On November 2, 2020, the Securities and Exchange Commission (SEC) adopted amendments geared toward improving, harmonizing, and simplifying the complex exempt offering framework under the Securities Act of 1933 (Securities Act), with the specifically articulated objectives of promoting capital formation while preserving or enhancing important investor protections. The SEC adopted the amendments substantially as proposed.

The full text of the amendments included in the final rule release, which will become effective 60 days following publication in the Federal Register, can be found here.

Background

The various exemptions from the registration requirements of the Securities Act have historically been an essential tool for issuers to access and raise capital, and are increasingly utilized as such. For example, the SEC notes in the final release that in 2019, capital procured in exempt offerings represented almost two-thirds of all capital estimated to be raised — approximately $2.7 trillion (69.2 percent) in exempt offerings, compared with approximately $1.2 trillion (30.8 percent) in registered offerings. As the number of exemptions available has grown, however, so too have the complexities, inconsistencies, and confusion surrounding the requirements and the potential interrelationships among them. As Chairman John Clayton noted in the SEC’s press release on the amendments, “While each component in this patchwork system makes some sense in isolation, collectively, there is substantial room for improvement.”

The amendments to the exempt offering framework generally:

• Increase the offering and investment limits in certain exempt offerings.

• Expand methods for verifying accredited investor status.

• Harmonize Regulation D and Regulation A disclosure requirements.

• Draw new contours for Regulation Crowdfunding and Regulation A eligibility.

• Establish consistent standards for exempt offering communications.

• Improve issuers’ ability to move from one exempt offering to another through an updated integration framework.

• Harmonize bad actor disqualifications across exempt offerings.

Increased Offering and Investment Limits

The amendments adopted by the SEC seek to raise the offering and investment limits under certain exemptions. The SEC predicts that raising the offering limits under these exemptions will facilitate capital formation while continuing to adequately protect investors. In particular, the SEC amended offering and investment limits as follows.

For Rule 504 of Regulation D, the amendments:

• Raise the offering limit from $5 million to $10 million.

For Regulation Crowdfunding, the amendments:

• Raise the offering limit from $1.07 million to $5 million.

• Remove the investment limit for accredited investors.

• Revise the method of calculating investment limits applicable to non-accredited investors to enable those investors to rely on the greater of their annual income or net worth when calculating their limits.

• Extend for 18 months the existing temporary relief that provides an exemption from certain Regulation Crowdfunding financial statement review requirements for issuers offering $250,000 or less of securities in reliance on the exemption within a 12-month period.

For Regulation A, the amendments:

• Raise the offering limit under Tier 2 of Regulation A from $50 million to $75 million.

• Raise the offering limit for secondary sales under Tier 2 of Regulation A from $15 million to $22.5 million.

• Revise the method of calculating investment limits applicable to non-accredited investors to enable those investors to rely on the greater of their annual income or net worth when calculating their limits.

Verification Requirements Under Rule 506(c) of Regulation D

The SEC added a new item to the non-exclusive list of methods to verify that all purchasers in an offering are accredited investors under Rule 506(c) of Regulation D. Under amended Rule 506(c), issuers may now establish that an investor which the issuer previously took reasonable steps to verify as an accredited investor in accordance with Rule 506(c)(2)(ii) remains an accredited investor as of the time of a subsequent sale, if the investor provides a written representation that the investor continues to qualify as an accredited investor and if the issuer is not aware of information to the contrary.

The release notes that issuers should consider the following non-exhaustive factors when verifying an accredited investor’s status: (i) the nature of the purchaser and the type of accredited investor that the purchaser claims to be, (ii) the amount and type of information that the issuer has about the purchaser, and (iii) the nature of the offering (e.g., the manner in which the purchaser was solicited to participate in the offering) and the terms of the offering (e.g., a minimum investment amount).

