be obtained by this time to enable the registration statement to be declared effective by the SEC and for pricing to take place. At the time of pricing, the company and the underwriters agree on the final price of the securities and execute the underwriting agreement. After pricing, the underwriters confirm sales and allocate shares. The securities begin to trade the day after pricing. Following pricing, the company files the final prospectus with the SEC. The final prospectus includes the determined sale price of the stock, the underwriters' compensation and the amount of proceeds the company will receive from the offering.
The offering typically closes on a T+2 schedule (meaning two business days after pricing). At closing, various executed documents are exchanged between the company and the underwriters, including legal opinions and negative assurance letters, the comfort letter, lock-up agreements (which 'lock up' certain existing shareholders from selling their shares for a certain period (typically 180 days)) and other closing certificates.
As described above, the working group acts in concert to ensure that each of the IPO stages progresses as seamlessly as possible. A company's internal team is crucial to the IPO process. The company ensures that the offering documents accurately describe the business, and the risks relating to the offering and the company, among other disclosures. Further, the company's internal finance team is critical in preparing the financial statements and other financial disclosure along with assistance from the company's outside auditors. Management of the company also needs to be available for drafting sessions, diligence calls and participation in the roadshow. Although the company is the key component of the IPO team, the other players have essential roles to ensure the success of the offering.
Company counsel guides the issuer through the offering process, from preparatory structuring through to the closing of the offering. Company counsel assist with drafting the required registration statement disclosure, negotiate agreements and other offering documentation, and assist the company in complying with applicable securities laws.
The underwriters design the marketing effort, set the company's valuation, lead the roadshow and assist the company in describing its business in a compelling way. They arrange investor meetings and control the book-building process. They also participate in certain aftermarket trading activities.
Underwriters' counsel assist the issuer through the offering process. They prepare the initial draft of the underwriting agreement, contribute to drafting other documents and negotiate agreements with company counsel. They advise the underwriters on FINRA compliance (including making the required filings with FINRA) and other issues, such as research reports, trading restrictions and any permitted testing-the-water activities.
The company's auditors are important in drafting the MD&A section of the prospectus. They assist the company with its required financial statements and deliver the comfort letter. They also assist the other members of the working group in responding to any financial or accounting comments from the SEC.
There are also several other key players in the IPO process, including the financial printer, which prints the preliminary and final prospectuses, and files the registration statement with the SEC; the transfer agent; and market maker or specialist. The company may also enlist the services of an IPO consultant, a compensation consultant or a public relations firm.
ii Pitfalls and considerations
Navigating the IPO process can be difficult and, without careful planning, there are many potential pitfalls that could affect the offering. Several of the key considerations in the IPO process come early in the planning stages when the company is preparing to become a public company.
One of the first crucial steps is to review existing agreements to identify any consent or approvals that may be required for the IPO to occur. Companies should also examine their current corporate structure and capitalisation early in the process to ensure that they correctly align with public company operations and the contemplated offering. For example, a company may need to increase the number of authorised shares or wish to authorise blank check preferred stock prior to the offering. Companies should also consider public company defensive measures such as creating a classified board and limiting the ability of shareholders to call meetings or act by written consent.
Companies must also spend significant time preparing their post-IPO governance structure. Existing policies, charters and other governance-related documents should be reviewed to determine any necessary changes that may be required to comply with public company governance requirements. Often, additional policies, charters and structural changes are required. As a general matter, FPIs may follow the governance requirements of their home jurisdictions instead of the requirements for domestic issuers, subject to certain exemptions and requirements.
Stock options can also prove to be problematic in the IPO process. For grants up to two years before an IPO, a company should be prepared for the SEC to ask for valuation support. Because of this, it is important for a company to obtain independent valuations for options to avoid cheap stock accounting charges.
