August 27, 2008

A Sleeper? The SEC’s Proposal Limiting the Ability of Subsidiaries to Issue Shelf Debt

Back in early July, the SEC snuck in a proposal – amidst a host of proposals directed at the rating agencies – that has the potential to limit the number of companies that can currently issue debt securities using a shelf registration statement, while at the same time expanding shelf eligibility to less creditworthy issuers. As proposed, the investment grade non-convertible debt securities transaction requirements in General Instruction I.B.2 of Form S-3 would be replaced with essentially the WKSI debt issuer standard – that the company has issued more than $1 billion for cash in registered offerings of non-convertible securites over the prior three years. The comment period for this proposal ends next week, on September 5.

This potentially could be a huge deal. For instance, junk bonds could be offered on Form S-3 under the proposed eligibility criteria, so long as the issuing company meets the $1 billion issuance standard. Further, a company could use S-3 if it met the $1 billion standard, even if some or all of the outstanding debt is in default. The SEC also asked questions about making disclosure concerning ratings mandatory (now it is permissive under Item 10(c) of S-K), including whether ratings and changes in ratings should be disclosed on Form 8-K. Further, in an unusual move, the eligibility standard for issuing asset-backed securities off of Form S-3 would look to, among other things, the status of the investors – namely whether they are QIBs. In its proposing release, the SEC says that only six corporate debt issuers would be kicked off of S-3 if they switched to the $1 billion issuance standard, but it is unclear at this point whether that estimate captures the full impact of the proposed rule change.

Unfortunately, this proposal appears to represent a purely facial change – pulling references to credit ratings out of all of the SEC’s rules because it supposedly gives the ratings (and the ratings process) an SEC “stamp of approval” – that could have some far-reaching ramifications for the markets at a time when issuers of asset-backed securities, hybrid instruments and corporate debt are most in need of the quick access to capital afforded by Form S-3 and shelf registration.

– Dave Lynn