Introduction
On March 4, 2020, the Securities and Exchange Commission (the SEC) issued a proposed rule (the “Proposed Rule”)1 on ways to “simplify, harmonize, and improve certain aspects of the exempt offering framework to promote capital formation while preserving or enhancing important investor protections.”2 In light of the increased amounts of capital currently being raised through exempt offerings, the SEC notes that the Proposed Rule constitutes the most recent step in its efforts to assess and improve the capital raising framework for the benefit of investors, entrepreneurs and more seasoned issuers. The current exempt offering framework has been developed over the years through various legislative action, including the Securities Act of 1933 (the “Securities Act”) and the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), as well as through exemptions adopted by the SEC.
The Proposed Rule is substantially informed by public input that was provided in response to the SEC’s June 2019 concept release3 on the harmonization of securities offering exemptions. The Proposed Rule, which reflects a comprehensive review of the system that developed over the years, seeks to address the inefficiencies and intricacies of the exempt offering framework that may limit an issuer’s access to capital and an investor’s access to investment opportunities.
The current framework has ten exemptions or safe harbors from the federal securities laws, each with distinct requirements. The goal of the Proposed Rule is to reduce the 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. Key topics identified throughout the 341-page Proposed Rule include:
- Integration;
- General solicitation and offering communications;
- 506(c) verification requirements;
- Offering and investment limits;
- Harmonization of disclosure requirements;
- Eligibility requirements in Regulation Crowdfunding and Regulation A, and
- Bad Actor disqualification provisions.
Integration
The integration doctrine provides a framework to determine if and when multiple sales of securities should be considered part of the same offering and helps identify if registration of the securities under the Securities Act is necessary. Over the years, the SEC has created safe harbors to simplify the question of whether one particular securities offering should be integrated with another. These various safe harbors provide objective standards upon which an issuer can rely to avoid integration of two offerings into one.
The SEC has proposed changes to the framework to better assess this determination by providing a general principle of integration that looks to the facts and circumstances of the offering, and focuses on the analysis of (i) whether the issuer can establish that each offering either complies with the Securities Act, or (ii) that an exemption from registration is available.
The SEC has also proposed four non-exclusive safe-harbors from integration:
- 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.
- Offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or in compliance with Regulation S would not be integrated with other offerings.4
- 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 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.
- 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.
BDCs and other investment companies would be 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.
“Test-the-Waters” and “Demo Day” Communications
The SEC proposed several amendments and new rules relating to general solicitation and offering communications, including:
- A proposed rule that would allow an issuer to use generic solicitation of interest materials5 to “test-the-waters” for an exempt offering of securities before it determines which exemption to rely on;
- A proposed rule amendment that would allow issuers relying on Regulation Crowdfunding to “test-the-waters” prior to filing an offering document with the SEC, and
- A proposed rule that would provide that certain “demo day” communications6 would not be considered general solicitation or general advertising.
BDCs conducting exempt offerings that currently prohibit general solicitation would benefit from these expansions of permitted communication options.
506(c) Verification Requirements
In efforts to address the concerns about challenges and costs associated with accredited investor status verification in Rule 506(c) offerings, the proposed amendments would create a new item to the non-exclusive list in Rule 506(c) that would allow an issuer to establish that an investor remains an accredited investor at the time of sale 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; and
- the issuer is not aware of the contrary.
Most private BDCs currently conduct exempt offerings under Rule 506(b) to avoid the onerous accredited investor status verification requirements. These proposed amendments may make Rule 506(c) offerings more attractive.
Offering and Investment Limits
Regulation A
Regulation A is an exemption from registration under the Securities Act that focuses on public offerings that are split into two tiers. Currently, Tier 1 covers offerings of up to $20 million in a 12-month period and Tier 2 covers offerings of up to $50 million in a 12-month period. Certain basic requirements – such as company eligibility criteria, bad actor disqualification provisions, disclosure and other requirements – apply to both tiers.
Currently, Regulation A is not available to BDCs or investment companies registered or required to be registered under the Investment Company Act of 1940, as amended.
The Proposed Rule proposes to raise the maximum offering amount under Tier 2 from $50 million to $75 million and to raise the maximum offering amount for secondary sales under Tier 2 of Regulation A from $15 million to $22.5 million.
Rule 504 of Regulation D
Rule 504 of Regulation D provides an exemption from registration under the Securities Act for some companies when they offer and sell up to $5 million of securities in a 12-month period. In most circumstances, purchasers of Rule 504 securities receive “restricted” securities that cannot be sold for at least six months to a year without being registered, and issuers are prohibited from soliciting or advertising the sale of securities.
While issuers conducting offerings under Rule 504 are not required to register their offering with the SEC, they do have to file a notice (known as Form D) with the SEC after the first sale of the securities in the offering and make associated state notice filings.
Currently, a number of issuers are not eligible to use the Rule 504 exemption, including issuers that must file reports under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), investment companies, BDCs, blank check companies and issuers that are disqualified under Rule 504’s “bad actor” disqualification provisions.
In the Proposed Rule, the SEC proposes raising the maximum offering amount for a Rule 504 offering from $5 million to $10 million.
