SEC Adopts Final Rule Amendments to Facilitate Intrastate and Regional Securities Offerings | Practical Law

SEC Adopts Final Rule Amendments to Facilitate Intrastate and Regional Securities Offerings | Practical Law

The SEC adopted amendments to modernize the existing Rule 147 safe harbor under Section 3(a)(11) of the Securities Act (the intrastate offering exemption) and created Rule 147A, a new intrastate offering exemption. The SEC also adopted amendments to Rule 504 of Regulation D and repealed Rule 505 of Regulation D, each under the Securities Act.

SEC Adopts Final Rule Amendments to Facilitate Intrastate and Regional Securities Offerings

by Practical Law Corporate & Securities
Published on 27 Oct 2016 • USA (National/Federal)
The SEC adopted amendments to modernize the existing Rule 147 safe harbor under Section 3(a)(11) of the Securities Act (the intrastate offering exemption) and created Rule 147A, a new intrastate offering exemption. The SEC also adopted amendments to Rule 504 of Regulation D and repealed Rule 505 of Regulation D, each under the Securities Act.
On October 26, 2016, the SEC adopted final rule amendments to Rule 147 under the Securities Act and Rule 504 of Regulation D to modernize the exemptions for intrastate and regional securities offerings. The amendments are intended to better facilitate smaller companies' capital raising efforts, including through offerings relying on intrastate crowdfunding provisions under state blue sky laws (see Implications for Intrastate Crowdfunding).
The final rule amendments:
  • Expand the existing Rule 147 safe harbor under Section 3(a)(11) of the Securities Act (see Amendments to Rule 147).
  • Establish Rule 147A under the Securities Act, a new intrastate offering exemption (see New Rule 147A).
  • Increase the amount of securities that may be offered and sold under Rule 504 in any 12-month period from $1 million to $5 million (see Amendments to Rule 504).
  • Disqualify bad actors from participation in Rule 504 offerings (see Amendments to Rule 504).
  • Repeal Rule 505 of Regulation D.
Last year, on October 30, 2015, the SEC announced proposed rule amendments to Rule 147 and Rule 504 (see Legal Update, SEC Proposes Rule Amendments to Facilitate Intrastate and Regional Securities Offerings). The final rule amendments are substantially the same as the proposed rule amendments except that the SEC decided to retain and modernize the existing Rule 147 safe harbor under Section 3(a)(11), which will be identical to the new exemption created by Rule 147A except that issuers relying on the Rule 147 safe harbor:
  • May not offer securities to out-of-state residents.
  • Must be incorporated or organized in the state in which the offering is conducted.
Amended Rule 147 and new Rule 147A will become effective 150 days after publication in the Federal Register. Amended Rule 504 will become effective 60 days after publication in the Federal Register. The repeal of Rule 505 will become effective 180 days after publication in the Federal Register.
The SEC is accepting comments regarding the collection of information requirements within the meaning of the Paperwork Reduction Act of 1995 until 60 days after publication in the Federal Register.
Update: On November 21, 2016, the final rules were published in the Federal Register. The rules take effect as follows:
  • Amended Rule 147 and new Rule 147A will be effective on April 20, 2017.
  • Amended Rule 504 will be effective on January 20, 2017.
  • The repeal of Rule 505 will be effective on May 22, 2017.
  • All other amendments will be effective on May 22, 2017.

Amendments to Rule 147

Existing Rule 147 provides a safe harbor for intrastate offerings exempt from registration under Section 3(a)(11) of the Securities Act. The final amendments to the Rule 147 safe harbor have substantially liberalized the safe harbor and include the following provisions:
  • Consistent with existing Rule 147, the issuer must be organized and have its "principal place of business" in the state where the securities are offered and sold (see Principal Place of Business).
  • Consistent with existing Rule 147, general advertising and general solicitation to market the securities are allowed only within the state where the securities are offered and sold, and there is no limit on the amount of securities that may be sold under the safe harbor.
  • The issuer must satisfy at least one of four threshold requirements demonstrating the in-state nature of the issuer's business (see Threshold Requirements for Issuers). Existing Rule 147 had a significantly more restrictive test for demonstrating that an issuer was "doing business" in-state.
  • Issuers may rely on a new "reasonable belief" standard with respect to the residence of the purchaser at the time of the sale of securities (see Reasonable Belief as to Purchaser Residency Status).
  • Issuers must obtain a written representation from each purchaser as to the purchaser's residency (see Residence of Purchasers).
  • Resales to persons residing within the state of the offering are restricted for a period of six months (reduced from nine months under existing Rule 147) from the date of the sale by the issuer to the original purchaser under the exemption (see Limitation on Resales).
  • Certain disclosures, including securities legends, must be provided to offerees and purchasers regarding the limits on resales and other matters (see Disclosure Requirements).
  • An integration safe harbor includes any prior offers or sales of securities by the issuer, as well as certain subsequent offers or sales occurring after the completion of the offering (see Integration Safe Harbor).
Based on feedback from commenters, the SEC decided not to include additional limitations on the types of intrastate offerings that satisfy the safe harbor, deferring to state regulators to include any additional limitations. Proposed provisions that were removed from the final rule amendments would have required that an offering under Rule 147 be either:
  • Registered in the state in which all of the purchasers are resident.
  • Conducted under an exemption from state law registration in a state that limits the amount of securities an issuer may sell under the exemption to no more than $5 million in a 12-month period and imposes an investment limitation on investors.

