The Commissioners of the Securities and Exchange Commission (“SEC”) have voted to overhaul significant portions of the regulatory framework for registered and exempt offerings under the Securities Act Rules. The Final Rule issued on November 2, 2020, “Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets” (the “November Rule”), has four stated goals:
- Modernizing and simplifying the Securities Act integration framework for registered and exempt offerings;
- Setting clear and consistent rules for communications between issuers and investors;
- Increasing offering and investment limits for certain exemptions; and
- Harmonizing certain disclosure requirements and “bad actor” provisions.
The New Integration Framework
One of the major concerns issuers face when attempting to raise capital in compliance with SEC guidelines is integration—in short, how can issuers ensure that the SEC will not consider two or more concurrent or consecutive exempt offerings to be a single offering for compliance purposes? Before the November Rule, the SEC looked at the “particular facts and circumstances” of each offering, applying a five-factor test to determine whether or not to integrate two or more concurrent or consecutive exempt offerings. While the SEC had issued some additional guidance regarding integration—including a six-month safe harbor rule—the regulatory framework prior to the November Rule ultimately created more confusion than clarity.
To address this problem, the November Rule replaces the old integration analysis with a General Principle and four non-exclusive safe harbors, as follows:
The General Principle
Offers and sales will not be integrated if, based on the particular facts and circumstances, the issuer can establish that each offering either complies with the registration requirements of the Securities Act, or that an exemption from registration is available for the particular offering.
For an exempt offering prohibiting general solicitation, issuers will be deemed to be in compliance if they can establish that they have a reasonable belief with respect to each purchaser in such offering that the issuer either did not solicit such purchaser using general solicitation or established a substantive relationship with such purchaser prior to the commencement of such offering. For concurrent exempt offerings that each allow general solicitation, issuers must comply with the requirements of the particular exemption relied on, and, if either offering contains information about the material terms of the other, concurrent offering, then each offering containing such information must comply with all requirements and restrictions for the other offering.
The Safe Harbors
- The 30-Day Rule: Any offering made 30 days prior to the commencement of any other offering or more than 30 days after the termination or completion of any other offering will not be integrated with such other offering.
- 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.
- An offering for which a Securities Act registration statement has been filed will not be integrated if it is 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 that was made only to qualified institutional buyer and institutional accredited investors; or (iii) an offering for which general solicitation is permitted that terminated or completed more than 30 days prior to the commencement of the registered offering.
- 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.
The November Rule also provided additional guidance regarding the commencement and termination of offerings in the form of various factors to consider based on the exemption applicable to the particular offering.
Communications between Issuers and Investors
Another issue facing most issuers conducting an offering is ensuring that communications with and verification procedures for potential investors are compliant with the solicitation and qualification requirements imposed by the Securities Act. In this regard, the November Rule provides greater clarity by imposing clear rules for “demo day” and “test-the-waters” communications and for investor verification requirements, as follows:
Issuers may engage in “demo days” where they can discuss their business and capital-raising plans, with the following limitations:
- The “demo day” is made in connection with an event sponsored by a higher education institution, state or local government or instrumentality, or a non-profit or “angel investor group”;
- More than one issuer participates in such an event;
- The advertising for the event may not reference a specific offering of securities by the issuer, and the information provided by the issuer about the particular offering must be limited to the basics (type and amount of securities offered, intended use of proceeds, and unsubscribed amount) of such offering;
- Event sponsors may not make investment recommendations to attendees, engage in negotiations between or receive any compensation for making introductions between issuers and attendees, charge attendees any fees (other than reasonable administrative fees), or receive any compensation with respect to the event that would require the sponsor to register as a broker or dealer or an investment adviser; and
- Such events held in an online format must be limited to individuals that are members of or otherwise associated with the sponsor, individuals that the sponsor reasonably believes are accredited investors, or individuals invited by the sponsor based on industry or investment-related experience.
So long as issuers comply with the restrictions listed above, communications between issuers and investors at such events will not be considered general solicitation for purposes of compliance with exempt offering requirements under the Securities Act.
Additionally, issuers may communicate directly with potential investors in order to gauge interest in a potential exempt securities offering before having to determine which exemption would apply, so long as such communications indicate that:
- The issuer is considering an exempt offering of securities but has not yet determined the particular exemption for such offering;
- No money or other consideration is being solicited and will not be accepted if sent;
- No offer to buy can be accepted or part of the purchase price can be received until the issuer determines and complies with the requirements of the applicable exemption; and
- A potential investor’s indication of interest does not involve any obligation or commitment of any kind.
If communications made by issuers to potential investors are limited to the information listed above, then such communications will not be considered general solicitation for purposes of compliance with exempt offering requirements under the Securities Act.
Rule 506(c) Verification Requirements
Rule 506(c) of the Securities Act, an exemption from registration allowing for general solicitation, requires issuers to take “reasonable steps” to verify the accredited investor status of potential investors. These steps may include soliciting and reviewing bank statements, tax assessments, income statements, or other financial information from the potential investor.
Under the November Rule, an investor’s accredited status will be deemed verified if:
- The issuer has, within the five years prior to the date of the proposed offering, previously taken steps to verify that the investor is an accredited investor;
- The investor provides the issuer with a written representation that it is an accredited investor; and
- The issuer is not aware of any information to the contrary.
Increase of Offering and Investment Limits
The November Rule also increased offering and investment limits for three exemptions:
- Regulation Crowdfunding Offerings
- Offering limit increased from $1.07 million to $5 million; and
- Investment limits for Regulation Crowdfunding investors have been relaxed:
- Accredited investors no longer have investment limits, and
- Non-accredited investors may use the greater of their annual income or net worth when determining investment limits.
- Regulation A Tier 2 Offerings
- Maximum offering amount under Tier 2 increased from $50 million to $75 million;
- Maximum offering amount for secondary sales by selling security holders under Tier 2 increased from $15 million to $22.5 million.
- Rule 504 Offerings
- Offering limit increased from $5 million to $10 million worth of securities in a 12-month period.
Harmonization of Disclosure Requirements and “Bad Actor” Provisions
The November Rule also altered disclosure requirements under Rule 502(d) to create greater consistency throughout the Act. Specifically, the November Rule revised the disclosure requirements for offerings under Regulation D to match the requirements for offerings made under Regulation A:
- For offerings of up to $20 million made under Regulation D, issuers will still be required to submit balance sheets, income statements, and other relevant financial statements for the two years prior to the date of the offering; however, these financial statements will no longer need to be audited.
- For offerings of $20 million or more made under Regulation D, issuers will have to provide the same financial information that would be required for an offering made under Tier 2 of Regulation A.
Finally, the November Rule standardized “bad actor” disqualification requirements by revising the lookback requirements to include the time of sale in addition to the time of filing of the offering.
Clear, Consistent, and Accessible Offerings
The SEC took a major step to facilitate access to capital by amending the definition of “accredited investor” in its August 2020 Final Rule. In the same vein, the November Rule provides further proof of SEC’s intent to modernize its regulatory framework as a means to expand and simplify access to capital in private markets while still affording necessary protections to investors.