On the right track: Securities & Exchange Commission adopts rules to streamline private offering exemptions

Eversheds Sutherland (US) LLPIntroduction 

On November 2, 2020, the Securities and Exchange Commission (the SEC) voted to adopt final amendments (the Amendments) 1 to “simplify, harmonize, and improve certain aspects of the exempt offering framework.” 2 The Securities Act of 1933, as amended (the Securities Act), requires that every offer and sale of securities be registered with the SEC, unless an exemption from registration is available. The current exempt offering framework includes ten exemptions or safe harbors from the registration requirements of the Securities Act, each with distinct requirements. The goal of the Amendments is to reduce unnecessary complexity within the exempt offering framework and to allow market participants (including business development companies, or BDCs) to navigate through the exempt offering framework more easily.

To summarize, the Amendments:

  • clarify the ability of issuers to move from one exemption to another;
  • revise certain offering and investment limits to address inconsistencies in current rules;
  • set clear and consistent rules governing offering communications between investors and issuers (e.g., “test-the-waters” and “demo day” activities); and
  • harmonize certain disclosures, eligibility requirements and bad actor disqualification provisions.

The Amendments were initially proposed in March 2020 (the Proposed Amendments) following the SEC’s June 2019 concept release, which solicited initial public comment on ways to simplify and improve the exempt offering framework.3 The Amendments were adopted in response to such comments and are designed to address gaps and complexities in the exempt offering framework that impede access to capital for issuers and access to investment opportunities for investors. 

The Amendments were adopted substantially as proposed, with certain modifications that are discussed in more detail below. Appendix A below also provides a list of each specific rule amendment.

Integration

The integration doctrine provides a framework for issuers to determine whether securities offerings occurring in close proximity are truly independent of one another or are really just one integrated offering. Prior to the Amendments, the integration doctrine was guided by a patchwork of SEC rules, staff guidance and market practices, including the “five-factor” test that was highly dependent on facts and circumstances and lacked clarity regarding which factors should be ascribed the greatest weight. The Amendments adopt a new, simpler approach to integration, which consists of a general guiding principle and four non-exclusive safe harbors. 

The new integration framework adopts a principles-based approach to determine whether an exemption from registration is available for a particular offering by looking at the particular facts and circumstances of each offering. To summarize, the general principle provides that offers and sales 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 an exemption from registration is available for that particular offering. Notably, the SEC also shortened the relevant period for determining whether securities offerings are conducted in close proximity to one another from six months to 30 days.

The Amendments also apply the general principle of integration to two fact patterns: (1) an offering in which general solicitation is not permitted and (2) an offering in which general solicitation is permitted. Finally, the SEC has adopted four non-exclusive safe harbors from integration, which were adopted substantially as proposed. For more detailed information on these safe harbors, see Appendix A.

BDCs and other investment companies are permitted to rely on the new integration doctrine to determine if and when multiple sales of securities should be considered part of the same registered or exempt offering. As such, the Amendments will make it easier for BDCs to commence subsequent offerings with less uncertainty of whether the offerings will be “integrated.” Further, the shortening of the relevant period for determining whether securities offerings are undertaken in close proximity with one another is particularly helpful, given the current pace of capital market activities and especially the prominence of exempt offerings in capital raising efforts for private BDCs.

“Test-the-waters” and “demo day” communications

The SEC adopted several amendments and new rules relating to general solicitation and offering communications, including provisions that:

  • allow issuers to use generic solicitation of interest materials 4 to “test-the-waters” for an exempt offering of securities before determining which exemption to rely on;
  • allow issuers relying on Regulation Crowdfunding to “test-the-waters” prior to filing an offering document with the SEC; and
  • provide that certain “demo day” communications, or communications included in presentations made at organized events where the issuer provides information about the business to a group of potential investors with a goal or securing investments, are not considered general solicitation or general advertising.

BDCs conducting exempt offerings that currently prohibit general solicitation may benefit from these expansions of permitted communication options.

Verification of investor’s “accredited investor” status in Rule 506(c) offerings

Rule 506(c) allows investors to generally solicit and advertise an offering so long as the investor has taken reasonable steps to verify that all purchasers in the offering are accredited investors.5 The Amendments add a new item to the non-exclusive list of verification methods to allow an issuer to verify that a previously verified accredited investor remains an accredited investor if:

  • the issuer previously took reasonable steps to verify the investor’s status as an accredited investor;
  • the investor provides a written representation to the issuer that it continues to qualify as an accredited investor; and
  • the issuer is not aware of the contrary.

In a change from the proposed rule, the SEC added a five-year time limit from the time of the initial verification for an issuer to rely on this method of verification.

Some issuers, including private BDCs, have declined to conduct offerings under Rule 506(c) to avoid the onerous accredited investor status verification requirements. This amendment reduces certain burdens associated with the verification requirements and may make such offerings more attractive to BDCs. Further, a BDC that decides to conduct an exempt offering under Rule 506(c) can also take advantage of its ability to use general solicitation offering materials, which would not be permitted if the BDC conducted an offering in reliance upon certain other Rule 506 exemptions.

