SEC Final Rule Changes For Exempt Offerings Archives

SEC Final Rule Changes For Exempt Offerings – Part 4

Posted by Securities Attorney Laura Anthony | February 26, 2021 Tags: SEC, SEC Final Rule Changes For Exempt Offerings

On November 2, 2020, the SEC adopted final rule changes to harmonize, simplify and improve the exempt offering framework. The new rules go into effect on March 14, 2021. The 388-page rule release provides a comprehensive overhaul to the exempt offering and integration rules worthy of in-depth discussion. As such, like the proposed rules, I am breaking it down over a series of blogs with this fourth blog discussing the changes to Regulation A. The first blog in the series discussed the new integration rules (see HERE). The second blog in the series covered offering communications (see HERE). The third blog focuses on amendments to Rule 504, Rule 506(b) and 506(c) of Regulation D (see HERE.

Background; Current Exemption Framework

The Securities Act of 1933 (“Securities Act”) requires that every offer and sale of securities either be registered with the SEC or exempt from registration. Offering exemptions are found in Sections 3 and 4 of the Securities Act. Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another). Section 3(b) allows the SEC to exempt certain smaller offerings and is the statutory basis for Rule 504 and Regulation A. Section 4 contains all transactional exemptions including Section 4(a)(2), which is the statutory basis for Regulation D and its Rules 506(b) and 506(c). The requirements to rely on exemptions vary from the type of company making the offering (private or public, U.S. or not, investment companies…), the offering amount, manner of offering (solicitation allowable or not), bad actor rules, type of investor (accredited) and amount and type of disclosure required. In general, the greater the ability to sell to non-accredited investors, the more offering requirements are imposed.

For a chart on the exemption framework incorporating the new rules, see Part 1 in this blog series HERE.

Regulation A

The current two-tier Regulation A offering process went into effect on June 19, 2015, as part of the JOBS Act. Since its inception there has been one rule modification opening up the offering to SEC reporting companies (see HERE) and multiple SEC guidance publications including through C&DI on the Regulation A process. For a recent summary of Regulation A, see HERE. In reviewing the rules, the SEC found a few areas where compliance with Regulation A is more complex or difficult than for registered offerings, including the rules regarding the redaction of confidential information in material contracts, making draft offering statements public on EDGAR, incorporation by reference, and the abandonment of a post-qualification amendment. The new rules address these points.

The SEC has simplified the requirements for Regulation A and established greater consistency between Regulation A and registered offerings by permitting Regulation A issuers to: (i) file certain redacted exhibits using the process previously adopted for registered offerings (see HERE); (ii) make draft offering statements and related correspondence available to the public via EDGAR to comply with the requirements of Securities Act Rule 252(d), rather than requiring them to be filed as exhibits to qualified offering statements (see HERE); (iii) incorporate financial statement information by reference to other documents filed on EDGAR and generally allow incorporation by reference to the same degree as a registered offering (see HERE); and (iv) to have post-qualification amendments declared abandoned.

In addition, as has been discussed for several years now, the new rules increase the Tier 2 offering limit. Moreover, the new rules add an eligibility standard such that an Exchange Act reporting company which is delinquent in such reports, will not qualify to rely on Regulation A.

Increase in Offering Limit

The new rules increase the maximum Regulation A Tier 2 offering from $50 Million to $75 million in any 12-month period. As such, the 30% offering limit for secondary sales has increased from $15 million to $22.5 million. Tier 1 offering limits remain unchanged.

Redaction of Confidential Information in Certain Exhibits

In March 2019, the SEC amended parts of Regulation S-K to allow companies to mark their exhibit index to indicate that portions of the exhibit or exhibits have been omitted. Under the rules, a company must include a prominent statement on the first page of the redacted exhibit stating that certain identified information has been excluded from the exhibit because it is both not material and would be competitively harmful if publicly disclosed. A company must also indicate with brackets where the information has been omitted from the filed version of the exhibit. At the time the Regulation A rules were not changed such that Regulation A filers were still compelled to submit an application for confidential treatment in order to redact immaterial confidential information from material contracts and plans of acquisition, reorganization, arrangement, liquidation, or succession.

