On November 2, 2020, the Securities and Exchange Commission (the “Commission”)  adopted amendments to its rules under the Securities Act  (the “Securities Act”)  in an effort to harmonize, simplify and modernize the exempt offering framework (the “Amendments”).  The Commission noted that the goal of the Amendments is to promote capital formation and expand investment opportunities in offerings exempt from the registration requirements under the Securities Act while continuing to protect investors.

The Amendments revise several of the exemptions that are frequently relied upon by small and medium-sized companies, including startups to raise capital.  

Highlights of the Amendment

Among other revisions, the Amendments:

• Revise the “integration” framework to provide issuers with increased flexibility to conduct multiple offerings;
• Expand and harmonize rules governing certain offering communications, including permitting certain “test-the-waters” and “demo day” activities;
• Increase the offering limits under Regulation A, Regulation Crowdfunding and Rule 504 offerings, and revise certain individual investment limits; and
• Align the financial disclosure requirements for Rule 506(b) offerings to non-accredited investors with the requirements under Regulation A.

Integration Framework

The Amendments overhaul the framework for evaluating whether multiple securities transactions should be “integrated,” meaning considered part of the same offering for purposes of determining whether an exemption is available.  The revised integration framework is contained in revised Rule 152.  Rule 152(a) states the updated general principle for integration and Rule 152(b) sets out four safe harbors.

General Principle

The general principle set out in Rule 152(a) is that two offerings will not be integrated if, based on the facts and circumstances, the issuer can establish that each offering either complies with the registration requirements of the Securities Act or qualifies for an exemption from registration. The key distinction made in Rule 152 is between exempt offerings that prohibit and allow general solicitations.

Exempt Offerings that Prohibit General Solicitations.  Where the exemption being used prohibits general solicitations, as to each purchaser of the offering, the issuer must have a reasonable belief, based on the facts and circumstances, that the issuer (or any person acting for the issuer) either did not solicit such purchaser through a general solicitation or had established a substantive relationship with the purchaser prior to the commencement of the offering.  In a footnote to the release, the SEC clarified that it does not consider self-certification of financial status and sophistication by a purchaser as sufficient to establish a substantive relationship.

Concurrent Exempt Offerings that Allow General Solicitations.  Where the issuer is conducting concurrent exempt offerings and using permitted general solicitation materials, if the materials for one offering include information about the terms of another concurrent exempt offering, the materials used in the first offering could be considered an offering of securities in the other concurrent offering. Therefore, the offering materials for each offering must also comply with the legend requirements and communications restrictions related to the other concurrent offer.

Integration Safe Harbors

Revised Rule 152(b) contains four safe harbors:

Any offering made more than 30 calendar days before the commencement of any other offering, or more than 30 calendar days after the termination or completion of any other offering, will not be integrated with such other offering(s); provided that:

• in the case where an exempt offering for which general solicitation is prohibited follows by 30 calendar days or more an offering that allows general solicitation, the issuer has a reasonable belief, based on the facts and circumstances, with respect to each purchaser in the exempt offering prohibiting general solicitation, that the issuer (or any person acting on the issuer’s behalf) either did not solicit such purchaser through the use of general solicitation or established a substantive relationship with such purchaser prior to the commencement of the exempt offering prohibiting general solicitation.

To prevent serial Rule 506(b) exempt offerings each month in reliance on a 30-day safe harbor, the Commission adopted an amendment to Rule 506(b) to limit the number of non-accredited investors purchasing in Rule 506(b) offerings to no more than 35 within a 90 calendar day period.

1. Offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or in compliance with Regulation S will not be integrated with other offerings.

2. An offering for which a Securities Act registration statement has been filed will not be integrated if it is made subsequent to:

• a terminated or completed offering for which general solicitation is not permitted;
• a terminated or completed offering for which general solicitation is permitted that was made only to qualified institutional buyers and institutional accredited investors; or
• an offering for which general solicitation is permitted that terminated or was completed more than 30 calendar days prior to the commencement of the registered offering.

3. Offers and sales 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.

Practice Note: These safe harbors address concerns that arise frequently and should eliminate a lot of the uncertainty regarding typical integration situations.  However, issuers and practitioners should be aware that state integration rules are not affected by the new SEC rules, except in Rule 506 offerings where they would be pre-empted under the National Securities Markets Improvement Act of 1996 (NSMIA).

Determination of When Offerings Commence and are Terminated

The Commission provided clarification on when offerings should be deemed to have commenced and terminated to assist in utilizing the new safe harbors in Rule 152(b). Revised Rule 152(c) sets out a non-exclusive list of factors to consider as to when an offering commences and Rule 152(d) sets out a non-exclusive list of factors to consider when an offering has terminated or been completed.

Practice Note:  The commencement of private communications between an issuer, or its agents (including private placement agents), and prospective investors in an exempt offering in which general solicitation is prohibited may be considered as the commencement of the non-public exempt offering for purposes of new Rule 152, if such private communication involves an offer of securities.

