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Multiple Changes To Private Offering Compliance And Disclosure Interpretations (C&DI)

Posted by Securities Attorney Laura Anthony | January 23, 2018 Tags: Exemption for Limited Offerings and Sales of Securities Not Exceeding $5 Million, Exemption for Limited Offers and Sales Without Regard to Dollar Amount of Offering, Filing of Notice of Sales (Form D), Multiple Changes To Private Offering Compliance And Disclosure Interpretations (C&DI), Regulation D, Rule 147, Rule 503, Rule 504, Rule 505, Rule 506

The SEC has been fine-tuning its Compliance and Disclosure Interpretations (C&DI), making multiple amendments, additions and deletions on September 20, 2017. The SEC made revisions to reflect changes to Rules 147 and 504, the repeal of Rule 505, as well as numerous non-substantive revisions throughout the C&DI to update for current rules and statutory references. Likewise, several C&DI have been removed that did not accurately reflect current rules.

On October 26, 2016, the SEC passed new rules to modernize intrastate and regional securities offerings. The final new rules amended Rule 147 to reform the rules and allow companies to continue to offer securities under Section 3(a)(11) of the Securities Act of 1933 (“Securities Act”). The SEC created a new Rule 147A to accommodate adopted state intrastate crowdfunding provisions. New Rule 147A allows intrastate offerings to access out-of-state residents and companies that are incorporated out of state, but that conduct business in the state in which the offering is being conducted. In addition, the SEC amended Rule 504 of Regulation D to increase the aggregate offering amount from $1 million to $5 million and to add bad-actor disqualifications from reliance on the rule. Finally, the SEC repealed the rarely used and now redundant Rule 505 of Regulation D.

Amended Rule 147 and new Rule 147A took effect on April 20, 2017. Amended Rule 504 took effect on January 20, 2017, and the repeal of Rule 505 was effective May 22, 2017. For a review of the rule changes, see my blog HERE.

This blog summarizes the substantive changes in the C&DI. Non-substantive changes were made to twenty-two C&DI, which the SEC marked with an asterisk (*) to indicate that they had been modified.

Regulation D

The SEC has made multiple changes to the C&DI related to Regulation D.

Rule 503 – Filing of Notice of Sales (Form D)

Rule 503 sets forth the requirements related to the filing of a Form D, notice of sales, with the SEC when completing an offering in reliance on Regulation D, including Rules 504 and 506. In 2009, the SEC issued a C&DI (Question 257.07) confirming that the filing of a Form D is not a condition to the availability of the exemptions under Rules 504 and 506.

All offers and sales of securities must comply with both federal and state securities laws, unless federal law specifically pre-empts state law compliance. The National Securities Markets Improvement Act of 1996 (“NSMIA”) amended Section 18 of the Securities Act to pre-empt state blue sky review of specified securities and offerings. The pre-empted securities are called “covered securities.” For more information on the NSMIA, see HERE and HERE.

The new C&DI (Question 257.08) bolsters the comfort level for issuers that fail to file a Form D (hopefully inadvertently) by confirming that the failure to file a Form D does not effect the Section 18 “covered security” status of securities issued under a Rule 506 offering.

Rule 504 – Exemption for Limited Offerings and Sales of Securities Not Exceeding $5 Million

The SEC has issued three new and withdrawn one C&DI related to Rule 504. Rule 504 provides an exemption from registration for offers and sales up to $5 million in securities in any twelve-month period. The purpose of Rule 504 is to assist small businesses in raising seed capital by allowing offers and sales of securities to an unlimited number of persons regardless of their level of sophistication – provided, however, that the offerings remain subject to the federal anti-fraud provisions; furthermore, general solicitation and advertising is prohibited unless sales are limited to accredited investors.

Rule 504, like Regulation A, is unavailable to companies that are subject to the reporting requirements of the Securities Exchange Act, are investment companies or are blank-check companies. Rule 144 has bad actor disqualification provisions matching those provisions in Rule 506. For more information on bad actor disqualification provisions, see HERE.

Rule 504 offerings do not pre-empt state law and are, in essence, a deferral to the states for small offerings. Rule 504 prohibits the use of general solicitation and advertising unless the offering is made (i) exclusively in one or more states that provide for the registration of the securities and public filing and delivery of a disclosure document; or (ii) in one or more states that piggyback on the registration of the securities in another state and they are so registered in another state; or (iii) exclusively according to a state law exemption that permits general solicitation and advertising so long as sales are made only to accredited investors (i.e., a state version of the federal 506(c) exemption).

