SEC Adopts Rules to Enhance and Improve Exempt Offering Framework
On November 2, 2020, the Securities and Exchange Commission (“SEC”) adopted final rules under the Securities Act of 1933 (the “Securities Act”) expanding a number of private placement exemptions. The amendments were adopted substantially in the form proposed by the SEC in March 2020, previously summarized by Polsinelli here. The amendments are part of the SEC's on-going efforts to simplify and harmonize the exempt offering framework and, as a result, help improve access to capital for issuers and expand investment opportunities while preserving or improving important investor protections.
The new rules will become effective 60 days after publication in the Federal Register, except for the extension of the temporary Regulation Crowdfunding provisions, which will be effective upon publication in the Federal Register.
Background and Intent of Amendments
A basic premise of the Securities Act is that all offers and sales of securities made in the United States must either be registered with the SEC or be exempt from such registration. The rules for conducting exempt “private placements” have evolved over many decades as a result of SEC rulemaking and direct acts of Congress. Over time, this regulatory regime has evolved into a complex system of exemptions that SEC Chairman Jay Clayton has referenced as a “patchwork system,” which often have been difficult for issuers of securities (particularly smaller enterprises) to understand and navigate. The newly adopted amendments are intended to reduce the expense and complexity associated with private placements and broaden the use of certain exemptions, making it easier for issuers to raise capital.
Overview of Amendments
The amendments are intended to meet evolving market needs by increasing the efficiency of the private capital raising process by:
Increasing the ceiling on the amount of funds that can be raised in three less commonly used exemptions under the Securities Act: Regulation A, Regulation Crowdfunding (“Regulation CF”) and Rule 504 of Regulation D.
Providing greater clarity around the SEC’s integration doctrine that can pose challenges for companies with ongoing or recurring financing needs, and adopting four new safe harbors that, among other things, expressly permit concurrent private and public offerings.
Establishing clear and consistent rules governing certain offering related communications exemptions, including permitting certain “test-the-waters” communications and “demo day” activities.
Harmonizing certain disclosure and issuer eligibility requirements and bad actor disqualification provisions across exemptions.
Certain of the newly adopted rules and amendments are outlined below.
Offering and Investment Limits
The amendments increase the investment limits applicable to certain private offering exemptions, including:
Regulation A: Raise the maximum offering amount (i) under Tier 2 of Regulation A from $50 million to $75 million in a twelve-month period; and (ii) for secondary sales under Tier 2 of Regulation A from $15 million to $22.5 million. Additionally, of note, the SEC confirmed that securities offered in Tier 2 offerings under Regulation A are preempted from state securities law registration and qualification requirements pursuant to the exemption for “covered securities”; however, it declined to extend that exemption to securities offered in Tier 1 offerings.
Regulation CF: Increase (i) the offering limit in Regulation CF from $1.07 million to $5.0 million; and (ii) the investment limits applicable to non-accredited investors that participate in a Regulation CF offering to allow them to rely on the greater of their annual income or net worth when calculating the annual investor limits (and exclude limits for “accredited investors”).
Rule 504 of Regulation D: Increase the maximum offering amount an issuer may raise in certain small offerings conducted in reliance on federal and state law exemptions in a twelve-month period from $5.0 million to $10.0 million.
It is hoped that these higher limitations may increase issuer and investor access to these types of private placements. For example, while still not commonplace, the use of Regulation A increased exponentially when Regulation A was amended to increase its offering limit from $5 million annually to up to $50 million annually. In particular, the $1 million offering limit for Regulation CF offerings made the cost of capital extremely high and thus the exemption has been little used. A $5 million limit has the potential to greatly increase the utility or Regulation CF, particularly for early stage projects relying on innovative technology.