The new rules have aligned the Regulation A requirements with those for registered offerings. The SEC has added a new instruction to the Form 1-A that allows companies to redact exhibits using the same procedure as for registered offerings. SEC staff will continue to review Forms 1-A filed in connection with Regulation A offerings and selectively assess whether redactions from exhibits appear to be limited to information that meets the appropriate standard. Upon request, companies are expected to promptly provide supplemental materials to the SEC similar to those currently required by Exchange Act reporting companies. The information that the SEC could request includes an unredacted copy of the exhibit and an analysis of why the redacted information is both not material and the type of information that the company customarily and actually treats as private and confidential. The new rules follow the updated definition of “confidential” which does not include the “competitive harm” factor in the analysis. See HERE.

Regulation A Companies are also still able to request confidentiality under Rule 83. For more on confidential treatment in SEC filings, see HERE.

Confidential Offering Statement

Companies that are conducting Regulation A offerings are permitted to submit non-public draft offering statements and amendments for review by the SEC if they have not previously sold securities pursuant to (i) a qualified offering statement under Regulation A or (ii) an effective Securities Act registration statement. Prior to the rule amendments, confidential submittals had to be filed as an exhibit to a public filing at least 21 days prior to the qualification of the offering statement, which adds time and expense to the process. Aligning with confidential treatment for registered offerings, the SEC has amended the rules to allow a company to make draft offering statements and related correspondence available to the public via EDGAR by changing the previous submission selection from “confidential” to “public.”

Incorporation by Reference

The ability to incorporate financial statements by reference to Exchange Act reports filed before the effective date of a registration statement is permitted on Form S-1, subject to certain conditions. Aligning Regulation A with the S-1 provisions, the new rules will allow previously filed financial statements to be incorporated by reference into a Regulation A offering circular. To avail itself of the ability to incorporate by reference companies that have a reporting obligation under Rule 257, or the Exchange Act must be current in their reporting obligations. In addition, companies must make incorporated financial statements readily available and accessible on a website maintained by or for the company and disclose in the offering statement that such financial statements will be provided upon request. Companies conducting ongoing offerings still need to file an annual post-qualification amendment with updated financial statements.

Abandonment of an Offering

Prior to the rule amendment, Regulation A permitted the SEC to declare an offering statement abandoned but did not provide the same authority for post-qualification amendments. The new rules now specifically allow for the SEC to declare a post-qualification filing abandoned.

Ineligibility for Delinquent Exchange Act Reporting Companies

Regulation A includes an eligibility requirement that company conducting a Regulation A offering must have filed all reports, with the SEC, required to be filed, if any, pursuant to Rule 257 during the two years before the filing of the offering statement (or for such shorter period that the issuer was required to file such reports). When the SEC amended Regulation A to allow Exchange Act reporting companies to rely on the rule, it did not amend the provision related to delinquent filings. Accordingly, since Exchange Act companies are not required to file reports pursuant to Rule 257, a company could technically be delinquent and eligible to use Regulation A. In actuality, the SEC generally commented and pushed back on such companies, but the new rules close this loophole. In particular, companies that do not file all the reports required to have been filed by Sections 13 or 15(d) of the Exchange Act in the two-year period preceding the filing of an offering statement are ineligible to conduct a Regulation A offering.

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SEC Final Rule Changes For Exempt Offerings – Part 3

Posted by Securities Attorney Laura Anthony | February 19, 2021 Tags: SEC Final Rule Changes For Exempt Offerings

On November 2, 2020, the SEC adopted final rule changes to harmonize, simplify and improve the exempt offering framework. The new rules go into effect on March 14, 2021. The 388-page rule release provides a comprehensive overhaul to the exempt offering and integration rules worthy of in-depth discussion. As such, like the proposed rules, I am breaking it down over a series of blogs with this second blog discussing offering communications including new rules related to demo days and generic testing the waters. The first blog in the series discussed the new integration rules (see HERE). The second blog in the series covered offering communications (see HERE). This third blog focuses on amendments to Rule 504, Rule 506(b) and 506(c) of Regulation D.

Background

The Securities Act of 1933 (“Securities Act”) requires that every offer and sale of securities either be registered with the SEC or exempt from registration. The purpose of registration is to provide investors with full and fair disclosure of material information so that they are able to make their own informed investment and voting decisions.

