Last month the Securities and Exchange Commission (the “SEC”) proposed a number of amendments to the existing rules governing exempt offerings. These amendments aim to simplify the current exemption framework, in order to improve access to capital and investment opportunities.
1. Regulation D
The proposed rules make several changes to the Regulation D exemption in an attempt to expand its availability.
A. Rule 504. The proposed rules raise the maximum offering amount exempt from registration under Rule 504, during any 12-month period, from $5 million to $10 million.
B. Rule 502(b) Disclosures.
The proposed rules amend the financial information requirements under Rule 502(b) for Regulation D offerings so that they align more closely to the disclosure requirements of Regulation A. The SEC hopes that, by aligning the disclosure requirements of Regulation D with those in Regulation A, issuers may be willing to include non-accredited investors in their offerings, which will expand investment opportunities for those investors. Additionally, the SEC believes such an alignment will establish greater uniformity in the financial statement requirements applicable to exempt offerings, permitting issuers to more readily prepare for a variety of exempt offerings at once.
2. Regulation Crowdfunding
In an attempt to better meet the needs of issuers and investors, the proposed rules also make several changes to the Regulation Crowdfunding exemption.
A. Maximum Offering Amount. The SEC suggests raising the maximum offering amount exempt from registration for certain crowdfunding transactions, during any 12-month period from $1.07 million to $5 million. Additionally, the SEC has proposed to reduce the Regulation Crowdfunding investor limitations by (1) doing away with the cap on accredited investors, and (2) amending the calculation method for the non-accredited investor investment limit so they can rely on the greater of their annual income or net worth.
B. Clarifications on Special Purpose Vehicles. The SEC has proposed to amend the Regulation Crowdfunding exemption to permit the use special purpose vehicles to facilitate investing in issuers relying on the Regulation Crowdfunding exemption. Under the current framework, Section 4A(f)(3) of the Securities Act prohibits investment companies from using the Regulation Crowdfunding exemption. As a result, issuers cannot use special purpose vehicles to facilitate investment, and investors purchasing securities in a Regulation Crowdfunding offering must hold the securities in his or her own name. This has created to a number of practical concerns, which has caused issuers to refrain from using the Regulation Crowdfunding exemption (i.e., managing the potentially large number of direct investors resulting from a crowdfunding offering).
The proposed rule would exclude 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 investing in a business. Specifically, these conditions require that the crowdfunding vehicle:
- Be organized and operated for the sole purpose of acquiring, holding, and disposing of securities issued by a single crowdfunding issuer and raising capital in one or more offerings made in compliance with Regulation Crowdfunding.
- Be prohibited from borrowing money and be required to use the proceeds of the securities it sells solely to purchase a single class of securities of a single crowdfunding issuer.
- Be permitted to issue only one class of securities in one or more offerings under Regulation Crowdfunding in which the crowdfunding vehicle and the crowdfunding issuer are deemed to be co-issuers under the Securities Act.
- Be required to obtain a written undertaking from the crowdfunding issuer to fund or reimburse the expenses associated with the crowdfunding vehicle’s formation, operation, or winding up, and the crowdfunding vehicle would not be permitted to receive other compensation.
- Be prohibited from paying any compensation paid to any person operating the crowdfunding vehicle, and any compensation paid to the person operating the crowdfunding vehicle must be paid solely by the crowdfunding issuer.
- Provide investors in the crowdfunding vehicle with the same economic exposure, voting power, legal rights and Regulation Crowdfunding disclosures as if the investors had invested directly in the crowdfunding issuer.
C. Types of Eligible Securities. The SEC has proposed to limit the types of securities that may be offered and sold in reliance on Regulation Crowdfunding. This amendment seeks to harmonize the rules for Regulation Crowdfunding with those for Regulation A offerings. Thus, the types of securities eligible for sale in an offering under Regulation Crowdfunding would be limited to equity securities, debt securities, and securities convertible or exchangeable to equity interests, including any guarantees of such securities.
