While everyone else has been hunkered down over the past few months, the SEC staff has been busy proposing and adopting new regulations, some of which may have a significant positive impact on raising private money. Among them are Harmonization Amendments to Exempt Offerings. (You can read about another of the SEC’s activities, Proposed Finder’s Rules, by clicking here.)

In March 2020, the SEC proposed amendments meant to “harmonize” (i.e., remove inconsistencies) from the rules surrounding exempt offerings. On November 2, 2020, the SEC adopted the following amendments to the existing rules, which will become effective 60 days after publication in the Federal Register.

The gist of the amendments is that:

  • Issuers can now switch from one offering exemption to another more easily.
  • Regulation A+ limits have been increased for Tier 1 offerings from $15M to $22.5M and for Tier 2 offerings from $50M to $75M in a 12-month period.
  • Regulation Crowdfunding offering limits have been increased from $1,070,000 to $5M in a 12-month period; investment limits have been removed for Accredited investors; and non-accredited investors can user the greater of their income or net worth when determining investment limits.
  • Rule 504 limits have been increased from $5M to $10M.
  • Rules regarding “demo day” communications and “testing the waters” solicitations of interest have been clarified as follows:
    • Issuers can now use “generic solicitation of interest materials” to test the waters for an exempt offering prior to determining which exemption it will use to sell its securities.
    • Regulation Crowdfunding Issuers can “test the waters” to gauge interest prior to filing their Form C with the SEC.
    • An Issuer’s participation in certain “demo day” communications in a setting where potential Issuers are invited to meet with potential investors (organized by a college, incubator, angel investor group, etc.) who have gathered to review investment opportunities for the purpose of investment will not be deemed general solicitation or advertising on the part of the Issuer.
  • Certain disclosure and bad actor disqualification requirements have been made consistent between Regulation D, Regulation A and Regulation Crowdfunding.
  • An Accredited investor verification for an investor who previously invested with an Issuer is now good for a period of up to 5 years so long as “the investor provides a written representation that the investor continues to qualify as an Accredited investor and the Issuer is not aware of information to the contrary.”
  • Integration rules with respect to successive offerings have been clarified; read more on this below.

The financial information an Issuer must provide to non-accredited investors in a Rule 506(b) private placement must mirror the financial information Issuers must provide to investors of Regulation A+ offerings; read more on this below.

Integration

One of the harmonization efforts was aimed at a concept called “integration,” which occurs when an Issuer makes parallel or successive offerings in close time proximity. In such cases, the SEC may take the position that the two offerings are really part of the same offering for purposes of determining compliance with securities laws. The issue is that if the offerings are integrated, the exemption may no longer be available.

For instance:

  1. What if an Issuer engaged in a Rule 506(b) offering that included 20 non-accredited/sophisticated investors and then did a second offering with another 20 non-accredited/sophisticated investors? If the two offerings were integrated (i.e., combined), collectively, the single offering would violate securities rules as it had exceeded the limit of 35 non-accredited investors.
  2. Or alternatively, if one offering was a Rule 506(b) offering followed closely by a Rule 506(c) offering, and the two offerings were integrated, the 506(b) exemption could be disallowed because general solicitation and advertising was used to attract investors in the Rule 506(c) offering; or conversely, the Rule 506(c) exemption could be disallowed because the investors in the Rule 506(b) offering were not all verified Accredited investors.

The final rule offered the following 4 “safe harbors” from integration:

Safe Harbor 1:

A Rule 506(b) offering where advertising is prohibited that follows a prior Rule 506(c) offering in which advertising is allowed, will not be integrated as long as:

There is a gap of 30 days between the time the first offering was completed and the second offering was started, and

  • The issuer did not find investors for the subsequent Rule 506(b) offering through advertising or the Issuer can demonstrate that it established a “substantive relationship”[1] with each investor prior to the commencement of the Rule 506(b) offering.

Safe Harbor 2:

A Regulation S offering[2] will not be integrated with other offerings. This means you can do a concurrent Regulation S and Rule 506 offering, without having the offerings be integrated.

Safe Harbor 3: 

A registered offering will not be integrated with a prior offering if the offering is made after:

  • A terminated or completed Rule 506(b) offering;
  • A terminated or completed Rule 506(c) offering made only to qualified institutional buyers and institutional accredited investors; or
  • A Rule 506(c) offering terminated or completed more than 30 calendar days prior to the commencement of the registered offering.

Safe Harbor 4:

An offering that allows advertising — such as Rule 506(c) — can immediately follow completion of an offering that doesn’t allow advertising without integration (no 30-day gap required).

 

[1] In the Final Rule, p. 31, the SEC reiterated its stance on what it believes constitutes a pre-existing substantive relationship necessary for an investor’s participation in a Rule 506(b) Offering (to prove that general solicitation was not used), with relevant excerpts provided below:
“We reiterate the guidance provided in the Proposing Release that we generally view a “pre-existing” relationship as one that the issuer has formed with an offeree prior to the commencement of the offering or, alternatively, that was established through another person… prior to that person’s participation in the offering. A “substantive” relationship is one in which the issuer (or a person acting on its behalf, such as a registered broker-dealer or investment adviser) has sufficient information to evaluate, and does, in fact, evaluate, an offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor.” The SEC additionally stated: “We do not believe that self-certification alone (by checking a box) without any other knowledge of a person’s financial circumstances or sophistication would be sufficient to form a “substantive” relationship for these purposes.” The SEC further opined: “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, or friends or family of the issuer’s control persons.”

[2] This Safe Harbor also applies to an offering made in compliance with Rule 701, pursuant to an employee benefit plan

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