The U.S. Securities and Exchange Commission (SEC) has proposed amendments to the exempt offering framework under the Securities Act of 1933, as amended, to simplify, harmonize and improve certain aspects of the framework in order to promote capital formation while maintaining investor protections. Below is a summary of the key proposed changes that are most relevant to Asian companies.
The intent of the doctrine of integration is to prevent an issuer from improperly avoiding registration under the Securities Act by artificially dividing a single offering that has no registration exemption into multiple offerings that technically fit within two or more separate exemptions. Improperly avoiding registration of the offer and sale of securities under the Securities Act can lead to rescission and a five-year capital-raising injunction under the “bad actor” rules.
The current integration framework for registered and exempt offerings under the Securities Act consists of a mixture of rules and the SEC’s guidance for determining whether multiple securities transactions should be considered part of the same offering. For example, in adopting Regulation S under the Securities Act, the SEC stated, ‘‘Offshore transactions made in compliance with Regulation S will not be integrated with registered domestic offerings or domestic offerings that satisfy the requirements for an exemption from registration under the Securities Act.” Proposed Rule 152(b)(2) under the Securities Act would codify this position. In some other contexts, such as a combination of Rule 506 of Regulation D with any other available exemption under Regulation D or two offerings made pursuant to Section 4(a)(2) of the Securities Act, the SEC uses the Five-Factor Test, except where (i) six months have passed between the completion of the first offering and the start of the second and (ii) there were no intervening offers or sales of the same or similar securities. The SEC is proposing a safe harbor in Rule 152(b)(1) under the Securities Act that would shorten the six-month period to 30 days and harmonize current Securities Act exemptions by providing the same 30-day safe harbor time period throughout their integration provisions.
The proposed amendments set forth a general principle of integration that would require an issuer to consider the particular facts and circumstances of each offering, including whether the issuer can establish that each offering either complies with the registration requirements of the Securities Act, or that an exemption from registration is available for the particular offering. The amendments also set out four nonexclusive safe harbors from integration:
Safe Harbor 1
Any offering made more than 30 calendar days before the commencement of any other offering, or more than 30 calendar days after the termination or completion of any other offering, would not be integrated with another offering; provided that, for an exempt offering for which general solicitation is not permitted, the purchasers either were not solicited through the use of general solicitation, or established a substantive relationship with the issuer prior to the commencement of the offering for which general solicitation is not permitted.
Safe Harbor 2
Offers and sales made in compliance with Rule 701 under the Securities Act, pursuant to an employee benefit plan, or in compliance with Regulation S would not be integrated with other offerings.
Safe Harbor 3
An offering for which a Securities Act registration statement has been filed would not be integrated with another offering if made subsequent to: (i) a terminated or completed offering for which general solicitation is not permitted; (ii) a terminated or completed offering for which general solicitation is permitted and made only to qualified institutional buyers and institutional accredited investors; or (iii) an offering that terminated or completed more than 30 calendar days prior to the commencement of the registered offering.
Safe Harbor 4
Offers and sales made in reliance on an exemption for which general solicitation is permitted would not be integrated with another offering if made subsequent to any prior terminated or completed offering.
The SEC is proposing amendments to Regulation S that would permit an issuer that is conducting an exempt offering that allows general solicitation, such as under Rule 506(c), and uses widely accessible internet or similar communications to continue to be able to rely on Regulation S for a concurrent offshore offering even though the general solicitation activity would likely be deemed “directed selling efforts” under current Rule 902(c). Under the proposal, an issuer that engages in general solicitation activity under an exemption that allows general solicitation would not be considered to have engaged in “directed selling efforts” in connection with an offering under Regulation S, if the general solicitation activity is not undertaken for the purpose of conditioning the market in the United States for any of the securities being offered in reliance on Regulation S.
