The Securities and Exchange Commission recently adopted amendments to facilitate the use of private, or “exempt,” offerings. The changes will impact offerings structured pursuant to Section 4(a)(2), Regulation D and Regulation S, as well as offerings conducted under Regulation A and Regulation Crowdfunding. The purpose of the changes is to facilitate capital formation and increase opportunities for investors by expanding access to capital for small and medium-sized businesses. The new rules provide clear safe harbors from integration of separate exempt offerings, ease the determination of accredited investor status, and relax restrictions on communications made in connection with “testing the waters” for a contemplated private offering. Highlights include:
Integration Safe Harbors in “New” Rule 152
Under certain circumstances, the Commission’s integration doctrine requires an issuer to treat two or more offerings that take place within the same general time-period as a single offering, which may have the effect of undermining reliance on private offering exemptions for one or more of the offerings. For example, if an offering for which general solicitation is prohibited is combined with another where general solicitation is permitted and occurs, the first offering could lose its exempt status. New Rule 152, which entirely replaces prior Rule 152, provides four distinct safe harbors that permit companies to conduct certain sequential or side-by-side offerings without integration concerns, as well as principles to apply in situations that do not fit any of the safe harbors. Some elements of the new rule codify prior Commission interpretation. The new rule applies to all exempt offerings of securities, including offerings made in accordance with Regulation D and Regulation S, and will replace the traditional five-factor test in Rule 502.
Verification of “Accredited Investor” Status Under Rule 506(c)
Rule 506(c) permits the use of general solicitation in an exempt offering when the issuer takes reasonable steps to verify that purchasers in the offering are accredited investors. The Commission amended Rule 506(c) to allow issuers to establish that an investor continues to be an accredited investor if the issuer, within the past five years, took reasonable steps to verify its accredited investor status in a previous offering under Rule 506(c), unless the issuer is aware of information to the contrary. The investor must provide a written representation at the time of sale that the investor continues to qualify as an accredited investor. This change should simplify the verification process for issuers conducting continuous or multiple offerings under this exemption.
For issuers using the rule’s principles-based method to verify accredited investor status, the Commission reiterated previous guidance that issuers should continue to consider factors such as the following:
the nature of the purchaser and the type of accredited investor the purchaser claims to be;
the amount and type of information that the issuer has about the purchaser; and
the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering and the terms of the offering, such as a minimum investment amount.
The Commission also expressed its view that, in some circumstances, an issuer could satisfy the “reasonable steps” requirement in the first instance with a representation from an investor as to his or her accredited investor status, if the issuer “reasonably takes into consideration a prior substantive relationship with the investor or other facts that make apparent the accredited status of the investor.” However, an investor representation alone would not be sufficient if the issuer has no other information about the investor.
“Testing the Waters”/Generic Solicitation
New Rule 241 permits an issuer, or any person authorized to act on behalf of the issuer, to use generic solicitation of interest materials for an offer of securities prior to making a determination as to the exemption under which the offering may be conducted, subject to certain conditions. These generic “testing-the-waters” materials must provide specific disclosures notifying potential investors about the limitations of the generic solicitation of interest. This exemption from registration applies only to the generic solicitation of interest, not to a subsequent offer or sale. Thus, if the issuer moves forward with an exempt offering following the generic solicitation of interest, the issuer needs to comply with an available exemption for the subsequent offering.
Generic solicitations of interest under Rule 241 are offers of a security for sale for purposes of the antifraud provisions of the Federal securities laws, and depending on how these materials are disseminated, they could be considered a general solicitation. If a generic solicitation of interest constitutes a general solicitation, and the issuer proceeds with an exempt offering that does not permit general solicitation, such as an offering under Rule 506(b), the issuer will have to determine whether the generic solicitation of interest should be integrated with the subsequent offering, using the new Rule 152 integration provision. If integration is required, the Rule 506(b) exemption would be unavailable because the issuer would have already engaged in a general solicitation for the same offering.
The Commission amended Regulation A, Regulation Crowdfunding and Rule 504 to increase the amounts that can be offered within a 12-month period as follows:
Tier 2 Regulation A offerings: from $50 million to $75 million;
Rule 504: from $5 million to $10 million; and
Regulation Crowdfunding: from $1.07 million to $5 million.
The Commission, recognizing that capital raising in the private markets has increased significantly in the past twenty-five years, attempted to even the playing field for small companies and smaller investors by reducing complexities in the exempt offering framework.
The new integration safe harbors should make it easier for companies to rely on the exemptions provided under Section 4(a)(2), Regulation D, and Regulation S in the context of multiple or concurrent offerings. Moreover, allowing issuers to rely on past verification of an individual’s accredited investor status creates additional flexibility to use Rule 506(c) by reducing the compliance burden involved in multiple offerings to common investors. The additional flexibility to use generic solicitations of interest will allow issuers to test the waters for a private offering, but issuers must exercise caution to ensure that their use of these materials does not jeopardize the availability of relevant exemptions.