On March 15, 2021, the Securities and Exchange Commission (SEC) implemented new rules to modernize aspects of the private placement framework. The goal was to simplify, harmonize, and improve private and exempt offering types under the Securities Act to help promote capital formation while preserving or enhancing investor protections. These recent changes were also recently accompanied by amendments on August 26, 2020, to the definition of an “accredited investor,” expanding the scope of investors who may purchase exempt offerings.
Overview of notable changes
These are notable takeaways that you should be aware of when conducting private offerings for your clients:
- Harmonizing Disclosure Requirements Under Regulation D with Regulation A
- Rule 502(b) of Regulation D has been amended to align with the financial information issuers must provide investors in Regulation A offerings. This provision governs financial information that non-reporting companies must provide to non-accredited, sophisticated investors participating in Regulation D offerings,
- By aligning the disclosure requirements in Rule 502(b) with those in Regulation A, the SEC believes that additional issuers may consider including non-accredited, sophisticated investors in their 506(b) offerings, which would expand investment opportunities for non-accredited investors.
- Demo Days and Testing the Waters Communications Under Rule 504 of Regulation D
- New Rule 148 exempts certain “demo day” communications from registration requirements, balancing the needs of startup companies with the SEC’s investor protection goals.
- New Rules 206 and 241 permits certain “testing the waters” communications prior to filing a Form C for Regulation Crowdfunding offerings (Rule 206) or filing a registration statement for registered offerings (Rule 241).
- Regulation A Eligibility for Delinquent Issuers
- Issuers registered under the Securities Exchange Act of 1934 (Exchange Act) that are delinquent in their reporting obligations are no longer eligible to rely on the exemption in Regulation A.
- Limits Have Been Substantially Increased in Regulation A and Rule 504 Offerings
- The maximum offering amount under Tier 2 of Regulation A has increased from $50 million to $75 million, and the maximum offering amount for secondary sales under Tier 2 of Regulation A has increased from $15 million to $22.5 million.
- The maximum offering amount under Rule 504 of Regulation D has doubled, from $5 million to $10 million.
- Overhaul Amendments to Regulation Crowdfunding
- The maximum offering amount has increased from $1.07 million to $5 million.
- For offerings of $250,000 or less, the SEC has extended the current temporary exemption from certain financial statement requirements for offerings until August 28, 2022.
- Investment limits for accredited investors, other than the ($5 million) aggregate limit applicable to the offering, has been removed.
- Investment limits for non-accredited investors have been revised. Going forward, the aggregate amount of Regulation Crowdfunding securities sold to any non-accredited investor across all issuers during any 12-month period shall not exceed: (i) the greater of $2,200, or 5% of the greater of the investor’s annual income or net worth (if either the investor’s annual income or net worth is less than $107,000); or (ii) 10% of the greater of the investor’s annual income or net worth, not to exceed an amount sold of $107,000 (if both the investor’s annual income and net worth are equal to or more than $107,000).
- The SEC has added a new exclusion from the Investment Company Act of 1940 to permit the use of certain special purpose vehicles to facilitate investing in Regulation Crowdfunding issuers.
- Harmonization of Bad Actor Disqualification Lookback Periods
- By adjusting the lookback requirements in Regulation A and Regulation Crowdfunding, the SEC has harmonized the bad actor disqualification provisions in Rule 506(d) of Regulation D, Rule 262(a) of Regulation A and Rule 503(a) of Regulation Crowdfunding.
- New Integration Framework and Safe Harbors
- New Rule 152 is focused on offering integration and provides a comprehensive integration framework composed of a general principle of integration and four safe harbors applicable to all registered and exempt securities offerings under the Securities Act, modernizing and simplifying the integration framework to keep up with developments in the capital markets and the evolution of communications technology.
- Amendments to the Definition of Accredited Investor
- New categories of natural persons now include:
- individuals holding certain professional certifications, designations, or credentials (including certain credentials issued by accredited educational institutions), which the SEC may designate from time to time by order; and
- individuals who are “knowledgeable employees” of a private fund (as defined in Rule 3c-5(a)(4) under the Investment Company Act), solely with respect to investments in that particular private fund.
- The SEC simultaneously exercised its discretion under the first of these new criteria by designating persons holding a FINRA-administered Series 7, Series 65, or Series 82 license in good standing to be “accredited investors.”
- New categories or clarifications in respect to entities now include:
- limited liability companies with $5 million in assets may be accredited investors provided they meet other requirements of Rule 501(a)(3).
- SEC and state-registered investment advisers (including sole proprietorships), exempt reporting advisers (within the meaning of Section 203 of the Investment Advisers Act), and rural business investment companies (RBICs) are added to the list of entities that may qualify as accredited investors.
- Rule 501(a)(9) adds a new category under which any entity may qualify as an “accredited investor,” including, without limitation, Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, if such entity (a) owns “investments” (as defined in Rule 2a51-1(b) under the Investment Company Act) in excess of $5 million, and (b) was not formed for the specific purpose of investing in the securities being offered.
- “Family offices” (as defined in Rule 202 promulgated under the Investment Advisers Act) that (a) have at least $5 million in assets under management, (b) were not formed for the specific purpose of acquiring the securities offered, and (c) have their prospective investments directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment, were added to the category of “accredited investors.” Furthermore, such qualifying family office’s “family clients” (as defined in Rule 202 promulgated under the Investment Advisers Act) were added to the category of “accredited investors,” as well, provided the investment is directed by the family office.
- A note was added to Rule 501(a)(8) to clarify that one may look through various forms of ownership to determine whether all-natural persons who are the ultimate owners of an entity qualify as “accredited investors” for purposes of that exemption.
- The term “spousal equivalent” was added to the accredited investor definition, so that spousal equivalents may pool their financial resources for purposes of satisfying the net worth or joint income tests to qualify as “accredited investors.” The SEC also added a note to Rule 501(a)(5), clarifying that an investor may aggregate net worth with his or her spouse (or spousal equivalent) to satisfy that test, and that securities being purchased by an investor relying on the joint net worth test need not be purchased jointly.
What This Means to You
- Going forward, Rule 501(a) of Regulation D will permit natural persons to qualify as “accredited investors” based on certain professional certifications, designations, or credentials (which the SEC will designate by order), rather than relying on a strictly wealth and income-based standard. This will provide the SEC with flexibility over time to reevaluate any designations it makes, and also to add certifications, designations, or credentials to the list in the future (subject to future public review and comment, which the SEC also clarified in the adopting release).
- It will be important for issuers planning to include one or more of these new categories of accredited investors in future Regulation D private offerings to work with their counsel to ensure their investor qualification due diligence procedures have been modified appropriately to cover the new categories. Additionally, fund managers should work carefully with their counsel to ensure their employees fall within the scope of “knowledgeable employees”—a specifically defined term—before offering and selling their fund securities to such persons.
- For entities, broadening the definitions of “accredited investor” in Rule 501(a) of Regulation D and “qualified institutional buyer” in Rule 144A will permit more entities to qualify as accredited investors. Although monetary thresholds triggering such qualifications remain unchanged, the broader range of entities covered by new Rule 501(a), inclusion of “family offices” as accredited investors.
- The most significant of these entity specific changes will likely be the increased breadth of the QIB definition in Rule 144A, as newly qualifying entities will now have access to the expansive market of Rule 144A securities. The SEC specifically noted that the inclusion of Indian tribes and governmental bodies as QIBs will provide these entities with expanded access to commercial paper issuances, which commenters on its original proposal identified as a problem that needed to be addressed due to increased utilization of the 144A market for these offerings in recent years.
