The SEC has proposed amendments to Rule 147 under the Securities Act of 1933, which currently provides a safe harbor for compliance with the Section 3(a)(11) exemption from registration for intrastate securities offerings. The SEC proposal would modernize the rule and establish a new exemption to facilitate capital formation, including through offerings relying upon recently adopted intrastate crowdfunding provisions under state securities laws. The proposed amendments to the rule would eliminate the restriction on offers and ease the issuer eligibility requirements, while limiting the availability of the exemption at the federal level to issuers that comply with certain requirements of state securities laws.
As an aside, I ponder what the SEC Investor Advocate is going to think of these far reaching and seemingly useful changes for issuers. The Investor Advocate has recently sought to nix useful amendments to the NYSE rules for emerging companies and has sent a letter NASAA on its “Proposed Model Legislation or Regulation To Protect Vulnerable Adults From Financial Exploitation” and to the MSRB on its “Draft Amendments to MSRB Rule A-3 to Lengthen the Term of Board Member Service.”
Basis for Amendments
Section 3(a)(11) of the Securities Act provides for an intrastate exemption and current Rule 147 helps to implement the statutory exemption. Rule 147, as proposed to be amended, would no longer fall within the statutory parameters of Section 3(a)(11). Accordingly, the SEC proposes to amend Rule 147 to create an exemption pursuant to its general exemptive authority under Section 28 of the Securities Act. As amended, Rule 147 would function as a separate exemption from Securities Act registration rather than as a safe harbor under Section 3(a)(11). The proposed amendments, if adopted, would not alter the fact that the Section 3(a)(11) statutory exemption continues to be a capital raising alternative for issuers with local operations seeking local financing.
Elimination of Limitation on Manner of Offering
The problem with posting offers related to the sales of securities on the internet means that even if you want to sell only to Missouri residents, people living in Kansas will read the offers, a faux pas under Rule 147 as currently written. Rule 147, as proposed to be amended, would require issuers to limit sales to in-state residents, but would no longer limit offers by the issuer to in-state residents. Accordingly, amended Rule 147 would permit issuers to engage in general solicitation and general advertising that could reach out-of-state residents in order to locate potential in-state investors using any form of mass media, including unrestricted, publicly available websites, to advertise their offerings, so long as all sales of securities so offered are made to residents of the state or territory in which the issuer has its principal place of business.
Given that amended Rule 147 would allow offers to be accessible by out-of-state residents, the proposed amendments would require an issuer to include a prominent disclosure on all offering materials used in connection with a Rule 147 offering, stating that sales will be made only to residents of the same state or territory as the issuer. This proposed disclosure requirement is intended to advise investors who are not residents of the state in which sales are being made that the intrastate offering would be unavailable to them.
Elimination of Residence Requirement for Issuers
Here the Commission gives a nod to Delaware and maybe Nevada. Rule 147 currently requires issuers to be incorporated or organized under the laws of the state or territory in which the intrastate offering is conducted. This requirement, while based on the language of Section 3(a)(11), is at odds with modern business practice in which issuers incorporate or organize in states other than the state or territory of their principal place of business, for example, to take advantage of well-established bodies of corporate or partnership law.
The SEC proposes to eliminate the current requirement of Rule 147 that limits the availability of the rule to issuers organized in the state in which an offering takes place. The proposed amendments would expand the universe of eligible issuers by eliminating the current “residence” requirement, while continuing to require that an issuer have a sufficient in-state presence determined by the location of the issuer’s principal place of business.
In conjunction with the proposed requirement that all purchasers be in-state residents, the SEC believes that requiring an issuer to have an in-state principal place of business and to satisfy at least one additional requirement that demonstrates the in-state nature of the issuer’s business should adequately ensure the intrastate nature of the offering, such that state authorities can effectively regulate an issuer’s activities and enforce states’ securities laws for the protection of resident investors.
Requirements for Issuers “Doing Business” In-State
The SEC proposes to simplify the doing business in-state determination by amending the current rule requirements so that an issuer’s ability to rely on the rule would be based on the location of the issuer’s principal place of business, as opposed to its “principal office.” For purposes of the rule, the SEC proposes to define the term “principal place of business” to mean the location from which the officers, partners, or managers of the issuer primarily direct, control and coordinate the activities of the issuer. As defined, an issuer would only be able to have a “principal place of business” within a single state or territory and would therefore only be able to conduct an offering pursuant to amended Rule 147 within that state or territory. Issuers also would be required to register the offering in the state in which all of the purchasers are resident, or rely on an exemption from registration that limits the amount of securities an issuer may sell pursuant to such exemption to no more than $5 million in a twelve-month period and imposes an investment limitation on investors.
Additionally, the SEC proposes to require issuers to satisfy an additional criterion that it believes would provide further assurance of the in-state nature of the issuer’s business within the state in which the offering takes place. For these purposes, the SEC proposes to retain the 80% threshold tests of the current rule in modified form with the addition of an alternative test based on the location of a majority of the issuer’s employees. While the substance of the 80% threshold requirements of current Rule 147(c)(2) would be retained in the proposed rules, the SEC proposes to make compliance with any one of the 80% threshold requirements sufficient to demonstrate the in-state nature of the issuer’s business. This would be a change to the current test, which requires issuers to meet all three conditions. The SEC further proposes to make certain technical revisions to the existing 80% thresholds that would simplify the structure, and clarify the application, of the rules.