Companies must review all related-party transactions prior to filing the registration statement to determine which, if any, must be disclosed. In addition, companies may wish to unwind certain transactions prior to the IPO for optical, legal or other reasons. Further, any loans to executive officers and directors must be unwound prior to the first filing of the registration statement.
Early in the planning stages, a company should work with its counsel to determine what financial statements will be required in the registration statement as well as begin to address any related MD&A issues. Generally, companies are required to include in the IPO registration statement three years of income statements, two years of balance sheet information and five years of selected financial statements. EGCs, however, are only required to include two years of audited financial statements and two years of selected financial statements. Mergers and acquisitions activity may trigger additional required financial statements such as pro formas and target financial statements, depending on the significance and timing of the mergers and acquisitions activity. These rules have received recent attention by the SEC and issuers should be alert to potential changes. Financial statement preparedness often drives (and delays) the timing of an offering. In addition, companies should be mindful of SEC 'hot buttons'. In recent years, these have included revenue recognition, cheap stock, segment reporting and loss contingencies.
Foreign issuers in particular need to be aware of applicable audit standards and any reconciliation that may be required with respect to any non-generally accepted accounting principles (GAAP) or certain non-International Financial Reporting Standards (IFRS) financial statements. If financial statements are not prepared in accordance with US GAAP or English-language IFRS as issued by the International Accounting Standards Board (IASB), they must be reconciled to US GAAP. FPIs must also ensure, regardless of the form of presentation of their financial statements, that such statements are audited in accordance with US generally accepted auditing standards.
Issuers must be extremely careful of what is known as 'gun jumping'. As a general matter, there are certain restrictions on communications when a company is contemplating or conducting a securities offering that are intended to prevent a company from conditioning the market for the offering. The communications covered by the gun jumping restrictions are extensive and include press releases, social media activity and interviews, among other forms of communications. Gun jumping is where a company violates these rules. The SEC may deem an action as gun jumping even if it was purely accidental. Therefore, companies must be mindful of the rules from the outset, even before the registration statement is filed. The consequences for gun jumping can be significant. If the SEC determines that gun jumping has occurred, it may impose a cooling-off period, during which the company must delay the offering. Gun jumping may also trigger sanctions, fines or rescission rights.
Aside from the technical legal considerations, it is crucial that a company be prepared to access market windows. This means being vigilant during the planning stages to ensure that the company is best positioned to move forward at the appropriate time when market windows are 'open'. The company's underwriters will be able to advise on the most advantageous time to launch the offering.
It should not be overlooked that becoming a public company exposes the issuer and other offering participants to liability under the US securities laws. In particular, Section 11 of the Securities Act states that if any part of an effective registration statement: 'contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security (unless it is proved that at the time of such acquisition such person knew of such untruth or omission) may sue' every person who signed the registration statement, as well as every underwriter, expert, and current and future member of the board of directors named in the registration statement, among others.
Though a due diligence defence is available to underwriters, experts and directors, it is not available to the company. The company is 'strictly liable' under Section 11 of the Securities Act, subject to a limited exception if the company can prove the purchaser of the securities knew of the untruth. Additional liability is imposed by Section 12(a)(2) of the Securities Act on any person who offers or sells a security by means of a prospectus or oral communication that contains a material misstatement or omission.
iii Considerations for foreign issuers
Though many of the procedural elements involved in a US IPO by a domestic issuer are essentially the same as those for an FPI, FPIs are provided with significant relief in several areas. These measures are designed to encourage them to go public in the United States.
In the registration process, FPIs typically utilise Form F-1 to register with the SEC instead of Form S-1 (the form for domestic issuers). Form F-1 contains reduced disclosure requirements compared with Form S-1.14 Notable differences in Form F-1 include, among others, compensation disclosure. Unlike domestic companies, FPIs are able to disclose more limited compensation information, particularly as it relates to individual compensation, compared with domestic issuers, unless the information is publicly disclosed elsewhere by the FPI. Notwithstanding the accommodations, however, the underwriters may encourage the issuer to provide disclosure akin to what is required for a domestic issuer for marketing purposes.
