On Nov. 2, 2020, the U.S. Securities and Exchange Commission (SEC) adopted final rules to “simplify, harmonize, and improve” the current exempt offering framework for the benefit of investors, emerging companies and more seasoned issuers. The final rules adopted by the SEC are largely similar to the proposed rules issued in March 2020, with a few exceptions.

Background and Purpose of Amendments

The Securities Act of 1933, as amended (Securities Act), and applicable SEC regulations require that any securities offering be registered under the Securities Act unless the offering qualifies for an exemption from registration. Private companies, entrepreneurs and investors often use one or more exemptions from registration requirements to raise capital for new businesses or to fund business growth. According to the SEC’s press release, these newly amended rules are intended to “harmonize, simplify, and improve the multilayer and overly complex exempt offering framework” and “promote capital formation and expand investment opportunities while preserving or improving important investor protections.”

Effective Date

The amended rules become effective 60 days after publication in the Federal Register, except for the extension of the temporary relief Regulation Crowdfunding provisions, which will be effective upon publication in the Federal Register.

Integration Framework (Safe Harbor Provisions)

The SEC replaced the existing integration framework, including the five-factor test in Rule 502(a) of the Securities Act, with a new comprehensive integration framework comprised of a general principle of integration and four safe harbor provisions applicable to all securities offerings under the Securities Act. The new integration framework is set forth in new Securities Act Rule 152. To harmonize and simplify the integration framework, all other integration provisions of the Securities Act will be removed and replaced with a cross-reference to the integration and safe harbor rules of Rule 152.

The general principle of integration in new Rule 152(a) looks to the particular facts and circumstances of each offering, and applies when the new safe harbor provisions under Rule 152(b) are not applicable. Specifically, the general principle provides that offers and sales will be integrated if, based on the particular facts and circumstances, the issuer can show that each offering either complies with the registration requirements of the Securities Act or is exempt from registration.

For issuers considering the application of the general principle to an exempt offering that prohibits general solicitation and one or more other offerings, new Rule 152(a)(1) requires that the issuer have a reasonable belief with respect to each purchaser in the exempt offering prohibiting general solicitation that either (i) the issuer did not solicit the purchaser through use of general solicitation, or (ii) the issuer established a substantive relationship with the purchaser before the exempt offering began.

In the context of two or more concurrent offerings, each relying on an exemption from Securities Act registration that permits general solicitation, new Rule 152(a)(2) clarifies that an issuer’s general solicitation offering materials for one offering that includes information about the material terms of the concurrent offering under another exemption, may constitute an “offer” of securities in such other offering, and therefore, the offer must comply with all the terms and conditions for the exemption being relied on for such other offering.

New Rule 152(b) provides four nonexclusive safe harbors in which offerings will not be integrated:

  1. Any offering made 30 days before the commencement of any other offering or 30 days after the termination or completion of any other offering will not be integrated with such other offering. However, in the case of an exempt offering for which general solicitation is not permitted that follows 30 calendar days or more after an offering that allows general solicitation, the provisions of Rule 152(a)(1) apply.
  2. Offers and sales made in compliance with Regulation S or Securities Act Rule 701, pursuant to an employee benefit program, will not be integrated with other offerings.
  3. An offering for which a registration statement under the Securities Act has been filed will not be integrated if it is made after (i) a terminated or completed offering for which general solicitation is not permitted; (ii) a terminated or completed offering for which general solicitation is permitted made only to qualified institutional buyers and institutional accredited investors; or (iii) an offering for which general solicitation is permitted that terminated or completed more than 30 calendar days before commencement of the registered offering.
  4. Offers and sales made in reliance on an exemption in which general solicitation is permitted will not be integrated if made subsequent to any terminated or completed offering.

The safe harbors apply to both offerings for which a registration statement has been filed under the Securities Act and exempt offerings.

To further clarify when the safe harbors apply, new Rule 152 provides factors to consider for determining when an offering has “commenced,” “terminated” or been “completed.”

The final rules also amend Rule 506(b) to limit the number of non-accredited investors purchasing in Rule 506(b) offerings to no more than 35 within a 90 calendar day period. This change is intended to prevent issuers from undertaking serial Rule 506(b) exempt offerings each month permitting up to 35 non-accredited investors in each offering in reliance on the 30-day safe harbor.

