SEC Amends Exempt Offering Framework
On November 2, 2020, the SEC adopted rule amendments intended to simplify, harmonize, and improve certain aspects of the exempt offering framework to promote capital formation while preserving or enhancing investor protections. Highlights of the amendments are described below.
The integration provisions of Regulation D, Regulation A, Regulation Crowdfunding, and Rules 147 and 147A have been replaced with new Rule 152, which includes a general principle of integration, two applications of such principle, and four non-exclusive safe harbor provisions (described below).1 The general principle applies to all offers and sales of securities not covered by one of the four safe harbors, and replaces the traditional five factor test first articulated by the SEC in 1962.2
|Non-Exclusive Integration Safe Harbors|
|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, will not be integrated with that other offering; provided that this safe harbor is not available 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, in which case the provisions of Rule 152(a)(1) (described below) apply.|
|Safe Harbor 2||Offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or in compliance with Regulation S will not be integrated with other offerings.3|
|Safe Harbor 3||An offering for which a Securities Act registration statement has been filed will not be integrated with: (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.|
|Safe Harbor 4||Offers and sales made in reliance on an exemption for which general solicitation is permitted would not be integrated with any prior terminated or completed offering.
|General Principle of Integration
||If the safe harbors 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 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.|
|Application of the General Principle to an exempt offering prohibiting general solicitation (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.4|
|Application of the General Principle to concurrent exempt offerings that each allow general solicitation (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.|
- Where an issuer conducts more than one offering under Rule 506(b), the number of non-accredited investors purchasing in all such offerings within 90 calendar days of each other is limited to 35.
- The final rules include a list of factors to consider in determining when an offering is deemed to be commenced, terminated or completed for purposes of Rule 152.
General Solicitation and Offering Communications
"Demo days" and similar events are generally organized by a group or entity that invites issuers to present their businesses to potential investors, with the aim of securing investment. New Rule 148 provides that an issuer would not be deemed to have engaged in general solicitation based on communications it makes in connection with such an event if the event is sponsored by a college, university, or other institution of higher education, a state or local government or instrumentality of a state or local government, a nonprofit organization, or an angel investor group (with defined processes and procedures for making investment decisions), incubator, or accelerator sponsoring the seminar or meeting. More than one issuer must participate in the seminar or meeting for the new rule to apply.
Under Rule 148, the sponsor would not be permitted to: (i) make investment recommendations or provide investment advice to event attendees; (ii) engage in any investment negotiations between the issuer and investor attendees; (iii) charge event attendees any fees, other than reasonable administrative fees; (iv) receive any compensation for making introductions between attendees and issuers, or for investment negotiations between the parties; or (v) receive any compensation with respect to the event that would require it to register as broker or dealer under the Exchange Act, or as an investment adviser under the Advisers Act.
In addition, online participation in the event is limited to: (a) individuals who are members of, or otherwise associated with the sponsor organization (for example, members of an angel investor group or students, faculty, or alumni of a college or university); (b) individuals that the sponsor reasonably believes are accredited investors; or (c) individuals who have been invited to the event by the sponsor based on satisfying industry or investment-related experience requirements reasonably selected by the sponsor in good faith and disclosed in the public communications about the event.
Advertising for the event may 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 is limited to: (i) notification that the issuer is in the process of offering or planning to offer securities; (ii) the type and amount of securities being offered; (iii) the intended use of the proceeds of the offering; and (iv) the unsubscribed amount in an offering.
Solicitations of Interest
Generic Solicitation of Interest Exemption
New Rule 241 permits an issuer to use generic solicitation of interest materials for an offer of securities prior to a making a determination as to the exemption under which the offering may be conducted. An issuer that chooses to "test-the-waters" under this exemption may not identify which specific exemption from registration it will rely upon for a subsequent offer and sale of the securities. The rule provides an exemption from registration only with respect to the generic solicitation of interest, and the solicitation will be deemed to be an offer of a security for sale for purposes of the antifraud provisions of the Federal securities laws. The SEC declined to preempt State blue sky laws for these offers.
Materials used under this exemption must state that: (i) the issuer is considering an offering of securities exempt from registration under the Securities Act, but has not determined a specific exemption from registration the issuer intends to rely upon for the subsequent offer and sale of the securities; (ii) no money or other consideration is being solicited, and if sent, will not be accepted; (iii) no offer to buy the securities can be accepted and no part of the purchase price can be received until the issuer determines the exemption under which the offering is intended to be conducted and, where applicable, the filing, disclosure, or qualification requirements of such exemption are met; and (iv) a person's indication of interest involves no obligation or commitment of any kind. Note that depending on the method of dissemination of the information, such offers may be considered a general solicitation.5
The generic solicitation materials must be (x) made publicly available as an exhibit to the filed offering materials if a Regulation A or Regulation Crowdfunding offering is commenced within 30 days of the generic solicitation and (y) provided to any purchaser that is not an accredited investor that purchases securities under Rule 506(b) within 30 days of the generic solicitation of interest.
