On March 4, 2020, the Securities and Exchange Commission (“SEC”) published Release No. 33-10763, “Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets” to propose amendments to its rules for exempt offerings under the Securities Act of 1933 (“Securities Act”). These proposals are premised on the SEC’s June 18, 2019 concept release that solicited public comment on possible ways to simplify, harmonize, and improve the exempt offering framework under the Securities Act, and are informed by the comments received on that release.
The SEC’s proposals address the ability of issuers to move from one exemption to another exempt or registered offering, increase offering and investment limits in the exemptions, establish consistent standards for offering communications, and harmonize disclosure and bad actor disqualification provisions across exemptions.
The SEC proposals encompass a broad range of issues relating to the structure for regulating the exempt offerings market. The proposing release contains 85 specific requests for comment, with most of the specific requests for comment asking multiple questions. Public comments regarding the proposals will be due 60 days following publication of the proposals in the Federal Register.
Broadly, the SEC intends the proposals to address the ability of issuers to move from one exemption to another exempt or registered offering, increase offering and investment limits in the exemptions, establish consistent standards for offering communications, and harmonize disclosure and bad actor disqualification provisions across exemptions.
The integration proposals would establish new Rule 152, which would replace current Rules 152 and 155. New Rule 152 would provide a general framework and four specific safe harbors and replace the various safe harbors currently set forth in the various exemptions. The integration proposals would not apply to business combination transactions.
- Proposed General Principle of Integration – For all offerings not covered by a safe harbor, offers and sales would not be integrated if, based on the particular facts and circumstances, the issuer can establish that each offering either complies with the registration requirements of the Securities Act, or that an exemption from registration is available for the particular offering. The proposed facts and circumstances analysis of integration would replace the traditional five factor test first articulated by the Commission in 1962.
- Proposed Safe Harbor 1 – 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; provided that, for an exempt offering for which general solicitation is not permitted, the purchasers either were not solicited through the use of general solicitation, or established a substantive relationship with the issuer prior to the commencement of the offering for which general solicitation is not permitted.
- Proposed Safe Harbor 2 – Offers and sales made in compliance with Rule 701 or Regulation S would not be integrated with other offerings.
- Proposed Safe Harbor 3 – A Securities Act-registered offering would not be integrated if made subsequent to:
- a terminated or completed offering for which general solicitation is not permitted;
- a terminated or completed offering for which general solicitation is permitted and made only to qualified institutional buyers and institutional accredited investors; or
- an offering for which general solicitation is permitted that terminated or completed more than 30 calendar days prior to the commencement of the registered offering.
- Proposed Safe Harbor 4 – Offers and sales made in reliance on an exemption for which general solicitation is permitted would not be integrated if made subsequent to any prior terminated or completed offering.
- Proposed Conforming Amendments to Exemptions – References to proposed Rule 152 would replace the integration provisions of Regulation D, Regulation A, Regulation Crowdfunding, and Rules 147 and 147A.
General Solicitation and Offering Communications
The proposals would address some longstanding issues presented with the meaning of “general solicitation” and its application to certain events, including “testing-the-waters” activities and “demo days.”
- “Demo Days” and Similar Events – Proposed new Rule 148, which would provide that certain “demo day” communications would not be deemed general solicitation or general advertising.
- A “demo day” would mean a seminar or meeting by a college, university, or other institution of higher education, a local government, a nonprofit organization, or an angel investor group, incubator, or accelerator. The sponsor would not be permitted to:
- make investment recommendations or provide investment advice to attendees of the event;
- engage in any investment negotiations between the issuer and investors attending the event;
- charge attendees of the event any fees, other than reasonable administrative fees;
- receive any compensation for making introductions between attendees and issuers, or for investment negotiations between the parties; or
- receive any compensation with respect to the event that would require it to register as a broker or dealer or an investment adviser.
- Advertising for the event could not reference any specific offering of securities by the issuer and the information conveyed at the event regarding the offering of securities by the issuer would be limited.
- Proposed instruction to new Rule 148 would define “angel investor group” as a group:
- of accredited investors;
- that holds regular meetings and has written processes and procedures for making investment decisions, either individually or among the membership of the group as a whole; and
- is neither associated nor affiliated with brokers, dealers, or investment advisers.
