On November 2, 2020, the SEC adopted final rule changes to harmonize, simplify and improve the exempt offering framework. The SEC had originally issued a concept release and request for public comment on the subject in June 2019 (see HERE). For my five-part blog series on the proposed rules, see HERE, HERE, HERE, HERE and HERE. The new rules go into effect on March 14, 2021.
The 388-page rule release provides a comprehensive overhaul to the exempt offering and integration rules worthy of in-depth discussion. As such, like the proposed rules, I will break it down over a series of blogs, with this first blog focusing on integration.
Current Exemption Framework
As I’ve written about many times, the Securities Act of 1933 (“Securities Act”) requires that every offer and sale of securities either be registered with the SEC or exempt from registration. The purpose of registration is to provide investors with full and fair disclosure of material information so that they can make informed investment and voting decisions.
In recent years, the scope of exemptions has evolved stemming from the JOBS Act in 2012, which broke Rule 506 into two exemptions, 506(b) and 506(c), and created the current Regulation A/A+ and Regulation Crowdfunding. The FAST Act, signed into law in December 2015, added Rule 4(a)(7) for re-sales to accredited investors. The Economic Growth Act of 2018 mandated certain changes to Regulation A, including allowing its use by SEC reporting companies, and to Rule 701 for employee stock option plans for private companies. Also relatively recently, the SEC eliminated the never-used Rule 505, expanded the offering limits for Rule 504 and modified the intrastate offering structure.
Offering exemptions are found in Sections 3 and 4 of the Securities Act. Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another). Section 4 contains all transactional exemptions including Section 4(a)(2), which is the statutory basis for Regulation D and its Section 4(a)(2) and 506(c). The requirements to rely on exemptions vary from the type of company making the offering (private or public, U.S. or not, investment companies…), the offering amount, manner of offering (solicitation allowable or not), bad actor rules, type of investor (accredited) and amount and type of disclosure required. In general, the greater the ability to sell to non-accredited investors, the more offering requirements are imposed.
For more information on Rule 504 and intrastate offerings, see HERE; on rule 506, see HERE; on Regulation A, see HERE; and on Regulation Crowdfunding, see HERE. The disparate requirements can be tricky to navigate and where a company completes two offerings with conflicting requirements (such as the ability to solicit), integration rules can result in both offerings failing the exemption requirements.
The chart at the end of this blog contains an overview of the offering exemptions, incorporating the new rule changes.
Rule Changes
The rule changes are meant to reduce complexities and gaps in the current exempt offering structure. As such, the rules amend the integration rules to provide certainty for companies moving from one offering to another or to a registered offering; increase the offering limits under, Rule 504 and Regulation Crowdfunding and increase the individual investment limits for investors under each of the rules; set clear and consistent rules that increase the ability to communicate during the offering process, including for offerings that historically prohibited general solicitation; and harmonize disclosure obligations and bad actor rules to decrease differences between various offering exemptions.
Integration; new Rule 152
Current Integration Structure
Prior to the amendments, the Securities Act integration framework for registered and exempt offerings consists of a mixture of rules and SEC guidance for determining whether two or more securities transactions should be considered part of the same offering. In general, the concept of integration is whether two offerings integrate such that either offering fails to comply with the exemption or registration rules being relied upon. That is, where two or more offerings are integrated, there is a danger that the exemptions for one or both offerings will be lost, such as when one offering prohibits general solicitation and another one allows it.
Prior to the amendments, Securities Act Rule 502(a) provides for a six-month safe harbor from integration with an alternative five-factor test including: (i) whether the offerings are part of a single plan of financing; (ii) whether the offerings involve the same class of security; (iii) whether the offerings are made at or around the same time; (iv) whether the same type of consideration will be received; and (v) whether the offerings are made for the same general purpose. For SEC guidance on integration between a 506(c) and 506(b) offering, see HERE). Although technically Rule 502(a) only applies to Regulation D (Rule 504 and 506 offerings), the SEC and practitioners often use the same test in other exempt offering integration analysis. The five-factor test has been completely eliminated in the new regulatory structure.
A different analysis is used when considering the integration between an exempt and registered offering and in particular, considering whether the exempt offering investors learned of the exempt offering through general solicitation, including the registration statement itself. Yet a different analysis is used when considering Regulation A, Regulation Crowdfunding, Rule 147 and Rule 147A offerings although each of those has a similar six-month test.
New Rule 152(a) – General Integration Principal
The amended rules completely overhaul the integration concept, creating a new Rule 152(a) setting forth a general integration concept and new Rule 152(b) containing four safe harbors applicable to all securities offerings whether registered or exempt. Where a safe harbor exists under Rule 152(b), that safe harbor may be relied upon.
