Exemptions To Facilitate Intrastate and Regional Securities Offerings, 83494-83554 [2016-26348]

Download as PDF 83494 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 200, 230, 239, 240, 249, 270 and 275 [Release Nos. 33–10238; 34–79161; File No. S7–22–15] RIN 3235–AL80 Exemptions To Facilitate Intrastate and Regional Securities Offerings Securities and Exchange Commission. ACTION: Final rules. AGENCY: We are adopting amendments to modernize Rule 147 under the Securities Act of 1933, which provides a safe harbor for compliance with the Section 3(a)(11) exemption from registration for intrastate securities offerings. We are also establishing a new intrastate offering exemption under the Securities Act, designated Rule 147A, which will be similar to amended Rule 147, but will have no restriction on offers and will allow issuers to be incorporated or organized outside of the state in which the intrastate offering is conducted provided certain conditions are met. The amendments to Rule 147 and new Rule 147A are designed to facilitate capital formation, including through offerings relying upon intrastate crowdfunding provisions under state securities laws, while maintaining appropriate investor protections and providing state securities regulators with the flexibility to add additional investor protections they deem appropriate for offerings within their state. We also are adopting amendments to Rule 504 of Regulation D under the Securities Act to facilitate issuers’ capital raising efforts and provide additional investor protections. The amendments to Rule 504 will increase the aggregate amount of securities that may be offered and sold in any twelvemonth period from $1 million to $5 million and disqualify certain bad actors from participation in Rule 504 offerings. In light of these amendments to Rule 504, we are also repealing Rule 505. DATES: Effective date: Revised 17 CFR 230.147 (Rule 147) and new 17 CFR 230.147A (Rule 147A) will be effective on April 20, 2017. The amendments to 17 CFR 230.504 (Rule 504) and 17 CFR 200.30–1 (Rule 30–1) will be effective on January 20, 2017. The removal of 17 CFR 230.505 (Rule 505) will be effective on May 22, 2017. All other amendments in this rule will be effective on May 22, 2017. Comment date: Comments regarding the collection of information asabaliauskas on DSK3SPTVN1PROD with RULES SUMMARY: VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 requirements within the meaning of the Paperwork Reduction Act of 1995 should be received on or before January 20, 2017. ADDRESSES: Persons submitting comments on the collection of information requirements should direct the comments to the Commission by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/final.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number S7– 22–15 on the subject line; or • Use the Federal eRulemaking Portal (https://www.regulations.gov). Follow the instructions for submitting comments. Paper Comments • Send paper comments to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. FOR FURTHER INFORMATION CONTACT: With regard to the final rules, Anthony G. Barone, Special Counsel, Jenny Riegel, Special Counsel, or Ivan Griswold, Attorney-Advisor, Division of Corporation Finance, at (202) 551–3460, and with regard to guidance on brokerdealer registration, Timothy J. White, Senior Special Counsel, Division of Trading and Markets, at (202) 551–5550, U.S. Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–3628. SUPPLEMENTARY INFORMATION: We are adopting new Rule 147A and are adopting amendments to Rule 147 1 and Rule 504 2 of Regulation D 3 under the Securities Act of 1933 (the ‘‘Securities Act’’).4 We are repealing Rule 505 5 of Regulation D. Table of Contents I. Introduction and Background II. Amendments to Rule 147 and New Rule 147A A. Explanation of Amendments to Rule 147 and New Rule 147A 1. Manner of Offering 2. Elimination of Residence Requirement for Issuers B. Common Requirements of the Amendments to Rule 147 and New Rule 147A 1. Requirements for Issuers ‘‘Doing Business’’ In-State 2. Reasonable Belief as to Purchaser Residency Status 3. Residence of Entity Purchasers 1 17 CFR 230.147. CFR 230.504. 3 17 CFR 230.500 through 230.508. 4 15 U.S.C. 77a et seq. 5 17 CFR 230.505. 2 17 PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 4. Limitation on Resales 5. Integration 6. Disclosures to Investors 7. State Law Requirements C. Additional Considerations 1. Notice Filings 2. Intrastate Broker Dealer Exemption 3. Section 12(g) Registration 4. Exclusion of Investment Companies 5. Trust Indenture Act 6. Other Requirements III. Amendments to Rules 504 and 505 of Regulation D A. Overview of Rules 504 and 505 B. Amendments to Rule 504 C. Repeal of Rule 505 IV. Other Matters V. Economic Analysis A. Baseline 1. Current Market Participants 2. Alternative Methods of Raising up to $5 Million of Capital B. Analysis of Final Rules 1. Broad Economic Considerations 2. Analysis of Amendments to Existing Rule 147 and New Rule 147A 3. Analysis of Amendments to Rule 504 4. Analysis of Repeal of Rule 505 VI. Paperwork Reduction Act A. Rules 147(f)(1)(iii) and 147A(f)(1)(iii) B. Amendments to Rule 504 of Regulation D VII. Final Regulatory Flexibility Act Analysis VIII. Statutory Basis and Text of Final Amendments I. Introduction and Background On October 30, 2015, we proposed amendments to Rule 147 and Rule 504 under the Securities Act to assist smaller companies with capital formation consistent with other public policy goals, including investor protection.6 In developing final rules, we considered recommendations by the Advisory Committee on Small and Emerging Companies (‘‘ACSEC’’) 7 and the most recent SEC GovernmentBusiness Forum on Small Business 6 See SEC Rel. No. 33–9973 [80 FR 69786] (Nov. 10, 2015) (‘‘Proposing Release’’). 7 See Recommendation to the Commission by the Advisory Committee on Small and Emerging Companies to Modernize Rule 147 under the Securities Act of 1933 (Sept. 23, 2015) (‘‘2015 ACSEC Recommendation’’), available at https:// www.sec.gov/info/smallbus/acsec/acsecrecommendation-modernize-rule-147.pdf. The Commission established the ACSEC in 2011 with the objective of providing the Commission with advice on its rules, regulations and policies with regard to its mission of protecting investors, maintaining fair, orderly and efficient markets and facilitating capital formation, as they relate to: (1) Capital raising by emerging privately-held small businesses (emerging companies) and publicly traded companies with less than $250 million in public market capitalization (smaller public companies) through securities offerings, including private and limited offerings and initial and other public offerings; (2) trading in the securities of emerging companies and smaller public companies; and (3) public reporting and corporate governance requirements of emerging companies and smaller public companies. Advisory Committee on Small and Emerging Companies, SEC Rel. No. 33–9258 (Sept. 12, 2011) [76 FR 57769 (Sept. 16, 2011)]. E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES Capital Formation (‘‘Small Business Forum’’) 8 and comment letters received on the Proposing Release.9 Today we are amending Rule 147 and establishing a new Securities Act exemption, designated Rule 147A. We are also amending Rule 504 of Regulation D. We believe the final rules will facilitate capital formation by smaller companies by increasing the utility of the current Securities Act exemptive framework for smaller offerings while maintaining appropriate protections for investors. The final rules complement recent efforts by the U.S. Congress,10 state legislatures,11 and state securities 8 See Final Report of the 2015 SEC Government Business Forum on Small Business Capital Formation (April 2016) (‘‘2015 Small Business Forum Recommendations’’), available at https:// www.sec.gov/info/smallbus/gbfor34.pdf. The Small Business Investment Incentive Act of 1980 directed the Commission to conduct an annual governmentbusiness forum to undertake an ongoing review of the financing problems of small businesses. 15 U.S.C. 80c–1. The Small Business Forum has met annually since 1982 to provide a platform to highlight perceived unnecessary impediments to small business capital formation and address whether they can be eliminated or reduced. Each forum seeks to develop recommendations for government and private action to improve the environment for small business capital formation, consistent with other public policy goals, including investor protection. Information about the Small Business Forum is available at https://www.sec.gov/ info/smallbus/sbforum.shtml. 9 The comment letters received in response to the Proposing Release are available at https:// www.sec.gov/comments/s7-22-15/s72215.shtml. 10 Congress enacted the Jumpstart Our Business Startups Act of 2012 (‘‘JOBS Act’’), which was signed into law by President Obama on April 5, 2012. Public Law 112–106, 126 Stat. 306. Pursuant to Title II of the JOBS Act, the Commission adopted new paragraph (c) of Rule 506 of Regulation D, removing the prohibition on general solicitation or general advertising for securities offerings relying on Rule 506. See SEC Rel. No. 33–9415 (July 10, 2013). Pursuant to Title IV of the JOBS Act, the Commission amended Regulation A in order to permit issuers to raise up to $50 million annually. See SEC Rel. No. 33–9741 (Mar. 25, 2015) (‘‘2015 Regulation A Release’’). Pursuant to Title III of the JOBS Act, the Commission adopted rules permitting companies to use the Internet to offer and sell securities through crowdfunding (‘‘Regulation Crowdfunding’’). See SEC Rel. No. 33–9974 (Oct. 30, 2015) (‘‘Regulation Crowdfunding Adopting Release’’). Congress also enacted the Fixing America’s Surface Transportation Act of 2015 (‘‘FAST Act’’), which was signed into law by President Obama on December 4, 2015. Public Law 114–94, Sec 129 Stat. 1312 (2015). The FAST Act includes several amendments to the federal securities laws, including a new exemption to Section 4 of the Securities Act for secondary sales of securities that are purchased by an accredited investor, among other requirements (Section 76001), and changes to facilitate initial public offerings by emerging growth companies (Sections 71001 through 71003). 11 See, e.g., Ala. Code § 8–6–11 (2014); Ariz. Rev. Stat. Ann. § 44–1844 (2015); Colo. Rev. Stat. § 11– 51–304(6) (2014); Fla. Stat. § 571.021, 517.061, 517.0611, 517.12, 517.121, 517.161, 626.9911; Ind. Code § 6–3.1–24–14 (2014); Ky. Rev. Stat. Ann. § 292.410–292.415 (2015); Me. Rev. Stat. Ann. tit. 32, § 16304, sub–§ 6–a (2014). VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 regulators 12 to modernize existing federal and state securities laws and regulations to assist smaller companies with capital formation. We believe our amendment to Rule 504 to increase its aggregate offering ceiling from $1 million to $5 million will significantly diminish the utility of Rule 505 and we are therefore repealing that rule. Consistent with commenters’ suggestions 13 and the recommendations of the 2015 Small Business Forum,14 we are retaining and modernizing Rule 147 under the Securities Act as a safe harbor for intrastate offerings exempt from registration pursuant to Securities Act Section 3(a)(11). These amendments will modernize the safe harbor, while keeping within the statutory parameters of Section 3(a)(11), so that issuers may continue to rely upon the rule for offerings pursuant to state law exemptions, including crowdfunding provisions, that are conditioned upon 12 See, e.g., D.C. Mun Regs. tit. 26–B, § 250 (2014); Ga. Comp. R. & Regs. 590–4–08 (2011); Idaho Code Ann. § 30–14–203 (providing an exemption by order on a case-by-case basis); Kan. Admin. Regs. § 81–5–21 (2011). 13 Letter from David M. Lynn, Chair, Federal Regulation of Securities Committee, Business Law Section, American Bar Association, April 8, 2016 (‘‘ABA Letter’’); Letter from Christopher D. Miller, Economic and Downtown Development Director, City of Adrian, Michigan, January 8, 2016 (‘‘City of Adrian Letter’’); Letter from Keith Paul Bishop, Former California Commissioner of Corporations, December 30, 2015 (‘‘Bishop Letter’’); Letter from Deborah L. Gunny and Cathryn S. Gawne, CoChairs, Corporations Committee, Business Law Section, State Bar of California, January 8, 2016 (‘‘California Bar Letter’’); Letter from Kim Wales, CEO, Wales Capital, and Executive Board Member, CrowdFund Intermediary Regulatory Advocates, January 11, 2016 (‘‘CFIRA Letter’’); Letter from Reps. Tom Emmer, Gwen Moore, Patrick McHenry, John Carney, Scott Garrett, Denny Heck, Randy Neugebauer, Terri Sewell, Luke Messer, Keith Ellison, Peter T. King, Robert Hurt, Robert Pittenger, Roger Williams and Stephen Fincher, U.S. House of Representatives, October 7, 2016 (‘‘Congressional Letter’’); Letter from Sara Hanks, CEO, CrowdCheck, Inc., January 2, 2016 (‘‘CrowdCheck Letter’’); Letter from Samuel S. Guzik, Securities Attorney, Guzik Associates, January 18, 2016 (‘‘Guzik Letter’’); Letter from Brian Knight, Associate Director, Financial Policy, and Staci Warden, Executive Director; Center for Financial Markets, Milken Institute, January 11, 2016 (‘‘Milken Letter’’); Letter from Judith M. Shaw, President, North American Securities Administrators Association, Inc. (‘‘NASAA’’) and Maine Securities Administrator, January 11, 2016 (‘‘NASAA Letter’’); Letter from Youngro Lee, Esq., Co-founder/CEO, NextSeed TX LLC, January 7, 2016 (‘‘NextSeed Letter’’); Letter from Amy E. Pearl, Founder and Executive Director, Hatch Innovation Inc., January 10, 2016 (‘‘Pearl Letter’’); Letter from Joe M. Wallin, Attorney, January 11, 2016 (‘‘Wallin Letter’’); Letter from Kristin Wolff, January 11, 2016 (‘‘Wolff Letter’’); Letter from Howard Orloff, CMO, ZacksInvest, November 19, 2015 (‘‘Orloff Letter’’); Letter from Anthony J. Zeoli, Partner, Freeborn & Peters LLP, November 5, 2016 (‘‘Zeoli Letter’’). No commenters supported the proposed elimination of Rule 147 as a safe harbor under Section 3(a)(11). 14 See 2015 Small Business Forum Recommendations. PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 83495 compliance with Section 3(a)(11) and Rule 147. Securities Act Section 3(a)(11) provides an exemption from registration under the Securities Act for ‘‘[a]ny security which is part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within, or, if a corporation, incorporated by and doing business within, such State or Territory.’’ 15 In 1974, the Commission adopted Rule 147 under the Securities Act to provide objective standards for local businesses seeking to rely on Section 3(a)(11).16 The Rule 147 safe harbor was intended to provide assurances that the intrastate offering exemption would be used for the purpose Congress intended in enacting Section 3(a)(11), namely the local financing of companies by investors within the company’s state or territory.17 Rule 147 reflects this Congressional intent and generally relies upon state regulation to effectively protect investors. Notwithstanding the importance of these limitations, due to developments in modern business practices and communications technology in the years since Rule 147 was adopted, we have determined that it is necessary to update the requirements of Rule 147 to ensure its continued utility.18 We are also establishing a new intrastate offering exemption under the Securities Act, designated Rule 147A, that will further accommodate modern business practices and communications technology and provide an alternative means for smaller companies to raise capital locally. We are adopting new Rule 147A pursuant to our general exemptive authority under Section 28 of the Securities Act,19 and therefore, new 15 15 U.S.C. 77c(a)(11). SEC Rel. No. 33–5450 (Jan. 7, 1974) [39 FR 2353 (Jan. 21, 1974)] (‘‘Rule 147 Adopting Release’’). See also SEC Rel. No. 33–5349 (Jan. 8, 1973) [38 FR 2468 (Jan. 26, 1973)] (‘‘Rule 147 Proposing Release’’). 17 See Rule 147 Adopting Release. See also H.R. Rep. No. 73–85, at 6–7 (1933), H.R. Rep. No. 73– 1838, at 40–41 (1934) (Conf. Rep.) and SEC Rel. No. 33–4434, at 4 (Dec. 6, 1961) [26 FR 11896 (Dec. 13, 1961)] (‘‘1961 Release’’). 18 The Commission has not amended Rule 147 since its adoption, other than in 2013 when the Commission adopted technical amendments to Rules 145, 147, 152 and 155 to update references to Section 4(2) of the Securities Act, which was renumbered as Section 4(a)(2) by Section 201(c) of the JOBS Act, Public Law 112–106, sec. 201(c), 126 Stat. 306, 314 (Apr. 5, 2012). See SEC Rel. No. 33– 9414 [78 FR 44730] (July 10, 2013). See also ABA Letter; Milken Letter. 19 15 U.S.C. 77z–3. For the reasons discussed throughout this release, we find that the Rule 147A 16 See E:\FR\FM\21NOR2.SGM Continued 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES 83496 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations Rule 147A will not be subject to the statutory limitations of Section 3(a)(11). Accordingly, Rule 147A will have no restriction on offers, but will require that all sales be made only to residents of the issuer’s state or territory to ensure the intrastate nature of the exemption. Rule 147A also will not require issuers to be incorporated or organized in the same state or territory where the offering occurs so long as issuers can demonstrate the in-state nature of their business, which we believe will expand the number of businesses that will be able to seek intrastate financing under Rule 147A, as compared to amended Rule 147. Certain provisions of existing Rule 147 concerning legends and mandatory disclosures to purchasers and prospective purchasers will apply to offerings conducted pursuant to amended Rule 147 and Rule 147A.20 As in current Rule 147, nothing in either amended Rule 147 or new Rule 147A will obviate the need for compliance with any applicable state law relating to the offer and sale of securities. Thus, states will retain the flexibility to adopt requirements that are consistent with their respective interests in facilitating capital formation and protecting their resident investors in intrastate securities offerings, including the authority to impose additional disclosure requirements regarding offers and sales made to persons within their state or territory, or the authority to limit the ability of certain bad actors from relying on applicable state exemptions. In addition, both federal and state antifraud provisions will continue to apply to offers and sales made pursuant to amended Rule 147 and new Rule 147A. The staff will seek to collaborate with state regulators in gathering information about intrastate crowdfunding offerings and, based on the sharing of this information and other relevant inputs, the staff will undertake to study and submit a report to the Commission, no later than three years following the effective date of amended Rule 147 and new Rule 147A, on capital formation and investor protection in offerings under these rules. The report will include, but not be limited to, a review of information about: (1) The use of amended Rule 147 and new Rule 147A; (2) repeat use by the same issuers of amended Rule 147 or new Rule 147A; (3) the use by issuers of alternative federal offering exemptions exemption being adopted today is necessary and appropriate in the public interest and consistent with the protection of investors. 20 See Rules 147(f) and 147A(f). VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 concurrently or close in time to an offer or sale under amended Rule 147 or new Rule 147A; (4) fraud associated with, or issuer non-compliance with provisions of, amended Rule 147 or new Rule 147A; (5) the role of intrastate broker-dealers and other intermediaries in offerings conducted pursuant to amended Rule 147 or new Rule 147A; and (6) the application of state bad actor disqualification provisions in offerings conducted pursuant to amended Rule 147 or new Rule 147A to inform whether the Commission should consider including bad actor disqualification provisions in amended Rule 147 and new Rule 147A. We also are amending Rule 504 of Regulation D under the Securities Act to increase the aggregate amount of securities that may be offered and sold pursuant to Rule 504 in any twelvemonth period from $1 million to $5 million and to disqualify certain bad actors from participation in Rule 504 offerings. The higher offering ceiling amount will promote capital formation by increasing the flexibility of state securities regulators to implement coordinated review programs to facilitate regional offerings.21 The bad actor disqualification provisions will provide for greater consistency across Regulation D. We believe these amendments to Rule 504 will significantly diminish the utility of Rule 505, which historically has been little utilized in comparison to Rule 506 of Regulation D.22 We, therefore, are repealing Rule 505. 21 The state registration of securities offerings under coordinated review programs is an example of the efforts being undertaken by states to streamline the state registration process for issuers seeking to undertake multi-state registrations. These programs establish uniform review standards and are designed to expedite the registration process, thereby potentially saving issuers time and money. Participation in such programs is voluntary. The states have created coordinated review protocols for equity, small company and franchise offerings; direct participation program securities; and for certain offerings of securities pursuant to Regulation A. More information on coordinated review programs is available at https:// www.nasaa.org/industry-resources/corporationfinance/coordinated-review/. 22 For the period 2009 through 2015, 132,091 Forms D were filed. Of these Forms D, 3,758 reported an offering made in reliance upon Rule 505 of Regulation D, representing approximately 3% of all offerings made in reliance upon Regulation D and 5% of all Regulation D offerings raising less than $5 million. During this time period, 1,548 Forms D reported reliance only on Rule 505, and 2,210 Forms D reported reliance on Rule 505 and another Regulation D exemption. By contrast, for the period 2009 through 2015, 5,532 filings reported an offering made in reliance upon Rule 504, representing approximately 4% of all offerings made in reliance upon Regulation D and 13% of all Regulation D offerings raising less than $1 million. During this time period, 4,308 Forms D PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 II. Amendments to Rule 147 and New Rule 147A A. Explanation of Amendments to Rule 147 and New Rule 147A Numerous commenters 23 and the 2015 Small Business Forum 24 recommended retaining Rule 147 as a safe harbor under Section 3(a)(11). Many of these commenters also recommended adopting a substantially similar new exemption pursuant to the Commission’s general exemptive authority under Section 28 as an alternative to the Section 3(a)(11) exemption and safe harbor for companies that wish to conduct intrastate offerings under slightly broader conditions than contemplated by Section 3(a)(11). After considering the comments, we are amending Rule 147 to modernize the rule to incorporate most of our proposed amendments, except for the two proposed amendments that do not fit within the statutory limits of Section 3(a)(11)— allowing issuers to make offers accessible to out-of-state residents and to be incorporated out-of-state. These two provisions are the distinguishing features of the new Rule 147A exemption that we are establishing pursuant to our general exemptive authority under Section 28. Aside from these two provisions, the remaining provisions of new Rule 147A are substantively the same as the provisions of amended Rule 147. 1. Manner of Offering a. Proposed Amendments Rule 147, as proposed, would have required issuers to limit sales to in-state residents, but would no longer have limited offers by the issuer to in-state residents.25 Accordingly, under our proposal, amended Rule 147 would have permitted issuers to engage in general solicitation and general advertising that could reach out-of-state residents in order to locate potential instate investors using any form of mass media, including unrestricted, publiclyavailable Internet Web sites, to advertise their offerings, so long as all sales of reported reliance only on Rule 504, and 1,224 Forms D reported reliance on Rule 504 and another Regulation D exemption. All other Form D filings during this period reported an offering made in reliance on Rule 506. 23 ABA Letter; City of Adrian Letter; Bishop Letter; California Bar Letter; CFIRA Letter; Congressional Letter; CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA Letter; NextSeed Letter; Pearl Letter; Wallin Letter; Wolff Letter; Orloff Letter; Zeoli Letter. No commenters supported the proposed elimination of Rule 147 as a safe harbor under Section 3(a)(11). 24 2015 Small Business Forum Recommendations. 