By Katherine Blair, Thomas Poletti and Jonathan Brecher

Law360 (May 4, 2020, 7:01 PM EDT )

Katherine Blair

Thomas Poletti

Jonathan Brecher

On March 4, the U.S. Securities and Exchange Commission proposed rules to expand and simplify certain aspects of exempt offerings with the goal of expanding access to capital for issuers and increasing opportunities for investors.

In light of the economic challenges posed by the coronavirus pandemic and the effect on the capital markets, it appears the SEC's proposed rules are fortuitously coming at the right time.

The proposed rules in SEC Release No. 33-10763 are designed to make offerings more accessible for companies and investors and easier and simpler for everyone. SEC Chairman Jay Clayton said it best:


This is not the first time Congress has attempted to simplify the capital-raising process in response to economic uncertainties. To address the recession and also counteract the drastic decrease in public offering and, generally, capital raising activities, in 2012, Congress passed the Jumpstart Our Business Startups, or JOBS, Act.

Then the Fixing America's Surface Transportation, or FAST, Act of 2015, and the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 were enacted.

The resulting regulations of these acts started opening the gates so that more companies could have easier access to the capital markets — both public and private. General solicitation is permitted under Regulation D, Regulation A was updated to become Reg A+, crowdfunding was launched, and many public offering rules were simplified.

The current proposed rules generally address:

• Clarifying integration analyses;
• Simplifying offering communication;
• Increasing exempt offering limits; and
• Harmonizing various exempt offering A requirements with registered offering requirements.

These proposed rules are a step in the right direction as they are designed to increase the stream of money flowing in the market by expanding the use of private capital markets.

Integration

Integration analysis has historically been difficult to navigate; if separate offerings are integrated, the issuer loses the available exemption from registration, which can be disastrous to issuers and investors. Currently, integration requires analysis of five factors, and if the offerings are deemed integrated, then each offering must comply with the offering exemption or registration requirements of the other offerings.[1]

As summarized in the table below, the SEC proposes a general principle and four nonexclusive safe harbors that would replace the traditional five-factor test. The best part of the safe harbors is that they provide guidance on the meaning of "terminated or completed."

We all appreciate certainty. Since the opening of general solicitation to crowdfunding, it seems that companies are seeking capital in a variety of ways and if not sequentially, then simultaneously. Although the proposed integration rules somewhat codify existing guidance, they at least provide more certainty.

This certainty could allow companies, especially smaller companies, to seamlessly move from one type of offering to the next without having to determine whether both offerings would be a violation as a result of integration issues. Even during these uncertain economic times and the days following, having clarity on integration can only help.

General Principle	If offerings are not covered by any of the four safe harbors, then offerings would nonetheless not be integrated if it can be established that each offering complied with either registration requirements or an offering exemption based on whether or not the offerings permit general solicitation.
30-Day Safe Harbor	Any offering made more than 30 calendar days before the commencement or more than 30 calendar days after the termination or completion of any other offering would not be integrated. Plus, for offerings not using general solicitation, purchasers either were not solicited through the use of general solicitation or there was a prior substantive relationship.
Rule 701/ Reg S	Rule 701 offerings (pursuant to employee benefit plans) and Regulation S offerings (offerings outside the United States) would not be integrated with other offerings.
Registered Offerings	A registered offering would not be integrated if made subsequent to (1) a terminated or completed offering for which general solicitation is not permitted; (2) a terminated or completed offering for which general solicitation is permitted and made only to qualified institutional buyers and institutional accredited investors; or (3) an offering for which general solicitation was used and that terminated or completed more than 30 calendar days prior to the commencement of the registered offering.
General Solicitation Offerings	General solicitation offerings would not be integrated if made subsequent to any prior terminated or completed offering.

Offering Communications

Communications before or while conducting an offering can be full of landmines. The proposed rules on offering communications settles some issues that have been lingering since general solicitation was permitted and provide more flexibility.

First, the examples of general solicitation are proposed to be expanded to include present-day communications, such as emails and text messages, and information sharing about companies by angel investors.

Second, demo day communications — presentations to angel groups, etc. — would not be deemed general solicitation as long as certain conditions are satisfied, such as no charging of fees to attendees or for introductions, making investment recommendations, or engaging in negotiations. Plus, information in the notice of the event would be limited.[2]

Third, oral communications in crowdfunding offerings would be permitted; currently, an issuer is prohibited from advertising an offering outside the intermediary's platform except for a notice with certain information.

