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SEC Adopts Changes to Harmonize Private Offering Exemptions十一月 19, 2020
On November 2, 2020, the Securities and Exchange Commission adopted a series of rule amendments under the Securities Act of 1933 to “harmonize, simplify, and improve” the “patchwork” and “multilayer and overly complex” framework for offerings exempt from registration under the Securities Act. The SEC’s proposal was informed by public comments received in response to a June 2019 SEC concept release (available here) and the March 2020 proposing release (available here).
Pursuant to Section 5 of the Securities Act, every offer or sale of securities must either be registered with the SEC or effected pursuant to a valid exemption from registration. As noted by the SEC in the press release announcing the rulemaking, a majority of entrepreneurs and emerging businesses rely on private offering exemptions rather than the registration process to raise capital due to the cost and complexity of a registered offering. The press release makes clear that the amendments are intended to “address gaps and complexities in the exempt offering framework that impede access to capital for issuers and access to investment opportunities for investors.”
The amendments follow and are consistent with other recent actions by the SEC to facilitate capital formation, including the recent expansion of “test-the-waters” communications and extensions of accommodations available to emerging growth companies under the JOBS Act of 2012 by the staff of the SEC’s Division of Corporation Finance, as explained in our prior client alerts, available here and here.
The adopting release is available here; the amendments are effective 60 days after publication in the federal register.
The amendments are voluminous and impact several existing private offering exemptions. The four main themes of the amendments are as follows:
- Integration. The rulemaking clarifies, through new rule 152, the ability of issuers to engage in contemporaneous or close-in-time transactions under independent exemptions or pursuant to an effective registration statement without such offerings being integrated.
- Increased offering limits. The amendments increase the maximum offering size under Regulation A, Regulation Crowdfunding, and Rule 504 of Regulation D, as well as revise certain individual investment limits.
- Communications prior to offerings. The amendments introduce a new concept of “generic solicitations” under Rule 241, broaden permitted testing-the-waters communications, and permit certain “demo day” activity under new Rule 148.
- Other adopted amendments. The amendments also (i) harmonize disclosure requirements and eligibility requirements under existing private exemptions to reduce differences between existing exemptions, (ii) add a new item to the non-exclusive list of verification methods in Rule 506(c), and (iii) revise the standard for redacting confidential information by removing the “competitive harm” standard and allowing information to be redacted if it is the type that the issuer both customarily and actually treats as private or confidential and is not material.
Pursuant to Section 5 of the Securities Act, all offers or sales of securities must either be registered with the SEC or accomplished pursuant to a valid exemption from registration. The significant differences between and requirements applicable to transactions accomplished pursuant to an effective registration statement and/or one or more exemptions have historically complicated the ability of issuers of securities to engage in contemporaneous or close-in-time offerings structured to comply independently with the registration requirement or potential exemptions. Actions taken in respect to one offering were at risk of causing non-compliance with requirements applicable to another offering. The SEC historically addressed the integration of securities offerings in a mixture of rules and evolving guidance, but there is still some uncertainty with respect to determinations of whether multiple securities transactions — and especially multiple concurrent private offerings — should be considered part of the same integrated offering.
The rulemaking addresses integration uncertainty in private offering exemptions by codifying under new Rule 152 a single unified principle of integration, focusing on whether the issuer can establish (based on all relevant facts and circumstances) that each offering either complied with the registration requirements of the Securities Act or that an exemption from registration was available for the particular offering.
The guiding principle alone may seem familiar to experienced practitioners and, given the continuing focus on relevant facts and circumstances, may not necessarily clarify whether given actions by an issuer would cause potentially independent offerings to be integrated. In the rulemaking, the SEC attempts to address some of the uncertainty created by the fact-based principle by also adopting four new non-exclusive safe harbors that will allow issuers to be certain that independent offerings will not be deemed a single transaction. The four safe harbors generally work as follows:
- Timing. 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 will not be integrated with another offering; provided that, for an exempt offering for which general solicitation is not permitted (such as an offering pursuant to Rule 506(b) of Regulation D), the purchasers either were not solicited through the use of general solicitation or had established a substantive relationship with the issuer prior to the commencement of the offering for which general solicitation is not permitted.