- Solicitations of Interest – The SEC proposals would allow all issuers and those authorized to act on their behalf to gauge market interest in a registered offering through discussions with qualified institutional buyers and institutional accredited investors prior to, or following, the filing of a registration statement. Proposed Rule 241 would allow an issuer to solicit indications of interest in an exempt offering orally or in writing prior to determining which exemption it would rely upon to conduct the offering.
- Proposed Rule 241(b) would require the materials used under this exemption to bear a specified legend or disclaimer.
- Proposed amendments to Rule 502(b) would provide that an issuer that sells securities under Rule 506(b) within 30 days of the generic solicitation of interest to any purchaser that is not an accredited investor would be required to provide such purchaser with any written communication used under proposed Rule 241.
- Proposed amendments would not provide for the preemption of state securities law registration and qualification requirements for offers made under proposed Rule 241.
- Regulation Crowdfunding – The SEC proposals would permit issuers to test-the-waters orally or in writing with all potential investors prior to filing a Form C with the Commission under proposed Rule 206. Proposed Rule 206 would permit issuers to test-the-waters with all potential investors, but would require issuers to include certain legends in the testing-the-waters materials. Proposed amendments to Rule 204 to conditionally permit oral communications with prospective investors are permitted once the Form C is filed.
- Regulation A – Proposed amendments to Form 1-A’s exhibit requirements would require an issuer to file the generic solicitation materials as an exhibit to the Form 1-A if the issuer conducts a generic solicitation of interest and then opts to rely on Regulation A for its offering within 30 days of the most recent generic solicitation communication.
- Regulation D – Proposed amendments to Rule 502(b)(2)(viii) would require an issuer that uses proposed Rule 241 to conduct a generic solicitation of interest and then opts to rely on Rule 506(b) within 30 days of the most recent generic solicitation communication and sells securities to any purchaser that is not an accredited investor, to provide the generic solicitation materials to such purchaser a reasonable time prior to sale.
Rule 506(c) Verification Requirements
The SEC noted that the structure of Rule 506(c)’s verification requirement, with its prominent description of several non-exclusive verification methods, may be creating uncertainty for issuers and inadvertently encouraging issuers (or those acting on their behalf) to rely only on the non-exclusive list. The proposals would add more certainty to the verification requirements.
- Principles-Based Method – The SEC reaffirmed and updated its prior guidance with respect to the principles-based method for verification, and in particular what may be considered “reasonable steps” to verify an investor’s accredited investor status.
- Non-exclusive List – The SEC proposals would add a new item to the non-exclusive list in Rule 506(c) that would allow an issuer to establish that an investor for which the issuer previously took reasonable steps to verify as an accredited investor remains an accredited investor as of the time of a subsequent sale if the investor provides a written representation to that effect and the issuer is not aware of information to the contrary.
Harmonization of Disclosure Requirements
The SEC proposals attempt to ease compliance with financial statement and non-financial statement requirements by clarifying those requirements, harmonizing Regulation A disclosure requirements and compliance with registered offerings, and updating the standard for confidential information to reflect a recent Supreme Court decision.
- Regulation D offerings of up to $20 million in securities – Issuers would no longer be required to comply with the requirements of paragraph (c) of Part F/S of Form 1-A and provide audited financial statements and would be required to comply with the requirements of paragraph (b) of part F/S of Form 1-A, which applies to Tier 1 Regulation A offerings.
- Regulation D offerings of greater than $20 million in securities – Issuers would be required to provide audited financial statements and comply with the requirements of Regulation S-X similar to Tier 2 Regulation A offerings.
- Regulation A offerings – The SEC proposals would permit issuers to:
- file certain redacted exhibits using the simplified process previously adopted for registered offerings and Securities Exchange Act of 1934 (“Exchange Act”) filings;
- make draft offering statements and related correspondence available to the public via EDGAR to comply with the requirements of Securities Act Rule 252(d), rather than requiring them to be filed as exhibits to qualified offering statements;
- incorporate financial statement information by reference to other documents filed on EDGAR; and
- have post-qualification amendments declared abandoned.
- Standard for Redacting Confidential information – In light of the Supreme Court decision in Food Marketing Institute v. Argus Leader Media, the SEC proposals would revise the standard used to allow redaction of information from certain exhibits. The proposals would remove the “competitive harm” requirement and replace it with a standard more closely aligned with the Supreme Court’s definition of “confidential.”
Offering and Investment Limits
The proposals would increase the opportunities for issuers to raise capital without registration under the Securities Act in reliance on Rule 504, Regulation A, and Regulation Crowdfunding.
