SEC proposes long-standing exemption amendments to propel capital raising

By Jay Fishman, J.D.

The SEC, following the June 2019 publication of a concept release on the Commission’s 10 long-standing rule exemptions (or safe harbors) from securities registration, has now proposed amendments to some of those exemptions, including the Rule 506, Regulation A and Regulation Crowdfunding exemptions. The rulemaking’s purpose is to simplify and harmonize the often complex and disparate requirements for claiming these exemptions to make it easier for issuers, especially new entrepreneurs and start-up companies, to use the exemptions to raise capital for their respective business projects in the global economy. Interested persons may comment on the proposals (see below).

Proposed amendments generally. The proposed rule amendments taken as a whole would achieve the following four goals:

1. address, in one broadly applicable rule, an issuer’s ability to move from one exemption to another, and ultimately to a registered offering; this "ease of movement" would enable issuers to more easily raise capital;
2. increase the offering limits for Regulation A, Regulation Crowdfunding and Rule 504 offerings, as well as revise certain individual investment limits determined from the Commission’s experience with the rules, marketplace practices, capital raising trends, and comments received;
3. set forth rules regarding offering communications between issuers and investors, including a "demo day" activity; these rules would ensure that the communications between issuers and investors are clear and consistent but do not violate the general solicitation prohibition; and
4. harmonize certain eligibility, disclosure requirements and bad actor disqualifications to reduce the differences between the exemptions while simultaneously preserving their investor protections.

Proposed amendments for specific exemptions. Amendments proposed for specific exemptions would include the following:

Rule 506(c). Add a new item to the non-exclusive list of accredited investor verification methods;

Rule 506(b) and Regulation A. Align the financial information that issuers must provide nonaccredited investors in a Rule 506(b) offering with the information issuers must provide investors in a Regulation A offering;

Regulation D, Regulation A and Regulation Crowdfunding. Harmonize the bad actor disqualification provisions in Regulation D, Regulation A and Regulation Crowdfunding;

Regulation A. Amend the eligibility restrictions in Regulation A; simplify certain requirements for Regulation A offerings and create greater consistency between Regulation A and registered offerings.

Regulation A Tier 2. Raise the maximum offering amount under Tier 2 of Regulation A from $50 million to $75 million; and raise the maximum offering amount for secondary sales under Tier 2 of Regulation A from $15 million to $22.5 million.

Regulation Crowdfunding. Amend the eligibility restrictions; permit the use of special purpose vehicles to facilitate investing in Regulation Crowdfunding issuers; limit the type of securities that may be offered and sold relying on Regulation Crowdfunding; raise the offering limit from $1.07 million to $5 million; and amend investor investment limits by: (a) not applying any investment limits to accredited investors; and (b) revising the calculation method for investment limits for nonaccredited investors to allow them to rely on the greater of their annual income or net worth when calculating the limit on how much they can invest;

Rule 504. Raise the maximum offering amount from $5 million to $10 million.

"Test-The-Waters" and "Demo Day" communications. Regarding the offering communications mentioned above:

• a proposed new rule would permit an issuer to use general solicitation of interest materials to "test-the-waters" for an exempt securities offer before determining which exemption to use to sell the securities;
• a proposed rule amendment would permit Regulation Crowdfunding issuers to "test-the-waters" before filing an offering document with the Commission in a manner similar to the one used to test-the-waters for current Regulation A; and
• a proposed new rule providing certain "demo day" communications would not be deemed general solicitation or general advertising.

Integration of securities offerings. To clarify the confusion about whether multiple securities transactions are or are not part of the same offering, the Commission has proposed to replace the current rules-and-guidance framework with a general integration principle that: (1) looks at an offering’s particular facts and circumstances; and (2) analyzes whether the issuer can determine if each particular offering either complies with the federal Securities Act’s registration requirements or falls within an available exemption.

The Commission has additionally proposed the following four non-exclusive safe harbors from integration:

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;
2. Offers and sales made in compliance with Rule 701, in accordance with an employee benefit plan, or in compliance with Regulation S would not be integrated with other offerings;
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 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; or
4. Offers and sales made relying 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.

SEC Chair Jay Clayton declared in the press release on the rule proposals that "emerging companies—from early-stage start-ups seeking seed capital to companies that are on a path to becoming a public reporting company—use the exempt offering rules to access critical capital needed to create jobs and scale their businesses. The complexity of the current framework is confusing for many involved in the process, particularly for those smaller companies whose limited resources spent on navigating our overly complex rules are diverted from direct investments in the companies’ growth. These proposals are intended to create a more rational framework that better allows entrepreneurs to access capital while preserving and enhancing important investor protections."

Public comment period. Interested persons may submit comments about the rule proposals for 60 days following publication of the proposed rule’s press release in the Federal Register.