On June 18, 2019, the SEC issued a 211-page concept release and request for public comment on ways to simplify, harmonize, and improve the exempt (private) offering framework. The concept release seeks input on whether changes should be made to improve the consistency, accessibility, and effectiveness of the SEC’s exemptions for both companies and investors, including identifying potential overlap or gaps within the framework.
From a high level the SEC is seeking public comment on (i) whether the exemptive framework as a whole is effective for both companies and investors; (ii) ways to improve, harmonize and streamline the exemptions; (iii) whether there are gaps in the regulations making it difficult for smaller companies to raise capital; (iv) whether the limitations on who can invest and amounts that can be invested (i.e., accredited investor status) pose enough investor protection and conversely create undue obstacles to capital formation; (v) integration and transitioning from one offering exemption to another; (vi) the use of pooled investment funds as a source of private capital and access to those funds by retail investors; and (vii) secondary trading and re-sale exemptions. The comment period remains open for 90 days.
This blog discussed the concept release and my views and recommendations but does not get into the granular detail of each offering exemption discussed by the SEC, which will be the topic of a future blog.
Background; Current Exemption Framework
As I’ve written about many times, the Securities Act of 1933 (“Securities Act”) requires that every offer and sale of securities either be registered with the SEC or exempt from registration. The purpose of registration is to provide investors with full and fair disclosure of material information so that they are able to make their own informed investment and voting decisions.
In recent years the scope of exemptions has evolved stemming from the JOBS Act in 2012 which broke up Rule 506 into two exemptions – 506(b) and 506(c), created the current Regulation A/A+ and Regulation Crowdfunding; the FAST Act, which added Rule 4(a)(7) for re-sales to accredited investors and the Economic Growth Act which mandated certain changes to Regulation A and Rule 701 for employee stock option plans for private companies. Also relatively recently, the SEC eliminated the never-used Rule 505 and expanded the offering limits for Rule 504. However, despite all of these changes, until now, the SEC has not undertaken a comprehensive review of all exemptions and their interaction.
Offering exemptions are found in Sections 3 and 4 of the Securities Act. Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another). Section 4 contains all transactional exemptions including Section 4(a)(2), which is the statutory basis for Regulation D and its Rules 506(b) and 506(c). The requirements to rely on exemptions vary from the type of company making the offering (private or public, U.S. or not, investment companies…), the offering amount, manner of offering (solicitation allowable), bad actor rules, type of investor (accredited) and amount and type of disclosure required. In general the greater the ability to sell to non-accredited investors, the more offering requirements are imposed.
The SEC concept release includes this table of the most commonly used offering exemptions:
Type of Offering
within 12- month Period
SEC Filing Requirements
Restrictions on Resale
State Registration and Qualification
|Section 4(a)(2)||None||No||None||Transactions by an issuer not involving any public offering. See SEC v. Ralston Purina Co.||None||Yes. Restricted securities||No|
|Rule 506(b) of Regulation D||None||No||“Bad actor” disqualifications apply||Unlimited accredited investors
Up to 35 sophisticated
but non-accredited investors
|Form D||Yes. Restricted securities||Yes|
|Rule 506(c) of Regulation D||None||Yes||“Bad actor” disqualifications apply||Unlimited accredited investors
Issuer must take reasonable steps to verify that all purchasers are accredited investors
|Form D||Yes. Restricted securities||Yes|
|Regulation A: Tier 1||$20 million||Permitted; before qualification, testing the waters permitted before and after the offering statement is filed||U.S. or Canadian issuers
Excludes blank check companies,25 registered investment companies, business development companies, issuers of certain securities, and certain issuers subject to a Section 12(j) order
“Bad actor” disqualifications apply
No asset-backed securities.
|None||Form 1-A, including two years of financial statements
|Regulation A: Tier 2||$50 million||Non-accredited investors are subject to investment limits based on annual income and net worth, unless securities will be listed
on a national securities exchange
|Form 1-A, including two years of audited financial statements
Annual, semi-annual, current, and exit reports
|Rule 504 of Regulation D||$5 million||Permitted in limited circumstances||Excludes blank check companies, Exchange Act reporting companies, and investment companies
“Bad actor” disqualifications apply
|None||Form D||Yes. Restricted securities except in limited circumstances||No|
|Intrastate: Section 3(a)(11)||No federal limit (generally, individual state limits between
$1 and $5 million)
|Offerees must be in- state residents.||In-state residents “doing business” and incorporated in-state; excludes registered investment companies||Offerees and purchasers must be in-state residents||None||Securities must come to rest with in-state residents||No|
|Intrastate: Rule 147||No federal limit (generally, individual state limits between
$1 and $5 million)
|Offerees must be in- state residents.||In-state residents “doing business” and incorporated in-state; excludes registered investment companies||Offerees and purchasers must be in-state residents||None||Yes. Resales must be within state for six months||No|
|Intrastate: Rule 147A||No federal limit (generally, individual state limits between
$1 and $5 million)
|Yes||In-state residents and “doing business” in-state; excludes registered investment companies||Purchasers must be in- state residents||None||Yes. Resales must be within state for six months||No|
|Regulation Crowdfunding; Section 4(a)(6)||$1.07 million||Permitted with limits on advertising after Form C is filed
Offering must be conducted on an internet platform through a registered
|Excludes non-U.S. issuers, blank check companies, Exchange Act reporting companies, and investment companies
“Bad actor” disqualifications apply
|Investment limits based on annual income and net worth||Form C, including two years of financial statements that are certified, reviewed or audited, as required
Progress and annual reports
|12-month resale limitations||Yes|
The concept release contains in-depth discussions on the most commonly used offering exemptions and on the definition of accredited investor, especially as it impacts offering exemptions. For more information on the accredited investor definition and the SEC’s December 2015 report and recommended changes, see HERE. For more information on Rule 504 and intrastate offerings, see HERE; on rule 506, see HERE; on Regulation A, see HERE; and on Regulation Crowdfunding, see HERE.
