October was a busy month for the Securities and Exchange Commission (SEC). On October 30, 2015, the day the agency finally voted to adopt the crowdfunding final rules, it also issued proposed rules to amend: (1) Rule 147, which currently provides a safe harbor for compliance with the intrastate exemption; and (2) Rule 504 of Regulation D, which provides an exemption for certain offerings conducted in compliance with applicable state law.[1] (For more discussion on Rule 504 of Regulation D) The full text of the proposed rules is available here. In this multi-part blog series, we will look at the proposed amendments to Rule 147 and Rule 504.
What are the Rules for an Offering in One State? Rule 147 Intrastate Exemption: Background
We touched briefly on the concept of intrastate exemption in our previous blog series, “Crowdfunding: Is It Right for My Business?”. But before there was intrastate crowdfunding, there was intrastate offering. What is an intrastate offering? It’s an offering of securities (often stock of a company) wholly within a single state.
Section 3(a)(11) of the Securities Act of 1933 is generally known as the “intrastate exemption,” an exemption as old as the statute itself. The obvious reason for the exemption is that intrastate offerings do not involve interstate commerce and, thus, are outside of the scope of the Securities Act. The Securities Act gets its authority based on certain connections to interstate commerce or other basis. To qualify for the intrastate offering exemption, the transaction must be “genuinely local in character,” that is, local financing by local industries carried out through local investment.[2] This means that the issuer is organized and does business in the state where it is offering the securities and makes offers and sales only to residents of that state.[3]
To help companies make a decision on whether they qualify, the rule creates a “safe harbor,” or a set of objective criteria for determining whether an issuer is deemed to be “doing business within” a state, which, if followed, will allow the issuer to know they are safe from legal challenge, as follows:
- The issuer derives at least 80% of its gross revenues within the state;
- The issuer has at least 80% of its assets located within the state;
- The issuer intends to use and uses at least 80% of the net proceeds from the offering in connection with the operation of a business or real property or rendering of services within the state; and
- The principal office of the issuer is located within the state.[4]
For truly local, community-based, businesses, this exemption offers a unique combination of flexibility and simplicity that is not available in other exempt offerings. For example, the intrastate exemption does not limit the amount to be raised or the number of purchasers, nor does it require that the purchasers be accredited investors or that there be certain prescribed disclosures. Moreover, the securities are freely transferable to other residents of the state, unlike restricted securities for which there is limited or no market if the investor wants to liquidate his or her investment. Additionally, general solicitation can be made, as long as it is restricted to residents of that state. The SEC has recently suggested that the use of the Internet would be permissible if the Internet site implements adequate measures to ensure that offers are made only to persons resident in the relevant state, such as disclaimers, restrictive legends, and limiting access to persons who confirm they are residents.[5]
The tricky part of the intrastate exemption is that it can be lost if one of the offerees or purchasers turns out to be a non-resident. Thus, the issuer should make every effort to ensure that every offeree and purchaser is a resident. And this may be a harder analysis with many potential investors (particularly the wealthy ones) having ties to multiple states. Rule 147 provides examples of precautions that an issuer must take, such as obtaining a written representation as to the purchaser’s residence and placing a legend on the certificate that the securities have not been registered and setting forth the limitations on resale.[6] Needless to say, this is an exemption from the federal registration requirements only and does not obviate the need for compliance with applicable state laws, which can be just as costly and burdensome as the federal registration, depending on the state. In some cases it might be easier to get a federal exemption from a different rule that pre-empts state law than try to comply with state requirements.
This post was part of a multi-part series on the SEC proposed rules on Rule 147 and Rule 504 of Regulation D. You can find the other posts by searching our blogs at www.mcbrideattorneys.com. In our next post, we will discuss the proposed amendments to Rule 147 in detail.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
Steps have been taken to verify the contents of this article prior to publication. However, readers should not, and may not, rely on this article. Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.
About the Author
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Firm, PLLC, which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: 407-517-0064; [email protected], or www.mcbrideattorneys.com.
[1] SEC, Exemption To Facilitate Intrastate and Regional Securities Offerings (Nov. 10, 2015), available at https://www.federalregister.gov/articles/2015/11/10/2015-28219/exemptions-to-facilitate-intrastate-and-regional-securities-offerings#h-88. Unless otherwise noted, all references to the proposed rules are from the aforesaid Federal Register notice.
[2] 17 C.F.R. § 230.147.
[3] 15 U.S.C. § 77c(a)(11).
[4] 17 C.F.R. § 230.147(c)(2).
[5] SEC, Securities Act Rule: Questions and Answers of General Applicability (Jan. 23, 2015), Question 141.04.
[6] 17 C.F.R. § 230.147(f).