SEC VOTES 3-0 TO AMEND INTRASTATE OFFERING RULES, BUT STEIN EXPRESSES RESERVATIONS

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The SEC demonstrated at its open meeting Oct. 26 that a unanimous vote does not necessarily equate to unilateral support for the measure under consideration.  All three commissioners voted to amend Securities Act Rule 147, the safe harbor for intrastate sales, and to adopt Rule 147A, a new regulatory exemption for local sales. Commissioner Kara M. Stein voted for the measure, but indicated that the rulemaking presented significant investor protection concerns.

As amended, Rule 147 remains as a safe harbor under Securities Act §3(a)(11) that issuers may use for securities offerings relying on current state law exemptions. The utility of the rule is limited by the statutory requirements that issuers must be incorporated in the state and that offers may only be made to state residents, thereby effectively prohibiting internet solicitations. New Rule 147A is substantially similar to Rule 147 except that it would allow offers (but not sales) to be accessible to out-of-state residents and for companies to be incorporated or organized in other jurisdictions. The new exemption may be attractive to crowdfunding issuers operating in states that have adopted exemptive rules that are more permissive than the federal crowdfunding rules.

Under both amended Rule 147 and new Rule 147A, issuers must have their “principal place of business” in-state and must satisfy at least one “doing business” requirement that would demonstrate the in-state nature of the issuer’s business:

  • the issuer derives at least 80 percent of its consolidated gross revenues from the state;
  • the issuer has at least 80 percent of its assets in the state;
  • the issuer uses at least 80 percent of the net proceeds of the offering in the state; or
  • a majority of the issuer’s employees are based in the state.

Issuers must obtain a written representation from each purchaser as to residency in the state under both provisions. A new “reasonable belief” standard for issuers to rely on in determining the residence of the purchaser at the time of the sale of securities is also included under both provisions.

Each rule also has a six-month period in which resales may only be made to other persons residing within the state. The final rules represent a change from the nine-month holding period in current Rule 147 and in the proposing release. According to the SEC, “a period of six months is adequate to establish that securities sold in an intrastate offering have ‘come to rest’ in a state.” Securities issued under either provision must bear a prominent legend concerning the resale restrictions.

Both rules also contain an integration safe harbor that would include any prior offers or sales of securities by the issuer made under another exemptive provision, as well as certain subsequent offers or sales of securities by the issuer occurring after the completion of the offering.

Commissioner Stein referred to the amendments as an “experiment” that raised investor protection concerns. She noted that neither amended Rule 147 nor Rule 147A contain a “bad actor” provision. These provisions serve as a check on fraud before an offering begins, she explained, and are a fundamental part of the Commission’s other recent offering exemptions. Commissioner Stein requested the inclusion of a bad actor provision, and noted that the North American Securities Administrators Association made a similar request. “Allowing bad actors to participate in such offerings not only undermines investor confidence, but also harms legitimate companies attempting to use these rules to raise capital,” she said.

She also expressed concern that the rules did not limit the size of offerings or cap individual investment amounts. The integration safe harbor also troubled her, as she stated that the provision “raised questions as to whether the rules have sufficient guardrails to protect investors.” The provision could, in her view, “facilitate evasion of our registration requirements, putting investors at greater risk.”

The Commission also raised the cap on exempt offerings under Securities Act Rule 504 from $1 million to $5 million. In light of this increase, the SEC also repealed the little-used Rule 505 exemption.

Amended Rule 147 and new Rule 147A will be effective 150 days after publication in the Federal Register.  Amended Rule 504 will be effective 60 days after Federal Register publication, and the Rule 505 repeal will be effective in 180 days after publication.

SEC Release No. 33-10238 (Oct. 26, 2016).