FPIs also have flexibility with their financial statement presentation. They may prepare and file their financial statements in accordance with US GAAP, IFRS or local GAAP. FPIs that utilise the English-language version of IFRS as issued by the IASB do not need to provide a reconciliation to US GAAP. However, if non-IASB IFRS or local GAAP are used, generally reconciliations to US GAAP must be included. In addition, FPIs have different 'staleness' dates (the date after which financial information may not be used) from domestic issuers, meaning semi-annual rather than quarterly financial statements are the only interim financial statements generally required
As a structural matter, instead of directly offering stock to the public, FPIs may choose to offer securities in the United States through the use of American depositary receipts (ADRs). ADRs are stand-alone securities (separate from the stock of the FPI) that represent a certain number of shares of the FPI. The underlying shares are held with a depositary that contracts with the issuer. In many instances, investors find ADRs more attractive than holding shares directly in a foreign corporation as ADRs may result in favourable currency conversions on dividends and other cash distributions.
Once the company is public, unlike a domestic issuer, an FPI is not required to file quarterly reports on Form 10-Q, annual reports on Form 10-K or periodic reports on Form 8-K. Instead, an FPI files annual reports on Form 20-F15 within four months of the company's fiscal year end, and must furnish to the SEC on Form 6-K information that it:
- makes or is required to make public in the jurisdiction where it is domiciled, or in which it is incorporated or organised;
- files or is required to file with a stock exchange on which its securities are traded, if made public by that exchange; or
- distributes or is required to distribute to its security holders.
Pursuant to the rules of the stock exchanges, FPIs are required to furnish semi-annual unaudited financial information on Form 6-K.
Post IPO, FPIs also enjoy the benefit of being exempt from the US proxy rules that generally require proxy solicitation in connection with shareholder meetings. They also do not need to comply with the rules for presenting shareholder proposals. Further, FPIs are exempt from filing insider trading reports under Section 16 of the Exchange Act, as well as from the short-swing profit rules, which generally prohibit a company insider from profiting from company stock that is bought and sold within a six-month period. Additional regulations from which FPIs are exempt include Regulation FD, which prohibits the selective disclosure of material, non-public information; Regulation G, which addresses the use of non-GAAP financial measures; and Regulation BTR, which covers trading during pension fund blackout periods.
Both the NYSE and Nasdaq provide accommodations to FPIs in the corporate governance arena. To utilise these exemptions, an FPI must disclose in its annual report on Form 20-F how the company's governance practices differ from those required for a domestic company under the rules of the applicable exchange.
Once a company becomes public, there are several ongoing governance and reporting requirements with which the company must comply. These requirements are considerably different for domestic issuers than for FPIs, which are provided relief from compliance in many instances as discussed above.
Domestic companies are required to file annual, quarterly and periodic reports with the SEC. The due date for these filings is based on the company's filer status as either a large accelerated filer, accelerated filer or non-accelerated filer. Among other requirements, large accelerated filers are companies that have a public float of US$700 million or more, whereas accelerated filers have a public float of more than US$75 million but less than US$700 million. For a newly public company, regardless of its filer status, the annual report on Form 10-K is due 90 days after the company's fiscal year end. This is shortened to 75 days for an accelerated filer and 60 days for a large accelerated filer for subsequent Form 10-K filings. Quarterly reports on Form 10-Q are due 40 days after the company's fiscal quarter end for large accelerated filers and accelerated filers, and 45 days for all other filers. Periodic reports on Form 8-K are typically due within four business days of the triggering event for all types of filers. There are various activities that trigger the need to file (or furnish) a Form 8-K, including entering into or terminating a material agreement, consummating a significant acquisition, or the departure of a director or executive officer. Form 8-K is also used to satisfy necessary disclosure under Regulation FD, which generally prohibits disclosure of material information by domestic issuers to certain people without disclosing it to the public as well. As previously discussed, FPIs generally file annual reports on Form 20-F and furnish other reports on Form 6-K.