Offering and investment limits

The Amendments also revise the current offering and investment limits under Regulation A, Rule 504 of Regulation D and Regulation Crowdfunding as follows:

  Offering Limits
(in millions) 
Investment Limits
  Current Rule Amended Rule Current Rule Amended Rule
Regulation A: Tier 1 $20 $20 None None
Regulation A: Tier 2 $50 $75

Accredited Investor: None 

Non-Accredited Investor: limits based on the greater of an income or net worth standard

Accredited Investor: None 

Non-Accredited Investor: limits based on the greater of an income or net worth standard

Regulation Crowdfunding $1.07 $5 All Investors: limits based on the lesser of an income or net worth standard 

Accredited Investor: None 

Non-Accredited Investor: limits based on the greater of an income or net worth standard

Rule 504 of Regulation D $5 $10 None None

Currently, BDCs are not able to rely on Regulation A, Regulation Crowdfunding and Rule 504 of Regulation D to conduct exempt offerings.

Regulation A and Regulation Crowdfunding eligibility

The SEC also adopted certain amendments to the eligibility restrictions in Regulation Crowdfunding and Regulation A. Currently, an issuer may not use a special purpose vehicle that invests in a single company or that is an investment company (or a company excluded from the definition of investment company under the 1940 Act) to conduct a Regulation Crowdfunding offering. The Amendments address this by adding new Rule 3a-9 under the 1940 Act to exclude a crowdfunding vehicle meeting certain conditions from the definition of “investment company” under the 1940 Act.

The Amendments provide a new option for investment companies looking to benefit from the fundraising opportunities that Regulation Crowdfunding may provide and that were previously excluded from Regulation Crowdfunding entirely.

In addition, the Amendments also impose eligibility restrictions on the use of Regulation A by issuers. The current rule excludes issuers that have not filed required reports under Regulation A in the past two years, and the Amendments will also exclude issuers that have not filed required Section 13(a) or 15(d) Exchange Act reports in the prior two years.

Harmonization of disclosure requirements

The SEC also adopted as proposed certain amendments to the financial statement information requirements in Regulation D to align them with the less burdensome disclosure requirements set out in Regulation A. Currently, when non-accredited investors are participating in an offering under Rule 506(b) of Regulation D, the issuer is required to furnish specified financial statement information (along with non-financial information) to non-accredited investors at a reasonable time prior to the sale of securities and must provide these investors with the opportunity to ask questions and receive answers about the offering. Although Regulation A issuers must also provide certain financial statement and non-financial statement information to non-accredited investors, Rule 506(b) offerings require more burdensome financial statement information to be provided than is required by Regulation A. The Amendments are designed to address this inconsistency.

The SEC also adopted amendments to simplify the requirements for Regulation A offerings and establish greater consistency between Regulation A offerings and registered offerings.

Bad actor disqualification provisions

The SEC’s exempt offering framework includes rules that disqualify certain covered persons, including felons and other “bad actors” from relying on Regulation A, Regulation Crowdfunding and Regulation D to offer and sell securities. The Amendments harmonize the bad actor disqualification provisions in Regulation D, Regulation A and Regulation Crowdfunding by adjusting the look-back requirements with respect to disqualifying events.

The Amendments do not change the bad actor provisions applicable to BDCs conducting exempt offerings under Regulation D.

Practical considerations

Exempt offerings have become an increasingly important mechanism for capital raising in the United States, as the amount of capital raised in exempt offerings vastly exceeds the amount of capital raised in SEC-registered offerings. The Amendments may expand capital-raising opportunities for private companies and expand the pool of eligible investors for certain issuers, including BDCs. Such expansion may increase the availability of capital and allow more flexibility for BDC fundraising activities. In addition, BDCs will be permitted to take advantage of the relaxed communications rules that would allow for increased market communications that do not run afoul of the federal securities laws. The Amendments will become effective 60 days after publication in the Federal Register, except for the temporary Regulation Crowdfunding relief, which will become effective upon publication in the Federal Register. 

Appendix A

The following table summarizes the Amendments: 