“Testing-the-Waters” Communications

The Amendments adopt new Rule 241, which permits an issuer to use generic “solicitation of interest” materials that comply with the requirements of the rule to “test-the-waters” for an exempt offer of securities prior to determining which exemption it will use for the actual sale of securities.  The actual sale will need to satisfy all of the requirements of the exemption ultimately chosen by the issuer and the issuer cannot accept any consideration until such exemption is determined and the offering is commenced.  Such communications are subject to the antifraud provisions of the securities laws.

The solicitation of interest must state that:

• The issuer is considering an offering of securities exempt from registration under the Securities Act, but has not determined the specific exemption from registration the issuer intends to rely upon for the offering or sale of securities;
• No money or other consideration is being solicited, and if sent in response, 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, where applicable, the filing, disclosure, or qualification requirements of such exemption are met; and
• A person’s indication of interest involves no obligation or commitment of any kind.

The Amendments adopt new Rule 206, which permits Regulation Crowdfunding issuers to “test the waters” prior to filing an offering document with the SEC in a manner similar to the process currently permitted under Regulation A.

Practice Note: Since solicitations of interest could be distributed to non-accredited investors, it could potentially be considered a general solicitation, which could complicate the ability of the issuer to then utilize an exemption that prohibits general solicitation.  The issuer would need to determine if the original general solicitation and the later exempt offering need to be integrated in accordance with the principles articulated in revised Rule 152.

“Demo Days” Communications

The Commission adopted new Rule 148 which permits certain communications related to “Demo days” without such communications being considered general solicitation. “Demo Days” are seminars and meetings or similar events, sponsored by eligible sponsors, where issuers present their business to potential investors, with the aim of securing investment.  Eligible sponsors include a college, university or other institution of higher education, state or local government or instrumentality, non-profit organization, or angel investor group, incubator, or accelerator.

Practice Note:  The list of eligible sponsors does not include private equity or venture capital funds.

Other conditions for an event to qualify for Rule 148 include:

• More than one issuer must participate in the event;
• No advertising for the seminar or meeting can reference a specific offering of securities by the issuer;
• The sponsor cannot:
  • Make recommendations or provide investment advice to attendees;
  • Engage in any investment negotiations between the issuer and attendees;
  • Charge attendees any fees, other than reasonable administrative fees;
  • Receive any compensation for making introductions between issuers and attendees, or for negotiations between them; or
  • Receive any compensation with respect to the event that would require registration as a broker-dealer or investment adviser;
• The information regarding any offering is limited to a notice that the issuer is in the process of offering or planning to offer securities, the type and amount being offered, the intended use of proceeds and the unsubscribed amount it the offering; and
• If the event allows for virtual participation, communications to non-accredited investors must be limited to:
  • Individuals who are members of, or otherwise associated with, the sponsor organization;
  • Individuals that the sponsor reasonably believes are accredited investors; and
  • Individuals who have been invited to the event by the sponsor based on their industry or investment-related experience reasonably selected by the sponsor in good faith and disclosed in the public communications about the event.

Offering and Investment Limits

The Commission has also amended the current offering and investment limits for certain exemptions.

Regulation A

• The maximum offering amount under Tier 2 of Regulation A is increased from $50 million to $75 million in a 12 month period; and
• The maximum offering amount for secondary sales under Tier 2 is increased from $15 million to $22.5 million.

The cap for Tier 1 of Regulation A remains at $20 million in a 12 month period.

Tier 2 offerings will continue to be preempted from State law registration and qualification requirements, and the States will retain oversight over Tier 1 offerings.

Regulation Crowdfunding

• The offering limit is raised from $1.07 million to $5 million.
• The investment limits are amended to (i) remove investment limits for accredited investors; and (ii) use the greater of investors’ annual income or net worth when calculating the investment limits for non-accredited investors.
• Extends for 18 months the existing temporary relief providing 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 (the “Extension Amendment”).

Rule 504 of Regulation D

• The maximum offering amount is increased from $5 million to $10 million.

Financial Disclosure Under Rule 502(b)

The Commission amended the financial disclosure requirements in Rule 502(b) in order to align the disclosure requirements with those under Regulation A.  These amendments repeal audit requirements for Rule 506(b) offerings of up to $20 million involving non-accredited investors.

Other Changes

Among other changes, the Amendments also:

• Clarify and update  guidance regarding verification of accredited investor status under Rule 506(c);
• Simplify certain requirements for Regulation A offerings establishing greater consistency between Regulation A and registered offerings;
• Establish rules to permit the use of certain special purpose vehicles to facilitate investing in a single Regulation Crowdfunding issuer;
• Impose eligibility restrictions on the use of Regulation A by issuers that are delinquent in their reporting obligations under the Exchange Act;
• Clarify that securities offered and sold under Regulation Crowdfunding constitute “covered securities” for state law preemption purposes;  and
• Harmonize the bad actor disqualification provisions in Regulation D, Regulation A, and Regulation Crowdfunding such that the look-back requirements generally also refer to the time of sale.

Effective Date

The Amendments, except for the Extension Amendment, will be effective in early January 2021, 60 days after the publication of the new rules in the Federal Register. The Extension Amendment will be effective upon the publication of the new rules in the Federal Register.