The concept release includes a lengthy discussion on the use of offering exemptions, the trillions of dollars raised each year in private offerings and the fact that the amounts raised privately continue to increase and surpass the amounts raised publicly during the same time periods. However, the SEC also lacks vital information to make a full assessment. Private offerings are “private” and unless a Form D is filed disclosing amounts raised, an 8-K/6-K filed where the company doing the raise is public, or other pubic disclosure the SEC has no source for information. Furthermore, it is most likely that the lack of information relates to small and emerging businesses.
As an initial inquiry, the SEC seeks comments on whether the existing exempt offering framework provides appropriate options for different types of companies to raise capital at key stages of their business cycle. Similarly, the SEC seeks comment on whether the exemptions address capital formation and investor protection in general and other high-level comments on each of the seven areas detailed in the introduction, including (i) whether the exemptive framework as a whole is effective for both companies and investors; (ii) ways to improve, harmonize and streamline the exemptions; (iii) whether there are gaps in the regulations making it difficult for smaller companies to raise capital; (iv) whether the limitations on who can invest and amounts that can be invested (i.e., accredited investor status) pose enough investor protection and conversely create undue obstacles to capital formation; (v) integration and transitioning from one offering exemption to another; (vi) the use of pooled investment funds as a source of private capital and access to those funds by retail investors; and (vii) secondary trading and re-sale exemptions.
Beyond that, the SEC is even unsure of what metrics it should be considering in its evaluations (should they be considering the cost of capital for a variety of companies?) and where the information can be obtained, and seeks public input on sources of credible information.
The SEC also seeks comments as to whether improvements in the offering exemptions would encourage companies to stay private longer. The SEC has been actively trying to improve the public market place and increase IPO’s over the past few years. In that regard, the SEC has made many changes including expanding the ability to file confidential registration statements (see HERE) and expanding test the waters communications (see HERE). However, at the same time, the public markets have become dramatically more difficult to access for emerging, smaller and middle market companies. Bank of America’s Merrill Lynch brokerage division has shut down transacting business with a large sector of these companies, citing the regulatory environment as the reason (see HERE).
Anyone that operates in the under $350 million market cap space knows that there is a strange dichotomy with the current regulatory regime – which, intended or not, feels anti-small business. SEC Commissioner Hester Peirce is steadily and consistently vocal in her views and understanding of these issues. Although I’ve written about some of these speeches and statements (see, for example, HERE), there are several others including an on-point discussion at the Heritage Foundation forum on June 25, 2019. Ms. Peirce noted that the current definition of an accredited investor is geographically discriminatory hurting small and emerging businesses in the U.S. that are not located in the highly populated, wealthier areas of the east and west coasts.
It is extremely difficult for small and emerging companies to raise capital and changes to the rules that will assist these companies should be pursued and encouraged. On that canvas, I find the question as to whether the SEC should be concerned that making private capital raises more accessible will discourage public offerings, incredibly frustrating.
Small businesses are job creators, generators of economic opportunity, and fundamental to the growth of the country. Small businesses account for the majority of net new jobs since the recession ended and are critical to the health and vitality of our country. In the absence of access to funding, small businesses cannot create new jobs, foster innovation, and develop into the next generation of publicly traded companies whose growth fuels Main Street investors’ retirement accounts. The SEC knows this; it has quoted the mantra many times, including in connection with the creation of its own new office, the Advocate for Small Business Capital Formation. All multifaceted large entities, whether they are a large and growing corporation or a regulator like the SEC, face challenges fostering competing goals (capital formation and investor protection) and ensuring the flow of information from different divisions and offices that are responsible for one goal over another (Advocate for Small Business Capital Formation and Enforcement).
In my view, in its efforts to protect Main Street Investors and combat micro-cap fraud, the SEC has inadvertently hampered and damaged the under-$350-million micro-cap class of company and one way to move the needle in the right direction is through exempt offering structure reform.
I advocate for (i) an expansion of the definition of “accredited investor” to take into account characteristics other than an individual’s wealth (see HERE); (ii) allow for investors to “opt-in” to accredited status after receiving disclosure including related to risks; (iii) allow for broader issuer communication to investors and potential investors through social media and other internet-based platforms; (iv) combine Rules 506(b) and 506(c) to allow for general solicitation and advertising across the board and investments by an unlimited number of non-accredited investors as long as certain disclosures are provided; (v) allow for the payment of finder’s fees subject to certain investor protections (see my views HERE); and (vi) expand the ability for non-accredited investors to invest in all exempt offerings subject to investment amount limitations.
Laura Anthony, Esq.
Anthony L.G., PLLC
A Corporate Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including sitting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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