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November 25, 2020

Stroock Client Alert

By: Evan Hudson, Akshay N. Belani, Richard G. Madris, André B. Nance, Eric Requenez, John J. Sottile, Samantha D. van der Bunt

On November 2, 2020, the U.S. Securities and Exchange Commission (the “Commission”) adopted several amendments (the “Amendments”) to the regulatory framework governing exempt offerings that aim to modernize, simplify and streamline the offering process, while expanding access by investors to private investment markets and allowing issuers to access a larger pool of potential capital.[1]  The Amendments both incorporate new rules designed to expand access to capital and the capital markets, and to codify existing Commission guidance and current practice among issuers.  The Amendments will generally become effective 60 days after publication in the Federal Register. 

The Amendments, among other items, (i) establish a new consolidated and overarching integration framework to govern the ability of issuers to transition from one exemption to another under Regulation D, Regulation A, Regulation Crowdfunding, and Rules 147 and 147A, (ii) create new exemptions to general solicitation prohibitions, (iii) increase the offering limits and investment limits imposed on offerings under Regulation A, Rule 504 of Regulation D and Regulation Crowdfunding, (iv) harmonize certain disclosure requirements and “bad-actor” disqualification provisions under Regulation D, Regulation A and Regulation Crowdfunding, and (v) simplify accredited investor verification requirements with respect to investors for whom an issuer has verified accredited investor status within the last five (5) years. 

Integration

The existing integration principles that govern when multiple public and/or private offerings by a single issuer should be considered to be “integrated” into a single offering (or otherwise risk the improper avoidance of registration) have developed over time into a complex framework consisting of both official rules and Commission guidance, including a five-factor facts-and-circumstances analysis first introduced in the early 1960s.  The Amendments are intended to replace this complex framework with new Rule 152(a), which stipulates a general principle of integration, and new Rule 152(b), which provides four new non-exclusive safe harbor exemptions to this general principle which are applicable to all offerings under the Securities Act of 1933 (the “Securities Act”), including both registered and exempt offerings.  The general principle of integration and the new safe harbor exemptions contained in new Rule 152 are described below:

General Principle of Integration – New Rule 152(a)

General Principle of Integration

If the safe harbors in Rule 152(b) do not apply, in determining whether two or more offerings are to be treated as one for the purpose of registration or qualifying for an exemption from registration under the Securities Act, 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.

 

Application of the General Principle of Integration to an exempt offering prohibiting general solicitation 
(Rule 152(a)(1))

Offerings and sales will not be integrated with other offerings if the issuer has a reasonable belief, based on the facts and circumstances, with respect to each purchaser, that the purchasers in each exempt offering: 

 (i) were not solicited purchasers through the use of general solicitation; or

 (ii) established a substantive relationship with the issuer (or person acting on the issuer’s behalf) prior to the commencement of the offering not permitting general solicitation.

 

Application of the General Principle of Intergration to concurrent exempt offerings that each allow general solicitation

(Rule 152(a)(2))

For an exempt offering permitting general solicitation that includes information about the material terms of a concurrent offering under another exemption also permitting general solicitation, the offering materials must include the necessary legends for, and otherwise comply with, the requirements and restrictions of each exemption.

 


However, no integration analysis under new Rule 152(a) is required if any of the following non-exclusive integration safe harbors applies:

Non-Exclusive Integration Safe Harbors – New Rule 152(b)

Safe Harbor 1

(Rule 152(b)(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, will not be integrated with such other offering; provided that, for an exempt offering for which general solicitation is not permitted that follows by 30 calendar days or more an offering that allows general solicitation, the purchasers either: (i) were not solicited through the use of general solicitation; or (ii) established a substantive relationship with the issuer prior to the commencement of the offering for which general solicitation is not permitted.

Safe Harbor 2

(Rule 152(b)(2))

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.

Safe Harbor 3

(Rule 152(b)(3))

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 buyers and institutional accredited investors; or (iii) an offering for which general solicitation is permitted that terminated or completed more than 30 calendar days prior to the commencement of the registered offering.

Safe Harbor 4

(Rule 152(b)(4))

Offers and sales made in reliance on an exemption for which general solicitation is permitted will not be integrated if made subsequent to any prior terminated or completed offering.


