On March 4, 2020, the U.S. Securities and Exchange Commission (the “SEC”) proposed amendments designed to simplify and harmonize the complex framework of private offering exemptions while preserving or enhancing important investor protections. These private offering exemptions allow businesses to raise capital in an offering that is not subject to the registration requirements under the Securities Act of 1933, as amended (the “Securities Act”).
Although the proposed amendments do not represent a complete overhaul of the framework for private offering exemptions, the incremental changes proposed would go a long way towards harmonizing the rules and expanding the usefulness of certain exemptions. If adopted, we expect the updated rules will help facilitate capital formation and expand investor access to increasingly important private markets.
The Securities Act requires every offer or sale of securities to either be registered with the SEC or to qualify for one of the various exemptions to registration. Entrepreneurs and private companies frequently raise capital in exempt offerings to avoid the substantial time, effort and cost associated with SEC-registered transactions. The SEC estimates that of the approximately $3.9 trillion of new capital raised in 2019, over 69% (approximately $2.7 trillion) was raised through exempt offerings. However, as outdated rules were changed and new exemptions were added over time, the exemption framework has grown into a convoluted and often confusing patchwork of rules that can be difficult for issuers and investors to understand and utilize efficiently.
The SEC notes in the proposing release that the proposals reflect a comprehensive review of this “patchwork system” of private offering exemptions and were informed by public input received in response to the SEC’s June 2019 concept release regarding the harmonization of securities offering exemptions. The SEC concept release (the “Concept Release”) can be found here, and our client alert summarizing the Concept Release can be found here.
Highlights of the Proposed Amendments
The major changes introduced by the proposed amendments generally fall within the following categories (each of which are described in more detail below):
- clarifying the ability of issuers to move from one exemption to another by revising the Securities Act’s “integration” determination framework;
- increasing the offering limits under Regulation A, Regulation Crowdfunding and Rule 504 offerings and revising certain individual investment limits;
- permitting certain “test the waters” and “demo day” communications without violating prohibitions on general solicitation; and
- harmonizing certain disclosure and eligibility requirements to reduce differences between exemptions.
The SEC proposes to revise the current “integration” determination framework—i.e., whether multiple securities transactions should be considered part of the same offering for purposes of determining whether an exemption is available. A mixture of SEC rules and formal and informal SEC staff guidance have addressed integration over the years.
The proposed changes would provide a general principle of integration that looks to the specific facts and circumstances of the offering and focuses on whether the issuer can establish that each offering either (a) complies with the Securities Act’s registration requirements or (b) qualifies for an exemption from registration.
The Commission also proposes four non-exclusive safe harbors from integration that will be generally applicable for all securities offerings:
- any offering made more than 30 calendar days before the commencement of any other offering, or more than 30 calendar days after the termination or completion of any other offering, would not be integrated with such other offering (provided that the issuer complies with applicable restrictions on general solicitation);
- offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or in compliance with Regulation S would not be integrated with other offerings;
- an offering for which a Securities Act registration statement has been filed (a “registered offering”) would not be integrated with another offering if made subsequent to: (a) a terminated or completed offering for which general solicitation is not permitted; (b) a terminated or completed offering for which general solicitation is permitted and made only to qualified institutional buyers and institutional accredited investors; or (c) an offering that terminated or completed more than 30 calendar days prior to the commencement of the registered offering; and
- offers and sales made in reliance on an exemption for which general solicitation is permitted would not be integrated with another offering if made subsequent to any prior terminated or completed offering.
Revised Offering and Investment Limits
The SEC proposes the following revisions to the current offering and investment limits for Regulation A, Regulation Crowdfunding and Rule 504 offerings:
- Regulation A
- raise the maximum offering amount from $50 million to $75 million; and
- raise the maximum offering amount for Regulation A secondary sales from $15 million to $22.5 million.
- Regulation Crowdfunding
- raise the offering limit from $1.07 million to $5 million;
- revise the investment limit calculation for non-accredited investors from the lesser of annual income or net worth to the greater of annual income or net worth; and
- remove entirely the investment limits for accredited investors.
