On October 26, 2016, the Securities and Exchange Commission adopted amendments to modernize intrastate and smaller private offerings of securities. The final rules, among other things, establish Rule 147A under the Securities Act of 1933, a new safe harbor for intrastate offerings to accommodate “offers” (but not “sales”) of securities to out-of-state residents and companies. The amendments also modernize Rule 147, the safe harbor for compliance with the exemption from Securities Act registration for intrastate offerings in Section 3(a)(11) of the Securities Act, and increase the offering threshold of Rule 504 of Regulation D under the Securities Act from $1 million to $5 million (while simultaneously repealing Rule 505). In voting to adopt the amendments, SEC Chair Mary Jo White noted that the amendments “update and expand the capital raising avenues for smaller companies” while “continuing to provide investor protections.”
The final adopting release is available here. Amended Rule 147 and new Rule 147A will be effective on April 20, 2017, amended Rule 504 will be effective on January 20, 2017, and the repeal of Rule 505 will be effective on May 22, 2017.
New Rule 147A and Modernization of The Rule 147 Safe Harbor
The revised intrastate offering regime retains the Rule 147 safe harbor under Section 3(a)(11) of the Securities Act while simultaneously expanding the availability of the intrastate offering exemption from Section 5 Securities Act registration by adopting new Rule 147A. As a result of the amendments, certain issuers will now be able to rely on the intrastate offering exemption even if offers are made outside of the relevant state—as long as sales are only made in that state.
Section 3(a)(11) of the Securities Act provides an exemption from federal registration of securities offerings under Section 5 of the Securities Act for “[a]ny security which is 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.” Rule 147, a non-exclusive safe harbor under Section 3(a)(11), provides objective standards for issuers that intend to rely on the Section 3(a)(11) exemption. The amendments to Rule 147 are as follows:
- Residency Requirement. Amended Rule 147 replaces the “principal office” requirement with a “principal place of business” requirement, meaning the “location from which the officers, partners, or managers of the issuer primarily direct, control and coordinate activities of the issuer.” The Rule also requires that an issuer be resident in the same state where purchasers are resident or where the issuer “reasonably believes” they are resident. In addition, issuers that change their principal place of business to another state after conducting an offering in reliance on Rule 147 may not rely on Rule 147 again until the offered securities have come to rest for a period of six months after the date of last sale.
- “Doing Business” Requirement. Rule 147 issuers must now satisfy at least one enumerated “doing business” requirement that demonstrates the in-state nature of the issuer’s business.
- Written Representations. Issuers must now obtain a written representation from each purchaser as to his or her residency.
- Integration. Amended Rule 147 now includes an integration safe harbor for prior offers or sales of securities by the issuer, as well as for certain subsequent offers or sales after completion of the offering.
- Disclosure Requirements. The amended rule includes legend requirements to offerees and purchasers about the limitations on resales of the offered securities.
New Rule 147A, adopted under the SEC’s exemptive authority under Section 28 of the Securities Act, is not strictly subject to the statutory limitations of Section 3(a)(11). Accordingly, unlike transactions accomplished under the Rule 147 safe harbor, Rule 147A offerings are permitted to be “offered” outside of the relevant state or territory (including general advertising and solicitation, such as offers made on public internet websites), as long as no “sales” are made outside of such state or territory. Rule 147A similarly has no requirement that issuers be incorporated or organized in the relevant state or territory, so long as the issuer can demonstrate the “in-state” nature of the issuer’s business. Aside from these two provisions, Rule 147A is substantively identical to Rule 147. Crucially, both Rule 147 and Rule 147A offerings must comply with applicable state blue-sky regulations.
Regulation D Updates: Rule 504 and Rule 505
Prior to these amendments, Rule 504 of Regulation D under the Securities Act provided a non-exclusive safe harbor under Section 4(a)(2) of the Securities Act for an exemption from Securities Act registration for offers and sales of up to $1 million in a 12-month period, as long as the issuer was not an investment company, Exchange Act reporting company, or blank check company. The amendments to Rule 504 retain the existing Rule 504 framework, except that: (i) the permitted dollar amount is increased to $5 million, and (ii) the “bad actor” disqualifications contained in Rule 506(d) are now applicable to Rule 504 offerings. Pursuant to Rule 506(d), an issuer is disqualified from relying on the Regulation D safe harbor if the issuer or any other person covered by Rule 506(d) (including, among other things, intermediaries such as broker-dealers and certain associated persons of the issuer and any intermediaries) is subject to an enumerated criminal conviction, regulatory or court order, or other disqualifying event occurring on or after September 23, 2013. Although issuers subject to the disqualification may continue to rely on the Section 4(a)(2) exemption from registration without the Regulation D safe harbor, any such transaction would be subject to significant regulatory uncertainty and would fall well outside of established market practice.
Because the revised Rule 504 dollar threshold mirrors the amount currently available under Rule 505, the amendments also repeal the Rule 505 safe harbor. The amendments will therefore effectively allow issuers to raise funds pursuant to Rule 504 in amounts equal to the current Rule 505 threshold, without the additional limitations placed on Rule 505 offerings. For example, in order to raise the $5 million currently permitted in a Rule 505 transaction, issuers would be required to (i) limit offers and sales to 35 unaccredited investors and an unlimited amount of accredited investors (versus an unlimited amount of unaccredited investors in a Rule 504 transaction), (ii) if offers are made to unaccredited investors, provide the information pursuant to Rule 502(b), and (iii) conduct offers without any general advertising or general solicitation.
If you have any questions regarding new Rule 147A, the amendments to Rule 147 and Rule 504, or how to structure transactions consistent with relevant precedent, please contact the authors of this alert or your O’Melveny advisor.