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Reg A and Reg D: Evolving Securities Exemptions for Private Placement Offerings

Navigating Regulation A+, the FAST ACT, Rule 506(c), and Accredited Investors; Recent SEC Guidance and the HALOS Act

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific TUESDAY, MAY 16, 2017

Arthur McMahon, III, Partner, Taft Stettinius & Hollister, Cincinnati Bridget C. Hoffman, Partner, Taft Stettinius & Hollister, Cincinnati Brandi N. Weekley, Attorney, Taft Stettinius & Hollister, Cleveland

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Regulation A and Regulation D: Evolving Securities Exemptions for Private Placement Offerings

Bridget C. Hoffman Arthur McMahon, III Brandi N. Weekley

May 16, 2017

Roadmap

• Introduction: The Securities Act in Brief
• Regulation A+
• The FAST Act; Private Resales of Securities
• Regulation D: Rules 506(b) and 506(c)
• Recent Compliance and Disclosure Interpretations

– Regulation A+ – Regulation D

• The HALOS Act and Beyond

2

The Securities Act in Brief

• You may not sell securities in the United States without

Securities Act registration or exemption

• Registration is not viable for many companies

– Cost ($3.7 million average for 1st time issuers) – Offering compliance – Ongoing compliance – Liabilities – Market and liquidity issues

3

The Securities Act in Brief

• Instead, most companies rely on exemptions from

registration:

– “Scaled Registration” – Regulation A – Private Placements – §4(a)(2); Regulation D

• Each exemption has unique requirements, restrictions,

costs, and benefits

4

The Securities Act in Brief: Key Questions

• Who Can You Sell To?

– Sophisticated Investors vs. Retail – Accredited Investors – Individual Investors

• $1 million net worth or $200,000 annual income ($300,000 for

married couples)

– Entities

• $5 million total assets
• Not “formed for the purpose”

5

The Securities Act in Brief: Key Questions

• How Can You Sell?

– Broadly, to strangers – Narrowly, through pre-existing relationships – General solicitation or advertising

• Print media, broadcast, internet
• Mass mailings, seminars

6

The Securities Act in Brief: Key Questions

• Interaction with state “blue sky” laws

– Pre-emption for “covered securities” under NSMIA – Onerous “merit review” process

• Transferability of Securities

– “Restricted Securities” under Rule 144 – Holding periods – Issuer information requirements

• Liability

– Strict: Securities Act§ § 11 and 12 – Scienter-based: Exchange Act Rule 10b-5

7

Old Regulation A

• 80 year-old “Scaled Registration” provision
• Key Terms:

– Up to $5 million per year – Robust offering circular – “Qualification” - SEC review and comment process – General solicitations and advertising permitted – Retail investors permitted without limit – Unrestricted securities – Audited financials not required – No ongoing reporting requirements – STRICT LIABILITY under Section 12 – NO BLUE SKY PRE-EMPTION

8

Old Regulation A

• Tremendously unpopular
• 19 Regulation A offerings between 2009 and 2012

– 27,500 Regulation D offerings of $5 million or less – 373 Registered Offerings of $5 million or less

• Why?

– Costly and inefficient – More attractive options, mainly Regulation D – NO BLUE SKY PRE-EMPTION – Market liquidity was an illusion

9

Regulation A+: Overview

• JOBS Act replacement for Regulation A
• Effective June 2015

– Early returns are not especially promising

• Two Tiers

– Tier One: Currently up to $20 million per year – Tier Two: Currently $20 to $50 million per year – Voluntary Tier Two compliance permitted

• Requirements and benefits differ by tier

10

Regulation A+: Tier One

• Tier One

– Currently up to $20 million – Otherwise very similar to old Regulation A

• Key Provisions:

– Offering Circular: informal, Q&A format permitted – SEC review and comment process – General solicitations permitted – Retail investors permitted without limit – Unrestricted securities – Audited financials not required – No ongoing reporting requirements – STRICT LIABILITY under Section 12 of the Securities Act – NO BLUE SKY PRE-EMPTION