Where a safe harbor does not exist, offers and sales will not be integrated if, based on the particular facts and circumstances, the company 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. Where solicitation is prohibited, the company must have a reasonable belief that each purchaser in the offering that does not allow for solicitation, was either not solicited or that such investor had a pre-existing substantive relationship with the company prior to commencement of the offering.
A “pre-existing” relationship is one that the company has formed with an offeree prior to the commencement of the offering or, that was established through another person, such as a registered broker-dealer or investment adviser, prior to that person’s participation in the offering. A substantive relationship is one in which the company, or someone acting on the company’s behalf such as a broker-dealer, has sufficient information to evaluate, and in fact does evaluate, such prospective investors’ financial circumstances and sophistication, and has established accreditation. A substantive relationship is determined by the quality of the relationship and information known about an investor as opposed to the length of a relationship. For more on substantive pre-existing relationships, including a summary of the SEC’s no action letter in Citizen VD, Inc., see HERE.
In a huge change from the prior structure, under the new integration principle in Rule 152(a), a company may conduct concurrent Rule 506(c) and Rule 506(b) offerings, or any other combination of concurrent offerings, involving an offering prohibiting general solicitation and another offering permitting general solicitation, without integration concerns, so long as the provisions of Rule 152(a)(1) and all other conditions of the applicable exemptions are satisfied. That is, if the company can establish that the purchasers in the 506(b) offering were not solicited using general solicitation or that there was a substantive relationship with that purchaser prior to the commencement of the 506(b) offering, the exemption would survive.
Rule 152(a) specifically provides that where two or more concurrent offerings are being completed which allow general solicitation, care must be given to ensuring that all offerings comply with each of the exemptions including any disclosures or regulatory legends required for such offering. For example, if a company is conducting a concurrent Rule 506(c) and Regulation A offering and discusses the terms of the Regulation A offering in its Rule 506(c) general solicitation material, all of the requirements in Regulation A must be met.
New Rule 152(a) contains introductory language that the provisions of either Rule 152(a) or (b) will not have the effect of avoiding 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.
New Rule 152(b) – Statutory Safe Harbors
New Rule 152(b) sets forth four new non-exclusive safe harbors from integration, including:
(i) Any offering made more than 30 calendar days before the commencement or after the termination of a completed offering will not be integrated – provided, however, that where one of the offerings involved general solicitation, the purchasers in an offering that does not allow for solicitation, did not learn of the offering through solicitation applying the principals in Rule 152(a) (this 30-day test would replace the six-month test across the board);
(ii) Offerings under Rule 701, pursuant to an employee benefit plan, or in compliance with Regulation S will not integrate with other offerings;
(iii) A registered offering will not integrate with another offering as long as it is subsequent to (a) a terminated or completed offering for which general solicitation is not permitted; (b) a terminated or completed offering for which general solicitation was permitted but that was made only to qualified institutional buyers (QIBs) or institutional accredited investors (IAIs); or (c) 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; and
(iv) Offers and sales that allow for general solicitation will not integrate with a prior completed or terminated offering. In particular, offerings under Regulation A, Regulation Crowdfunding, Rule 147 or 147A, Rule 504, Rule 506(b), Rule 506(c), Section 4(a)(2) and registered offerings will not integrate with a subsequent Regulation A, Regulation Crowdfunding, Rule 147 or 147A, Rule 504 or Rule 506(c) offering.
New Rules 152(c) and 152(d) – Commencement, Termination and Completion of Offerings
New Rules 152(c) and 152(d) provide a non-exclusive set of factors to consider when determining when an offer has commenced, terminated or been completed. New Rule 152(c) provides a non-exclusive list of factors to consider in determining when an offering will be deemed to be commenced. Regardless of the type of offering, it will be commenced at the time of the first offer of securities in the offering by the issuer or its agents. The Rule also includes a list of factors that should be considered in determining when an offering is commenced, including:
(i) On the date the company first makes a generic offer soliciting interest in a contemplated offering where the company has not yet determined the exemption it will rely upon (new Rule 241 covering generic solicitations of interest will be discussed in Part 2 of this blog series);
(ii) For Section 4(a)(2), Regulation D or Rule 147 or 147A, on the date the company first made an offer of its securities in reliance on these exemptions;
(iii) For Regulation A, on the earlier of the first day of testing the waters or the public filing of a Form 1-A;
(iv) For Regulation Crowdfunding, on the earlier of the first day of testing the waters or the public filing of a Form C;
(v) For registered offerings – for a continuous offering on the date of the initial filing with the SEC or for a delayed offering, on the earliest of which the company or its agents commence public efforts to offer and sell which could be evidenced by the earlier of the filing of a prospectus supplement or use of public disclosure such as a press release.
