On October 26, 2016, the Securities and Exchange Commission (the “SEC”) adopted final rules to modernize and expand the capital raising avenues available to small businesses through regional and intrastate securities offerings, while maintaining investor protections. The final rules amend Rule 504 of Regulation D, repeal Rule 505 of Regulation D, modernize Rule 147 under the Securities Act of 1933, as amended (the “Securities Act”), and establish a new intrastate offering exemption under Rule 147A of the Securities Act.
Amendment of Rule 504 of Regulation D
Rule 504 of Regulation D previously exempted from registration the offer and sale of up to $1 million of securities in a 12-month period by an issuer that is not (i) a reporting company under the Securities Exchange Act of 1934, as amended, (ii) an investment company, or (iii) a blank check company. The final rules amended Rule 504 of Regulation D by increasing the aggregate amount of securities that may be offered and sold annually from $1 million to $5 million and disqualifying certain bad actors from participating in Rule 504 offerings. The addition of bad boy disqualifications is consistent with similar rules that apply to offerings made under Rule 506(b) and Rule 506(c) of Regulation D, Regulation A, and Regulation Crowdfunding. In addition, amended Rule 504 permits general solicitation and the issuance of unrestricted securities in certain limited circumstances. The SEC’s amendments to Rule 504 became effective on January 20, 2017.
Repeal of Rule 505 of Regulation D
In addition, the final rules repeal Rule 505 of Regulation D, which permits offerings of up to $5 million in a 12-month-period to an unlimited number of accredited investors and no more than 35 non-accredited investors. The SEC concluded that the changes to Rule 504 and the continued availability of Rule 506(b) and Rule 506(c) obviated the need for the Rule 505 exemption. The repeal of Rule 505 will become effective on May 22, 2017. After that, issuers may no longer offer and sell securities in reliance on Rule 505.
Amendment of Rule 147 and Adoption of Rule 147A
Rule 147 provides a safe harbor for the intrastate exemption from registration under Section 3(a)(11) of the Securities Act. To qualify, (i) an issuer must be organized and have its “principal place of business” in the state in which it is offering and selling securities, and (ii) limit offers and sales of securities to residents of that state. “Principal place of business” is defined as the state in which an issuer carries out at least 80% of its operations. Issuers relying on Rule 147 may not offer securities to out-of-state residents or engage in general solicitation or general advertising.
The SEC amended Rule 147, rather than repealing it, so that issuers can continue to rely on current state law exemptions from registration, including crowdfunding exemptions, that are conditioned on compliance with Rule 147 and Section 3(a)(11) of the Securities Act.
Although slightly broader, Rule 147A is substantially similar to amended Rule 147. Under Rule 147A, however, offers may be accessible to out-of-state residents – as long as sales are limited to in-state residents – and issuers may be incorporated or organized out-of-state as long as their principal place of business is located in the state in which the securities are sold. For example, a Delaware corporation may rely on Rule 147A to offer and sell securities in Texas if its “principal place of business” is located in Texas and all sales are made to Texas residents.
Both new Rule 147A and amended Rule 147 include the following provisions:
- A requirement that the issuer has its “principal place of business” in-state and satisfies at least one “doing business” requirement that would demonstrate the in-state nature of the issuer’s business;
- A new “reasonable belief” standard for issuers to rely on in determining the residence of the purchaser at the time the securities are sold;
- A requirement that issuers obtain a written representation from each purchaser as to residency;
- A limit on resales to persons residing within the state or territory of the offering for a period of six months from the date of the sale by the issuer to the purchaser;
- An integration safe harbor that would include any prior offers or sales of securities by the issuer made under another provision, as well as certain subsequent offers or sales of securities by the issuer following the completion of the offering; and
- Legend requirements to offerees and purchasers about resale limitations.
The SEC’s amendments to Rule 147 and the new Rule 147A will take effect on April 20, 2017.