11

Regulation A+: Tier Two

• Tier 2

– Currently $20 to $50 million – Otherwise, very close to full registration

• Key Provisions

– Robust, S-1 equivalent offering circular – SEC review and comment process – General solicitations permitted – Retail investors subject to personal volume limitations – Unrestricted securities – Audited financials required – Ongoing periodic and current reporting – STRICT LIABILITY of the Securities Act – FULL BLUE SKY PRE-EMPTION

12

Regulation A+: Tier Two

• Investor volume limit

– Applies to investors who are not accredited – Per offering limit equal to the greater of:

• 10% of the investor’s net worth
• 10% of the investor’s annual income
• Ongoing reporting
• Estimated costs

– $400,000 for offering – $200,000 annual compliance

13

Regulation A+: Who’s Using It?

• SEC Division of Economic and Risk Analysis (DERA)

Study

• 81 offerings qualified as of 10/31/2016
• Average size

– Tier One: $700,000 – Tier Two: $26 million

• Virtually all “best efforts”
• Under 20% underwritten
• 60% pre-revenue issuers; nearly 90% no net income
• Plurality Real Estate/REIT
• 120 day average time to qualify

14

The FAST Act: Overview

• What is the FAST Act?

– Fixing America’s Surface Transportation Act (the “FAST Act”) signed into law by President Obama on December 4, 2015

• What does it do?

– Primary purpose: provide long-term funding certainty for surface transportation – Also made several changes to the federal securities laws – Provided a safe harbor for the “Section 4(a)(1½)” Exemption

15

The FAST Act: “Section 4(a)(1½)” Exemption

• Resale Exemptions before the FAST Act:

– Section 4(a)(1) – “Ordinary Trading” Exemption – Rule 144A – Exemption for “Qualified Institutional Buyers” (QIBs)

• “Section 4(a)(1½)” – Private Resale Exemption

– Developed over time by securities professionals and discussed in case law – Relies on elements of Section 4(a)(1) and Section 4(a)(2) – Requirements:

• Sophisticated investors (e.g., accredited investors) who would have

been eligible to purchase such securities directly from the issuer

• Comply with rules typically prescribed for Section 4(a)(2) or

Regulation D private placements by issuers

– Restrictions vary based on issuer, nature of investors, and size

• f the offering

16

The FAST Act: Section 4(a)(7)

• FAST Act added Section 4(a)(7) exemption
• Nonexclusive safe harbor for private resales under the

“Section 4(a)(1½)” exemption

– Similar to Rule 506 of Regulation D operating as a safe harbor for Section 4(a)(2) exemption

• Exemption available for private resales of restricted

securities to “accredited investors” where no general solicitation or advertising is used and certain information concerning the issuer and the transaction is provided to the purchaser

17

The FAST Act: Requirements for Exemption

• For the resale transaction to be exempt from registration

under the Section 4(a)(7) Exemption, the transaction must meet the following requirements:

1. Each purchaser must be an “accredited investor,” as such term is defined in Rule 501(a) of Regulation D under the Securities Act; 2. Neither the Resale Holder nor any person acting on the Resale Holder's behalf may engage in any form of general solicitation

• r general advertising; and

3. In the case of an issuer that is not an SEC reporting company, the Resale Holder and Purchaser must obtain from the issuer reasonably current information.

18

The FAST Act: Information Requirements

• What constitutes reasonably current information?
• The issuer's exact name (as well as the name of any predecessor);
• The address of the issuer's principal place of business;
• The exact title and class of the offered security, its par or stated

value, and the current capitalization of the issuer;

• The name and address of the transfer agent, corporate secretary or
• ther person responsible for stock transfers;
• A statement of the nature of the issuer's business that will be

presumed current if it is as of 12 months before the transaction date;

• The issuer's officers and directors;

(continued)

19

The FAST Act: Information Requirements

• What constitutes reasonably current information?
• Information about any broker, dealer, or other person being paid a

commission or fee in connection with the sale of the securities;

• The issuer's most recent balance sheet and profit and loss

statement for such part of the two preceding fiscal years as it has been in operation, prepared in accordance with U.S. generally accepted accounting principles (GAAP) (or, in the case of a foreign private issuer, International Financial Reporting Standards (IFRS)); and

• If the Resale Holder is a Control Holder, a statement regarding the

nature of the affiliation accompanied by a certification from the Control Holder that it has no reasonable grounds to believe that the issuer is in violation of the securities laws or regulations.

