On November 2, 2020, the SEC adopted significant rule amendments to simplify, harmonize and improve the exempt offering framework to facilitate capital formation and investment opportunities in startups and emerging companies. The rule amendments were initially proposed in March 2020, and first conceived in a concept release in June 2019.  The reforms simplify the integration doctrine, revise the offering and individual investment limits for certain exemptions, clarify communication rules regarding “testing-the-waters” and demo days and harmonizes disclosure and eligibility requirements and bad actor disqualification provisions. The amendments will generally become effective 60 days after publication in the Federal Register, likely to occur sometime in February 2020.

Each of the foregoing reforms is significant, and deserves its own blog post, so over the next several weeks I’ll aim to write more extensively about each one.  In the meantime, this post provides a brief summary of the amended rules, and for those who would like to go to the 388-page source, here’s a link to the SEC release containing the final rule amendments.

Background

The amount of capital raised in exempt offerings in the United States is at least twice the amount raised in SEC-registered offerings. Emerging companies rely on multiple rounds of exempt offerings as to enable them to scale, and the trend has been for such companies to defer initial public offerings in favor of late stage private funding or other liquidity events.  The exempt offering framework has developed over time through legislative changes and SEC rules, including Regulation D and SEC rulemaking under the JOBS Act of 2012.  The current exempt offering framework is widely regarded as extremely complex and made up of differing, exemption-specific requirements and conditions.

On June 18, 2019, the SEC issued a concept release that solicited public comment on possible ways to simplify, harmonize and improve the exempt offering framework to promote capital formation and expand investment opportunities while maintaining appropriate investor protections.  After processing the comments received in response to the concept release, the SEC proposed a set of amendments in March 2020 that would generally retain the current exempt offering structure but reduce potential friction points, address gaps and complexities and help provide viable alternatives to dominant capital raising tools.

On November 2, 2020, the SEC issued a final rule release adopted the amendments substantially as proposed.

Integration Framework Reforms

The integration doctrine seeks to prevent an issuer from improperly separating a single offering into two or more separate offerings in an effort to fit the “separate” offerings within registration exemptions that would not be available for the combined offering. The Securities Act integration framework consists of a mixture of rules and SEC guidance for determining whether ostensibly separate securities transactions should be considered part of the same offering.

The amendments establish a new integration framework with a general principle that looks to the particular facts and circumstances of two or more offerings, 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 new integration framework appears in the form of an amendment to Rule 152 under the Securities Act.  New Rule 152 will provide that offers and sales will not be integrated if, based on the particular facts and circumstances of the offerings, the issuer can establish that each offering either complies with the registration requirements of the Securities Act, or is eligible for an exemption from registration.

The amendments also provide the following four non-exclusive safe harbors from integration:

  • Any offering made more than 30 days before the commencement of any other offering, or more than 30 days after the termination or completion of any other offering, provided certain conditions are met.
  • 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
  • an offering for which a registration statement has been filed will not be integrated if it 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 that was made only to qualified institutional buyers and institutional accredited investors, or (iii) an offering for which general solicitation is permitted that terminated or was completed more than 30 calendar days prior to the commencement of the registered offering; and
  • offers and sales made in reliance on an exemption for which general solicitation is permitted if made subsequent to any terminated or completed offering.

Offering and Investment Limit Reforms

The new reforms will increase the offering and individual investment limits for certain exempt offerings, as follows:

Regulation AThe maximum offering amount under Tier 2 of Regulation A will increase from $50 million to $75 million, and for secondary sales from $15 million to $22.5 million.

Regulation CrowdfundingFor Regulation Crowdfunding, the amendments (i) raise the offering limit from $1.07 million to $5 million, and amend investment limits for investors by not applying any investment limits to accredited investors and allowing non-accredited investors to rely on the greater of their annual income or net worth when calculating the limit on how much they can invest.

Rule 504 of Regulation DThe maximum offering amount under Rule 504 of Regulation D will increase from $5 million to $10 million.

“Test-the-Waters” and “Demo Day” Communications

The rule amendments include several changes relating to offering communications, including:

  • permitting an issuer to use generic solicitation of interest materials to “test-the-waters” for an exempt offering of securities prior to determining which exemption it will use for the sale of the securities;
  • permitting Regulation Crowdfunding issuers to “test-the-waters” prior to filing an offering document with the SEC in a manner similar to current Regulation A; and
  • providing that certain “demo day” communications will not be deemed general solicitation or general advertising.

Special Purpose Vehicles for Regulation Crowdfunding

The amendments will allow sponsors to use Regulation Crowdfunding to raise capital into a special purpose vehicle whose purpose is to invest in an operating company.  Previously, special purpose vehicles were excluded from Regulation Crowdfunding.

Other Reforms to Specific Exemptions

The amendments 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.

Stay tuned to my next blog post on the new integration rules, my first deeper dive installment on the new reforms.