This is an extended version of a story originally published on January 24.
These are quiet times at the US Securities and Exchange Commission. Since the shutdown of the country’s government began on December 22, the SEC, like other government agencies, has been operating on a skeleton staff. Of its roughly 4,400 employees, probably not more than about 300 – most of whom are in critical law enforcement or protection roles – are working.
Contrary to what you might imagine, shutdown is a remarkably quick process at the SEC. Internal guidance is that it should take no more than four hours to close down most of its systems. The day after the government shutdown became effective, staff had to attend their workplaces to start powering down. They are allowed to set up out-of-office voicemails and emails, but can’t do a whole lot more.
They cannot work for free even if they want to. As the SEC reminded its staff in a memo, doing so would violate the Antideficiency Act, that part of legislation that restricts what government agencies are allowed to do in the event of there being no appropriations to fund them – the technical definition of a shutdown.
Anyone who happens to be travelling for work as a shutdown hits must return immediately, and all planned travel is cancelled. Training is stopped; anything scheduled is put on hold. Paid leave is scrapped. Almost all staff are placed on furlough.
If you filed before the shutdown, you need to have launched by February 14 or your numbers will be stale
– Capital markets head
For all those staff stuck without earnings, it’s a miserable existence. But it also doesn’t add up to a great mix for any companies looking to complete securities offerings. They can still file if they wish: the mighty Edgar – as the SEC’s Electronic Data Gathering Analysis and Retrieval system is known – hums along relentlessly. It’s still absorbing more than 3,000 or so items every day, similar to what it was at around this time of year in 2017 (there was another shutdown in January 2018).
That’s because the Edgar system itself runs under a contract, putting it outside the purview of the shutdown. It’s the same for Edgar’s cousin, the less humanly named IARD, or Investment Adviser Registrations Depository, which also continues to take filings. Likewise, at CRD, the Central Registration Depository of brokers and representatives.
The same does not apply, however, to those living and breathing SEC staff that spend their days delving into Edgar to scrutinize registration documents and other filings.
There are a few folk around to help the system stay up and running. If you need an Edgar access code (which you need in order to submit a filing) or you need to reset your password, you are able to get help. Some other questions deemed sufficiently urgent might also be answered. The few available staff at CorpFin, as the department of Corporation Finance is known to insiders, will answer questions about how to calculate filing fees.
But in short, across the departments of CorpFin, Investment Management, Trading and Markets, and the Office of Compliance Inspections and Examinations, you are mostly unable to get documents processed or receive substantive advice.
The last effectiveness notices showing on the SEC’s website were issued on Wednesday December 26, which was the first business day after the shutdown began. Since then, nothing.
Plumas Bancorp, a California-based independent bank that was filing a shelf registration of up to $40 million, looks to have the distinction of being the last out of the door. Its effectiveness notice was timed at 17:30.
Two routes
Fortunately, the shutdown doesn’t bring all capital markets deals grinding to a halt. Those organizations deemed to be Well Known Seasoned Issuers (WKSIs) don’t have to worry too much about all this. Their registration statements are automatically effective when they file them. The real problem is for the rest, including IPOs.
For the moment, Wall Street’s equity capital markets bankers are counting themselves lucky that the shutdown hasn’t come at a busier time of year.
“It’s not helpful, but typically you only get about 5% of US IPOs in January anyway,” notes one New York-based capital markets head. “But at the same time we are seeing a backlog of issues. When the shutdown ends, there will be a much larger number of companies than usual that will need sign-off.” Clearing the backlog could take until well into March, even if the shutdown was to be resolved in early February, say bankers.
According to Dealogic data, only one US IPO has technically closed in January, a small deal for Rhinebeck Bancorp. However, it was a reorganization and had already determined its offer price and structure well before the shutdown began.
In January 2018, there were 19 IPOs in the US, with proceeds of $6.7 billion. In January 2017, there were 12 deals worth a total of $5.3 billion.
These are companies that are finding cures and therapies, and without money they will have to start making decisions to shut some of them down. This is not about someone wanting a larger yacht
– ECM banker
This year, if you are among the lucky candidates with an effectiveness notice already issued, there are still hurdles. You are still able to use Rule 430A, which is the mechanism by which issuers can file registration documents that do not contain final pricing information. The rule has a 15-business-day time limit attached to it, but issuers can keep restarting that 15-day period by filing post-effective amendments under the provisions of Rule 462(c).
That works because such amendments are effective automatically upon filing, so they don’t need scrutiny from SEC staff to be declared effective.
In this way, an issuer could keep delaying a deal whose registration document is already effective until after the end of the shutdown, although this would only be permitted as long as there is no substantive change needed to the documentation by the time of final pricing.
There is another route to keep deal plans alive, even for those that did not get an effectiveness notice in time. Organizations typically file with a standard pre-effective amendment that deliberately delays the effectiveness of their registration document for 20 days, to allow for CorpFin staff to examine the paperwork.
Companies that filed before the shutdown but did not receive an SEC effectiveness notice can keep filing these same pre-effective amendments to delay for another 20 days.
Urgency
Do these options solve the problem for the moment? Not really. The “red”, as bankers call preliminary deal documents, needs to be a good document, by which they mean it has to still be relevant at the time of executing a deal. Most importantly, the financials have to still be current.
“Basically, if you filed before the shutdown, you need to have launched by February 14 or your numbers will be stale,” says the capital markets head. “If you are pricing a week after that, you probably have to go back to the SEC.”