20

The FAST Act: Disqualifications

• The Section 4(a)(7) Exemption is not available if:

– The Resale Holder is a direct or indirect subsidiary of the issuer; – The Resale Holder or any person that will be compensated in connection with the resale transaction, such as a broker-dealer or finder, is subject to the “bad actor” disqualification provisions under Rule 506(d)(1) of Regulation D under the Securities Act or a disqualification described under Section 3(a)(39) of the Securities Act; – The issuer is blank check company, blind pool, shell company, special purpose acquisition company, or in bankruptcy or receivership; – The transaction relates to a broker-dealer's or underwriter's unsold allotment; or – The security that is the subject of the transaction is part of a class of securities that has not been authorized and outstanding for at least 90days prior to the date of the transaction.

21

The FAST Act: Tips for Practitioners

• Practitioners seeking to rely on the Section 4(a)(7) Exemption should

consider updating their form equity purchase agreements used in resale transactions to add the following:

– Representations and warranties by the Purchaser confirming receipt of the specific enumerated items of information in the Section 4(a)(7) Exemption – Representations and warranties by the Resale Holder and the Purchaser regarding the “bad actor” disqualifications – Schedules or exhibits to the equity purchase agreement that will document and contain each disclosure required to be provided to the Purchaser

• Securities sold in Section 4(a)(7) Exemption transaction will still be

restricted securities, requiring registration or exemption for resale

• Securities sold in Section 4(a)(7) Exemption transaction are “covered

securities” under Section 18, which preempts registration requirements

• f state securities laws

22

Rule 506(b)

• No cap on amount
• No general solicitation or advertising
• Unlimited number of accredited investors
• Up to 35 “sophisticated” non-accredited investors
• Disclosure to non-accredited investors
• Restricted securities
• Bad actor restrictions
• Limited confirmation of accredited investors’ status
• Form D
• Blue sky notice filings and fees

23

Rule 506(c)

• No cap on amount
• General solicitations and advertising are permitted
• Restricted securities
• All purchasers must be accredited investors
• Issuer must take “reasonable steps” to verify accredited

investor status.

• Bad actor restrictions
• Form D
• Blue sky notice filings and fees

24

Rule 506(c): Investor Verification

• Principles-based method:

– Nature of purchaser/type of AI – Amount and type of information available – Nature of the offering

• Manner of solicitation
• Terms and minimum investment amount
• Safe harbor method:

– Tax forms – Bank statements, tax assessments and U.S. credit reports – Gatekeepers, such as brokers, accountants and attorneys – Previous investors

• Staff guidance on technical questions

25

Rule 506(c): Who’s Using It

• Rule 506(c) is being used, but not nearly as much as

Rule 506(b)

• Most recent DERA Study (9/13-12/15)

– $1.5 trillion under Rule 506(b) – Less than $50 billion under Rule 506(c)

• For non-funds, amount offered per transaction is

comparable, but proceeds per offering are about half.

• Surprisingly, fewer investors per Rule 506(c) transaction

26

Recent C&DI: Regulation A+

• Filing date of Exchange Act Registration in Tier Two
• fferings
• Suspension of Tier Two ongoing reporting obligations for
• fferings withdrawn before sale
• Age of financial statements in Tier Two offerings
• Tax opinions need not be filed
• Auditor’s consent need not be filed
• Industry Guide 5 does not apply

27

Integration

• Sales of securities with 6 months may be viewed as one

transaction

• Advertising from a 506(c) offering may impede a later

4(a)(2) private placement or traditional Regulation D

• ffering
• Rescission and SEC sanctions are possible

consequences

• More likely, issuer would be forced to delay the next

round

28

Recent C&DI: Regulation D

• Some integration concerns

– Relying on Rule 152, the Staff concluded that a Rule 506(c)

• ffering less than 6 months after a Rule 506(b) will not “pollute”

the 506(b) offering as long as 506(b) requirements were met prior to the general solicitation.