Offering exemptions are found in Sections 3 and 4 of the Securities Act. Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another). Section 3(b) allows the SEC to exempt certain smaller offerings and is the statutory basis for Rule 504 and Regulation A. Section 4 contains all transactional exemptions including Section 4(a)(2), which is the statutory basis for Regulation D and its Rules 506(b) and 506(c). The requirements to rely on exemptions vary from the type of company making the offering (private or public, U.S. or not, investment companies…), the offering amount, manner of offering (solicitation allowable or not), bad actor rules, type of investor (accredited) and amount and type of disclosure required. In general, the greater the ability to sell to non-accredited investors, the more offering requirements are imposed.

Section 4(a)(2) of the Securities Act exempts transactions by an issuer not involving a public offering from the Act’s registration requirements. Section 4(a)(2) does not limit the amount a company can raise or the amount any investor can invest. Rule 506 is “safe harbor” promulgated under Section 4(a)(2). If all the requirements of Rule 506 are complied with, then the exemption under Section 4(a)(2) would likewise be complied with.

Rule 506 is bifurcated into two separate offering exemptions. 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, must be provided to potential investors. Rule 506(b) prohibits the use of any general solicitation or advertising in association with the offering. Rule 506(c) allows for general solicitation and advertising; however, all sales must be strictly made to accredited investors and the company has an additional burden of verifying such accredited status. In a 506(c) offering, it is not enough for the investor to check a box confirming that they are accredited, as it is with a 506(b) offering.

For a chart on the exemption framework incorporating the new rules, see Part 1 in this blog series HERE.

Rule 506(c) Verification Requirements

Rule 506(c) allows for general solicitation and advertising; however, all sales must be made to accredited investors and the company must take reasonable steps to verify that purchasers are accredited. It is not enough for the investor to check a box confirming that they are accredited, as it is with a 506(b) offering. For more on Rules 506(b) and 506(c), see HERE.

Rule 506(c) provides for a principles-based approach to determine whether an investor is accredited as well as setting forth a non-exclusive list of methods to determine accreditation. After consideration of the facts and circumstances of the purchaser and of the transaction, the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the company would have to take to verify accredited investor status, and vice versa. Where accreditation has been verified by a trusted third party, it would be reasonable for an issuer to rely on that verification.

Examples of the type of information that companies can review and rely upon include: (i) publicly available information in filings with federal, state and local regulatory bodies (for example: Exchange Act reports; public property records; public recorded documents such as deeds and mortgages); (ii) third-party evidentiary information including, but not limited to, pay stubs, tax returns, and W-2 forms; and (iii) third-party accredited investor verification service providers.

The SEC has added a new item to the non-exclusive methods of verification. In particular, where the company has previously gone through the steps to verify accredited status for an existing investor, it can rely on the written representation that the investor continues to qualify as an accredited investor as long as the company is not aware of information to the contrary. With the rule change, the entire non-exclusive methods of verification included in the rule are:

Review of copies of any Internal Revenue Service form that reports income including, but not limited to, a Form W-2, Form 1099, Schedule K-1 and a copy of a filed Form 1040 for the two most recent years along with a written representation that the person reasonably expects to reach the level necessary to qualify as an accredited investor during the current year. If such forms and information are joint with a spouse, the written representation must be from both spouses.
Review of one or more of the following, dated within three months, together with a written representation that all liabilities necessary to determine net worth have been disclosed. For assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraiser reports issued by third parties and for liabilities, credit reports from a nationwide agency.
Obtaining a written confirmation from a registered broker-dealer, an SEC registered investment advisor, a licensed attorney, or a CPA that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months.
A written certification verifying accredited investor status from existing accredited investors of the company that have previously invested in a 506(b) offering with the same issuer prior to the enactment of 506(c); and
A written representation from a person at the time of sale that he or she qualifies as an accredited investor where the company previously took reasonable steps to verify such person as an accredited investor in accordance with the rules, and so long as the company is not aware of information to the contrary. A written representation under this method of verification will satisfy the issuer’s obligation to verify the person’s accredited investor status for a period of five years from the date the person was previously verified as an accredited investor.

