On November 2, the U.S. Securities and Exchange Commission (SEC) adopted final rules relating to the modernization and harmonization of the private offering framework. These rules were initially proposed on March 4, 2020, and were adopted with few changes based on comments received:

• New Rule 152 modernizes the integration doctrine, providing that offerings will not be integrated if one of the four safe harbors applies, or the issuer can establish compliance with either registration or exemption requirements.
• New Rule 148 clarifies who can sponsor a “demo day,” and what information issuers can provide at these events, without it being characterized as a general solicitation, although the rule is narrower with respect to virtual events.
• New Rule 241 permits an issuer to “test the waters” prior to determining the exemption under which an offering will be conducted.
• Regulation Crowdfunding was also amended to incorporate “testing the waters” provisions in new Rules 206 and 201(z), as well as to extend COVID relief measures (through February 28, 2022) and to incorporate the concept of investing through a conduit crowdfunding vehicle.
• Certain offering limitations were increased: Regulation A Tier 2 (now $75 million), Regulation Crowdfunding (now $5 million), and Rule 504 (now $10 million).
• Certain disclosure requirements were revised to simplify compliance: Rule 506(c) (permitting reliance on prior verification of accredited investor status for up to five years), Rule 502(b) (aligning Regulation D financial disclosure requirements with those for Regulation A), and Regulation A (simplifying redaction procedures and permitting incorporation by reference).

The remainder of this alert provides greater detail with respect to these final rules.

Changes to Rules Governing Integration of Offerings

The integration doctrine prevents an issuer from conducting multiple exempt offerings under different exemptions from registration where the offerings are in fact a single offering where all offers and sales must comply with a single exemption. This doctrine has been part and parcel of securities regulation since its inception, and has traditionally been enforced primarily by evaluating five factors, namely, whether different offerings were (1) part of a single plan of financing, (2) involved issuance of the same class of security, (3) made at or about the same time, (4) exchanged for the same type of consideration, and (5) made for the same general purpose. The SEC had also adopted safe harbors from integration for many exempt offerings. The rules regarding enforcement have, however, become more patchwork over time.

In order to eliminate this patchwork and in light of developments in the capital markets and communications technology, the SEC adopted Rule 152 to modernize the integration framework. (This replaces existing Rule 152.) The SEC also harmonized the integration provisions across the exempt offering framework by amending rules to incorporate cross-references to Rule 152,^[1] and by removing rules that are replaced by the provisions of Rule 152.^[2] Rule 155 has also been repealed.

Rule 152(a) – General Rule

The general rule provides that offers and sales will not be integrated if, based on the particular facts and circumstances, the issuer can establish that each offering either complied with the registration requirements of the Securities Act or that an exemption from registration is available.

For exempt offerings prohibiting general solicitation, this means that an issuer must have a reasonable belief, with respect to each purchaser, either (i) that the issuer did not solicit the purchaser through general solicitation, or (ii) that the issuer had established a substantive relationship with the purchaser prior to the commencement of the offering. Preexisting relationships can include direct relationships between the issuer and the purchaser, as well as indirect relationships established through an intermediary, such as a registered broker-dealer or investment adviser. A preexisting relationship is substantive if the issuer (or intermediary) has sufficient information to evaluate, and does in fact evaluate, a purchaser’s financial circumstances and sophistication.

The introductory language for this section is also significant, embracing the SEC’s traditional “substance-over-form” approach to regulation by cautioning that the rule, and its safe harbors (discussed below), will not apply to a series of transactions that, “although in technical compliance with the rule, are part of a plan or scheme to evade the registration requirements of the Securities Act.”^[3]

Rule 152(b) – Four Safe Harbors

The first safe harbor provides that offerings will not be integrated if they occur more than 30 calendar days apart. This is a significant change from the current safe harbors, which impose a six-month waiting period. The SEC stated this change was warranted by technological advancements that accelerate access to market information. In connection with this shortening, however, the safe harbor incorporates the investor protections from Rule 152(a) that require either no general solicitation or a pre-existing substantial relationship, and the SEC amended Rule 506(b)(2)(i) to provide that, in the case of successive 506(b) offerings, an issuer cannot sell securities to more than 35 non-accredited investor purchasers in a 90-day period. (The impact of this limitation may be somewhat abrogated by the recent expansion of the definition of “accredited investor,” which we wrote about here.)