- Employees and Offshore Transactions. Offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or in compliance with Regulation S will not be integrated with other offerings.
- Registered Offerings. An offering for which a Securities Act registration statement has been filed with the SEC will not be integrated with another offering if the registered offering is 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 such offering was made only to qualified institutional buyers and institutional accredited investors (i.e., in a manner that would comply with existing “test-the-waters” communications); or (iii) an offering that was terminated or completed more than 30 calendar days prior to the commencement of the registered offering.
- General solicitation. Offers and sales made in reliance on an exemption for which general solicitation is permitted will not be integrated with another offering if made subsequent to any prior terminated or completed offering.
New Rules 152(c) and (d) also provide non-exclusive lists of factors to consider in determining when an offering will be deemed “commenced” and “terminated or completed”, respectively. In the adopting release, the SEC also reaffirmed its prior guidance on its interpretation of “pre-existing” and “substantive” relationships. Experienced practitioners may note that the integration framework (including the safe harbors) is generally consistent with established market practice and therefore may not significantly alter the structure or timing of most securities transactions.
Increased Offering Limits
The amendments also increase dollar amount limitations for existing private offering exemptions, as follows:
- Regulation A. Increase the maximum offering amount under Tier 2 of Regulation A from $50 million to $75 million and increase the maximum offering amount for secondary sales under Tier 2 of Regulation A from $15 million to $22.5 million.
- Regulation Crowdfunding. Increase the maximum offering amount from $1.07 million to $5 million and amend the investment limitation for investors by: (i) not applying any investment limits to accredited investors and (ii) revising the calculation method for investment limitations 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. The rulemaking also extends for 18 months the existing temporary relief providing an exemption from certain financial statement review requirements for issuers offering $250,000 or less of securities within a 12-month period.
- Rule 504 of Regulation D. Increase the maximum offering amount from $5 million to $10 million in a 12-month period.
Communications Prior to Offerings
As explained in our prior client alerts regarding recent SEC and Staff action to expand “test-the-waters” communications in the context of registered securities offerings, the SEC and Staff have demonstrated consistent interest in facilitating permissible communications between issuers and investors early in the life of a potential securities offering. “Test-the-water” communications currently permit an issuer to engage in oral or written communications with certain eligible investors to gauge potential interest in an offering before or after filing a registration statement for that offering. Regulation A currently permits issuers to “test-the-waters”, allowing solicitations of interest in a potential offering from the general public provided certain legending and other requirements are met. Other exemptions do not, however, permit issuers to “test-the-waters.”
The rulemaking expands the scope of permissible communications between issuers and investors by (i) adopting new Rule 241 to permit the use of generic solicitation of interest materials prior to determining which exemption will be applicable to such transaction, (ii) amending a rule under Regulation Crowdfunding to permit “test-the-waters” activities in a manner similar to permissible activities under Regulation A, and (iii) adopting new Rule 148 to permit certain “demo day” communications that would not be deemed general solicitation or advertising.
Generic Solicitations of Interest: New Rule 241
New Rule 241 permits an issuer or any person authorized to act on behalf of an issuer to communicate orally or in writing to potential investors to determine whether there is an interest in a contemplated exempt offering of securities so long as the issuer has not decided the exemption that will be used to effect the transaction and the transaction is not contemplated to be a registered offering. Issuers that engage in such “generic solicitations” will be permitted to engage in a number of different exempt offerings and are not limited to any specific transaction structure. Pursuant to the new rule, no solicitation or acceptance of money or other consideration, nor of any commitment, binding or otherwise, from any person is permitted until the issuer makes a determination as to the exemption on which it will rely and commences the offering in compliance with the applicable exemption.