The SEC has provided guidance on the application of some of the non-exclusive methods of verifying accredited status. To wit: related to jointly held property, assets in an account or property held jointly with a person who is not the purchaser’s spouse may be included in the calculation for the accredited investor net worth test, but only to the extent of his or her percentage ownership of the account or property. Where the most recent tax return is not available but the two years prior are, a company may rely on the available returns together with a written representation from the purchaser that (i) an Internal Revenue Service form that reports the purchaser’s income for the recently completed year is not available, (ii) specifies the amount of income the purchaser received for the recently completed year and that such amount reached the level needed to qualify as an accredited investor, and (iii) the purchaser has a reasonable expectation of reaching the requisite income level for the current year. However, if the evidence is at all questionable, further inquiry should be made.

The new rule release reaffirms that the rule is meant to be principles-based and that by offering suggested methods of verification, the SEC is not discouraging any reasonable methods a company may deem appropriate. Companies are encouraged to consider (i) the nature of the purchaser and the type of accredited investor that the purchaser claims to be; (ii) the amount and type of information that the company has about the purchaser; and (iii) 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.

Rule 506(b); Harmonization of Disclosure Requirements

Rule 506(b) has scaled disclosure requirements based on the size of the offering, where unaccredited investors are included. Prior to the amendments, the scaled requirements were broken into 4 categories. The amended rules update the information requirements for investors under Rule 506(b) where any unaccredited investors are solicited to align with information required under Regulation A. For Rule 506(b) offerings up to $20 million, the same financial information that is required for Tier 1 Regulation A offerings, is now required. For offerings greater than $20 million, the same financial information that is required for Tier 2 Regulation A offerings is now required.

In standardizing the 506(b) and Regulation A disclosures, the SEC has eliminated the ability to only provide a balance sheet where a company has trouble getting financial statements when conducting a Rule 506(b) offering. Foreign private issuers may provide the financial information in either U.S. GAAP or IFRS as would be permitted in a registration statement.

If the company is not subject to the Exchange Act reporting requirements, it must also furnish the non-financial statement information required by Part II of Form 1-A or Part I of a Securities Act registration statement on a form that the issuer would be eligible to use (usually Form S-1). If the company is subject to the Exchange Act reporting requirements, it must provide its definitive proxy with annual report, or its most recent Form 10-K. These information requirements only apply where non-accredited investors will be solicited to participate in the offering.

Finally, as mentioned in Part I of this blog series related to integration where an issuer conducts more than one offering under Rule 506(b), the number of non-accredited investors purchasing in all such offerings within 90 calendar days of each other is limited to 35.

Rule 504

On October 26, 2016, the SEC passed new rules to modernize intrastate and regional securities offerings. The final new rules amended Rule 147 to allow companies to continue to conduct intrastate offerings under Section 3(a)(11) of the Securities Act and created a new Rule 147A to accommodate adopted state intrastate crowdfunding provisions. 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. At that time, the SEC also 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. For more on the 2016 rule amendments, see HERE.

Even with the increased offering limits, as of today only approximately 2% of all Regulation D offerings under $5 million, rely on Rule 504. The amended rules hope to encourage the use of Rule 504 by raising the offering limits to $10 million in any 12-month period.

Rule 504 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 504 does not have any specific investor qualification or limitations. However, Rule 504 does not pre-empt state law and as such, the law of each state in which an offering will be conducted must be reviewed and complied with.

Bad-Actor Provisions

Rules 504, 506(b), 506(c), Regulation A and Regulation Crowdfunding all have bad-actor disqualification provisions. While the disqualification provisions are substantially similar, the look-back period for determining whether a covered person is disqualified differed between Regulation D and the other exemptions. The amended rules harmonize the bad-actor provisions among Regulations D, A and Crowdfunding by adjusting the look-back requirements in Regulation A and Regulation Crowdfunding to include the time of sale in addition to the time of filing.

Under Regulation D, the disqualification event is measured as of the time of sale of the securities in the offering. Prior to the amendment, the look-back period was measured from the time the company files an offering statement for both Regulation A and Regulation Crowdfunding. However, the SEC believes that it is important to look to both the time of filing of the offering document and the time of the sale with respect to disqualifying bad actors from participating in an offering. The amended rules add “or such sale” to any look back references in Regulation A and Regulation Crowdfunding.

