The U.S. Securities and Exchange Commission has issued a release adopting amendments (“final rules”) to certain of its rules relating to exemptions from registration under the Securities Act of 1933 (Securities Act). The amendments are designed to simplify, harmonize and improve certain aspects of the exempt offering framework. That landscape had grown complex as a result of new rules and statutory provisions, including those initiated by, or included in, the JOBS Act of 2012, the FAST Act of 2015 and the Economic Growth Act of 2018. The new rules will be effective 60 days after publication in the Federal Register.
Notably, the final rules provide a general principle of integration that focuses analysis on whether 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. In addition, they provide four non-exclusive safe harbors from integration of concurrent private and public offerings, and clarify when offerings will not be integrated in situations where general solicitation is not permitted for exempt offerings.
Of specific interest for private companies, the final rules cover a variety of topics related to exempt offerings, and the following are key takeaways:
The exempt offerings addressed by the rule changes in the final rules include private placement and intrastate offerings contained in Sections 4(a)(2) and 3(a)(11) of the Securities Act, private placement offerings conducted under Regulation D, offerings conducted under Regulation A, offerings conducted under Regulation Crowdfunding, intrastate offerings conducted under Rules 147 and 147A, Rule 701 equity compensation offerings and Regulation S offshore offerings.
The final rules also modify the requirements for redacting confidential information from filed exhibits.
Background: The concept of integration refers to the potential integration of one offering with another purportedly distinct offering to determine if the requirements for the exemption(s) or registration(s) of such offerings would be satisfied if indeed the two or more offerings were regarded as a single offering. For decades, the leading authority on the integration analysis has been the SEC’s five-factor test: (i) are the different offerings part of a single plan of financing, (ii) do the offerings involve issuance of the same class of security, (iii) are the offerings made at or about the same time, (iv) is the same type of consideration to be received, and (v) are the offerings made for the same general purpose?1 Though a helpful starting point, the five-factor test has been met with criticism due to the SEC’s lack of definitive guidance surrounding the weight to assign each factor and/or how many of them must be met to find integration. Further, the application of the five-factor test—a somewhat conceptual framework—has been largely subjective.
In response to this criticism, the SEC has taken steps to make the application of the five-factor test more definitive and objective. Rule 152 provides that a good private placement under Section 4(a)(2) of the Securities Act will not cease to be such if the company subsequently determines to make a public offering or files a registration statement for a public offering. Rule 155 provides safe harbors for the conduct of a public offering after the abandonment of a private offering, and the conduct of a private offering after the abandonment of a public offering, with a key component of each safe harbor being a 30-day waiting period between the abandonment of the first offering and commencement of the second. Rule 502 of Regulation D provides that offerings that are made more than six months before or after the completion of the Regulation D offering will not be integrated with that offering. In a 2007 release proposing certain changes to Regulation D, the SEC provided helpful commentary to the effect that the filing of a registration statement does not, per se, eliminate a company’s ability to conduct a concurrent private offering. In doing so, the SEC commented that the determination as to whether the filing of the registration statement should be considered to be a general solicitation or general advertising that would affect the availability of a private placement exemption for such a concurrent unregistered offering should be based on a consideration of whether the investors in the private placement were solicited by the registration statement or through some other means that would otherwise not foreclose the availability of the exemption. In connection with the adoption of Regulation A amendments and of Regulation Crowdfunding in 2015, the SEC set forth a facts and circumstances integration framework in the context of concurrent exempt offerings, although the Regulation Crowdfunding framework was not codified in the rule itself. Rules 147 and 147A contain similar integration safe harbors.
Final Rules: The final rules amend the current integration framework to better facilitate the determination as to whether separate sales of securities are part of the same offering (i.e., are considered integrated). This framework provides a general principle of integration that looks to the particular facts and circumstances of the offering, and focuses the analysis on whether 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. To assist in the application of this general principle, the final rule includes four non-exclusive safe harbor integration provisions.
The final rules include a rewriting of Rule 152 and the elimination of Rule 155, as the concepts that it currently covers are included in revised Rule 152. Subsection (a) of Rule 152 contains the general integration principle and subsection (b) contains four integration safe harbors. The below table shows the new framework for Rule 152(a):
Rule 152(a): For all offerings not covered by a safe harbor, 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.
Exempt Offerings Under Rule 152(a) Prohibiting General Solicitation
Concurrent Exempt Offerings Under Rule 152(a) Where General Solicitation is Permitted
The subject offering(s) will not be integrated with other offerings if the company has a reasonable belief, based on the facts and circumstances, with respect to each purchaser in such offering that the company (or any person acting on its 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 offering not permitting general solicitation.
