With its recent adoption of Regulation Crowdfunding, the SEC has decided to propose changes to other exempt offerings in an effort to modernize them. Crowdfunding is poised to change the way that small businesses raise capital, and the SEC is seeking to increase the utility of existing rules and facilitate capital formation by smaller companies.
Tuesday, December 08. 2015
SEC Proposes Amendments to Increase Utility of Existing Exemptions in Effort to Facilitate Smaller Company Capital Formation
Changes to Rule 147
Rule 147 of the Securities Act of 1933 currently provides a safe harbor for securities offerings conducted pursuant to Section 3(a)(11), which is an exemption from registration for intrastate offerings. Rule 147 permits companies to raise money from investors within their state pursuant to their state’s securities laws without having to concurrently register the offers and sales at the federal level.
Many states have enacted or plan to enact crowdfunding bills that enable businesses to raise capital using crowdfunding provisions within the state. However, the current restrictions from Rule 147 and Section 3(a)(11) are making it difficult for companies to take advantage of these new crowdfunding provisions. For example, the public nature of Internet websites means that it’s nearly impossible for a company to limit offers to in-state residents using the Internet.
As such, the SEC is proposing to amend Rule 147 to do the following: allow an issuer to engage in any form of general solicitation or general advertising (including the use of public Internet websites) to offer and sell its securities, so long as all sales occur within the same state or territory as the issuer’s principal place of business, and the offering is registered in the state in which all of the purchasers are residents or is conducted pursuant to an exemption from state law registration in such state that limits the amount of securities an issuer may sell pursuant to such exemption to no more than $5 million in a twelve-month period and imposes an investment limitation on investors.
As proposed, these changes would allow an issuer to make offers accessible to out-of-state residents as long as sales are made only to in-state residents and the issuer’s principal place of business is located in-state and the issuer satisfies at least one of the following additional requirements that proves the in-state nature of the issuer’s business:
– The issuer derived at least 80% of its consolidated gross revenues from the operation of a business or of real property located in or from the rendering of services within such state or territory;
– The issuer had at the end of its most recent semi-annual fiscal period prior to the first offer of securities pursuant to the exemption, at least 80% of its consolidated assets located within such state or territory;
– The issuer intends to use and uses at least 80% of the net proceeds to the issuer from sales made pursuant to the exemption in connection with the operation of a business or of real 24 property, the purchase of real property located in, or the rendering of services within such state or territory;
– A majority of the issuer’s employees are based in such state or territory
An issuer would no longer need to be incorporated or organized under the laws of the state. Additionally, the issuer would need to prominently disclose on all offering materials that sales would be made only to residents of the same state or territory as the issuer to advise out-of-state investors that the offering is unavailable to them. A nine-month limitation on resales by resident purchasers to non-residents is also proposed.
Similar to the requirements in Regulation D, the SEC also proposes to add a “reasonable belief” standard when determining the residence of a purchaser at the time of sale of securities and to eliminate the current requirement in Rule 147 that issuers obtain a written representation from each purchaser as to his or her residence.
Rule 147 would cease to be a safe harbor under Section 3(a)(11) but would rather function as a separate exemption. The Section 3(a)(11) statutory exemption would continue to be an alternative for raising capital within a state.
Changes to Regulation D
The SEC is proposing to amend Rules 504 and 505 of Regulation D. As proposed, the aggregate amount of securities that may be offered and sold in any twelve-month period pursuant to Rule 504 will be increased from $1 million to $5 million and certain bad actors will be disqualified from participation in Rule 504 offerings. The proposed disqualification provisions are similar to related provisions of Rule 506 of Regulation D as well as those in Regulation A and Regulation Crowdfunding. The disqualification provisions would apply to the issuer and other covered persons (such as underwriters, placement agents, and the directors, officers and significant shareholders of the issuer).
Because of the proposed increase in the amount of securities that could be offered under Rule 504, the SEC is also seeking comment on whether Rule 505 would continue to be utilized as an exemption from registration. If Rule 505 was eliminated from Regulation D, only two offering exemptions would remain under Regulation D: Rule 504 and Rule 506. Rule 504 would be available only to non-reporting issuers (that are not investment companies or development stage companies) for offerings of up to $5 million in a twelve-month period and would permit general solicitation and the issuance of unrestricted securities in certain limited situations. Rule 506 would be available to all issuers without any aggregate offering limitations and would permit the issuance of only restricted securities, while allowing general solicitation under certain limited circumstances.
The SEC is seeking comment on these proposed changes. The comment period will remain open until January 11, 2016. Comments that have already been received by the SEC can be viewed here.