25 See proposed Rule 147(d). E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations securities so offered were made to residents of the state or territory in which the issuer has its principal place of business. In the Proposing Release, the Commission noted that market participants and commenters have indicated that the combined effect of the statutory limitation on offers in Section 3(a)(11) and the prescriptive threshold requirements of Rule 147 unduly limits the availability of the exemption for local companies that would otherwise conduct intrastate offerings.26 Given that proposed Rule 147 would have allowed offers to be made to or be accessible by out-of-state residents, including advertising offers on publiclyavailable Internet Web sites, the proposal would have required an issuer to include a prominent disclosure on all offering materials used in connection with a Rule 147 offering stating that sales will be made only to residents of the same state or territory as the issuer.27 This proposed disclosure requirement was intended to advise investors who are not residents of the state in which sales are being made that the intrastate offering would be unavailable to them. As proposed, Rule 147 would no longer have remained a safe harbor for conducting a valid intrastate exempt offering under Section 3(a)(11). An issuer that attempted to comply with Rule 147, as proposed to be amended, but failed to do so, could rely on any other available exemption. Failure to satisfy the requirements of Rule 147, as proposed to be amended, however, would also have likely resulted in a failure to satisfy the statutory requirements for the intrastate offering exemption under Section 3(a)(11), since the requirements of Section 3(a)(11) would be more restrictive than under Rule 147, as proposed to be amended. b. Comments on Proposed Amendments asabaliauskas on DSK3SPTVN1PROD with RULES All commenters that addressed the issue expressed support for eliminating the limitation on offers to in-state residents while continuing to require that all sales be made to in-state residents.28 Many of these commenters 26 See Proposing Release at text accompanying note 18. 27 See proposed Rule 147(f)(3). 28 ABA Letter; NASAA Letter; Letter from Kurt N. Schacht, CFA, Managing Director, Standards and Advocacy, and Linda L. Rittenhouse, Director, Capital Markets Policy, CFA Institute, January 11, 2016 (‘‘CFA Letter’’); CrowdCheck Letter; CFIRA Letter; Guzik Letter; NextSeed Letter; Milken Letter; Zeoli Letter; Bishop Letter; Wolff Letter; City of Adrian Letter; Pearl Letter; Finn Terdal, Technology Coordinator, Hatch Innovation, January 11, 2016 (‘‘Terdal Letter’’); Letter from Simon R. Love, Managing Director, Hatch Lab, January 11, 2016 (‘‘Love Letter’’); Letter from John MacDougall, VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 also expressed support for retaining existing Rule 147 as a safe harbor under Section 3(a)(11), in order to allow issuers to take advantage of existing state crowdfunding provisions.29 As explained by one commenter, if the Commission eliminated the Rule 147 safe harbor, state legislative and/or rulemaking action would be required, since almost all of the state crowdfunding exemptions are premised on the offering qualifying under Section 3(a)(11) and its Rule 147 safe harbor.30 The commenter noted that eliminating the Rule 147 safe harbor would leave these state crowdfunding exemptions unavailable until states modified their exemptions to accommodate the removal of Rule 147 as a safe harbor to Section 3(a)(11).31 In order to avoid this problem, some commenters recommended that the Commission interpret Section 3(a)(11) and Rule 147 to allow for offers to be viewed by outof-state residents.32 A few of these commenters stated that Section 3(a)(11) should be interpreted to allow for offers to be viewed by out-of-state residents, so long as such offers indicate that they are being made to residents of a single state.33 One commenter also noted that issuers currently rely on Section 3(a)(11) Founder & CEO, MacDougall & Sons Bat Co. Inc., January 10, 2016 (‘‘MacDougall Letter’’); Letter from Erin Ely, January 10, 2016 (‘‘Ely Letter’’); Letter from Jim Newcomer, Ph.D., 4mation Advisers, January 10, 2016 (‘‘Newcomer Letter’’); Brandon P. Romano, Content Director, Brelion, LLC, January 6, 2016 (‘‘Brelion Letter’’); Letter from Sean Shepherd, CrwdCorp LLC, December 30, 2015 (‘‘CrwdCorp Letter’’). See also Congressional Letter (expressing general support for the proposed amendments to Rule 147). 29 See ABA Letter; CFIRA Letter; Congressional Letter; CrowdCheck Letter; NASAA Letter; California Bar Letter; Guzik Letter; Milken Letter; NextSeed Letter; Zeoli Letter; Bishop Letter; Wolff Letter; Pearl Letter; City of Adrian Letter; Orloff Letter; Wallin Letter. 30 NASAA Letter. According to the NASAA Letter, as of January 2016, of the 29 states plus the District of Columbia that adopted or were finalizing rulemaking implementing crowdfunding exemptions, 29 were premised on the offering qualifying under Section 3(a)(11) and its Rule 147 safe harbor: Alabama, Arizona, Colorado, District of Columbia, Georgia, Florida, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Montana, Nebraska, New Jersey, New Mexico, Oregon, South Carolina, Tennessee, Texas, Vermont, Virginia, Washington, and Wisconsin. As of January 2016, the exemptions were effective in 27 of the 30 jurisdictions: Minnesota and New Jersey were finalizing rulemaking, and New Mexico was working on draft regulations. Of the states with state crowdfunding exemptions, only Iowa and Vermont do not explicitly reference Rule 147, and Maine relies on Rule 504 rather than Section 3(a)(11). 31 Id. 32 ABA Letter; Guzik Letter; Zeoli Letter; Milken Letter; Pearl Letter. 33 ABA Letter; Guzik Letter; Zeoli Letter. PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 83497 and Rule 147 to conduct forms of intrastate offerings other than pursuant to state crowdfunding provisions.34 In the view of this commenter, removal of Rule 147 as a safe harbor under Section 3(a)(11) would also present problems for these exempt offerings, thereby severely restricting other local capital raising options.35 Although commenters overwhelmingly supported retaining existing Rule 147 as a safe harbor to Section 3(a)(11), many commenters also supported adopting a substantially similar new exemption under the Commission’s general exemptive authority under Section 28 for companies that conduct an intrastate offering but may not qualify for the Section 3(a)(11) exemption.36 Similarly, the 2015 Small Business Forum recommended that the Commission take a ‘‘side-by-side’’ approach in introducing a new Rule 147—as it did with Rule 506 and Regulation A 37— keeping old Rule 147 in place as a safe harbor under Section 3(a)(11) (but amending it to the extent permissible given the statutory limitations of Section 3(a)(11)) while also adopting a new exemption.38 Several commenters stated that establishing a new exemption under Section 28, in addition to retaining existing Rule 147, would afford the states time to amend their existing state crowdfunding provisions, as well as to adopt new state crowdfunding provisions.39 One commenter supported leaving the existing Rule 147 as a safe harbor to Section 3(a)(11) while adopting the proposed new exemption as new Rule 505.40 Several commenters supported our proposal to require prominent disclosure on all offering materials used in connection with a Rule 147 offering stating that sales will be made only to residents of the same state or territory as 34 NASAA Letter. For example, issuers may rely upon Section 3(a)(11) and Rule 147 for offerings registered under state securities laws, or pursuant to exemptions from state registration other than state crowdfunding provisions. 35 Id. 36 ABA Letter; City of Adrian Letter; Bishop Letter; California Bar Letter; CFIRA Letter; Congressional Letter; CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA Letter; NextSeed Letter; Pearl Letter; Wallin Letter; Orloff Letter; Zeoli Letter. 37 For example, pursuant to Title II of the JOBS Act, the Commission adopted the Rule 506(c) exemption that permits an issuer to engage in general solicitation under certain circumstances while retaining Rule 506(b) as a safe harbor, which prohibits general solicitation. Pursuant to Title IV of the JOBS Act, the Commission also adopted Tier 1 and Tier 2 categories under Regulation A. 38 2015 Small Business Forum Recommendations. 39 See, e.g., Pearl Letter; Orloff Letter. 40 Orloff Letter. E:\FR\FM\21NOR2.SGM 21NOR2 83498 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations the issuer.41 One commenter supported the proposed prominent disclosure requirement, but only to the extent it is required on all general solicitation and advertising materials.42 Two other commenters noted that appropriate accommodations should be made to permit use of space-constrained social media communications such as Twitter.43 Two commenters noted that the Commission’s efforts to modernize these requirements should preserve state authority over intrastate offerings, including the authority to impose additional disclosure requirements.44 c. Final Rules After considering these comments and the recommendations of the 2015 Small Business Forum, we are adopting new Rule 147A to allow issuers to make offers accessible to out-of-state residents, so long as sales are limited to in-state residents. We are also retaining amended Rule 147 as a safe harbor under Section 3(a)(11) to preserve the continued availability of existing state exemptive provisions that are specifically conditioned upon issuer reliance on Section 3(a)(11) and Rule 147. Issuers relying on amended Rule 147 as a safe harbor under Section 3(a)(11) must continue to limit all offers and sales to in-state residents.45 We believe offers made over the Internet that can be viewed by a significant number of out-of-state residents are not consistent with Section 3(a)(11) and Rule 147, even if such offers include prominent disclosure stating that sales will be made only to residents of the same state or territory as the issuer.46 When Section 3(a)(11) was enacted in 1934, Congress noted, among other things, that ‘‘a person who comes within the purpose of the exemption, but happens to use a newspaper for the circulation of his advertising literature, which newspaper is transmitted in interstate commerce, does not thereby lose the benefits of the exemption.’’ 47 Further, in 1937 the Commission released guidance on the nature of the Section 3(a)(11) exemption in the form of a letter from the Commission’s asabaliauskas on DSK3SPTVN1PROD with RULES 41 CFA Letter; CFIRA Letter; CrowdCheck Letter; NASAA Letter. 42 NASAA Letter. 43 CFIRA Letter; CrowdCheck Letter. 44 Congressional Letter; NASAA Letter. 45 See Rule 147(b). 46 Cf. ABA Letter; Guzik Letter; Zeoli Letter; Milken Letter; Pearl Letter. 47 See H.R. Rep. No. 73–1838, at 40–41 (1934) (Conf. Rep.). Section 3(a)(11) initially was enacted as Securities Act Section 5(c). When Congress enacted the Securities Exchange Act of 1934, it also amended the Securities Act, including revising and redesignating Section 5(c) as Section 3(a)(11). VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 General Counsel.48 The letter stated that securities exempt from registration pursuant to Section 3(a)(11) ‘‘may be made the subject of general newspaper advertisement (provided the advertisement is appropriately limited to indicate that offers to purchase are solicited only from, and sales will be made only to, residents of the particular state involved).’’ 49 In its 1961 Release, the Commission explained that in order ‘‘[t]o give effect to the fundamental purpose of the exemption, it is necessary that the entire issue of securities shall be offered and sold to, and come to rest only in the hands of residents within the state. If any part of the issue is offered or sold to a nonresident, the exemption is unavailable not only for the securities so sold, but for all securities forming a part of the issue, including those sold to residents.’’ 50 We do not read the legislative history for Section 3(a)(11) and the prior Commission statements as envisioning widespread out-of-state offers, but rather as recognition that some media of communication, such as a local newspaper or periodical, could only be imperfectly targeted to residents of a particular state. The Internet, however, is not similarly targeted to residents of a particular state, making it difficult for issuers to keep the distribution of such offers local in nature. Given the foregoing, we believe that the most appropriate means to permit the offer and sale of securities on Internet Web sites, or using any other form of mass media likely to reach significant numbers of out-of-state residents, is to adopt a new intrastate offering exemption pursuant to the Commission’s general exemptive authority under Section 28. Accordingly, new Rule 147A will require issuers to limit sales to in-state residents, but will not limit offers by the issuer to in-state residents. New Rule 147A thereby will permit issuers to engage in general solicitation and general advertising of their offerings, using any form of mass media, including unrestricted, publiclyavailable Internet Web sites, so long as sales of securities so offered are made only to residents of the state or territory in which the issuer is resident. 48 See SEC Rel. No. 33–1459 (May 29, 1937) [11 FR 10958 (Sept. 27, 1946)] (‘‘1937 Letter of General Counsel’’). 49 Id. 50 1961 Release; see also 1937 Letter of General Counsel (stating that Section 3(a)(11) is ‘‘limited to cases in which the entire issue of securities is offered and sold exclusively to residents of the state in question’’). PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 Consistent with the proposal, both Rule 147A and amended Rule 147 will require issuers to include prominent disclosure with all offering materials stating that sales will be made only to residents of the same state or territory as the issuer.51 We believe this disclosure will help alert potential investors that only residents of the state in which the issuer is located are eligible to participate in the offering. Nothing in this disclosure requirement, however, will prevent state authorities from imposing additional disclosure requirements or other requirements on offers or sales made to persons within their states. Two commenters noted that appropriate accommodations should be made to permit use of space-constrained social media communications such as Twitter.52 To accommodate spaceconstrained social media communication, when offering materials are distributed through a communications medium that has technological limitations on the number of characters or amount of text that may be included in the communication and including the required statements in their entirety, together with the other information, would cause the communication to exceed the limit on the number of characters or amount of text, an issuer could satisfy the disclosure requirement by including an active hyperlink to the required disclosure that otherwise would be required by the rules.The communication should prominently convey, through introductory language, that required information is provided through the hyperlink. We believe this guidance will accommodate advancements in social media, while still providing potential investors with the disclosure required by the rules. Where an electronic communication is capable of including the entirety of the required disclosure, along with the other information, without exceeding the applicable limit on the number of characters or amount of text, the use of a hyperlink to the required statements should not be used. 2. Elimination of Residence Requirement for Issuers a. Proposed Amendments For corporations, limited partnerships, trusts, or other forms of business organizations, we proposed to eliminate the current requirement in Rule 147 that limits the availability of the rule to issuers incorporated or 51 See Rules 147(f)(3) and 147A(f)(3). Letter; CrowdCheck Letter. 52 CFIRA E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations organized in the state in which an offering takes place. Our proposed amendments would have expanded the universe of eligible issuers by eliminating the current ‘‘residence’’ requirement, while continuing to require that an issuer have a sufficient in-state presence determined by the location of the issuer’s principal place of business.53 The proposed amendments also would have replaced the current rule’s ‘‘principal office’’ 54 requirements for an issuer with a ‘‘principal place of business’’ requirement.55 The proposed rule defined the term ‘‘principal place of business’’ to mean the location from which the officers, partners, or managers of the issuer primarily direct, control and coordinate the activities of the issuer.56 As noted in the Proposing Release, an issuer would have been able to have a ‘‘principal place of business’’ within only one state or territory and would have therefore been able to conduct an offering pursuant to amended Rule 147 only within that particular state or territory. We also proposed to restrict the ability of an issuer that has changed its principal place of business from conducting an intrastate offering in a different state for a period of nine months from the date of the last sale in the prior state,57 which was consistent with the duration of the resale limitation period specified in proposed Rule 147(e).58 asabaliauskas on DSK3SPTVN1PROD with RULES b. Comments on Proposed Amendments Commenters were divided on the proposal to eliminate the requirement in Rule 147 that entities be incorporated or organized under the laws of the state or territory in which the offering takes place. Several commenters supported eliminating this requirement and stated that the jurisdiction of entity formation should not affect the ability of an issuer to be considered resident for purposes of an intrastate offering and that there are valid business reasons for incorporating or organizing in states, such as Delaware, which do not detract from an issuer’s connection to the state 53 See proposed Rule 147(c)(1). See also discussion on principal place of business in Section II.B.1 below, and the related discussion of the proposed requirement that an issuer satisfy at least one of four threshold requirements in order to help ensure the in-state nature of its business. 54 See 17 CFR 230.147(c)(1)(ii) and 17 CFR 230.147(c)(2)(iv). 55 See proposed Rule 147(c)(1). 56 See proposed Rule 147(c)(1). 57 See Note 1 to proposed Rule 147(c)(1). 58 See proposed Rule 147(e) (proposing to limit resales of a given security purchased in an offering pursuant to Rule 147 to out-of-state residents for a nine-month period from the date such security is sold by the issuer). VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 in which its principal place of business is located.59 Other commenters opposed eliminating the requirement that entities be incorporated or organized under the laws of the state in which the offering takes place,60 and some of these commenters stated that the intrastate exemption should promote state and local economic development goals in addition to capital formation—goals that, in their view, would be curtailed in the absence of an in-state organization requirement.61 Commenters also were divided on replacing the current in-state organization requirement in Rule 147(c)(1) with a principal place of business requirement. While two commenters viewed the principal place of business standard along with a ‘‘doing business’’ test as sufficiently demonstrating the in-state nature of an issuer’s business,62 two other commenters opposed the proposed principal place of business requirement.63 One commenter noted that the jurisdictional reach of state securities laws is independent of whether an issuer is conducting any business within the state and indicated that a state’s jurisdiction is established by the offer or sale of a security within the state.64 Another commenter stated 59 See Bishop Letter (‘‘The application of state securities laws is not dependent upon the state of incorporation or organization of the issuer. Rather, the application of these laws depends upon whether an offer or sale is being made within the state.’’); CFIRA Letter; CFA Letter (the proposed approach ‘‘continues the issuer-state connection through the actual business activities and employment aspects that accompany a principal place of business and recognizes the lack of connection between state of incorporation and actual business activities.’’); CrowdCheck Letter; NASAA Letter; NextSeed Letter. 60 Love Letter; MacDougall Letter; Newcomer Letter; Pearl Letter; Wolff Letter. 61 Love Letter (‘‘If the company is incorporated in the state where sales occur, it is another way to encourage local funds to be retained locally’’); MacDougall Letter (stating that incorporating out of state to avoid state taxes ‘‘goes against the ‘spirit’ of the law and sends the wrong message’’); Pearl Letter (‘‘intrastate laws are focused on state economic development in addition to capital formation for entrepreneurs and financial return for investors, and therefore the retention of capital within the state is a necessary component of the successful spread of benefits’’); Wolff Letter (stating that local investing confers benefits that extend beyond financial return and seeks to encourage the spread of such social, economic, and other benefits while lifting the restriction on state incorporation entirely changes the nature of the intrastate crowdfunding). 62 NASAA Letter; NextSeed Letter. 63 Bishop Letter; Letter from David L. Sjursen, CEO & Founder, Exante Regulatory Compliance Consultants Inc., December 2, 2015 (‘‘Exante Letter’’). 64 Bishop Letter (‘‘[T]he Commission’s proposed ‘presence’ requirements would not augment California’s ability to enforce its securities laws for the protection of resident investors as assumed by PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 83499 that the principal place of business requirement is ‘‘anti-competitive in nature and disruptive in spurring economic growth for small businesses.’’ 65 Several commenters supported the proposed nine-month waiting period until the offering comes to rest, consistent with the requirements of proposed Rule 147(e), before an issuer may change its principal place of business to another state or territory and make a subsequent offering of securities in that new state or territory in reliance on proposed Rule 147.66 No commenters opposed the proposed waiting period. c. Final Rules We are adopting changes to the residency requirements for issuers conducting exempt intrastate offerings largely as proposed, but with certain modifications to reflect our decision to retain existing Rule 147 as a safe harbor to the Section 3(a)(11) exemption. Since we are retaining Rule 147 as a safe harbor and since Section 3(a)(11) expressly requires that if the issuer is a corporation that it be ‘‘incorporated by and doing business within, such state or territory,’’ we are not eliminating the ‘‘residence’’ requirement in current paragraph (c)(1) of Rule 147, as proposed. Instead, we are retaining the requirement that an issuer shall be deemed a resident of a state or territory in which it is incorporated or organized for issuers that are incorporated or organized under state or territorial law, such as corporations, limited partnerships and trusts. In addition, for consistency between the provisions of Rule 147 and new Rule 147A,67 throughout amended Rule 147, we are replacing the ‘‘principal office’’ requirement with the proposed ‘‘principal place of business’’ requirement.68 Instead of ‘‘principal the Commission. If a state believes that its existing qualification or exemption requirements inadequately protect offerees and purchasers, it can amend those requirements. . . . [I]t is far more logical to require only that the issuer be organized in the state or territory or qualified to transact intrastate business in the state or territory’’). 65 Exante Letter. 66 CFIRA Letter; CrowdCheck Letter; NASAA Letter. 67 See Rules 147(c)(1), 147(d)(1), 147A(c)(1) and 147A(d)(1). The principal place of business definition is consistent with the use of that term in Exchange Act Rule 3a71–3, 17 CFR 240.3a71–3, for cross-border security based swap dealing activity, and the use of the term ‘‘principal office and place of business’’ in Investment Advisers Act Rule 203A–3(c), 17 CFR 275.203A–3(c). 68 For example, as proposed, we are amending paragraph (d)(1) of Rule 147 to replace the ‘‘principal office’’ requirement with ‘‘principal place of business.’’ See also Section II.B.3 below E:\FR\FM\21NOR2.SGM Continued 21NOR2 83500 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES office,’’ amended Rule 147 and new Rule 147A will refer to the term ‘‘principal place of business’’ to mean the location from which the officers, partners, or managers of the issuer primarily direct, control and coordinate the activities of the issuer.69 We do not expect this change will significantly alter the scope of existing Rule 147 as we believe ‘‘principal place of business’’ is conceptually similar to principal office location. Under amended Rule 147, issuers that are incorporated or organized under state or territorial law will be deemed a ‘‘resident’’ of a particular state or territory in which they are both incorporated or organized and have their ‘‘principal place of business.’’ 