Increase in Offering and Investment Limits in Various Exempt Offerings

The amended rules increase offering and investment limits as follows:

  • The Tier 2 Regulation A maximum offering amount will increase from $50 million to $75 million, and the maximum offering amount for secondary sales will increase from $15 million to $22.5 million.
  • The Rule 504 maximum offering amount will increase from $5 million to $10 million.
  • The Regulation Crowdfunding offering limit will increase from $1.07 million to $5 million. Plus, amendments to the investment limits for investors in Regulation Crowdfunding offerings:
    • remove investment limits for accredited investors; and
    • change the method of calculating the investment limits for non-accredited investors to use the greater of their annual income or net worth.

Regulation Crowdfunding

Covered Security Status

To clarify that securities issued under Regulation Crowdfunding are “covered securities” within the meaning of the Securities Act and are not subject to state securities law registration and qualification requirements, a new Rule 504 was added to Regulation Crowdfunding to confirm that purchasers in a Regulation Crowdfunding offering are “qualified purchasers” for purposes of Section 18(b)(3) of the Securities Act.

Extension of Relief for Financial Statement Review

The amended rules extend for 18 months the existing temporary relief provided for certain Regulation Crowdfunding financial statement review requirements for issuers offering a target amount of more than $107,000 but no more than $250,000 of securities in reliance on the exemption within a 12-month period. These issuers may provide financial statements and certain information from the issuers’ federal income tax returns, both certified by the issuer’s principal executive officer, rather than financial statements reviewed by an independent public accountant that would otherwise be required under the rules. This temporary relief will apply only if reviewed or audited financial statements of the issuer are not otherwise available.

Eligible Issuers

Section 4A(f)(3) of the Securities Act prohibits investment companies, as defined in the Investment Company Act of 1940, as amended (Investment Company Act), or companies that are excluded from the definition of an investment company under section 3(b) or 3(c) of the Investment Company Act, from using the Regulation Crowdfunding exemption. As a result, investors purchasing securities in an offering under Regulation Crowdfunding may not invest through a special purpose vehicle, which can create certain practical impediments for issuers using Regulation Crowdfunding, such as unwieldy and lengthy stockholder lists.

To address these impediments, the final rules adopted a number of changes related to limited-purpose crowdfunding vehicles. The final rules amend the definition of “investment company” under Rule 3a-9 of the Investment Company Act to exclude crowdfunding vehicles that meet certain conditions designed to require that they function as a conduit for investors to invest in a business seeking to raise capital through a crowdfunding vehicle. These conditions require, among other things, that the crowdfunding vehicle be organized and operated for the sole purpose of directly acquiring, holding and disposing of securities issued by a single crowdfunding issuer, and raising capital in one or more offerings made in compliance with Regulation Crowdfunding. Consistent with the crowdfunding vehicle’s purpose as a conduit, the amended rules will require the crowdfunding vehicle to redeem or offer to repurchase its securities if there is a liquidity event applicable to the crowdfunding issuer since its reason for existence will cease on the occurrence of such liquidity event.

The amended rules consider crowdfunding vehicles and crowdfunding issuers to be co-issuers and will generally require that they jointly file the Form C. A crowdfunding issuer may file its own Form C if it is separately offering securities both through a crowdfunding vehicle and directly to investors.

Demo Day Exemption From General Solicitation

“Demo days” and similar events are generally organized by a group or entity (such as a university, angel investors, an accelerator or an incubator) that invites issuers to present their businesses to potential investors, with the aim of securing investment. New Securities Act Rule 148 provides that communications in connection with a “demo day” will not be deemed general solicitation or general advertising as long as certain conditions are met, including that more than one issuer participates in the event, and that the event is sponsored by a college, university or other institution of higher education; a state or local government (or instrumentality thereof); a nonprofit organization; or an angel investor group, incubator or accelerator. In addition, no advertisement for the event may reference a specific offering of securities by the issuer, and the sponsor of the event may not:

  • make investment recommendations or provide investment advice to attendees of the event;
  • engage in any investment negotiations between the issuer and investors attending the event;
  • charge attendees of the event any fees, other than reasonable administrative fees;
  • receive any compensation for making introductions between event attendees and issuers, or for investment negotiations between the parties; or
  • receive any compensation with respect to the event that would require it to register as a broker or dealer under the Securities Exchange Act of 1934, as amended (Exchange Act), or as an investment adviser under the Investment Advisers Act of 1940, as amended.

The issuer is only permitted to notify demo day attendees of the following:

  • that the issuer is in the process of offering or planning to offer securities;
  • the type and amount of securities being offered;
  • the intended use of the proceeds of the offering; and
  • the unsubscribed amount in an offering.

In addition, if the event allows attendees to participate virtually, new Rule 148 restricts online participation in the event to (i) individuals who are members of, or otherwise associated with, the sponsor organization; (ii) individuals the sponsor believes to be accredited investors; and (iii) individuals who were 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.

