As seems to be common practice these days, the SEC cancelled its open meeting scheduled for yesterday morning and instead went ahead and posted its proposal to amend the rules to harmonize and simplify the framework for private securities offering exemptions. Here is the 341-page proposing release and the related press release. The proposal draws on input received in response to the SEC’s concept release issued in June of last year (see this PubCo post), which sought public comment on ways to promote capital formation, to harmonize and streamline the patchwork universe of private placement exemptions and “to expand investment opportunities while maintaining appropriate investor protections.” Currently, the framework has 10 different exemptions or safe harbors, with different sets of requirements. As SEC Chair Jay Clayton said in a 2018 speech, the current framework would not likely exist as it is if the SEC were starting with blank slate. The comment period will be open for 60 days.

According to the press release, the proposal would

  • “address, in one broadly applicable rule, the ability of issuers to move from one exemption to another, and ultimately to a registered offering, providing more certainty to issuers raising capital;
  • “increase the offering limits for Regulation A, Regulation Crowdfunding, and Rule 504 offerings, and revise certain individual investment limits based on the Commission’s experience with the rules, marketplace practices, capital raising trends, and comments received;
  • “provide greater certainty to issuers and protection to investors by setting clear and consistent rules governing offering communications between investors and issuers, including permitting certain ‘demo day’ activity without running afoul of the prohibition on general solicitation; and
  • “harmonize certain disclosure and eligibility requirements and bad actor disqualification provisions to reduce differences between exemptions, while preserving or enhancing investor protections.”

Commenting on the proposal, Clayton observed that “[e]merging companies—from early-stage start-ups seeking seed capital to companies that are on a path to become a public reporting company—use the exempt offering rules to access critical capital needed to create jobs and scale their businesses….The complexity of the current framework is confusing for many involved in the process, particularly for those smaller companies whose limited resources spent on navigating our overly complex rules are diverted from direct investments in the companies’ growth. These proposals are intended to create a more rational framework that better allows entrepreneurs to access capital while preserving and enhancing important investor protections.”

Commissioner Allison Lee dissented. In her view, while harmonization and simplification are good things, this “proposal goes far beyond what can rightly be called harmonization. If adopted, it would erode significant distinctions between the public and private markets that are well-grounded in law and policy. Specifically, today’s proposal would weaken two cornerstones of protection for retail investors in private markets–the ban on general solicitation for the bulk of private offerings, and the limitation on sales of those offerings mainly to accredited investors.” She also expressed concern about taking these sweeping actions in the face of a data deficit about the nature and extent of offerings under Reg D, under which more new capital is raised than any other form of offering. And here’s a familiar irony that she raises: “we fail in both contexts to adequately address a significant factor in the decline of the public markets–the growing availability of increasingly unrestricted private offerings.”

While her primary concerns arose out of the proposed loosening of restrictions on general solicitation and potential weakening of the requirement to verify accredited-investor status, she also challenged the balanced nature of a proposal that would:

  • “raise the offering limits for three different exempt offerings;
  • remove statutorily imposed investment limitations for certain investors;
  • shorten the integration safe harbor period from six months to 30 days, thus effectively collapsing different exemptions to the lowest common denominator for investor protection;
  • reduce the disclosure required for non-accredited investors under Regulation D;
  • expand the use of test-the-waters communications across all exempt offerings and for all types of investors;
  • expand the use of general solicitation overall; and,
  • weaken requirements for establishing whether an investor is accredited to little more than self-certification.”

Commissioner Peirce viewed the proposal as a “welcome next step.” Her thoughts on the proposal involved potential implementation of additional reforms: for example, in light of the continue complexity of integration, she wondered whether it would not be simpler to just deregulate offers and focus attention on the time of sale. Another suggestion was to extend federal preemption to certain secondary trading. She also proposed freeing VC funds from their current constraints by providing greater flexibility to make follow-on investments in their portfolio companies and thus facilitate their ability to “sustain their support of their portfolio companies as those companies grow.” And finally, she asked whether the SEC should just eliminate all the complexity of these offering exemptions and “instead, to the extent our statutory authority allows it, start anew and create a simpler framework to provide a clear path for issuers trying to raise capital at different stages of their lifecycle.” Of course, issues of investor protection must also be taken into account, including the integrity of the market, antifraud protections and effective disclosure. But to Peirce, “[i]nvestor protection also means allowing investors of all income levels to participate in a wide range of offerings that allows them to build balanced and diversified portfolios.”

