On March 4, 2020, the Securities and Exchange Commission (“SEC”) issued Release No. 33-10763, “Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets” (the “Release”), in which the SEC proposed amendments (the “Proposals”) to several SEC rules providing exemptions from the registration requirements of the Securities Act of 1933, as amended (“Securities Act”). The Proposals are intended to increase the utilization of infrequently relied upon private offering exemptions under the Securities Act and to harmonize various private offering exemptions and related SEC rules.
Background. Countless companies and investment funds raise capital in reliance on one or more of the exemptions from the registration requirements of the Securities Act. Private placements and other exempt offerings comprise more than a majority of the capital raised in the United States. According to the SEC, in 2019 approximately $2.7 trillion of capital (69.2 percent) was raised through exempt offerings in contrast to registered offerings that accounted for $1.2 trillion (30.8 percent) of capital raised. Of the approximately $2.7 trillion raised in exempt offerings, approximately 55 percent was raised in reliance on Rule 506(b) of Regulation D, with a much smaller fraction raised under Rule 506(c) of Regulation D, Regulation A or under Regulation Crowdfunding (“Regulation CF”).
Overview of the Proposals. The Proposals are intended to meet evolving market needs by increasing the efficiency of the capital raising process by raising the ceiling on the amount of funds that could be raised in three infrequently used exemptions under the Securities Act: Regulation A, Regulation CF and Rule 504 of Regulation D. The Proposals also seek to afford greater clarity around the SEC’s integration doctrine that can pose challenges for companies with ongoing or recurring financing needs. Finally, the Proposals would harmonize certain rules common to many types of exempt offerings, with the intent to potentially make it easier for companies to avoid compliance pitfalls in their private capital raising initiatives. Certain of the amendments proposed in the Release are outlined below.
Offering and Investment Limits. The Proposals would 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; and (ii) for secondary sales under Tier 2 of Regulation A from $15 million to $22.5 million.
- 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 a twelve-month period from $5.0 million to $10.0 million.
Integration Framework. The SEC’s “integration” doctrine analyzes whether two or more purportedly exempt offerings 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 required to be registered under the Securities Act. Historically, the SEC has used a so-called “five factor test” to analyze whether two private financing transactions should be integrated. Because the five factor test is heavily dependent on the particular facts and circumstances at issue, it has been subject to interpretive challenges for securities lawyers and their clients with ongoing capital needs.
The Proposals would establish a new Rule 152 of the Securities Act that would replace current Rules 152 and 155 to facilitate assessment of whether two or more securities offerings should be deemed integrated. New Rule 152 would replace the five factor test with four new specific safe harbors:
- Safe Harbor No. 1 (30-Day Safe Harbor): Any offering made more than 30 calendar days before the commencement of another offering, or more than 30 calendar days after the termination or completion 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 (i) not solicited by means of general solicitation; or (ii) identified from an established substantive relationship prior to the commencement of the offering for which general solicitation is not permitted. The SEC states in the Release that waiting less than 30 days between offerings would not necessarily result in integration of two offerings, but instead would require an analysis of the facts and circumstances surrounding the offerings at issue.
- Safe Harbor No. 2 (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 “offshore” in compliance with Regulation S, would not be integrated with other offerings.
- Safe Harbor No. 3 (Subsequent Registered Offerings): New Rule 152(b)(3) would provide a safe harbor for certain types of private offerings made prior to the commencement of an offering for which a Securities Act registration statement is filed. Neither a private offering for which general solicitation is not permitted, nor certain private offerings for which general solicitation is permitted – such as a Rule 506(c) offering that was terminated or completed more than 30 calendar days prior to the commencement of the registered offering – will be integrated with the subsequent registered offering.
- Safe Harbor No. 4 (Private Offerings Preceding Exempt Offerings Utilizing General Solicitation): An offering made in reliance on an offering exemption that permits general solicitation would not be integrated if made after any prior terminated or completed offering. The Proposals indicate that this safe harbor would apply to offerings conducted under Rule 506(c) made subsequent to the completion or termination of an offering conducted under Rule 506(b).