• Technical guidance on investor verification

29

Other Recent Regulation D Changes

• Repeal of Rule 505 – effective May 2, 2017
• Amendments to Rule 504 – effective January 20, 2017

– Increase aggregate amount from $1 million to $5 million within 12 months – Bad actor restrictions

30

The HALOS Act

• “Helping Angels Lead Our Startups” Act (HALOS)

– Passed by the U.S. House of Representatives on April 28, 2016 – Clarifies the definition of “general solicitation” – Goal: address the issue of when start-ups may make a pitch to potential investors without triggering accredited investor verification procedures

31

The HALOS Act

“Our economy works better for all Americans when small businesses can focus on creating jobs rather than navigating bureaucratic red tape. The early-stage capital for a startup provided by angel investors is vitally important. The HALOS Act fixes a regulatory overreach so it will be easier for small businesses to attract early-stage investment.”

– House Financial Services Committee Chairman Jeb Hensarling

32

The HALOS Act: “General Solicitation”

• What constitutes “general solicitation”?

– Subjective, but primary factors include:

• Manner of communication: the less selective the manner of

communication chosen, greater the likelihood it will be deemed general solicitation

• Subject matter: Rule 502(c) only prohibits general solicitation used

to “offer or sell the securities”

• “Demo Days” or “Venture Fairs”

– Pitch events and demo days are commonplace for startups and emerging companies – 502(c) may restrict communications at such events

33

The HALOS Act: What is an Offer?

• Section 2(a)(3) defines “offer” or “offer to sell” to include

“every attempt or offer to dispose of, or solicitation of an

• ffer to buy, a security or interest in a security, for value.”
• Communications that do not mention the issuer’s

securities or offering may also be deemed offers

– SEC position is that an offer is any communication that has the effect of conditioning the market or arousing public interest in an issuer or its securities

34

The HALOS Act: Proposed Changes

• Prohibition against general solicitation will not apply

where a presentation or other communication is made by

• r on behalf of an issuer at an event sponsored by any of

the following groups:

1. United States, any territory or State (or political subdivision thereof) or government agency 2. Institution of higher learning 3. Nonprofit organization 4. Angel investor group 5. Venture forum or venture capital association or trade association 6. Any other group or entity as determined by the SEC, provided that such groups abide by certain rules

35

The HALOS Act: Rules

• The following rules were promulgated (and will be further

clarified by the SEC):

– Advertising may not refer to any specific offering of securities by the issuer. – The sponsor of an event may not: (1) provide investment recommendation or advice to attendees; (2) engage in investment negotiations with attendees; (3) charge event attendees fees (other than administrative fees); or (4) receive any compensation in connection with the event that would require registration as a broker or dealer or as an investment advisor. – No specific information regarding the securities offering may not be communicated beyond the type and amount of securities being

• ffered, the amount of securities already subscribed for, and the

intended use of proceeds of the offering.

36

The HALOS Act: Angel Investor Group

• What constitutes an Angel Investor Group?

– The entity must be composed primarily of individual accredited investors who are interested in investing personal capital in early-stage companies; – The entity must hold regular meetings and have defined procedures for making investment decisions, either individually

• r among the membership of the group as a whole; and

– The entity cannot be connected to broker-dealers or investment advisers.

37

Proposed Accredited Investor Definitions

• Dodd-Frank – primary residence
• December 2015 Staff report and recommendations
• Piwowar’s “Forgotten Investor”?
• Academic criticism of equating means with sophistication

38

Thank You

Bridget C. Hoffman hoffman@taftlaw.com Arthur McMahon, III amcmahon@taftlaw.com Brandi N. Weekley bweekley@taftlaw.com

39