SEC Adopts Rules to Modernize and Streamline Exempt Offerings

On November 2, 2020, the Securities and Exchange Commission (the “SEC”) adopted amendments (the “Amendments”) to certain rules under the Securities Act of 1933, as amended (“Securities Act”) that are intended to, among other things, close gaps and reduce complexities in the exempt offering framework that may impede access to capital for issuers and thereby limit investment opportunities, while preserving or enhancing investor protections. The Amendments impact numerous types of exempt offerings, including offerings conducted under Regulation D and Regulation S. We highlight below certain of the Amendments that may be of particular interest to our clients that regularly conduct offerings under those exemptions. The Amendments will become effective 60 days after their publication in the Federal Register.

Background

Regulation D is a series of rules that provides several exemptions from the registration requirements of the Securities Act. Rule 506(b) of Regulation D is a non-exclusive safe harbor under Section 4(a)(2) of the Securities Act pursuant to which an issuer may offer and sell an unlimited amount of securities, provided that offers are made without the use of general solicitation or general advertising and sales are made only to accredited investors and up to 35 non-accredited investors who meet an investment sophistication standard. A second non-exclusive safe harbor, Rule 506(c) of Regulation D, is substantially the same as Rule 506(b) except that (1) offers may be made through general solicitation or general advertising and (2) all purchasers in the offering must be accredited investors and the issuer must take reasonable steps to verify their accredited investor status. Rule 506(c) provides a principles-based method for verification of accredited investor status, as well as a non-exclusive list of verification methods that issuers may use, but are not required to use, when seeking to satisfy the verification requirements with respect to natural persons. Offerings under both Rule 506(b) and Rule 506(c) must satisfy a number of other terms and conditions set forth in Regulation D, including the requirements in Rule 502(a) regarding integration (discussed below).

Regulation S provides a safe harbor from Securities Act registration for offers and sales that occur outside of the United States. Rule 903 of Regulation S requires, among other things, that (i) the offer or sale is made in an “offshore transaction,” and (ii) no “directed selling efforts” are made in the United States by the issuer, a distributor, any of their respective affiliates, or any person acting on behalf of any of the foregoing. “Directed selling efforts” is generally defined to mean any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States for any of the securities being offered in reliance on Regulation S.

Existing Rule 502(a) provides that “offers and sales that are made more than six months before the start of a Regulation D offering or are made more than six months after completion of a Regulation D offering will not be considered part of that Regulation D offering, so long as during those six month periods there are no offers or sales of securities by or for the issuer that are of the same or a similar class as those offered or sold under Regulation D….” Existing Rule 502(a) includes five factors to be considered in determining whether offers and sales should be integrated for purposes of the exemptions under Regulation D. In addition, in adopting Regulation S, the SEC stated that ‘‘[o]ffshore transactions made in compliance with Regulation S will not be integrated with registered domestic offerings or domestic offerings that satisfy the requirements for an exemption from registration under the Securities Act.” As described above, offerings exempt from Securities Act registration under Rule 506(b), Rule 506(c) and Regulation S must satisfy a number of terms and conditions, which differ depending on the exemption relied upon. If two offerings relying on different exemptions were to be integrated, the integrated offering may no longer be eligible for either exemption because the integrated offering may not satisfy the terms and conditions of either exemption.

Amendments to the Integration Framework

The Amendments include substantial changes to Rule 152, which will replace the current integration framework. New Rule 152(a) sets forth a general principle of integration, and new Rule 152(b) provides four new safe harbors from integration. The new rule includes an anti-evasion provision that states that the provisions of the rule will not have the effect of avoiding integration for any transaction or series of transactions that, although in technical compliance with the rule, is a part of a plan or scheme to evade the registration requirements of the Securities Act.