New Rule 152(d) provides a non-exclusive list of factors to consider in determining whether an offering is terminated or completed. Regardless of the type of offering, termination or completion of an offering is likely to occur when the company and its agents cease efforts to make further offers to sell the issuer’s securities under such offering. The Rule also includes a list of factors that should be considered including:
(i) For a Section 4(a)(2), Regulation D, Rule 147 or Rule 147A offering, the later of the date the company has a binding commitment to see all the securities offered or the company and its agents have ceased all efforts to sell more securities;
(ii) For a Regulation A offering, when the offering statement is withdrawn, a Form 1-Z has been filed, a declaration of abandonment is made by the SEC or the third anniversary after qualification of the offering;
(iii) For Regulation Crowdfunding, upon the deadline of the offering set forth in the offering materials or as indicated in any notice to investors by the intermediary;
(iv) For registered offerings, on the date of withdrawal of the registration statement, the filing of a prospectus supplement or amendment disclosing the offering termination, a declaration of abandonment is made by the SEC, the third anniversary after effectiveness of the initial registration statement, or any other evidence of abandonment or termination of the offering such as the filing of a Form 8-K or a press release.
An offering may also be effectively terminated. For example, if a company commences a Rule 506(b) offering and then begins to solicit under Rule 506(c) and relies exclusively on Rule 506(c) once it commences solicitation, the Rule 506(b) offering will be deemed to be terminated.
As will be discussed in this blog series, Rule 506(b) has been amended such that a company may sell to 35 unaccredited investors within any 90 calendar days. This provision alleviates concerns that a company would engage in consecutive 506(b) offerings every 30 days selling to 35 accredited investors each time.
Rules 502(a), 251(c) (i.e., Regulation A integration provision), 147(g) and 147A(g) (both intrastate offering provisions), and Rule 500(g) have been amended to cross reference the new Rule 152. Other rules including Rules 255(e), 147(h), 147A(h) and Rule 155 (related to abandoned offerings) have been eliminated as the provisions are covered in Rule 152.
Exemption Overview Chart
The following chart is includes the most commonly used offering exemptions as updated by the amended rules:
|
Type of Offering |
Offering Limit within 12- month Period |
General Solicitation/Manner of Offering |
Issuer Requirements |
Offeree and Investor Requirements |
SEC Filing and Information Requirements |
Restrictions on Resale |
Preemption of State Registration and Qualification |
| Section 4(a)(2) | None | No general solicitation. | None | Transactions by an issuer not involving any public offering. See SEC v. Ralston Purina Co.
Offerees and purchasers must be sophisticated and be given access to information. |
None | Yes. Restricted securities | No preemption. Must qualify in each state |
| Rule 506(b) of Regulation D | None | No general solicitation. Rule 148 “demo days” (sponsored investor event) will not be general solicitation, with attendee limits if done virtually | “Bad actor” disqualifications apply | No offeree qualifications.
Unlimited accredited investors Up to 35 sophisticated but non-accredited investors in any 90 day period but must provide certain financial and non-financial disclosures |
Form D with SEC not later than 15 days of first sale though failure to file will not destroy exemption.
No information requirement for accredited investor except disclosure of resale restrictions and investors must be given access to information if requested. For any non-accredited investors: (A) if 1934 Act reporting company, certain reports or filings or (B) if non-reporting company, (1) Regulation A narrative information for eligible issuers and otherwise narrative information required by Part I of applicable registration form and (2) Regulation A financials that may be unaudited if offering $20,000,000 or less and audited if more |
Yes. Restricted securities | Exempt as “covered security,” subject to state fees and notice filings. |
| Rule 506(c) of Regulation D | None | General solicitation permitted if all purchasers are verified accredited investors. Non-exclusive safe harbors available for verification of natural persons and previous investors who self-certify within 5 years. | “Bad actor” disqualifications apply | No offeree qualifications.
Unlimited accredited investors. No non-accredited investors. Issuer must take reasonable steps to verify that all purchasers are accredited investors |
Form D with SEC not later than 15 days of first sale though failure to file will not destroy exemption.
No information requirement except disclosure of resale restrictions and investors must be given access to information if requested.
|
Yes. Restricted securities | Exempt as “covered security,” subject to state fees and notice filings. |
| Regulation A: Tier 1 | $20 million but no more than $6,000,000 by affiliate selling security holders subject to aggregate 30% price cap by selling security holders in first Reg A offering and any Reg A offerings in 12 months | Permitted; before qualification, testing the waters permitted before and after the offering statement is filed.
No sales or direct or indirect commitments for sales until after qualified with SEC.
General solicitation permitted after qualified with SEC. |
U.S. or Canadian issuers
Excludes blank check companies, registered investment companies, business development companies, issuers of certain securities, and certain issuers subject to a Section 12(j) order; and Regulation A Exchange Act reporting companies that have failed to file certain required reports “Bad actor” disqualifications apply No asset-backed securities. |
None | Form 1-A, including two years of unaudited financial statements.
