This article appeared on the Society for Corporate Governance's website on November 10. Members can access it here.
On November 2, the Securities and Exchange Commission (SEC) adopted amendments to the exempt offering framework. These amendments are designed to benefit small and midsize companies looking to raise capital by increasing the amount of money companies can raise and clarifying and streamlining compliance requirements.
“For many small and medium-sized business, our exempt offering framework is the only viable channel for raising capital,” SEC Chairman Jay Clayton said in a press release. “These businesses and their prospective investors must navigate a system of multiple exemptions and safe harbors, each with different requirements. While each component in this patchwork system makes some sense in isolation, collectively, there is substantial room for improvement.”
Specifically, the amendments are designed to:
- Address the ability to move between exemptions.
- Provide more certainty through clear and consistent rules on certain offering communications.
- Increase offering limits and revise certain investment limits.
- Harmonize bad actor disqualification provisions and certain eligibility and disclosure requirements.
The following highlights the exempt offering framework amendments:
Simplifying the Integration Framework
As the number of offering exemptions has evolved over time, the offerings integration framework for registered and exempt offerings has become increasingly complex. To modernize and simplify this framework, the SEC established a general principle of integration, which analyzes the facts and circumstances of each offering, contemplating whether such offering complies with Securities Act registration requirements or an exemption from registration. A simplified integration framework can help to reduce perceived risks as a company contemplates capital raising options.
To further simplify the integration analysis and framework, four non-exclusive safe harbors from integration are available such that no further analysis would be necessary if an offer and sale meet the conditions of a safe harbor. Additionally, the SEC adopted two provisions – “Application of the General Principle to an exempt offering prohibiting general solicitation” and “Application of the General Principle to concurrent exempt offerings that each allow general solicitation” – to provide guidance for the analysis under the general principle of integration. These provisions apply the general integration principle to the two particular fact patterns if the safe harbors from integration are inapplicable.
Please see the chart taken from the text of the SEC’s final rule at the end of this alert for an overview of the general integration principle and safe harbors. It is important to remember, however, that these amendments to the integration framework are not available for a transaction or any series of transactions that are part of a scheme to avoid Securities Act registration requirements even if such transactions are in technical compliance with the rule.
Greater Flexibility to Test the Waters
“Demo days” and similar events occur when a company is invited by a group or entity to present its business to potential investors for the purpose of securing an investment. To keep a company from violating general solicitation rules, the amendments require a “demo day” or similar event to have one or more companies participate and may be sponsored by:
- A college or university.
- A state or local government unit.
- A nonprofit.
- An accelerator, angel investor group, or incubator.
The amendments also prohibit a sponsor from making investment recommendations or providing investment advice to attendees, engaging in investment negotiations between the company and investors, charging attendees fees except reasonable administrative fees, receiving any compensation for making introductions or investment negotiations, or receiving compensation from the event that would require it to register as a broker, dealer or investment advisor. Any event advertising may not reference a specific offering of securities.
The amendments take an incremental approach to easing restrictions on virtual “demo days” due to concerns of non-accredited investors receiving broad offering-related communications. Online participation in a virtual “demo day” is limited to:
- Members of, or individuals otherwise associated with, the sponsor organization.
- Individuals that are reasonably believed by the sponsor to be accredited investors.
- Individuals invited by the sponsor to the event based on investment or industry experience reasonably selected in good faith and disclosed in the public event communications.
In contrast, in person “demo days” are limited only by the event space’s capacity and other similar administration considerations with respect to the number of investors attending. During either a virtual or in-person “demo day,” a company may only provide the following information regarding the offering of securities:
- Notification of the offering or planning to offer securities.
- Amount and type of securities being offered.
- Intended use of the proceeds.
- Unsubscribed amount.
Additionally, the amendments provide for a general solicitation of interest exemption that would allow a company or any person authorized to act on its behalf to communicate orally or in writing (with required legends on any materials) to gauge interest in a contemplated exempt offering. Once a company has determined to move forward with an exempt offering after the general solicitation of interest, it would need to comply with the rules for that specific exemption.
Further, the amendments permit a company to also “test-the-waters” under Regulation Crowdfunding prior to filing a Form C with the SEC, and offering communications with prospective investors would be permitted once the Form C is filed, so long as the company complies with Regulation Crowdfunding terms, including Rule 204 restrictions on advertising.
Increasing Offering Limits and Revising Certain Investment Limits
The amendments change the offering and investment limits for Regulation A, Regulation Crowdfunding and Rule 504 of Regulation D as follows:
- Regulation A:
- Raise the offering limit under Tier 2 from $50 million to $75 million.
- Raise the offering limit for secondary sales under Tier 2 from $15 million to $22.5 million.
- Regulation Crowdfunding:
- Raise the offering limit from $1.07 million to $5 million.
