On June 18, 2019, the US Securities and Exchange Commission (SEC) issued a concept release1 soliciting "comment on possible ways to simplify, harmonize, and improve the exempt offering framework to promote capital formation and expand investment opportunities while maintaining appropriate investor protections." Under the Securities Act of 1933, as amended (Securities Act), every offer and sale of securities must be registered with the SEC unless an exemption from registration is available. In the concept release, the SEC specifically notes that the overall framework for exempt offerings has, particularly recently, changed significantly due to the introduction, expansion or revision of various registration exemptions.
The concept release does not contain specific rule proposals. Rather, the SEC is seeking public comment on whether there are:
- Ways to make the exemption framework more consistent, accessible and effective in application;
- Ways to simplify the complexity that now exists in the exempt offering framework;
- Gaps in the exempt offering framework that make it difficult for some companies to rely on an exemption from registration at key stages of their business cycle; and
- Ways to allow issuers to transition from exempt offering types to registered public offerings without undue friction or delay.
Many of the requests for comment focus on smaller issuers and whether the exempt offering framework works for them. The SEC identified 138 separate areas on which it is specifically asking for comment and many of those areas contain multiple sub-requests for information. Rather than comprehensively describing the matters under consideration, this Legal Update highlights some of the more interesting questions raised in the concept release. The comment period is expected to remain open through late September 2019.
Exempt offering framework generally
The concept release provides a helpful overview of the exempt offering framework generally and provides details on the background of many of the exemptions from Securities Act registration. The SEC also addresses the requirements for various exemptions, including how the requirements differ among those exemptions, as well as how those exemptions are being utilized.
The SEC asks a series of questions about the overall exempt offering framework. Areas where the SEC is seeking input on this topic include:
- Whether the existing framework provides appropriate options for different types of issuers to raise capital at key stages of their business cycles
- Whether the existing framework or the exemptions themselves are too complex either because of the number of exemptions or because of the way they are structured;
- Whether offers should be deregulated;
- How technology impacts decisions to rely on a specific exemption; and
- Whether more investors should be able to participate in exempt offerings.
Accredited investor definition
A person who qualifies as an accredited investor2 is eligible to participate in many exempt offerings that otherwise are generally not available to nonaccredited investors.3 The Dodd-Frank Wall Street Reform and Consumer Protection Act directed the SEC to, among other things, review the accredited investor definition as it relates to natural persons every four years to determine whether the definition should be revised for the protection of investors, in the public interest and in light of the economy.
Currently, natural persons are accredited investors if their income exceeds $200,000 in each of the two most recent years (or $300,000 in joint income with the person's spouse) and they reasonably expect to reach the same income level in the current year, or their net worth exceeds $1,000,000 (individually or jointly with a spouse) excluding the value of their primary residence. In addition, directors, executive officers and general partners of the issuer are accredited investors. The SEC last reviewed the definition in 2015. Areas where the SEC is seeking input on this topic include whether:
- The current definition should be retained;
- The financial thresholds should be adjusted;
- The definition of spouse should be expanded to include spousal equivalents; and
- Other measures of sophistication should be included that would allow a person to qualify as an accredited investor.
In addition, the SEC is seeking comment on whether revisions should be made to other aspects of the definition of accredited investor, including whether:
- Other entities should be eligible to qualify as accredited investors in addition to those enumerated in the existing rule; and
- The current $5,000,000 asset test should be replaced by an investments test.
Rule 506 of Regulation D
Section 4(a)(2) of the Securities Act exempts from the registration requirements "transactions by an issuer not involving any public offering." Whether any specific transaction involved a public offering was left to the interpretation of the courts and the SEC. In order to provide objective standards that issuers could rely on, the SEC adopted Rule 506 under Regulation D of the Securities Act, now Rule 506(b), as a nonexclusive "safe harbor" under Section 4(a)(2). Subsequently the SEC adopted Rule 506(c) as another non-exclusive "safe harbor" under Section 4(a)(2) that eliminates the prohibition on general solicitation, provided that all purchasers of the securities offered are accredited investors and the issuer takes reasonable steps to verify their accredited investor status. Areas where the SEC is seeking input on this topic include whether:
- Rules 506(b) and 506(c) should be combined into one exemption and, if so, what features of the existing rules should be retained;
- It is important to allow non-accredited investors to be able to participate in a Rule 506(b) offering;
- The information requirements of Regulation D should be aligned with those of other exempt offerings;
- The SEC should define general advertising and general solicitation;
- Investment limits should be added for nonaccredited investors; and
- Non-accredited investors should be allowed to participate in an offering that involves a general solicitation.
1 Available at https://www.sec.gov/rules/concept/2019/3310649.pdf
2 Various definitions of the term accredited investor are contained in Section 2(a)(15) of the Securities Act, as well as in Rule 215 and in Rule 501(a) of Regulation D, each promulgated under the Securities Act.
3 The term has other uses including in determining whether a company is required to register under Section 12(g) of the Exchange Act, who an emerging growth company can communicate with when it is "testing-the-waters" and which FINRA member firms must file private offering documents with FINRA.
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