- Rule 504 of Regulation D
- raise the maximum offering amount from $5 million to $10 million.
“Test-the-Waters” and “Demo Day” Communications
Historically, the SEC has broadly interpreted the terms “offer,” “general solicitation” and “general advertising” in the context of private offerings. Since certain exemptions from registration prohibit “general solicitation” and “general advertising” (e.g., Rule 506(b) under Regulation D), this broad interpretation can severely limit the opportunities for issuers to reach larger audiences of potential investors. In addition, since the adoption of the Jumpstart Our Business Startups Act of 2012, certain issuers have been permitted to engage in communications with potential investors that are qualified institutional buyers (QIBs) or institutional accredited investors (IAIs) before filing a registration or offering statement in order to gauge potential interest in the offering. These “testing-the-waters” meetings give issuers an opportunity to consult with potential investors before incurring the costs associated with an offering, and to incorporate feedback regarding the structuring of the offering, but are currently only available in the context of registered or Regulation A offerings. In order to address these concerns raised by commentators in response to the Concept Release, the SEC is proposing several amendments relating to offering communications, including:
- permitting issuers to use generic solicitation of interest materials to “test-the-waters” for an exempt offer of securities prior to determining which exemption it will use for the actual sale of the securities;
- permitting Regulation Crowdfunding issuers to “test-the-waters” prior to filing an offering document with the SEC in a manner similar to the process currently permitted under Regulation A; and
- providing that certain communications related to “demo days” and similar events (i.e., a seminar or meeting by a college, university, local government, nonprofit organization, angel investor group, incubator, or accelerator sponsoring the seminar or meeting during which issuers present their businesses to potential investors, with the aim of securing investment) would not be deemed general solicitation or general advertising as long as certain conditions are met, including that no advertising for the meeting references a specific offering of securities and that the sponsor of the meeting does not provide investment advice or charge fees for the event.
Miscellaneous Improvements to Specific Exemptions
To lessen the burden on issuers in connection with verifying that an investor is an accredited investor, the proposal adds a new item to Rule 506(c) of Regulation D that would allow an issuer to establish accredited investor status if (a) the issuer has previously (such as in a prior offering) taken reasonable steps to verify that an investor was an accredited investor and (b) the investor provides a written representation that the investor remains an accredited investor at the time of the proposed offering.
The proposal also includes amendments to the eligibility restrictions in Regulation Crowdfunding and Regulation A, which would permit the use of certain special purpose vehicles to facilitate investing in Regulation Crowdfunding issuers.
In an effort to harmonize Regulation Crowdfunding with Regulation A, the amendments would also limit the types of securities that may be offered and sold in reliance on Regulation Crowdfunding. Issuers would no longer be permitted to issue non-traditional securities (such as Simple Agreements for Future Equity (commonly known as SAFEs) and certain revenue sharing agreements) and would be limited to the eligible securities currently permitted under Regulation A—i.e., equity securities, debt securities, and securities convertible or exchangeable into equity securities (including any guarantees of such securities).
The proposed amendments would, among other things, also:
- change the financial information that must be provided to non-accredited investors in Regulation D Rule 506(b) private placements to align with the less-burdensome requirements for Regulation A offerings (for example, issuers would no longer be required to provide audited financial statements in a Regulation D securities offering of less than $20 million);
- simplify certain requirements for Regulation A offerings to establish greater consistency between Regulation A and registered offerings, such as allowing issuers the option of filing redacted versions of material contracts and plans of acquisition, liquidation or succession consistent with Regulation S-K; and
- harmonize the bad actor disqualification provisions in Regulation D, Regulation A and Regulation Crowdfunding by adjusting the look-back requirements in Regulation A and Regulation Crowdfunding to also refer to the time of sale (as opposed to only referencing the time the issuer files an offering statement).
Public Comment Period
The comment period for the proposed amendments will remain open for 60 days following publication in the Federal Register. To read the full 341-page proposal, please click here.
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