By Larry K. Harris, Polsinelli, shareholder in the St. Louis office of Polsinelli P.C
On Nov. 2, 2020, the U.S. Securities and Exchange Commission (“SEC”) issued final rules that became effective at the start of 2021. These rule changes affected many of the regulations pertaining to the offering of securities under various “exemptions.” Some of the more important changes are discussed below. In this discussion, those raising capital are referred to as “issuers” because they issue stock or other securities to investors as the means of raising capital.
Exempt offerings are key to capital raising for small issuers and startups. The basic rule under the Securities Act of 1933 (the “Securities Act”) is that any issuer offering to sell its securities must register that offering with the SEC unless the offering is exempt from the registration requirements. While the Securities Act itself provides for some offerings, and even some types of securities, to be exempt from registration, the exemptions issuers have found to be most useful are those that the SEC has provided under its authority to promulgate regulations establishing exemptions.
By far, the most commonly used set of exemptions was created in the early 1980s when the SEC adopted Regulation D. As initially designed, there were three versions of exempt offerings; one each established under Rule 504, Rule 505 and Rule 506. In 2016 the SEC revised Regulation D, enlarging the amount of capital that can be raised under Rule 504 to $5 million, eliminating Rule 505 (which was almost never used), and liberalizing Rule 506 by creating two tracks — one for private offerings and one for offerings using public (general) solicitations. No dollar limit on Rule 506 offerings exists, as the SEC relies instead on methods of offering, limits on the number of “non-accredited investors,” and mandated disclosures to provide the necessary protection to investors.
As initially designed, there were three versions of exempt offerings; one each established under Rule 504, Rule 505 and Rule 506. In 2016 the SEC revised Regulation D, enlarging the amount of capital that can be raised under Rule 504 to $5 million, eliminating Rule 505 (which was almost never used), and liberalizing Rule 506 by creating two tracks—one for private offerings and one for offerings using public (general) solicitations.
In addition to revising certain aspects of Regulation D, the 2020 amendments also addressed several other exemptions from registration. Among the more important is a revitalized Regulation A. After the adoption of Regulation D in the 1980s, the cumbersome, expensive and slow process under Regulation A was mostly abandoned by issuers. Regulation A was revised in 2015, in response to Congress’ direction in the JOBS Act of 2012. While still more complex and difficult to comply with than Regulation D, the 2015 revised Regulation A (commonly referred to as “Reg A+”) allows public offerings of securities in two tiers. These tiers are distinguished by differences in dollar limits, method of offering and limits placed upon non-accredited investors participating in the offering.
One of the intricacies of the dollar limits of Regulation D Offerings and Reg A+ offerings is a concept referred to by the SEC as “integration.” The concept behind integration is to provide rules for determining when an offering is deemed started and stopped and only include toward the dollar limits those sales that occur as a part of that offering. The problem is what to do with sales of securities that occur on the shoulders of an exempt offering. Under Regulations A and D (before the 2020 amendments), sales not technically part of a Regulation A or D offering could be treated as part of the offering (“integrated”) if they occurred within six months before or after the dates of the offering (timing is not the only factor, but is an important one when considering integration).
In the 2020 amendments adopted by the SEC, the maximum dollar limit for a Rule 504 offering was increased from $5 million to $10 million. The dollar limit for Tier 1 Reg A+ offerings was increased to $22.5 million from $15 million, and for Tier 2 offerings to $75 million from $50 million. Furthermore, the period used for measuring the integration of offerings was shortened from six months to 30 days, but with certain limitations applicable when dealing with a mixture of offerings permitting general solicitations and those made on a private offering basis.
In addition to the foregoing, the SEC revised certain disclosure requirements for Regulation D offerings. When non-accredited investors are offered securities in a Regulation D offering, there are specified disclosures that must be made, including certain financial information that must be disclosed. Specific details of what must be disclosed varied depending upon the size of the offering. The disclosures under these Regulation D offerings were different from those required under Reg A+, and in some circumstances, more burdensome. In the 2020 amendments, the SEC “aligned” the disclosure required under Regulation D to match that of Regulation A.
In addition to these changes to Reg A+ and Regulation D, other changes were made to less common exemptions and securities activities.
- New Rule 241 permits an issuer to use generic solicitation of interest materials to “test-the-waters” for an exempt offering before determining the offering exemption it will use. However, until the issuer determines which exemption it will use and the offering is commenced, no money may be solicited or accepted from investors.
- In addition, under Rule 241, subject to certain limitations, an issuer may solicit indications of interest in an exempt offering orally or in writing before determining the exemption upon which it will rely.
- New Rule 206 allows an issuer using Regulation CF (the “crowdfunding” rule) to “test-the-waters” before filing an offering document with the SEC, in a manner similar to “testing-the-waters” communications permitted in advance of a potential Reg A+ offering.
- In addition, under Regulation CF, an issuer is permitted to communicate orally with prospective investors after Form C has been filed with the SEC, so long as the oral communications comply with the requirements of Regulation CF.
With these changes, the SEC has enhanced the existing exemptions available to issuers and made the raising of capital a less burdensome process.
