Don't Jump the Gun
By RiskMetrics Group on June 4, 2004 12:10 PM
It doesn't happen too often, but every year or so a company preparing to go public derails itself, at least temporarily, by getting too close to conduct known as "gun-jumping." The most recent example of this is salesforce.com, which apparently had planned to go public on May 13.
"Gun-jumping" generally refers to actions that condition the public mind or arouse public interest in an issuer or in the securities of an issuer in advance of a public offering. As I discussed in this article several years ago, gun-jumping can occur after a company has filed a registration statement and is in the waiting period between filing and effectiveness. Although oral offers may be made during this period, Section 5(b)(1) of the Securities Act requires that written offers be made through the preliminary prospectus filed with the registration statement. Thus, written "offers" that do not meet the requirements of a preliminary prospectus (or a tombstone ad pursuant to Rule 134 under the Securities Act) may be in violation of Section 5(b)(1). Notably, the SEC takes a broad view of what constitutes an "offer," and has stated that any publicity that has the effect of "conditioning the public mind or arousing public interest in the issuer or in the securities of an issuer" may be deemed part of the selling effort.
When the SEC comes across conduct such as interviews or news stories that it deems to be gun-jumping, it typically requires the company that is poised to go public to delay its IPO through a so-called "cooling-off" period. The cooling-off period theoretically allows the "aroused public interest" to dissipate, and permits the company to argue that its IPO, when it finally does occur, is "offered" only through the prospectus and not through some other written materials such as a news article.
In addition, as discussed by Broc Romanek in his blog on May 25, the SEC also commonly requires that a risk factor be included in the company's IPO prospectus regarding the potential gun-jumping violation. The reason for this risk factor is that the consequences of gun-jumping can be dramatic: Under Section 12 of the Securities Act, any person who offers or sells a security in violation of Section 5 is civilly liable to the purchaser of that security for the full amount paid for the security, plus interest. Thus, a company that violates Section 5 may have unwittingly written the equivalent of a "put" contract guaranteeing that it will buy back its securities at the price at which it sold them.
Indeed, as discussed in this article, salesforce.com delayed its IPO following certain comments by its CEO in the New York Times in the days leading up to the offering, and then added a risk factor in this amended prospectus explaining that:
If our involvement in a lengthy May 9th New York Times article about salesforce.com or any other publicity regarding salesforce.com or the offering during the waiting period were held to be "gun jumping" in violation of the Securities Act of 1933, we could be required to repurchase securities sold in this offering. You should only rely on statements made in this prospectus in determining whether to purchase our shares.
The disclosure added:
In order to reduce the risk of investors' possible reliance on the New York Times article and other news reports and articles, we stopped our offering on May 13, 2004. We then allowed a "cooling off" period to pass so that the effect of this article and other reports, articles and information would be dissipated.
It is uncertain whether our involvement in the May 9th New York Times article or any of our other publicity related activities could be held to be a violation of Section 5 of the Securities Act of 1933. If our involvement or such activities were held by a court to be in violation of the Securities Act, we could be required to repurchase the shares sold to purchasers in this offering at the original purchase price for a period of one year following the date of the violation. We would contest vigorously any claim that a violation of the Securities Act occurred.