Securities Offering Exemptions – SEC Concept Release

SEC Concept Release on Harmonization of Securities Offering Exemptions

Securities Offering Regulation A Rule 506

In the wake of the stock market crash of 1929, the public had lost confidence in the entirely unregulated U.S. markets. Congress sought to restore it by creating a regulatory structure. The first step taken was passage of the Securities Act of 1933 (“Securities Act”), which required issuers of securities to provide accurate information about their business, the securities they sold, and the risks involved in investing in those securities.  The following year, the Securities Exchange Act of 1934 (“Exchange Act”) was signed into law.  The Exchange Act created the Securities and Exchange Commission (“SEC”), whose mission was and is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.

Since the 1930s, the Securities Act and the Exchange Act have been amended and expanded many times, but they are still the principal laws that govern the activity of the SEC and the regulation of our capital markets.  One of the agency’s chief activities is “rulemaking”:  from time to time, it proposes new rules whose purpose is to accommodate developments in the marketplace, new laws, new technologies that affect how the markets operate, and more. Proposed rules are preceded by “concept releases,” which explore whether there’s a need for a new rule, and solicit comment from market participants and the general public.

In June 2019, the SEC introduced a “Concept Release on Harmonization of Securities Offering Exemptions.”  One of the chief reasons companies choose to go public is to be able to raise money more easily.  Facilitating that process—the process of capital formation—is part of the SEC’s job.  There are many ways for issuers to attract investment, and the new concept release seeks information about whether existing rules should be left as they are, altered, or expanded.

The Securities Act, according to the SEC, “requires that every offer and sale of securities be registered with the Securities and Exchange Commission,… unless an exemption is available.”  Even in 1933, lawmakers realized that sometimes there was no practical need or public benefit from registration, and created exemptions for certain types of offerings of securities.  Over the nearly 100 years since passage of the 1933 and 1934 Acts, the number and kind of exemptions has increased, and that increase has accelerated in the past decade.  Contributing factors were the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”), the Fixing America’s Surface Transportation Act of 2015 (the “FAST Act”) and the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (the “Economic Growth Act”).


These new laws have created some confusion for smaller issuers wondering what kind of exempt offering is best for them.  The JOBS Act in particular made for significant changes to the offerings landscape.  First of all, it made it possible for companies to stay private longer than before.  As noted above, from the outset the idea of “registration” applied to stock sold in offerings rather than to issuers themselves.  Today, we refer to companies that have filed registration statements—usually Form 10 or Form S-1—with the SEC as “SEC registrants,” but what those forms actually register are securities.  Forms 10 register a class of securities; Forms S-1 register only the transaction where the securities are sold in the offering proposed.  Upon an initial registration statement becoming effective, the company is rs subject to SEC reporting requirements. The issuer must submit periodic financial reports on Forms 10-K and 10-Q to EDGAR, the agency’s electronic reporting system.

Companies become SEC registrants either because they must, or because they want to enjoy the prestige being an SEC registrant confers.  Once the JOBS Act became law, companies were only required to register a class of stock only if they had assets exceeding $10 million and a class of equity securities held by either 2,000 shareholders of record (shareholders whose stock is held in certificate form), or 500 non-accredited investors.  Previously, the threshold for shareholders of record had been only 300 shareholders of record.  Very few issuers are compelled to register, though Alphabet (better known as Google) is one notable exception.  Most that wish to go public do so at a time of their own choosing, by filing an initial registration statement.  If they wish to trade on one of the national exchanges, they must register a class of stock with the SEC.

As the case of Google illustrates, most private companies issue stock.  Since the Securities Act prescribes that all securities issued either be registered with the SEC or qualify for an exemption from registration, those private companies will need to find an appropriate exemption from registration even if they only want to issue stock to management and a few board members.  Even companies that intend to file registration statements, or are eventually forced to do so, will begin their securities issuances with exempt securities.  Google, for example, used exemptions to issue a considerable amount of stock to a considerable number of employees, until the threshold for registration was triggered.

Some companies want to trade publicly, but don’t wish to go to the expense of becoming an SEC registrant.  The registration process, and the ongoing filing commitment, which includes audited financial statements, can cost more than a microcap or startup company is able or willing to pay.  Such issuers, along with SEC registrants that don’t want to list on a national exchange or can’t meet listing requirements, can easily qualify to trade on the Over-the-Counter market.  The non-registrants won’t need to make any public disclosure at all, unless it’s required in connection with an exemption from registration they use to make a public offering.

Exempt Offerings

It may seem logical to imagine the value of public offerings of registered securities by big companies trading on the national exchanges would far exceed that of capital raised in exempt offerings.  But that would be incorrect.  In 2018, $1.4 trillion was raised in registered offerings, while more than double that amount–$2.9 trillion—was raised though exempt offerings.  Those numbers seem all the more impressive when the fact that most exemptions are not available to registrants is taken into account.

Regulation D of the Securities Act provides several different kinds of exemptions, all but one of which have been in existence for decades.  Rule 506(b) allows issuers to raise an unlimited amount of money.  Securities may be sold to an unlimited number of accredited investors and up to 35 “sophisticated but non-accredited” investors.  The issuer must file a Form D—a simple form requiring little more information than the size and value of the offering, and the type of securities being sold—and provide some additional disclosure to non-accredited investors.  Rule 506(c), which was created in response to certain provisions of the JOBS Act, is identical, except that general solicitation is permitted, and the securities on offer can only be sold to accredited investors.