The SEC has consistently viewed exempt offerings that involve general solicitation as public offerings. Accordingly, where a Rule 504 offering involves general solicitation or advertising, it would be considered a public offering.

One new C&DI (Question 258.03) confirms that a private fund which relies on either the Section 3(c)(1) or 3(c)(7) exemption from registration under the Investment Company Act of 1940 would not be able to make a public Rule 504 offering. The Investment Company Act exemptions in Sections 3(c)(1) and 3(c)(7) are not available to funds that conduct public offerings. If a private fund made a “public offering” of its securities, that private fund would no longer be able to rely on the applicable exclusion under Section 3(c)(1) or (7) and thus would be required to be registered under the Investment Company Act, unless another exclusion or exemption is available.

In the same C&DI, the SEC notes that a private fund could, however, rely on Rule 506(c) without losing its Investment Company Act exemption because Section 201(b)(2) specifically provides that offerings under Rule 506(c) are not considered “public offerings” under the federal securities laws. Interestingly, on November 17, 2016, the SEC issued a C&DI related to the integration of a 506(b) offering with a new 506(c) offering. Relying on Securities Act Rule 152, the SEC concluded that the two offerings would not integrate because the subsequent Rule 506(c) offering would be considered a “public offering.” See my blog HERE.

In new Question 258.05, the SEC confirms that the example for calculating aggregate offering price found in the instructions to Rule 504 does not contemplate integration of multiple offerings. Withdrawn Question 258.04 had also dealt with the calculation of the aggregate offering price.

In new Question 258.06, the SEC addresses the compliance date for the new Rule 504 bad actor disqualifications. That is, Rule 504 is not available to any issuer that is subject to disqualification under Rule 506(d) on or after January 20, 2017. On or after this date, issuers must determine if they are subject to bad actor disqualification any time they are offering or selling securities in reliance on Rule 504.

Rule 505

C&DI Questions 259.01 through 259.05 and 659.01 relating to Rule 505 have all been withdrawn consistent with the withdrawal of the Rule 505 exemption effective May 22, 2017.

Rule 506 – Exemption for Limited Offers and Sales Without Regard to Dollar Amount of Offering

Rule 506(b) allows offers and sales to an unlimited number of accredited investors and up to 35 unaccredited investors, provided however that if any unaccredited investors are included in the offering, certain delineated disclosures, including an audited balance sheet and financial statements, are provided to potential investors. Rule 506(b) prohibits the use of any general solicitation or advertising in association with the offering. Rule 506(c) requires that all sales be strictly made to accredited investors and adds a burden of verifying such accredited status to the issuing company.

The SEC did not add any new C&DI on Rule 506 but did withdraw Question 260.02, which had addressed the now outdated preclusion of general solicitation or advertising for any Rule 506 offering.

Rule 147

For a complete summary of Rule 147, see HERE. The SEC has each added one and deleted one C&DI related to determining residence of a trust.

Section 3(a)(11) of the Securities Act of 1933, as amended (Securities Act) provides an exemption from the registration requirements of Section 5 for “[A]ny security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.” Section 3(a)(11) is often referred to as the Intrastate Exemption. Rule 147, as amended is a safe harbor under Section 3(a)(11) of the Securities Act.

Rule 147 defines the residence of a purchaser that is a legal entity, such as a corporation or trust, as the location where, at the time of the sale, it has its principal place of business. The Rule specifies that if a trust is not a separate legal entity, it is deemed to be a resident of each state or territory in which its trustee is, or trustees are, resident.

The added C&DI (541.03) provides that where a family trust is not a separate legal entity and has two trustees residing in two separate states, an issuer may offer and sell securities to the trust, in reliance on Rule 147, as long as the Rule 147 offering is being conducted in one of the states in which a trustee resides.

The deleted C&DI (541.02) had provided that a trust could not be offered securities where the trust had a non-resident beneficiary that held a 50% interest in the trust.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
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West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
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LAnthony@LegalAndCompliance.com
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Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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Recommendations Of SEC Government-Business Forum On Small Business Capital Formation

Posted by Securities Attorney Laura Anthony | May 23, 2017 Tags: ATS Registration, Blue Sky Pre-Emption, Finra, Form S-3, NASAA, Non-GAAP Accounting Standards, OTC Markets, Regulation A, Regulation CF, Regulation S-K, Rule 144, Rule 147, Rule 147A, Rule 15C2-11, Rule 504, Rule 506(b) Offerings, SEC, SEC Advisory Committee, SEC Office of Small Business Policy, SEC Rule 15c2-11, Section 4(a)(2), Small Business Capital Formation, Smaller Reporting Companies

In early April, the SEC Office of Small Business Policy published the 2016 Final Report on the SEC Government-Business Forum on Small Business Capital Formation, a forum I had the honor of attending and participating in. As required by the Small Business Investment Incentive Act of 1980, each year the SEC holds a forum focused on small business capital formation. The goal of the forum is to develop recommendations for government and private action to eliminate or reduce impediments to small business capital formation.