As a refresher, the bad actor rules relate to certain activities or events involving covered persons. Covered persons include:

The issuer and any predecessor of the issuer or affiliated issuer;
Any director, general partner or managing member of the issuer and executive officers (i.e., those officers that participate in policymaking functions) and officers who participate in the offering (participation is a question of fact and includes activities such as involvement in due diligence, communications with prospective investors, document preparation and control, etc.);
Any beneficial owner of 20% or more of the outstanding equity securities of the issuer calculated on the basis of voting power (voting power is undefined and meant to encompass the ability to control or significantly influence management or policies; accordingly, the right to elect or remove directors or veto or approve transactions would be considered voting (for SEC guidance on voting control, see HERE;
Investment managers of issuers that are pooled investment funds; the directors, executive officers, and other officers participating in the offering; general partners and managing members of such investment managers; the directors and executive officers of such general partners; and managing members and their other officers participating in the offering (i.e., the hedge fund coverage; the term “investment manager” is meant to encompass both registered and exempt investment advisers and other investment managers);
Any promoter connected with the issuer in any capacity at the time of the sale (a promoter is defined in Rule 405 as “any person, individual or legal entity, that either alone or with others, directly or indirectly takes initiative in founding the business or enterprise of the issuer, or, in connection with such founding or organization, directly or indirectly receives 10% or more of any class of issuer securities or 10% or more of the proceeds from the sale of any class of issuer securities other than securities received solely as underwriting commissions or solely in exchange for property”);
Any person who has been or will be paid, either directly or indirectly, remuneration for solicitation of purchasers in connection with sales of securities in the offering; and
Any director, officer, general partner, or managing member of any such compensated solicitor.

Disqualifying events include:

Criminal convictions (felony or misdemeanor) within the last five years in the case of issuers, their predecessors and affiliated issuers, and ten years in the case of other covered persons, in connection with the purchase or sale of any security; involving the making of a false filing with the Commission; or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities;
Court injunctions and restraining orders, including any order, judgment or decree of any court of competent jurisdiction, entered within five years before such sale that, at the time of such sale, restrains or enjoins such person from engaging or continuing to engage in any conduct or practice in connection with the purchase or sale of any security; involving the making of a false filing with the Commission; or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities;
Final orders issued by a state securities commission (or any agency of a state performing like functions), a state authority that supervises or examines banks, savings and associations, or credit unions, state insurance regulators, federal banking regulators, the CFTC, or the National Credit Union Administration that, at the time of the sale, bars the person from association with any entity regulated by the regulator issuing the order or from engaging in the business of securities, insurance or banking or engaging in savings association or credit union activities; or constitutes a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct within the last ten years before the sale;
Any order of the SEC entered pursuant to Section 15(b) or 15B(c) of the Exchange Act or section 203(e) or (f) of the Investment Advisors Act that, at the time of such sale, suspends or revokes such person’s registration as a broker, dealer, municipal securities dealer or investment advisor; places limitations on the activities, functions or operations of such person; or bars such person from being associated with any entity or from participating in the offering of any penny stock;
Is subject to any order of the SEC entered within five years before such sale that, at the time of such sale, orders the person to cease and desist from committing or causing a violation of future violation of any scienter-based anti-fraud provision of federal securities laws (including, without limitation, Section 17(a)(10) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, Section 15(c)(1) of the Exchange Act and Section 206(1) of the Advisor Act, or any other rule or regulation thereunder) or Section 5 of the Securities Act;
Suspension or expulsion from membership in, or suspension or bar from association with, a member of an SRO, i.e., a registered national securities exchange or a registered national or affiliated securities association for any act or omission to act constituting conduct inconsistent with just and equitable principles of trade;
Has filed (as a registrant or issuer), or was or was named as an underwriter in, any registration statement or Regulation A offering statement filed with the Commission that, within five years before such sale, was the subject of a refusal order, stop order, or order suspending the Regulation A exemption, or is, at the time of such sale, the subject of an investigation or proceeding to determine whether a stop order or suspension order should be issued; and
U.S. Postal Service false representation orders, including temporary or preliminary orders entered within the last five years.

For further reading on SEC guidance on the bad actor provisions, see HERE.

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SEC Final Rule Changes For Exempt Offerings – Part 2

Posted by Securities Attorney Laura Anthony | February 12, 2021 Tags: SEC, SEC Final Rule Changes For Exempt Offerings

On November 2, 2020, the SEC adopted final rule changes to harmonize, simplify and improve the exempt offering framework. The new rules go into effect on March 14, 2021. The 388-page rule release provides a comprehensive overhaul to the exempt offering and integration rules worthy of in-depth discussion. As such, like the proposed rules, I am breaking it down over a series of blogs with this second blog discussing offering communications including new rules related to demo days and generic testing the waters. The first blog in the series discussed the new integration rules (see HERE).

