November 28, 2016
On October 26, 2016, the SEC adopted final rules regarding “intrastate” offerings. The SEC “modernized” Rule 147 under the Securities Act of 1933 to reflect developments in current business practices and communication technologies, particularly the internet, to ensure the “continued utility” of Rule 147 as a safe harbor for offerings relying on Section 3(a)(11) of the Securities Act. At the same time, the SEC adopted a new Rule 147A that is similar to Rule 147 but has added flexibility for issuers.
In the FAQs below, we explain these new developments and how they may rejuvenate the intrastate offering exemption for the 21st century. The SEC’s adopting release can be found at https://www.sec.gov/rules/final/2016/33-10238.pdf. All quoted language below is from the adopting release unless otherwise identified. The new rules will become effective on April 20, 2017. (In this Client Alert, we refer to the version of Rule 147 that is currently in effect as “current Rule 147” and the version of Rule 147 that will become effective on April 20, 2017 as “amended Rule 147.”)
After the FAQs below, we give our views on the practicable effects of the new rules in the Conclusions section of this Client Alert.
Q1. What is the “intrastate” offering exemption?
A. Section 3(a)(11) of the Securities Act exempts from registration “any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.”
The SEC initially adopted Rule 147 in 1974 to serve as a safe harbor for issuers that conduct intrastate offerings. If an issuer complies with all of the provisions of Rule 147, then the issuer will be deemed to have complied with Section 3(a)(11).
Q2. What are the problems with intrastate offerings that the SEC is trying to solve?
A. The SEC identified the following issues, among others, that have reduced the utility of current Rule 147:
For these and other reasons, lawyers have often advised issuers that the intrastate offering exemption is either not available or is fraught with risk.
Q3. Why did the SEC amend Rule 147 AND adopt a new Rule 147A, instead of just amending Rule 147?
A. The SEC decided to retain Rule 147 “as a safe harbor under Section 3(a)(11) to preserve the continued availability of existing state exemptive provisions [including crowdfunding provisions] that are specifically conditioned upon issuer reliance on Section 3(a)(11) and Rule 147.” Given the restrictive language in Section 3(a)(11) and the need to retain Rule 147 as a safe harbor, the SEC determined that it could not address the “single offer” problem and the “state of organization” problem noted above by amending Rule 147. Instead the SEC (a) amended Rule 147 where it could do so without contradicting the express language in Section 3(a)(11) and (b) adopted a new intrastate offering exemption—Rule 147A—pursuant to the SEC’s general exemptive authority under Section 28 of the Securities Act.
States are free to amend their current exemptive laws or regulations to refer to Rule 147A instead of Section 3(a)(11) and Rule 147. Until that happens, the amended Rule 147 will be available to issuers upon its effectiveness, but the additional benefits of Rule 147A will not be available for offerings intended to comply with state laws or regulations that explicitly refer to Section 3(a)(11) and Rule 147, as many such laws and regulations do.
Q4. How do amended Rule 147 and Rule 147A differ?
A. Amended Rule 147 and new Rule 147A are almost identical, except that Rule 147A:
Q5. Are securities sold under amended Rule 147 and Rule 147A “covered securities” (i.e., securities for which state securities law registration and qualification requirements are preempted)?
A. No. As is the case with current Rule 147, issuers must comply with any applicable state law relating to the offer and sale of securities issued pursuant to amended Rule 147 or Rule 147A.
Q6. Who can conduct an intrastate offering under amended Rule 147 and new Rule 147A?
A. Under amended Rule 147, an issuer must:
Under new Rule 147A, an issuer must:
Under both amended Rule 147 and new Rule 147A:
(a) derive at least 80% of its consolidated gross revenues within the state,
(b) have at least 80% of its consolidated assets within the state at the end of its most recent semi-annual fiscal period,
(c) use at least 80% of the offering’s net proceeds within the state, or
(d) have a majority of its employees based in the state.
The above requirements are significantly less restrictive than those under current Rule 147.
If an issuer uses amended Rule 147 or Rule 147A for an offering in one state and then changes its principal place of business to another state, the issuer may not use the exemption “to conduct another intrastate offering in [the other] state for a period of 6 months from the date of the last sale of securities under the prior” offering.
Q7. Who can purchase the securities offered in an intrastate offering under amended Rule 147 and Rule 147A?
A. At the time of the sale of securities, all purchasers must be residents of the same state in which the issuer is a resident.
Q8. How does an issuer determine the residency of a purchaser under amended Rule 147 and Rule 147A?
A. An issuer will satisfy the requirement that the purchaser in the offering be a resident of the same state in which the issuer is resident “by either the existence of the fact that the purchaser is a resident of the applicable state or territory, or by establishing that the issuer had a reasonable belief that the purchaser of the securities in the offering was a resident of such state or territory.”
Q9. How can an issuer establish a “reasonable belief” that the purchaser of the securities in an offering under amended Rule 147 or Rule 147A was a resident of the state where the offering is made?
A. A “reasonable belief” will be determined based on the facts and circumstances, which include (according to the SEC’s adopting release, but not the provisions of the rule itself):
Q10. How does an issuer determine the residence of a legal entity?
A. The residence of a purchaser that is a legal entity is where the legal entity has its “principal place of business” at the time of the sale. A purchaser’s “principal place of business” is determined in the same manner as an issuer’s residency, as explained above.
Q11. Can an issuer just rely on a written certification from the purchaser regarding the purchaser’s residency?
A. No. Although the issuer must obtain a written representation from each purchaser that the purchaser resides in the state, this representation, by itself, is not enough to meet the “reasonable belief” standard.