70 Specifically, the ‘‘principal office’’ requirement contained in current Rule 147(c)(2)(iv) 71 will be updated and replaced with the ‘‘principal place of business’’ requirement in amended Rule 147(c)(1)(i). Similarly, issuers that are general partnerships, or in the form of another business organization not organized under any state or territorial law, shall be deemed to be a ‘‘resident’’ of the state or territory in which they have their ‘‘principal place of business.’’ 72 Consistent with the proposal, new Rule 147A(c)(1) will rely solely on the principal place of business requirement to determine the state or territory in which the issuer shall be deemed a ‘‘resident,’’ not only for corporate issuers, but for all issuers, including issuers that are not organized under any state or territorial law, such as general partnerships.73 Although commenters were divided on whether to retain the requirement that entities be incorporated or organized under the laws of the state in which the offering takes place, we continue to believe that using a principal place of business requirement in lieu of an in-state formation requirement to establish the issuer’s residency is more consistent with modern business practices in which issuers are permitted to incorporate or organize in states other than the state or territory of their principal place of business, for example, to take advantage of well-established bodies of corporate or partnership discussing the use of the ‘‘principal place of business’’ standard for the residence of entity purchasers. 69 See Rules 147(c)(1), 147(d)(1), 147A(c)(1) and 147A(d)(1). 70 See 17 CFR 230.147(c)(1)(i). 71 See 17 CFR 230.147(c)(1)(iv). 72 See 17 CFR 230.147(c)(1)(ii). 73 See note 56 above. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 law.74 We continue to believe that, outside the statutory requirements of Section 3(a)(11), the jurisdiction of entity formation should not affect the ability of an issuer to be considered ‘‘resident’’ for purposes of an intrastate offering exemption at the federal level. While we recognize that some commenters supported retaining an instate formation requirement as a means of ensuring that the economic and social benefits of the offering remain within the state, the objectives of our rulemaking in this area are more broadly focused on facilitating capital formation by small businesses.75 We believe that retaining an in-state formation requirement in new Rule 147A would be unnecessarily restrictive and limit the usefulness of the exemption, potentially to the detriment of local economic development. We are, however, retaining the proposed principal place of business requirement, despite the views of several commenters that such a requirement is unnecessary or inappropriate.76 Although, as noted by one commenter, the jurisdictional reach of state securities laws is independent of whether an issuer is conducting any business within the state since a state’s jurisdiction is established by the offer or sale of a security within the state,77 we believe that states will have a particular interest in regulating intrastate offerings for the protection of investors where there is a meaningful nexus between the state, issuers and investors. To ensure an appropriate connection between the state, issuers and investors, amended Rule 147(d) and Rule 147A(d) will require an issuer to be a resident of the same state where purchasers are resident or where the issuer reasonably believes they are resident.78 Viewed together, paragraphs (c) and (d) of each of Rules 147 and 147A help to ensure the local intrastate character of the offering by requiring that both issuers and purchasers reside and have their principal place of business (for purchasers, the principal place of business requirement only applies to 74 For example, data provided by issuers in Form D filings with the Commission indicates that approximately 37% of Rule 504 offerings and 39% of Rule 505 offerings indicated in their Form D filings that they had different states of incorporation and principal places of business. Form D data also indicates that approximately 65% of all Rule 506 offerings initiated during 2009–2015 reported different states of incorporation and operations. See discussion in Section V.B.2.b.ii below. 75 See e.g., Rule 147 Adopting Release at text accompanying note 2. 76 Bishop Letter; Exante Letter. 77 Bishop Letter. 78 See Rule 147A(c)(1). PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 purchasers who are legal entities) 79 in the same state or territory where the offering takes place. For situations where an issuer changes its principal place of business to another state after conducting an intrastate offering in reliance on Rule 147 or Rule 147A, we are adopting provisions in both rules that limit the ability of an issuer to conduct a subsequent intrastate offering pursuant to Rule 147 or Rule 147A until such time as securities sold in reliance on the exemption in the prior state have come to rest in that state.80 This is consistent with the view that securities sold in an intrastate offering in one state should have to come to rest within such state before purchasers may resell their securities to out-of-state residents.81 Accordingly, both rules provide that issuers who have previously conducted an intrastate offering pursuant to Rule 147 or Rule 147A will not be able to conduct another subsequent intrastate offering pursuant to either rule in a different state for a period of six months from the date of the last sale in the prior state, which is consistent with the duration of the resale limitation period specified in our amendments to Rule 147(e) and new Rule 147A(e).82 The use of a six-month period is a change from the proposed nine-month period, and aligns these provisions with changes being made to amended Rule 147(e) and new Rule 147A(e), consistent with commenters’ suggestions to reduce the nine-month resale limitation period to six months.83 B. Common Requirements of the Amendments to Rule 147 and New Rule 147A Our amendments to Rule 147 and the provisions of new Rule 147A are substantially identical, except that, as discussed above, new Rule 147A allows an issuer to make offers accessible to out-of-state residents and to be incorporated or organized out-of-state.84 Under the rules we adopt today, both amended Rule 147 and new Rule 147A will include the following provisions: • A requirement that the issuer satisfy at least one ‘‘doing business’’ requirement that will demonstrate the in-state nature of the issuer’s business. 79 Under both amended Rule 147(d)(2) and Rule 147A(d)(2), the residence of an individual (natural person) is determined by the state or territory in which his or her principal residence is located at the time of the offer and sale to the individual. 80 See Rules 147(e) and 147A(e). 81 See 1961 Release at 4. 82 See Instruction to paragraph (c)(1) of Rule 147 and Instruction to paragraph (c)(1) of Rule 147A. 83 See Section II.B.4.c below. 84 See Sections II.A.1and II.A.2 above. E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations • A new ‘‘reasonable belief’’ standard for issuers to rely upon in determining the residence of the purchaser at the time of the sale of securities. • A requirement that issuers obtain a written representation from each purchaser as to his or her residency. • The residence of a purchaser that is a non-natural person, such as a corporation, partnership, trust or other form of business organization, will be defined as the location where, at the time of the sale, the entity has its ‘‘principal place of business.’’ • A limit on resales to persons resident within the state or territory of the offering for a period of six months from the date of the sale by the issuer to the purchaser of a security sold pursuant to the exemption. • An integration safe harbor that will include any prior offers or sales of securities by the issuer, as well as certain subsequent offers or sales of securities by the issuer occurring after the completion of the offering. • Disclosure requirements, including legend requirements, to offerees and purchasers about the limits on resales. 1. Requirements for Issuers ‘‘Doing Business’’ In-State asabaliauskas on DSK3SPTVN1PROD with RULES a. Proposed Amendments Under the proposed rules, an issuer would be required to meet at least one of the following requirements in order to be considered ‘‘doing business’’ instate: • The issuer derived at least 80% of its consolidated gross revenues from the operation of a business or of real property located in or from the rendering of services within such state or territory; 85 • The issuer had at the end of its most recent semi-annual fiscal period prior to the first offer of securities pursuant to the exemption, at least 80% of its consolidated assets located within such state or territory; 86 • The issuer intends to use and uses at least 80% of the net proceeds to the issuer from sales made pursuant to the exemption in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services within such state or territory; 87 or • A majority of the issuer’s employees are based in such state or territory.88 85 See proposed Rule 147(c)(2)(i) and related notes to the rule indicating how and when an issuer would calculate its revenue for purposes of compliance with the proposed rule, based on when the first offer of securities is made pursuant to the exemption. 86 See proposed Rule 147(c)(2)(ii). 87 See proposed Rule 147(c)(2)(iii). 88 See proposed Rule 147(c)(2)(iv). VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 b. Comments on the Proposed Amendments Several commenters supported our proposed amendments to the current ‘‘doing business’’ requirements in Rule 147(c)(2).89 One commenter specifically favored the proposed disjunctive approach, requiring an issuer to satisfy one of four threshold tests, thereby enabling different types of issuers (e.g., a brick-and-mortar business versus an online business) to confirm local residency and demonstrate the in-state nature of their business.90 Another commenter, although noting that the proposed requirements and thresholds appropriately reflect characteristics that are in keeping with establishing a local presence, was concerned that having to meet only one requirement may not establish the local connection of the issuer to the state to the degree anticipated by Section 3(a)(11) and encouraged a close review of this issue in a Commission study.91 Two commenters supported our proposed amendment to the ‘‘doing business’’ test to add an alternative threshold requirement based on the location of a majority of an issuer’s employees.92 Several commenters supported using this additional criterion, but with different percentage thresholds.93 Some of these commenters recommended requiring that at least 80% of the issuer’s employees be based in the state,94 while another commenter supported requiring that at least 75% of the issuer’s employees be based in the state.95 Several commenters opposed our proposed ‘‘doing business’’ requirements in favor of alternative standards.96 For example, some of these commenters supported the use of five alternative criteria in order for an issuer to be deemed a ‘‘state business,’’ specifically: the issuer’s main office be located in-state, and at least 80% of the funds raised be used in-state, work is done in-state, employees live in-state 89 CFA Letter; CFIRA Letter; CrowdCheck Letter; NASAA Letter. 90 NASAA Letter. 91 CFA Letter (‘‘If the Commission determines to adopt the proposed approach, however, we encourage a close review in the study the Commission intends to undertake within three years of the adoption of the amendments.’’). See note 106. 92 Milken Letter; NASAA Letter. 93 Ely Letter; MacDougall Letter; Pearl Letter; Terdal Letter; Wolff Letter. 94 Ely Letter; MacDougall Letter; Pearl Letter; Terdal Letter. 95 Wolff Letter. 96 Ely Letter; MacDougall Letter; Pearl Letter; Terdal Letter. PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 83501 and owners reside in-state.97 Another commenter supported generally these same criteria, but using 75% thresholds as opposed to 80% thresholds.98 Other commenters recommended a more flexible standard that would move away from the strict 80% thresholds in favor of majority requirements that would harmonize the current ‘‘doing business’’ tests with the proposed test for number of employees.99 Finally, another commenter suggested a periodic review by the Commission to evaluate the 80% thresholds to determine whether the exemption succeeds in facilitating the goal of small business capital formation while protecting investors.100 c. Final Rules After considering the comments, we are adopting, as proposed, updated and modernized ‘‘doing business’’ requirements in Rule 147 and new Rule 147A to comport with contemporary small business practices.101 We believe these updated requirements will expand the universe of issuers that may rely on Section 3(a)(11) and the amended Rule 147 safe harbor, as well as new Rule 147A, to conduct exempt intrastate offerings, while continuing to require issuers to have an in-state presence sufficient to justify reliance on these provisions. Given the increasing ‘‘interstate’’ nature of small business activities, we believe it has become increasingly difficult for companies, even smaller companies that are physically located within a single state or territory, to satisfy the issuer ‘‘doing business’’ requirements of current Rule 147(c)(2).102 Accordingly, we believe these issuer ‘‘doing business’’ requirements, identical for both amended Rule 147 and new Rule 147A, will provide issuers with greater flexibility in conducting intrastate offerings and expand the availability of 97 Ely Letter; MacDougall Letter; Pearl Letter (recommending that an issuer be required to satisfy ‘‘at least three’’ of these five criteria or from an alternative ‘‘reasonable list’’). Cf. Terdal Letter (‘‘A more appropriate test of a ‘‘local company’’ would be one that has at least 80% of the employees’ wages paid in state, or perhaps 80% of the work (i.e. manufacturing, producing, brewing, etc.) be done in state.’’). 98 Wolff Letter (recommending 75% thresholds for use of funds, work done in-state, and number of employees residing in-state but that the rules require only a majority of the owners’ primary residences be located in-state). 99 Milken Letter (stating that the requirement for a precise 80% threshold ‘‘can be confusing and difficult for issuers to assess. Additionally, the high and precise threshold can exclude issuers that rationally should qualify.’’); Pearl Letter. 100 NASAA Letter. 101 See Rules 147(c)(2) and 147A(c)(2). 102 See discussion in Section II.A.2 above. E:\FR\FM\21NOR2.SGM 21NOR2 83502 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations these two intrastate offering provisions.103 As proposed, we are adopting amendments to Rule 147(c)(2) and including provisions in new Rule 147A(c)(2) that will provide issuers with greater flexibility to satisfy the current ‘‘doing business’’ requirements by adding an alternative test based on the location of a majority of the issuer’s employees while retaining the three 80% threshold tests in current Rule 147(c)(2).104 Furthermore, while the substance of the three 80% threshold requirements of current Rule 147(c)(2) is being retained in the final rules, compliance with any one of the 80% threshold requirements (or the additional test based on the majority of employees) will be sufficient to demonstrate the in-state nature of the issuer’s business, as proposed. This is a change from current Rule 147(c)(2), which requires issuers to satisfy all three 80% threshold requirements. We recognize that commenters had various alternative views on these requirements. While some commenters sought to require issuers to meet additional criteria, other commenters sought to lower the percentage thresholds in the criteria to ease the issuer requirements. We believe that the approach we are adopting in the final rules will provide issuers with additional flexibility to satisfy the requirements, while continuing to function as meaningful indicia of the instate nature of the issuer’s business. In light of the fact that issuers will need to meet only one of the threshold tests, we are not changing the current 80% threshold tests to a majority requirement as one commenter suggested.105 We believe it is appropriate to first observe how the updated doing business in-state requirements are used by issuers in practice before making any further changes.106 Except as discussed below, we also are not adopting alternative criteria for the doing business in-state requirements, as suggested by several commenters.107 We believe the existing criteria have generally served states, issuers and investors well by being easy to understand and apply, and when updated as discussed above, will appropriately reflect characteristics in keeping with a local business presence.108 We are also making certain technical revisions to the three current 80% thresholds, as proposed, that we believe will simplify the structure and application of the rules.109 In light of our amendments to require issuers to satisfy only one of the threshold tests, we are eliminating the current provision in Rule 147(c)(2)(i)(B), which does not apply the revenue test to issuers with less than $5,000 in revenue during the prior fiscal year.110 While this accommodation may be reasonable in the context of the current conjunctive 80% threshold requirements of Rule 147(c)(2), we do not believe it is necessary under the new disjunctive approach that we are adopting in these rules. Consistent with the proposal, and as supported by commenters, we are adding an alternative requirement to the three modified 80% threshold requirements. This requirement, which relates to the location of a majority of the issuer’s employees, will provide an additional method by which an issuer may demonstrate that it conducts instate business sufficient to justify reliance on either Rule 147 or new Rule 147A. For these purposes, we are permitting an issuer to satisfy the ‘‘doing business’’ requirements by having a majority of its employees based in such state or territory.111 An employee would be based in the same state or territory of the issuer for purposes of this test if such employee is based out of offices located within such state or territory.112 For example, if an employee provides services in the Maryland, Virginia and Washington, DC metro area out of the offices of a company in Maryland, the employee would be based in Maryland for purposes of this test. While some commenters suggested different thresholds for the employee test (ranging from 75% to 80%), we believe that using a majority of the employees test provides a standard that more 108 See asabaliauskas on DSK3SPTVN1PROD with RULES 103 See, e.g., Transcript of Record 82–91, SEC Advisory Committee on Small and Emerging Companies (June 3, 2015). 104 See Rules 147(c)(2) and 147A(c)(2). 105 See Milken Letter. 106 As we indicated in the Proposing Release, we expect the staff to undertake to study and submit a report to the Commission no later than three years following the effective date of the final rules on whether this new framework appropriately provides assurances that an issuer is doing business in the state in which the offering takes place. 107 See Ely Letter; MacDougall Letter; Pearl Letter; Terdal Letter. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 CFA Letter. example, in order to streamline the presentation of Rule 147(c)(2), we are re-designating current Rule 147(c)(2)(i)(A)–(B), 17 CFR 230.147(c)(2)(i)(A)–(B), which includes instructions on how to calculate revenue under Rule 147(c)(2)(i), as Instruction to paragraph (c)(2)(i) of Rule 147. Similarly, Rule 147A will also include an instruction on how to calculate revenue under Rule 147A(c)(2)(i). 110 17 CFR 230.147(c)(2)(i)(B). 111 See Rules 147(c)(2)(iv) and 147A(c)(2)(iv). 112 The state or territory in which an employee is based may, or may not, be the same state or territory in which the employee resides. 109 For PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 accurately captures the increasingly flexible ways that companies structure and conduct their business operations, while still requiring that more employees be located in-state than elsewhere. Current workforce trends, such as telecommuting, whereby employees often work in a different geographical location from their employer, suggest that flexibility is particularly needed in this area. We believe adding this criterion to expand upon the current doing business requirements in Rule 147(c)(2) will provide additional flexibility to issuers by making these requirements more consistent with modern business practices, especially in light of the different roles employees play within smaller companies and the different locations in which employees carry out such roles, while still providing important indicia of the in-state nature of an issuer’s business. 2. Reasonable Belief as to Purchaser Residency Status a. Proposed Amendments Consistent with the requirements in Regulation D,113 we proposed to add a reasonable belief standard to the issuer’s determination as to the residence of the purchaser at the time of the sale of the securities.114 As proposed, an issuer would satisfy the requirement that the purchaser in the offering be a resident of the same state or territory as the issuer’s principal place of business by either the existence of the fact that the purchaser is a resident of the applicable state or territory, or by establishing that the issuer had a reasonable belief that the purchaser of the securities in the offering was a resident of such state or territory.115 We also proposed to eliminate the requirement in current Rule 147 that issuers obtain a written representation from each purchaser as to his or her residence, as we believed this requirement may be unnecessary in light of the proposed reasonable belief standard.116 b. Comments on the Proposed Amendments Several commenters supported the proposal to include a reasonable belief standard.117 One of these commenters 113 Rule 501(a) of Regulation D includes in the definition of ‘‘accredited investor,’’ persons who come within the enumerated categories of the rule, or who the issuer reasonably believes come within any of such categories, at the time of sale to such person. 17 CFR 230.501(a). 114 See proposed Rule 147(d). 115 Id. 116 17 CFR 230.147(f)(1)(iii). 117 ABA Letter; City of Adrian Letter; CFA Letter; NASAA Letter. E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations stated that a reasonable belief standard will provide more certainty for issuers about the availability of the exemption and increase its utility without sacrificing investor protection.118 Commenters were divided on whether to eliminate the requirement to obtain a written representation from the purchaser as to his or her residence, with two commenters supporting the proposed elimination of the requirement 119 and two commenters opposing it.120 Commenters opposing elimination of the requirement stated that the written representation should not be the sole indication of residency under a facts and circumstances exercise, but asserted that it is a useful indication of residency.121 Several commenters requested that the Commission provide a safe harbor for determining an individual purchaser’s residence, based upon certain objective criteria.122 Two of those commenters supported the creation of a non-exclusive safe harbor setting out the means by which a reasonable belief may be established, including the circumstances in which an issuer may rely on the steps taken by a third-party, such as a service provider or intermediary.123 Another of those commenters stated that Commission staff should work with the states to standardize requirements for determining state of residency for purposes of investor participation in an offering to help ensure compliance with the residency requirement.124 In addition, the 2015 Small Business Forum recommended that the Commission create a safe harbor for determining the ‘‘place of business’’ of a non-natural person investor in Rule 147 offerings, which could be as simple as a self-certification as to its place of business.125 c. Final Rules Consistent with the proposal, and with the determination of accredited investor status under Regulation D,126 we are adopting amendments to Rule 118 NASAA Letter. Letter; CrowdCheck Letter. 120 CFA Letter; NASAA Letter. 121 NASAA Letter (‘‘this requirement should remain in place but may be construed as evidence of, but not be dispositive of, a reasonable belief of purchaser residency.’’). 