Under new Rule 206, Regulation Crowdfunding issuers may now test-the-waters orally or in writing prior to filing a Form C. Test-the-waters materials (which must include specified legends) would be considered offers that are subject to the antifraud provisions of the Federal securities laws. Any Rule 206 solicitation materials must be included as an exhibit to the filed Form C. Once the Form C is filed, any offering communications would be required to comply with the terms of Regulation Crowdfunding, including advertising restrictions.
Other Regulation Crowdfunding Offering Communications
Under Rule 204 of Regulation Crowdfunding, an issuer may not advertise the terms of a Regulation Crowdfunding offering outside of the intermediary's platform except in a notice that directs investors to the intermediary's platform and includes no more than certain specified information. However, an issuer may communicate with investors and potential investors about the terms of the offering through communication channels provided on the intermediary's platform. Rule 204 has been amended to clarify that oral communications with prospective investors are permitted once the Form C is filed, so long as the communications comply with the requirements of the rule. In addition, the information that an issuer may provide in accordance with Rule 204 has been expanded to include: (i) a brief description of the planned use of proceeds of the offering; and (ii) information on the issuer's progress toward meeting its funding goals. Further, an issuer may provide information about the terms of a Regulation Crowdfunding offering in the offering materials for a concurrent offering (i.e., under Regulation A offering or a Securities Act registration statement) without violating Rule 204. However, the information provided about the Regulation Crowdfunding offering must be in compliance with Rule 204, including the requirement to include a link directing the potential investor to the intermediary's platform (which may not be an active hyperlink).
Rule 506(c) Verification Requirements
Rule 506(c) permits issuers to generally solicit and advertise an offering, provided that: (i) all purchasers in the offering are accredited investors, (ii) the issuer takes reasonable steps to verify that purchasers are accredited investors, and (iii) certain other conditions are satisfied.
Rule 506(c) provides a principles-based method for verification of accredited investor status as well as a non-exclusive list of verification methods. The principles-based method of verification requires an objective determination by the issuer (or those acting on its behalf) as to whether the steps taken are "reasonable" in the context of the particular facts and circumstances of each purchaser and transaction. A new item has been added 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. Such a representation will satisfy the issuer's obligation to verify the person's accredited investor status for a period of five years from the date the person was previously verified as an accredited investor.
An issuer's receipt of a representation from an investor as to his or her accredited status could meet the "reasonable steps" requirement if the issuer reasonably takes into consideration a prior substantive relationship with the investor or other facts that make apparent the accredited status of the investor. That same representation from an investor may not meet the "reasonable steps" requirement if the issuer has no other information available to it about the investor or has information that does not support the view that the investor was an accredited investor.
Harmonization of Disclosure Requirements
502(b) of Regulation D
The financial statement information requirements in Regulation D have been amended to align with the disclosure requirements in Regulation A. Specifically, for Regulation D offerings of up to $20 million in securities, the requirement for audited financial statements has been replaced with the financial statement requirements applicable to Tier 1 Regulation A offerings. For Regulation D offerings of greater than $20 million in securities, issuers are required to provide audited financial statements and comply with the requirements of Regulation S-X similar to Tier 2 Regulation A offerings.
Compliance with Regulation A
Regulation A has been simplified by aligning it with the rules for registered offerings regarding the redaction of confidential information in material contracts, permitting draft offering statements to be made public on EDGAR, permitting incorporation by reference of previously-filed financial statements on Form 1-A, and permitting the declaration of post-qualification amendment as abandoned.
Confidential Information Standard
Currently, registrants may redact provisions or terms of exhibits required to be filed if those provisions or terms are both (i) not material and (ii) would likely cause competitive harm to the registrant if publicly disclosed. The "competitive harm" requirement was based on the standard then being used by the US Circuit Court of Appeals for the District of Columbia to define what information was exempt from disclosure under Exemption 4 of the Freedom of Information Act. In June 2019, the Supreme Court rejected that test and adopted a new standard that does not include a competitive harm requirement. To conform to this new standard, information may be redacted from material contracts in specified forms if it is the type of information that the issuer both customarily and actually treats as private and confidential, and which is also not material.6
Offering and Investment Limits
The offering and investment limits established under Regulation A, Regulation Crowdfunding, and Rule 504 of Regulation D have been amended as follows:
|Offering Limits||Investment Limits|
|Current Rules||Final Rules||Current Rules||Final Rules|
|Regulation A: Tier 1||$20 million||$20 million||None||None|
|Regulation A: Tier 27||$50 million||$75 million||Accredited investors: no limits
Non-Accredited Investors: limits based on the greater of annual income or net worth standard
|Accredited investors: no limits
Non-Accredited Investors: limits based on the greater of annual income or net worth standard
|Regulation Crowdfunding||$1.07 million||$5 million||All investors: limits based on the lesser of annual income or net worth standard||Accredited investors: no limits
Non-Accredited Investors: limits based on the greater of annual income or net worth standard
|Rule 504 of Regulation D||$5 million||$10 million||None||None|
Temporary final rules under Regulation Crowdfunding previously adopted in response to COVID-19, providing an exemption from May 4, 2020 through February 28, 2021 from certain financial statement review requirements (and specified disclosure requirements) for issuers offering more than $107,000 but less than $250,000 of securities in reliance on Regulation Crowdfunding within a 12-month period have been extended to offerings by eligible issuers initiated under Regulation Crowdfunding between March 1, 2021 and August 28, 2022 (COVID Financial Statement Relief). This temporary relief only applies if reviewed or audited financial statements are not otherwise available.
