The phrase “jumping the gun” is a colloquial expression that refers to somebody engaging in actions that are premature, or ones that can seem hasty. One of the most well-known examples of jumping the gun was the 1948 Chicago Daily Tribune headline that read “Dewey Defeats Truman” only to find that President Harry S. Truman had, in fact, won the election. Oops. Although this is one of the more notorious examples, every election night brings cries of “foul” from one party or another as networks attempt to jump the gun by “calling” a national race even when polls in the West are still open.
In fact, in a 24-hour news cycle, there are examples of jumping the gun that happen almost every day when opinions are cited, and conclusions are drawn, well ahead of when facts are available. You can probably think of other examples of jumping the gun. However, to investors, jumping the gun refers to the practice of companies who, while entering the capital market, make public statements that are seen as an attempt to presell a security to potential investors prior to a declaration of their Initial Public Offering from the Securities & Exchange Commission (SEC). To help prevent this, companies are subject to a quiet period, and that’s the subject of this article.
In this article, we’ll define the quiet period, give a history of when and why it came into existence, how it has changed over the years, what the potential consequences can be for companies who violate the quiet period, and some of the amendments that have been written into the law since the quiet period was established.
What is the quiet period?
There are two definitions of quiet period depending on the context. For businesses that are issuing an Initial Public Offering (IPO) that will allow them to enter the capital market and begin to trade their stock on a major exchange, the quiet period refers to the period of time (called the waiting period) that starts once the company and the underwriters of the IPO agree to proceed with the offering. During this period of time, the company will file a registration statement with the Securities and Exchange Commission (SEC). The quiet period lasts until the SEC declares the registration statement to be in effect. Statements made within 30 days of the company filing their registration statement that may be viewed as an attempt to presell the security is considered a violation.
The second definition of a quiet period occurs in the four weeks leading up to a company filing its quarterly earnings report. Corporate insiders cannot speak to the public about their business to avoid the appearance, real or perceived, of providing insider information to analysts, journalists, investors, and portfolio managers.
How does the quiet period work?
According to rules published by the Securities & Exchange Commission, a company is prohibited from releasing information about its activities and related parties to the public after it has filed for its Initial Public Offering (IPO). “Company” is broadly interpreted by the SEC to include not just top-level employees such as a Chief Executive Officer and Chief Financial Officer but also board members, management, and even employees who are talking about the company. In this way, the guidelines for the quiet period are similar to those used for insider trading. The quiet period remains in place until the SEC has had the opportunity to ensure all the documentation is in order and subsequently approves the registration for the offering.
During the quiet period, it is a common and legal practice for key management personnel of the company to perform "road shows" that will allow them to present information to prospective investors and the investment community. This is done to meet due diligence requirements and assess the potential market and share price point, for the IPO. To help prevent the possibility of a company committing a violation of the quiet period, companies are strongly discouraged from engaging in marketing and public relations strategies such as press interviews, participation in conferences, and new advertising campaigns.
When did the quiet period come into existence?
After the stock market crash of 1929, there was pressure on the government to create enforceable guidelines to regulate the purchase and marketing of securities on a federal level (it was previously done by the states). The first major piece of legislation to emerge was the 1933 Securities Act. For the first time, the sales of securities would be regulated by the Federal Government via the Securities & Exchange Commission (SEC).
One of the primary objectives of the Securities Act was to ensure that investors would receive pertinent financial information prior to shares going public. The act required companies to register with the SEC and provide both the commission and potential investors with a registration statement and a prospectus so that all parties would have access to the same relevant information. The prospectus, which is required to be made available on the SEC website, is the most important piece of this legislation and is required to include:
- A description of the company’s properties and business
- A description of the security being offered
- Information regarding the company’s management
- Independently certified financial statements
While providing information to investors was important, another key objective of the Securities Act was to ban companies from marketing their securities using potentially fraudulent or actions that misrepresented the security. This is what spawned the quiet period.
Since its inception many amendments have been made to the Securities Act to accommodate changes in the way information is disseminated, making it easy for companies to conduct their business without running afoul of the provisions in the Securities Act. The most recent amendment was made via the JOBS Act in 2012.