The second safe harbor provides that there will be no integration of offers and sales of securities made pursuant to Rule 701, made pursuant to an employee benefit plan, or made in compliance with Regulation S, regardless of when the offerings occur.

The third safe harbor provides protection for three categories of pre-registration offerings that private companies traditionally use to raise the operating capital they need to get them through the initial public offering process. This safe harbor will protect pre-registration offerings from integration with the registered offering if (i) the terminated or completed pre-registration offering did not permit general solicitation; (ii) the terminated or completed pre-registration offering permitted general solicitation, but only to institutional investors (QIBs and IAIs)^[4]; or (iii) the pre-registration offering permitted general solicitation, but was terminated or completed more than 30 calendar days prior to the registered offering.

The fourth safe harbor provides more generally that exempt offerings where general solicitation is permitted (“Offering 2” below) that follow any other terminated or completed offering (“Offering 1” below) will not be integrated.

Table 3 from the SEC Discussion of Final Amendments.

Rules 152(c) and 152(d) – Factors for Determining When an Offering Has Commenced, Terminated, or Completed

Determining when an offering has commenced and when it has terminated or completed is important in applying Rules 152(a) and (b). Under the final rules, when an offering has commenced, terminated, or completed, depends on the type of offering:

*These rules are also new. Please see below for further discussion.

Changes to Rules Governing Solicitation

The SEC also sought to modernize and clarify the rules relating to when a solicitation or other communication constitutes an offer and when it is permissible “testing the waters.”^[5]

Demo Days – Rule 148

“Demo days” refer to events during which issuers provide information to potential investors for the purpose of securing investment.

Under new Rule 148, these presentations do not constitute a general solicitation if they are made in connection with an event hosted by an authorized sponsor and the issuer provides only certain information. Authorized sponsors are limited to colleges, universities, or other institutions of higher education; a State or local government, or instrumentality of a State or local governments; a nonprofit organization; or, an angel investor group, incubator, or accelerator. An authorized sponsor is also prohibited from profiting from its involvement in the event (although this does not preclude fees to cover administrative costs).^[6] Additionally, issuers are only permitted to provide notice that an offering is in process or planned and information regarding the number and type of securities being offered, the intended use of the proceeds, and the unsubscribed amount in the offering.

The Rule 148 exception is narrower when applied to an event that is hosted virtually. In that event, the sponsor must also limit the types of investors who can participate to (1) individuals who are members of, or otherwise associated with the sponsor, (2) individuals that the sponsor reasonably believes are accredited investors, and (3) individuals who have been invited to the event based on industry or investment-related experience and who are disclosed in the public communications about the event.

Testing the Waters – Rule 241 and Crowdfunding Rules 206 and 201(z)

Rules 163B and Regulation A currently permit certain “testing the waters” communications to prospective investors, but only in limited circumstances.

New Rule 241 applies more broadly to permit an issuer (or a person authorized to act on behalf of an issuer) to solicit interest orally or in writing where the issuer has not yet made a determination as to the exemption under which an offering would be conducted. No solicitation or acceptance of consideration or commitment is permitted, however, and any materials must contain a legend with specific disclosures,^[7] but an issuer can collect contact information. In addition, any materials must later be made publically available (if the offering proceeds under Regulation A or Regulation Crowdfunding) or provided to non-accredited investors purchasers (if the offering proceeds under Rule 506(b)), although in each case only if the offering is commenced within 30 days.

The SEC expressly declined to preempt State blue sky laws, preferring to roll-out new Rule 241 on a “more measured” basis, so be sure to consult your advisers with respect to applicable State law requirements.

