The SEC’s exempt private offerings rule to enhance small business capital raising efforts receives commissioner approval and dissent.
The SEC voted 3-2 to approve a final rule comprising a year-long 400-page proposal to harmonize 10 long-time exempt offering provisions, by relaxing certain restrictions on them to make the exemptions more available to small- and medium-sized businesses for capital raising purposes. Commission Chairman Jay Clayton cast the deciding vote for the final rule in the November 2, 2020 open meeting, which was also supported by Commissioners Hester Peirce and Elad Roisman but opposed by Commissioners Allison Herren Lee and Caroline Crenshaw.
Clayton’s opening and closing remarks. Opening remarks. Chairman Clayton, in his opening remarks, affirmatively stated that despite the naysayers, the exempt offering harmonization final rule will simultaneously accomplish all three of the following Commission objectives without having to trade one to achieve the others. The rule will namely: (1) modernize capital formation and market integration; (2) advance technology; and (3) reduce costs for small and medium sized businesses and their retail investors. Regarding objective (1), Clayton said that the final rule will not affect large companies in either the public or private markets and will not affect them whether their investment of choice is an equity or debt security. Clayton emphasized that the final rule is for small- and medium-sized business that historically have been barred from the public market because of their low investment capital and that, therefore, need to rely on the private market to realize investment opportunities. Unfortunately, the SEC’s private exempt offering rule has, overtime, become too complex for these smaller businesses to understand, rendering it near impossible for them raise capital in any market.
Regarding objective (2), Clayton stated the COVID-19 pandemic has forced the SEC to realize that it can no longer completely rely on the mail to communicate with issuers or investors but that recent-year technological advances at the Commission have facilitated faster electronic communication with investing parties to help them more quickly and easily accomplish their capital raising and investing goals. And regarding objective (3), Clayton remarked that these technological advances have greatly reduced paperwork and lawyer costs for companies and investors. Clayton thanked the Corporate Finance Division staff and its Director William Hinman for spearheading the year-long effort. Director Hinman, who is leaving the Commission at the end of 2020, reiterated many of the remarks that Clayton made.
Closing remarks. Chairman Clayton, in his closing remarks, acknowledged that such a large proposal on the all-important exempt offerings’ topic will garner widely differing opinions from his four commissioners which has, in fact, happened by two commissioners approving the final rule and two dissenting from it. Moreover, Commissioners’ Roisman and Peirce challenged Commissioner Crenshaw’s dissent. But after taking the Commissioners’ opposing discourse into account, Clayton stressed the need to adopt the harmonization proposal immediately in order to move the exemption framework toward cohesiveness following years of having to grapple with a very difficult-to-understand patchwork of inconsistent hard-to-apply rules. Chairman Clayton emphasized, however, that this adoption was but a first step on the long road to perfecting the exempt offering regime. He simply wants a first step in place to provide future chairmen and commissioners with a strong starting point from which to advance the exemptions even further toward striking the correct balance between capital raising and investor protection.
Concept and proposing releases. This large rulemaking project began with a June 2019 concept release followed by the March 2020 proposing release. The Commission considered the 300 comments it received in crafting the final rule.
SEC rule changes voted on. The final rule changes voted on (and approved) do the following:
- Raise the Regulation A, Tier 2 offering limit from $50 million to $75 million (and for secondary sales, from $15 million to $22.5 million);
- Raise the Regulation D, Rule 504 offering limit from $5 million to $10 million;
- Also pertaining to Regulation D, revise Securities Act Rule 502(b) concerning financial statement information, to refer to revised Form 1-A requirements;
- Raise the crowdfunding aggregate amount sold (inflation adjusted) from $1,070,000 to $5 million;
- Also pertaining to crowdfunding: (1) change "lesser of" to "greater of" in two instances to allow non-accredited investors to make larger investments; (2) remove investment limits for accredited investors; (3) expand the ability to advertise offerings; and (4) add Investment Company Rule 3a-9 (to the 1940 Act rules) to clarify that a "crowdfunding vehicle" is not an investment company if certain conditions are met;
- Amend the integration rules for exempt offerings so that these rules refer to a single integration provision to be housed in proposed Securities Act Rule 152;
- Add "or such sale" or similar language to the look-back periods in the bad actor disqualification provisions of numerous rules in order to harmonize these look-back periods with the language contained in Securities Act Rule 506(d);
- Expand an issuer’s ability to test-the-waters by adding Securities Act Rule 241, which: (1) allows any issuer to test-the-waters for indications of interest in a communication before selecting a type of exempt offering, but the SEC’s antifraud rules apply, and an issuer cannot ask for, or receive, consideration or engage in a binding commitment until selecting the type of exempt offering and starting the offering; (2) requires any communication to state four conditions set forth in the rule; (3) defines "indication of interest" as "any written communication under this rule," and (4) permits an issuer to require a person to state in a response form their "name, address, telephone number, and/or e-mail address;"
- Pertaining to Regulation S-K, permits certain information to be redacted from exhibits (which is required by Regulation S-K Rule 601), by retaining the "not material" requirement for exclusion of information from an exhibit, but changing the current competitive harm prong to one addressing information that the registrant "customarily and actually" treats as "private or confidential;"
- Regarding demo day events, adds new Securities Act Rule 148 to clarify that demo day events do not constitute general advertising or solicitation if certain conditions are met; the rule mirrors the Helping Angels Lead Our Startups (HALOS) Act of 2019; and
- Makes conforming amendments to Forms S-6, N-14, 1-A, C, 20-F, S-K, N-1A, N-2, N-3, N-4, N-6 and N-8B-2.