122 CFIRA Letter; CrowdCheck Letter; Letter from Brandon Smith, Managing Principal, Localstake Marketplace LLC, November 17, 2015 (‘‘Localstake Letter’’); Letter from Rose Oswald-Poels, President/ CEO, Wisconsin Bankers Association, January 8, 2016 (‘‘WBA Letter’’). 123 CFIRA Letter; CrowdCheck Letter. 124 Localstake Letter. 125 See 2015 Small Business Forum Recommendations. 126 See note 113 above. asabaliauskas on DSK3SPTVN1PROD with RULES 119 CFIRA VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 147 and a provision in new Rule 147A that will include a reasonable belief standard for the issuer’s determination as to the residence of the purchaser at the time of the sale of the securities.127 Under the final rules, an issuer will satisfy the requirement that the purchaser in the offering be a resident of the same state or territory in which the issuer is resident by either the existence of the fact that the purchaser is a resident of the applicable state or territory, or by establishing that the issuer had a reasonable belief that the purchaser of the securities in the offering was a resident of such state or territory.128 Under current Rule 147(d), regardless of the efforts an issuer takes to determine that potential investors are residents of the state in which the issuer is resident, the exemption is lost for the entire offering if securities are offered or sold to just one investor that was not in fact a resident of such state. We continue to believe that permitting issuers to sell on the basis of a reasonable belief of a purchaser’s instate residency status will increase the utility of amended Rule 147 and new Rule 147A by providing issuers with additional certainty about the availability of the exemption under Section 3(a)(11) or new Rule 147A while still providing appropriate investor protections.129 In a change from the proposal, both amended Rule 147 and new Rule 147A will include a requirement that issuers obtain a written representation from each purchaser as to his or her residence.130 We are persuaded by those commenters who stated that this requirement should be retained and considered as evidence of, but not be dispositive of, the purchaser’s residency. In the context of Section 3(a)(11), the Commission has previously indicated that ‘‘[t]he mere obtaining of formal representations of residence . . . should not be relied upon without more as establishing the availability of the exemption.’’ 131 Whether an issuer has formed a reasonable belief that the prospective purchaser is an in-state resident will be determined on the basis of all facts and circumstances. Obtaining a written representation from purchasers of in-state residency status will not, without more, be sufficient to 127 See Rules 147(d) and 147A(d). 128 Id. 129 The burden will continue to be on the issuer to establish that the purchaser is an in-state resident or that the issuer had a reasonable belief as to residency. Otherwise, the sale to a non-resident purchaser would preclude reliance on amended Rule 147 or new Rule 147A. 130 See Rules 147(f)(1)(iii) and 147A(f)(1)(iii). 131 See 1961 Release at 3. PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 83503 establish a reasonable belief that such purchasers are in-state residents.132 In addition to the written representation, other facts and circumstances could include, but will not be limited to, for example, a preexisting relationship between the issuer and the prospective purchaser that provides the issuer with sufficient knowledge about the prospective purchaser’s principal residence or principal place of business so as to enable the issuer to have a reasonable basis to believe that the prospective purchaser is an in-state resident. An issuer may also consider other facts and circumstances when establishing the residency of a prospective purchaser, such as evidence of the home address of the prospective purchaser, as documented by a recently dated utility bill, pay-stub, information contained in state or federal tax returns, any documentation issued by a federal, state, or local government authority, such as a driver’s license or identification card, or a public or private database that the issuer has determined is reasonably reliable, including credit bureau databases, directory listings, and public records. While a few commenters 133 and the 2015 Small Business Forum recommended that the Commission provide a safe harbor for determining a purchaser’s residence, including the circumstances in which a reasonable belief may be established, we are not doing so in the final rules. Our rules do not provide a safe harbor for the reasonable belief determination made under Rule 501(a) of Regulation D for exempt offerings, and we do not believe that the determinations required for amended Rule 147 and new Rule 147A present a more compelling case for having such a provision. In addition, we are concerned that a safe harbor could be viewed as an exclusive or minimum standard. We believe that requiring issuers to consider the facts and circumstances in order to establish a reasonable basis to believe that the purchaser is a resident of the same state or territory in which the issuer is resident is appropriate and will provide sufficient certainty for issuers seeking to satisfy the requirements of the exemption. Commission staff will consider available information on issuer compliance with the ‘‘reasonable belief’’ standards in connection with the study 132 See Instruction to paragraph (d) of Rule 147 and Instruction to paragraph (d) of Rule 147A. 133 CFIRA Letter; CrowdCheck Letter; Localstake Letter; WBA Letter. E:\FR\FM\21NOR2.SGM 21NOR2 83504 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations of amended Rule 147 and new Rule 147A.134 3. Residence of Entity Purchasers a. Proposed Amendments We proposed to define the residence of a purchaser that is a legal entity, such as a corporation, partnership, trust or other form of business organization, as the location where, at the time of the sale, the entity has its principal place of business.135 For these purposes, we also proposed to define a purchaser’s ‘‘principal place of business,’’ consistent with the proposed definition for issuer eligibility purposes, as the location in which the officers, partners, or managers of the entity primarily direct, control and coordinate its activities.136 b. Comments on the Proposed Amendments Two commenters supported the proposed amendments to replace the ‘‘principal office’’ requirement for entity purchasers with the ‘‘principal place of business’’ standard, consistent with the standard for issuers.137 One commenter suggested that the Commission clarify how the residency of non-business trusts should be determined.138 c. Final Rules Consistent with the proposal, we are adopting amendments to Rule 147 and a provision in new Rule 147A that will define the residence of a purchaser that is a legal entity, such as a corporation, partnership, trust or other form of business organization, as the location where, at the time of the sale, the entity has its principal place of business.139 The final rules define a purchaser’s ‘‘principal place of business,’’ consistent with the definition for determining issuer residency contained in paragraph (c)(1) of Rules 147 and 147A, as the location in which the officers, partners, or managers of the entity primarily direct, control and coordinate its activities.140 In addition, as suggested by one commenter, 141 we are adding an 134 See Section I above. proposed Rule 147(d). Under the current rule, an entity is a resident of the state or territory where the entity has its ‘‘principal office.’’ Current Rule 147 does not define ‘‘principal office.’’ 17 CFR 230.147(c)(2)(iv). 136 See proposed Rule 147(c)(1). 137 NASAA Letter; NextSeed Letter. 138 Bishop Letter (recommending that Rule 147(d)(1) be amended to add: ‘‘A trust that is not deemed by the law of the state or territory of its creation to be a separate legal entity is deemed to be a resident of each state or territory in which its trustee is, or trustees are, resident.’’). 139 See Rules 147(d) and 147A(d). 140 See Rules 147(c)(1), 147(d)(1), 147A(c)(1) and 147A(d)(1). 141 Bishop Letter. asabaliauskas on DSK3SPTVN1PROD with RULES 135 See VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 instruction to the requirement as to the residency of the purchaser stating that a trust that is not deemed by the law of the state or territory of its creation to be a separate legal entity should be deemed to be a resident of each state or territory in which its trustee is, or trustees are, resident.142 4. Limitation on Resales a. Proposed Amendments We proposed to amend the limitation on resales in Rule 147(e) to provide that for a period of nine months from the date of the sale by the issuer of a security sold pursuant to this rule, any resale by a purchaser would need to be made only to residents within the purchaser’s state or territory of residence.143 In contrast, Rule 147(e) currently requires that during the period in which securities are offered and sold in reliance on the intrastate offering exemption, and for a period of nine months from the date of the last sale by the issuer of such securities, all resales of any securities sold in the offering shall only be made to persons resident within the state or territory of which the issuer is a resident. In the Proposing Release, we explained that the determination as to when a given purchase of securities in an intrastate offering has come to rest in-state depends less on a defined period of time after the final sale by the issuer in such offering than it does on whether a resident purchaser has taken the securities ‘‘without a view to further distribution or resale to nonresidents.’’ 144 In this regard, we believed that a time-based limitation on potential resales to non-residents that relates back to the date of the purchase by a resident investor from the issuer would more precisely address the concern regarding out-of-state resales. We also proposed to amend Rule 147(b) so that an issuer’s ability to rely on Rule 147 would no longer be conditioned on a purchaser’s compliance with Rule 147(e).145 We believed that this proposed amendment to the application of Rule 147(e), as it relates to Rule 147(b), would increase the utility of the exemption by eliminating the uncertainty created in the offering process for issuers under the current rules. As proposed, issuers would remain subject to requirements relating to, for example, in-state sales limitations, legends, stop transfer instructions for transfer agents, and offeree and purchaser disclosures in order to satisfy the exemption at the federal level. In addition, issuers would continue to be subject to the antifraud and civil liability provisions of the federal securities laws, as well as state securities law requirements. Lastly, although we did not propose to amend our rules to provide that securities issued under amended Rule 147 be considered ‘‘restricted securities’’ under Rule 144(a)(3), 146 we requested comments on this question. b. Comments on the Proposed Amendments Several commenters supported the proposed change to the limitation on resales by resident purchasers to nonresidents based on the date of sale by the issuer to the relevant purchaser rather than based on the date when the offering terminates.147 Commenters, however, had differing views on the length of the holding period from the date of sale. Two commenters supported a nine-month holding period from the date of sale.148 One of these commenters reasoned that this period sufficiently demonstrates the purchase was for investment without an intent to distribute out-of-state or avoid registration.149 Two other commenters stated that a period of six months is adequate to establish that securities have ‘‘come to rest’’ in a state.150 Those commenters noted that a nine-month period does not exist in any other securities law requirements, so the potential exists for confusion. One commenter recommended that the Commission clarify that bona fide gifts are not subject to the limitation on resales out-of-state, and that a donee is deemed to have acquired the securities when they were acquired by the donor.151 Commenters were divided on whether securities issued under amended Rule 147 should be considered ‘‘restricted securities’’ under Rule 144(a)(3). One commenter stated that securities issued under amended Rule 147 should be considered ‘‘restricted securities’’ under Rule 144(a)(3).152 Two other 146 17 CFR 230.144(a)(3). Letter; CFIRA Letter; CrowdCheck Letter; NASAA Letter. 148 CFA Letter; NASAA Letter. 149 NASAA Letter. 150 CrowdCheck Letter; CFIRA Letter. These commenters stated that allowing a six-month period, by analogy to parts of Rule 144, is more appropriate. 151 Bishop Letter. 152 NASAA Letter. 147 CFA 142 See Instruction 1 to paragraph (d)(1) of Rule 147 and Instruction 1 to paragraph (d)(1) of Rule 147A. 143 Proposed Rule 147(e). 144 See Proposing Release, at text accompanying note 87. 145 See proposed Rule 147(b). As proposed, current Rule 147(a) would be re-designated as Rule 147(b). PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations commenters stated that the securities should not be treated as ‘‘restricted securities’’ under Rule 144(a)(3), noting that the ‘‘coming to rest’’ in-state purpose of the nine-month restriction is sufficiently distinct from the policy considerations underlying Rule 144.153 In addition, several commenters supported no longer conditioning the availability of the exemption on purchaser compliance with Rule 147(e).154 One of those commenters reasoned that if an issuer takes reasonable steps to comply with the limitations on resale, the issuer should not lose the original exemption if a purchaser does not comply with the resale restrictions at a later date.155 c. Final Rules After considering the comments, we are adopting a requirement in amended Rule 147 and new Rule 147A providing that for a period of six months from the date of the sale of the security by the issuer any resale of the security shall be made only to persons resident within the state or territory in which the issuer was resident at the time of the sale of the security by the issuer.156 We are persuaded by those commenters that indicated that a period of six months is adequate to establish that securities sold in an intrastate offering have ‘‘come to rest’’ in a state by analogizing to provisions of Rule 144, in which a sixmonth holding period is deemed sufficient to establish a requisite investment intent.157 In this regard, given the use of a six-month resale restriction in the Rule 144 context, we believe that a similar resale restriction in the intrastate offering context should provide adequate assurance that the securities will come to rest in-state.158 We note that bona fide gifts are not subject to the limitation on resales in amended Rule 147 or new Rule 147A.159 Since bona fide gifts are not transactions for value, they require no investment decision by the donee and thus do not involve the sale of a security subject to 153 CFIRA asabaliauskas on DSK3SPTVN1PROD with RULES 154 CFIRA Letter; CrowdCheck Letter. Letter; CrowdCheck Letter; NASAA Letter. 155 NASAA Letter. 156 Rules 147(e) and 147A(e). 157 See CFIRA Letter and CrowdCheck Letter. Rule 144 provides a safe-harbor from being deemed a ‘‘statutory underwriter’’ under Section 2(a)(11) of the Securities Act. Specifically, Rule 144(d)(1)(i) requires a six-month holding period for restricted securities sold by issuers reporting under the Exchange Act in order for a purchaser to resell such securities and not be deemed an underwriter. 158 In such circumstances, resales of securities that were initially purchased in an intrastate offering must themselves be registered or exempt from registration pursuant to any state securities laws where such resale takes place. 159 See Bishop Letter. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 regulation under the Securities Act.160 However, we note that subsequent resales of donated securities are subject to the resale restrictions regardless of the state in which the holder of the donated securities resides. To address bona fide gifts of securities to out-ofstate donees, as well as the resales of securities that were wrongfully sold to out-of-state purchasers, within the six month re-sale limitation period, we are revising our proposed resale limitation to focus on the state or territory in which the issuer was resident, as opposed to where the last purchaser of the securities may have resided. Accordingly, the resale limitation in the final rules limits resales to ‘‘persons resident within the state or territory in which the issuer was resident . . . at the time of the sale of the security by the issuer’’ as opposed to limiting resales to ‘‘persons resident within the purchaser’s state or territory of residence,’’ as proposed. We believe this revision will address situations in which purchasers in the offering subsequently gift or wrongfully sell their securities to out-of-state residents who then wish to resell their securities within the six month limitation of paragraph (e). This change to the rules makes clear that the six-month limitation on resales applies to all holders of the securities, including holders subsequent to the original purchaser, whether they received the shares as a gift, donation, or by purchase.161 As proposed, the resale limitation period for both amended Rule 147(e) and new Rule 147A(e) will relate back to the date of purchase by a resident investor from the issuer, in contrast to current Rule 147(e) that does not start the resale limitation period until the offering has terminated (i.e., until all offers and sales have ceased).162 We continue to believe that a time-based limitation on potential resales to nonresidents of securities purchased in an intrastate offering that relates back to the date of purchase by a resident investor from the issuer would more 160 Section 2(a)(3) of the Securities Act defines ‘‘sale’’ or ‘‘sell’’ to ‘‘include every contract of sale or disposition of a security or interest in a security, for value.’’ A lack of monetary consideration, however, does not always mean that there was not a sale or offer for sale for purposes of Section 5. See, e.g., Capital General Corporation, 54 SEC Docket 1714, 1728–29 (July 23, 1993) (Capital General’s ‘‘gifting’’ of securities constituted a sale because it was a disposition for value, the ‘‘value’’ arising ‘‘by virtue of the creation of a public market for the issuer’s securities.’’). See also SEC v. Harwyn Industries Corp., 326 F. Supp. 943 (S.D.N.Y. 1971). 161 See Rules 147(e) and 147A(e). 162 The resale limitation period may end on different dates for different purchasers if the issuer sold shares on multiple dates. PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 83505 precisely address the concern regarding out-of-state resales. In light of our revision to the resale limitation to focus on the state where the issuer is a resident, we are including additional language in amended Rule 147(e) and new Rule 147A(e) to specify that all re-sales during this six month resale limitation period will be restricted to the state or territory in which the issuer was a resident at the time of the sale of the security by the issuer to a purchaser. Accordingly, if an issuer were to change its state or territory of residence during the six month resale limitation period, all resales would, nevertheless, continue to be limited to the state or territory in which the issuer resided at the time of the original sale of securities in reliance upon either Rule 147 or Rule 147A. We believe this additional language will preserve the intent of the proposed resale restriction—to help ensure that the securities offered pursuant to an intrastate offering exemption have come to rest within the state of the offering before being resold. As proposed, an issuer’s ability to rely on the respective rules will not be conditioned on a purchaser’s compliance with Rule 147(e) and Rule 147A(e).163 As discussed in the Proposing Release, the application of current Rule 147(e) in the overall scheme of the safe harbor can cause uncertainty for issuers. We continue to believe that removing the condition on purchaser compliance with Rule 147(e) will increase the utility of the exemption by eliminating the uncertainty created in the offering process for issuers under the current rules. As one commenter noted, if an issuer takes reasonable steps to comply with the limitations on resale, it should not lose the availability of the exemption due to a purchaser not complying with the resale limitations.164 We continue to believe that eliminating this uncertainty should not result in an increased risk of issuer non-compliance with the rules, because issuers will remain subject to requirements relating to, for example, in-state sales limitations, legends, stop transfer instructions for transfer agents, and offeree and purchaser disclosures, in order to satisfy the exemption at the federal level.165 In addition, issuers will 163 See Rules 147(b) and 147A(b). Current Rule 147(a) would be re-designated as Rule 147(b). 164 NASAA Letter. 165 Commission staff will seek to review information gathered by state regulators on issuer compliance with the legend requirements in amended Rule 147(f) and new Rule 147A(f) as part E:\FR\FM\21NOR2.SGM Continued 21NOR2 83506 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations continue to be subject to the antifraud and civil liability provisions of the federal securities laws, as well as state securities law requirements. Lastly, while one commenter believed that securities issued under amended Rule 147 should be considered ‘‘restricted securities’’ under Rule 144(a)(3), 166 we believe that limiting the resale of these securities only to persons resident within the same state or territory in which the issuer is a resident for a period of six months from the date of the sale of the security by the issuer to the purchaser is sufficient to assure that the offering has come to rest in the state or territory in which the issuer resides and thereby preserve the local character of the offering. We note that states are free to impose any additional requirements they believe are necessary to protect the residents of their states, including imposing further transfer restrictions on securities issued under amended Rule 147 or new Rule 147A similar to that required under Rule 144(a)(3). In addition, persons reselling securities will need to consider whether they could be an ‘‘underwriter’’ if they acquired the securities with a view to ‘‘distribution’’ or if they are participating in a ‘‘distribution.’’ 167 A seller that complies with the conditions of the Rule 144 safe harbor will not be deemed to be an underwriter.168 5. Integration a. Proposed Amendments asabaliauskas on DSK3SPTVN1PROD with RULES The proposed Rule 147 integration safe harbor would include any prior offers or sales of securities by the issuer, as well as certain subsequent offers or sales of securities by the issuer occurring within six months after the completion of an offering exempted by Rule 147. As proposed, offers and sales made pursuant to Rule 147 would not be integrated with: • Prior offers or sales of securities; or • Subsequent offers or sales of securities that are: • Registered under the Act, except as provided in proposed paragraph (h) of Rule 147; • Exempt from registration under Regulation A (17 CFR 230.251 et seq.); • Exempt from registration under Rule 701 (17 CFR 230.701); of the study of amended Rule 147 and new Rule 147A. See Section I. 166 Id. 167 See Section 4(a)(1) of the Securities Act (exempting from registration ‘‘transactions by any person other than an issuer, underwriter, or dealer’’) and Section 2(a)(11) of the Securities Act (defining the term ‘‘underwriter’’). 15 U.S.C. 77d(a)(1) and 15 U.S.C. 77b(a)(11). 168 17 CFR 230.144. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 • Made pursuant to an employee benefit plan; • Exempt from registration under Regulation S (17 CFR 230.901 through 230.905); • Exempt from registration under Section 4(a)(6) of the Act (15 U.S.C. 77d(a)(6)); or • Made more than six months after the completion of an offering conducted pursuant to this rule.169 b. Comments on the Proposed Amendments One commenter supported including registered offers and sales and certain other exempt offerings occurring within six months after completion of the offering in the integration safe harbor, as proposed.170 The same commenter did not support providing a safe harbor for any and all prior offers or sales of securities by the issuer, as proposed in paragraph (g)(1) of the amended rule, and instead recommended restricting the safe harbor to cover only offers and sales of securities that take place before the six-month period immediately preceding the Rule 147 offering.171 While acknowledging that the proposed integration safe harbor is consistent with the integration safe harbor in Rule 251(c) of Regulation A, the commenter distinguished Regulation A from Rule 147 by noting that ‘‘Regulation A is a quasi-registration subject to regulatory oversight by the Commission and the states while a Rule 147 offering may be exempt at both the federal and state level.’’ In determining an integration safe harbor model to follow, the commenter indicated it would be better to look to Rule 502(a) of Regulation D, which limits the safe harbor for private offerings to offers and sales occurring either six months before, or six months after, a Regulation D offering.172 On the other hand, two commenters believed that Rule 147 offerings should not be integrated with any other exempt offerings.173 One of these commenters recommended that Rule 147 contain language expressly stating that an offering made in reliance on Rule 147 169 See proposed Rule 147(g). Letter. 170 NASAA 171 Id. 172 Id. Rule 502(a) provides that ‘‘Offers and sales that are made more than six months before the start of a Regulation D offering or are made more than six months after completion of a Regulation D offering will not be considered part of that Regulation D offering, so long as during those six month periods there are no offers or sales of securities by or for the issuer that are of the same or a similar class as those offered or sold under Regulation D, other than those offers or sales of securities under an employee benefit plan as defined in Rule 405 under the Act.’’ 17 CFR 230.502(a). 173 NextSeed Letter; Localstake Letter. PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 will not be integrated with another exempt offering made concurrently, provided that each offering meets the requirements of the claimed exemption.174 c. Final Rules After considering the comments, we are adopting amendments to the integration safe harbor under Rule 147 and providing an identical integration safe harbor provision in new Rule 147A, substantially as proposed. The integration safe harbor will cover any prior offers or sales of securities by the issuer, as well as certain subsequent offers or sales of securities by the issuer occurring after the completion of an offering pursuant to Rule 147 or Rule 147A, as applicable. Accordingly, offers and sales made pursuant to Rules 147 and 147A will not be integrated with: • Offers or sales of securities made prior to the commencement of offers and sales of securities pursuant to Rules 147 or 147A; or • Offers or sales of securities made after completion of offers and sales pursuant to Rules 147 or 147A that are: • Registered under the Securities Act, except as provided in Rule 147(h) or Rule 147A(h); • Exempt from registration under Regulation A (17 CFR 230.251 et seq.); • Exempt from registration under Rule 701 (17 CFR 230.701); • Made pursuant to an employee benefit plan; • Exempt from registration under Regulation S (17 CFR 230.901 through 230.905); • Exempt from registration under Section 4(a)(6) of the Act (15 U.S.C. 77d(a)(6)); or • Made more than six months after the completion of an offering conducted pursuant to Rules 147 or 147A.175 As discussed in the Proposing Release, integration safe harbors provide issuers, particularly smaller issuers whose capital needs often change, with greater certainty about their eligibility to comply with an exemption from Securities Act registration.176 Consistent with the proposal and the approach taken in Rule 251(c) of Regulation A, the safe harbor from integration provided by Rule 147(g) and Rule 147A(g) will expressly provide that any offer or sale made in reliance on the respective rules will not be integrated with any other offer or sale made either before the commencement of, or more than six 174 NextSeed Letter. Rules 147(g) and 147A(g). 176 See Proposing Release at Section II.B.4.d. (Integration); see also 2015 Regulation A Release at Section II.B.5. (Integration). 175 See E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations months after the completion of, the respective intrastate offerings under either Rule 147 or Rule 147A. For transactions that fall within the scope of the safe harbor, issuers will not have to conduct an integration analysis of the terms of any offering being conducted under the other specified provisions in order to determine whether the two offerings would be treated as one for purposes of qualifying for either exemption.177 While one commenter recommended that the Commission adopt a safe harbor more closely aligned with the provisions of Rule 502(a) of Regulation D,178 we believe the integration safe harbor in Rule 251(c) of Regulation A is more consistent with the Commission’s post-JOBS Act approach to integration that has evolved since the adoption of Regulation D in 1982 to better articulate the principles underlying the integration doctrine in light of current offering practices and developments in information and communication technology.179 As we explained in the Proposing Release, we believe that our approach to integration will provide issuers with greater certainty as to the availability of an exemption for a given offering and increase consistency in the application of the integration doctrine among the exemptive rules available to smaller issuers, while preserving important investor protections provided in each exemption.180 The bright-line integration safe harbor we are adopting in amended Rule 147(g) and new Rule 147A(g) will assist issuers, particularly smaller issuers, in analyzing certain transactions, but will not address the issue of potential offers or sales that occur concurrently with, or close in time after, a Rule 147 or 147A offering. There is no presumption that offerings outside the integration safe harbors should be integrated. Rather, whether concurrent or subsequent offers and sales of securities will be integrated with any securities offered or sold pursuant to amended Rule 147 or new Rule 147A will depend on the particular asabaliauskas on DSK3SPTVN1PROD with RULES 177 The issuer will, however, need to comply with the requirements of each exemption that it is relying upon. For example, an offering made pursuant to Rule 506(b) will not be integrated with a subsequent offering pursuant to Rule 147A, but the issuer will need to comply with the requirements of each rule, including the limitation on general solicitation for offers made pursuant to Rule 506(b). 178 NASAA Letter. 179 See also, Regulation Crowdfunding Adopting Release. 180 See Proposing Release at text accompanying note 103. See also Rule 251(c) of Regulation A [17 CFR 230.251(c)]; Rule 701 [17 CFR 230.701]. Each exemption is designed based on a particular type of offer and investor, with corresponding requirements that must be satisfied. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 facts and circumstances, including whether each offering complies with the requirements of the exemption that is being relied upon for the particular offering.181 For example, an issuer conducting a concurrent exempt offering for which general solicitation is not permitted will need to be satisfied that purchasers in that offering were not solicited by means of the offering made in reliance on Rule 147 or new Rule 147A.182 If an offer fails to comply with the requirements of the exemption, and the offer is not registered and no other exemption is available, that offer would be in violation of Section 5 of the Securities Act. Amended Rule 147, as a safe harbor under Section 3(a)(11), will continue to prohibit out-of-state offers to any person not residing in the same state or territory in which the issuer is resident. Accordingly, an issuer conducting a concurrent exempt offering for which general solicitation is permitted across state lines would be unlikely to comply with the in-state offer restriction in Rule 147(b).183 For example, issuers relying 181 The integration concept was first articulated by the Commission in 1933 and was further developed in two interpretive releases issued in the 1960s. See SEC Rel. No. 33–97 (Dec. 28, 1933); SEC Rel. No. 33–4434 (Dec. 6, 1961); SEC Rel. No. 33– 4552 (Nov. 6, 1962). The interpretive releases stated that determining whether a particular securities offering should be integrated with another offering requires an analysis of the specific facts and circumstances of the offerings. The Commission identified five factors to consider in making the determination of whether the offerings should be integrated. See SEC Rel. No. 33–4552 (Nov. 6, 1962). See also Rule 502(a) of Regulation D. More recently, the Commission has provided additional guidance to help issuers evaluate whether two offerings should be integrated. In 2007, the Commission provided a framework for analyzing how an issuer can conduct simultaneous registered and private offerings. See SEC Release No. 33–8828 (Aug. 3, 2007) [72 FR 45116 (Aug. 10, 2007)]. In 2015, when implementing provisions of the JOBS Act, the Commission applied this framework to concurrent exempt offerings, including situations where one offering permits general solicitation and the other does not. See 2015 Regulation A Release at Section II.B.5 and Regulation Crowdfunding Adopting Release at Section II.A.1.c. In those releases, the Commission noted that an offering made pursuant to Regulation A or Regulation Crowdfunding should not be integrated with another exempt offering made by the issuer, provided that each offering complies with the requirements of the exemption that is being relied upon for the particular offering. Id. 182 For a concurrent offering under Rule 506(b), purchasers in the Rule 506(b) offering could not be solicited by means of a general solicitation under Rule 147 or new Rule 147A. The issuer would need an alternative means of establishing how purchasers in the Rule 506(b) offering were solicited. For example, the issuer may have had a preexisting substantive relationship with such purchasers. Otherwise, the solicitation conducted in connection with the Rule 147 or Rule 147A offering would very likely preclude reliance on Rule 506(b). See also SEC Rel. No. 33–8828 (Aug. 3, 2007) [72 FR 45116 (Aug. 10, 2007)]. 183 See Rule 147(b). PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 83507 on amended Rule 147 will not be able to conduct a concurrent Regulation Crowdfunding offering, since by its nature a Regulation Crowdfunding offering would involve a multistate offer due to the offering terms being made publicly available from an intermediary’s online platform.184 An issuer relying on the new Rule 147A exemption, which permits multistate offers, may conduct a concurrent exempt offering for which general solicitation is permitted, so long as the issuer complies with the legend and disclosure requirements of Rule 147A(f), as well as any additional restrictions on the general solicitation required by the other exemption concurrently being relied upon by the issuer. For example, the limitations imposed on advertising the terms of the offering pursuant to Rule 204 of Regulation Crowdfunding would limit the issuer’s general solicitation in a concurrent offering made pursuant to Rule 147A. Similarly, an issuer conducting a concurrent Rule 506(c) offering could not include in its Rule 506(c) general solicitation materials an advertisement of a concurrent Rule 147A offering, unless that advertisement also included the disclosure required by, and otherwise complied with, paragraph (f) of Rule 147A.185 As discussed in the Proposing Release, we are mindful of the risk that offers made pursuant to an exemption shortly before a registration statement is filed could be viewed as conditioning the market for that registered offering. Accordingly, final Rules 147 and 147A will exclude from the safe harbor any such offer made to persons other than qualified institutional buyers and institutional accredited investors within the 30-day period before a registration statement is filed with the Commission.186 Commission staff expects to review issuer compliance with the expanded integration safe harbor as part of the study of amended Rule 147 and new Rule 147A.187 6. Disclosures to Investors a. Proposed Amendments We proposed to retain the substance of the disclosure requirements of 184 For the same reasons, issuers will not be able to rely on amended Rule 147 and conduct concurrent Regulation A offerings or registered public offerings. 185 See Rule 147A(f); see also discussion in Section II.A.1. 186 See Rules 147(h) and 147A(h). In such circumstances, whether an offer made within the thirty-day period before the filing of a registration statement constitutes an impermissible offer for purpose of Securities Act Section 5(c) will be based on the facts and circumstances of such offer. 187 See Section I above. E:\FR\FM\21NOR2.SGM 21NOR2 83508 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations current Rule 147(f)(3), in modified form. As proposed, Rule 147(f)(3) would require issuers to make specified disclosures to offerees and purchasers about the limitations on resale contained in proposed Rule 147(e) and to include the legend set forth in proposed Rule 147(f)(1)(i) on the certificate or other document evidencing the offered security. Although the disclosure should be prominently disclosed to each offeree and purchaser at the time any offer or sale is made by the issuer to such person, the proposed amendments would no longer require that such disclosure be made in writing in all instances. Instead, the proposed amendments would require issuers to provide the required disclosure to offerees in the same manner in which an offer is communicated, while continuing to require written disclosure to all purchasers. In addition, the proposed amendments would no longer require issuers to disclose to offerees and purchasers the stop transfer instructions provided by an issuer to its transfer agent 188 or the provisions of Rule 147(f)(2) regarding the issuance of new certificates during the Rule 147(e) resale period.189 asabaliauskas on DSK3SPTVN1PROD with RULES b. Comments on the Proposed Amendments Two commenters supported the proposal to include in the text of the amended rule the specific language of the required disclosure.190 These commenters also stated that all offerees and purchasers should continue to receive written disclosures, rather than, as proposed, permitting offerees to receive oral disclosures if the offer is communicated orally.191 c. Final Rules After considering the comments, we are adopting amendments to Rule 147 and a provision in new Rule 147A that will require issuers to make specified disclosures to offerees and purchasers about the limitations on resale contained in Rules 147(e) and 147A(e), respectively. Issuers will also be required to meet the legend requirement of Rules 147(f)(1)(i) and 147A(f)(1)(i), respectively. Although the disclosure should be prominently disclosed to each offeree and purchaser at the time any offer or sale is made by the issuer to such person, consistent with the proposal, the amendment and new rule will not require that such disclosure be made in writing in all instances. 188 See 17 CFR 230.147(f)(1)(ii). 17 CFR 230.147(f)(2). 190 CFA Letter; NASAA Letter. 191 Id. 189 See VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 While two commenters recommended that we require issuers to provide all offerees written disclosures, rather than permitting offerees to receive oral disclosures if the offer is communicated orally,192 we are not adopting that requirement in our rules. We believe the approach we are adopting—requiring issuers to provide the disclosure to offerees in the same manner in which an offer is communicated—will provide appropriate flexibility to issuers in the conduct of their offerings and avoid potential confusion as to when, for example, an oral offer must be followed up with a written disclosure.193 Requiring the disclosure to be made orally if the offer is made orally also will help ensure that the investor receives the required disclosure when most relevant (i.e., immediately upon learning about the offer). Furthermore, we believe our amendments to Rule 147(f)(3) and the provision in new Rule 147A(f)(3) will maintain appropriate investor protections, especially in light of the new provision requiring issuers to provide written disclosure to all purchasers within a reasonable period of time before the date of sale. We note that this requirement to provide written disclosure a reasonable period of time before the date of sale is consistent with the disclosure delivery requirements of Regulation D and Rule 701.194 Finally, while we are not adopting commenters’ suggestions to require that written disclosure be provided to all offerees, nothing in our rules prevents state regulators, that deem it necessary and appropriate, from requiring such written disclosures for offers to residents within their states. State regulators are in a position to tailor any such rules to their local capital markets in a manner that addresses capital market practices and investor protection measures they deem appropriate for offers and sales to residents of their state. Consistent with the proposal, issuers will also be required to satisfy the legend requirement in Rules 147(f)(1)(i) and 147A(f)(1)(i), respectively. However, issuers will not be required to disclose to offerees and purchasers the stop transfer instructions provided by an issuer to its transfer agent 195 or the provisions of Rules 147(f)(2) and 192 Id. 193 In addition, it may not be possible for an issuer to provide written disclosures to all offerees. For example, an issuer conducting an offer over the radio would not be able to provide the written disclosures to everyone listening to the offer on the radio as it would not know the identity of each of the offerees. 194 See e.g., Rules 501(i)(4) and 502(b)(1) of Regulation D and Rule 701(e). 195 See 17 CFR 230.147(f)(1)(ii). PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 147A(f)(2), respectively, regarding the issuance of new certificates during the resale period.196 Although issuers will have to comply with these transfer agent instruction requirements,197 we continue to believe that requiring issuers to disclose information regarding such requirements to offerees and purchasers at the time of the offer and/ or sale will not enhance the disclosure requirements under Rules 147(e), 147A(e), 147(f)(1) or 147A(f)(1), and we therefore are eliminating the disclosure requirements related to stop transfer instructions and the issuance of new certificates from Rule 147 and not including them in new Rule 147A.198 Finally, in order for the required disclosure to offerees and purchasers under amended Rule 147(f) and new Rule 147A(f) to be as clear as possible, and consistent with our revisions to make the issuer’s state of residency the focus of the relevant resale restrictions, we are adding a requirement that the issuer identify in this disclosure the particular state or territory in which the issuer was resident at the time of the original sale of the security. Since a small business may change the location of its residence and principal activities within the six-month resale limitation period provided for in amended Rule 147(e) and new Rule 147A(e), we believe this information, which should be readily available to the issuer, will assist purchasers in understanding the implications of the applicable resale restrictions. 7. State Law Requirements a. Proposed Amendments We proposed to limit the availability of Rule 147 to issuers that have registered an offering in the state in which all of the purchasers are resident or that conduct the offering pursuant to an exemption from state law registration in such state that limits the amount of securities an issuer may sell pursuant to such exemption to no more than $5 million in a twelvemonth period and that limits the amount of securities an investor can purchase in any such offering.199 In the Proposing Release, we expressed our preliminary view that, in light of the other proposed changes to 196 See 17 CFR 230.147(f)(2). Additionally, as discussed in Section II.B.1 above, we are requiring issuers in offerings conducted pursuant to Rule 147 or Rule 147A to disclose to each offeree in the manner in which any offer is communicated and to each purchaser of a security in writing that sales will be made only to residents of the same state or territory as the issuer. See Rules 147(f)(3) and 147A(f)(3). 197 See Rules 147(f)(1)(ii), 147(f)(2), 147A(f)(1)(ii) and 147A(f)(2). 198 See Rules 147(f)(3) and 147A(f)(3). 199 See proposed Rule 147(a). E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations Rule 147, including a maximum offering amount limitation and investment limitations in the rule would provide investors with additional protection and would be consistent with existing state law crowdfunding provisions.200 b. Comments on the Proposed Amendments All commenters that addressed the issue opposed any limits at the federal level on offering size or investment size.201 In general, these commenters preferred that any limits be imposed through the state legislative and/or rulemaking process, which they stated may be better situated to making a determination about specific limits.202 Commenters also stated that the requirements are unnecessary at the federal level since these are local offerings where only the individual state’s residents are involved.203 One of these commenters noted the potential disparate impact on larger versus smaller states with different resident populations and gross domestic products.204 Another of these commenters noted that, in addition to the regulation of these offerings at the state level, to the extent federal regulatory oversight is deemed necessary, these offerings are also subject to the Commission’s powers to enforce the antifraud provisions of Section 10(b) of the Exchange Act and Rule 10b–5 thereunder.205 Another of these commenters stated that the baseline cost of the proposed federal requirements may prevent state policy makers from adding investor protection provisions that the states consider to be more effective due to the cumulative compliance burden.206 In addition, the 2015 Small Business Forum recommended that the Commission remove the $5 million limit in the proposal, permitting the states to set their own limits as appropriate.207 200 See Proposing Release. ABA Letter; Letter from Rutheford B. Campbell, Jr., Spears-Gilbert Professor of Law, University of Kentucky College of Law, March 30, 2016 (‘‘Campbell Letter’’); CFIRA Letter; Congressional Letter (‘‘the states are better positioned to determine offering and investment caps that best meet their local population and business needs’’); CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA Letter; NextSeed Letter; WBA Letter. 202 See, e.g., ABA Letter; Campbell Letter; CFIRA Letter; Congressional Letter; CrowdCheck Letter; Guzik Letter; NASAA Letter; WBA Letter. 203 ABA Letter; Campbell Letter; CFIRA Letter; CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA Letter; NextSeed Letter; WBA Letter. 204 NASAA Letter. 205 Guzik Letter. 206 Milken Letter. 207 See 2015 Small Business Forum Recommendations. asabaliauskas on DSK3SPTVN1PROD with RULES 201 See VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 A few commenters stated that, if the proposed limits were retained, any limit on the amount a company can raise under Rule 147 should be indexed for inflation,208 with one of these commenters suggesting an automatic, periodic review of any such limits.209 One commenter strongly encouraged the Commission to raise the offering limit significantly.210 Two commenters believed that, if the proposed limits were retained, Rule 147 should be amended to require that the offering, not the state exemption, be limited to no more than $5 million in order to allow issuers to rely upon existing state law exemptions.211 One of these commenters also suggested that, if the proposed investment limits were retained, the Commission should establish them as direct requirements of amended Rule 147 and should only apply them to non-accredited investors.212 c. Final Rules Given the comments received, the recommendations of the 2015 Small Business Forum and the intrastate nature of the offerings, we are not limiting amended Rule 147 and new Rule 147A to offerings that either are registered in the state where all of the purchasers are resident or that are conducted pursuant to an exemption from state law registration in a state that limits the amount of securities an issuer may sell pursuant to such exemption to no more than $5 million in a twelvemonth period and that limits the amount of securities an investor can purchase in any such offering. Consistent with the policy underlying Section 3(a)(11), we believe it appropriate that the resident investor protections in intrastate offerings primarily flow from the requirements of state securities law. For example, as with the federal securities laws, states generally require an issuer to register an offering with appropriate state authorities when offers or sales of securities are made to their residents, unless the state has adopted, by rule or statute, an exemption from registration. As noted in the Proposing Release, of the states that have adopted and/or enacted crowdfunding provisions that require an issuer to comply with Rule 147, either alone or in conjunction with Section 3(a)(11), no state has adopted and/or enacted a crowdfunding provision with an aggregate offering 208 ABA Letter; NASAA Letter; Milken Letter. Letter. 