New Rule 206 and Rule 201(z) apply only under Regulation Crowdfunding. Testing-the-waters materials used in this context must also contain a cautionary legend^[8] and be included if and when the Form C offering statement is filed. Rule 204 was also amended in connection with these new rules, in order to explicitly permit oral communications, clarify that an issuer may include a description of the planned use of proceeds and progress information, and permit issuers to provide information about the offering in a concurrent offering (e.g., under Regulation A).

The Best of All the Rest

Offering Limitations

Regulation A’s Tier 2 offering maximum was increased to $75 million (from $50 million), and, commensurate with this change, the offering maximum for secondary sales was also increased to $22.5 million (from $15 million).

Rule 504’s offering maximum was increased to $10 million (from $5 million). The twelve-month aggregation concept was not changed, however.

Regulation Crowdfunding’s offering restrictions were amended to increase the offering maximum to $5 million (from $1.07 million), to remove investment limits for accredited investors, and to revise the calculation for non-accredited investors to rely on the greater of annual income or net worth (the current calculation relies on the lesser of the two).

Disclosure Requirements

Rule 506(c) was updated to allow issuers to rely on prior verification of an accredited investor’s status for up to five years, and the principles-based verification method was reaffirmed.^[9]

Rule 502(b) requirements for Regulation D financial disclosures were amended to align with the Regulation A requirements.

Regulation A was also amended to simplify disclosure compliance, and now (i) provides an option to file redacted exhibits without first having to apply for confidential treatment (similar to Regulation S-K); (ii) codifies the SEC staff practice of permitting redaction of personal identifying information without first having to submit a confidential treatment request; (iii) permits the use of EDGAR to publicly disclose documents previously submitted for non-public review (similar to emerging growth companies); (iv) permits incorporation by reference for previously-filed financial statements if the issuer meets the eligibility criteria; and (v) allows the SEC to declare post-qualification amendments to offering statements abandoned.^[10]

Bad Actor Look-Back Period

Regulation A, Regulation Crowdfunding, and Regulation D each disqualify certain “bad actors” (e.g., felons) from offering and selling securities for a designated period of time. Regulation A and Regulation Crowdfunding measure this period from the time an issuer files an offering statement (i.e., they “look-back” to the time of filing), and Regulation D measures this period from the time an issuer sells the securities. In order to harmonize these bad actor look-back period, Rule 262(a) (under Regulation A) and Rule 503(a) (under Regulation Crowdfunding) were amended to include the time of sale as an optional point of reference for the look-back.

Regulation Crowdfunding

Several other crowdfunding-specific provisions will be implemented as well, including extension of the temporary COVID relief rules through February 28, 2022. These temporary rules apply only to offerings between $107,000 and $250,000, and provide that an issuer can use financial statements certified by the principal executive officer if no audited financial statements are available and such disclosure features a prominent indication of reliance on this temporary rule.

Additionally, new Rule 3a-9 under the Investment Company Act creates an exception to the definition of “investment company” for a crowdfunding vehicle that operates as a conduit for crowdfunding investors to purchaser crowdfunding issuer securities. To qualify for this exception, the crowdfunding vehicle must:

• Be organized and operated for the sole purpose of directly acquiring, holdings, and disposing of the securities of a single crowdfunding issuer (the “Issuer”) and raising capital in one or more crowdfunding offerings;
• Issue only one class of securities in a crowdfunding offering alongside the Issuer (i.e., as a co-issuer);^[11]
• Have a written undertaking from the Issuer to fund or reimburse the costs of formation, operation, and wind-up, (but no other compensation may be paid);
• Maintain the same fiscal year as the Issuer;
• Maintain a one-to-one relationship between the number, denomination, type and rights of Issuer securities the crowdfunding vehicle owns and the number, denomination, type and rights of its own outstanding securities;
• Vote Issuer securities and participate in tender or exchange offers only in accordance with investor instructions;
• Promptly provide all Issuer disclosures and information to the investors and the relevant intermediary;
• Provide investors with any information received from the Issuer as a shareholder of record in the Issuer;
• Not borrow money;
• Reinvest any proceeds in a single class of securities of a single crowdfunding issuer;
• Redeem or offer to repurchase its securities from investors if there is a liquidity event at the Issuer level; and
• Require that any compensation paid to a person operating the crowdfunding vehicle be paid solely by the Issuer.
• Provide investors the right to direct the crowdfunding vehicle to assert State or Federal law rights that the investor would have if the investor invested directly in the Issuer.