Post IPO, domestic companies must also file proxy statements, which are due 120 days after the company's fiscal year end if certain information in Form 10-K incorporates by reference information from the proxy statement (as is typically the case) that must comply with the detailed US proxy rules. Domestic companies are also required to hold annual meetings, for which significant advance preparation is required.
The company's board of directors and the committees of the board must hold regular meetings. Directors and certain officers of the company, among others, must also file reports relating to their shareholdings and be mindful of the rules regarding trading by insiders. In addition, various annual certifications are required to be delivered to the exchange on which the company is listed.
One of the more onerous requirements for many companies is compliance with SOX 404, which addresses a company's internal control over financial reporting. A company's (1) management must report on the company's internal control over financial reporting and (2) an auditor is required to attest to the assessment of management.
This is neither required in a company's IPO registration statement nor in the first annual report following its IPO. However, in the second annual report, part (1) is required and part (2) may be required depending on a company's filer status or other special designation.
Outlook and conclusion
In the United States, 2019 represented a solid year for IPO performance where a modest decrease in the number of deals was offset by an increase in deal size, causing the market to grow, overall. Globally, headwinds including Brexit and global trade tensions that have stifled the IPO market have somewhat improved. Going into 2020, the strength of the US IPO market will depend on several key factors, including the economic impact of the coronavirus, the outcome of the US election and general recessionary fears, and the ability of entrants to achieve their desired valuations. However, there is reason for cautious optimism concerning the US IPO market in 2020. The SEC has remained focused on easing regulatory burdens and facilitating continued access to IPOs, by both domestic companies and FPIs. If global economic volatility remains muted and macroeconomic conditions, domestic and global geopolitical events and US Federal Reserve and trade policies continue to be favourable, the IPO market in the United States may have a strong 2020. Regardless of any uncertainty that may exist, it is expected that the US IPO market will remain at the forefront of the global IPO arena.
1 David J Goldschmidt is a partner at Skadden, Arps, Slate, Meagher & Flom LLP.
7 Though this chapter deals primarily with the IPO process and requirements, in addition to direct listings, exchange offers and distribution of shares in a public company's spin-off transaction are other less common paths to becoming a public company in the United States.
8 Rule 405 of the Securities Act defines an FPI as: 'any foreign issuer other than a foreign government except an issuer meeting the following conditions as of the last business day of its most recently completed second fiscal quarter: (i) More than 50 percent of the outstanding voting securities of such issuer are directly or indirectly owned of record by residents of the United States; and (ii) Any of the following: (A) The majority of the executive officers or directors are United States citizens or residents; (B) More than 50 percent of the assets of the issuer are located in the United States; or (C) The business of the issuer is administered principally in the United States.' The determination date for FPI status in connection with an IPO is a date within 30 days before the filing of the initial registration statement.
9 So named because 24 stockbrokers signed the agreement under a buttonwood tree on Wall Street. Library of Congress, 'History of the New York Stock Exchange', available at www.loc.gov/rr/business/hottopic/stock_market.html (last visited 18 February 2020).
10 There are alternative standards in certain instances, including for real estate investment trusts with less than three years of operating history and special purpose acquisition companies.
11 Slightly different numerical standards apply to banks, savings and loan holding companies, and bank holding companies.
12 Through testing-the-water activities, an issuer or someone authorised to act on its behalf may make oral or written communications with certain qualified potential investors prior to or after the filing of the registration statement.
14 Historically, certain FPIs were permitted to file their registration statements confidentially with the SEC. Although this ability remains in place, the changes in 2017 that enable all issuers to file confidentially make this 'benefit' significantly less relevant.
15 Certain Canadian FPIs are able to file annual reports on Form 40-F, which has significantly reduced disclosure requirements compared with Forms 10-K and 20-F.