Calfee, Halter & Griswold LLPSEC Expands Small Business Capital Formation Opportunities Through Intrastate and Small Offering Exemptions

November 8, 2016

With the objective of facilitating capital formation by smaller companies, on October 26, 2016, the U.S. Securities and Exchange Commission (SEC) amended and adopted rules under the federal Securities Act of 1933 (the Securities Act) to create a new “intrastate” offering exemption from registration requirements of the Securities Act, and to significantly increase the amount of securities that may be offered and sold under an existing limited offering exemption. Also, with an eye to assisting issuers making offerings in reliance upon intrastate equity crowdfunding provisions in state securities laws, the SEC modernized Rule 147, which is the existing “safe harbor” for assuring the availability of the federal intrastate offering exemption that acts as the common predicate for intrastate crowdfunding.

The new federal intrastate offering exemption, adopted by the SEC administratively as Rule 147A under the Securities Act, eliminates several restrictions that historically limited the utility of the statutory federal intrastate offering exemption in section 3(a)(11) of the Securities Act, which exempts offers and sales of securities made solely to persons resident within a single state or territory by an issuer resident and doing business within that state or territory. Such restrictions, for example, permit only in-state “offers” of securities, and thus preclude issuers from utilizing a publicly-available website, or social media, to reach potential investors. That and other restrictions remain in place for issuers who choose to rely on the existing Rule 147 safe harbor to assure a section 3(a)(11) compliant intrastate offering. Existing Rule 147 is retained, although modernized to some extent by the October 26, 2016 SEC rulemaking. Its retention, however, includes the retention of the significant restrictions mentioned above that have historically impacted its utility. New Rule 147A, on the other hand, is a separate, free-standing federal intrastate offering exemption adopted by the SEC pursuant to its general authority under the Securities Act to administratively create an exemption from any provision of the Securities Act.

Among other things, the new exemption permits multi-state offers, requiring only that all sales of the securities be made to in-state residents. It also allows issuers to be incorporated or organized outside the state in which an intrastate offering is conducted, depending on the nature of the issuer's activities within that state. The October 26, 2016 rulemaking also addressed the limited offering exemption provided by Rule 504 of Regulation D under the Securities Act. As one of the series of rules comprising Regulation D, Rule 504 established an exemption from Securities Act registration requirements for offerings of an aggregate amount up to $1 million in any twelve-month period, made in compliance with certain conditions. By its actions on October 26, 2016, the SEC amended Rule 504 to increase the aggregate amount of securities that may be offered and sold during any twelve-month period to $5 million, subject to certain conditions, including newly-added “bad actor” disqualifications from participation in such offerings. By increasing the maximum offering amount for Rule 504 offerings, the SEC believes this will allow more small businesses to use the capital raising tool, and better satisfy the needs of these businesses for capital formation.

It also believes that the increased offering amount limit will further facilitate multi-state offerings. Rule 504 has no territorial restriction, and there are no investor restrictions or qualifications. Issuers may rely on it to conduct an offering in multiple states, and while Rule 504 offerings remain subject to state registration and qualification requirements in the absence of a state-level exemption, in the contemporary state securities regulation environment coordinated regional review of such offerings is available.

Overall, of course, the increase was seen primarily as facilitating capital formation by smaller businesses. Increasing the permitted amount of a Rule 504 offering to $5 million significantly diminished the utility of existing Rule 505 of Regulation D (which had provided an exemption for offerings not exceeding $5 million, subject to qualifying conditions that included limitations on purchasers). Rule 505 was rarely used, and was repealed as part of the October 26, 2016 rulemaking. These actions by the SEC represent further initiatives in the wake of the 2012 federal Jumpstart Our Business Start-Ups (JOBS) Act, and compliment post-JOBS Act initiatives by state legislatures and securities regulators to promote small business capital formation, including in particular offerings by small businesses relying on intrastate crowdfunding provisions now in place in many states. Effective dates for each of the actions taken by the SEC are keyed to publication of the action in the Federal Register. Amended Rule 147 and new Rule 147A will be effective 150 days after their publication. Amended Rule 504 will be effective 60 days after publication, and the repeal of Rule 505 will be effective 180 days after publication.

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