On June 18, 2019, the Securities and Exchange Commission (SEC) requested public comment on “Harmonization of Securities Offerings Exemptions” – specifically, with regard to certain exemptions from registration under the Securities Act of 1933 (Securities Act) – with the goal of simplifying the exempt offering framework and expanding investment opportunities. The move comes following statements made by SEC Chairman Jay Clayton in April 2019 regarding the lack of investment opportunities for retail investors, particularly with growth companies. With hundreds of companies targeting IPOs in 2019, U.S. capital markets would likely benefit from a comprehensive review of the framework to expand investment opportunities as the market continues to grow and provide varying ways to participate. Companies may benefit from more options to raise money through private offerings in lieu of public offerings. In addition, providing companies access to capital earlier in their life cycle through exempt offerings may give them the funds necessary to grow to be in a position to access the public markets, and thus may increase the number of IPOs.
The Securities Act requires that every offer and sale of securities be registered with the SEC, unless an exemption is available. The purpose of registration is to provide investors full and fair disclosure of material information so they can make informed investment decisions. In the past several years Congress has recognized that certain situations provide no practical need for registration, and has passed legislation that expands the scope of exempt offerings in an effort to enhance capital formation.
The Jumpstart Our Business Startups Act of 2012 (JOBS Act), the Fixing America’s Surface Transportation Act of 2015 (FAST Act), and the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (Economic Growth Act) resulted in significant revisions to Securities Act registration exemptions. These revisions, however, exacerbated the complex patchwork of the varying, and sometimes overlapping, requirements and conditions. The resulting difficulties presented market participants, particularly smaller companies with more limited resources, with no road map to navigate the exempt offering framework.
On June 18, the SEC provided a concept release to undertake a “broad review of available exemptions to the registration requirements of the federal securities laws that facilitate capital raising,” seeking input to assess whether the exempt offering framework is accessible for both issuers and investors. Specifically, the SEC seeks to (1) determine whether overlapping exemptions create confusion for issuers seeking efficient ways to raise capital; (2) identify gaps that make it difficult to rely on an exemption from registration to raise capital at key stages; and (3) consider whether limitations on who can invest in certain exempt offerings, and on the amount that can be invested, provide the appropriate level of investor protection. In doing so, the SEC will determine whether to simplify, improve and/or harmonize the exempt offering framework.
The Need for Change
The amount raised in exempt offerings has increased relative to public registered offerings: In 2018, registered offerings accounted for $1.4 trillion of new capital compared with the $2.9 trillion raised through exempt offering channels. Some of the Securities Act registration exemptions are based on the characteristics of the securities, and others are based on the transaction. In addition, specific investor characteristics are required for some registration exemptions – specifically, whether investors are able to fend for themselves in an offering not subject to the Securities Act registration requirements. In today’s exempt offering framework, the fewest conditions apply to an offering under an exemption in which sales are restricted to accredited investors. For individuals, an accredited investor is generally one who earns $200,000 per year individually or $300,000 as a married couple, or who has $1,000,000 in assets excluding the primary residence. But strong demand over the past several years to invest in exempt offerings that permit nonaccredited investors to participate demonstrates that such investors are indeed very interested in participating in our capital markets.
This is no longer a market for just wealthy, sophisticated investors. With the rise of social media and other forms of communication, along with online trading platforms for unregistered securities, information about exempt securities is more accessible, with investors able to participate at a lower cost than at the time many of the exemptions were created. The SEC is reexamining whether wealth should be the sole, or even the primary, gauge of whether an investor is “accredited.” After all, SEC commissioners earn a salary lower than the requirement for an individual accredited investor, but obviously are able to fend for themselves in the capital markets arena.
The Request for Comment
Generally, the concept release requests comment on seven topics:
The Exempt Offering Network: Whether the SEC’s exempt offering framework is consistent, accessible, and effective for both companies and investors, or whether the SEC should simplify, improve or harmonize the exempt offering network.
Capital Raising: Whether changes should be made to improve, harmonize or streamline capital raising exemptions, such as the Securities Act Section 4(a)(2) exemption, Rule 506 of Regulation D, Regulation A, Rule 504 of Regulation D, the intrastate offering exemptions and Regulation Crowdfunding.
Gaps in the Framework: Whether there are gaps in the SEC’s framework that might make it difficult – especially for smaller companies – to rely on an exemption from registration to raise capital at key stages of their business cycle.
Limitations: Whether limitations on who can invest in certain exempt offerings, or the amount they can invest, provide the appropriate level of investor protection or pose an undue obstacle to capital formation or investor access to investment opportunities.
Integration: Whether the SEC can and should do more to allow companies to transition from one exempt offering to the next, and ultimately, to a registered public offering without delay.
Pooled Investment Funds: Whether the SEC should take steps to facilitate capital formation in exempt offerings through pooled investment funds, including interval funds and other closed-end funds, and whether retail investors should be allowed greater exposure to growth-stage companies through pooled investment funds in light of potential advantages and risks involved in investing through such funds.
Secondary Trading: Whether the SEC should revise its rules governing exemptions for resales of securities to facilitate capital formation and to promote investor protection by improving secondary market liquidity.
The SEC will take comments on or before September 24, 2019.
The concept release is the first step toward what will likely be a long journey in changing the rules governing exempt offerings and who can invest in them. However, the SEC has long been laying the groundwork for this release. For example, in an August 2018 speech, Chairman Jay Clayton discussed private capital raising, acknowledging that there has not yet been a comprehensive review of the exemptive framework “to ensure that the system, as a whole, is rational, accessible and effective.” Referring to the exemption landscape as “elaborate patchwork,” Chairman Clayton went on to note the importance of considering whether current rules that limit who can invest in certain offerings “should be expanded to focus on the sophistication of the investor, the amount of the investment, or other criteria rather than just the wealth of the investor.” Moreover, in this reassessment of, and analysis of assumptions underlying, the exemptions from registration, commenters would be wise to suggest that the SEC expand its scope to include modernization and principle-based rules that are nimble, to accommodate various technological advancements in our financial markets – from blockchain and digital assets to the next innovative technology.