Testing the Waters

Generic Solicitation of Interest Exemption

The new rules create an offering exemption that will permit issuers, and those communicating on their behalf, to use generic solicitation of interest materials to determine level of interest in a contemplated offering of securities exempt from registration under the Securities Act, before making a determination as to the particular exemption from registration under which the offering will be conducted, as long as certain conditions are met. Under this new Securities Act Rule 24, the testing-the-waters material must state all of the following:

  • The issuer is considering an offering of securities exempt from registration under the Securities Act, but has not determined a specific exemption from registration the issuer intends to rely on for the subsequent offer and sale of the securities.
  • No money or other consideration is being solicited, and if sent in response, will not be accepted.
  • No offer to buy the securities can be accepted and no part of the purchase price can be received until the issuer determines the exemption under which the offering is intended to be conducted and, where applicable, the filing, disclosure or qualification requirements of such exemption are met.
  • A person’s indication of interest involves no obligation or commitment of any kind.

No solicitation or acceptance of money or other consideration, nor of any commitment, binding or otherwise, from any person will be permitted until the issuer makes a determination as to the exemption to be relied on and the offering has commenced.

The SEC also adopted amendments to Regulation A and Regulation Crowdfunding to require that the Rule 241 generic solicitation materials be made publicly available as an exhibit to the offering materials filed with the SEC if a Regulation A or Regulation Crowdfunding offering is commenced within 30 days of the generic solicitation of interest.

Regulation Crowdfunding

Similar to new Rule 241, new Securities Act Rule 206 allows Regulation Crowdfunding issuers to test the waters with prospective investors before filing the Form C; however, all generic solicitation materials must later be filed in conjunction with the Form C. Crowdfunding issuers are also required to include a legend on testing-the-waters materials, stating all of the following:

  • No money or other consideration is being solicited, and if sent, will not be accepted.
  • No offer to buy the securities can be accepted and no part of the purchase price can be received until the offering statement is filed and only through an intermediary’s platform.
  • A prospective purchaser’s indication of interest is nonbinding.

The final rules also allow issuers to communicate orally with potential investors after filing the Form C so long as the issuer complies with amended Rule 204. Among the changes to Rule 204 is an expansion of the information that issuers may provide to prospective investors in accordance with Rule 204, including (i) a brief description of the planned use of the proceeds of the offering, and (ii) information on the issuer’s progress toward meeting its funding. In addition, an issuer may now provide information about the terms of an offering under Regulation Crowdfunding, in the offering materials for a concurrent offering without violating Rule 204, so long as the information provided about the Regulation Crowdfunding offering is made in compliance with Rule 204.

Accredited Investor Verification Method

Rule 506(c) permits issuers to generally solicit and advertise an offering, provided that all purchasers in the offering are accredited investors, the issuer takes reasonable steps to verify that purchasers are accredited investors, and certain other conditions in Regulation D are satisfied. Rule 506(c) provides a principles-based method for verification of accredited investor status as well as a nonexclusive list of verification methods. The final rules allow an issuer to rely on a prior verification of accredited investor status for an investor to establish that the investor remains an accredited investor at the time of a subsequent sale as long as the investor provides a written representation stating that the investor continues to qualify as an accredited investor, and the issuer is not aware of information to the contrary. There is a five-year time limit on the issuer’s ability to rely on the prior verification.

The final rules also reaffirm and update the SEC’s prior guidance with respect to the principles-based method for verification of accredited investor status, and what may be considered “reasonable steps” to verify an investor’s accredited investor status. The SEC staff cautioned issuers that it continues to believe that an issuer will not be considered to have taken reasonable steps to verify accredited investor status if it requires only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status.

Financial Statement Requirements in Rule 506(b) Offerings

The amended rules change the financial information that must be provided to non-accredited investors in Rule 506(b) private placements to align with the financial information that issuers must provide to investors in Regulation A offerings. Specifically, for Rule 506(b) offerings up to $20 million, the requirement for audited financial statements will be the same as the financial statement requirements applicable to Tier 1 Regulation A offerings. For Rule 506(b) offerings greater than $20 million, issuers will be required to provide audited financial statements and comply with Regulation S-X requirements similar to those applicable to Tier 2 Regulation A offerings.