For two or more concurrent exempt offerings permitting general solicitation, general solicitation offering materials for one offering that includes information about the material terms of a concurrent offering under another exemption may constitute an offer of 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.
Subsection (b) of Rule 152 now contains four safe harbors, as described below:
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 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 152(a)(1) shall 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 would not be integrated with other offerings.
Safe Harbor 3
An offering for which a Securities Act registration statement has been filed would not be integrated if 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 and 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 if made subsequent to any prior terminated or completed offering.
The most significant aspect of Rule 152 is that it provides for the application of a 30-day waiting period safe harbor to exempt offerings across the board. As noted above, the current safe harbor in Regulation D includes a six-month waiting period, as do the safe harbors contained in Regulation A and Rules 147 and Rule 147A. The safe harbors for Rule 701 and Regulation S offerings do not break new ground, as Rule 701 and SEC guidance regarding the use of Regulation S provide that these offerings will not be integrated with other offerings. The third safe harbor provides some clarification relating to “gun jumping” considerations that might arise when a public offering is launched in close proximity to the completion or abandonment of a private offering. New subsection (c) of Rule 152 provides relatively specific guidelines as to when various types of exempt offerings and registered offerings will be deemed commenced, and, similarly, new subsection (d) provides specific guidelines regarding the termination or completion of various types of offerings.
In the adopting release, the SEC clarified 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 its existing guidance with respect to concurrent Regulation S and domestic offerings.
In addition to providing new Rule 152 and eliminating Rule 155, the rules replace the integration provisions of Regulation D, Regulation A, and the intrastate offering rules with references to Rule 152. In the case of Regulation Crowdfunding, an integration provision has been added that similarly consists of a reference to Rule 152.
General Solicitation and Offering Communications
The final rules make or amend rules in three different aspects of communications that might be regarded as general solicitation or advertising: (i) exemptions for “demo days” and similar events, (ii) allowing “testing the waters” (TTW) in connection with exempt offerings and (iii) allowing oral communications with potential investors in a crowdfunding offering after a Form C has been filed. The changes are designed to provide safe harbors that certain communications will not foreclose the use of specified exemptions.
Demo Days: Demo days are events organized by a group or entity (such as a university, angel investors, an accelerator or an incubator) that invite companies to present their businesses to potential investors. If a company’s participation in these events constitutes an offer of its securities to the attendees, the company may have foreclosed its ability to make an exempt private placement to such attendees. The adopting release notes that if the event organizer has limited the attendees to those potential investors with whom the organizer has a pre-existing substantive relationship, or to those that have been contacted through an informal, personal network of experienced, financially sophisticated individuals, such as angel investors, the participating companies will not be deemed to have participated in general solicitation. The SEC further notes, however, that in many cases it may not be practical for the organizer to limit participation in this manner.
As a result of this difficulty in managing demo day attendees, the SEC has adopted new Rule 148, which states that certain demo day communications will not be deemed to be general solicitation or general advertising. Specifically, a company will not be deemed to have engaged in general solicitation if the communications are made in connection with a seminar or meeting with at least two participating companies by a college, university, or other institution of higher education, a local government, a nonprofit organization, or an angel investor group, incubator, or accelerator. An instruction to Rule 148 defines “angel investor group” for the purposes of this rule.
Rule 148 imposes certain conditions on sponsors for the holding of a complying demo day. The sponsor will not be permitted (i) to make investment recommendations or provide investment advice to attendees of the event, (ii) to engage in any investment negotiations between the companies and investors attending the event, (iii) to charge attendees any fees, other than reasonable administrative fees, (iv) to receive any compensation for making introductions between attendees and companies, or for investment negotiations between parties, or (v) to 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, the advertising for the event may not reference any specific offering of securities by a participating company and the information conveyed at the event regarding the offering of securities by the presenting companies must be limited to certain elemental facts. Additionally, if virtual participation is allowed at the seminar or meeting, such virtual participation must be limited to (i) individuals associated with the sponsor organization, (ii) individuals that the sponsor reasonably believes to be accredited investors, or (iii) individuals who have been invited to the event by the sponsor based on industry or investment-related experience reasonably selected by the sponsor in good faith and disclosed in public communications about the event.
