Last week, amid a flurry of other news, the Securities and Exchange Commission (the “SEC”) voted to approve significant updates to the rules governing exempt offerings, aiming to simplify and harmonize the procedures for exempt securities offerings, with the overall stated goal to promote capital formation and expand investment opportunities while preserving or improving existing investor protections.These amendments include, among other things, revisions to the SEC’s rules regarding offering communications, increases to the offering and investment limitations applicable to certain exempt offerings, and the establishment of a new framework for evaluating the integration of securities offerings.
Companies trying to raise capital through the sale of securities must either register the offering with the SEC or rely on a statutory exemption from registration. Rule 506 of Regulation D under the Securities Act of 1933, as amended (the “Securities Act”), is the most widely used exemption from registration, exempting certain capital raises that are conducted through private offerings. Seven years ago, the SEC added Rule 506(c), which allows issuers to use general solicitation and general advertising, otherwise prohibited in private offerings under Rule 506, to offer unregistered securities to “accredited investors” meeting certain income or net wealth requirements. As discussed in a previous publication, the definition of “accredited investor” was recently revised by the SEC, expanding the pool of investors eligible to participate in such offerings.
As further described below, the restrictions on offering communications for private placements of securities are now further relaxed by (1) exempting “demo day” communications from being considered general solicitations, and (2) permitting an issuer to use limited materials to “test-the-waters” before deciding which exemption to use for an offering. With these revisions, the SEC sought to clarify that certain activities would not be considered an illegal “offer” under the securities laws.
Under the newly revised rules, issuers are now permitted to engage in “demo days,” where they can discuss their business and capital-raising plans with potential investors. Under the new rule, an issuer will not be deemed to have engaged in general solicitation if the demo day communications are made in connection with an event sponsored by a college, university or other higher education institution, a state or local government (or instrumentality), a nonprofit or an “angel investor group,” subject to certain limitations:
- More than one issuer must participate in such event;
- No advertising for the event may reference a specific offering of securities by the issuer;
- The event sponsor is not permitted to (1) make investment recommendations or provide investment advice to attendees, (2) engage in any investment negotiations between an issuer and attendees, (3) charge attendees any fees, other than reasonable administrative fees, (4) receive any compensation for making introductions or for investment negotiations, or (5) receive any compensation with respect to the event that would require it to register as a broker or dealer or an investment adviser;
- The information conveyed at the event by an issuer about an offering of securities must be limited to (1) notification that the issuer is in the process of offering or planning to offer securities, (2) the type and amount of securities being offered, (3) the intended use of the proceeds of the offering, and (4) the unsubscribed amount in an offering; and
- To reduce potential solicitation of non-accredited investors, online participation in such event must be limited to (1) individuals who are members of, or otherwise associated with, the sponsor organization (such as members of an angel investor group or students, faculty, or alumni of a college or university), (2) individuals that the sponsor reasonably believes are accredited investors, or (3) 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 the public communications about the event.
Under the newly revised rules, an issuer may “test-the-waters” by communicating directly with potential investors to determine whether there is any interest in a contemplated offering of securities exempt from registration before having to determine which exemption would apply.
The new rule provides an exemption from registration only with respect to a “generic” solicitation of interest, and does not apply to any subsequent offer or sale of securities. An issuer must ultimately determine which exemption will apply, initiating the offering in compliance with such exemption, before being permitted to solicit or accept money or other consideration from any potential investor. Issuers should keep in mind that, depending on how they are conducted, these generic solicitations may constitute general solicitations, which are prohibited under certain exemptions. The generic test-the-waters materials must provide certain disclosures notifying potential investors about the limitations of the generic solicitation, including that:
- The issuer is considering an offering of securities exempt from registration under the Securities Act, but has not determined a specific exemption from registration that it intends to rely on for the offering;
- No money or other consideration is being solicited, and if sent in response, will not be accepted;
- No offer to purchase 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 requirements of such exemption are met; and
- A potential investor’s indication of interest involves no obligation or commitment.
The SEC declined to preempt state blue sky laws for these communications. Although acknowledging that the lack of preemption could affect the utility of the rule and potentially expose issuers to civil and criminal liabilities, the SEC believes issuers should be able to navigate such requirements as with other exemptions that do not provide for preemption. Therefore, issuers seeking to rely on this exemption should consult with knowledgeable counsel about potential state law issues prior to embarking on any testing the waters communications.
In addition, the new rules permit Regulation Crowdfunding issuers to “test-the-waters” prior to filing an offering document with the SEC provided that such communications include appropriate legends providing that: (1) no money or other consideration is being solicited, and if sent, will not be accepted; (2) no sales will be made or commitments accepted until the Form C offering statement is filed with the SEC and only through the intermediary’s platform; and (3) prospective purchaser’s indications of interest are non-binding.
Offering and Investment Limits
The various exemptions from registration contain a variety of requirements, including limitations on the amount of securities that may be offered and sold pursuant to such exemptions. Last week’s amendments make several notable changes to these requirements.