Confidential Information Standard for Exhibit Filings

The current rule requiring registrants to file material contracts as exhibits to their disclosure documents with the SEC, permits registrants to redact provisions or terms of exhibits required to be filed if those provisions or terms both (i) are not material, and (ii) would likely cause competitive harm to the registrant if publicly disclosed. This “competitive harm” requirement was patterned on the standard then being used by the U.S. Circuit Court of Appeals for the District of Columbia relating to what was confidential under Exemption 4 of the Freedom of Information Act. In June 2019, the U.S. Supreme Court rejected the Circuit Court’s longstanding test for determining what was confidential under Exemption 4 and adopted a new definition of “confidential” that does not include a competitive harm requirement. The Supreme Court stated that “[a]t least where commercial or financial information is both customarily and actually treated as private by its owner and provided to the government under an assurance of privacy, the information is ‘confidential’ within the meaning of Exemption 4.”

The amended rules adjust the exhibit filing requirements under Regulation S-K and in various forms to remove the competitive harm requirement and replace it with a standard more closely aligned with the Supreme Court’s definition of “confidential.” Under the new standard, information may be redacted from material contracts if it is the type of information the issuer both customarily and actually treats as private and confidential, and if the information is also not material.

Simplification of Disclosure Requirements in Regulation A Offerings

The amended rules extend to Regulation A issuers certain accommodations presently available to reporting companies. Regulation A issuers will now have the option to file redacted material contracts and plans of acquisition, reorganization, arrangement, liquidation or succession without applying for confidential treatment, consistent with the recent amendments to Regulation S-K. The amended rules also will allow Regulation A issuers to redact information in any exhibit listed in Item 17 of Form 1-A that “would constitute a clearly unwarranted invasion of personal privacy,” such as home addresses, bank account numbers and social security numbers.

In addition, to further harmonize and simplify the process of publicly filing previously nonpublic Regulation A offering statements, amendments and SEC correspondence, Regulation A issuers will now be able to use EDGAR to make these documents available to the public using the same process as issuers conducting a registered offering, instead of submitting them as exhibits to an offering statement as required under the old Regulation A rules.

Also under the amended rules, (i) issuers may incorporate by reference previously filed financial statements into their Regulation A offering statements if they satisfy criteria similar to the requirement in connection with Form S-1; and (ii) the SEC may declare as abandoned a particular post-qualification amendment to a Regulation A offering statement, consistent with the rule applicable to registered offerings.

Regulation A Eligibility

Under the existing rules, Regulation A includes an eligibility requirement that an issuer conducting a Regulation A offering must have filed with the SEC all reports 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). However, because Exchange Act registrants are not required to file reports pursuant to Rule 257, the existing eligibility provision does not expressly require those registrants to have filed their Exchange Act reports in order to rely on Regulation A. Under the amended rules, issuers that fail to comply with the Exchange Act reporting requirements in a two-year period preceding the filing of an offering statement are ineligible to conduct a Regulation A offering. By adopting this limitation, the amended rules hold Exchange Act reporting companies to the same standard as repeat Regulation A issuers.

Bad Actor Disqualification (Look-Back Period)

Bad actors are disqualified from using Regulation A, Regulation D and Regulation Crowdfunding to offer and sell securities. In order to harmonize the disqualification provisions across the exempt offering framework, the amended rules will make the disqualification look-back period the same for participants in each of these exempt offerings — both from the time of filing of the offering document and from the time of sale (except there will be no change to the disqualification look-back period for covered beneficial owners under Regulation A and Regulation Crowdfunding).

For a more detailed account and explanation of the adopted changes, please see the final rules.

Next Steps for Potential Issuers

These new rules should provide more flexibility for issuers and simplify capital formation through exempt offerings. Some of the steps companies relying on these amended exemptions may consider include the following:

  • When initiating a securities offering, consider the revised offering and investment limits, preliminary communications and filing requirements that may make it easier and more cost-effective to raise capital through an exempt securities offerings.
  • Structure exempt offerings to occur more than 30 days apart or otherwise within the new safe harbors provided in Rule 152, or otherwise analyze integration issues under the new general principle of integration.
  • Reassess participation in demo days and confirm that the sponsor and issuer conduct the demo day within the new safe harbor.
  • Check applicable state blue sky laws to make sure there is also a state law exemption for any contemplated test-the-water solicitations.
  • Change how redactions of material contracts filed with the SEC are evaluated to the new confidentiality standard based on whether the information is customarily and actually treated as private and confidential and whether it also is not material.
  • Evaluate whether use of a limited purpose crowdfunding vehicle might be helpful in any future Regulation Crowdfunding offering.
  • Consider whether the new safe harbor for verification of accredited investor status based on previous verification within a five-year period would make a Rule 506(c) offering a more viable option for raising capital.
  • Update questionnaires and other covered person materials used in connection with an exempt offering in light of the new “bad actors” look-back period.
  • Remember to redact personally identifiable information, such as home addresses and bank account and social security numbers, from filings with the SEC.