210 WBA Letter. 211 Bishop Letter; WBA Letter. 212 WBA Letter. 209 NASAA PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 83509 amount that exceeds $5 million.213 Additionally, almost all of these states have adopted provisions that impose investment limitations on investors. In light of these existing limitations in state exemptions and the fact that all commenters opposed our proposed limits at the federal level on offering size and investment size, we are not adopting the proposed federal limits on state exemptions. As commenters noted, states can decide whether to adopt requirements not specifically contemplated by the federal requirements that are consistent with their respective interests in facilitating capital formation and protecting their resident investors in intrastate securities offerings within their jurisdiction.214 If any states determine to amend their statutes and/or rules to require compliance with new Rule 147A, those states can consider whether any additional requirements should be adopted at the state level given their interest in regulating local offerings within their jurisdiction. Moreover, in addition to state securities law requirements, issuers will continue to be subject to the antifraud and civil liability provisions of the federal securities laws. C. Additional Considerations In addition to soliciting specific comments on the proposals, we also solicited general comments, including additional or different revisions to the rules and other matters that may impact the proposals. 1. Notice Filings Commenters were divided on whether to require issuers utilizing the exemption to make a notice filing with the Commission. While one commenter specifically stated that additional federal administrative obligations, such as new minimum disclosure or delivery requirements, registration and/or additional filings with the Commission, should not be imposed on issuers for 213 See https://www.nasaa.org/industry-resources/ corporation-finance/instrastate-crowdfundingresource-center/intrastate-crowdfunding-directory/. Illinois is the only state with a crowdfunding provision allowing for a maximum aggregate offering amount up to $5 million in a twelve-month period. All other states that have adopted some form of a state-based crowdfunding provision limit the aggregate offering amount to between $1 million and $2.5 million. See Illinois House Bill 3429, § 4.T. (2015), available at https://legiscan.com/IL/text/ HB3429/id/1257029. 214 States currently employ this approach to varying degrees in their respective state crowdfunding statutes. See, e.g., D.C. Mun. Regs. tit. 26–B, § 250 (2014) (escrow required until minimum offering amount satisfied), Ind. Code § 6–3.1–24–14 (2014) (funding portal required). E:\FR\FM\21NOR2.SGM 21NOR2 83510 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations conducting intrastate crowdfunding,215 another commenter recommended that the Commission require issuers utilizing Rule 147 to file a notice with the Commission, but (similar to Regulation D) the exemption should not be conditioned on the filing.216 Given the local intrastate nature of the exemptions, we continue to believe that the limited benefits of a notice filing with the Commission would not justify the costs and burdens on issuers to add such a requirement. We note, however, that states could make a notice filing (at the state level) a condition to any state law exemption.217 In this regard, we note that a vast majority of intrastate crowdfunding provisions require a notice filing with a state regulator.218 Commission staff will seek to collaborate with state regulators to consider filing data in connection with the study of amended Rule 147 and new Rule 147A.219 2. Intrastate Broker Dealer Exemption Exchange Act Section 15(a)(1) exempts from broker-dealer registration requirements under Section 15(b) a broker-dealer whose business is exclusively intrastate and who does not use any facility of a national securities exchange (‘‘intrastate broker-dealer exemption’’).220 Several commenters supported interpreting the intrastate broker-dealer exemption under the Exchange Act to include intermediaries whose activities are limited to facilitating intrastate offerings using the Internet.221 One commenter was concerned that intrastate intermediaries operating exclusively online may not 215 NextSeed Letter. Letter. 217 See NASAA Letter. 218 E.g., Alabama, Arizona, Colorado, Delaware, Florida, Georgia, Idaho, Illinois, Iowa, Indiana, Kansas, Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Montana, Nebraska, New Mexico, North Carolina, Oregon, South Carolina, Tennessee, Texas, Vermont, Washington, West Virginia, Wisconsin, Wyoming and the District of Columbia. Other states have pending legislation that would require notice filings for intrastate crowdfunded offerings, e.g., California, Hawaii, Missouri, Nevada, and New Hampshire. 219 See Section I above. 220 Under Section 15(a)(1) of the Exchange Act, it is generally unlawful for any broker or dealer to use any means or instrumentality of interstate commerce to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any security (other than an exempt security) unless the broker or dealer is registered with the Commission. Section 15(a)(1) provides an exemption from registration for ‘‘a broker or dealer whose business is exclusively intrastate and who does not make use of any facility of a national securities exchange.’’ 221 See NASAA Letter; NextSeed Letter; WBA Letter. The commenters were focused, in particular, on intermediaries that facilitate intrastate crowdfunding offerings using the Internet. asabaliauskas on DSK3SPTVN1PROD with RULES 216 Campbell VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 qualify for the intrastate exemption from registration if they post information on the Internet and it is accessed by out-ofstate residents.222 The commenter, therefore, suggested that the Commission clarify that an entity will not relinquish its ability to rely on the intrastate broker-dealer exemption solely because it has a web presence, as long as it continues to operate and conduct sales intrastate.223 Two commenters similarly suggested that intrastate intermediaries should be able to rely on the intrastate broker-dealer exemption from broker-dealer registration if they use the Internet to facilitate offerings being conducted in reliance on Rule 147.224 We agree with the commenters that it would be helpful to provide guidance regarding the use of the Internet by a person that seeks to rely on the intrastate broker-dealer exemption.225 In providing this guidance, we are seeking to take into account the contemporary business practices of broker-dealers, which have evolved over the years to include as a routine matter the use of the Internet as an essential tool in conducting business. As noted elsewhere, the actions we are taking today are intended to facilitate capital formation, while maintaining appropriate investor protections. We believe that a broker-dealer whose business otherwise meets the 222 NASAA Letter. This commenter noted that an SEC staff Guide to Broker-Dealer Registration indicates that information posted on the Internet that is accessible by persons in another state would be considered an interstate offer of securities and would require federal broker-dealer registration. See id. See also Guide to Broker-Dealer Registration, Division of Trading and Markets, U.S. Securities and Exchange Commission (Apr. 2008), available at https://www.sec.gov/divisions/marketreg/ bdguide.htm. The Commission has not previously spoken to this issue, and the guidance in this release is intended to take into account modern business practices of broker-dealers and clarify the permissibility of the use of the Internet by brokerdealers relying on the intrastate broker-dealer exemption. To the extent the staff guidance is inconsistent, it is superseded. 223 See NASAA Letter. The commenter also suggested that intrastate broker-dealers be permitted to advertise and use the Internet without having to register with the Commission so long as they used certain disclaimers. Id. 224 NextSeed Letter (‘‘[S]tate crowdfunding intermediaries should be permitted to use the internet to facilitate intrastate crowdfunding offerings pursuant to Rule 147 and still be able to rely on the intrastate broker-dealer exemption.’’); WBA Letter (‘‘If crowdfunding offerings conducted in accordance with amended Rule 147 are intrastate in nature, then state crowdfunding portals which exclusively host such offerings should be deemed to conduct ‘exclusively intrastate’ business under [Section] 15(a)(1).’’). 225 Although commenters focused on brokerdealers who facilitate intrastate crowdfunding offerings, we are providing more general guidance not limited to offerings relying upon intrastate crowdfunding provisions under state law. PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 requirements of the intrastate brokerdealer exemption should not cease to qualify for the intrastate broker-dealer exemption solely because it has a Web site that may be viewed by out-of-state persons, so long as the broker-dealer takes measures reasonably designed to ensure that its business remains exclusively intrastate.226 The use of disclaimers clearly indicating that the broker-dealer’s business is exclusively intrastate and that the broker-dealer can only act for or with, and provide brokerdealer services to, a person in its state could be one means reasonably designed to ensure that the brokerdealer’s business remains exclusively intrastate so long as the broker-dealer does not provide brokerage services to a person that indicates that it is, or that the broker-dealer has reason to believe is, not within the broker-dealer’s state of residence.227 These measures are not 226 As noted, Section 15(a)(1) of the Exchange Act provides an exemption from registration for ‘‘a broker or dealer whose business is exclusively intrastate.’’ Our guidance today is intended to provide clarity regarding when a broker-dealer’s business will be ‘‘exclusively intrastate’’ in connection with its use of the Internet. As discussed in this section of this release, a brokerdealer with a Web site that may be viewed by an out-of-state person may still be able to rely on the intrastate exemption if the broker-dealer implements measures reasonably designed to ensure that its business remains exclusively intrastate. This guidance is separate and apart from the question of whether a security may be offered and sold on the broker-dealer’s Web site in reliance on an exemption from registration under Section 5 of the Securities Act. In this regard, we note that an offer in the context of the Securities Act has generally been defined broadly, and the considerations involved in determining whether an offer includes an impermissible general solicitation are necessarily distinct from the considerations as to whether a broker-dealer’s activities occur exclusively within a single state. Therefore, a broker-dealer facilitating an offering pursuant to an exemption from registration under the Securities Act should be careful not to engage in activity that would compromise the issuer’s ability to rely on the applicable exemption to Securities Act Section 5. See, e.g., Rules 147 and 147A, including paragraphs (d) and (f) and the Instruction to paragraph (d). 227 This guidance is consistent with the concepts articulated in prior Commission guidance for foreign broker-dealers. See Interpretation: Re: Use of Internet Web sites to Offer Securities, Solicit Securities Transactions, or Advertise Investment Services Offshore, SEC Rel. No. 33–7516 (Mar. 23, 1998) (‘‘Offshore Interpretation’’). In the Offshore Interpretation, the Commission stated that it would not consider a foreign broker-dealer’s advertising on an Internet Web site to constitute an attempt to induce a securities transaction with U.S. persons if the foreign broker-dealer takes measures reasonably designed to ensure that it does not effect securities transactions with U.S. persons as a result of its Internet activities. The Commission further stated that, as applied in the broker-dealer context, a foreign broker-dealer generally would be considered to have taken measures reasonably designed to ensure it does not effect securities transactions with U.S. persons as a result of its Internet activities if it: (i) Posts a prominent disclaimer on the Web site either affirmatively delineating the countries in which the broker-dealer’s services are available, or E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations intended to be exclusive. A brokerdealer could adopt other measures reasonably designed to ensure that it does not provide brokerage services to persons that are not within the same state as the broker-dealer. We do not believe, however, that an intermediary’s business would be ‘‘exclusively intrastate’’ if it sold securities or provided any other brokerage services to a person that indicates that it is, or that the broker-dealer has reason to believe is, not within the broker-dealer’s state of residence.228 We believe that this guidance will facilitate capital formation by smaller companies while maintaining appropriate protections for investors.229 This guidance also is consistent with, and will further, the goal of modernizing our rules to comport with contemporary business practices. asabaliauskas on DSK3SPTVN1PROD with RULES 3. Section 12(g) Registration Several commenters recommended exempting securities issued in reliance upon Rule 147 from the reporting requirements of Section 12(g) of the Exchange Act.230 Most of these commenters asserted that the Rule 147 exemption would be of limited utility if the securities were not exempted from Section 12(g).231 In addition, the 2015 Small Business Forum recommended that the Commission provide a permanent exemption from Section 12(g) registration under the Exchange Act for securities sold in a Rule 147 offering.232 As amended by the JOBS Act, Section 12(g) requires, among other things, that an issuer with total assets stating that the services are not available to U.S. persons; and (ii) refuses to provide brokerage services to any potential customer that the brokerdealer has reason to believe is, or that indicates that it is, a U.S. person, based on residence, mailing address, payment method, or other grounds. 228 See, e.g., In the Matter of Professional Investors, Inc., 37 SE.C. 173, 175–176 (1956) (indicating that a broker-dealer that effected transactions on national securities exchanges for its customers and its own account and, as an underwriter, sold stock on behalf of an out-of-state issuer no longer had an exclusively intrastate business and the intrastate exemption from registration as a broker-dealer was therefore not available); Peoples Securities Company, 39 SE.C. 641, 652–653 (1960) (stating that a broker-dealer’s business was not exclusively intrastate based on its interstate activities, which included sales of securities to out-of-state residents), aff’d sub nom. Peoples Securities Co. v. SE.C., 289 F.2d 268 (C.A. 5, 1961). 229 Commission staff expects to consider the role of intrastate broker-dealers and other intermediaries in offerings under amended Rule 147 or new Rule 147A in connection with its study. See Section I above. 230 CFIRA Letter; CrowdCheck Letter; Guzik Letter; Milken Letter; City of Adrian Letter. 231 CFIRA Letter; CrowdCheck Letter; Guzik Letter; City of Adrian Letter. 232 See 2015 Small Business Forum Recommendations. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 exceeding $10,000,000 and a class of securities held of record by either 2,000 persons or 500 persons who are not accredited investors to register such class of securities with the Commission.233 Section 12(g) was originally enacted by Congress as a way to ensure that purchasers of over-the-counter securities about which there was little or no information, but which had a significant shareholder base, were provided with ongoing information about their investment.234 Unlike Tier 2 offerings under Regulation A 235 or Regulation Crowdfunding,236 where the Commission provided conditional exemptions from registration under Section 12(g), issuers that utilize the exemptions under amended Rule 147 or new Rule 147A will not be required to comply with ongoing reporting requirements. Given the lack of ongoing reporting requirements, we believe that the Section 12(g) record holder and asset thresholds continue to provide an important baseline above which issuers should generally be subject to the disclosure obligations of the Exchange Act. As the shareholder base of these issuers and their total assets grow, we believe that the additional protections that will be provided by registration under Section 12(g) are necessary and appropriate. 4. Exclusion of Investment Companies In the proposing release, we asked whether we should leave existing Rule 147 in place and unchanged as a safe harbor under Section 3(a)(11) while adopting the proposed revisions to Rule 147 as a new rule, and if so, whether we should make any additional changes to the proposed rule. One commenter that recommended retaining the existing Rule 147 safe harbor and adopting a new exemption also recommended that the new exemption exclude investment companies subject to the Investment Company Act of 1940 (the ‘‘Investment 233 See Section 501 of the JOBS Act. See also 17 CFR 240.12g–1. In the case of an issuer that is a bank, a savings and loan holding company or a bank holding company, Exchange Act Section 12(g)(1)(B) (15 U.S.C. 78l(g)(1)(B)) requires, among other things, that the issuer, if it has total assets exceeding $10,000,000 and a class of securities held of record by 2,000 persons, register such class of securities with the Commission. See Section 601 of the JOBS Act and Section 85001 of the FAST Act. See also 17 CFR 240.12g–1. 234 See generally Report of the Special Study of Securities Markets of the Securities and Exchange Commission, House Document No. 95, House Committee on Interstate and Foreign Commerce, 88th Cong., 1st Sess. (1963), at 60–62. 235 See 2015 Regulation A Release at Section II.B.6. 236 See Regulation Crowdfunding Adopting Release at Section II.E.4. PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 83511 Company Act’’),237 including private equity funds, from relying upon Rule 147.238 Under Section 24(d) of the Investment Company Act,239 the Section 3(a)(11) exemption is not available for an investment company registered or required to be registered under the Investment Company Act.240 Since we are retaining Rule 147 as a safe harbor under Section 3(a)(11), Rule 147 will continue to be unavailable for an investment company registered or required to be registered under the Investment Company Act. To provide a consistent treatment between Rule 147 and new Rule 147A, we are specifically excluding an issuer that is an investment company registered or required to be registered under the Investment Company Act from relying on Rule 147A.241 As described above, the final rules maintain a consistent approach across the two intrastate offering exemptions, where possible, including with respect to issuer eligibility. In addition, this same commenter also recommended excluding other types of issuers from Rule 147.242 Since these other types of issuers are not excluded from existing Rule 147 and because we believe that, absent specific Congressional direction or evidence of abuse, the states should have the discretion to determine whether any additional restrictions are appropriate for offerings conducted exclusively within their jurisdiction, we 237 15 U.S.C. 80a–1 et seq. Letter. 239 15 U.S.C. 80a–24(d). 240 See 1961 Release at note 1. 241 See Rule 147A(a). Investment companies are companies that are registered or required to be registered under the Investment Company Act. 15 U.S.C. 80a–1 et seq. Private funds (including private equity funds and other pooled investment vehicles) generally rely on the exclusions from the definition of ‘‘investment company’’ in Sections 3(c)(1) or 3(c)(7) of the Investment Company Act. See 15 U.S.C. 80a–3(c). Private funds are precluded from relying on either of these exclusions if they make a public offering of their securities. Id. Accordingly, if such a private fund engaged in a public offering of its securities, that private fund would no longer be able to rely on the applicable exclusion under Section 3(c)(1) or (7) and thus would be required to be registered under the Investment Company Act, unless another exclusion or exemption is available. As a result, the private fund would be an ‘‘investment company’’ for purposes of Section 24(d) and would be excluded from the Section 3(a)(11) exemption and safe harbor of existing Rule 147. 242 Specifically, NASAA also recommended excluding the following types of issuers from the exemption: holding companies (i.e., companies whose principal purpose is owning stock in, or supervising the management of, other companies); blind pools; commodity pools; public companies reporting under the Exchange Act; and blank check companies (i.e., development stage companies that either have no specific business plan or purpose or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies or other entity or person). 238 NASAA E:\FR\FM\21NOR2.SGM 21NOR2 83512 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations are not amending Rule 147 or including a provision in Rule 147A to exclude other types of issuers from these provisions. 5. Trust Indenture Act Two commenters supported exempting securities issued in reliance upon Rule 147, as proposed to be amended, from the Trust Indenture Act of 1939.243 Rule 147 offerings are exempt from the Trust Indenture Act pursuant to Section 304(a)(4) which exempts any security issued in reliance on Section 3(a)(11) of the Securities Act.244 Since the Trust Indenture Act applies to any debt security sold through the use of the mails or interstate commerce, including debt securities sold in transactions that are exempt from Securities Act registration, the issuance of a debt security under new Rule 147A, as a new exemption not under Section 3(a)(11), raises questions about the applicability of the Trust Indenture Act. We note, however, that Trust Indenture Act Section 304(a)(8) 245 and Rule 4a–1 246 provide an exemption for the issuance of up to $50 million of debt securities without an indenture in any 12-month period. Given the existing exemption for up to $50 million of debt securities, we do not believe that a specific exemption from the requirements of the Trust Indenture Act for offerings of debt securities under Rule 147A is necessary at this time. asabaliauskas on DSK3SPTVN1PROD with RULES 6. Other Requirements Two commenters recommended that the Commission work with the states to encourage, or amend Rule 147 in a way that encourages, issuers to use any U.S. escrow agent, as opposed to using only escrow agents registered in the state of the offering, which is often a requirement of state law.247 Another commenter recommended amending Rule 147 to include bad actor disqualification provisions similar to those set forth under Rule 506(d).248 As noted elsewhere, the amendments we are adopting today are intended to facilitate capital formation, while maintaining appropriate investor protections and providing state securities regulators with the flexibility to add additional investor protections they deem appropriate for offerings within their state. Moreover, a broad consensus of commenters opposed additional requirements for exempt 243 NextSeed Letter; WBA Letter. U.S.C. 77ddd(a)(4). 245 15 U.S.C. 77ddd(a)(8). 246 17 CFR 260.4a–1. 247 City of Adrian Letter; Localstake Letter. 248 NASAA Letter. 244 15 VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 intrastate offerings beyond those currently contemplated by our rules.249 State legislatures and/or securities regulators have a significant interest in intrastate offerings made to their residents and therefore may wish to impose, and are uniquely positioned to determine, additional requirements they deem necessary or appropriate for the protection of their residents. Consistent with our approach to other aspects of the final rules, we believe it is appropriate in these circumstances to defer to the states regarding which, if any, of the additional provisions recommended by commenters should supplement the federal rules. In this regard, we note that bad actor disqualification provisions are a feature of most state crowdfunding exemptions.250 In addition, a majority of states have adopted the Uniform Limited Offering Exemption (‘‘ULOE’’), or a variant of that uniform exemption.251 The ULOE includes a bad actor disqualification provision.252 Other state exemptions include bad actor disqualification provisions,253 and the small corporate offering registration (‘‘SCOR’’) program 254 also contemplates 249 See Section II.B.7 above. NASAA Letter. See, e.g., Alabama, Arizona, Colorado, Florida, Georgia, Idaho, Illinois, Iowa, Indiana, Kansas, Kentucky, Maine, Maryland, Massachusetts, Michigan, Mississippi, Montana, Nebraska, New Jersey, New Mexico, North Carolina, Oregon, South Carolina, Tennessee, Texas, Vermont, Washington, Wisconsin and the District of Columbia. 