3. Clarification of the Integration Rules.
Integration describes the situation when the SEC determines that multiple security offerings should be treated as a single offering. This can be problematic for an issuer if it was relying on different registration exemptions for each offering. Therefore, it has been paramount for issuers to understand when and why the SEC chooses to integrate offerings.
Historically, the SEC has utilized a number of different tests for analyzing whether a series of offerings should be integrated. This has caused a great deal of uncertainty and confusion among issuers. The proposed rules seek to simplify and clarify the integration rules by (i) codifying general guiding principles of integration, and (ii) enacting four safe harbors under which multiple offerings will, by law, be considered separate.
A. General Principals of Integration.
Under the proposed rules, 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.
For offerings where general solicitation is permitted, this means that, if the issuer’s general solicitation materials for one offering discuss the material terms of another concurrent offering, then the solicitation materials must comply with all the requirements of both exemptions being relied upon.
For offerings where general solicitation is not permitted, this means either (1) the issuer has a reasonable belief, based on the facts and circumstances, that the purchasers in each exempt offering were not solicited through the use of general solicitation, or (2) the purchasers in each exempt offering established a substantive relationship with the issuer prior to the commencement of the offering (i.e., the purchasers are prior investors, investors in prior deals of the issuer’s management, or friends or family of the persons in control of the issuer).
B. Statutory Safe Harbors.
Additionally, the proposed rules establish four statutory safe harbors. Offers and sales that meet the conditions of one of these safe harbors, will not be integrated, and the issuer need not conduct any further integration analysis.
i. The 30-Day Safe Harbor. 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, provided that, for an exempt offering for which general solicitation is not permitted, either (1) the purchasers must not have been solicited through the use of general solicitation, or (2) the purchasers must have established a substantive relationship with the issuer prior to the commencement of the offering. This safe harbor reduces the current safe harbor waiting period from 6 months to 30 days. The SEC views this change as a means of modernizing the current rules, given the accelerating speed and consumption of electronic information in today’s financial marketplace.
ii. Rule 701, Employee Benefit Plan and Regulation S Safe Harbor. 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. This is because offers and sales made pursuant to Rule 701 and employee benefit plans are limited to investors, such as employees, consultants and advisors, with whom the issuer has an existing relationship. Given the privity between these investors and the issuer, these offers do not raise the same level of investor protection concerns as other offerings. The SEC included offers and sales made in connection with Regulation S in order to codify the SEC’s current practice of refusing to integrate concurrent offshore offerings with domestic offerings.
iii. Safe Harbor for Subsequent Registration Offerings. An offering for which a registration statement has been filed will not be integrated if it is made subsequent to (1) a terminated or completed offering for which general solicitation was not permitted, (2) a terminated or completed offering for which general solicitation was permitted and made only to qualified institutional buyers and institutional accredited investors, or (3) an offering for which general solicitation was permitted that terminated or completed more than 30 calendar days prior to the commencement of the registered offering. The public offering process is lengthy and complex, and often times companies need capital in the interim while the public offering process is ongoing. This safe harbor allows issuers to continue capital raising activities without having to worry about a lengthy waiting period prior to engaging in a registered offering.
iv. Safe Harbor for Issuances Preceding Exempt Offerings Permitting General Solicitation. Offers and sales made in reliance on an exemption for which general solicitation is permitted will not be integrated if made subsequent to any prior terminated or completed offering. This safe harbor is built upon the same theory as the prior safe harbor but seeks to expand its protections to exempt offerings where general solicitation is permitted, such as offerings made pursuant to Regulation A; Regulation Crowdfunding; Rule 147 or 147A; Rule 504(b)(1)(i), (ii), or (iii); and Rule 506(c).
4. Conclusion
The proposed rules are open for comment until June 1, 2020.
Contact Cavitch attorneys Michael Rasor or Marcus Notaro for assistance in your private securities offerings.