Harmonizing Disclosure Requirements

Amendments to Regulation D

The SEC amended required information that must be provided to non-accredited investors in Regulation D private placements. The SEC desired to align the financial disclosure requirements under Regulation D with those of Regulation A. Rule 502(b) of Regulation D is amended to reflect the following changes:

• For Regulation D offerings of up to $20 million, issuers do not need to provide audited financial statements to non-accredited investors. However, issuers are now required to comply with certain requirements applicable to Tier 1 Regulation A offerings.

• For Regulation D offerings of greater than $20 million, issuers must provide audited financial statements to non-accredited investors. Issuers must also comply with certain requirements applicable to Tier 2 Regulation A offerings.

Amendments to Regulation A

In an effort to create greater consistency between Regulation A and registered offerings, the SEC amended Regulation A disclosure requirements. Specifically, Regulation A now permits issuers to:

• File certain redacted exhibits using the process available for registered offerings and Securities Exchange Act of 1934 (Exchange Act) filings.

• Make draft offering statements and correspondence available to the public via EDGAR to comply with Rule 252(d) of the Securities Act.

• Incorporate financial statement information by reference to other previously filed documents on EDGAR.

• Declare post qualification amendments abandoned.

Regulation Crowdfunding and Regulation A Eligibility

The SEC amended the Investment Company Act to expand the availability of Regulation Crowdfunding for offerings of non-traditional securities. Specifically, the SEC adopted a new exclusion to the Investment Company Act for “crowdfunding vehicles”^[1] that act solely as conduits for investors to facilitate investing in Regulation Crowdfunding issuers.

The amendments also narrow Regulation A eligibility, to exclude reporting companies that are not current in their Exchange Act reports from using Regulation A. This exclusion is consistent with the existing exclusion of issuers that are not subject to Exchange Act reporting and have not filed required Regulation A periodic reports for the past two years.

Communications Expansions

The amended exempt offering framework includes new safe harbors for demo day communications, testing-the-waters communications, and certain Regulation Crowdfunding issuer communications.

Demo Day Communications: Rule 148

The SEC promulgated Rule 148, which provides that certain demo day communications will not be deemed general solicitations. Under new Rule 148, a “demo day” is characterized as a seminar or meeting sponsored by a college, university, or other institution of higher learning; by a state or local government or instrumentality of a state or local government; by a nonprofit organization; or by an angel investor group, incubator, or accelerator. However, the sponsor is not permitted to:

• Make investment recommendations or provide investment advice to attendees of the event.

• Engage in any investment negotiations between the issuer and the investors attending the event.

• Charge attendees of the event any fees, other than reasonable administrative fees.

• Receive any compensation for making introductions between event attendees and issuers, or for investment negotiations between the parties.

• Receive any compensation with respect to the event that would require the sponsor to register as a broker or dealer under the Exchange Act, or as an investment adviser under the Advisers Act.

Testing-the-Waters Expansion: Rule 241

The SEC modernized and expanded the ability of issuers to communicate with investors during an exempt offering through “testing-the-waters” communications. Before the SEC adopted the amendments, emerging growth companies, issuers in registered offerings, and (to some extent) issuers in Regulation A offerings could communicate with eligible investors to gauge interest in an offering before or after filing a registration statement for that offering. However, other exemptions did not similarly permit issuers to test the waters in this manner.

Under newly promulgated Rule 241(a), issuers can now use generic solicitation of interest materials to test the waters for an exempt offering prior to determining which exemption the issuer will use in the offering. Any such communications must be made prior to the issuer determining which exemption it will rely on, and will be deemed an offer for purposes of the antifraud provisions of federal securities laws. The SEC noted that this expanded communication allows issuers to gauge interest and reduce uncertainty about whether they can successfully complete an offering before engaging in a potentially costly registration process.

However, to make such communications, issuers must also comply with certain conditions. Specifically, the communications must state the following:

• 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 the issuer intends to rely on for the subsequent offer and sale of the securities.

• No money or other consideration is being solicited, and if sent in response, it will not be accepted.

• 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 until (where applicable) the filing, disclosure, or qualification requirements of such exemption are met.

• A person’s indication of interest involves no obligation or commitment of any kind.

