The SEC recently proposed revisions to Regulation D. The proposed revisions would:
- provide a new safe harbor exemption for sales of securities exclusively to "large accredited investors," a new category of investors;
- revise the definition of "accredited investor" to:
- add an alternative "investments-owned";
- define the term "joint investments";
- establish a mechanism to adjust the dollar-amount thresholds to reflect inflation; and
- expand the type of entities that could qualify as accredited and large accredited investors;
- shorten the integration safe harbor for Regulation D offerings from six months to 90 days; and
- disqualify certain "bad actors" from being able to rely on Regulation D.
In addition to requesting comments to the proposed revisions to Regulation D,2 the SEC also requested comments on whether to amend Rule 504 to provide that securities sold pursuant to a state law exemption that permits sales only to accredited investors would be deemed "restricted securities" for purposes of Rule 144.
The Rule 507 Offering - The Large Accredited Investors Exemption
The SEC proposed a new exemption in new Rule 507 from the registration requirements of the Securities Act for offers and sales of securities by issuers exclusively to a new category of investors called large accredited investors.
Sales Only to Large Accredited Investors. Securities may be sold only to large accredited investors. This differs from a Rule 506 offering, which permits sales to up to 35 non-accredited investors, in addition to an unlimited number of accredited investors.
Under the proposed rule, large accredited investors consist of:
- the issuer's directors and executive officers;
- entities that have $10 million in investments;
- individuals who own $2.5 million in investments or have annual income of $400,000 (or $600,000 with spouse); and
- investors that qualify as accredited investors without being subject to an assets test or dollar-amount threshold (e.g., banks, registered investment companies, private business development companies).
Unlimited Number of Purchasers; No Underwriters. An unlimited amount of securities may be sold to an unlimited number of large accredited investors. However, no sales may be made to underwriters.
Limited Advertising Permitted. Rather than a total ban on general solicitation and general advertising, as is the case in Rule 506 offerings, issuers in Rule 507 offerings may publish a limited announcement of the offering and may provide additional information (e.g., sales material or an offering circular) to prospective purchasers they reasonably believe are large accredited investors. The ability to engage in limited advertising may provide issuers with an alternative to using finders and placement agents to locate prospective investors, which may help reduce the costs of raising capital.
The limited announcement, if used, must provide three required prominent disclosures and may provide any or all of six optional disclosures:
- Sales will be made to large accredited investors only.
- No money or other consideration is being solicited or will be accepted through the announcement.
- The securities have not been registered with or approved by the SEC and are being offered and sold pursuant to an exemption.
- Issuer's name and address.
- A description of the issuer's business in 25 or fewer words.
- A brief description of the securities being offered.
- Description of what "large accredited investor" means.
- Any suitability standards and minimum investment requirements.
- Information for the person to contact for additional information.
The limited announcement, as contemplated by the SEC, would be anticipated to be part of the offering process. It could be published only "in written form," in any written medium, such as in a newspaper or on the Internet. Radio or television broadcast spots or "infomercials" would be prohibited.
Covered Security Status. Rule 507 securities would be considered "covered securities" under Section 18 of the Securities Act and would therefore be primarily regulated on the federal level with limited state securities regulation.
Restricted Securities. Rule 507 securities would be treated as "restricted securities" under Rule 144 and would therefore be subject to limitations on resale.
Proposed Revisions Related to the Definition of "Accredited Investor"
The Investments-Owned Standard. Generally, under the current definition, an accredited investor may meet certain dollar-amount tests: entities must have total assets above $5 million and individuals must have a net worth above $1 million or annual income above $200,000 (or $300,000 with spouse). The proposal would add an alternative way to qualify as an accredited investor based on investments owned: $5 million for entities and $750,000 for individuals.
Unlike the practice used in calculating total assets for entities and net worth for individuals, the value of personal residences and places of business would be excluded in determining investments owned. The proposed definition of "investments" also excludes securities that constitute a "control interest" in an issuer, which would exclude, among other things, controlling ownership interests in family-owned and other closely held businesses.