Rule 241 permits an issuer to seek “generic solicitations” of interest from any investor—not only qualified institutional buyers or institutional accredited investors—if the issuer intends to pursue an offering under an exemption that permits general solicitation. Crucially, however, if the generic solicitation is done in a manner that would constitute general solicitation, and the issuer ultimately decides to conduct an unregistered offering under an exemption that does not permit general solicitation, the issuer will need to analyze whether that solicitation and the subsequent private offering will be integrated, thereby making unavailable an exemption that does not permit general solicitation. As explained in the adopting release,
[u]nder the new integration rules adopted in [the adopting] release, an issuer will not be able to follow a generic solicitation of interest that constituted a general solicitation with an offering pursuant to an exemption that does not permit general solicitation, such as Rule 506(b), unless the issuer has a reasonable belief, based on the facts and circumstances, with respect to each purchaser in the exempt offering prohibiting general solicitation, that the issuer (or any person acting on the issuer’s behalf) either did not solicit such purchaser through the use of general solicitation or established a substantive relationship with such purchaser prior to the commencement of the exempt offering prohibiting general solicitation.
Certain other conditions apply to generic solicitations, including legends and disclaimers. If securities are sold under Rule 506(b) within 30 days of the testing-the-waters communications to any purchaser who is not an accredited investor, the issuer must provide purchasers with any written testing-the-waters materials and, if a Regulation A or Regulation Crowdfunding offer is commenced within 30 days of the testing-the-waters communication, the written materials used must be made publicly available as an exhibit to the offering materials filed with the SEC. Moreover, the exemption applies only to the solicitation itself; issuers would therefore still need to ensure that all conditions of the private offering exemption itself are satisfied.
“Demo Day” Communications: New Rule 248
New Rule 248 provides additional flexibility for so-called “demo day” communications, which are expressly not deemed a general solicitation or advertising. Except for certain precautionary steps required for virtual events as described below, “demo day” communications do not require the issuer to take reasonable steps to verify that the ultimate purchasers in an offering are accredited investors (unlike requirements for general solicitation applicable under Rule 506(c)). The rulemaking permits communications made in connection with a seminar or meeting by a college, university, or other institution of higher education, state or local government or instrumentality thereof, a nonprofit organization, or an angel investor group, incubator, or accelerator sponsoring the seminar or meeting.
Certain conditions for “demo day” communications apply: more than one issuer must attend the event and issuers are not permitted, among other things, to make investment recommendations, engage in investment negotiations, or charge fees. In addition, advertising or marketing of the event may not reference any securities offering, and information conveyed at the event regarding the offering must be limited to: (i) notification of the planned offering; (ii) the type and amount of securities being offered; (iii) the intended use of proceeds; and (iv) the unsubscribed amount of the offering. If the event is held virtually, online participation should be limited to: (i) individuals who are associated with the sponsor organization; (ii) individuals the sponsor reasonably believes are accredited investors; and (iii) individuals invited by the sponsor based on industry or investment-related experience reasonably selected by the sponsor in good faith and disclosed in public communications about the event.
Other Adopted Amendments
The rulemaking adopted by the SEC also:
- changes 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;
- adds a new item to the non-exclusive list of verification methods in Rule 506(c) permitting accredited investors to verify such status by providing a written representation to the issuer, so long as the issuer is not aware of anything to the contrary (on which the issuer may rely for a period of up to five years);
- harmonizes the bad actor disqualification provisions in Regulation D, Regulation A, and Regulation Crowdfunding (which are currently similar, but not identical) by using the same disqualification lookback period;
- and amends Items 601(b)(2) and 601(b)(10) of Regulation S-K to update the standard for redacting confidential information by removing the “competitive harm” standard and allowing information to be redacted if it is the type that the issuer both customarily and actually treats as private or confidential, and is not material.1
As with any current securities offering, issuers should remain cognizant that other federal and state securities laws remain applicable to offers or sales of securities and communications made in connection with such offers or sales, including anti-fraud and other liability provisions.
1 This change eliminates a mismatch in the standard for redacting confidential information from exhibit filings under the streamlined process adopted by the SEC in March 2019 and the standard applicable to traditional confidential treatment applications, including under Securities Act Rule 406, following a June 2019 U.S. Supreme Court decision that rejected the previous “competitive harm” standard for purposes of Exemption 4 under the Freedom of Information Act.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. John-Paul Motley, an O’Melveny partner licensed to practice law in California, Shelly Heyduk, an O’Melveny partner licensed to practice law in California, Robert Plesnarski, an O’Melveny partner licensed to practice law in the District of Columbia and Pennsylvania, and James M. Harrigan, an O’Melveny counsel licensed to practice law in the District of Columbia and Maryland, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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