1. Integration Principles

The general principle of integration under new Rule 152(a) applies to all offers and sales of securities not covered by any of the four safe harbors set forth in new Rule 152(b). New Rule 152(a) provides that offers and sales will not be integrated if, based on the particular facts and circumstances, 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. This facts and circumstances analysis is a codification of the SEC’s prior guidance first provided in 2007 in the context of a simultaneous registered and private offering, and extends it to other contexts. New Rule 152 replaces the traditional five-factor test that appears in existing Rule 502(a), which has been amended to simply cross-reference new Rule 152. New Rule 152(a)(1) provides that for an exempt offering prohibiting general solicitation, offers and sales will not be integrated with other offerings if the issuer has a reasonable belief, based on the facts and circumstances, that with respect to each purchaser in the exempt offering prohibiting general solicitation, the issuer (or any person acting on the issuer’s behalf) either (i) did not solicit that purchaser using general solicitation or (ii) established a substantive relationship with that purchaser prior to the commencement of the offering. The Adopting Release states that under the integration principle in new Rule 152(a), an issuer may conduct concurrent offerings under Rule 506(b) and Rule 506(c) without integration concerns, so long as the provisions of new Rule 152(a)(1) and all other conditions of the applicable exemptions are satisfied. However, the Adopting Release cautions that a general solicitation permitted in connection with one offering that mentions the material terms of a concurrent or subsequent exempt offering prohibiting general solicitation may constitute an offer for the concurrent or subsequent exempt offering prohibiting general solicitation, and thereby violate the prohibition on general solicitation with respect to that concurrent or subsequent offering prohibiting general solicitation. As a result of this caution, in some circumstances, issuers may prefer to rely on a safe harbor in Rule 152(b) rather than the general language of Rule 152(a). In addition, the Adopting Release cautions that an issuer could not engage in general solicitation in an offering made in reliance on Rule 506(c) and then sell to investors in an offering made in reliance on Rule 506(b), unless either the issuer did not solicit the purchase in the Rule 506(b) offering through the use of the general solicitation used in the Rule 506(c) offering, or the issuer established a substantive relationship with such purchaser prior to the commencement of the Rule 506(b) offering.

2. Integration Safe Harbors

New Rule 152(b) sets forth the following four non-exclusive safe harbors from integration: (i) 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 such other offering; provided that, for an exempt offering for which general solicitation is not permitted that follows by 30 calendar days or more an offering that allows general solicitation, the provisions of Rule 152(a)(1) (discussed above) will apply, (ii) offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or Regulation S under the Securities Act, will not be integrated with other offerings, (iii) registered offerings made following terminated or completed offerings for which general solicitation is not permitted (or following certain terminated or completed offerings for which general solicitation is permitted) will not be integrated, and (iv) offers and sales made in reliance on an exemption for which general solicitation is permitted will not be integrated if made subsequent to any terminated or completed offering. We highlight certain aspects of the first two safe harbors and the fourth safe harbor below.

• 30-Day Safe Harbor. As mentioned above, existing Rule 502(a) provides a safe harbor from integration for offerings made outside of a six-month period. New Rule 152(b)(1) reduces this six-month period to provide that offerings made more than 30 calendar days apart will not be integrated, provided that for an exempt offering for which general solicitation is prohibited (e.g., a Rule 506(b) offering) that follows by 30 calendar days or more an offering that allows general solicitation (e.g., a Rule 506(c) offering), the provisions of Rule 152(a)(1) apply. That is, in such a fact pattern, the issuer must have a reasonable belief, based on the facts and circumstances, that with respect to each purchaser in the exempt offering prohibiting general solicitation (i.e., the Rule 506(b) offering), the issuer (or any person acting on its behalf) (i) did not solicit that purchaser using general solicitation or (ii) established a substantive relationship with that purchaser prior to the commencement of the offering. The SEC states in the Adopting Release that waiting less than 30 days after terminating or completing an offering before commencing a subsequent offering would not necessarily result in integration, provided that the terms and conditions of the general principle of integration in Rule 152(a) are met. The Amendments include new Rule 152(d), which provides that the termination of an offering is deemed to have occurred when the issuer and its agents cease efforts to make further offers to sell the issuer’s securities under such offering, and includes a non-exclusive list of factors that should be considered when an offering is deemed to be terminated or completed. New Rule 152(d) provides that an offering made in reliance on Regulation D will be deemed to be terminated or completed on the later of the date that (i) the issuer entered into a binding commitment to sell all securities to be sold under the offering (subject only to conditions outside of the investor’s control); or (ii) the issuer and its agents ceased efforts to make further offers to sell the issuer’s securities under such offering.
• Regulation S Safe Harbor. New Rule 152(b)(2) codifies the SEC’s long-standing position, mentioned above, that concurrent offshore offerings that are conducted in compliance with Regulation S are not currently, and will not be, integrated with registered domestic offerings or domestic offerings that are conducted in compliance with any exemption. The Adopting Release states that when determining the availability of this safe harbor, it will still be necessary to assess each transaction for compliance with Regulation S and the conditions of the other exemption. When proposing this safe harbor, the SEC had also proposed amendments to the definition of “directed selling efforts” in Rule 902(c) and proposed Rule 906 under Regulation S to address perceived concerns about whether it is possible to conduct concurrent Regulation S and Rule 506(c) offerings, particularly where the offerings are conducted using the internet, or whether the general solicitation activity in connection with the Rule 506(c) offering would be deemed “directed selling efforts” under current Rule 902(c) under Regulation S. However, citing commenters who asserted that the existing regulatory framework appropriately addresses such concerns and commenters who expressed concern that the proposed amendments would disrupt existing market practices, the SEC determined not to adopt those proposed amendments to Regulation S. However, to address perceived concerns of some commenters, the SEC states in the Adopting Release that it does not believe that general solicitation activity for exempt domestic offerings would preclude reliance on Regulation S for concurrent offshore offerings. The SEC also states that it is aware that issuers have conducted domestic exempt or registered offerings concurrently with a Regulation S offering under existing SEC guidance, and that compliance with the terms of both Regulation S and another applicable exemption, such as Rule 506(c), will depend on the facts and circumstances of a particular situation. The Adopting Release states that, for example, the use of the same website to solicit U.S. investors under Rule 506(c) and offshore investors under Regulation S could raise concerns about the issuer’s compliance with the prohibition on directed selling efforts in Regulation S because the offering material on the website could be deemed to have the effect of conditioning the market in the United States. In such situations, the Adopting Release states that an issuer can take certain steps to distinguish the Regulation S and domestic offering materials.
• Safe Harbor for Offers or Sales Preceding Exempt Offerings Permitting General Solicitation. New Rule 152(b)(4) provides a safe harbor for offers and sales made in reliance on an exemption for which general solicitation is permitted if such offers and sales are made subsequent to any terminated or completed offering. Importantly, the Adopting Release provides guidance that an issuer may rely on new Rule 152(b)(4) if, for example, it commenced an offering under Rule 506(b) and thereafter engages in general solicitation in reliance on Rule 506(c), so long as once the issuer engages in general solicitation, it relies on Rule 506(c) for all subsequent sales, thereby effectively terminating the Rule 506(b) offering, including by selling exclusively to accredited investors and taking reasonable steps to verify the accredited investor status of each purchaser. The Adopting Release states that the use of general solicitation in reliance on Rule 506(c) will not affect the exempt status of prior offers and sales of securities made in reliance on Rule 506(b). Further, it is not necessary for an issuer to use different offering materials for offerings that rely on different exemptions, so long as the issuer satisfies the disclosure and other requirements of each applicable exemption.