Rule Amendments
Rule 152(a) –
General Principle of Integration
The Amendments adopt new Rule 152 (Rule 152) substantially as proposed, which will replace current Rule 152 and Rule 155 to provide a new comprehensive integration framework. Specifically, Rule 152(a) adopts a general principle of integration to replace the current five-factor integration test utilized by the SEC and applies the general principle to two specific fact patterns: 
  • Offering that Prohibits General Solicitation: If general solicitation is not permitted in an exempt offering, the issuer must have a reasonable belief, based on the facts and circumstances, with respect to each purchaser in the exempt offering that the issuer (a) did not solicit such purchaser through the use of general solicitation or (b) established a substantive relationship with such purchaser prior to the commencement of the exempt offering.  
  • Offering that Permits General Solicitation: If an issuer in an exempt offering is using general solicitation materials that include information about the material terms of a concurrent offering under another exemption, such materials may be deemed to constitute an offer of the securities in the concurrent offering, and therefore must comply with the requirements for the exemption being relied upon for the concurrent offering (e.g., legend requirements, communications restrictions).  
Rule 152 –Introductory Language  The Amendments adopt introductory language that cautions issuers that Rule 152 may not be used as a plan or scheme to evade the requirements of the Securities Act. 
Rule 152(b) – Non-Exclusive Safe Harbors
The Amendments adopt four non-exclusive safe harbors with certain modifications as compared to the Proposed Amendments to respond to investor concerns: 
  • Safe Harbor 1: 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, would not be integrated with another offering; provided that, for an exempt offering for which general solicitation is not permitted, the purchasers either were not solicited through the use of general solicitation, or established a substantive relationship with the issuer prior to the commencement of the offering for which general solicitation is not permitted.
  • Safe Harbor 2: Offers and sales made in compliance with Rule 701, 6  pursuant to an employee benefit plan, or in compliance with Regulation S would not be integrated with other offerings.
  • Safe Harbor 3: An offering for which a Securities Act registration statement has been filed would not be integrated with another offering if made subsequent to: (i) a terminated or completed offering 7 for which general solicitation is not permitted; (ii) a terminated or completed offering for which general solicitation is permitted and made only to qualified institutional buyers and institutional accredited investors; or (iii) an offering that terminated or completed more than 30 calendar days prior to the commencement of the registered offering.
  • Safe Harbor 4: Offers and sales made in reliance on an exemption for which general solicitation is permitted would not be integrated with another offering if made subsequent to any prior terminated or completed offering.
Rule 152(c) – Commencement of Offering The Amendments adopt a list of factors to consider in determining when an offering will be deemed to be commenced for purposes of Rule 152(a) and (b).
Rule 152(d) – Termination of Offering The Amendments adopt a non-exclusive factor list to consider in determining when an offering is deemed to be terminated or completed for purposes of Rule 152(a) and (b).
Rule 506(b) The Amendments amend Rule 506(b) to limit the number of non-accredited investors that may participate in an exempt offering under Rule 506(b) to no more than 35 within a 90-calendar-day period.
Rule 506(c) The Amendments add a new item to the non-exclusive list in Rule 506(c), by allowing an issuer to establish that an investor for which the issuer previously took reasonable steps to verify status as an accredited investor remains an accredited investor as of the time of a subsequent sale if the investor provides a written representation to that effect and the issuer is not aware of information to the contrary. The Amendments added a 5 year time limit for issuers to rely on Rule 506(c), which was a deviation from the Proposed Amendments.
Rule 148 – “Demo Day” Communications The Amendments adopt new Rule 148, which provides that certain “demo day” communications will not be deemed to be a general solicitation for purposes of Rule 506(b).
Rule 241 – Solicitation of Interest The Amendments adopt new Rule 241, which permits an issuer to engage in efforts to determine whether there is interest in a contemplated exempt offering without deciding which exemption is being relied upon ahead of time, subject to certain requirements.
Rule 502(b) – Regulation D The Amendments modify the disclosure requirements under Rule 502(b) of Regulation D to align the disclosure requirements with those required by Regulation A.
Rule 3a-9 – 1940 Act The Amendments add Rule 3a-9 under the Investment Company Act of 1940, as amended (the 1940 Act), in order to exclude from the definition of “investment company” a crowdfunding vehicle meeting certain conditions.
Item 17 of Form 1-A – Regulation A The Amendments add a new instruction to Item 17 of Form 1-A to align the disclosure requirements for Regulation A offerings with those for SEC-registered offerings.
Offering Thresholds and Investment Limits The Amendments increase or revise the offering thresholds and investment limits for Regulation A, Regulation Crowdfunding and Rule 504.
Bad Actor Provisions The Amendments harmonize the bad actor disqualification provisions in Regulation A, Regulation Crowdfunding and Regulation D by adopting the same lookback period with respect to disqualifying events.
 

1 Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Rel. Nos. 33-10884; 34-90300 (November 2, 2020).
2 SEC Press Release, SEC Harmonizes and Improves “Patchwork” Exempt Offering Framework (November 2, 2020), https://www.sec.gov/news/press-release/2020-273.
3 For more information on the Proposed Amendments, please see the prior Eversheds Sutherland legal alert, available here.
4 Generic solicitation of interest means an oral or written communication used to determine whether there is an interest in a potential securities offering.
5 On August 26, 2020, the SEC adopted amendments that expanded the definition of “accredited investor.” For more information on this subject, please see the prior Eversheds Sutherland legal alert linked here.
6 Rule 701 (17 CFR § 230.701) provides an exemption from registration under the Securities Act for the sale of certain securities made to compensate employees, consultants and advisors.
7 To determine whether an offering has been “terminated or completed” for purposes of Rule 152(b), an issuer should rely on the factors listed in Rule 152(d).

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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