In conjunction with the introduction of the general principle of integration, the Commission issued new Rule 152 in order to clarify what constitutes the “commencement” and the “termination or completion” of an offering  for purposes of determining integration.  New Rule 152 contains a non-exclusive list of factors to be considered in making such determinations, which include:

Commencement

  • the date the issuer first made a generic offer soliciting interest in a contemplated securities offering under Rule 241;
  • the date the issuer first made an offer of its securities in reliance on the exemptions under Section 4(a)(2), Regulation D, or Rule 147 or 147A;
  • the earlier of the date the issuer first made an offer soliciting interest in a contemplated securities offering in reliance on Rule 255, or the public filing of a Form 1-A offering statement under a Regulation A offering;
  • the earlier of the date the issuer first made an offer soliciting interest in a contemplated securities offering in reliance on new Rule 206, or the public filing of a Form C offering statement under a Regulation Crowdfunding offering; and
  • with respect to offerings made pursuant to the filing of a registration statement under the Securities Act: (i) in the case of an offering which is continuous and will commence on the date of initial effectiveness, on the date the issuer first filed its registration statement with the Commission, or (ii) in the case of a delayed offering, on the earliest date on which the issuer or its agents commenced public efforts to offer and sell the securities, which could be evidenced by the earlier of the first filing of a prospectus supplement with the Commission describing the delayed offering, or the issuance of a widely disseminated public disclosure, such as a press release, confirming the commencement of the delayed offering.

Termination or Completion

  • the later of the date (i) the issuer entered into a binding commitment to sell all securities to be sold under the offering (subject only to conditions outside of the investor’s control); or (ii) the issuer and its agents ceased efforts to make further offers to sell the issuer’s securities under such offering under Section 4(a)(2), Regulation D, or Rule 147 or 147A;
  • the (i) withdrawal of an offering statement under Rule 259(a); (ii) filing of a Form 1-Z with respect to a Tier I offering under Rule 257(a); (iii) declaration by the Commission that the offering statement has been abandoned under Rule 259(b); or (iv) date, after the third anniversary of the date the offering statement was initially qualified, on which Rule 251(d)(3)(i)(F) prohibits the issuer from continuing to sell securities using the offering statement, or any earlier date on which the offering terminates by its terms, under Regulation A;
  • on the deadline of the offering identified in the offering materials pursuant to Rule 201(g), or indicated by the Regulation Crowdfunding intermediary in any notice to investors delivered under Rule 304(b) under any offering made pursuant to Regulation Crowdfunding; and
  • with respect to offerings made pursuant to the filing of a registration statement filed under the Securities Act, on: (i) the withdrawal of the registration statement after an application is granted or deemed granted under Rule 477; (ii) the filing of a prospectus supplement or amendment to the registration statement indicating that the offering, or particular delayed offering in the case of a shelf registration statement, has been terminated or completed; (iii) the entry of an order of the Commission declaring that the registration statement has been abandoned under Rule 479; (iv) the date, after the third anniversary of the initial effective date of the registration statement, on which Rule 415(a)(5) prohibits the issuer from continuing to sell securities using the registration statement, or any earlier date on which the offering terminates by its terms; or (v) any other factors that indicate that the issuer has abandoned or ceased its public selling efforts in furtherance of the offering, or particular delayed offering in the case of a shelf registration statement, which could be evidenced by the filing of a Current Report on Form 8-K or the issuance of a widely disseminated public disclosure by the issuer, or its agents, informing the market that the offering, or particular delayed offering, in the case of a shelf registration statement, has been terminated or completed.

General Solicitation and Offering Communications

Rule 506 of Regulation D, adopted by the Commission in 1982, provides objective, though non-exclusive, standards on which issuers may rely to ensure they meet the “not involving any public offering” requirement of Section 4(a)(2) of the Securities Act, although, as noted by the Commission, such a determination is necessarily dependent upon the facts and circumstances of the offering.  In the Amendments the Commission delineated certain bright-line exemptions pursuant to which an issuer may be deemed to not have undertaken a “general solicitation” (i.e., participated in a public offering), as discussed further below. 

