Wednesday, November 2, 2016

Intrastate Offerings Made Easy

Last week, the Securities and Exchange Commission (the "SEC") made an important step towards facilitating intrastate securities offerings.  Up until now, the intrastate securities offerings had to rely on Section 3(a)(11) and Rule 147 that was developed by the SEC in 1974 as a safe harbor for Section 3(a)(11) exemption.  This federal level exemption applied to the securities offerings  to persons resident in a single state, provided that the issuer of such securities was formed in, was a resident of, and was doing business within, such state.  The exemption was not widely used because many companies are registered in Delaware even though they are doing business in other states.

The SEC "modernized" Rule 147 while keeping it consistent with the requirements of Section 3(a)(11) exemption.  The final rules can be found here. The issuer is still required to be incorporated or organized in that state, have its principal place of business there, and be doing business within that state.  Offerings can only be made to residents of that state or to those who the issuer reasonably believes are residents of that state.  Obtaining a written representation regarding the residency is not sufficient to establish a reasonable belief.  The SEC is leaving it up to the issuers to determine which verification method to use in addition to the representation.

Amended Rule 147 will vary from the new Rule 147A only in two provisions: Rule 147 limits offers to in-state residents (i.e., no general solicitation allowed here) and issuers must be formed in the state where they conduct the intrastate offering.

The new Rule 147A is not a safe harbor for exemption under Section 3(a)(11).  It is a separate exemption from Section 5 registration requirements.  It allows the use of general solicitation and advertising (for example, it will be permissible to announce the intrastate offering on the company's website and therefore make offers to out of state residents) so long as the following requirements are met:

  • The issuer is be resident of the state (has its principal place of business in that state).  Note that it is no longer required that the issuer be formed in that state, which will enable more companies to rely on intrastate offerings to raise capital.
  • The issuer is doing business within the state (need to satisfy one of the four well-defined tests).
  • As opposed to offers, the actual sales of securities can only made to residents of that state (same reasonable belief standard as in Rule 147)
  • There is a six month restriction on resale of securities into other states.

The ability to use a whole array of advertising options, including online advertising, in Rule 147A offerings will facilitate state-based crowdfunding offerings that rely heavily on online platforms.

If companies rely on either Rule 147 or 147A, they still need to comply with the state blue sky laws.  However, they do not need to file Form D with the SEC. Rule 147 or 147A do not impose any restriction with respect to "accredited" or "sophisticated" status of investors (but states may do so).  Investors will continue to count for the purposes of Section 12(g) (it requires the issuer to register its securities with the SEC if its assets exceed $10 million and that class of securities is held by either 2,000 persons or 500 non-accredited investors). Some investors (Tier 2 offerings and Regulation Crowdfunding) do not count towards the totals.

Additionally (and importantly), the SEC revised Rule 504 of Regulation D (another private placement exemption that is rarely used) to increase the offering limit from $1 million to $5 million and applied bad actor disqualification provisions of Rule 506(d) to Rule 504 offerings.  It also repealed Rule 505 of Regulation D.

Amended Rule 147 and the new Rule 147A will be effective at the end of March 2017 (150 days from the publication in the Federal Register), and the amendments to Rule 504 will be effective in about two months (60 days after the publication in the Federal Register).

In conclusion, I'd like to note that these are exciting changes that will lead to an increase in intrastate crowdfunding offerings.  There are already a number of existing exemptions that startups and small businesses can use to raise capital.  These include Rule 147 under Section 3(a)(11) (and soon the new Rule 147A), Section 4(a)(2) for "transactions by the issuer not involving a public offering", Regulation A, Section 4(a)(6) for the Regulation Crowdfunding offerings, and finally Rules 504, 505 (for a little while longer), 506(b) and 506(c) of Regulation D.  Each exemption has its own limitations, and an experienced legal counsel can help you find the best suitable exemption for your company.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

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