On November 2, 2020, the SEC announced the adoption of extensive amendments to the rules governing exempt offerings, more commonly known as “private placements.” The announcement stated that the amendments are intended to “harmonize, simplify, and improve” the exempt offering framework, allowing issuers to move from one exemption to another, and to (1) increase the offering limits for certain private placements and revise certain individual investment limits, (2) establish consistent rules governing offering communications and permit certain “test-the-waters” and “demo day” activities, and (3) harmonize disclosure and eligibility and bad actor disqualification provisions.
The amendments are designed to promote better access to private capital while maintaining investor protections and simplifying the complex patchwork of federal private placement exemptions that has existed for over 50 years. However, they contain their own complexities and some pitfalls that can make compliance challenging.
Below are highlights of the amendments adopted by the SEC.
General Principles of Integration and Safe Harbors
An important component of the harmonization effort is new Rule 152. Under the existing framework, an issuer relying on private placement offering exemptions for a single offering or several proximate private offerings risked that one or more of the offerings might be “integrated” by the SEC for purposes of analyzing compliance, causing the issuer to be out of compliance if the offerings were viewed as one integrated offering.
The new Rule 152 provides a comprehensive integration framework composed of a general principle of integration and the following four non-exclusive integration safe harbors:
- 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 the 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 provisions of Rule 152(a)(1) will apply and the issuer must have a reasonable belief with respect to each purchaser that the issuer either (i) did not solicit such purchaser through the use of general solicitation; or (ii) established a substantive relationship with such purchaser prior to the commencement of the exempt offering prohibiting general solicitation.
- Any offering compliant with the Rule 701 safe harbor exemption for an employee benefit plan or with the Regulation S safe harbor exemption will not be integrated with other offerings.
- Any registered public offering will not be integrated if made after: (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 made only to qualified institutional buyers and institutional accredited investors; or (iii) an offering for which general solicitation is permitted that was either terminated or completed more than 30 calendar days prior to the commencement of the registered public offering.
- Any offering in reliance on an exemption for which general solicitation is permitted will not be integrated if it occurs after an offering that is terminated or completed.
While the amendments facilitate the ability of issuers to move from one exemption to another, issuers should exercise caution if they are engaging in concurrent or contemporaneous offerings, some using general solicitation and some not, as the rules covering those offerings are complex. Moreover, the SEC has repeated its customary admonition that the safe harbors under Rule 152 would not be available for any transaction or series of transactions that, although in technical compliance with the rule, is part of a plan or scheme to evade the registration requirements of the Securities Act.
The use of general solicitation to market an issuer’s securities is prohibited under Rule 506(b) of Regulation D under the Securities Act. The SEC’s harmonization effort added a new Rule 148, which provides that certain “demo day” communications will not be deemed to constitute a general solicitation. Specifically, an issuer will not be deemed to have engaged in a general solicitation if the communications are made in connection with a seminar or meeting:
- That is sponsored by one of certain types of institutions, such as a college, a government agency, or an incubator, accelerator, or angel investor group, subject to certain limitations;
- That is subject to specified restrictions on advertising;
- Whose sponsors are subject to restrictions on their activities; and
- In which online participation is limited to specified individuals.
Rule 506 Amendments
The SEC’s harmonization effort also introduced amendments to Rule 506 of Regulation D under the Securities Act. The amendments to Rule 506(c) permit an issuer to rely for five years on a prior verification that an investor is an accredited investor. Such investor will be deemed an accredited investor as of the time of a subsequent sale under the amendments, provided that: (1) the issuer has previously taken reasonable steps to verify such accredited investor status pursuant to Rule 506(c)(2)(ii); (2) the investor provides a written representation that the investor continues to qualify as an accredited investor; and (3) the issuer is not aware of information to the contrary.
Issuers of Regulation D offerings up to $20 million are no longer required to provide audited financial statements. Issuers raising more than $20 million under Regulation D have to provide audited financial statements and comply with the requirements of Regulation S-X similar to Tier 2 Regulation A offerings.
Solicitation of Interest Exemption and Regulation Crowdfunding “Test the Waters”
The SEC’s harmonization effort added a new offering exemption under Rule 241, which allows an issuer (or any person authorized to act on behalf of an issuer) to 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 new rule provides an exemption from registration only with respect to the generic solicitation of interest. If the issuer proceeds with an exempt offering, it will have to comply with the applicable exemption for the offering.
Rule 241 requires the generic testing-the-waters materials to provide specified disclosures notifying potential investors about the limitations of the generic solicitation. The materials must state that: (1) the issuer is exploring an exempt offering but has not determined a specific exemption the issuer intends to rely on for the subsequent offering; (2) no consideration is being solicited and will not be accepted; (3) no offers can be accepted, and no part of the purchase price can be received until the issuer determines the exemption for the subsequent offering and the filing, disclosure or qualification requirements of such exemption are complied with; and (4) a person’s indication of interest involves no obligation or commitment of any kind.
Also, issuers relying on Rule 241 must provide purchasers with any written materials used in solicitations of interest if the issuer sells securities under Rule 506(b) within 30 days of the generic solicitation of interest to any purchaser that is not an accredited investor. The Rule 241 generic solicitation materials must be publicly available as an exhibit to the offering materials filed with the SEC in connection with a Regulation A or Regulation Crowdfunding offering commenced within 30 days of the generic solicitation.
Unlike Regulation A issuers, Regulation Crowdfunding issuers may not solicit interest or make offers or sales before filing a Form C with the SEC. The SEC’s harmonization effort added a new Rule 206, which permits Regulation Crowdfunding issuers to test the waters orally or in writing before filing a Form C with the SEC.
Under Rule 206, issuers must include legends in the testing-the-waters materials that state: (1) no money or other consideration is being solicited, and if sent, will not be accepted; (2) no offer to buy the securities can be accepted, and no part of the purchase price can be received until the offering statement is filed and only through an intermediary’s platform; and (3) a prospective purchaser’s indication of interest is non-binding.
With the ability to test the waters and gauge interest in advance of selling the securities, issuers will be able to determine if an offering will be successful before incurring the full costs of an offering.
Increases to Exempt Offering Limits
The new rules increase the limits that apply to the following exempt offerings:
- Tier 2 of Regulation A: Increase the limit from $50 million to $75 million;
- Tier 2 of Regulation A – Secondary Sales: Increase the limit from $15 million to $22.5 million;
- Rule 504: Increase the limit from $5 million to $10 million; and
- Regulation Crowdfunding: (1) Increase the limit from $1.07 million to $5 million; (2) remove investment limits for accredited investors; and (3) increase investment limits for non-accredited investors by allowing them to rely on the greater of their income or net worth.
The amendments will become effective 60 days after publication in the Federal Register, except that the extension of the temporary Regulation Crowdfunding provisions will be effective upon publication in the Federal Register.