Recently, the Securities and Exchange Commission (“SEC”) updated the regulatory framework governing intrastate and small offerings to adapt to modern fundraising trends. The SEC amended its Rule 147 and adopted Rule 147A to ease restrictions on advertising to out-of-state investors and allow for more flexibility in defining an issuer’s home state. Additionally, the SEC amended Rule 504 of Regulation D to increase the aggregate limit on securities offerings that can be made during any 12 month period without registration from $1 million to $5 million. The final rules also repeal Rule 505. These changes were part of the SEC’s push to modernize the regulatory framework governing smaller issuers while maintaining investor protection.
Amendment of Rule 147 and Adoption of Rule 147A
Section 3(a)(11) of the Securities Act of 1933 (’33 Act) exempts from registration securities “offered and sold” within a single state. SEC Rule 147 was promulgated under the ’33 Act to define objective standards for issuers seeking to rely on the Section 3(a)(11) exemption.
In order to be exempt under the old Rule 147, a company would have to limit the offer and sale of its securities to investors within its state of incorporation. Thus, a business incorporated in Delaware, but with its principal place of business in New York, could only be exempt from registering with the SEC if it raised capital exclusively in Delaware.
One big problem for issuers using the old Rule 147 was that the internet necessarily transcends state borders. Thus, smaller issuers had to choose between assuming the prohibitive costs of SEC regulation and limiting themselves to archaic fundraising methods.
When Rule 147 was promulgated in 1974, the SEC could not have contemplated the impact of the internet on modern fundraising. Amended Rule 147 and new Rule 147A modernize the existing intrastate offering framework to allow more flexibility for issuers that want to raise capital within their state without registering with the SEC.
Rule 147, as amended, remains a safe harbor under Section 3(a)(11). Issuers may continue to use Rule 147 for securities offerings provided they are in compliance with state blue sky securities laws.1 Rule 147A substantially parallels the amended Rule 147 except:
- offers may be made to out-of-state residents so long as sales are made only to in-state residents; and
- the issuer need not be incorporated or otherwise organized in the state where the offering takes place provided that it can demonstrate that it does business in that state.
SEC Chair Mary Jo White hopes that these final rules will allow smaller companies to “more fully take advantage of changes in technology and business practices.”
Additions and Amendments
Both the amended Rule 147 and the new Rule 147A include the following:
- Principal Place of Business – An issuer may raise capital in the state of its “principal place of business.” The issuer must demonstrate that it is “doing business” in the state where sales are made by meeting one of several requirements, such as deriving 80% of its consolidated gross revenues from operations or real property within the state, or having the majority of its employees based in the state.
- “Reasonable Belief” Standard – Issuers are held to a “reasonable belief” standard in determining whether they knew that a purchaser resided in-state at the time of sale.
- Written Representation – Issuers must obtain a written representation from the purchaser as to the purchaser’s residency at the time of sale. The representation is potentially probative in establishing whether the issuer had a “reasonable belief” that the purchaser resided in-state at the time of sale.
- Six-Month Restriction on Out-of-State Resale – For six months from the date of sale by the issuer to the purchaser, resales may only be made to persons residing within the state or territory of the offering.
- Integration Safe Harbor – Offers and sales made in reliance on Rule 147 are not integrated with offers or sales made by the issuer in certain circumstances under another provision prior to, or for certain offers and sales made subsequent to, the completion of the offering.2
- Legend Requirement – Issuers are required to include a prominent legend disclosing to offerees and purchasers the nature of the sale and information about limitations on resales.
Amendment to Rule 504 and Repeal of Rule 505
Rules 504 and 505 of Regulation D create exemptions from registration for offerings of limited size and character. The amendments to Rule 504 increase the aggregate amount of securities that can be offered within any 12-month period without registering with the SEC from $1 million to $5 million, which is the maximum statutory limit under Section 3(b)(1) of the ’33 Act. The aggregate offering amount limit was last raised in 1988 from $500,000 to $1 million.3
Rule 505 exempted from registration offerings of up to $5 million annually sold to either accredited investors only or up to 35 non-accredited investors. The amendments to Rule 504 minimize the utility of Rule 505 – the aggregate fundraising limits would be the same, but issuers using Rule 505 would have to verify that their securities were sold only to accredited investors or to no more than 35 investors. By contrast, Rule 504 allows public solicitation – the chief benefit of Rule 504 over the old Rule 505 is that offerings made under Rule 504 can be sold to anyone.4
Amended Rule 147 and new Rule 147A will become effective 150 days after publication in the Federal Register. Amended Rule 504 will become effective 60 days after publication in the Federal Register. The repeal of Rule 505 would become effective 180 days after publication in the Federal Register.
Cumulatively, the changes implemented in the final rules should make it easier for smaller issuers to raise capital without being subject to SEC registration requirements.