Background

Offering exemptions are found in Sections 3 and 4 of the Securities Act. Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another). Section 4 contains all transactional exemptions including Section 4(a)(2), which is the statutory basis for Regulation D and its Rules 506(b) and 506(c). The requirements to rely on exemptions vary from the type of company making the offering (private or public, U.S. or not, investment companies…), the offering amount, manner of offering (solicitation allowable or not), bad actor rules, type of investor (accredited) and amount and type of disclosure required. In general, the greater the ability to sell to non-accredited investors, the more offering requirements are imposed.

Effective September 2013, in accordance with the JOBS Act, the SEC adopted final rules eliminating the prohibition against general solicitation and advertising in Rule 506 by bifurcating the rule into two separate offering exemptions. The historical Rule 506 was renumbered to Rule 506(b) and new rule 506(c) was enacted. 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, must be provided to potential investors. Rule 506(b) prohibits the use of any general solicitation or advertising in association with the offering.

Rule 506(c) allows for general solicitation and advertising; however, all sales must be strictly made to accredited investors and the company has an additional burden of verifying such accredited status. In a 506(c) offering, it is not enough for the investor to check a box confirming that they are accredited, as it is with a 506(b) offering. Accordingly, in the Rule 506 context, determining whether solicitation or advertising has been utilized is extremely important.

Other private offerings also allow for solicitation and advertising. In particular, Regulation A, Regulation Crowdfunding, Rule 147 and 147A, and Rule 504 all allow for solicitation and advertising. For more information on Rule 504, Rule 147 and 147A, see HERE; on Regulation A, see HERE; and on Regulation Crowdfunding, see HERE. Part 1 of this blog series talked about issues with integration, including between offerings that allow and don’t allow solicitation, but equally important is determining what constitutes solicitation in the first place.

Prior to the JOBS Act, general solicitation and advertising was prohibited in most exempt offerings and “testing the waters” was not yet a mainstream term of art in the capital markets. Following the JOBS Act creation of Rule 506(c), Regulation Crowdfunding and the new Regulation A/A+ structure, offering solicitation and pre-offering testing the waters became the norm. Recognizing the benefits of additional offering communications, and testing the waters prior to launching an offering, the SEC has included expanded offering communications and testing the waters provision in its modernized exempt offering rules.

For a chart on the exemption framework incorporating the new rules, see Part 1 in this blog series HERE.

Offering Communications; Expansion of Test-the-Waters Communications; Addition of “Demo Days”

The Securities Act defines the term “offer” very broadly and includes any publication of information or communication in advance of a financing that would have the effect of arousing interest in the securities being offered. Likewise, general solicitation and advertising have been interpreted very broadly. Although Rule 502(c) lists some examples, the SEC has expanded upon those examples over the years, including information posted on an unrestricted website as a general solicitation.

Rule 502(c) lists the following examples of solicitation or advertising:

Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and
Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising; provided, however,that publication by a company of a notice in accordance with Rule 135c or filing with the SEC of a Form D shall not be deemed to constitute general solicitation or general advertising; and provided further that, if the requirements of Rule 135e are satisfied, providing any journalist with access to press conferences held outside of the U.S., to meetings with companies or selling security holder representatives conducted outside of the U.S., or to written press-related materials released outside the U.S., at or in which a present or proposed offering of securities is discussed, will not be deemed to constitute general solicitation or general advertising.

Generally, testing the waters through contacting potential investors in advance of an exempt offering to gauge interest in the future offering, could be deemed solicitation. In 2015 the SEC issued several C&DI to address when communications would be deemed a solicitation or advertisement, including factual business communications in advance of an offering and demo days or venture fairs.

At that time, the SEC indicated that participation in a demo day or venture fair does not automatically constitute general solicitation or advertising under Regulation D. If a company’s presentation does not involve the offer of securities at all, no solicitation is involved. If the attendees of the event are limited to persons with whom either the company or the event organizer have a pre-existing, substantive relationship, or have been contacted through a pre-screened group of accredited, sophisticated investors (such as an angel group), it will not be deemed a general solicitation. However, if invitations to the event are sent out via general solicitation to individuals and groups with no established relationship and no pre-screening as to accreditation, any presentation involving the offer of securities would be deemed to involve a general solicitation under Regulation D. For more on a pre-existing substantive relationship, see HERE.