Highlights of the Proposal

Below are the highlights of the proposal as set forth in the press release:

Offering and Investment Limits. The proposal would raise the offering limits under various exemptions as follows:

“For Regulation A:

  • raise the maximum offering amount under Tier 2 of Regulation A from $50 million to $75 million; and
  • raise the maximum offering amount for secondary sales under Tier 2 of Regulation A from $15 million to $22.5 million.

“For Regulation Crowdfunding:

  • raise the offering limit in Regulation Crowdfunding from $1.07 million to $5 million;
  • amend the investment limits for investors in Regulation Crowdfunding offerings by:
    • not applying any investment limits to accredited investors; and
    • revising the calculation method for investment limits for non-accredited investors to allow them to rely on the greater of their annual income or net worth when calculating the limit on how much they can invest.

“For Rule 504 of Regulation D:

  • raise the maximum offering amount from $5 million to $10 million.”

“Test-the-Waters” and “Demo Day” Communications. The proposal would include the following changes related to offering communications:

  • “a proposed new rule that would permit an issuer to use generic solicitation of interest materials to ‘test-the-waters’ for an exempt offer of securities prior to determining which exemption it will use for the sale of the securities;
  • a proposed rule amendment that would permit Regulation Crowdfunding issuers to ‘test-the-waters’ prior to filing an offering document with the Commission in a manner similar to current Regulation A; and
  • a proposed new rule that would provide that certain ‘demo day’ communications would not be deemed general solicitation or general advertising.”

Regulation A and Regulation Crowdfunding Eligibility. The proposal would amend the eligibility restrictions in Regulation Crowdfunding and Regulation A to permit the use of certain special purpose vehicles to facilitate investing in Regulation Crowdfunding issuers, and would limit the types of securities that may be offered and sold in reliance on Regulation Crowdfunding.

Integration Framework. Currently, the concept of “integration” —whether multiple securities transactions should be considered part of the same offering—relies on a combination of rules and SEC guidance.

The proposal would provide “a general principle of integration that looks to the particular facts and circumstances of the offering, and focuses the analysis on whether the issuer can establish that each offering either complies with the registration requirements of the Securities Act, or that an exemption from registration is available for the particular offering.”

The proposal includes four non-exclusive safe harbors from integration, described in this table from the press release:

“Safe Harbor 1 “Any offering made more than 30 calendar days before the commencement of any other offering, or more than 30 calendar days after the termination or completion of any other offering, would not be integrated with another offering; provided that, for an exempt offering for which general solicitation is not permitted, the purchasers either were not solicited through the use of general solicitation, or established a substantive relationship with the issuer prior to the commencement of the offering for which general solicitation is not permitted.
“Safe Harbor 2 “Offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or in compliance with Regulation S would not be integrated with other offerings.
“Safe Harbor 3 “An offering for which a Securities Act registration statement has been filed would not be integrated with another offering if made subsequent to: (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 and made only to qualified institutional buyers and institutional accredited investors; or (iii) an offering that terminated or completed more than 30 calendar days prior to the commencement of the registered offering.
“Safe Harbor 4 “Offers and sales made in reliance on an exemption for which general solicitation is permitted would not be integrated with another offering if made subsequent to any prior terminated or completed offering.”

Other Improvements to Specific Exemptions. The proposal would also:

  • “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;
  • add a new item to the non-exclusive list of verification methods in Rule 506(c);
  • simplify certain requirements for Regulation A offerings and establish greater consistency between Regulation A and registered offerings; and
  • harmonize the bad actor disqualification provisions in Regulation D, Regulation A, and Regulation Crowdfunding.”

See also the SEC’s recent proposal to change the definition of “accredited investor.” (See this PubCo post.)