Why does the quiet period matter?
The SEC acts as a neutral party in evaluating the veracity of a company's filing documents. The quiet period allows the commission to perform this evaluation without undue disruption that could be caused by public exposure and hype. The quiet period also serves to prevent the leak of information that could cause investors to make uninformed decisions regarding the proper valuation and expectations for the company. In this way, the quiet period acts as a way to ensure all investors have access to the same information and to help ensure that the information they receive is accurate before the security is released for sale on the market.
What are the consequences of violating the quiet period?
If a company makes a statement within 30 days of filing their registration statement that the SEC considers to be an attempt to pre-sell the public offering, they could deem it a “gun-jumping” (Section 5) violation of the Securities Act. Possible consequences include:
- Liability for violating securities laws
- A delayed public offering date
- A requirement to disclose potential securities laws violations in the prospectus
Over the years, investors (particularly small investors) have debated the objectives behind the quiet period and how the SEC chooses to enforce the rules. Like any regulated market, there are bound to claim that certain parties are being given access to information in violation of the quiet period. One such example occurred before the IPO for Facebook in 2012. This IPO led to over a dozen lawsuits from shareholders that claimed the social network giant along with its underwriters deliberately did not disclose information ahead of the listing regarding growth forecasts that were significantly weaker than projected.
What are some amendments to the quiet period?
The Securities Act has been amended frequently throughout its history to provide clarification to companies on specific practices, but also to reflect the changes brought about by electronic communication in all its forms. Some of the most notable exceptions are listed here.
- Rule 163A Exception – This is an allowance for the fact that a company may have engaged in certain communications prior to the 30-day period in advance of their pre-filing. Rule 163A exempts those communications provided they do not reference the offering and “reasonable steps” are taken to ensure that the information is not disseminated during the quiet period.
- Rule 135A Safe Harbor – This exemption allows a company to publish what is known as a “tombstone” ad regarding the public offering before the filing of the registration statement. This notice must meet specific guidelines to ensure it does not constitute an offer.
- Rule 169 Safe Harbor – This exemption allows companies to continue to release communications regarding factual information about their business that has been part of the company’s ordinary course of business. The information must not contain any information about the public offering.
- Section 105(c) of the JOBS Act – This provision is known as the “Test the Waters” initiative and it applies to Emerging Growth Companies. The exemption created new process and disclosures for companies (which are defined as companies with less than $1 billion in total annual gross revenues during its most recently completed fiscal year. Under this exemption, these companies can communicate verbally or in writing with qualified institutional buyers (QIBs) and institutional accredited investors (IAIs) to assess interest in the proposed offering prior to or during the quiet period. The company, however, may not sell the security unless the communication is accompanied by or preceded by a prospectus.
The bottom line on the quiet period
One of the pillars of our capitalist economy today is the free and fair exchange of information. But that wasn’t always the case. In the early part of the 20thcentury, the trading of securities was left to the states to regulate, and the standards of what was considered “free and fair exchange” varied widely. After the crash of 1929, the Securities Act of 1933 was the U.S. Government’s first major piece of legislation that would attempt to change the way securities were sold, particularly when a company was first attempting to be listed on an exchange.
One of the provisions of the Securities Act is known as a quiet period. This takes place during the “pre-filing” period when the parameters of an initial public offering (IPO) have been agreed on but before it has been announced to the public. During this time, the SEC requires companies to issue a prospectus and registration statement. Companies can engage in “road shows” where they meet with institutional investors to gauge interest in the offering. They cannot, however, presell shares or engage in any action that may be viewed as contractually obligating the sale of the security.
The SEC has broad powers of enforcement of the quiet period. High-ranking officers of a company are not the only ones subject to this regulation. Members of the board of directors all the way down to rank-and-file employees may commit violations that constitute a breach of the quiet period. One of the most common penalties for violating the quiet period is a delay in the date for the IPO.
Over the years, the Securities Act has been amended in an effort to recognize the need for a company to continue to conduct regular business including issuing regular financial statements during the quiet period.