May be submitted confidentially for SEC review if publicly filed for 21 days; file sales material; file generic test the waters materials as exhibit if Regulation A used within 30 days. Exit report on Form 1-Z within 30 days of offering completion. |
No | No preemption. Must qualify in each state. |
| Regulation A: Tier 2 | $75 million but no more than $22,500,000 by affiliate selling security holders subject to aggregate 30% price cap by selling security holders in first Tier 2 offering and any Reg A offerings in 12 months | Non-accredited investors are subject to investment limits of 10% of the greater of annual income and net worth, unless securities will be listed on a national securities exchange | Form 1-A, including two years of audited financial statements.
May be submitted confidentially for SEC review if publicly filed for 21 days; file sales material; file generic test the waters materials as exhibit if Regulation A used within 30 days. Annual, semi-annual, current, and exit reports |
No | Exempt as “covered security,” subject to state fees and notice filings. | ||
| Rule 504 of Regulation D | $10 million including all Section 3(b)(1) sales and sales in violation of Section 5 | No general solicitation. Rule 148 “demo days” (sponsored investor event) will not be general solicitation, with attendee limits if done virtually. Generic testing the waters permitted.
General solicitation permitted if registered in state requiring use of substantive disclosure document or under exemption in state for sales to accredited investors |
Excludes blank check companies, Exchange Act reporting companies, and investment companies
“Bad actor” disqualifications apply |
None | Form D with SEC not later than 15 days of first sale though failure to file will not destroy exemption.
Can register in a state based on state disclosure requirements for issuance of unrestricted securities. |
Yes. Restricted securities unless registered in a state requiring use of a substantive disclosure document or sold under state exemption for sale to accredited investors with general solicitation | Need to comply with state blue sky law by registration (Form U-7 may be available) or state exemption. State crowdfunding may be available |
| Intrastate: Section 3(a)(11) | No federal limit (generally, individual state limits between
$1 and $5 million) |
Solicitation permitted but all offerees must be in- state residents making internet advertising difficult. | In-state residents “doing business” and incorporated in-state; excludes registered investment companies | Offerees and purchasers must be in-state residents | None | Securities must come to rest with in-state residents.
Generally states require a one year hold. |
No preemption. Must qualify in state. |
| Intrastate: Rule 147 | No federal limit (generally, individual state limits between
$1 and $5 million) |
Solicitation permitted but all offerees must be in- state residents making internet advertising difficult.
Testing the waters is permitted |
In-state residents “doing business” and incorporated in-state; excludes registered investment companies | Offerees and purchasers must be in-state residents | None | Yes. Resales must be within state for six months | No preemption. Must qualify in state. |
| Intrastate: Rule 147A | No federal limit (generally, individual state limits between
$1 and $5 million) |
Solicitation permitted but all purchasers must be in- state residents.
Testing the waters is permitted |
In-state residents and “doing business” in-state; excludes registered investment companies | Offerees and Purchasers must be in- state residents | None | Yes. Resales must be within state for six months | No preemption. Must qualify in state. |
| Regulation Crowdfunding; Section 4(a)(6) | $5 million | Testing the waters permitted before Form C is filed.
Solicitation permitted with limits on advertising after Form C is filed Offering must be conducted on an internet platform through a registered intermediary |
Excludes non-U.S. issuers, blank check companies, Exchange Act reporting companies, and investment companies
“Bad actor” disqualifications apply |
No investment limits for accredited investors.
Non-accredited investors investment limits in any 12-month period through crowdfunding of (i) the greater of $2,200 or 5% of the greater of annual income or net worth if either is less than $107,000, or (ii) 10% of the greater of annual income or net worth, but not more than $107,000, if both are at least $107,000. |
Form C, including two years of financial statements that are certified, reviewed or audited, as required based on offering amount. Must file test the waters materials with Form C.
Up to $107,000 – latest tax return and financials certified by officers; from $107,000 to $535,000 – financials reviewed by public accountant; above $535,000, audited financials but may be reviewed for first-time issuer up to $1,070,000.
Progress and annual reports |
12-month resale limitations | Exempt as “covered security,” subject to state notice filing with primary state. State antifraud rules apply. |
It is extremely difficult for small and emerging companies to raise capital, and any changes to the rules that will assist these companies is a positive step. Small businesses are job creators, generators of economic opportunity, and fundamental to the growth of the country. Small businesses account for the majority of net new jobs since the recession ended and are critical to the health and vitality of our country. In the absence of access to funding, small businesses cannot create new jobs, foster innovation, and develop into the next generation of publicly traded companies whose growth fuels capital markets investors’ retirement accounts.
I am very interested to see the new administration’s regulatory and general policies and agendas that impact small business capital raising efforts.