The forum is taken seriously by the SEC and its participants, including the NASAA, and leading small business and professional organizations. The forum began with short speeches by each of the SEC commissioners and a panel discussion, following which attendees, including myself, worked in breakout sessions to drill down on specific issues and suggest changes to rules and regulations to help support small business capital formation, as well as the related, secondary trading markets. In particular, the three breakout groups were on exempt securities offerings; smaller reporting companies; and the secondary market for securities of small businesses.

Each breakout group is given the opportunity to make recommendations. The recommendations were refined and voted upon by the forum participants in the few months following the forum and have now been released by the SEC in a report containing all 15 final recommendations. In the process, the participants ranked the recommendations by whether it is likely the SEC will give high, medium, low or no priority to each recommendation.

Recommendations often gain traction. For example, the forum first recommended reducing the Rule 144 holding period for Exchange Act reporting companies to six months, a rule which was passed in 2008. Last year the forum recommended increasing the financial thresholds for the smaller reporting company definition, and the SEC did indeed propose a change following that recommendation. See my blog HERE for more information on the proposed change. Also last year the forum recommended changes to Rule 147 and 504, which recommendations were considered in the SEC’s rule changes that followed. See my blog HERE for information on the new Rule 147A and Rule 147 and 504 changes.

Forum Recommendations

The following is a list of the recommendations listed in order or priority. The priority was determined by a poll of all participants and is intended to provide guidance to the SEC as to the importance and urgency assigned to each recommendation. I have included my comments and commentary with the recommendations.

As recommended by the SEC Advisory Committee on Small and Emerging Companies, the SEC should (a) maintain the monetary thresholds for accredited investors; and (b) expand the categories of qualification for accredited investor status based on various types of sophistication, such as education, experience or training, including, but not limited to, persons with FINRA licenses, CPA or CFA designations, or management positions with issuers. My blog on the Advisory Committee on Small and Emerging Companies’ recommendations can be read HERE. Also, to read on the SEC’s report on the accredited investor definition, see HERE.
The definition of smaller reporting company and non-accelerated filer should be revised to include an issuer with a public float of less than $250 million or with annual revenues of less than $100 million, excluding large accelerated filers; and to extend the period of exemption from Sarbanes 404(b) for an additional five years for pre- or low-revenue companies after they cease to be emerging-growth companies. See my blog HERE for more information on the current proposed change to the definition of smaller reporting company and HERE related to the distinctions between a smaller reporting company and an emerging-growth company.
Lead a joint effort with NASAA and FINRA to implement a private placement broker category including developing a workable timeline and plan to regulate and allow for “finders” and limited intermediary registration, regulation and exemptions. I think this topic is vitally important. The issue of finders has been at the forefront of small business capital formation during the 20+ years I have been practicing securities law. The topic is often explored by regulators; see, for example, the SEC Advisory Committee on Small and Emerging Companies recommendations HERE and a more comprehensive review of the topic HERE which includes a summary of the American Bar Association’s recommendations.

Despite all these efforts, it has been very hard to gain any traction in this area. Part of the reason is that it would take a joint effort by FINRA, the NASAA and both the Divisions of Corporation Finance and Trading and Markets within the SEC. This area needs attention. The fact is that thousands of people act as unlicensed finders—an activity that, although it remains illegal, is commonplace in the industry. In other words, by failing to address and regulate finders in a workable and meaningful fashion, the SEC and regulators perpetuate an unregulated fringe industry that attracts bad actors equally with the good and results in improper activity such as misrepresentations in the fundraising process equally with the honest efforts. However, practitioners, including myself, remain committed to affecting changes, including by providing regulators with reasoned recommendations.