251 See, e.g., Alabama, Arizona, Colorado, Georgia, Illinois, Iowa, Kansas, Louisiana, Massachusetts, Maryland, Mississippi, Nebraska, New Hampshire, New Mexico, North Carolina, North Dakota, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin, Wyoming and the District of Columbia. The Uniform Limited Offering Exemption was adopted by NASAA in 1983 and again in 1989 (available from the NASAA Web site at https://www.nasaa.org/ wp-content/uploads/2011/07/UNIFORM–LIMITED– OFFERING–EXEMPTION.pdf). 252 See Section 1.B of the ULOE. 253 See, e.g., the Model Accredited Investor Exemption (available from the NASAA Web site at https://www.nasaa.org/wp-content/uploads/2011/ 07/24-Model_Accredited_Investor_Exemption.pdf), as well as other state exemptions such as the Small Issuer Exemption in Pennsylvania, 10 Pa. Code § 203.187, and the Small Offering Exemption in Washington, WAC 460–44A–504. 254 Forty-three states, the District of Columbia and the Commonwealth of Puerto Rico have adopted some form of the SCOR program or recognize the filing of Form U–7 (also referred to as uniform limited offering registration (‘‘ULOR’’)). See CCH Blue Sky Law Reporter, Blue Sky Findings Lists, Small Corporate Offering Registration Program and Form U–7, ¶ 6461 (2016). SCOR and Form U–7 were developed by NASAA as a registration format for companies registering securities under state securities laws when relying upon an exemption from Securities Act registration, including Rule 504. A company may not use the SCOR Form to offer and sell its securities if the company or any of its officers, directors, principal stockholders or 250 See PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 disqualification of an issuer or any of its officers, directors, principal stockholders or promoters because of prior violations of the securities laws. We believe that state and federal regulators share an interest in collaborative efforts that facilitate capital formation and investor protection. Accordingly, Commission staff will seek to collaborate with state regulators to review data on the application of state bad actor disqualification provisions in offerings conducted pursuant to amended Rule 147 or new Rule 147A to inform whether the Commission should consider including bad actor disqualification provisions in Rules 147 and 147A.255 III. Amendments to Rules 504 and 505 of Regulation D A. Overview of Rules 504 and 505 Rule 504 256 of Regulation D provides issuers with an exemption from registration for offers and sales of up to $1 million of securities in a twelvemonth period, provided that the issuer is not: • Subject to reporting pursuant to Section 13 or 15(d) of the Exchange Act; 257 • an investment company; 258 or • a development stage company that either has no specific business plan or purpose or that has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies (‘‘blank check company’’).259 Additionally, Rule 504 imposes certain conditions, including limitations on the use of general solicitation or general advertising in the offering and the restricted status of securities issued pursuant to the exemption, with limited exceptions for offers and sales made: • Exclusively in one or more states that provide for the registration of the securities, and require the public filing and delivery to investors of a substantive disclosure document before sale, and are made in accordance with state law requirements; • in one or more states that have no provision for the registration of the securities or the public filing or delivery promoters are disqualified because of prior violations of the securities laws. A company also may not use salespersons who are disqualified because of prior violations of the securities laws. See SCOR Overview, available from the NASAA Web site at https://www.nasaa.org/industryresources/corporation-finance/scor-overview/. 255 See Section I above. 256 17 CFR 230.504. 257 17 CFR 230.504(a)(1). 258 17 CFR 230.504(a)(2). 259 17 CFR 230.504(a)(3). E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES of a disclosure document before sale, if the securities have been registered in at least one state that provides for such registration, public filing and delivery before sale, offers and sales are made in that state in accordance with such provisions, and the disclosure document is delivered before sale to all purchasers (including those in the states that have no such procedure); or • exclusively according to state law exemptions from registration that permit general solicitation and general advertising so long as sales are made only to ‘‘accredited investors’’ as defined in Rule 501(a) of Regulation D.260 Rule 504, together with Rules 505 and 506, comprise the Securities Act exemptions and safe harbor in Regulation D.261 Regulation D offerings are exempt from the registration requirements of the Securities Act. Offerings conducted pursuant to Rule 504 or Rule 505, however, must be registered in each state in which they are offered or sold unless an exemption to state registration is available under state securities laws.262 The vast majority of states have adopted a uniform registration form for offerings 260 17 CFR 230.504(b)(1). State exemptions of this nature include those based upon the ‘‘Model Accredited Investor Exemption,’’ which was adopted by NASAA in 1997. CCH NASAA Reporter Para. 361. Generally, the model rule exempts offers and sales of securities from state registration requirements, if among other matters, the securities are sold only to persons who are, or are reasonably believed to be, ‘‘accredited investors’’ as defined in Rule 501(a) of Regulation D, 17 CFR 230.501(a). The model rule restricts transfer of the securities for 12 months after issuance except to other accredited investors or if registered. General solicitations by any means under that provision are generally limited to a type of ‘‘tombstone’’ ad. See Model Accredited Investor Exemption, available from the NASAA Web site at https://www.nasaa.org/wpcontent/uploads/2011/07/24-Model_Accredited_ Investor_Exemption.pdf. 261 17 CFR 230.500 through 508. Rules 501 through 503 contain definitions, conditions, and other provisions that apply generally throughout Regulation D. Rules 504, 505 and 506(c) are exemptions from registration under the Securities Act, while Rule 506(b) is a ‘‘safe harbor’’ for compliance with the non-public offering exemption in Section 4(a)(2) of the Securities Act. Rule 507 disqualifies issuers from relying on Regulation D, under certain circumstances, for failure to file a Form D notice. Rule 508 provides a safe harbor for certain insignificant deviations from a term, condition, or requirement of Regulation D. 262 Section 18(b)(4)(D) of the Securities Act provides ‘‘covered security’’ status to all securities sold in transactions exempt from registration under Commission rules promulgated under Section 4(a)(2), which includes Rule 506 of Regulation D. Covered security status under Section 18 provides for the preemption of state securities laws registration and qualification requirements for offerings of such securities. In comparison, securities issued pursuant to either Rules 504 or 505 are not covered securities as these two exemptions are adopted pursuant to the Commission’s authority under Section 3(b)(1) of the Securities Act. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 relying upon Rule 504.263 One state, however, recently adopted a form of state-based crowdfunding that permits the use of general solicitation but has provided for an abbreviated state registration procedure where, in addition to following various statespecific requirements for registration, an issuer also complies with Rule 504 of Regulation D.264 Additionally, offerings conducted pursuant to Rules 505 and 506 are subject to bad actor disqualification provisions, while offerings conducted pursuant to Rule 504 are not subject to such provisions.265 B. Amendments to Rule 504 1. Proposed Amendments to Rule 504 In an effort to facilitate capital formation, including facilitating the development of comprehensive regional coordinated review programs at the state level, and enhance investor protection, we proposed to increase the aggregate amount of securities that may be offered and sold in any twelve-month period pursuant to Rule 504 from $1 million to $5 million and to disqualify certain bad actors from participation in Rule 504 offerings. We further proposed a technical amendment to Rules 504 and 505 to account for the re-designation of Securities Act Section 3(b) as Section 3(b)(1) that occurred as a result of the enactment of the JOBS Act in 2012.266 Additionally, to account for the proposed increase in the Rule 504 aggregate offering amount limitation, we proposed technical amendments to the notes to Rule 504(b)(2) that would update the current illustrations in the rule regarding how the aggregate offering limitation is calculated in the event that an issuer sells securities pursuant to Rule 504 and Rule 505 within the same twelve-month period.267 2. Comments on the Proposed Amendments to Rule 504 Many commenters supported, and no commenters opposed, increasing the Rule 504 offering amount limit from $1 263 See note 254 above. the 34 states and the District of Columbia that have adopted intrastate crowdfunding provisions, only Maine allows an issuer to rely upon Rule 504 of Regulation D where the issuer is required to file with the Maine securities regulator in an abbreviated registration procedure. See Me. Rev. Stat. tit. 32, § 16304(6–A)(D) (2013). 265 See Rule 505(b)(2)(iii), 17 CFR 230.505(b)(2)(iii), and Rule 506(d), 17 CFR 230.506(d), of Regulation D. 266 Public Law 112–106, 126 Stat. 306. 267 See proposed Notes 1 and 2 to Rule 504(b)(2). See also 17 CFR 230.504(b)(2). 264 Of PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 83513 million to $5 million.268 These commenters stated that increasing the offering amount limit will allow more small businesses to use this capital raising tool, better satisfying the needs of these businesses for capital formation and helping to facilitate multi-state offerings.269 Several commenters stated that Rule 504 is currently being underutilized, in part, due to the low offering amount limit of $1 million and the erosion of the dollar’s value due to inflation since the offering amount limit was last raised in 1988 from $500,000 to $1 million.270 As Rule 504 allows issuers to conduct an offering in multiple states and provides an opportunity for states to coordinate a regional review of the offering, commenters stated that an increase in the Rule 504 offering amount limit will encourage new interstate, regional approaches to crowdfunding and other small business offerings and will provide greater utility to a regional review of those offerings.271 Two commenters stated that the offering amount limit should be increased to $10 million in order to offset the significant compliance costs involved in state registration and review.272 In addition, the 2015 Small Business Forum recommended that the Commission increase the proposed limit on Rule 504 to $10 million, permitting the states to set their own limit as appropriate.273 Another commenter stated that Rule 504 should be automatically indexed for inflation in order to preserve the utility of the rule from the erosion of the dollar’s value in real terms.274 Two commenters stated the Commission should use its general exemptive 268 ABA Letter; CFA Letter; CFIRA Letter; CrowdCheck Letter; Milken Letter; NASAA Letter. 269 Id. 270 ABA Letter; Milken Letter; NASAA Letter. 271 NASAA Letter (‘‘Maine currently permits interstate crowdfunding under the federal exemption in Rule 504 and Mississippi and Vermont dually offer intrastate crowdfunding under Section 3(a)(11) and interstate crowdfunding under Rule 504. Many other states are presently exploring a dual option for crowdfunding, including additional regional review programs under Rule 504.’’). See also CFA Letter. 272 CrowdCheck Letter (‘‘Having recently gone through the coordinated review process in the context of a Regulation A offering, we believe that the compliance cost involved in state registration and review is significant, and Rule 504 will only be of interest to issuers if they can raise enough capital to offset this burden.’’); CFIRA Letter. 273 See 2015 Small Business Forum Recommendations. 274 Milken Letter (‘‘Rule 504’s current obsolescence is largely a result of the erosion of the dollar’s value in real terms . . . Indexing would place Rule 504 in a similar position to Regulation Crowdfunding offerings where, under Section 4A(h)(1) of the 1933 Act the annual dollar amount is to be adjusted for inflation at least every five years.’’). E:\FR\FM\21NOR2.SGM 21NOR2 83514 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations authority under Section 28 for future increases in the Rule 504 offering limitation.275 Several commenters also supported, and no commenters opposed, amending Rule 504 to include bad actor disqualification provisions to provide a more uniform set of bad actor triggering events across Regulation D.276 In response to our solicitation for comment on whether to repeal Rule 504(b)(1)(iii) or amend the rule to place limitations on resale, one commenter recommended that the Commission not repeal or amend Rule 504(b)(1)(iii), but retain this provision to provide an environment that ‘‘allow[s] the states to experiment’’ and innovate in a manner that may prove useful for state and federal policy makers.277 Rule 504(b)(1)(iii) provides an exemption from registration for offers and sales of securities that are conducted ‘‘according to state law exemptions from registration that permit general solicitation and general advertising so long as sales are made only to ‘accredited investors’ as defined in Rule 501(a).’’ Securities sold without registration in reliance on this provision are not subject to the limitations on resale established in Rule 502(d) and, as such, are not ‘‘restricted securities’’ for purposes of Rule 144(a)(3)(ii). Another commenter indicated that ‘‘the Commission should consider amending Rule 504 to permit resales of securities issued in Rule 504 ‘public offerings’ in states where the offering complies with exemptions that permit general solicitation or advertising and that require dissemination of a state law compliant disclosure document.’’ 278 One commenter recommended that the Commission exempt securities sold under Rule 147 and 504 from the requirements of Section 12(g) of the Securities Exchange Act of 1934.279 In addition, the 2015 Small Business Forum recommended that the 275 ABA Letter; Milken Letter. Letter; CFA Letter (‘‘It not only clarifies the applicability to new Rule 504 offering limits, but also provides consistency across Regulation D.’’); CFIRA Letter; CrowdCheck Letter; NASAA Letter (‘‘We also strongly support a more uniform set of bad actor triggering events across Regulation D . . . as this would align with bad actor disqualification provisions already included in state crowdfunding exemptions.’’). 277 Milken Letter (noting that this approach ‘‘will allow for innovation in a tightly controlled environment that may prove useful for other state and federal policy makers.’’). 278 ABA Letter. 279 Milken Letter (‘‘Given the expected local nature of Rule 147 offerings and the likelihood that they will be made to the general public for relatively small amounts, it is very possible that small companies making even modest offerings would accrue sufficient numbers of non-accredited investors to be forced to register with the Commission.’’). asabaliauskas on DSK3SPTVN1PROD with RULES 276 ABA VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 Commission provide a permanent exemption from Section 12(g) registration under the Exchange Act for securities sold in a Rule 504 offering.280 3. Final Amendments to Rule 504 The amendments that we are adopting to Rule 504 will raise the aggregate amount of securities an issuer may offer and sell in any twelve-month period from $1 million to $5 million, which is the maximum statutorily allowed under Section 3(b)(1).281 The Commission has not raised the 12-month aggregate offering amount limit in Rule 504 since 1988, when the Commission increased the original Rule 504 offering amount limit of $500,000 to $1 million.282 Adjusted for inflation, the $1 million limit in 1988 would equate to approximately $2 million today.283 We believe the $5 million limit will facilitate issuers’ ability to raise capital. We also believe that our amendments to increase the aggregate offering amount limit in Rule 504 to $5 million may bolster efforts among the states to enter into, or revise existing, regional coordinated review programs that are designed to increase efficiencies associated with the registration of securities offerings in multiple jurisdictions without increasing risks to investors. Increasing the aggregate offering amount limit from $1 million to $5 million will also increase the flexibility of state securities regulators to set their own limits and to consider whether any additional requirements should be implemented at the state level. Although two commenters and the 2015 Small Business Forum recommended that the Commission increase the Rule 504 offering amount limit to $10 million, we are not exceeding the maximum offering amount permitted under Section 3(b)(1). Although, as several commenters noted, we could use our exemptive authority under Section 28 of the Securities Act to raise the maximum offering amount above $5 million,284 in accord with the suggestion of one of those 280 See 2015 Small Business Forum Recommendations. 281 Rules 504 and 505 were adopted pursuant to the Commission’s small issues exemptive authority under Section 3(b)(1) of the Securities Act, which gives the Commission authority to adopt an exemption for offerings not exceeding $5 million where the Commission believes registration under the Securities Act is not necessary by reason of the small amount involved or the limited character of the public offering. 282 See SEC Rel. No. 33–6758 (Mar. 3, 1988) [53 FR 7870 (Mar. 10, 1988)]. 283 Annual inflation rates (1988–2015) based on consumer price index data, for all urban consumers, obtained from the Bureau of Labor Statistics. 284 ABA Letter; Milken Letter. PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 commenters,285 we believe it appropriate to first observe market activity under a new maximum offering amount of $5 million before raising the Rule 504 offering limit higher. In conjunction with our increase to the Rule 504 aggregate offering amount limit, we are also adopting provisions that will disqualify certain bad actors from participation in offerings conducted pursuant to the exemption.286 We believe that the disqualification provisions that we are adopting, which are substantially similar to related provisions in Rule 506 of Regulation D,287 will create a more consistent regulatory regime across Regulation D and provide additional protections to investors in Rule 504 offerings. The Rule 504 disqualification provisions will be implemented by reference to the disqualification provisions of Rule 506 of Regulation D.288 We believe that creating a uniform set of bad actor triggering events across the various exemptions from Securities Act registration should simplify due diligence, particularly for issuers that may engage in different types of exempt offerings. In accordance with the views of several commenters,289 the bad actor triggering events for Rule 504 will be substantially similar to existing provisions in Regulation D,290 Regulation A,291 and Regulation Crowdfunding 292 and will apply to the issuer and other covered persons (such as underwriters, placement agents, and the directors, officers and significant shareholders of the issuer). Consistent with the Commission’s treatment of disqualification in Rule 506(e),293 disqualification will only occur for triggering events that occur after effectiveness of any amendments, but disclosure will be required for triggering 285 ABA Letter (‘‘If the increase to $5 million is adopted, after there is experience with the use and operation of new Rule 504, the Commission may wish to consider using its exemption authority under Section 28 to increase the dollar limitation amount that may be offered under Rule 504.’’). 286 See Rule 504(b)(3). 287 See 17 CFR 230.506(d). See also Rule 262 of Regulation A, 17 CFR 230.262, and Rule 505(b)(2)(iii) of Regulation D, 17 CFR 230.505(b)(2)(iii). 288 See Rule 504(b)(3), referencing the disqualification provisions of Rule 506(d), 17 CFR 230.506(d), and Instruction to paragraph (b)(3) of Rule 504, referencing the disclosure provisions of Rule 506(e), 17 CFR 230.506(e). 289 CFA Letter; NASAA Letter. 290 See Rules 505(b)(2)(iii) and 506(d) of Regulation D, 17 CFR 230.505(b)(2)(iii), 230.506(d). 291 See Rule 262 of Regulation A, 17 CFR 230.262. 292 See Rule 503 of Regulation Crowdfunding, 17 CFR 227.503. 293 See 17 CFR 230.506(e). E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations events that pre-date effectiveness of any amendments.294 We also sought public comment on whether additional changes to Rule 504 should be adopted in the final amendments. In particular, in conjunction with the increase in the Rule 504 offering amount limit, we contemplated amending the calculation of the aggregate offering limit in Rule 504(b)(2). Currently, this rule requires issuers to aggregate all securities sold within the preceding 12 months in any transaction that is exempt under Section 3(b) or in violation of Section 5(a) of the Securities Act for purposes of computing the aggregate offering amount under Rule 504.295 This rule also includes illustrations of how the aggregate offering limit is calculated in the event that an issuer sells securities pursuant to Rule 504 and Rule 505 within the same twelve-month period.296 When the current aggregation provisions in Rules 504 and 505 were originally adopted in Rule 505’s predecessor, Rule 242, the Commission noted that aggregating offering amounts across offerings conducted pursuant to Section 3(b) was intended to ‘‘limit the potential for the issuer to raise large sums by circumventing the registration provisions of the Securities Act through multiple offerings pursuant to Section 3(b).’’ 297 In the intervening years, however, in implementing Congressional mandates,298 the Commission has increased the number of exemptive provisions available to issuers, particularly smaller issuers, to raise large sums of capital in a more cost-effective manner in offerings that are exempt from registration, while continuing to provide appropriate safeguards for investors.299 Therefore, we sought comment on whether the current requirements for Rule 504(b)(2), as they relate to the aggregation of offering proceeds across all offerings that are conducted pursuant to 294 See Rule 504(b)(3). CFR 230.504(b)(2); see also 17 CFR 230.505(b)(2). 296 See 17 CFR 230.504(b)(2). 297 SEC Rel. No. 33–6180 (Jan. 17, 1980). This provision was subsequently carried over into Rule 505 and incorporated into Rule 504 when Regulation D was adopted by the Commission in 1982. See SEC Rel. No. 33–6389 (Mar. 8, 1982); SEC Rel. No. 33–6339 (Aug. 7, 1981). 298 See JOBS Act, Public Law 112–106, 126 Stat. 306. 299 See, e.g., Regulation A, 17 CFR 230.251 et seq., providing non-Exchange Act reporting companies with the option to raise up to $20 million annually pursuant to the requirements of Tier 1 and up to $50 million annually pursuant to the requirements of Tier 2. asabaliauskas on DSK3SPTVN1PROD with RULES 295 17 VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 Securities Act Section 3(b)(1), should be retained in the amendments.300 Although no commenters responded to our request for comment on this issue, in light of our repeal today of Rule 505, which is the only other existing exemption in Regulation D promulgated under Section 3(b)(1), we are amending Rule 504(b)(2) to omit any reference to the aggregation of offering proceeds across all offerings that are conducted pursuant to Section 3(b) of the Securities Act. Correspondingly, we are also deleting the related note under Rule 504(b)(2) illustrating how the aggregate offering amount limitation is calculated in the event that an issuer sells securities pursuant to Rule 504 and Rule 505 within the same twelve-month period. We are also adopting a further technical amendment to the second note to Rule 504(b)(2), as proposed. Specifically, we are updating the illustration of how the aggregate offering amount limitation is calculated to account for the increase to the Rule 504 aggregate offering amount limitation from $1 million to $5 million.301 One commenter 302 and the 2015 Small Business Forum recommended that the Commission provide an exemption from Section 12(g) registration under the Exchange Act for securities sold in a Rule 504 offering.303 As discussed above, Section 12(g) requires, among other things, that an issuer with total assets exceeding $10,000,000 and a class of securities held of record by either 2,000 persons, or 500 persons who are not accredited investors, register such class of securities with the Commission.304 Unlike Tier 2 offerings under Regulation A 305 or Regulation Crowdfunding,306 where the Commission provided conditional exemptions from registration under Section 12(g), issuers that utilize the exemptions under amended Rule 504 will not be required to comply with ongoing reporting requirements. Given the lack of ongoing reporting requirements under Rule 504, we believe that the Section 12(g) record holder and asset thresholds continue to provide an important baseline above which issuers should generally be 300 We are referring to Section 3(b)(1) instead of Section 3(b), due to the changes that occurred as a result of the Securities Act amendments in Title IV of the JOBS Act. 301 See Instruction to paragraph (b)(2) to Rule 504. 