In connection with this structure, the crowdfunding vehicle must jointly file the Form C with the Issuer, unless the Issuer is offering securities both through the vehicle and directly to investors,^[12] in which case the Issuer must file a separate Form C.^[13]

In Closing

The changes to the exempt offering framework are significant. This alert provides a brief overview of the main features. How these features affect a particular offering will vary and each offering or investment will need to be evaluated carefully in light of these changes.

^[1] Rule 502(a), Rule 251(c), Rule 147(g), Rule 147A(g), Rule 500(g), and Rule 100 have been amended to incorporate a cross-reference to Rule 152 in place of their own integration provisions.

^[2] Rule 255(e), Rule 147(h), and Rule 147A(h) have been eliminated because new Rule 152(b)(3) replaces these provisions.

^[3] For example, if general solicitation materials for one exempt offering include information about the material terms of a concurrent offering under another exemption, the general solicitation materials may constitute an offer of the securities for both offerings.

^[4] Qualified Institutional Buyers and Institutional Accredited Investors.

^[5] Although the solicitations permitted under these new rules are not “offers” that constitute unlawful gun-jumping, they are considered “offers” for the purpose of the antifraud provisions of the securities laws.

^[6] Specifically, the rule prohibits sponsors from (1) making investment recommendations or providing investment advice to attendees, (2) engaging in any investment negotiations between the issuer and investors attending the event, (3) charging attendees any fees other than reasonable administrative fees, or (4) receiving any compensation with respect to the event that would require it to register as a broker or dealer under the Exchange Act or an investment advisor under the Advisers Act.

^[7] Specifically, the materials must state that (1) the issuer is considering an offering of securities exempt from registration under the Act, but has not determined a specific exemption from registration the issuer intends to rely on for the subsequent offer and sale or the securities; (2) no money or other consideration is being solicited, and if sent in response, will not be accepted; (3) no offer to buy the securities can be accepted an no part of the purchaser price can be received until the issuer determines the exemption under which the offering is intended to be conducted and, where applicable, the filing, disclosure, or qualification requirements of such exemption are med; and (4) a person’s indication of interest involves no obligation or commitment of any kind.

^[8] Specifically, the legend must state 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 to purchase accepted unit the Form C offering statement is filed with the Commission and other through an intermediary’s platform; and (3) prospective purchaser’s indications of interest are non-binding.

^[9] Specifically, the principles-based method takes into account (1) the nature of the purchaser and the type of accredited investor that the purchaser claims to be, (2) the amount and type of information that the issuer has about the purchaser, and (3) the nature of the offering (e.g., manner of solicitation).

^[10] Regulation A will also now require reporting companies (issuers that are subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act) to file all required Rule 257 reports for the two years preceding the filing of the Regulation A offering statement.

^[11] The SEC confirmed that a crowdfunding vehicle would, therefore, not implicate broker-dealer registration requirements.

^[12] The SEC also clarified that the crowdfunding vehicle itself is not considered an investor for the purposes of Regulation Crowdfunding.  This means that the individual investment limitations do not apply to a transfer of securities from the Issuer to the crowdfunding vehicle and that the number of securities transferred from the Issuer to the crowdfunding vehicle does not reduce the number of securities that can be sold directly to investors.  Somewhat conceptually contrary to this, new Rule 12g5-1(a)(9) specifies that the crowdfunding vehicle is a single record holder for the purpose of determining whether the Issuer is required to register the securities, to the extent that all investors in the crowdfunding are natural persons. 

^[13] The SEC declined to adopt amendments that would have imposed Regulation A limitations on the types of securities that can be offered.