- Rule 504 Offering Limit – Would raise the offering limit to $10 million in a 12-month period.
- Regulation A Tier One Offering Limit – No changes to the offering limits were proposed.
- Regulation A Tier Two Offering Limit – Would increase the maximum offering amount from $50 million to $75 million and increase the maximum offering amount for secondary sales from $15 million to $22.5 million.
- Regulation Crowdfunding Offering Limit – Would raise the offering limit from $1.07 million in a 12-month period to $5 million in a 12-month period.
- Regulation Crowdfunding Investment Limit – Would no longer apply any investment limits for accredited investors and allow non-accredited investors to determine their investment limit based on the greater of their annual income or net worth.
Regulation Crowdfunding and Regulation A Eligibility
The proposed rules would address developments in the Regulation Crowdfunding and Regulation A markets regarding the eligibility to use those exemptions. The proposals would address issues arising under the Investment Company Act of 1940 (“Investment Company Act”) that may be limiting the usefulness of Regulation Crowdfunding and limiting the availability of Regulation Crowdfunding for offerings of non-traditional securities. The proposals also would revise Regulation A to address recent changes permitting eligibility for that exemption to issuers that are subject to the on-going reporting obligations of the Exchange Act.
- Regulation Crowdfunding Issuer Eligibility – The proposed rules include a new exclusion under the Investment Company Act for limited-purpose vehicles (“crowdfunding vehicles”) that function solely as conduits to invest in businesses raising capital through the vehicle under Regulation Crowdfunding. Proposed Rule 3a‐9 under the Investment Company Act would exclude from the definition of “investment company” under that Act a crowdfunding vehicle that meets the conditions in the rule.
- Regulation Crowdfunding Eligible Securities – Currently, there is no restriction on the type of security that may be offered and sold in reliance on Regulation Crowdfunding. As proposed, the standard would be changed such that the eligible securities would be limited to equity securities, debt securities, and securities convertible or exchangeable to equity interests, including any guarantees of such securities.
- Regulation A Issuer Eligibility – The proposed rules would amend Regulation A to provide that an issuer that is required to file on-going reports under Section 13(a) or 15(d) of the Exchange Act would not be eligible to use Regulation A if the issuer does not file all the required Exchange Act reports in the two-year period preceding the filing of a Regulation A offering statement. If an issuer is delayed in filing a report, it would need to become current in its reports over the last two years in order to become eligible again.
Bad Actor Disqualification Provisions
The proposed amendments would address inconsistencies in the application of the “bad actor” disqualification provisions in Regulation D, Regulation A, and Regulation Crowdfunding. Specifically, these inconsistencies relate to the “look-back” period in each such provision.
- Regulation D – A disqualification occurs if: (1) a covered person is involved in the offering; (2) that covered person is subject to one or more of the disqualifying events in Rule 506(d); and (3) the disqualifying event occurs within the look-back period provided by the regulation. This look-back period is measured from the time of the sale of securities in the relevant offering.
- Regulation A and Regulation Crowdfunding – For Rule 262(a) of Regulation A and Rule 503(a) of Regulation Crowdfunding, the look-back period is measured from the time the issuer files an offering statement.
- Proposed Harmonization – The proposed rules would harmonize the bad actor disqualification provisions in Rule 506(d) of Regulation D, Rule 262(a) of Regulation A and Rule 503(a) of Regulation Crowdfunding noted above by adjusting the look-back requirements in Regulation A and Regulation Crowdfunding to include the time of sale in addition to the time of filing. The proposals would require an analysis at both the time of filing of the offering document and the time of the sale with respect to disqualifying bad actors from participating in an offering by adding “or such sale” to any look-back references that refer to the time of filing.
- Proposed Harmonization – In order to reflect the offering statement filing requirement before the first Regulation Crowdfunding sale and more closely track the requirement in Rule 262(a) of Regulation A, the proposed rules include “any promoter connected with the issuer in any capacity at the time of filing, any offer after filing, or such sale” in Rule 503(a).
- Application to Covered Beneficial Owners – The proposed rules would retain the current look-back period applicable to covered beneficial owners in Regulation A and Regulation Crowdfunding rather than amending it to start at the time of sale.
The SEC’s proposed amendments to the Securities Act exemptive framework are subject to a 60-day comment period.