The Securities and Exchange Commission has adopted final rules to facilitate intrastate and regional securities offerings. The rules amend Securities Act Rule 147 to modernize the safe harbor under Section 3(a)(11) and establish a new intrastate offering exemption under Securities Act Rule 147A. Regulation D is also being amended to increase the aggregate offering ceiling for Rule 504 and to repeal Rule 505.
Thursday, November 10. 2016
Modernizing the existing rules for exempt offerings was undertaken after the SEC adopted Regulation Crowdfunding as the SEC sought to increase the utility of the existing rules and facilitate capital formation by smaller companies. We previously covered the proposed changes to Rule 147 and Regulation D back in 2015.
Rule 147 and Rule 147A
The largest difference between the proposing rules and the rules as adopted is the creation of a new intrastate offering exemption under the Securities Act, Rule 147A.
Both Rule 147 and Rule 147A will have the following provisions under the adopted rules:
- A requirement that the issuer satisfy at least one “doing business” requirement that will demonstrate the in-state nature of the issuer’s business. “Doing business” means the issuer meets at least one of the following requirements:
- 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 the 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 the 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 property, the purchase of real property located in, or the rendering of services within the state or territory; or
- A majority of the issuer’s employees are based in the state or territory.
- A new “reasonable belief” standard for issuers to rely upon in determining the residence of the purchaser at the time of the sale of securities. This standard includes a requirement that issuers obtain written representation from each purchaser as to his or her residency. The written representation is not sufficient to satisfy the reasonable belief standard; issuers will be required to obtain other facts or evidence of a purchaser’s residency such as a pre-existing relationship or, for example, a home address documented by a utility bill or pay stub. The residence of a purchaser that is a non-natural person, such as a corporation, partnership, trust or other form of business organization, will be defined as the location where the entity has its “principal place of business” at the time of the sale.
- A limit on resales to persons resident within the state or territory of the offering for a period of six months from the date of the sale by the issuer to the purchaser of a security sold pursuant to the exemption.
- An integration safe harbor that will include any prior offers or sales of securities by the issuer, as well as certain subsequent offers or sales of securities by the issuer occurring after the completion of the offering.
- Disclosure requirements, including legend requirements, to offerees and purchasers about the limits on resales.
For Rule 147, these provisions are being adopted as proposed. However, two provisions are not being adopted: the proposed provision to allow issuers to make offers accessible to out-of-state residents and the proposed provision to allow issuers to be incorporated out of state. Rule 147 is being retained as a safe harbor under Section 3(a)(11) because many state crowdfunding exemptions are premised on an offer qualifying under the Rule 147 safe harbor. Issuers relying on amended Rule 147 as a safe harbor under Section 3(a)(11) must continue to limit all offers and sales to in-state residents.
These two provisions are the defining features of new Rule 147A. Rule 147A is being adopted under Section 28 of the Securities Act, so it will not be subject to the statutory limitations of Section 3(a)(11). Rule 147A will allow issuers to make offers accessible to out-of-state residents (via an unrestricted publicly-available website, for example, or other form of modern mass media) so long as the sales are limited to in-state residents. Rule 147A also does not require issuers to be incorporated or organized in the same state where the offering occurs provided that issuers can demonstrate the in-state nature of their business. Under the amended Rule 147, issuers that are incorporated under state or territorial law are deemed a resident of a state or territory in which they are both incorporated and have their “principal place of business” and issuers that are general partnerships or in the form of another business organization not organized under any state or territorial law are deemed a resident of the state or territory in which they have their “principal place of business”. Rule 147A relies solely on the principal place of business to determine an issuer’s residency for all issuers.
Both Rule 147 and new Rule 147A will require issuers to include prominent disclosure with all offering materials stating that sales will be made only to residents of the same state or territory as the issuer. Individual states may also impose additional disclosure requirements or other requirements on offers or sales made within their states.
Additionally, both rules include provisions to limit the offerings that can be conducted by issuers that have moved to a different state. When an issuer changes its principal place of business to another state after conducting an intrastate offering relying on Rule 147 or Rule 147A, the issuer cannot conduct a new intrastate offering pursuant to either rule for a period of six months from the date of the last sale in the prior state. This six month period is a change from the proposed rule, in which the period was proposed to be nine months.
Finally, an issuer that is an investment company registered or required to be registered under the Investment Company Act of 1940 will be excluded from relying on Rule 147A. Rule 147 will continue to be unavailable to investment companies.
For now, there will be no notice filing to the SEC when an issuer utilizes Rule 147 or Rule 147A. States may require a notice filing at the state level.
The adopted amendments to Rule 504 of Regulation D will increase the aggregate amount of securities an issuer may offer and sell in any twelve- month period from $1 million to the maximum amount statutorily allowed under Section 3(b)(1), $5 million. Because of this increase, Rule 504 will also have provisions to prevent bad actors from participating in offerings conducted pursuant to the rule. The Rule 504 disqualification provisions will be implemented by reference to the disqualification provisions of Rule 506 of Regulation D.
In lieu of this increase, the SEC has repealed Rule 505 of Regulation D.
The amendments to Rule 147 and new Rule 147A will be effective 150 days after the final rule is published in the Federal Register. The amendments to Rule 504 will be effective 60 days after the final rule is published in the Federal Register. Rule 505 will be repealed 180 days after the final rule is published in the Federal Register.