Regulation Crowdfunding
Regulation Crowdfunding allows eligible companies to offer and sell securities via crowdfunding without registering the securities with the SEC. This exemption was added to the Securities Act pursuant to Title III of the JOBS Act, which passed in 2012. To qualify for this exemption, transactions must meet several requirements, including limits on the total sum that can be raised (a maximum aggregate amount of $1.07 million in a 12-month period), restrictions on the amount an individual may invest and a mandate that transaction be conducted through an SEC-registered intermediary (such as a broker-dealer or a funding portal).
The SEC is proposing to raise the offering limit in Regulation Crowdfunding from $1.07 million to $5 million. The SEC is also proposing to amend the investment limits for investors in Regulation Crowdfunding offerings by (i) not applying any investment limits to accredited investors and (ii) revising the calculation method for non-accredited investors to allow such investors to rely on the greater of their net worth or annual income when calculating the limit of their investment.
Harmonization of Disclosure Requirements
The SEC proposed amendments to the financial statement information requirements in Regulation D to align it with the disclosure requirements set out in Regulation A. Under the current regulatory framework, when non-accredited investors are participating in an offering under Rule 506(b), 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. Regulation A issuers must also provide certain financial statement and non-financial statement information to non-accredited investors. However, Regulation 506(b) offerings require more burdensome financial statement information to be provided than is needed in Regulation A.
The SEC is also proposing to simplify the requirements for Regulation A offerings and establish greater consistency between Regulation A offerings and registered offerings by permitting Regulation A issuers to:
1. file certain redacted exhibits using the simplified process previously adopted for registered offerings and filings made under the Exchange Act;
2. make draft offering statements and related correspondence available to the public via EDGAR to comply with the requirements of Securities Act Rule 252(d), rather than requiring them to be filed as exhibits to qualified offering statements;
3. incorporate financial statement information by reference to other documents filed on EDGAR; and
4. to have post-qualification amendments declared abandoned.
Regulation A and Regulation Crowdfunding Eligibility
In the Proposed Rule, the SEC proposes amendments to the eligibility restrictions in Regulation Crowdfunding and Regulation A. These proposed rules would permit the use of certain special purpose vehicles to facilitate investing in Regulation Crowdfunding issuers, and would limit the types of securities that may be offered and sold in reliance on Regulation Crowdfunding.
Specifically, the Proposed Rule expands the realm of eligible issuers under Regulation Crowdfunding, and permits issuers to create limited-purpose vehicles that function solely as conduits to invest in businesses raising capital through the vehicle. Investment companies have previously been excluded from Regulation Crowdfunding entirely, so the Proposed Rule provides a new option for issuers looking to benefit from the fundraising opportunities that Regulation Crowdfunding may provide.
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. Although the disqualification provisions are very similar, the look-back period for determining whether a covered person is disqualified differs between Regulation D and the other exemptions. The SEC is proposing to harmonize the bad actor disqualification provisions in Rule 506(d) of Regulation D, Rule 262(a) of Regulation A and Rule 503(a) of Regulation Crowdfunding by adjusting the look-back requirements in Regulation A and Regulation Crowdfunding to include the time of sale in addition to the time of filing. The Proposed Rule would not change the bad actor provisions applicable to BDCs conducting exempt offerings under Regulation D.
Conclusion
This Proposed Rule presents the next step for companies to potentially obtain greater access to capital in a more efficient manner. If adopted, these changes could bring a wider variety of investors and distribution channels back into the market for issuers, including for BDCs. Such expansion would increase the availability of capital and allow more flexibility for BDC fundraising activities. The flexibility would enable private BDCs conducting a Rule 506(b) offering to take advantage of less burdensome financial reporting obligations, saving time and money. In addition, BDCs would 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 SEC is now seeking comment on the Proposed Rule, and the comment period is open for 60 days following March 4, 2020. To the extent companies wish to weigh in on the Proposed Rule, there are multiple avenues to do so.
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1 Proposed Rule on Facilitating Capital Formation and Expanding Investment Opportunities by Improving
Access to Capital in Private Markets, Rel. Nos. 33-10763; 34-88321 (March 4, 2020).
2 SEC Press Release, SEC Proposes Rule Changes to Harmonize, Simplify and Improve the Exempt Offering Framework (March 4, 2020), https://www.sec.gov/news/press-release/2020-55.
3 Concept Release on Harmonization of Securities Offering Exemptions, Rel. Nos. 33-10649; 34-86129, at 32-33 (June 18, 2019); Legal Alert: In tune with the SEC—staff continues dialogue on harmonizing private exemptions (September 20, 2019), https://us.eversheds-sutherland.com/NewsCommentary/Legal-Alerts/225010/Legal-Alert-In-tune-with-the-SECstaff-continues-dialogue-on-harmonizing-private-exemptions.
4 Proposed Rule on Facilitating Capital Formation and Expanding Investment Opportunities by Improving
Access to Capital in Private Markets, Rel. Nos. 33-10763; 34-88321, at 29 (March 4, 2020).
5 Generic solicitation of interest means an oral or written communication used to determine whether there is an interest in a potential securities offering.
6 “Demo day” communications include presentations made at an organized event where the issuer provides information about the business to a group of potential investors with the goal of securing investment.
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