Fourth, issuers would be permitted to solicit indications of interest (i.e., test the waters) in an exempt offering orally or in writing, without limiting it to qualified institutional buyers and institutional accredited investors) prior to determining which exemption, or whether the offering would be under Reg A or Reg CF, it would rely on to conduct the offering.

Of course, the SEC cautions that if soliciting generic indications of interest is done in a manner that would constitute general solicitation, and the issuer ultimately decides to conduct an exempt offering that does not permit general solicitation, the issuer would need to analyze whether the generally solicited offer and the subsequent private offering could be integrated.[3]

These are all common-sense solutions to communication issues that companies and their lawyers have been dealing with over the years. These rule changes would not necessarily increase the number of offerings a company could conduct, but it loosens the constraints on communications and provides certainty, which could make it easier to navigate an offering.

Increase Offering Maximums

The SEC has proposed to increase maximum offering amounts for Rule 504, Reg CF and Reg A offerings.

• Rule 504/Reg D: Increase the maximum offering limit of $5 million to $10 million in a 12-month period.
  
  
• Crowdfunding: Increase the offering limit to $5 million with no investment limits for accredited investors, and nonaccredited would be allowed to rely on the greater of 10% of their annual income or net worth.[4]
  
  
• Reg A/Tier 2: Raise the maximum offering amount from $50 million to $75 million.

Increasing the maximum offering limits seems to be a case of "If you build it, they will come." In other words, if we raise the offering limits, then more companies will raise more capital. This may not necessarily be the case.

Even the SEC stated that as of the end of 2019, fewer than 30 issuers raised the maximum offering amount under crowdfunding. Maybe those issuers that were able to raise the current maximum amount of about $1 million will benefit, but if a company cannot raise that much, increasing the maximum amount will not necessarily mean they can raise more.

However, the SEC believes that "permitting larger offerings under Reg CF may encourage more issuers to use the exemption and additionally would lower the offering costs per dollar raised for issuers." Perhaps that's true. Perhaps issuers that were raising capital under Reg A, Tier I may move to crowdfunding, which unlike a Tier 1, Reg A offering, preempts state securities laws.

In any event, although it is questionable that raising the offering maximums will increase actual offerings, it at least provides issuers flexibility and can also allow issuers that are raising large amounts of capital to use forms of general solicitation without actually conducting traditional public offerings. This may be especially important given the current condition of the stock market.

Harmonize

The remaining proposed rules go in the category of clean up and harmonize. For example, Reg CF would permit the use of certain special purpose vehicles, which are currently ineligible, to facilitate investing in Reg CF issuers, or crowdfunding vehicles.

Reg A would permit issuers that are delinquent in their Exchange Act reporting obligations exclude — in addition to those that file Reg A reports — in the prior two years.

Financial statement information for Reg D offerings would be generally the same as for Reg A offerings, which are not as burdensome, and Reg A offerings would be harmonized with traditional registered offerings by having some of the same filing benefits.

Overall, the proposed rules to expand and simplify exempt offerings would be beneficial to issuers and the capital markets. Comments to the proposed rules are currently due June 1, and as of the issuance of this article, the date has not been extended. Perhaps the SEC will fast-track the adoption of these rules given the unexpected and sudden deterioration of the market.

We don't know if it would help, but it certainly would not hurt.

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Katherine Blair and Thomas Poletti are partners, and Jonathan Brecher is an associate, at Manatt Phelps & Phillips LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] The five factors of integration analysis are whether (1) the different offerings are part of a single plan of financing, (2) the offerings involve issuance of the same class of security, (3) the offerings are made at or about the same time, (4) the same type of consideration is to be received, and (5) the offerings are made for the same general purpose. Adding to this complexity are overlaying no-action letters that allow for offerings among qualified institutional buyers (as defined in Rule 144A of the Securities Act) and institutional accredited investors notwithstanding failure of the five-factor test.

[2] Advertising for the event would be limited to (1) notification that the issuer is in the process of offering or planning to offer securities, (2) the type and amount of securities being offered, and (3) the intended use of the proceeds of the offering.

[3] Integration sneaks up on us again!

[4] Reg CF currently provides for an offering limit of $1.07 million during a 12-month period and limits the amount individual investors are allowed to invest during a 12-month period to (1) the greater of $2,200 or 5% of the lesser of the investor's annual income or net worth, if either of an investor's annual income or net worth is less than $107,000; or (2) 10% of the lesser of their annual income or net worth, if both annual income and net worth are equal to or more than $107,000.

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