In relation to the expanded testing-the-waters communications, the SEC also amended Regulation D, Regulation A, and Regulation Crowdfunding as follows.

For Rule 502(b) of Regulation D, the amendments:

• Require issuers, where they sell securities in exempt offerings under Rule 506(b) within 30 days of making a generic solicitation of interest under Rule 241, to provide purchasers with any written materials relating to the generic solicitation of interest, regardless of whether the issuer engaged in a general solicitation of interest and regardless of whether such general solicitation of interest would be subject to integration with the Rule 506(b) offering.

For Regulation A and Regulation Crowdfunding, the amendments:

• Require that if an offering is commenced within 30 days of making such general solicitation of interest under Rule 241, issuers must publicly file any solicitation materials as an exhibit to the offering materials.

Expanded Crowdfunding Communications: Rule 206

In addition to the broadly applicable testing-the-waters expansion under Rule 241, the SEC promulgated Rule 206 to permit issuers under Regulation Crowdfunding to test the waters orally or in writing with all potential investors prior to filing a Form C with the SEC. However, such communications must meet the requirements in Rule 206(b). Rule 206(b) provides that the communications must state the following:

• No money or other consideration is being solicited, and if sent in response, it will not be accepted.

• No offer to buy the securities can be accepted, and no part of the purchase price can be received, until the offering statement is filed, and it must be filed through an intermediary’s platform.

• A person’s indication of interest involves no obligation or commitment of any kind.

Updated Integration Framework: Rule 152

When companies engage in multiple offerings close in proximity to one another, the question becomes whether the issuer improperly bypassed the registration requirements of the Securities Act, and whether these offerings should be “integrated” into a single offering — requiring a single exemption to apply to all as if all were part of the same offering.

The SEC acknowledges the extent to which the complexity of the integration framework has expanded over time. In an effort to mitigate these historical issues, provide for a more comprehensive integration framework, and simplify integration analysis, the SEC promulgated new Rule 152, which replaces the integration provisions of several Securities Act exemptions. Specifically, the SEC amended Rule 502(a), Rule 251(c), Rule 147(g), and Rule 147A(g) to provide cross-references to the new general principle of integration and safe harbors for integration in Rule 152.

General Integration Principle: Rule 152(a)

Rule 152 provides a new general principle of integration, available for all offers and sales of securities not covered by one of its four safe harbors. The table below outlines the new general integration principle.

Integration Safe Harbors: Rule 152(b)

In addition to the general integration principle, Rule 152 provides issuers with the following non-exclusive integration safe harbors.

Commencement, Termination, and Completion of Offerings: Rule 152(c) and Rule 152(d)

In order to further clarify this new integration analysis, and recognizing that the existing rules do not clearly define the meaning of “commenced” or “terminated or completed” with respect to exempt and registered offerings, the SEC adopted provisions for determining when an offering has “commenced” (new Rule 152(c)) and has “terminated or completed” (new Rule 152(d)).

Harmonizing Bad Actor Disqualifications

Finally, the amendments address inconsistencies in the application of the “bad actor” disqualification provisions in Regulation D, Regulation A, and Regulation Crowdfunding. Prior to the adoption of the amendments, an offering participant could be disqualified from participating in an offering for a disqualifying event that occurred during the “lookback” period as defined in the above-mentioned regulations. Regulation A and Regulation Crowdfunding measured the lookback period from the time an issuer files an offering statement, and Regulation D measured the lookback period from the time of the sale of securities in the offering.

In the interest of harmonizing these provisions, the SEC amended Regulation A and Regulation Crowdfunding to adjust the lookback requirements to include the time of sale of securities in addition to the time of filing an offering statement. However, the SEC retained the current lookback period (using the time of filing) applicable to covered beneficial owners in Regulation A and Regulation Crowdfunding rather than amending it to start at the time of sale.

[1] Newly promulgated Rule 3a-9 of the Investment Company Act defines “crowdfunding vehicles.”

Liam B. Doolin contributed to this article.