- Amend the investment limits for accredited and non-accredited investors as follows:
- For accredited investors, remove investment limits, and
- For non-accredited investors, establish limits based upon the greater of a non-accredited investor’s annual income or net worth.
- For 18 months, extend the current temporary relief for an exemption from certain Regulation Crowdfunding financial statement review requirements for companies offering $250,000 or less of securities relying on the exemption within a 12-month period.
- Rule 504 of Regulation D
- Raise the offering limit from $5 million to $10 million.
Accredited Investor Verification
Rule 506(c) of Regulation D requires a company to take reasonable steps to verify that purchasers are accredited investors. The amendments allow a company that previously took reasonable steps to verify that a purchaser was an accredited investor to establish that the purchaser remains an accredited investor at the time of a subsequent sale if a written representation to that effect is given by the purchaser and the company is unaware of any contrary information, all within a five year period.
Harmonizing Disclosure Requirements
The amendments also make the following changes to harmonize disclosure requirements for exempt offerings:
- Revising the financial information requirements provided by Rule 506(b) of Regulation D, so that the financial information non-reporting companies must provide to non-accredited investors aligns with the information required to be provided in Regulation A offerings.
- Simplifying Regulation A by aligning it with registered offering regarding:
- Redaction in material contracts of confidential information.
- Draft offering statements being made public on EDGAR.
- Incorporate by reference previously filed financial statements on Form 1-A.
- Declaration of a post-qualification amendment as abandoned.
- Amending Regulation Crowdfunding to allow certain special purpose vehicles to be used to facilitate investing under this exemption.
- Amending Regulation A to exclude companies delinquent in their Exchange Act reporting obligations from relying on this exemption.
- Aligning the bad actor look-back period requirements in Regulation A, Regulation Crowdfunding and Regulation D.
Effective Date for the Final Rule
The amendments take effect 60 days after publication in the Federal Register. The extension of the temporary Regulation Crowdfunding provisions, however, take effect upon publication in the Federal Register.
For more information, please contact us or your regular Parker Poe contact.
The following tables have been taken directly from the SEC’s final rule:
Table 2(a): Overview of the General Integration Principle in New Rule 152
Integration Principle in New Rule 152(a)
General Integration Principle
If the safe harbors in Rule 152(b) do not apply, in determining whether two or more offerings are to be treated as one for the purpose of registration or qualifying for an exemption from registration under the Securities Act, offers and sales will 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.
Application of the General Principle to an exempt offering prohibiting general solicitation
17 CFR 230.152(a)(1) (“Rule 152(a)(1)”)
The issuer must have a reasonable belief, based on the facts and circumstances, with respect to each purchaser in the exempt offering prohibiting general solicitation, that the issuer (or any person acting on the issuer’s behalf) either:
(i) Did not solicit such purchaser through the use of general solicitation; or
(ii) Established a substantive relationship with such purchaser prior to the commencement of the exempt offering prohibiting general solicitation.
Application of the General Principle to concurrent exempt offerings that each allow general solicitation
17 CFR 230.152(a)(2) (“Rule 152(a)(2)”)
In addition to satisfying the requirements of the particular exemption relied on, general solicitation offering materials for one offering that include information about the material terms of a concurrent offering under another exemption may constitute an offer of the securities in such other offering, and therefore the offer must comply with all the requirements for, and restrictions on, offers under the exemption being relied on for such other offering, including any legend requirements and communications restrictions.
Table 2(b): Overview of the Integration Safe Harbors in New Rule 152
Non-Exclusive Integration Safe Harbors in new Rule 152(b)
Safe Harbor 1
17 CFR 230.152(b)(1) (“Rule 152(b)(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, will not be integrated with such other offering; provided that, for an exempt offering for which general solicitation is not permitted that follows by 30 calendar days or more an offering that allows general solicitation, the provisions of Rule 152(a)(1) shall apply.
Safe Harbor 2
17 CFR 230.152(b)(2) (“Rule 152(b)(2)”)
Offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or in compliance with 17 CFR 230.901 through 230.905 (“Regulation S”) will not be
integrated with other offerings.
Safe Harbor 3
17 CFR 230.152(b)(1) (“Rule 152(b)(3)”)
An offering for which a Securities Act registration statement has been filed will not be integrated if it is made subsequent to: (i) a terminated or completed offering for which general solicitation is not permitted; (ii) a terminated or completed offering for which general solicitation is permitted that was made only to qualified institutional buyers (“QIBs”) and institutional accredited investors (“IAIs”); or (iii) 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.
See 17 CFR 230.144(a)(1) for the definition of “qualified institutional buyer,” and 17 CFR 230.501(a)(1), (2), (3), (7), (8), (9), (12), and (13) for a list of entities that are considered “institutional accredited investors.”
Safe Harbor 4
17 CFR 230.152(b)(1) (“Rule 152(b)(4)”)
Offers and sales made in reliance on an exemption for which general solicitation is permitted will not be integrated if made subsequent to any terminated or completed offering.