General Principles: The SEC’s “integration” doctrine analyzes whether two or more purportedly exempt offerings conducted within any six month period properly may be viewed as separate and distinct, or whether they should be, or should have been, properly viewed as part of a single integrated financing potentially required to be registered under the Securities Act. Historically, the SEC has used a so-called “five factor test” to analyze whether two purportedly exempt offerings should be integrated. Additionally, over the years the SEC has issued interpretative guidance on integration principles in a variety of formats. Because the practical application of the five factor test and other integration principles has required detailed knowledge of the SEC’s guidance and analyses of the facts and circumstances underlying each potential offering, the integration doctrine has posed challenges for issuers with frequent capital needs.
To simplify this process, the SEC adopted new Rule 152 to make it easier to pursue exempt offerings. New Rule 152 will replace existing Rules 152 and 155; it includes four new specific, but non-exclusive safe harbors and, if none of these safe harbors is available, new Rule 152 codifies SEC guidance on integration and sets out a principles-based approach to analyzing the potential integration of two or more securities offerings.
Safe Harbors: The new non-exclusive safe harbors in Rule 152 are:
- 30-Day Safe Harbor: In a significant decrease from the current six month safe harbor, under this new safe harbor, any offering completed or terminated more than 30 calendar days before the commencement of another offering, or commenced more than 30 calendar days after the completion or termination of another offering, would not be integrated with the other offering; provided that, for an exempt offering for which general solicitation is not permitted, the purchasers either were:
not solicited by means of general solicitation; or
identified from an established substantive relationship prior to the commencement of the offering for which general solicitation is not permitted.
Rule 701; Employee Benefit Plans; and Regulation S: Offers and sales of securities made in compliance with Rule 701, pursuant to an employee benefit plan, or effected “offshore” in compliance with Regulation S, will not be integrated with other offerings. This codifies existing SEC guidance that offshore transactions conducted in accordance with Regulation S will not be integrated with registered or exempt domestic offerings.
Subsequent Registered Offerings: Under new Rule 152(b)(3) an offering for which a registration statement has been filed will not be integrated if it is made after:
a terminated or completed private offering for which general solicitation is not permitted (such as an offering under Rule 506(b));
a terminated or completed private offering for which general solicitation is permitted (i.e., a Rule 506(c) or Rule 144A offering) that was made only to qualified institutional buyers and institutional accredited investors; or
a private offering for which general solicitation is permitted (regardless of the types of investors that participated in that offering) that was terminated or completed 30 days prior to the commencement of the registered offering.
As a result, these new safe harbors permit an issuer to conduct offerings shortly before the filing of a Securities Act registration statement without concern that the two offerings would be integrated. In addition, because the safe harbors in new Rule 152 are not exclusive, exemptions based on other SEC guidance on concurrent public and private offerings may be available to an issuer.
Private Offerings Preceding Exempt Offerings Utilizing General Solicitation: An offering made in reliance on an offering exemption that permits general solicitation will not be integrated if made after any prior terminated or completed public or private offering. This safe harbor would apply to offerings conducted under Rule 506(c), Regulation A or Regulation CF made subsequent to the completion or termination of an offering conducted under Rule 506(b), Rule 506(c) or other commonly used private placement exemptions.
New Rule 152 is intended to provide clarity on when a given offering is deemed to have been commenced or “terminated or completed.” The rule contains a non-exclusive list of factors to be considered in determining the date of commencement of an offering, including: the date on which the issuer first makes a generic offer soliciting interest in a contemplated offering pursuant to “testing the waters” under new Rule 241 (discussed below); the date the issuer first makes an offer of securities in reliance on certain private placement exemptions, such as Section 4(a)(2) and Regulation D; and the earlier of the date on which: the issuer first makes an offer soliciting interest in a contemplated offering in reliance on Regulation A; or the public filing of a Form 1-A offering statement. The rule also includes a non-exclusive list of factors to be considered in determining whether an offering has been “terminated or completed”, including, for most private placements, the later of: the date the issuer entered into a binding commitment to sell the securities in the offering (subject only to conditions outside of the issuer’s control); or the date the issuer and its agents ceased efforts to make further offers to sell the securities in the offering. In addition, new Rule 152 has the effect of significantly shortening any “cooling off period” between offerings if one aspect of a private placement were violated and the issuer later resumes that private placement.