Testing the Waters (TTW): The JOBS Act allows emerging growth companies to engage in oral or written communications with QIBs and IAIs regarding a potential public offering. Recently adopted Rule 163B extended this flexibility to all companies. The SEC has adopted a new rule, Rule 241, which will allow companies to engage in generic TTW communications for an exempt offering prior to making a determination of the exemption under which the offering will be made. This new exemption is substantially based on Rule 255 of Regulation A. The SEC has also adopted an addition to Regulation Crowdfunding, new Rule 206, to allow crowdfunding companies to test the waters prior to filing a Form C.
A company that desires to use Rule 241 must make its communications prior to determining the exemption under which the offering will be made. Once that determination has been made, the company must comply with the specific terms of that exemption. Any materials used under the new rule must contain a legend containing specified information, including that no sales will be made or commitments to purchase accepted until the company has determined the exemption under which the offering will be made. These communications will be deemed to be offers of a security for the purpose of the antifraud provisions of the federal securities laws. The adopting release final rules note that TTW communications could be done in a manner that is considered general solicitation (without obviating the availability of the new rule) and cautions that if a company elects to proceed with this type of communication, it may then be unable to conduct an exempt offering that prohibits general solicitation, such as Rule 506(b).
In connection with the adoption of Rule 241, the final rules amend Regulation A and Regulation Crowdfunding to require that the generic solicitation materials be filed as exhibits to the offering materials required to be filed if a Regulation A or Regulation Crowdfunding offering is commenced within 30 days of the generic solicitation. Similarly, Rule 506 is amended to provide that if the company sells any securities to a non-accredited investor within 30 days of the generic solicitation of interest under Rule 241, the company must provide any such written solicitation materials to such purchaser.
Of note, the final rules did not preempt state securities law registration and qualification requirements for offers made under Rule 241. State securities laws have previously been preempted for Regulation D offerings, other than those under Rule 504, for Tier 2 Regulation A offerings and for Regulation Crowdfunding offerings.
In addition to the allowance of generic TTW under Rule 241, new Rule 206 has been added to Regulation Crowdfunding to allow companies that have elected to do a crowdfunding offering to test the waters orally or in writing prior to filing a Form C. A company conducting a crowdfunding offering is currently prohibited from making any offers, or sales, prior to filing a Form C. The TTW materials used under Rule 206 will be required to contain certain legends and under new Rule 201(z) will have to be filed as an exhibit to the company’s Form C. One difference between Rule 206 and existing Rule 255, which also allows oral and written TTW before and after filing a Regulation A offering statement, is that TTW communications under Regulation Crowdfunding could only be used prior to filing the Form C. Once the Form C is filed, any offering communications must comply with the terms of Regulation Crowdfunding, including the Rule 204 advertising restrictions.2 As with Rule 241, Rule 206 communications will be deemed to be offers of a security for the purpose of the antifraud provisions of the federal securities laws.
Oral Offers After Filing Crowdfunding Form C: Under Rule 204 of Regulation Crowdfunding, a company 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 limited information. Although advertising the terms of the offering other than through the intermediary’s platform is limited to a brief notice, a company may communicate with investors and potential investors about the terms of the offering through communication channels provided on the intermediary’s platform. Uncertainty has arisen among crowdfunding companies as to whether they may orally communicate with potential investors outside of the intermediary’s platform once the Form C is filed. The final rules amend Rule 204 to permit oral communications with prospective investors once the Form C is filed, so long as the communications comply with the requirements of Rule 204.
Rule 506(c) Verification Requirements
Rule 506(c) permits companies to generally solicit and advertise an offering, subject to certain conditions, including that all purchasers in the offering be accredited investors and that the company have taken reasonable steps to verify that the purchasers are accredited investors. Rule 506(c) further provides both a principles-based method for verification, as well as a non-exclusive list of verification methods. The final rules provide that if a company has previously verified an investor as an accredited investor during a five-year time period, the company may establish that the 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 company is not aware of information to the contrary.
The SEC further reaffirmed its position that, in making its determination of whether a purchaser is an accredited investor under the principles-based method, an company should exercise its best judgment tailored to the specific facts and circumstances and should consider the following factors (among others):
Harmonization of Disclosure Requirements
Confidential Treatment Coverage Broadened
The final rules amend disclosure requirements for Regulation A offerings to establish greater consistency between Regulation A and registered offerings, and also modifies the financial statement information requirements in Regulation D to align them with the disclosure requirements in Regulation A. In addition, the rules amend the confidentiality test to be used for redacting information from filed exhibits.