Principal Place of Business

An issuer's principal place of business is defined as the location in which the officers, partners, or managers of the issuer primarily direct, control, and coordinate the activities of the issuer. An issuer may have a principal place of business only within a single state or territory. Issuers that change their principal place of business after making sales in an intrastate offering under amended Rule 147 will not be allowed to conduct an intrastate offering under Rule 147 in another state for a period of six months from the date of the last sale in the prior state (the proposed rules restricted issuers for a nine-month period).

Threshold Requirements for Issuers

In addition to the requirement that an issuer be incorporated or organized and have its principal place of business in the state where it offers or sells securities under Rule 147, under the final amendments, an issuer is also required to meet at least one of the following requirements to demonstrate that the issuer's business is sufficiently intrastate:
  • The issuer derived at least 80% of its consolidated gross revenues from the operation of a business or of real property located in or from the rendering of services within the state or territory.
  • At the end of its most recent semi-annual fiscal period prior to the first offer of securities under the exemption, the issuer had at least 80% of its consolidated assets located within the state or territory.
  • The issuer intends to use and uses at least 80% of the net proceeds to the issuer from sales made under the exemption in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services within the state or territory.
  • A majority of the issuer's employees are based in the state or territory.
Existing Rule 147(c)(2) contains more restrictive requirements to demonstrate that an issuer is doing business predominantly in-state.

Reasonable Belief as to Purchaser Residency Status

Under amended Rule 147, an issuer can satisfy the requirement that each purchaser in the offering be a resident of the same state or territory in which the issuer conducts the offering if:
  • The purchaser is, in fact, a resident of the state or territory.
  • The issuer can establish that it had a reasonable belief that the purchaser was a resident of the state or territory.
Whether an issuer formed a reasonable belief that the prospective purchaser was an in-state resident will be determined based on the facts and circumstances (similar to the analysis under Regulation D for determining accredited investor status). These facts and circumstances could include:
  • A pre-existing relationship between the issuer and the prospective purchaser that provides the issuer with sufficient insight and knowledge about the prospective purchaser's primary residence.
  • Evidence of the prospective purchaser's home address on a recent utility bill, pay stub, state or federal tax return, or on any state-issued document, such as a driver's license or identification card.
This new reasonable belief standard is a significant liberalization of existing Rule 147, under which the safe harbor could be lost entirely if the issuer offered or sold securities to just one investor that was not in fact a resident of the issuer's state, regardless of the efforts the issuer took to determine that potential investors were residents of that state.

Residence of Purchasers

Under amended Rule 147, issuers must obtain a written representation from each purchaser as to the purchaser's residency. The proposed rule amendments had suggested removing this requirement, but the SEC was persuaded by commenters to retain it and consider it evidence of (though not dispositive of) a purchaser's residence under the new reasonable belief standard. Obtaining a written representation from purchasers of in-state residency status will not, without more, be sufficient to establish a reasonable belief that those purchasers are in-state residents.
The residence of a purchaser that is a legal entity, such as a corporation, partnership, trust, or other form of business organization, is the location where, at the time of sale, the entity has its principal place of business. A legal entity's principal place of business is defined as the location in which the officers, partners, or managers of the entity primarily direct, control, and coordinate the activities of the entity.

Limitation on Resales

The final rule amendments changed the limitation on resales in Rule 147(e) to provide that resales of a security offered and sold in reliance on Rule 147 by a holder must be made only to residents of the state or territory in which the issuer was resident at the time of sale of the security by the issuer for a period of six months from the sale by the issuer to the original purchaser.
Amended Rule 147 also no longer conditions an issuer's ability to rely on Rule 147 on a purchaser's compliance with the limitation on resales in Rule 147(e) (as is currently the case).

Disclosure Requirements

The final rule amendments to Rule 147(f) require an issuer in a Rule 147 offering to include prominent disclosure on all offering materials used in connection with the offering stating that:
  • All sales will be made only to residents of the same state or territory as the issuer.
  • Offers and sales of the securities are made under an exemption from the registration requirements of the Securities Act.
  • For a period of six months from the date of sale by the issuer of the securities, any resale of the securities can only be made to persons resident in the same state or territory in which the issuer resided at the time of the initial sale.
Amended Rule 147 also requires issuers to include a prominent legend on all securities sold under the exemption informing purchasers of the resale restrictions under Rule 147(e). The legend will no longer be required to include disclosure regarding the issuer's obligations under Rule 147(f) to issue stop transfer instructions or new legended certificates during the resale period.