Demo Days

New Rule 148 exempts a communication made by an issuer in connection with a “demo day,” an event where a specific group or entity (e.g., a university, incubator, accelerator, state or local government or instrumentality of such government, nonprofit or angel investor group (such angel investor group is required to have “defined” processes and procedures for making investment decisions)) invites issuers to present to potential investors, from being considered a “general solicitation.”  Under new Rule 148, for “demo day” communications to qualify for the exemption, (i) the communications must be made in connection with a seminar or meeting in which more than one issuer participates, that is sponsored by one of the above-mentioned groups or entities, incubator, or accelerator, and (ii) the sponsor group or entity may not: (A) make investment recommendations or provide investment advice to attendees of the event, (B) engage in any investment negotiations between the issuer and investors attending the event, (C) charge attendees of the event any fees, other than reasonable administrative fees, or (D) receive any compensation for making introductions between event attendees and issuers, or for investment negotiations between the parties, or (E) receive any compensation with respect to the event that would require it to register as a broker or dealer under the Exchange Act, or as an investment adviser under the Advisers Act.

Information disseminated by any particular issuer in connection with a “demo day” may not reference any specific offering of securities by participating issuers and may not disclose more than: (i) notification of a planned or in-process offering, (ii) the type and amount of securities being offered, (iii) the intended use of the proceeds of the offering, and (iv) the unsubscribed amount in the offering.  Virtual “demo days,” by virtue of their ability to reach a wider audience, are subject to additional restrictions. 

Generic Solicitations of Interest

New Rule 241 permits the use of “generic solicitation of interest materials” for an exempt offering of securities prior to making a determination as to the exemption under which such offering may be conducted.  Under new Rule 241 an issuer may communicate orally or in writing to determine whether there is any interest in a contemplated offering of securities exempt from registration under the Securities Act.  The rule does not allow issuers to identify the specific exemption from registration a subsequent offer and sale would rely on and does not negate the remaining aspects of the exempt offering regulatory regime.  The issuer must consider whether the solicitation and subsequent offering will be integrated under the new integration rules, as an integrated offering will not qualify for an exemption that does not permit general solicitation, unless “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.”  An issuer must also make any written generic solicitation materials available (i) to any purchaser that is not an accredited investor if the issuer sells securities under Rule 506(b) within 30 days of the generic solicitation of interest or (ii) publicly, as an exhibit to the offering materials filed with the Commission, if a Regulation A or Regulation Crowdfunding offering is commenced within 30 days of the generic solicitation.  

New Rule 241 also requires disclosure to potential investors regarding the limitations of the generic solicitation of interest stating that:

  • the issuer is considering an offering of securities exempt from registration under the Securities Act, but has not determined a specific exemption from registration the issuer intends to rely on for the subsequent offer and sale of the 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.

Increased Offering and Investment Limit Exemptions

The Commission estimates that, in 2019, a mere 0.05% of capital raised through exempt offerings was raised through Regulation A, Regulation Crowdfunding and Rule 504 combined.  In an effort to attract a larger pool of investors and provide assistance to issuers who have exhausted the current pool of available capital, the Commission has raised the prescribed maximum offering amounts for each of Regulation A, Regulation Crowdfunding and Rule 504.  The Commission also eliminated investor limits on accredited investors and established a new standard for non-accredited investors, to allow for a “greater of” their income or net worth standard (as opposed to a “lesser of” requirement) in determining eligibility to participate in such offerings.

 

Offering Limits

Investment Limits

 

 

Current Rules

New Rules

Current Rules

New Rules

Regulation A: Tier 1

$20 million

$20 million

No Limits

No Limits

Regulation A: Tier 2

$50 million

$75 million

Accredited Investors:

No Limits

Non-Accredited: No more than 10% of greater of (i) annual income or net worth (for natural persons) or (ii) revenue or net assets (for non-natural persons)

Accredited Investors:

No Limits

Non-Accredited: No more than 10% of greater of (i) annual income or net worth (for natural persons) or (ii) revenue or net assets (for non-natural persons)

Rule 504 – Regulation D

$5 million

$10 million

No Limits

No Limits

Regulation Crowdfunding

$1.07 million

$5 million

(1) greater of $2,200 or 5% of the lesser of investor’s annual income or net worth, if either of an investor’s annual income or net worth is less than $107,000 or

