Non-accredited investors are estimated to constitute approximately 92% of the U.S. population. Yet restrictive rules governing exempt offerings have significantly limited their freedom to invest in private offerings and prevented or discouraged issuers from selling them privately offered securities. But in a recently issued concept release, the Securities and Exchange Commission has signaled a willingness to approach the issue in a much more creative way, suggesting the possibility of expanded opportunities for companies to include non-accredited investors in exempt offerings without unduly compromising their protection.

The SEC’s June 18, 2019 concept release seeks public comment on ways to simplify, harmonize and improve exempt offerings by removing some of the existing complexity, thereby promoting capital formation without unduly compromising investor protections and expanding opportunities for investors. In its press release issued the same day, SEC Chairman Jay Clayton noted that “input from startups, entrepreneurs and investors who have first-hand experience with [the SEC’s] exempt offering framework will be key to its efforts to analyze and improve the complex system we have today.”

Significant changes over the past few years to the rules governing exempt offerings (most notably through the Jumpstart Our Business Startups Act of 2012, the Fixing America’s Surface Transportation Act of 2015 and the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018) have resulted in a complex framework of differing requirements and conditions, which may be difficult for issuers to navigate, particularly startups and emerging companies with more limited resources.

Interestingly, the amount raised in exempt offerings has been trending higher in both absolute terms and relative to registered offerings, and now is twice the amount raised in registered public offerings. The concept release estimates that in 2018, registered offerings accounted for $1.4 trillion of new capital compared to approximately $2.9 trillion raised through exempt offerings.

Given the dominance of exempt offerings, the focus of the release is to seek input on whether the current regulatory framework provides adequate access to capital for a variety of issuers, particularly smaller issuers, and adequate access to investment opportunities for non-accredited investors while maintaining investor protections. Non-accredited investors’ primary investment opportunities have historically been in registered markets because of the restrictions on their participation in private offerings. Non-accredited investors have not had the same level of access to investment opportunities in exempt markets as an accredited investor would, and the upward trend in exempt offerings only exacerbates the problem.

Consequently, the SEC is seeking comment on whether it would be consistent with capital formation and investor protection for it to consider steps to make a broader range of investment opportunities available to non-accredited investors. In particular, the SEC is seeking comment on the following specific questions (among others):

Accredited Investor Definition. To be considered an accredited investor, an entity would need to fall under one of the designated categories of financial institutions, have more than $5 million in assets or have only accredited investor owners, while an individual must pass either a net worth or income test. The SEC is seeking comment on:

• Whether the $5 million asset test for entities should be replaced with a $5 million investments test that includes all entities rather than specifically enumerated types of entities?
• Whether individuals should be allowed to qualify based on other measures of sophistication, such as minimum amount of investments, certain professional credentials, experience investing in exempt offerings, knowledgeable employees of private funds for investments in their employer’s funds, individuals who pass an accredited investor examination?
• Currently, a natural person just above the income or net worth thresholds would be able to invest without limits, but a person just below the thresholds cannot invest at all as an accredited investor. Should that be changed?

Rule 506 of Regulation D. Currently, Rule 506(b) allows sales to up to 35 non-accredited investors (and an unlimited number of accredited investors), but the exemption from the specific, mandated disclosure obligations of Regulation D for offerings sold only to accredited investors serves as a significant incentive to exclude non-accredited investors.   Accordingly the SEC seeks comment on:

• Whether it is important to continue to allow non-accredited investors to participate in Rule 506(b) offerings, and if so are the information requirements having an impact on the willingness of issuers to allow non-accredited investors to participate?
• Whether the SEC should consider eliminating or scaling the information requirements depending on the characteristics of the non-accredited investors participating in the offering, such as if all non-accredited investors are advised by a financial professional or a purchaser representative?
• Whether information requirements should vary if non-accredited investors can only invest a limited amount or if they invest alongside a lead accredited investor on the same terms as the lead investor?
• Should non-accredited investors be allowed to purchase securities in an offering that involves general solicitation? If so, what types of investor protection conditions should apply? For example, only if: (i) such non-accredited investors had a pre-existing substantive relationship with the issuer or were not made aware of the offering through the general solicitation; (ii) the offering is done through a registered intermediary; or (iii) a minimum percentage of the offering is sold to institutional accredited investors that have experience in exempt offerings and the terms of the securities are the same as those sold to the non-accredited investors?

Regulation A. In a Tier 2 offering by an issuer of securities that are not going to be listed on a national securities exchange upon qualification, non-accredited individual investors are limited in how much they can invest to no more than 10% of the greater of their annual income or net worth, alone or together with a spouse and excluding the value of their primary residence and any loans secured by the residence (up to the value of the residence). The SEC seeks comment on:

• Whether the individual investment limits for non-accredited investors in Tier 2 offerings should be changed or eliminated?
• If the investment limits are changed, what limits would be appropriate?

Responses to the foregoing or any other requests for comment set forth in the concept release may be submitted to the SEC here prior to the deadline of September 24, 2019.