SEC Issues New Rules on Private Placements

On November 2, 2020, the Securities and Exchange Commission (SEC) voted to adopt broad revisions to the private placement regime under the Securities Act of 1933, as amended (Securities Act).  Among other changes, the amendments (1) establish a new integration framework for issuers to move from one exemption to another; (2) increase the current offering and investment limits for Regulation A, Regulation Crowdfunding and Rule 504 offerings; and (3) amend “Test-the-Waters” and “Demo Day” offering communications rules (collectively, the Amendments).  The Amendments will become effective 60 days after publication in the Federal Register, except for the extension of the temporary Regulation Crowdfunding provisions, which will be effective upon publication in the Federal Register.

Overview

It is axiomatic that every offering of securities must either be registered with the SEC or be exempt from such registration.  To keep pace with long-term developments in the capital markets, the rules for conducting private placements have evolved organically over many decades via SEC rulemaking and through direct action by Congress.  Over time, this regulatory regime has evolved into a complex, multi-level, “patchwork” system of exemptions.  As a result, the current exempt offering framework is often difficult for issuers of securities (particularly smaller enterprises) to understand and navigate.  The Amendments will reduce the expense and complexity associated with private placements, making it easier for issuers to access capital through a private offering. 

Integration Framework

Under the SEC’s integration doctrine, two offerings conducted in close proximity to one another may, based on the facts and circumstances, be collapsed into a single offering for purposes of assessing whether a private placement exemption is available.  The current integration framework for determining whether multiple securities transactions made within a short period of time should be considered part of the same offering (i.e., “integrated”) for compliance purposes, derives from a series of SEC rules, formal and informal SEC guidance issued over many years, and certain market practices that have developed over time.  Notwithstanding the large body of available guidance, many grey areas remain, and even seasoned securities practitioners sometimes encounter challenges in interpreting the SEC’s pronouncements on the subject.  The Amendments establish a new integration framework that more clearly looks to the facts and circumstances of multiple offerings and analyzes 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.

Additionally, the Amendments provide four non-exclusive safe harbors from integration:

Safe Harbor 1	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 in the case where an exempt offering for which general solicitation is prohibited follows by 30 calendar days or more an offering that allows general solicitation, 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.
Safe Harbor 2	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.
Safe Harbor 3	An offering for which a Securities Act registration statement has been filed will not be integrated with another offering if the offering is made after: a terminated or completed offering for which general solicitation is prohibited; a terminated or completed offering for which general solicitation is permitted that was made only to qualified institutional buyers and institutional accredited investors; or an offering for which general solicitation is permitted that was terminated or completed more than 30 calendar days prior to the commencement of the registered offering.
Safe Harbor 4	Offers and sales made in reliance on an exemption for which general solicitation is permitted will not be integrated with another offering if made after any prior terminated or completed offering.

Offering and Investment Limits

The Amendments increase the offering and investment limits for certain exempt offerings.

• For Regulation A:
  • raise the maximum offering amount under Tier 2 from $50 million to $75 million, and
  • raise the maximum offering amount for secondary sales under Tier 2 from $15 million to $22.5 million

• For Regulation Crowdfunding:
  • raise the offering limit from $1.07 million to $5 million;
  • revise the investment limits for investors in such offerings by removing investment limits for accredited investors, and revising the calculation method for investment limits for non-accredited investors to allow them to rely on the greater of their annual income or net worth when calculating the investment limits; and
  • extend the existing temporary relief for 18 months providing an exemption from certain Regulation Crowdfunding financial statement review requirements for issuers offering $250,000 or less of securities in reliance on the exemption within a 12-month period.

• For Rule 504 of Regulation D:
  • raise the maximum offering amount from $5 million to $10 million

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

 The Amendments make 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 before determining which exemption it will use for the sale of the securities;
• permitting Regulation Crowdfunding issuers to “test-the-waters” before filing an offering document with the SEC in a manner similar to current Regulation A; and
• providing that certain “demo day” communications are not general solicitation or general advertising.

Regulation A and Crowdfunding Eligibility

The Amendments permit the use of certain special purpose vehicles to facilitate investing in Regulation Crowdfunding issuers while limiting the types of securities a company may offer and sell in reliance on Regulation Crowdfunding.  Additionally, the Amendments impose eligibility restrictions on the use of Regulation A by issuers that are delinquent in their reporting obligations under the Securities and Exchange Act of 1934.

Other Improvements to the Exempt Offering Framework

The Amendments also:

• change the financial information issuers must provide 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

Final Thoughts

By simplifying the exempt offering framework, the Amendments will reduce the time and cost associated with private placements, making it easier for entrepreneurs and smaller enterprises to complete a private offering and raise capital in the United States.  However, companies should note that the final rule is within the lookback period of the Congressional Review Act.  Consequentially, the outcome of the national election of November 3, 2020, could affect the final rule’s permanency.

Appendix A