SEC Adopts Amendments to Exempt Offering Rules

One change that has gotten little attention is the SEC’s liberalized standard for “verification” of an accredited investor in an offering made pursuant to Rule 506(c) under the Securities Act of 1933 (Securities Act), which may encourage broader acceptance of an exemption for which the market has not shown the enthusiasm that had been expected when it was adopted.

The Amendments involve many technical and conforming changes, but this client alert focuses on the changes that we think will be the most meaningful. The Amendments, which will become effective 60 days after they are published in the Federal Register, should go into effect in the first quarter of 2021.

One of the most useful features of the SEC’s adopting release for capital market participants is a table that provides an overview of the principal private offering exemptions. We have attached this table, with modifications, as Annex A to this client alert. Among other things, this table reflects the following increases made by the SEC to maximum offering amounts:

• Tier 2 of Regulation A: increased from $50 million to $75 million
• Secondary Sales under Tier 2 of Regulation A: increased from $15 million to $22.5 million
• Rule 504: increased from $5 million to $10 million
• Regulation Crowdfunding: increased from $1.07 million to $5 million

New Integration Framework and Safe Harbors

The SEC’s long-standing integration doctrine addresses the question whether two or more purportedly discrete offerings of securities are really part of a single offering (i.e., “integrated”) that would not qualify for the exemptions claimed or that would require registration under the Securities Act. Integration issues might arise, for example, if an issuer immediately followed a private offering with a registered public offering or vice versa. If the two offerings were deemed integrated or combined into a single offering, the integrated offering would have violated Section 5 of the Securities Act because the general solicitation and general advertising involved in the public offering portion of the integrated offering means that the private offering exemption would not be available (other than in the case of private placements utilizing general solicitation and general advertising pursuant to Rule 506(c) under the Securities Act). In addition, so-called “gun jumping” issues (i.e., prohibitions against actions and communications that have the effect of conditioning the market before an offering) would be raised by the offers and sales in a private offering that precedes a public offering.

Historically, Rule 502(a) under the Securities Act provided a safe harbor for offers and sales made more than six months prior to or following a Regulation D offering, but otherwise market participants were left to employ a five-factor test to determine whether purportedly separate offerings should be integrated. This resulted in a facts-and-circumstances analysis that could involve significant legal analysis but did not always yield clarity, or corresponding comfort, to market participants.

In the Amendments, the SEC has overhauled its Securities Act rules on integration. As a general matter, the new integration framework establishes general principles and safe harbors in respect of the integration of offers and sales in different offerings in circumstances in which the SEC has concluded that the issuer’s actions in each offering would not be fundamentally inconsistent with the requirements applicable to the other offerings. Many of the principles followed have emerged gradually over decades of experience with integration issues, but the new rules provide welcome clarity.

As described in more detail below, revised Rule 152 under the Securities Act (Rule 152) provides:

• a statement of general principles of integration, in Rule 152(a); and
• four specific safe harbors from integration, in Rule 152(b).

General Principles of Integration

The general principles in Rule 152(a) provide that, in determining whether two or more offerings should be integrated, if the safe harbors in Rule 152(b) do not apply, the offerings will not be integrated if, based on the particular facts and circumstances, the issuer can establish that each offering either complies with the registration requirements of the Securities Act or has an available exemption from registration.

In the case of integration of exempt offerings that prohibit general solicitation with either exempt offerings that permit general solicitation or with registered offerings, Rule 152(a)(1) requires that the issuer have a reasonable belief, with respect to each purchaser in the exempt offering that prohibits general solicitation, that the issuer either (i) did not solicit such purchaser through the use of general solicitation (where, for example, direct contact of such purchaser by the issuer or its agents outside of the public offering effort would not constitute such a solicitation) or (ii) established a substantive relationship with such purchaser prior to the commencement of the exempt offering that prohibits general solicitation. The SEC also made clear that revised Rule 152 will apply equally to one or more business combination and/or capital-raising transactions that occur concurrently or close in time.

Rule 152(a)(2) also permits concurrent private offerings if all of the offering materials comply with applicable requirements for each of the different offerings.

Safe Harbors from Integration

Rule 152(b) provides four non-exclusive safe harbors from the integration of offerings.

Rule 152(b)(1) provides a safe harbor for offerings made more than 30 days before or after any other offering, as long as the issuer reasonably believes that, for each purchaser in a private offering for which general solicitation is prohibited where that private offering follows an offering that allowed general solicitation, the issuer either (i) did not solicit the purchaser through general solicitation or (ii) had previously established a substantive relationship with the purchaser. The SEC stated in the adopting release for the Amendments that investors with whom the issuer has a pre-existing substantive relationship may include:

• the issuer’s existing or prior investors;
• investors in prior deals of the issuer’s management;
• friends or family of the issuer’s control persons; and
• customers of a registered broker-dealer or investment adviser with whom the broker-dealer or investment adviser established a substantive relationship prior to the participation in the exempt offering by the broker-dealer or investment adviser.

Rule 152(b)(2) preserves the existing rule that offerings made pursuant to employee benefit plans that are exempt under Rule 701 under the Securities Act, or that are made in compliance with Regulation S, will not be integrated with any other offering.

