The Securities and Exchange Commission has adopted final rules that modernize how companies can raise capital through intrastate and small offerings, while attempting to balance those efforts with investor protections.
The final rules amend Securities Act Rule 147 to modernize an existing safe harbor so issuers may continue to use state law exemptions. The final rules also establish a new intrastate offering exemption, Securities Act Rule 147A. It would be substantially identical to Rule 147 except that it would allow offers to be accessible to out-of-state residents and for companies to be incorporated or organized out-of-state.
To facilitate capital formation through regional offerings, the final rules also amend Rule 504 of Regulation D under the Securities Act to increase the aggregate amount of securities that may be offered and sold from $1 million to $5 million. The rules also apply bad actor disqualifications to Rule 504 offerings to provide additional investor protection.
“Over the last few years, the Commission has adopted several important new rules to facilitate capital raising by smaller issuers, including new provisions for federal crowdfunding and enhanced Regulation A offerings,” Chairman Mary Jo White said prior to the Commission’s vote. “The rules have given companies new options for funding their businesses within a strong framework of investor safeguards. During this time, many state securities regulators have been working to update their regulatory structures to better accommodate how local offerings have evolved, including through crowdfunding and the use of modern information technology. The rules related to these intrastate offerings, however, have not been updated for decades, and do not sufficiently take into account how technology and business practices have changed.”
The adoption of new Rule 147A and the amendments to Rule 147 would update and modernize the existing intrastate offering framework that permits companies to raise money from investors within their state without concurrently registering the offers and sales at the federal level.
Amended Rule 147 would remain a safe harbor so that issuers may continue to use the rule for securities offerings relying on current state law exemptions. Both new Rule 147A and amended Rule 147 would include the following provisions:
A requirement that the issuer has its “principal place of business” in-state and satisfies at least one “doing business” requirement that would demonstrate the in-state nature of the issuer’s business
A new “reasonable belief” standard for issuers to rely on in determining the residence of the purchaser at the time of the sale of securities
A requirement that issuers obtain a written representation from each purchaser as to residency
A limit on resales to persons residing within the state or territory of the offering for a period of six months from the date of the sale by the issuer to the purchaser
An integration safe harbor that would include any prior offers or sales of securities by the issuer made under another provision, as well as certain subsequent offers or sales of securities by the issuer occurring after the completion of the offering.
Legend requirements to offerees and purchasers about the limits on resales
“Most significantly, the new exemption from registration under the federal securities laws for local and regional offerings eliminates an existing restriction on offers that has been outmoded by the tremendous expansion of internet communications,” White said. “While previously required to be confined to the state of the issuer, offerings will now be accessible by out-of-state residents through the Internet or otherwise, so long as—and this is a key investor protection—sales are made only to residents of the state or territory of the issuer’s principal place of business.”
Issuers using the exemption will need to demonstrate a meaningful presence in the state of the offering, a critical safeguard for ensuring that the offerings are of a local nature.
White said she has directed Commission staff to continue to collaborate with state regulators to consider, among other things, data on the use of the new and amended rules and on the application of state bad actor disqualification provisions in intrastate crowdfunding offerings.
Neverthleless, Commissioner Kara Stein expressed concern about how the rule changes might affect investor protections.
“Like other experimental capital-raising rules, such as Regulation A+ and Regulation Crowdfunding, only time will tell how well the theory works in practice,” she said. “Only time will tell whether we can relax capital-raising regulations, while also maintaining appropriate investor protections. So, while today’s rules may provide smaller companies with additional funding opportunities, they also raise some investor protection concerns.”
For example, amended rule 147 and the new exemption under 147A do not contain a bad actor provision. S”uch bad actor disqualifications are a fundamental part of the new offering exemptions we have instituted under Regulation A, Regulation Crowdfunding, and Regulation D,” she said. “These provisions serve as a check before an offering ever commences. They prohibit people who have committed fraud or engaged in other serious misconduct from being involved in an offering of securities pursuant to these exemptions from registration. “
The North American Securities Administrators Association, which represents state regulators, specifically requested that bad actor disqualifications be included in these rules, Stein explained. While a majority of states and territories have some version of bad actor provisions, some states have not yet enacted similar disqualifications. “Allowing bad actors to participate in such offerings not only undermines investor confidence, but also harms legitimate companies attempting to use these rules to raise capital,” she said. I supported and requested the inclusion of bad actor disqualifications in amended rule 147 and the new 147A for these reasons. Such provisions would serve as a floor for states, which they could choose to raise with state-specific bad actor disqualifications. Unfortunately, a majority of the Commission did not support this view.”
Stein also expressed concern that, unlike the proposed rule, the final rules do not contain a maximum offering limit, not dothey do not provide a cap on the amount a single investor may contribute.
The newly approved amendments to Rule 504 and Regulation D offerings would retain the existing framework, while increasing the aggregate amount of securities that may be offered and sold under Rule 504 in any 12-month period from $1 million to $5 million while disqualifying certain bad actors from participation in Rule 504 offerings. The final rules also would repeal Rule 505, which permits offerings of up to $5 million annually that must be sold solely to accredited investors or no more than 35 non-accredited investors.
Amended Rule 147 and new Rule 147A will be effective 150 days after publication in the Federal Register; amended Rule 504 will be effective 60 days after publication; and the repeal of Rule 505 will be effective 180 days after publication.