The SEC should adopt rules that pre-empt state registration for all primary and secondary trading of securities qualified under Regulation A/Tier 2, and all other securities registered with the SEC. I have been a vocal proponent of state blue sky pre-emption, including related to the secondary trading of securities. Currently, such secondary trading is usually achieved through the Manual’s Exemption, which is not recognized by all states. There is a lack of uniformity in the secondary trading market that continues to negatively impact small business issuers. For more on this topic, see my two-part blog HERE and HERE.
Regulation A should be amended to: (i) pre-empt state blue sky regulation for all secondary sales of Tier 2 securities (included in the 4th recommendation above); (ii) allow companies registered under the Exchange Act, including at least business development companies, emerging-growth companies and smaller reporting companies, to utilize Regulation A (see my blog on this topic, including a discussion of a proposed rule change submitted by OTC Markets, HERE ); and (iii) provide a clearer definition of what constitutes “testing-the-waters materials” and permissible media activities.
Simplify disclosure requirements and costs for smaller reporting companies and emerging-growth companies with a principles-based approach to Regulation S-K, eliminating information that is not material, reducing or eliminating non-securities-related disclosures with a political or social purpose (such as pay ratio, conflict minerals, etc.), making XBRL compliance optional and harmonizing rules for emerging-growth companies with smaller reporting companies. For more on the ongoing efforts to revise Regulation S-K, including in manners addressed in this recommendation, see HERE and for more information on the differences between emerging-growth companies and smaller reporting companies, see HERE.
Mandate comparable disclosure by short sellers or market makers holding short positions that apply to long investors, such as through the use of a short selling report on Schedule 13D.
The SEC should provide scaled public disclosure requirements, including the use of non-GAAP accounting standards that would constitute adequate current information for entities whose securities will be traded on secondary markets. This recommendation came from the secondary market for securities of small businesses breakout group. I was part of the smaller reporting companies breakout group, so I did not hear the specific discussion on this recommendation. However, I do note that Rule 144 does provide for a definition of adequate current public information for companies that are not subject to the Exchange Act reporting requirements. In particular, Rule 144 provides that adequate current public information would include the information required by SEC Rule 15c2-11 and OTC Markets specifically models its alternative reporting disclosure requirements to satisfy the disclosures required by Rule 15c2-11.
The eligibility requirements for the use of Form S-3 should be revised to include all reporting companies. For more on the use of Form S-3, see my blog HERE.
The SEC should clarify the relationship of exempt offerings in which general solicitation is not permitted, such as in Section 4(a)(2) and Rule 506(b) offerings, with Rule 506(c) offerings involving general solicitation in the following ways: (i) the facts and circumstances analysis regarding whether general solicitation is attributable to purchasers in an exempt offering should apply equally to offerings that allow general solicitation as to those that do not (such that even if an offering is labeled 506(c), if in fact no general solicitation is used, it can be treated as a 506(b); and (ii) to clarify that Rule 152 applies to Rule 506(c) so that an issuer using Rule 506(c) may subsequently engage in a registered public offering without adversely affecting the Rule 506(c) exemption. I note that within days of the forum, the SEC did indeed issue guidance on the use of Rule 152 as applies to Rule 506(c) offerings, at least as relates to an lternative trading systemintegration analysis between 506(b) and 506(c) offerings. See my blog HERE.
The SEC should amend Regulation ATS to allow for the resale of unregistered securities including those traded pursuant to Rule 144 and 144A and issued pursuant to Sections 4(a)(2), 4(a)(6) and 4(a)(7) and Rules 504 and 506.
The SEC should permit an ATS to file a 15c2-11 with FINRA and review the FINRA process to make sure that there is no undue burden on applicants and issuers. An ATS is an “alternative trading system.” The OTC Markets’ trading platform is an ATS. This recommendation would allow OTC Markets to directly file 15c2-11 applications on behalf of companies. A 15c2-11 application is the application submitted to FINRA to obtain a trading symbol and allow market makers to quote the securities of companies that trade on an ATS, such as the OTC Markets. Today, only market makers seeking to quote the trading in securities can submit the application. Also today, the application process can be difficult and lack clear guidance or timelines for the market makers and companies involved. This process definitely needs attention and this recommendation would be an excellent start.
Regulation CF should be amended to (i) permit the usage of special-purpose vehicles so that many small investors may be grouped together into one entity which then makes a single investment in a company raising capital under Regulation CF; and (ii) harmonize the Regulation CF advertising rules to avoid traps in situations where an issuer advertises or engages in general solicitations under Regulation A or Rule 506(c) and then converts to or from a Regulation CF offering.
The SEC should provide greater clarity on when trading activities require ATS registration, and when an entity or technology platform needs to a funding portal, broker-dealer, ATS and/or exchange in order to “be engaged in the business” of secondary trading transactions.
Reduce the Rule 144 holding period to 3 months for reporting companies. I fully support this recommendation.

The Author

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