The definition of “directed selling efforts” currently covers any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the U.S. market for the Regulation S securities. Due to the nature of a widely accessible general solicitation communication, it is likely that the “reasonably be expected to have the effect of” provision would be implicated by such activity, even though the issuer may not have undertaken the activity “for the purpose of” conditioning the U.S. market. Under the proposal, this definition would be narrowed, only for the purposes of general solicitation activities undertaken in connection with offers and sales under an exemption from registration, such that general solicitation activity that may have the effect of conditioning the U.S. market, but is not undertaken for the purpose of doing so, would not be covered.
The SEC is mindful that, regardless of the issuer’s intent, such activities may increase the risk of flowback of the Regulation S securities to the United States when there is a concurrent exempt offering of the securities in the United States using general solicitation. Therefore, the SEC is proposing new Rule 906 of Regulation S, which will be applicable to securities offered and sold in a transaction subject to the conditions of Rule 901 or Rule 903. Rule 906 would require an issuer that engages in general solicitation activity covered by the proposed exclusion from the definition of “directed selling efforts” to prohibit resales to U.S. persons (or for the account or benefit of a U.S. person) of the Regulation S securities for a period of six months from the date of sale except to qualified institutional buyers or institutional accredited investors. This six-month limitation on resales would apply regardless of the Regulation S category applicable to the securities and is in addition to any applicable distribution compliance period.
Even when permitted, it is not market practice for Asian companies to engage in general solicitation for private placements in the United States that are concurrent with a Regulation S offering. So if new Rule 906 is adopted, it is unlikely to have much effect on offerings by Asian companies.
Communications with Potential Investors
An issuer may be permitted to use generic solicitation of interest materials to “test the waters” for an exempt offer of securities prior to determining which exemption it will use for the sale of the securities.
Under Rule 506(b) of Regulation D under the Securities Act, general solicitation is currently prohibited.
The proposed amendments include excluding certain “demo day” communications from being deemed general solicitation or general advertising if the communications are made in connection with a seminar or meeting by a college, university or other institution of higher education, a local government, a nonprofit organization or an angel investor group, incubator or accelerator sponsoring the seminar or meeting.
Other Changes to Specific Exemptions
Further proposed amendments to the exempt offering framework would:
- Raise the maximum offering amount from $5 million to $10 million for an offering made pursuant to Rule 504 of Regulation D under the Securities Act.
- Change the financial information that must be provided to non-accredited investors in Rule 506(b) private placements to align with the financial information that issuers must provide to investors in Regulation A offerings. Specifically, for Regulation D offerings of up to $20 million in securities, issuers would no longer be required to provide audited financial statements and would have to comply with the requirements that apply to offerings under Tier 1 of Regulation A under the Securities Act. For Regulation D offerings of greater than $20 million in securities, issuers would be required to provide audited financial statements and comply with requirements similar to offerings under Tier 2 of Regulation A.
- Add a new item to the non-exclusive list of verification methods in Rule 506(c) that would allow an issuer to establish that an investor for which the issuer previously took reasonable steps to verify as an accredited investor remains an accredited investor as of the time of a subsequent sale if the investor provides a written representation to that effect and the issuer is not aware of information to the contrary.
The SEC also proposed various amendments to Regulation A and Regulation Crowdfunding under the Securities Act. Regulation A is only available to an entity organized under the laws of the United States or Canada, with its principal place of business in the United States or Canada. Regulation Crowdfunding is only available to an entity organized under the laws of the United States. As these exemptions are not relevant to Asian companies, we have not summarized the proposed changes in this Alert.
The public has until June 1, 2020, to send comments on the proposed amendments to the SEC.
For Further Information
If you have any questions about this Alert, please contact Jamie A. Benson, Gerard A. Hekker, Jonathan E. Crandall, any of the Asia- or U.S.-based attorneys in our Capital Markets Group or the attorney in the firm with whom you are in regular contact.
 The traditional test for integration is whether (1) different offerings are part of a single plan of financing; (2) the offerings involve issuance of the same class of security; (3) the offerings are made at or about the same time; (4) the same type of consideration is to be received in each offering; and (5) the offerings are made for the same general purpose (collectively, the “Five-Factor Test“). See Final Rule: Nonpublic Offering Exemption, Release No. 33-4552 (Nov. 6, 1962).
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.