Q12. When and how can purchasers resell the securities they acquire in an intrastate offering pursuant to amended Rule 147 and Rule 147A?
A. For a period of six months from the date of the issuer’s sale of a security to the purchaser, any resale by the purchaser must be made only to residents of the state in which the issuer resided at the time the issuer sold the security. After this six-month period, the securities are freely saleable.
Q13. Can an issuer use other securities offering exemptions while employing amended Rule 147 or Rule 147A?
A. When a company issues securities under an offering exemption, it must examine whether the offering might be “integrated” with other offerings that the issuer has conducted before, during, or after the offering. If the offerings are integrated, the supposedly separate offerings could “be treated as one for purposes of qualifying for either exemption.” That integration could be fatal to both exemptions.
Amended Rule 147 and Rule 147A provide for an expanded six-month integration safe harbor that is consistent with Regulation A’s integration safe harbor provision. Offers and sales made in reliance on the rules will not be integrated with:
* If, after relying on the Rules to make offers solely to qualified institutional buyers (QIBs) and institutional accredited investors (IAIs), the issuer decides to register the offering, the amended Rule 147 or Rule 147A offers will not be integrated with any subsequent registered offering. If the issuer, relying on amended Rule 147 or Rule 147A, makes offers to persons other than QIBs and IAIs, the offers will not be integrated with the subsequent registered offering if the issuer waits 30 days between the last offer made under amended Rule 147 or Rule 147A and the filing of the registration statement.
An amended Rule 147 or Rule 147A offering will not be integrated with concurrent offerings made under other exemptions so long as the offerings comply with the requirements of their respective exemptions. As explained in considerable detail on pages 48-53 of the adopting release, however, the integration analysis for concurrent offerings and for registered offerings that closely follow offerings under amended Rule 147 and Rule 147A can be highly complex.
Q14. What must an issuer disclose to offerees and purchasers when conducting an offering under amended Rule 147 or Rule 147A?
A. Issuers must:
Q15. Are securities issued in reliance upon amended Rule 147 or Rule 147A exempt from the reporting requirements of Section 12(g) of the Securities Exchange Act of 1934?
A. No. As amended by the JOBS Act, Section 12(g) requires, among other things, that an issuer with total assets exceeding $10,000,000 and a class of securities held of record by either 2,000 persons or 500 persons who are not accredited investors to register that class of securities with the SEC. Unlike Tier 2 offerings under Regulation A or Regulation Crowdfunding, where the SEC provided conditional exemptions from registration under Section 12(g), issuers that use the exemptions under amended Rule 147 or new Rule 147A will not be required to comply with ongoing reporting requirements. Given the lack of ongoing reporting requirements, the SEC stated in the adopting release that the Section 12(g) record holder and asset thresholds continue to provide an important baseline above which issuers should generally be subject to the disclosure obligations of the Exchange Act.
Q16. State securities regulators and the SEC have sometimes battled over federal preemption for covered securities and Tier 2 Regulation A offerings, among other things. What do state securities regulators think about amended Rule 147 and new Rule 147A?
A. The initial reaction by the President of the North American Securities Administrator Association (NASAA) in a statement released on October 25, 2016 was positive:
“The SEC’s rule changes represent a significant step toward better alignment with modern technology and business practices. These changes will allow small companies to make better use of state crowdfunding and limited offering exemptions to raise capital. Investors and small companies will also benefit from changes to capital formation rules that include significant investor protections and preserve state authority. We look forward to closely reviewing the final rules and working with the Commission in their implementation.”
This statement, issued on the date of the SEC vote on the new rules, is consistent with the SEC’s statements in the adopting release about the benefits of state registration of securities offerings under coordinated review programs.
We believe that the modernization of the rules for intrastate offerings may make intrastate offerings more popular for private company capital raises, especially if states revise their state crowdfunding laws or regulations to refer to Regulation 147A. Below are a few of the relevant considerations for issuers and their counsel to consider as they analyze what registration exemptions to use in various circumstances:
Rule 505: Repealed effective May 22, 2017
Amended Rule 504: Effective January 20, 2017
Federal Regulation Crowdfunding:
Amended Rule 147:
New Rule 147A:
In summary, we believe that if the states amend their exemptive laws and rules to coordinate with new Rule 147A, the use of state crowdfunding for “local” issuers and investor bases may increase. Those offerings may incur lower offering costs than (a) federal Regulation Crowdfunding offerings, which have the considerable drawbacks cited above, or (b) Rule 504 offerings that must be registered in the state where the offering is made in the absence of other state exemption(s). Issuers may also use Rule 147A for offerings that are larger than $5 million (unlike Rule 504) and that are registered with the applicable state.
As helpful as the amendments to Rule 147 and the adoption of new Rule 147A may otherwise be, however, the unwillingness of the SEC to provide a permanent exemption from Section 12(g) registration under the Exchange Act for securities sold in an offering under amended Rule 147 or Rule 147A may limit the usefulness of these rules as a practical matter.
If you have questions regarding this publication, please call any of the lawyers listed below or your regular Nelson Mullins contact:
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Neil Grayson: 864.250.2235 or at firstname.lastname@example.org
John Jennings: 864.250.2207 or at email@example.com
Janis Kerns: 202.712.2813 or firstname.lastname@example.org
Daniel Nunn: 904.665.3601 or at email@example.com
Jim Rollins: 617.573.4722 or at firstname.lastname@example.org
Brennan Ryan: 404.322.6218 or at email@example.com
Douglas Spear: 404.322.6266 or at firstname.lastname@example.org
Jon Talcott: 202.712.2806 or at email@example.com
Charles Vaughn: 404.322.6189 or at firstname.lastname@example.org
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