Integration Safe Harbor

Amended Rule 147(g) expands the scope of the existing integration safe harbor to make it consistent with Rule 251(c) of Regulation A, the SEC's most recently adopted integration safe harbor. Under the amendments, adopted substantially as proposed, offers and sales made under Rule 147 will not be integrated with:
  • Prior offers or sales of securities.
  • Subsequent offers or sales of securities that are:
    • registered under the Securities Act, except as provided in Rule 147(h) (as discussed in the following paragraph);
    • exempt from registration under Regulation A;
    • exempt from registration under Rule 701;
    • made under an employee benefit plan;
    • exempt from registration under Regulation S;
    • exempt from registration under Section 4(a)(6) of the Securities Act (the crowdfunding exemption); or
    • made more than six months after the completion of the offering.
Under the final amendments, Rule 147(h) provides that, where an issuer decides to register an offering after making offers in reliance on Rule 147 limited only to qualified institutional buyers (QIBs) and institutional accredited investors (IAIs), the offers will not be subject to integration with any subsequent registered offering. If the issuer makes offers in reliance on Rule 147 to persons other than QIBs or IAIs, the offers will not be subject to integration if the issuer (and any underwriter, broker, dealer, or agent used by the issuer in connection with the offering) waits at least 30 calendar days between the last offer made in reliance on Rule 147 and the filing of the registration statement.
A Rule 147 offering will not be integrated with another exempt offering made concurrently by the issuer as long as each offering complies with the requirements of the exemption that the issuer relies on for the particular offering.
If the integration safe harbor does not apply, whether subsequent offers and sales would be integrated with any securities offered or sold under Rule 147 will depend on the particular facts and circumstances.
For more information on integration, see Practice Note, Multiple Offerings: Dealing With Integration.

New Rule 147A

The SEC has created a new intrastate offering exemption in Rule 147A using its general exemptive authority under Section 28 of the Securities Act. The requirements of Rule 147A are substantially identical to the requirements of the amended Rule 147 safe harbor under Section 3(a)(11) of the Securities Act except as follows:
  • Issuers may be incorporated or organized outside of the state in which they conduct an offering under Rule 147A, provided their principal place of business is in the state and they otherwise comply with the requirements of Rule 147A. For example, a Delaware corporation or LLC that has its principal place of business outside the state of Delaware may be able to rely on Rule 147A to conduct an offering in the state where the issuer resides but would still not satisfy the requirements of amended Rule 147.
  • Issuers relying on Rule 147A may make offers accessible to out-of-state residents (through general solicitation or general advertising on the internet, for example), so long as sales are limited to in-state residents. Amended Rule 147 requires that issuers make offers and sales only to in-state residents.

Amendments to Rule 504

Rule 504 of Regulation D currently provides certain issuers with a safe harbor from registration for offers and sales of up to $1 million of securities in a 12-month period. The final rule amendments increase the amount of securities that may be offered and sold in any 12-month period from $1 million to $5 million, which is the maximum statutorily allowed under Section 3(b)(1) of the Securities Act.
In addition, the final rule amendments disqualify certain "bad actors" from participation in Rule 504 offerings. The disqualification provisions will be implemented by reference to the disqualification provisions set out in Rule 506(d) of Regulation D (see Practice Note, Section 4(a)(2) and Regulation D Private Placements: Bad Actors Disqualified from Relying on Safe Harbor).
In light of the proposed changes to Rule 504, the SEC has decided to repeal Rule 505 of Regulation D.

Implications for Intrastate Crowdfunding

The impetus for modernizing Rule 147 and Rule 504 was to facilitate intrastate crowdfunding offerings. Most state crowdfunding statutes that state legislatures have passed to date explicitly relied on Section 3(a)(11) of the Securities Act and the existing Rule 147 safe harbor for their exemption from the registration requirements of the Securities Act. A minority of states structured their blue sky crowdfunding exemptions using Rule 504.
Existing Rule 147, because of its restriction on offering securities to out-of-state residents, precluded the ability of issuers to use the internet to market their offerings (a key component of crowdfunding). Due to the constraints of the SEC's statutory interpretation of Section 3(a)(11), amended Rule 147 likewise precludes issuers from making offers (as broadly interpreted by the SEC) to out-of-state residents. For many states that have crowdfunding statutes relying on Section 3(a)(11) and Rule 147, the amendments to Rule 147 (while welcome) likely do not go far enough to allow them to avoid the need to amend their crowdfunding statutes to allow issuers to use the new exemption under Rule 147A.
Proponents of intrastate crowdfunding had also hoped that the SEC would exclude securities issued in intrastate or regional crowdfunding offerings under Rules 147, 147A, and 504 when calculating the record holders for purposes of Section 12(g) of the Exchange Act (as it had done in the context of Regulation Crowdfunding and Tier 2 of Regulation A). The SEC declined to do so, citing the lack of ongoing reporting requirements as the primary factor in its analysis. As a result, intrastate crowdfunding issuers may need to limit the number of crowdfunding investors that become shareholders or risk becoming subject to Exchange Act reporting requirements once their total assets exceed $10 million. For more information on Section 12(g) of the Exchange Act, see Practice Note, Exchange Act Registration: Overview.