The proposed new “80% thresholds” are as follows:
- The issuer derived at least 80% of its consolidated gross revenues from the operation of a business or of real property located in or from the rendering of services within such state or territory;
- The issuer had at the end of its most recent semi-annual fiscal period prior to the first offer of securities pursuant to the exemption, at least 80% of its consolidated assets located within such state or territory;
- The issuer intends to use and uses at least 80% of the net proceeds to the issuer from sales made pursuant to the exemption in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services within such state or territory; or
- A majority of the issuer’s employees are based in such state or territory.
Reasonable Belief as to Purchaser Residency Status
Current Rule 147(d) requires that offers and sales of securities pursuant to the rule be made only to persons resident within the state or territory of which the issuer is a resident. Regardless of the efforts an issuer takes to determine that potential investors are residents of the state in which the issuer is a resident, the exemption would be lost for the entire offering if securities are offered or sold to one investor that was not in fact a resident of the state. The SEC believes that this requirement in the current rule is unnecessarily restrictive and gives rise to uncertainty for issuers.
The SEC proposes to add a reasonable belief standard to the issuer’s determination as to the residence of the purchaser at the time of the sale of the securities. As proposed, an issuer would satisfy the requirement that the purchaser in the offering be a resident of the same state or territory as the issuer’s principal place of business by either the existence of the fact that the purchaser is a resident of the applicable state or territory, or by establishing that the issuer had a reasonable belief that the purchaser of the securities in the offering was a resident of such state or territory.
Here, the SEC is offering up a two edged sword. The proposing release states the SEC has also eliminated the current requirement in Rule 147 that issuers obtain a written representation from each purchaser as to his or her residence. The proposing release goes on to state smaller issuers likely to conduct intrastate offerings may mistakenly believe that obtaining a written representation from purchasers of in-state residency status would, without more, be sufficient to establish a reasonable belief that such purchasers are in-state residents.
Limitation on Resales
The SEC proposes to amend the limitation on resales in Rule 147(e) to provide that “for a period of nine months from the date of the sale by the issuer of a security sold pursuant to this rule, any resale of such security by a purchaser shall be made only to persons resident within such state or territory . . .”
The SEC also proposes to amend Rule 147(b) so that an issuer’s ability to rely on Rule 147 would no longer be conditioned on a purchaser’s compliance with Rule 147(e). The SEC believes that this proposed amendment to the application of Rule 147(e), as it relates to Rule 147(b), would increase the utility of the exemption by eliminating the uncertainty created in the offering process for issuers under the current rules.
The proposed Rule 147 safe harbor would include any prior offers or sales of securities by the issuer, as well as certain subsequent offers or sales of securities by the issuer occurring within six months after the completion of an offering exempted by Rule 147. As proposed, offers and sales made pursuant to Rule 147 would not be integrated with:
- Prior offers or sales of securities; or
- Subsequent offers or sales of securities that are:
- Registered under the Act, except as provided in Rule 147(h);
- Exempt from registration under Regulation A;
- Exempt from registration under Rule 701;
- Made pursuant to an employee benefit plan;
- Exempt from registration under Regulation S;
- Exempt from registration under section 4(a)(6) of the Act; or
- Made more than six months after the completion of an offering conducted pursuant to proposed Rule 147.
An offering made in reliance on Rule 147 would not be integrated with another exempt offering made concurrently by the issuer, provided that each offering complies with the requirements of the exemption that is being relied upon for the particular offering. For example, an issuer conducting a concurrent exempt offering for which general solicitation is not permitted would need to be satisfied that purchasers in that offering were not solicited by means of the offering made in reliance on amended Rule 147. Alternatively, an issuer conducting a concurrent exempt offering for which general solicitation is permitted would need to comply with the legend and disclosure requirements of proposed Rule 147(f). If the concurrent exempt offering for which general solicitation is permitted imposes additional restrictions on the general solicitation, such as, for example, the limitations imposed on advertising pursuant to Rule 204 of Regulation Crowdfunding, the issuer’s general solicitation would not be able to go beyond the more restrictive requirements. Also, an issuer conducting a concurrent Rule 506(c) offering could not include in its Rule 506(c) general solicitation materials and advertisement of a concurrent Rule 147 offering, unless that advertisement also included the necessary disclosure for, and otherwise complied with, Rule 147(f).
State Law Requirements
Rule 147 does not currently have an offering amount limitation and does not currently limit the amount of securities an investor can purchase in an offering pursuant to the rule. Preliminarily, however, the SEC believes that, in light of the proposed changes to Rule 147, which, as noted above, would no longer be a safe harbor for compliance with Section 3(a)(11), a maximum offering amount limitation and investor investment limitations in the rule would provide investors with additional protection and would be consistent with existing state law crowdfunding provisions. As such, the SEC is proposing to limit the availability of Rule 147, as proposed to be amended, to issuers that have registered an offering in the state in which all of the purchasers are resident or that conduct the offering pursuant to an exemption from state law registration in such state that limits the amount of securities an issuer may sell pursuant to such exemption to no more than $5 million in a twelve-month period and that limits the amount of securities an investor can purchase in any such offering.