The amended rules specifically exempt “demo days” from the definition of general solicitation and advertising for all offerings; allow companies to use generic solicitations of interest communications prior to determining which exempt offering they will rely upon or pursue; and add test-the-waters provisions to Regulation Crowdfunding.

Demo Days; New Rule 148

“Demo days” and similar events are generally organized by a group or entity that invites issuers to present their businesses to potential investors, with the aim of securing an investment.

New Rule 148 provides that certain demo day communications will not be deemed to be a general solicitation or advertising. Specifically, a company will not be deemed to have engaged in general solicitation if the communications are made in connection with a seminar or meeting sponsored by a college, university, or other institution of higher education, a local government, a state government, instrumentalities of state and local governments, a nonprofit organization, or an angel investor group, incubator, or accelerator and in which more than one company participates. Rule 148 excludes broker-dealers and investment advisors from the scope of the exemption.

Rule 148 requires that “angel investor groups” maintain defined processes and procedures for making investment decisions, though the rule does not require that the processes be memorialized in writing.

Sponsors of events are not permitted to: (i) make investment recommendations or provide investment advice to attendees of the event; (ii) engage in any investment negotiations between the company and investors attending the event; (iii) charge attendees fees beyond a reasonable administrative fee; (iv) receive compensation for making introductions; or (v) receive any compensation with respect to the event that would require registration as a broker-dealer or investment advisor.

Advertising for the event is also limited and may not reference any specific offering of securities by a participating company. To address concerns that communications for demo day events will encompass a large number of non-accredited investors especially in light of the increase in virtual events, the new rule limits online participation for an event to: (i) individuals who are members of, or otherwise associated with the sponsor organization; (b) individuals that the sponsor reasonably believes are accredited investors; or (iii) individuals who have been invited to the event by the sponsor based on industry or investment related experience reasonably selected by the sponsor in good faith and disclosed in the public communications about the event.

Rule 148 also regulates the information a presenting company can convey to: (i) notification that the company is in the process of an offering or planning an offering of securities; (ii) the type and amount of securities being offered; (iii) use of proceeds; and (iv) the remaining unsubscribed amount of an offering.

Rule 148 is a non-exclusive method of communicating with potential investors. Companies may continue to rely on previously issued guidance to attend events where the participation is limited to individuals or groups of individuals with whom the company or the organizer has a pre-existing substantive relationship or that have been contacted through an informal, personal network of experienced, financially sophisticated individuals. In those events, the information provided by the company is not limited.

Solicitations of Interest; New Rule 241

Prior to the JOBS Act, almost no exempt offerings (except intrastate offerings when allowed by the state) allowed for advertising or soliciting, including solicitations of interest or testing the waters. The JOBS Act created the current Regulation A, which allows for testing the waters subject to certain SEC filing requirements and the inclusion of specific legends on the offering materials. For a discussion on Regulation A test-the-waters provisions, see HERE.

The SEC recognizes the benefits of testing the waters prior to incurring the costs associated with an offering. As such, the SEC is adopting new Rule 241, which exempts companies from the registration requirements for generic pre-offering communications that are made in compliance with the rule. Rule 241 allows companies to solicit indications of interest in an exempt offering, either orally or in writing, prior to determining which exemption they will rely upon, even if the ultimate exemption does not allow for general solicitation or advertising. Rule 241 is an exemption from the registration requirements for “offers” but not “sales,” but since communications under the rule are considered “offers,” they are subject to the antifraud provisions under the federal securities laws.

Rule 241 is similar to existing Rule 255 of Regulation A. Rule 241 communications require a legend or disclaimer stating that: (i) the company is considering an exempt offering but has not determined the specific exemption it will rely on; (ii) no money or other consideration is being solicited, and if sent, will not be accepted; (iii) no sales will be made or commitments to purchase accepted until the company determines the exemption to be relied upon and where the exemption includes filing, disclosure, or qualification requirements, all such requirements are met; and (iv) a prospective purchaser’s indication of interest is non-binding.