“Test-the-Waters”, “Demo Day” Communications and Offering Communications
The new rules expand the scope of permissible communications by issuers considering private offerings.
- New Rule 241 permits an issuer to use generic solicitation of interest materials to “test-the-waters” for an exempt offering before determining the offering exemption it will use. However, until the issuer determines which exemption it will use, and the offering is commenced, no money or other consideration may be solicited or accepted from investors.
In addition, under Rule 241, subject to certain limitations, an issuer may solicit indications of interest in an exempt offering orally or in writing before determining on which offering exemption to rely. New Rule 241 provides an exemption from registration only with respect to a general solicitation of interest, not for the private offering itself. Of note, generic solicitations of interest under new Rule 241 could constitute general solicitation, depending on the means of dissemination employed by the issuer and its representatives.
New Rule 206 allows an issuer using Regulation CF to “test-the-waters” before filing an offering document with the SEC, in a manner similar to “testing-the-waters” communications permitted in advance of a potential Regulation A offering.
In addition, under Regulation CF, an issuer will be permitted to communicate orally with prospective investors after a Form C has been filed with the SEC, so long as the oral communications comply with the requirements of Regulation CF, including the advertising restrictions contained in Rule 204.
New Rule 148 confirms that certain “demo day” communications will not constitute general solicitation or general advertising. “Demo days” are seminars or meetings sponsored by entities such as colleges, universities, angel investor groups (as defined in new Rule 148), incubators, or accelerators during which issuers present their business to potential investors, with the aim of securing future investment. Rule 148 imposes a number of conditions on its exemption, including that more than one issuer must participate in the event; the sponsor may not make investment recommendations, provide investment advice to attendees of the event, or receive compensation for making introductions or compensation that might require the sponsor to register as a broker; virtual participation in the event is limited; and advertising for the meeting or seminar may not reference a specific offering of securities. This new rule has the potential to remove some uncertainty for early-stage companies, particularly tech companies, for which discussing the product and discussing the offering often go hand-in-hand because they are interdependent on each other.
Other Harmonization Efforts and Improvements to Offering Exemptions
The SEC also made several other amendments to simplify and harmonize private offering exemptions, including those outlined below.
Rule 506(c) Accredited Investor Verification. The amendments expand the methods by which an issuer may verify an investor’s accredited investor status. Here, to lessen the burden on issuers when verifying that an investor is an accredited investor, the amendments 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 continues to qualify as an accredited investor at the time of the proposed offering. An issuer may only use this re-verification process if it is not aware of any information to the contrary, and may not rely on this method after five years have elapsed from the initial verification. Together with the recent addition of new classes of accredited investor, discussed by Polsinelli here, this may significantly reduce the burden in establishing accredited investor status for purposes of Rule 506(c).
Financial Disclosure Requirements. The amendments change the financial information required to be provided to non-accredited investors in Rule 506(b) private placements to align with the requirements applicable to Regulation A offerings. For Rule 506(b) offerings of up to $20 million, issuers will be required to provide non-accredited investors with financial and other disclosures comparable to those required in Tier 1 Regulation A offerings. For Rule 506(b) offerings targeting greater than $20 million in gross proceeds, issuers would be required to provide non-accredited investors with audited financial statements and other disclosures similar to those required in Tier 2 Regulation A offerings.
“Bad Actor” Disqualification Provisions. The amendments harmonize the “bad actor” disqualification rules of Regulation D, Regulation A and Regulation CF by adjusting the look-back requirements in Regulation A and Regulation CF to align with those of Regulation D and to refer to the time of sale, as opposed to only referencing the time the issuer files an offering statement.
Simplification of Regulation A Offerings. The amendments also made various amendments to SEC rules intended to simplify certain requirements for Regulation A offerings and establish greater consistency between Regulation A and registered offerings – such as enabling issuers to file certain redacted exhibits to offering documents using the simplified process previously adopted for registered offerings and Exchange Act filings and allowing issuers to incorporate financial statement information by reference to other documents filed on EDGAR.