In 2012, after much debate, the Congress passed the Jumpstart Our Business Startups Act (the “JOBS Act”), which, among other things, opened up equity crowdfunding (internet-based capital raises of relatively small amounts of money from a large pool of investors). Building on the relaxation of rules regarding general solicitation, a company looking to raise capital can not only issue press releases or leverage social networks by posting investment opportunities on Twitter or Facebook, such companies can also provide a link to a funding portal where an investor can make a small investment online.
Prior to the implementation of the JOBS Act, crowdfunding was already poised for growth—boasting over $99 million raised by one non-equity crowdfunding site (Kickstarter) in 2011 (Kickstarter does not sell equity, but rather allows people to support projects either out of altruistic motives or in exchange for discounts or prizes). By 2018, the global crowdfunding market topped $10.2 billion and is projected to be two to three times that figure by 2025.
In an effort to modernize the crowdfunding rules passed in 2012 for this projected continued surge, the SEC has made the following amendments:
- Increased the offering limit under Regulation Crowdfunding from $1.07 million to $5 million;
- Amended the investment limits for investors in Regulation Crowdfunding offerings by:
- Removing investment limits for accredited investors; and
- Using the greater of their annual income or net worth when calculating the investment limits for non-accredited investors; and
- Extended for 18 months the existing temporary relief from certain Regulation Crowdfunding financial statement review requirements for issuers offering $250,000 or less of securities within a 12-month period.
The JOBS Act also sought to make more effective the “mini-IPO” rules promulgated by the SEC in amendments to Regulation A (so-called Regulation A+), raising the cap on small public offerings to general investors—accredited and non-accredited alike. Those rules expanded the existing Regulation A exemption from registration for smaller issuers of securities; specifically providing for two tiers of offerings up to $20 million and $50 million, respectively, in a 12-month period with the two tiers representing two differing levels of reporting requirements and, in the case of Tier 2, exemption from state blue sky laws. Last week’s revisions further increased the qualifying offering amounts as follows:
- Increased the maximum offering amount under Tier 2 of Regulation A from $50 million to $75 million; and
- Increased the maximum offering amount for secondary sales by selling security holders under Tier 2 of Regulation A from $15 million to $22.5 million.
Rule 504 Offerings
Rule 504 of Regulation D provides an exemption from registration for qualifying issuers offering a small amount of securities in a 12-month period. In 2016, the SEC increased the amount of securities an issuer may offer under this exemption from $1 million to $5 million. Last week’s revisions further increase the offering limit to $10 million of securities in a 12-month period.
When issuers conduct private and public offerings or use multiple private offering exemptions concurrently or in rapid succession, the SEC may “integrate” the offerings—viewing them in combination as one or more larger offerings for the purpose of analyzing compliance with SEC rules. If offerings with different requirements are structured separately but analyzed as one “integrated” offering, it is possible that the integrated offering will fail to meet all of the applicable conditions and limitations that applied to each smaller offering individually. Many exemptions for private offerings have differing limitations and conditions, including whether general solicitation of investors is permitted. Before now, the integration framework has been patchy and inconsistent, leaving issuers unclear on how to structure sequential offerings.
In last week’s amendments, the SEC established an integration framework that clarified, in one rule, the ability of issuers to move from relying on one exemption to another and ultimately to a registered offering. Specifically, the revised rule significantly reduces the uncertainty and legal risk associated with the integration of otherwise separate offerings by establishing a general principle that no integration is required if each offering, based on its particular facts and circumstances, meets the requirements for an exemption or complies with the registration requirements of the Securities Act.
Additionally, the revised rule provides four non-exclusive safe harbors from integration:
- Offerings separated by more than 30 days (a reduction from the current six-month separation period) will not be integrated, provided that, in the case of an exempt offering that does not permit general solicitation that follows an offering that permits general solicitation, the issuer either has a reasonable belief that each purchaser in the exempt offering that does not permit general solicitation was not solicited through general solicitation or has a preexisting substantive relationship with the purchaser. In addition, where an issuer conducts more than one offering under Rule 506(b), there may not be more than 35 non-accredited investors in all such offerings during a 90-day period.
- Rule 701 and Regulation S offerings will be “walled off” so that neither will be integrated with other offerings.
- Offerings for which a registration statement has been filed will not be integrated if made after (1) a terminated or completed offering for which general solicitation is not permitted, (2) a terminated or completed offering for which general solicitation is permitted, if such solicitation was made only to qualified institutional buyers or institutional accredited investors, or (3) more than 30 days from the termination or completion of an offering for which general solicitation is permitted.
- Offerings 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.
Consistent with previous rules governing integration of securities offerings, the new integration framework will not be available to any issuer for any transaction or series of transactions that, although in technical compliance with the rules, is part of a plan or scheme to evade the registration requirements of the Securities Act.
Prior to their adoption, SEC Chairman Jay Clayton said in support of these amended offering exemption rules: “The amendments we are considering today will add important efficiencies to our private offering framework, but I believe they will not, I repeat will not, materially alter the choice of whether to access the public markets or the private markets for larger companies.” Although it is unclear how an issuer’s incentives to raise capital may change with this updated offering framework, issuers now have expanded and clarified securities offering exemptions in their financial toolkit. These amendments will be effective 60 days after publication in the federal register.