Once a company determines which type of offering it intends to pursue, it would no longer be able to rely on Rule 241 but would need to comply with the rules associated with that particular offering type, including its solicitation of interest and advertising rules. Moreover, since the solicitation of interest would likely be a general solicitation, if the chosen offering does not allow general solicitation or advertising, the company would need to conduct an integration analysis to make sure that there would be no integration between the solicitation of interest and the offering. Under the new rules, that would generally require the company to wait 30 days between the solicitation of interest and the offering (see Part 1 of this blog series HERE). I say “would likely be a general solicitation” because a company may still indicate interest from persons that it has a prior business relationship with, without triggering a general solicitation, as they can now under the current rules.

If a company elects to proceed with a Regulation A or Regulation Crowdfunding offering, it will need to file the Rule 241 test-the-waters materials if the Rule 241 solicitation is within 30 days of the ultimate offering, as such solicitation of interest would integrate with the following offering. If more than 30 days pass, the Rule 241 communications would not need to be filed, but any Rule 255 communication would need to be filed in a Regulation A offering and new Rule 206 communications would need to be filed in a Regulation Crowdfunding offering.

Although new Rule 241 does not limit the type of investor that can be solicited (accredited or non-accredited), under the new rules, if a company determines to proceed with a Rule 506(b) offering within 30 days of obtaining indications of interest, it must provide the non-accredited investors, if any, with a copy of any written solicitation of interest materials that were used.

New Rule 241 does not pre-empt state securities laws. Accordingly, if a company ultimately proceeds with an offering that does not pre-empt state law, it will need to consider whether it has met the state law requirements, including whether each state allows for solicitations of interest prior to an offering. This provision will likely be a large impediment to a company that is considering an offering that does not pre-empt state law.

Regulation Crowdfunding; New Rule 206; Amended Rule 204

Prior to the amendments, a company could not solicit potential investors until their Form C is filed with the SEC. New Rule 206 will allow both oral and written test-the-waters communications prior to the filing of a Form C much the same as Regulation A. Under Rule 206, companies are permitted to test the waters with all potential investors.

The testing-the-waters materials will be considered offers that are subject to the antifraud provisions of the federal securities laws. Like Regulation A, any test-the-waters communications will need to contain a legend including: (i) no money or other consideration is being solicited, and if sent, will not be accepted; (ii) no sales will be made or commitments to purchase accepted until the Form C is filed with the SEC and only through an intermediary’s platform; and (iii) a prospective purchaser’s indication of interest is non-binding. Any test-the-waters materials will need to be filed with the SEC as an exhibit to the Form C.

Unlike Regulation A, Rule 206 only allows for testing the waters prior to the filing of a Form C with the SEC. Once the Form C is filed, any offering communications are required to comply with the terms of Regulation Crowdfunding, including the Rule 204 advertising restrictions.

However, the SEC has also amended Rule 204 to permit oral communications with prospective investors once the Form C is filed. The SEC has also expanded upon the allowed categories of advertised information that can be provided under Rule 204. Rule 204 generally allows a company to advertise a Regulation Crowdfunding offering by directing potential investors to the intermediary’s platform. Rule 204 allows such advertisements to include limited information about the offering. The SEC has added: (i) a brief description of the planned use of proceeds of the offering; and (ii) information on the company’s progress towards meeting its funding goals, to the already allowable: (a) statement that the company is conducting an offering under Regulation Crowdfunding; (b) the name of the intermediary and a link to the intermediary’s platform; (c) the terms of the offering; and (d) factual information about the legal identity and business location of the company including its full name, address, phone number, web site address, email of a representative and a brief description of the business.

The SEC has further amended Rule 204 to specify that a company may provide information about the terms of an offering under Regulation Crowdfunding in the offering materials for a concurrent offering, such as in an offering statement on Form 1-A for a concurrent Regulation A offering or a Securities Act registration statement filed with the SEC, without violating Rule 204. To do so, the information provided about the Regulation Crowdfunding offering must be in compliance with Rule 204, including the requirement to include a link directing the potential investor to the intermediary’s platform. However, since SEC rules prohibit live links to locations outside the EDGAR system, the link in such a filing could not be a live hyperlink.

Further Background Reading

Prior to the rule changes, the SEC issued a concept release and request for public comment on the subject in June 2019 (see HERE). Also, for my five-part blog series on the proposed rules, see HERE, HERE , HERE, HERE, and HERE.

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