(2) 10% of the lesser of investor’s annual income or net worth, if both annual income and net worth are equal to or more than $107,000

Accredited Investors:

No Limits

Non-Accredited: No more than 10% of greater of (i) annual income or net worth (for natural persons) or (ii) revenue or net assets (for non-natural persons)


Rule 506(c) Verification

Under Rule 506(c), an issuer may utilize general solicitation provided that certain conditions are satisfied, including that all purchasers are accredited investors and that the issuer takes reasonable steps to verify such status, with the rule providing a non-exhaustive list of verification methods.  In the Amendments, the Commission added an additional verification method by permitting an issuer to establish that, in the case of an investor for whom the issuer previously (within the prior five years) took reasonable steps to verify accredited investor status, such investor would remain an accredited investor as of the time of a subsequent sale, provided that the investor must provide a written representation that the investor continues to qualify as an accredited investor and the issuer must not be aware of any information to the contrary.    

Regulation D and Regulation A Disclosure Requirements

The Commission amended Rule 502(b) to harmonize the financial disclosure requirements exempt issuers are required to provide to non-accredited investors in offerings under Rule 506(b) with the financial disclosure requirements of issuers in Regulation A offerings.  Regulation D offerings of $20 million or less are now required to provide to non-accredited investors the same disclosures as Tier 1 Regulation A offerings, while Regulation D offerings of more than $20 million are now required to provide to non-accredited investors the same disclosures as Tier 2 Regulation A offerings.  Amended Rule 502(b) also aligns the rules for Regulation A offerings with the rules for registered offerings concerning the filing of redacted material contracts, the public filing of draft offering statements on EDGAR and the incorporation by reference of previously filed financial statements, and permits the Commission to declare an offering statement or a post-qualification amendment to an offering statement “abandoned.” 

The previous disclosure rules permitted issuers to redact certain provisions or terms in exhibits if those items were (i) not material and (ii) would likely cause competitive harm to the issuer if publicly disclosed.  Issuers are also required to mark the exhibit index to indicate that portions of the exhibit or exhibits have been omitted and indicate with brackets where the information has been omitted from the filed version of the exhibit.  In the amended rule, the Commission has eliminated the requirement that disclosure would likely result in competitive harm and thus permits redaction of information if it (i) is not material and (ii) is the type of information that the issuer both customarily and actually treats as private and confidential.  Redacted filings are subject to Commission Staff compliance reviews, through which the Staff can request the unredacted exhibits with the redacted information highlighted and require the issuer to provide justification for the redaction.

The Commission has also brought certain reporting requirements under Regulation A in line with similar requirements imposed on public companies filing Form S-1.  Issuers conducting Regulation A offerings may now incorporate previously filed financial statements by reference.  The Commission considered whether it should, but ultimately declined to, allow for forward incorporation by reference of financial statements.

Bad Actor Disqualification

The Commission noted that while the existing framework governing “bad actor” disqualifications was substantially similar in substance across the different kinds of exempt offerings, there was disparity in the “lookbacks,” or the periods of time for determining whether a covered person had engaged in disqualifying acts.  Whereas Regulation D measured the lookback commencing from the time of sale, Regulation A and Regulation Crowdfunding measured from the time the issuer filed the offering statement.  The Commission therefore amended the lookback periods in Regulation A and Regulation Crowdfunding to include the time of sale. 

***

Except for the extension of the temporary Regulation Crowdfunding provisions, which will be effective upon publication in the Federal Register, the amendments will be effective 60 days after publication in the Federal Register.  This alert does not purport to contain a complete description of the revised regulatory framework for exempt offerings or a comprehensive restatement of any rule or part thereof.  For more information regarding these changes to the exempt offering framework, please contact any of the authors. 

___________________________________________

For More Information:

Evan Hudson

Akshay N. Belani

Richard Madris

André B. Nance

Eric Requenez

John J. Sottile

Samantha D. van der Bunt

[1] Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, SEC Rel. Nos. 33-10884; 34-90300; IC-34082 (Nov. 2, 2020), available at: https://www.sec.gov/rules/final/2020/33-10844.pdf

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