Regulation Crowdfunding and Regulation A Eligibility
New Rule 3a-9 under the Investment Company Act excludes from the definition of "investment company" under that Act a crowdfunding vehicle that meets certain conditions designed to require that it function as a conduit for investors to invest in a business that seeks to raise capital through a crowdfunding vehicle. The crowdfunding vehicle would be a co-issuer formed by or on behalf of the underlying crowdfunding issuer to serve merely as a conduit for investors to invest in the crowdfunding issuer and will not have a separate business purpose. A crowdfunding vehicle and persons operating the vehicle will not implicate the broker-dealer registration requirements of Section 15(a) of the Exchange Act so long as they limit their activities solely to those permitted by the rule. The crowdfunding issuer and crowdfunding vehicle will jointly file a Form C. In addition, new Rule 12g5-1(a)(9) specifies that, for purposes of determining whether a crowdfunding issuer is required to register a class of equity securities pursuant to Section 12(g)(1) of the Exchange Act, a crowdfunding issuer may exclude securities issued by a crowdfunding vehicle in accordance with Rule 3a-9 that are held by natural persons, but must include securities issued by a crowdfunding vehicle that are held by investors that are not natural persons. The same provision applies to a crowdfunding vehicle.
Regulation A has been amended to harmonize its eligibility restrictions by excluding Exchange Act registrants that are delinquent in their Exchange Act reporting obligations from relying on the exemption.
Bad Actor Disqualification Provisions
The exempt offering framework includes rules disqualifying certain covered persons, including felons and other "bad actors" from relying on Regulation A, Regulation Crowdfunding, and Regulation D to offer and sell securities. Under 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. For Regulation D, the look-back period is measured from the time of the sale of securities in the relevant offering. 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. To harmonize the bad actor disqualification provisions, the lookback provisions in Regulation A and Regulation Crowdfunding have been adjusted to include the time of sale in addition to the time of filing.
Additionally, Rule 503(a) of Regulation Crowdfunding now applies to "any promoter connected with the issuer in any capacity at the time of filing, any offer after filing, or such sale." Previously, this rule only covered promoters connected with the issuer in any capacity "at the time of such sale," making it possible that a promoter that previously engaged in fraudulent activities or violated securities or other laws or regulations, could be involved in offering activities under Regulation Crowdfunding so long as such promoter is not connected with the issuer in any capacity at the time of sale.
The final rules are effective 60 days after publication in the Federal Register, except for the COVID Financial Statement Relief provisions, which will become effective upon publication in the Federal Register (or March 1, 2021 if earlier) and will expire on March 1, 2023.
© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
Rule 152 contains a typical anti-avoidance provision to the effect that it does not prevent integration for any transaction or series of transactions that, although in technical compliance with the rule, is part of a plan or scheme to evade the registration requirements of the Securities Act.
The SEC previously identified the following five factors to consider in determining whether offerings should be integrated: (1) whether the different offerings are part of a single plan of financing; (2) whether the offerings involve issuance of the same class of security; (3) whether the offerings are made at or about the same time; (4) whether the same type of consideration is to be received; and (5) whether the offerings are made for the same general purpose.
In the adopting release, the SEC expressed the view that it does not believe that general solicitation activity for exempt domestic offerings would preclude reliance on Regulation S for concurrent offshore offerings, and reaffirmed existing guidance with respect to concurrent Regulation S and domestic offerings.
Investors with whom the issuer has a pre-existing substantive relationship may include the issuer’s existing or prior investors, investors in prior deals of the issuer’s management, or friends or family of the issuer’s control persons. Similarly, such investors may also include customers of a registered broker-dealer or investment adviser with whom the broker-dealer or investment adviser established a substantive relationship prior to the participation in the exempt offering by the broker-dealer or investment adviser.
If soliciting generic indications of interest is done in a manner that would constitute general solicitation, and the issuer ultimately decides to conduct an unregistered offering under an exemption that does not permit general solicitation, the issuer would need to analyze whether the generally solicited offer and the subsequent private offering could be integrated, thereby making the exemption that does not permit general solicitation unavailable. Under the new integration rules, an issuer will not be able to follow a generic solicitation of interest that constituted a general solicitation with an offering pursuant to an exemption that does not permit general solicitation, such as Rule 506(b), unless the issuer has a reasonable belief, based on the facts and circumstances, with respect to each purchaser in the exempt offering, that the issuer (or any person acting on the issuer’s behalf) either did not solicit such purchaser through the use of general solicitation or established a substantive relationship with such purchaser prior to the commencement of the exempt offering.