New Accredited Investor Verification Method

As discussed above, Rule 506(c) permits issuers to engage in general solicitation and advertisement provided that (i) all purchasers in the offering are accredited investors, (ii) the issuer takes reasonable steps to verify that purchasers are accredited investors, and (iii) certain other conditions in Regulation D are satisfied. Rule 506(c) provides a principles-based method for verification of accredited investor status, as well as a non-exclusive list of verification methods that issuers may use when seeking to satisfy the verification requirement with respect to natural persons. The Amendments include a new verification safe harbor that allows an issuer to establish that an investor for which the issuer previously took reasonable steps to verify as an accredited investor remains an accredited investor as of the time of a subsequent sale, if the investor provides a written representation to that effect and the issuer is not aware of information to the contrary. In a change from the proposed rule in response to commenter feedback, new Rule 506(c)(2)(ii)(E) includes a time limit on the ability of an issuer to rely on the earlier verification. As a result, a written representation under this method of verification will satisfy the issuer’s obligation to verify the person’s accredited investor status for a period of five years from the date the person was previously verified as an accredited investor.

Although the SEC did not adopt additional amendments to expand the list of verification methods, the Adopting Release reaffirms and updates the SEC’s prior guidance with respect to the principles-based method for accredited investor verification, and what may be considered “reasonable steps” to verify an investor’s accredited investor status, in order to reduce concerns that an issuer’s method of verification may be second guessed by regulators or other market participants without regard to the analysis performed by the issuer in making the determination, and to encourage more issuers to rely on additional verification methods tailored to their specific facts and circumstances. The Adopting Release states that the principles-based method is intended to provide issuers with significant flexibility in deciding the steps needed to verify a person’s accredited investor status and to avoid requiring them to follow uniform verification methods that may be ill-suited or unnecessary to a particular offering or purchaser in light of the facts and circumstances. Notably, the Adopting Release states that the SEC is of the view that in some circumstances, the “reasonable steps” determination may not be substantially different from an issuer’s development of a “reasonable belief” for Rule 506(b) purposes. As an example, the Adopting Release states that an issuer’s receipt of a representation from an investor as to his or her accredited status could meet the reasonable steps requirement if the issuer reasonably takes into consideration a prior substantive relationship with the investor, or other facts that make apparent the accredited status of the investor. The Adopting Release also states that the same representation may not meet the reasonable steps requirement if the issuer has no other information available to it about the investor, or has information that does not support the view that the investor was an accredited investor. The SEC cautions issuers that it continues to believe that an issuer will not be considered to have taken reasonable steps to verify accredited investor status if it, or those acting on its behalf, requires only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status.

The complete publication, including footnotes, is available here.