What was left out of the final rule. The following items from the March 2020 proposing release were dropped from the final rule:
- A Regulation S proposal that would have added new Securities Act Rule 906 to clarify that an issuer whose activities under an exemption that are not "direct selling efforts" can make concurrent offers and sales under Regulation S, but the issuer- or affiliate-or distributor-acquired securities cannot be resold to a U.S. person for six months, except to qualified institutional buyers or institutional accredited investors;
- An expansion of the verification methods in Regulation D Rule 506(c) for ensuring investors are accredited investors;
- A harmonization of eligible securities for crowdfunding and Regulation A; and
- A barring of SAFEs (Simple Agreement for Future Equity) under Reg. crowdfunding.
wo commissioners favor the final rule. Commissioners Peirce and Roisman approved the rule. Commissioner Peirce praised the final rule overall, applauding the Regulation A Tier 2, Rule 504 and crowdfunding offering limit increases, as well as the four safe harbor provisions added to the integration rules and the 18-month extension on filing crowdfunding financial statements because the pandemic. Peirce, however, did not agree with limiting the number of non-accredited investors to 35 in a 90-day period upon finding this provision too restrictive for small businesses. Also, she thought that the demo days provision should provide investors with more detail and that state securities regulators should be federally preempted from regulating special vehicles in order to foster more crowdfunding.
Commissioner Roisman wholeheartedly approved the final rule, additionally agreeing with Commissioner Peirce that state securities regulators should be federally preempted from regulating special vehicle crowdfunding. Additionally, he remarked upon the favorable reception the Commission received from small businesses and investors pertaining to the August 2020 extension of temporary regulation crowdfunding rules for small businesses until September 2021. He hopes that these temporary rules will be made permanent in a future rulemaking.
Two commissioners oppose the final rule. Commissioners Lee and Crenshaw opposed the rule. While praising the staff for creating the final rule, Commissioner Lee opposed them. She believes that the final rule’s opening investment opportunities to more accredited and unaccredited investors does so without adequately protecting them from the ensuing risks, and will result in the SEC having to police exempt offering transactions at the federal level while simultaneously making it harder for the already resource-stressed state regulators to police the offerings on main street. Lee also stressed that issuers never wanted increased offering limits on Rule 504, Regulation A or regulation crowdfunding offerings because previously increased limits have not generated increased interest in these offerings. She is most concerned that the changes made to Rules 506(b) and (c) will blur the distinctions between them, thereby allowing unqualified issuers to partake of the wrong subsection and risk the financial wellbeing of more unsuitable investors getting lured into these transactions. Lee is also adamantly opposed to the four integration safe harbors, stating that their expansiveness will destroy the integration rule itself by allowing issuers to unjustly treat as a single exempt offering those offerings that should, instead, be considered separate offerings. Lee’s main point, however, is that the Commission should work to make public rather than private offerings more available to small- and medium-sized businesses and their retail investors.
Commissioner Crenshaw also dissented, contending that the final rule would play out against its intended purpose to help small businesses raise capital, by increasing the economic divide between the rich and poor. She said that the large companies (whom she coined venture capitalists) would be the unintended beneficiaries of the relaxed rule changes, along with the wealthy investors who buy into the venture capitalists’ projects. Crenshaw believes that the intended beneficiaries of the relaxed rule changes, namely small- and medium-size business and main street investors, will still not have the funds to go forward with their private enterprises and, moreover, those that manage to do so, will be investing at increased peril because the final rules do not adequately provide investor protections such as mandating more disclosure to the investors. Crenshaw’s above-statements supporting her dissent arise from a concern that the Commission set forth the proposal without gathering data from actual market participants about the effect the final rule would have in reality, or what changes the market participants, themselves, thought would accomplish the SEC’s capital raising goals for small businesses and retail investors.
Commissioners Roisman and Peirce challenged Commissioner Crenshaw’s remarks. Roisman asked her to elaborate on her statement that the final rule would increase the existing economic divide between large and small companies; large and small investors; and the rich and poor in general. She reiterated that the relaxed rule would help increase the profits for the venture capitalists and their wealthy investors who do not need the rule but would further increase the risks to small businesses and middle-income investors. Both Roisman and Peirce pointed out, however, that every investment has risks and, therefore, does not justify holding off on a final rule that has capital enhancing and investor protecting provisions for the businesses and people Crenshaw says the rule will go against. Roisman, furthermore, reiterated Chairman Clayton’s point that the rule is but a first step toward finding ways to help small businesses raise capital while protecting retail investors who invest in those businesses. He also proclaimed that once the final rule is used in practice, the Commission will undoubtedly reach out to small businesses and retail investors for their thoughts about the rule’s impact on them and how it could be amended to better serve them.
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