Regulation A: The final rules amend Regulation A to align certain of its requirements with those for registered offerings by permitting Regulation A companies to:
Regulation D Financial Statement Information: Currently, in order for non-accredited investors to participate in a Rule 506 offering, the company must furnish to the non-accredited investors the information required by Rule 502(b). This information includes financial statements, the specific terms of which vary depending on the size of the offering, with different requirements for offerings up to $2 million, offerings up to $7.5 million and offerings in excess of $7.5 million.
The Final Release amends Rule 502 of Regulation D to provide that, for offerings of up to $20 million in securities in which non-accredited investors are participating, companies will now be required to comply with the requirements of paragraph (b) of part F/S of Form 1-A, which applies to Tier 1 Regulation A offerings. These requirements differ most notably from the previous Rule 502requirements in that they do not require any audited financial statements (unless the company has obtained audited financial statements for another purpose). For such Regulation D offerings of greater than $20 million in securities, companies will be required to provide audited financial statements and comply with the requirements of Regulation S-X similar to Tier 2 Regulation A offerings.
The SEC noted in its March 2020 release proposing the amendments that there will remain a discrepancy in the way in which the $20 million cap is calculated under each exemption. Tier 1 of Regulation A includes the sum of all cash and other consideration to be received for the securities being offered plus the gross proceeds for all securities sold pursuant to other offering statements within the 12-month period before the start of and during the current Regulation A offering. Regulation D does not include any such lookback period.
Offering and Investment Limits
In the June 2019 concept release, the SEC estimated that, of the approximately $2.9 trillion of new capital raised through exempt offering channels in 2018, less than $3 billion (0.1%) was raised under Regulation A, Regulation Crowdfunding and Rule 504. The SEC has increased the offering limits and amended investment limits under the exemptions as stated below in order to more accurately reflect current capital-raising trends and improve investor access and companies’ ability to raise capital:
Regulation Crowdfunding and Regulation A Eligibility
Regulation Crowdfunding: In adopting Regulation Crowdfunding, the SEC declined to create an exception to the statutory prohibition codified in Section 4A(f)(3) of the Securities Act prohibiting investment companies from using the Regulation Crowdfunding exemption, stating that investment companies did not represent the type of company that Regulation Crowdfunding was intended to benefit. Since then, the SEC has received public feedback indicating that the use of such vehicles could address concerns associated with managing the potentially large number of direct investors that could result from an offering under Regulation Crowdfunding, as well as provide small investors with more leverage alongside a sophisticated lead investor in negotiating better terms and protecting against dilution in future financings.
The SEC has amended Regulation Crowdfunding to permit the use of limited-purpose vehicles (crowdfunding vehicles) solely to function as a conduit for investors to invest directly in a business. The crowdfunding vehicle will also provide investors with all the rights and protections to which they would have been entitled had they been a direct investor in the offering. The company and the crowdfunding vehicle will be co-issuers for purposes of the Securities Act and will therefore be required to jointly file a Form C, limiting confusion for potential investors. If the crowdfunding issuer is separately offering securities directly to investors, it must file its own Form C. The crowdfunding vehicle will constitute a single record holder in the company only to the extent that all investors in the crowdfunding vehicle are natural persons.
Regulation A: Regulation A currently excludes companies that have not filed required reports in the two prior years under Regulation A. Now that companies subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act are permitted to conduct Regulation A offerings, the SEC has amended Regulation A to further tighten 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
Exempt offerings under Regulation A, Regulation Crowdfunding and Regulation D all include rules that disqualify certain covered persons, including felons and other “bad actors” from relying on such exemptions to offer and sell securities. While the disqualification provisions are largely similar, the look-back periods differ. The SEC has harmonized the bad actor disqualification provisions in Regulation D, Regulation A and Regulation Crowdfunding by adjusting the look-back requirements in each of Regulation A and Regulation Crowdfunding to include the time of sale in addition to the time of filing.
Regulation S-K and, as noted above per the final rules, Regulation A permit the redaction of confidential information from filed exhibits. Companies could previously redact only 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” element of the test was based on a standard created in a Circuit Court of Appeals ruling that was overturned by the U.S. Supreme Court in 2019. In line with the Supreme Court’s ruling, information may now be redacted if it is not material and is the type of information that the issuer both customarily and actually treat as private and confidential.
1. The five-factor test has been codified in Rule 502(a) of Regulation D and is referred to from time to time in various SEC releases. ↩
2. See the amendment to Rule 204 that is discussed below.↩