Regulation D, Rule 506(b) and 506(c) offerings are the most popular exempt offerings, and the ones that raise the most money overall.  There’s also a Rule 504, which caps offerings at $5 million.  It’s frequently used by private companies wishing to sell small amounts of stock to “friends and family,” often with a view to going public in the future.  There was once a Rule 505, but it was repealed in 2016; the SEC believes that accounted for an uptick in Rule 504 offerings beginning in that year.  All Regulation D offerings result in the issuance of restricted stock.

Regulation A has existed since 1936, but in this century was seldom used until the JOBS Act mandated its redesign.  The SEC created a new two-tier system that was for awhile called “Reg A+”.  Tier 1 has an offering limit of $20 million; the securities may be offered to non-accredited investors.  The issuer must file a Form 1-A, which includes a prospectus and two years of unaudited financial statements, with the SEC.  When it’s completed the offering, it must file an “exit report” within 30 days.  Tier 2 has an offering limit of $50 million, and although sales to non-accredited investors are permitted, the investors are subject to investment limits based on annual income and net worth.  A Form 1-A with two years of audited financial statements must be filed, as must annual, semi-annual, “current event” reports (on Form 8-K) and exit reports.

An attractive feature of both types of Regulation A offerings is that issuers can “test the waters” to gauge investor interest before and after the offering statement is filed.  That can help management decide whether the time is right to try to raise capital.  Another appealing feature of Regulation A is that there is no restriction on the resale of stock purchased in the offering.  If the issuer is already a public company—not all are—the investor can sell into the market immediately.

Considerably less popular with issuers and investors are three types of intrastate offerings:  Section 3(a)(11), Rule 147, and Rule 147A of the Securities Act.  They have low offering limits—between $1 and $5 million—imposed by individual states. Purchasers must be in-state residents, and resales are restricted.

Finally, and currently not doing as well as some thought it might, is the much-ballyhooed Regulation Crowdfunding.  Like the revised Regulation A+, it was mandated by the JOBS Act, and became effective in May 2016.  It’s extremely complex, though the most an issuer can raise within a 12-month period is $1.07 million.  Similarly, interested buyers are limited in the amount they can invest.  The most anyone, regardless of income or net worth, can spend is $107,000.  All Regulation Crowdfunding offerings must be conducted through an online platform.  The platform must be either a broker-dealer or a crowdfunding portal registered with the SEC.  The intermediary that runs the platform must provide information about the issuer at its website, and it must also, according to some who’ve complained, communicate frequently with the Financial Industry Regulatory Authority (“FINRA”).  Needless to say, the intermediaries charge fees, which can be quite high for the tiny companies most likely to consider using equity crowdfunding.  Issuers can’t even engage in advertising or general solicitation, except to direct potential investors to the intermediary’s platform, using a brief notice that includes only cursory information about the company and the offering.

Because the animating principle behind equity crowdfunding is to raise capital from many people of modest means rather than from a few with deep pockets, securities issued pursuant to Regulation Crowdfunding are conditionally exempted from the record holder count under Section 12(g) of the Exchange Act.  It’s possible, even likely, that some crowdfunding offerings could be purchased by more than 500 non-affiliated shareholders, and if the company’s asset level was high enough, it would therefore be compelled to register a class of stock with the SEC.  Even so, this and related issues have resulted in some issuers refusing to accept more than 500 investors for any single crowdfunding offering.

Based on complaint and comment from market participants, the SEC believes it may be possible to fine-tune the structure of offerings to better serve the issuers they’re meant to serve.  While some types of exempt offerings—Regulation D, Rule 506(b) and 506(c)—are simple for issuers to navigate, others, most notably Regulation Crowdfunding, are difficult for inexperienced issuers to use, and extremely expensive as well.

Since the JOBS Act became law, the options available to issuers who wish to raise capital through exempt offerings has increased.  Still, the SEC is concerned that very small companies, principally startups, aren’t getting the minimal funding they need.  Some have suggested a “micro-offering” or “micro-loan” exemption that would permit startups to raise amounts less than $250,000.

The purpose of the concept release is to solicit ideas that may help resolve existing problems.  Capital formation isn’t just for industry giants; in fact, small companies not listed on a national exchange usually have a greater need to raise money.  As long as some investor protections are included, the agency wouldwelcome new and novel approaches.

Hamilton & Associates Law Group, P.A provides ongoing corporate and securities counsel to private companies and public companies listed and publicly traded on the Frankfurt Stock Exchange, London Stock Exchange, NASDAQ Stock Market, the NYSE MKT and OTC Markets. For two decades the Firm has served private and public companies and other market participants in corporate law matters, securities law and going public matters. The firm’s practice areas include, but are not limited to, forensic law and investigations, SEC investigations and SEC defense, corporate law matters, compliance with the Securities Act of 1933 securities offer and sale and registration statement requirements, including Regulation ARegulation A+ , private placement offerings under Regulation D including Rule 504 and Rule 506 and Regulation S and PIPE Transactions as well as registration statements on Forms S-1Form F-1,  Form S-8 and Form S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including Form 8-A and Form 10 registration statements, reporting on Forms 10-QForm 10-K and Form 8-KForm 6-K and SEC Schedule 14C Information and SEC Schedule 14A Proxy Statements; Regulation A / Regulation A+ offerings; all forms of going public transactions; mergers and acquisitions; applications to and compliance with the corporate governance requirements of national securities exchanges including NASDAQ and NYSE MKT and foreign listings; crowdfunding; corporate; and general contract and business transactions.