Rule 152(b)(3) provides, consistent with existing Rule 155 (which Rule 152(b)(3) replaces), a safe harbor from integration of an offering for which a registration statement has been filed under the Securities Act with an earlier private offering if the registered offering:

• is made after the earlier private offering was terminated or completed and no general solicitation was permitted in the private offering;
• is made after the earlier private offering was terminated or completed and general solicitation was made only to qualified institutional buyers or institutional accredited investors; or
• commences at least 30 days after the earlier private offering was terminated or completed.

The SEC also confirmed, through a safe harbor in Rule 152(b)(4), the general view of practitioners that offers and sales made pursuant to an exemption for which general solicitation is permitted will not be integrated with any prior offering that has been terminated or completed.

Integration Summary

The SEC’s adopting release provided two tables that summarize the new integration framework. We have combined and attached these tables, with modifications, as Annex B to this client alert.

We believe that these new integration rules, which are centered around clarified general principles of integration and four safe harbors, will facilitate capital-raising by providing much-overdue clarity to an area that has been plagued by uncertainty. Going forward, unless an offering occurs within 30 days of another offering, integration should no longer remain an obstacle in most cases, and issuers will have much greater flexibility to navigate between different offering types.

Confidential Treatment Standard

The SEC has adjusted its permissions for registrants to redact provisions of material contracts required to be filed as exhibits to their disclosure documents by replacing the prior “competitive harm” standard with a standard more closely aligned with the Supreme Court’s recent pronouncement of the definition of “confidential.” Specifically, information may now be redacted from material contracts if it is the type of information that the issuer both customarily and actually treats as private and confidential and that is also not material.

Demo Days

The SEC is now exempting certain “demo day” communications from the registration requirements of the Securities Act pursuant to a new Rule 148 under the Securities Act. This rule is intended to allow issuers, in discussing their business plans with potential investors at “demo day” events, the flexibility to note that they are seeking capital without uncertainty as to whether they have jeopardized their ability to rely on a certain exemption from registration. Rule 148 contains several restrictions, including the identity of the sponsor of the demo day, that should be consulted by market participants who wish to take advantage of this exemption.

Generic Solicitation of Interest Exemption

The SEC is creating a new exemption pursuant to a new Rule 241 under the Securities Act, pursuant to which issuers who use generic solicitation of interest materials pursuant to the conditions of the rule are exempted from the prohibitions on offers prior to filing a registration statement pursuant to Section 5(c) of the Securities Act. The SEC designed this “testing-the-waters” rule for issuers to gauge market interest, tailor the size and other terms of an offering (possibly with input from potential investors) and reduce the costs of conducting an exempt offering. If an issuer moves forward with an exempt offering following a generic solicitation of interest, the issuer will be required to comply with an available exemption for the offering.

Under the new integration framework in Rule 152, an issuer will not be able to follow a generic solicitation of interest that constitutes a general solicitation with an offering pursuant to an exemption that does not permit general solicitation (such as Rule 506(b), which continues to be the predominant method used today for exempt offerings) unless the issuer has a reasonable belief, based on the facts and circumstances, that the issuer (or any person acting on the issuer’s behalf) either (i) did not solicit such purchaser through the use of general solicitation or (ii) established a substantive relationship with such purchaser prior to the commencement of the exempt offering prohibiting general solicitation. If an issuer uses Rule 241 and then sells securities under Rule 506(b) within 30 days to non-accredited investors, the issuer must provide those non-accredited investors with any written generic solicitation of interest materials that it used.

Note that state preemption of blue sky laws has not been provided for offers made pursuant to Rule 241, which may have a chilling effect on market adoption of the permissions made available by Rule 241.

Verification of Accreditation

Rule 506(c), which permits general solicitation in a Rule 506 offering if sales are made only to accredited investors, has failed to generate enthusiasm, as market participants continue to look mainly to Rule 506(b) despite its prohibition of general solicitation. A principal reason that has been advanced for this failure is the requirement in Rule 506(c) that issuers take reasonable steps to “verify” the accreditation of purchasers, whereas issuers in Rule 506(b) offerings have been able to take a more streamlined approach by accepting investors’ own representations regarding their accreditation. The “verification” requirement has been viewed as creating uncertainty that issuers and broker-dealers prefer to avoid.

In an effort to address this issue, the SEC is now permitting issuers using Rule 506(c) to determine that, if an issuer took reasonable steps to verify the accreditation of an investor within the past five years, then the investor remains an accredited investor as of the time of a subsequent sale if the investor provides a written representation that it continues to qualify as an accredited investor and the issuer is not aware of information to the contrary. It remains to be seen if this will make enough of a difference to prompt a transition from Rule 506(b) to Rule 506(c), but it is a step in the right direction.

Other Regulation D Amendments

To address the possibility of multiple Rule 506(b) offerings in a limited period of time (in light of the changes made to the integration framework), the SEC is now limiting the number of non-accredited investors purchasing in Rule 506(b) offerings to no more than 35 within a 90-day period. In addition, the financial information that is required to be furnished to non-accredited investors has been changed to align to the financial information that issuers must provide in Regulation A offerings.

Regulation Crowdfunding and Rule 504

As noted above, the Amendments raise the offering limit for Rule 504 offerings to $10 million and for Regulation Crowdfunding offerings to $5 million. Market participants who rely on Regulation Crowdfunding would be well-advised to review all of the other changes made by the SEC to Regulation Crowdfunding. Nonetheless, for most capital-raising purposes, there are far more flexible and less burdensome exemptions available, and we do not foresee a significant uptick in the usage of Regulation Crowdfunding or Rule 504 solely by virtue of the Amendments.

Please click here for the related Annexes.