Proposed Definition of "Joint Investments." Current SEC rules allow issuers to count all of the assets that an individual owns jointly with a spouse or that are part of a shared community interest in determining whether the individual is an accredited investor. The SEC proposes revising this approach with respect to calculating joint investments. As proposed, an individual investing without the signature and binding commitment of his or her spouse may include only 50% of any investments held jointly with his or her spouse or in which the individual shares a community property interest. However, where spouses both sign and are bound by the investment documentation, the full amount of their investments (whether made jointly or separately) may be included in the calculation. The proposed amendment would not affect the calculation for determining an investor's net worth (i.e., an issuer could count 100% of the assets held jointly with an individual's spouse or as part of a shared community interest in determining net worth of an individual investing without his or her spouse).
Future Inflation Adjustments. To maintain the accredited investor standards in the future, starting on July 1, 2012, and every five years thereafter, all dollar-amount thresholds set forth in Rule 501 would adjust to reflect the effects of inflation. As proposed, the adjustment would reflect changes in the value of the Personal Consumption Expenditures Chain-Type Price Index from December 31, 2006. Despite some criticism, the SEC does not propose to make an immediate one-time adjustment to the dollar-amount thresholds to reflect the effects of inflation since the current thresholds were established.
Expanding the Types of Entities that Qualify as Accredited and Large Accredited Investors. Rule 501(a)(3) currently lists entities that may qualify as accredited investors (e.g., organizations described in Section 501(c)(3) of the Internal Revenue Code, corporations, Massachusetts or similar business trusts, and partnerships). As proposed, the list would be expanded to include limited liability companies, Indian tribes, labor unions, governmental bodies, and other entities with substantially similar legal attributes, which the SEC suggests would cover entities such as joint ventures or college or university endowments.
Revisions to General Conditions of Regulation D
90-Day Integration Safe Harbor. Currently, Rule 502(a) provides that offers and sales more than six months before a Regulation D offering or more than six months after the completion of a Regulation D offering will not be considered part of the same offering and therefore will not be integrated. To give issuers more flexibility with their capital raising needs, the SEC proposes to shorten the six-month window to 90 days.
Disqualification Provisions. The SEC proposes to add a new Rule 502(e) to prohibit an issuer from relying on Regulation D if the issuer or certain persons associated with the issuer have been found by a court, governmental agency or self-regulatory organization to have violated the law or engaged in other wrongdoing, generally, with respect to securities laws. The proposed disqualification provisions would apply to (i) the issuer and any of its predecessors; (ii) any director, executive officer, general partner, or managing member of the issuer; (iii) any beneficial owner of 20% or more of the issuer's equity securities; and (iv) any promoter connected with the issuer. Underwriters would not be subject to the disqualification provisions. The proposed disqualification would be for either five or 10 years, with the longer period reserved for conduct resulting in a criminal conviction.
Guidance Regarding the Integration of Concurrent Public and Private Offerings
Issuers are sometimes reluctant to file a registration statement while the issuer is conducting a private offering out of concern that the registration statement could be deemed to be general solicitation or general advertising, thereby voiding the exemption from registration upon which the issuer is relying for its private offering. The SEC reiterated its view of Rule 152 that the filing of a registration statement does not, per se, eliminate an issuer's ability to conduct a concurrent private offering, whether it is commenced before or after the filing of the registration statement. The issue as framed by the SEC is whether investors in the private offering were solicited through the marketing of the public offering, including the registration statement, or through some other means that would not render the exemption from registration unavailable. The SEC added that the analysis should not focus exclusively on the number or nature of the investors.
These proposals, if adopted, could have far-reaching implications for private offerings, virtually eliminating the restrictions for "super accredited" investors. Together with the Regulation D reform, these proposals could make it easier and less costly to raise money privately.