Then there’s the urgency of funding. IPO candidate companies in the biotech or healthcare sphere need to do their deals, because the proceeds will have been earmarked for development. “These are companies that are finding cures and therapies, and without money they will have to start making decisions to shut some of them down,” notes a senior ECM banker. “This is not about someone wanting a larger yacht.”
This matters because January’s US IPO business typically sees a disproportionate volume of deals from such sectors, say bankers, often looking to capitalize on interest garnered by JPMorgan’s annual healthcare conference, the biggest event in that sector’s calendar.
It hasn’t slowed down our ability to pitch business. We’re just building a pipeline instead of executing
– Capital markets head
An IPO candidate that is determined to go ahead during the shutdown does have one option, but it’s not without risk. The flipside of that standard 20-day delaying amendment is that an issuer choosing to file without it, or remove it from an existing filing, sees their documentation become automatically effective after that period, without SEC approval.
In practice, it means a company can file its paperwork and then complete an IPO 20 days later, all without having had its documentation examined by regulators at all. It’s entirely permitted, and CorpFin’s own shutdown-related frequently asked questions for potential issuers even flag it up as an option.
A few companies are looking to do just that, say bankers.
New Fortress Energy, which filed its Nasdaq IPO through Morgan Stanley and Barclays on November 9, 2018, followed the usual method of submitting its preliminary prospectus without pricing details. On December 21, it filed an amendment and then on January 14 it filed again, this time for 22.2 million shares with a price range of $17.00 to $19.00 and an offering size of up to $485 million. By now, Citigroup and Credit Suisse had been added to the top line of the deal, with Evercore ISI, Allen & Company and JMP Securities below them.
So far, then, the deal is following a normal track – albeit delayed – but bankers on January 24 indicated to Euromoney that the IPO might yet emerge with amended documentation containing an offer price to take advantage of the ability to have its deal become effective 20 days later.
If New Fortress Energy were to do that, it would be following on from biotech firm Gossamer Bio, one issuer that has definitely plumped for the technique – something that bankers think is the first time it has happened.
Speculation over its plans, first reported by the Wall Street Journal earlier this month, was confirmed when the company filed an amendment on January 23 announcing that its IPO would be for 14.375 million shares priced at $16.00, making a deal size of $230 million. Leading the deal are Bank of America Merrill Lynch, SVB Leerink, Barclays and Evercore ISI.
In a separate letter filed on January 24, Gossamer said it had included the proposed IPO price, the number of shares and had amended the filing’s language to make it automatically effective after 20 days, putting the pricing date at February 20.
“In the event that the federal government and the SEC resume normal operations prior to February 12, 2019, Gossamer Bio will re-evaluate the use of Section 8(a) in connection with the offering,” the filing added, thus indicating that it could revert to a more conventional approach if it had the opportunity to do so.
Three hurdles
If it’s possible to make a deal automatically effective after 20 days, why wouldn’t companies rush at the chance, not just during a shutdown but more generally?
It’s certainly not for lack of discussion. “We have talked to every single client about it,” says the ECM banker, but there are a few reasons why it won’t suit all of them.
First, investors are unlikely to want to leap into unexamined deals, which means that any issuer tempted to use this route is going to need to have a very strong relationship with at least some investors already – enough to effectively anchor a deal. That probably rules out many sectors, although not those that would have relied on earlier private rounds of funding, such as biotechs, and who can rely on earlier funders to support a public deal too.
Secondly, and most problematic from a technical perspective, the flexibility afforded by Rule 430A – namely, the ability to file documentation without pricing details – is not possible for any issuer filing without the delaying amendment or removing it from a document already filed.
That’s because companies are only granted that disclosure flexibility on condition that their plans are scrutinized by staff and declared effective by them. In practice, this means that companies have to file with a fixed price and proceeds amount, even though they cannot complete their deal and see their stock trade for another 20 days.
Third, there’s also a legal risk. If the SEC later decides that an organization’s unexamined paperwork was deficient, it might want to take action.
According to a client memorandum by lawyers at Davis Polk: “We believe the likelihood of such action to be remote (absent egregious circumstances).” However, they also cautioned: “Companies should be careful to address any outstanding SEC comments that pre-existed the shutdown.”
It’s not just the SEC, though: investors could also take pot shots at a deal after the event, although that is only really likely if it were to fail. As bankers like to say, no one sues you for a deal that goes up.
The myriad risks are real enough for all parties involved with a deal to take them seriously. “This has gone to the top of the house in our firm,” says one banker.
It’s not surprising: issuers don’t tend to launch fixed-price deals precisely because they need to gauge the market appetite – something that they wouldn’t be able to do formally without having filed documentation.
And even with some confidence over where a deal could price now, it is a different prospect to then wait for 20 days before it can formally complete and trade. After a private round of funding last July, Gossamer would have some awareness of investor appetite: other potential candidates might not.
Given that it has decided to go ahead, it is also likely that Gossamer had not been involved in a protracted back-and-forth with the SEC over its initial filings. One reason that bankers cite for companies being wary to adopt the auto-effective route would be if the first documentation had elicited substantive questions from the SEC, questions that an issuer would probably want to deal with before pressing ahead.
“If you were already close on a document, then you can consider this path,” says one ECM banker. “If you were not close, you probably shouldn’t.”
For the moment, then, the option looks limited to issuers in very specific circumstances, but if the shutdown continues, that could change. As one banker puts it: “Maybe people climb out further along the risk curve.”
Bankers say they are not much less busy just because they can’t price IPOs, since they have to continue to work with clients to discuss options – and prepare for more normal times for flotations later.
“It hasn’t slowed down our ability to pitch business,” says the capital markets head. “We’re just building a pipeline instead of executing.”
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