SEC Adopts Final Rules to Facilitate Intrastate and Regional Securities Offerings

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The Securities and Exchange Commission (SEC) has adopted final rules modernizing and expanding the ways in which smaller companies can raise capital.

Rule 147 of the Securities Act of 1933, as amended, provides a safe harbor for the exemption from registration for intrastate offerings. In addition, the final rules adopt new Rule 147A, which provides an intrastate offering exemption that has no restrictions on offers and accommodates companies that are incorporated or organized outside the state where the offering is conducted.

The final rules also amend Rule 504 of Regulation D to increase the aggregate amount of securities that may be offered and sold in any 12-month period from $1 million to $5 million, and to disqualify certain bad actors from participating in such offers. Lastly, the final rules repeal Rule 505 of Regulation D.

The final rules amending Rule 147 and adopting Rule 147A will become effective 150 days after publication in the Federal Register. The final rules amending Rule 504 will become effective 60 days after publication in the Federal Register. The repeal of Rule 505 will become effective 180 days after publication in the Federal Register.

The SEC adopted the final rules on October 26, 2016. The SEC noted in the adopting release that a number of commenters, market participants, and state regulators indicated that the combined effect of the statutory limitation on offers to persons residing in the same state or territory as the issuer and the prescriptive eligibility requirements of Rule 147 limit the availability of the exemption for companies that would otherwise conduct intrastate offerings. As a result, the SEC adopted final rules that would modernize the manner in which companies can raise capital to fund their businesses through intrastate and small offerings while also maintaining investor protections. In a press release, SEC Chair Mary Jo White noted, "[t]hese final rules, while continuing to provide investor protections, update and expand the capital raising avenues for smaller companies, allowing them to more fully take advantage of changes in technology and business practices."

The final rules implement considerable changes to Rule 147 of the Securities Act, including the requirement that an issuer which is a corporation, limited partnership, trust, or other form of business organization will be deemed a resident of the state or territory if it is both incorporated or organized and has its principal place of business in the state or territory. The final rules also amend the issuer's "doing business" requirement. In particular, an issuer must satisfy only one of four "doing business" requirements to demonstrate the in-state nature of the business.

In addition to amending the issuer's residency and place of business requirements, the final rules adopt a reasonable belief standard to the issuer's determination as to the residence of the purchaser at the time of the sale of the securities. An issuer may now satisfy the purchaser's residency requirement if the issuer offers or sells securities to residents of the state or territory in which the issuer is a resident or persons who the issuer reasonably believes, at the time of the offer and sale, are residents of the state or territory in which the issuer is a resident. The issuer is required to obtain written representations from each purchaser as to his or her residence, however, obtaining a written representation from purchasers of in-state residency status will not, without more, be sufficient to establish a reasonable belief that such purchasers are in-state residents. The final rules provide that the residency of a purchaser that is a corporation, partnership, trust, or other form of business organization is now defined by the location where, at the time of the sale, the purchaser has its principal place of business.

Additionally, the final rules reduce the resale period of the securities from nine months to six months. Specifically, the final rules mandate for a period of six months from the date of the sale by the issuer, any resale of such security shall be made only to persons residing within the state or territory in which the issuer was a resident at the time of the sale of the security by the issuer. The final rules also require that in addition to issuing stop transfer instructions to the issuer's transfer agent with respect to the securities and to obtaining a written representation from each purchaser as to residency, the issuer must now place a prominent legend on the certificate or other document evidencing the security that contains specific language concerning the sale and the limitations on resale. The final rules require that certain disclosures should also be made to each offeree at the time any offer is made.

Finally, and most significantly, the final rules adopt an integration safe harbor. Specifically, offers and sales made in reliance on Rule 147 will not be integrated with prior offers or sales of securities by the issuer made under another provision or certain offers and sales made by the issuer occurring after the completion of the offering. Further, when an issuer registers an offering under the Securities Act after making offers to qualified institutional buyers and institutional accredited investors in reliance on Rule 147, such offers will not be subject to integration with any subsequent offering. Additionally, if the issuer makes offers in reliance on Rule 147 to persons other than qualified institutional buyers and institutional accredited investors, such offers will not be subject to integration if the issuer waits at least 30 calendar days between the last offer made in reliance on Rule 147 and the filing of the registration statement with the SEC.

In addition to amending Rule 147, the final rules adopt new Rule 147A. Offers and sales made in accordance with Rule 147A are exempt from Section 5 of the Securities Act. Under Rule 147A, an issuer may make offers and sales using any form of general solicitation and general advertising, including to out-of-state residents, so long as sales are limited to in-state residents. Rule 147A requires that, at the time of the offers and sales, the issuer be a resident and doing business within the state or territory in which all of the sales are made. Residency is determined by principal place of business.

Rule 147A is similar to Rule 147 in nearly all other respects, including but not limited to, the definition of doing business within a state or territory, the adoption of the reasonable belief standard for a purchaser's residency, the six-month resale limitation, the inclusion of a prominent legend disclosing to purchasers a description of the sale and the limitations of resale and the integration safe harbor of prior offers or sales of securities by the issuer made under another provision or certain offers and sales made by the issuer occurring after the completion of the offering.

With regard to Rule 504 of Regulation D, the SEC noted in the adopting release that many commenters supported increasing the Rule 504 offering amount limit from $1 million to $5 million in a 12-month period in order to allow more small businesses to use this capital-raising tool. Several commentators perceived Rule 504 as underutilized, in part due to the low offering amount limit of $1 million and the erosion of the dollar's value due to inflation since the offering amount limit was last raised in 1988 from $500,000 to $1 million. As a result, the SEC implemented final rules that would facilitate issuers' ability to raise capital and increase the flexibility of state securities regulators to set their own limits and to consider whether additional requirements should be implemented at the state level.

Accordingly, the final rules increase the aggregate price for an offering to $5 million, which is the maximum statutorily allowed under Section 3(b)(1). The final rules also prohibit the issuance of securities from certain issuers (bad actors) that would be subject to disqualification under Rule 506(d).

As a result of the implementation of the amendments to Rule 504, the final rules repeal Rule 505 of Regulation D. The SEC noted that the amendment to Rule 504 will further reduce the incentives to use Rule 505 by issuers contemplating an exempt offering. Further, if the SEC were to increase the Rule 505 aggregate offering amount limit from $5 million to $10 million, or some higher amount, such a higher limit would not increase the utility of the Rule 505 exemption as compared to Rule 506, which has no limit, given the historical use of Rule 505 as compared to Rule 506.

All of the changes adopted in the final rules should make it easier for smaller companies to utilize the exemptive frameworks for smaller offerings within the Securities Act to raise capital. The incorporation of the integration safe harbor will enable issuers to rely upon Rule 147 for offerings pursuant to state law exemptions that are conditioned upon compliance with Section 3(a)(11) and Rule 147. The adoption of Rule 147A provides an alternative means for smaller companies to raise capital locally yet reach more potential investors. The amendment of Rule 504 will enable smaller companies to raise more capital in their offerings. The repeal of Rule 505 should not impede smaller companies from raising capital, as they can rely on Rules 504 and 506.

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