Rule 152, as amended, is intended to provide clarity on when a given offering is deemed “terminated or completed.” For example, offerings under Regulation D would be considered “terminated or completed” on the later of the date: (i) the issuer entered into a binding commitment to sell securities under the offering (subject only to conditions outside of the investor’s control); or (ii) the issuer and its agents ceased efforts to make further offers to sell the issuer’s securities.
General Solicitation and Offering Communications. The Proposals would expand the scope of permissible communications of issuers in private offerings.
- “Test-the-Waters” and “Demo Day” Communications. The Proposals would:
- Allow issuers 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 Regulation A offerings;
- Deem certain “demo day” communications (including those by or with an angel investor group, incubator or accelerator) not to constitute general solicitation or general advertising;
- Permit issuers utilizing Regulation CF to test-the-waters with all potential investors, provided that certain legends are included in the testing-the-waters materials. In addition, under proposed amendments to Rule 204, oral communications with prospective investors would be permitted once the Form C is filed; and
- Allow an issuer to use generic solicitation of interest materials to “test-the-waters” for an exempt offering before determining on which offering exemption it will rely.
- Solicitation of Interests Under Proposed Rule 241. Through proposed Rule 241, issuers could solicit indications of interest in an exempt offering orally or in writing before determining on which offering exemption to rely.
Rule 506(c) Accredited Investor Verification. The Proposals would allow an issuer to establish that an investor, whom the issuer previously had taken reasonable steps to verify as an accredited investor, remains an accredited investor as of the time of a subsequent sale if that investor provides a written representation to that effect and the issuer is not aware of information to the contrary. In the Release the SEC stated that “in some circumstances, the reasonable steps determination may not be substantially different from an issuer’s development of a ‘reasonable belief’ for Rule 506(b) purposes.” This language suggests that “reasonable steps” for Rule 506(c) offerings may require no more than the “reasonable belief” standard – in a footnote in the Release states that reasonable steps require more than just having an investor to check a box or sign a form to satisfy the verification requirement.
Harmonize Financial Disclosure Requirements. The Proposals would change the financial information required to be provided to non-accredited investors in Rule 506(b) private placements to align with the financial information that issuers must provide to investors in Regulation A offerings. For Rule 506(b) offerings of up to $20 million, issuers be required to provide non-accredited investors with financial and other disclosures comparable to those required in Tier 1 Regulation A offerings. For offerings conducted under Rule 506(b) seeking to raise greater than $20 million and involving non-accredited investors, issuers would be required to provide audited financial statements and provide other disclosures complying with requirements similar to Tier 2 Regulation A offerings.
Harmonize Securities Eligible to be Offered Under Certain Exemptions. The Proposals would limit the types of securities that may be offered and sold in reliance on Regulation CF. Currently, Regulation CF contains no restriction on the types of securities eligible to be offered under that exemption while Regulation A permits only equity securities, debt securities, and securities convertible or exchangeable to equity interests to be offered under Regulation A. The Proposals would harmonize Regulation A and Regulation CF by restricting Regulation CF offerings to the same securities eligible to be sold under Regulation A. Additionally, the Proposals would allow special purpose vehicles to participate in offerings conducted under Regulation CF as permitted in other private offerings.
Harmonize “Bad Actor” Disqualification Provisions. The Proposals would 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 also 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 Proposals would make 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 Securities Exchange Act of 1934 filings and allowing issuers to incorporate financial statement information by reference to other documents filed on EDGAR.
Clarification of, and Proposed Amendments to, Regulation S. The SEC proposed amendments to Regulation S to codify and clarify the SEC’s position that, subject to certain requirements, an issuer conducting an exempt offering that allows general solicitation and uses widely accessible internet or similar communications, may continue to be able to rely on Regulation S for a concurrent offshore offering even though the general solicitation activity would likely be deemed “directed selling efforts” under current Rule 902(c) under Regulation S. However, because general solicitation could increase the risk of the Regulation S securities flowing back into the United States, the SEC has proposed to add new Rule 906 to Regulation S that would require the issuer to prohibit resales of the securities to U.S. persons for a period of six months from the date of sale except to “qualified institutional buyers” as defined in Rule 144A or institutional accredited investors under Rule 501.
The Proposals are subject to a 60-day public comment period following publication in the Federal Register and include more than 80 items on which to comment.