302 Milken Letter. 303 See 2015 Small Business Forum Recommendations. 304 See note 233 above. 305 See 17 CFR part 251. See also 2015 Regulation A Release at Section II.B.6. 306 See 17 CFR 227.100. See also Regulation Crowdfunding Adopting Release at Section II.E.4. PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 83515 subject to the disclosure obligations of the Exchange Act. As the shareholder base of these companies and their total assets grow, we believe that the additional protections that will be provided by registration under Section 12(g) are necessary and appropriate. Another commenter recommended that the Commission amend Rule 504 to permit the resale of securities issued in Rule 504 ‘‘public offerings’’ in states where the offering complies with exemptions that permit general solicitation or advertising and that require a public filing and delivery of a state law compliant disclosure document before any sales to purchasers.307 As discussed above, Rule 504 currently permits the resale of securities issued in Rule 504 offerings that involve general solicitation or advertising where either the offering is registered in one or more states and one or more states require the dissemination of a state-approved disclosure document or the offering is exempt but sales are only made to accredited investors.308 Consistent with the limitations on resales in other Securities Act exemptions that permit general solicitation or advertising, such as Rule 506(c) and Regulation Crowdfunding, we have concerns with expanding the ability to issue freely tradable securities under Rule 504 to offerings that permit general solicitation or advertising to non-accredited investors without state registration. Further, we believe that the additional protections that will be provided by the limitations on resale for securities offered and sold in these transactions, which are directed primarily to non-accredited investors,309 are necessary and appropriate given that these offerings are not registered at either the state or federal level. C. Repeal of Rule 505 In light of the proposed amendments to Rule 504, we solicited comments on whether we should repeal Rule 505 as an exemption from registration. Rule 505 is used far less frequently than Rule 506,310 and in the Proposing Release, we noted that an increase in the Rule 504 offering amount limit from $1 million to $5 million could further diminish its utility.311 307 ABA Letter. 17 CFR 230.504(b). 309 In contrast, general solicitation or advertising is permitted under Rule 506(c), so long as the issuer limits all sales exclusively to accredited investors and the issuer takes reasonable steps to verify that the investor is an accredited investor. 310 See note 22 above. See also Table 5 in Section V.A.2.a below. 311 See Proposing Release at Section III.C. 308 See E:\FR\FM\21NOR2.SGM 21NOR2 83516 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations 1. Comments on Repealing Rule 505 Three commenters responded to our request for comment on Rule 505. One commenter recommended that the Commission review the Rule 505 exemption ‘‘to consider whether modifications may and/or should be made to modernize the exemption; for example, reviewing the aggregate offering amount or information requirements.’’ 312 This commenter strongly opposed, however, replacing Rule 505 with a new Securities Act exemption providing ‘‘covered security status’’ under Section 18 of the Securities Act to securities issued in reliance on the new exemption.313 This commenter cautioned ‘‘against considering a new framework for Rule 505 that is contrary to the rule’s original intent and purpose—to be a coordinated federal-state exemption and ‘to achieve a uniform system of federal-state limited offering exemptions that facilitates capital formation consistent with the protection of investors.’ ’’ 314 Another commenter stated that changes to Rule 505 aimed at facilitating very small offerings by early stage companies merit further consideration.315 This commenter also recommended that the Commission consider ‘‘whether an exempt, simple debt-only offering is feasible and could be made cost-efficient for smaller issuers.’’ 316 According to this commenter, the Commission should explore whether an exemption focused on simple debt securities could serve the needs of small businesses and investors, especially since the unique nature of simple debt securities may warrant more modest and easier compliance requirements, while not sacrificing investor protections, as compared to an exemption that permits both debt and equity offerings.317 312 NASAA Letter. (opposing extension of covered security status ‘‘by either enacting a new ‘safe harbor’ pursuant to Securities Act Section 4(a)(2) or by defining purchasers of securities issued in an offering pursuant to the exemption as ‘qualified purchaser,’ pursuant to Securities Act Section 18(b)(3).’’) 314 Id. (‘‘In 1983, NASAA adopted a model exemption, the Uniform Limited Offering Exemption (‘‘ULOE’’), designed to provide an exemption at the state level for offerings that are exempt at the federal level under Rules 505 and 506 of Regulation D.’’). 315 Milken Letter. 316 Id. 317 Id. In commenting on the proposed amendments to Rule 147, one commenter noted that small businesses are likely to seek debt financing more frequently than equity offerings. See Nextseed Letter (‘‘equity offerings are more likely to be attractive to technology-based, high growth companies that cannot financially support debt obligations,’’ as compared to ‘‘Main Street’’ asabaliauskas on DSK3SPTVN1PROD with RULES 313 Id. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 Finally, another commenter stated that, if the proposed changes to Rule 504 are adopted, Rule 505 would be substantially similar to Rule 504, making Rule 505 unnecessary, unless the Commission increases the aggregate offering amount that may be raised under Rule 505 in any twelve-month period.318 This commenter recommended, for example, that the ceiling could be raised from $5 million to $10 million or some larger amount, thereby preserving Rule 505 as a viable alternative exemption. Despite its infrequent use, the commenter noted that Rule 505 serves the purpose of permitting issuers to sell to up to 35 non-accredited investors without having to be satisfied that these investors meet a financial sophistication test.319 2. Repeal of Rule 505 After considering these comments, we are repealing Rule 505. After the effective date of the repeal of Rule 505, issuers will no longer be able to make offers and sales of securities in reliance on Rule 505. We believe that amending Rule 504 to increase the aggregate offering amount from $1 million to $5 million will further reduce the incentives to use Rule 505 by issuers contemplating an exempt offering. We also believe that, even if we were to raise the Rule 505 aggregate offering amount limit from $5 million to $10 million, or some higher amount, such a higher limit would not increase the utility of the Rule 505 exemption as compared to Rule 506, which has no limit, given the historical use of Rule 505 as compared to Rule 506. Further, although Rule 505 provides issuers the ability to sell securities to up to 35 nonaccredited investors without having to make a finding, as in Rule 506(b)(2)(ii), that such persons have the knowledge and experience in financial matters that they are capable of evaluating the merits and risks of the prospective investment,320 this provision does not appear to have historically resulted in the Rule 505 exemption being widely utilized.321 businesses (e.g., local restaurants operated by friends and families) that are inherently local in nature seeking to raise not millions of dollars, but much smaller amounts of capital that traditional lenders are increasingly reluctant to fund). 318 ABA Letter. 319 Id. In contrast, issuers relying upon Rule 506(b) may sell to up to 35 non-accredited investors, but each non-accredited investor must satisfy a financial sophistication test set forth in Rule 506(b)(2)(ii). 320 Cf., 17 CFR 230.506(b)(2)(ii). 321 For the period 2009–2015, there were a total of 1,542 Rule 505 offerings. During this same time period, there were a total of 70,793 Rule 506(b) offerings of $5 million or less. See Table 5 in PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 We believe the flexibility of the requirements of Rule 504, as amended today, as well as the availability of Rule 506(b) and Rule 506(c) will continue to fulfill the original objectives of Regulation D to achieve uniformity between state and federal exemptions in order to facilitate capital formation consistent with the protection of investors.322 Amended Rule 504 will be available only to non-reporting issuers 323 that are not investment companies 324 or development stage companies 325 for offerings of up to $5 million in a twelve-month period and will permit general solicitation and the issuance of unrestricted securities in certain limited situations.326 Rule 506(b) and 506(c) are available to all issuers without any aggregate offering amount limitations. Rule 506(b) prohibits general solicitation and limits sales to no more than 35 non-accredited investors.327 Rule 506(c) permits general solicitation where all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that the purchasers are accredited investors.328 Securities issued pursuant to Rules 506(b) and 506(c) are deemed restricted securities.329 Reporting issuers also can register the offer and sale of securities on Form S–1, for which the Commission recently promulgated rules permitting forward incorporation by reference.330 IV. Other Matters If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, Section V.A.2.b below. See also Scott Bauguess, Rachita Gullapalli and Vladimir Ivanov, ‘‘Capital Raising in the U.S.: An Analysis of the Market for Unregistered Securities Offerings, 2009–2014’’ (October 2015) (‘‘Unregistered Offerings White Paper’’), available at https://www.sec.gov/dera/staffpapers/white-papers/unregistered-offering102015.pdf. 322 See SEC Rel. No. 33–7644 (Feb. 25, 1999) [64 FR 11090 (Mar. 8, 1999)] (‘‘Seed Capital Release’’) at text accompanying note 4. See also Release No. 33–6389 (Mar. 8, 1982) [47 FR 11251] (Regulation D adopting release). 323 See Rule 504(a)(1). 324 See Rule 504(a)(2). 325 See Rule 504(a)(3). 326 See Rule 504(b)(1). 327 See 17 CFR 230.506(b)(2). 328 See 17 CFR 230.506(c). 329 See 17 CFR 230.506(b)(2) and 17 CFR 230.502(d). 330 See SEC Release No. 33–10003 [81 FR 2743] (Jan. 19, 2016) (revising Form S–1 to permit a smaller reporting company to incorporate by reference into its registration statement any documents filed by the issuer subsequent to the effective date of the registration statement). The information delivery requirements under Rule 505 for an Exchange Act reporting issuer that sells securities to a non-accredited investor are similar to the disclosure requirements for a registered offering under the Securities Act. See Rule 502(b)(2)(ii). E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. V. Economic Analysis This section analyzes the expected economic effects of the final rules relative to the current baseline, which is the regulatory framework and state of the market 331 in existence today, including current provisions available to potential issuers to raise capital up to $5 million. We are mindful of the costs imposed by, and the benefits obtained from, the final rules. Relative to this baseline, our analysis considers the anticipated benefits and costs for market participants affected by the final rules as well as the impact of the final rules on efficiency, competition and capital formation.332 We also analyze the asabaliauskas on DSK3SPTVN1PROD with RULES 331 The term ‘‘market’’ as used throughout this economic analysis refers to capital markets in general, and where discussed in the context of a specific rule, relates to the provisions of the relevant exemption or safe harbor. We refer, for example, to the Rule 147 safe harbor and Rule 504 exemption as the Rule 147 and Rule 504 markets because each of those rules’ provisions prescribe requirements that determine who can participate and how the participants (issuers/investors/ intermediaries) can engage in transactions under each exemption. Participants face different tradeoffs when choosing between the markets created by each of the exemptions and safe harbors. 332 Securities Act Section 2(b) and Exchange Act Section 3(f) direct us, when engaging in rulemaking that requires us to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. See 15 U.S.C. 77b(b) and 15 U.S.C. 78c(f). In addition, VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 potential benefits and costs stemming from alternatives to the final rules that we considered. Many of the benefits and costs discussed below are difficult to quantify, especially when analyzing the likely effects of the final rules on efficiency, competition and capital formation. For example, it is difficult to precisely estimate the extent to which amended Rule 147 and new Rule 147A will promote future reliance by issuers on these provisions, or the extent to which future use of amended Rule 147 and new Rule 147A will affect the use of other offering methods. Similarly, it is difficult to quantify the effect of the final rules on investor protection. Therefore, much of the discussion in this section is qualitative in nature. However, where possible, we have attempted to quantify the expected effects of the final rules. A. Baseline The final rules will modernize Rule 147, a safe harbor under Section 3(a)(11), and establish new Rule 147A in order to facilitate intrastate offerings, including intrastate crowdfunded offerings under state securities laws. We also are amending Rule 504 of Regulation D to raise the aggregate amount that can be raised during a twelve-month period from $1 million as established in 1988, to $5 million and to disqualify certain bad actors from participating in Rule 504 offerings. In light of the amendments to Rule 504, we Exchange Act Section 23(a)(2) requires us, when adopting rules, to consider the impact that any new rule would have on competition. See 15 U.S.C. 78w(a)(2) PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 83517 are also repealing Rule 505, an alternate exemption available under Regulation D for offerings of up to $5 million during a twelve-month period. The final rules will primarily impact the financing market for startups and small businesses.333 The baseline for our economic analysis—including the baseline for our consideration of the effects of the final rules on efficiency, competition and capital formation—is the regulatory framework and market structure in existence today in which startups and small businesses seeking to raise capital through securities offerings must register the offer and sale of securities under the Securities Act, unless they can rely on an existing exemption from registration under the federal securities laws. In addition to a description of the type and number of issuers that currently offer and sell securities in reliance on Rules 147, 504 and 505, our analysis includes a description of the types of investors who purchase or may consider purchasing such securities and a discussion of the role of intermediaries in such offerings. Table 1 summarizes the main characteristics of Rules 147, 504 and 505. 333 According to the Longitudinal Business Database of the U.S. Census Bureau, there were more than 6.7 million active establishments in the U.S., of which approximately 5.5 million had fewer than 500 paid employees and approximately 5.2 million had less than 100 paid employees. See U.S. Department of Commerce, United States Census Bureau, Business Dynamics Statistics, Data: Firm Characteristics (2013), available at https:// www.census.gov/ces/dataproducts/bds/data_ firm.html. E:\FR\FM\21NOR2.SGM 21NOR2 83518 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations TABLE 1—MAIN CHARACTERISTICS OF EXISTING RULES 147, 504 AND 505 Type of offering Offering limit 334 Solicitation Issuer and investor requirements Filing requirement Restriction on resale Blue sky law preemption and bad actor disqualification provisions Rule 147 .......................... None ..................... Only intrastate solicitation. None ..................... Interstate resales are restricted for nine months from the later of the last sale in, or the completion of, the offering 335. State Law Preemption: No. Bad Actor Provisions: Required by the majority of states at the state level.336 Rule 504 Regulation D .... $1 million .............. General solicitation permitted in specified circumstances 337. All issuers must be incorporated and ‘‘doing business’’ in state. Statutory exemption excludes investment companies. All investors must be residents in state. Excludes investment companies, blankcheck companies, and Exchange Act reporting companies. File Form D .......... Restricted, unless offering is within specified circumstances 338. Rule 505 Regulation D .... $5 million .............. No general solicitation. Excludes investment companies. Unlimited accredited investors and up to 35 non-accredited investors. File Form D .......... Restricted securities State Law Preemption: No. Bad Actor Provisions: Required by the majority of states at the state level.339 State Law Preemption: No. Bad Actor Provisions: Yes. 1. Current Market Participants The final rules that amend existing Rules 147 and 504, establish new Rule 147A, and repeal Rule 505 will primarily affect securities issuers, particularly startups and small businesses, that rely on unregistered offerings under these and other provisions or safe harbors to raise capital, as well as accredited and nonaccredited investors who participate in unregistered offerings. a. Issuers asabaliauskas on DSK3SPTVN1PROD with RULES i. Rule 147 Issuers Under current Rule 147, there is no limit on the amount of capital that can be raised. Since the Section 3(a)(11) exemption is not available for an investment company registered or required to be registered under the Investment Company Act,340 the existing Rule 147 safe harbor is also not available to these issuers. Current Rule 334 Aggregate offering limit on securities sold within a 12-month period. 335 See 17 CFR 230.147(e). Additional resale restrictions may apply under state securities laws. 336 See text accompanying notes 250, 251, 252, 253 and 254 above. 337 No general solicitation or advertising is permitted unless the offering is registered in a state requiring the use of a substantive disclosure document or sold under a state exemption that permits general solicitation or advertising so long as sales are made only to accredited investors. See Rule 504(b). 338 Restricted unless the offering is registered in a state requiring the use of a substantive disclosure document or sold under a state exemption limiting sales only to accredited investors. See Rule 504(b). 339 See text accompanying notes 250, 251, 252, 253 and 254 above. 340 See 15 U.S.C. 80a–24(d) and 1961 Release at note 1. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 147 has no other restrictions on the type of issuers that may rely on the safe harbor. However, there are in-state residency and eligibility requirements that an issuer must satisfy in order to rely on Rule 147. Eligible issuers are those that are incorporated or organized in-state, have their ‘‘principal office’’ instate, and can satisfy three 80% threshold requirements concerning their revenues, assets and use of net proceeds. While we lack data on the number and size of Rule 147 offerings 341 or the type of issuers currently relying on the Rule 147 safe harbor, the nature of the eligibility requirements and other restrictions of the rule lead us to believe that it is used by U.S. incorporated entities that are likely small businesses seeking to raise small amounts of capital locally without incurring the costs of registering with the Commission. Currently, most of the states that have enacted crowdfunding provisions require issuers that intend to conduct intrastate crowdfunding offerings to use Rule 147.342 Based on information from NASAA,343 as of May 20, 2016, 34 states 341 Unlike Regulation D, which requires the filing of a Form D, Rule 147 does not require any filing with the Commission, and we thus have no source of reliable data about the prevalence and scope of Rule 147 offerings. Commission staff will seek to collaborate with state regulators in gathering information for the study of amended Rule 147 and new Rule 147A. See Section I above. 342 See https://www.nasaa.org/industry-resources/ corporation-finance/instrastate-crowdfundingresource-center/intrastate-crowdfunding-directory/. 343 See NASAA’s Intrastate Crowdfunding Resource Center at https://www.nasaa.org/industryresources/corporation-finance/instrastatecrowdfunding-resource-center/. See also https:// www.nasaa.org/industry-resources/corporation- PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 and the District of Columbia have enacted crowdfunding provisions, and more states are expected to promulgate similar provisions in the near future. Since December 2011, when the first state (Kansas) enacted its crowdfunding provisions, 179 state crowdfunding offerings have been reported to be filed with the respective state regulator.344 Of these offerings, 166 were reported to be approved or cleared, as of July 2016.345 Given that investment companies are statutorily restricted from relying on Section 3(a)(11) 346 and that almost all the enacted state crowdfunding provisions currently exclude reporting companies, we expect that issuers that rely on Rule 147 are likely operating companies (‘‘non-fund issuers’’) that are not reporting under the Exchange Act. As stated above, information on the size of these issuers is not available. Data from NASAA shows that most issuers are from various industries including agriculture, manufacturing, business services, retail, entertainment, and technology. finance/instrastate-crowdfunding-resource-center/ intrastate-crowdfunding-directory/. 344 See Slide Presentation on ‘‘NASAA Intrastate Crowdfunding Update,’’ NASAA July 18, 2016 available at https://nasaa.cdn.s3.amazonaws.com/ wp-content/uploads/2014/12/IntrastateCrowdfunding-Slides-7-18-16.pdf. 345 Id. Most of the early approved or cleared offerings were in Georgia, Michigan, Oregon, Kansas and Indiana. See Slide Presentation on ‘‘Intrastate Equity Crowdfunding’’ by Anya Coverman, Deputy Director of Policy, NASAA at the SEC Government Business Forum on Small Business Capital Formation, November 19, 2015 available at https://www.sec.gov/info/smallbus/ sbforum119015-coverman-presentation.pdf. 346 See also note 241 above. E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations 83519 number of new Rule 504 offerings peaked in 1999, with 3,402 new offerings initiated, and steeply declined afterward.348 Compared to the early 1990s when Rule 504 offerings constituted approximately 28% of all new Regulation D offerings, the proportion of Rule 504 offerings between 2009 and 2015 ranged between 3% and 4% of all new Regulation D offerings. The number of new Rule 505 offerings peaked in 1996 at 1,124 (12% of all new Regulation D offerings), and during 2015, less than 1% of all new Regulation D offerings claimed the Rule 505 exemption. The current limited use of the Rule 504 and Rule 505 exemptions and the predominance of Rule 506, especially Rule 506(b), are also evident when we consider the total amount raised in offerings under each of these exemptions. Overall, capital formation in the Rule 504 and Rule 505 markets individually constituted approximately 0.1% of the capital raised in all Regulation D offerings initiated during 2009–2015.350 Considering only Regulation D offerings of up to $1 million (the maximum amount that a Rule 504 offering can raise in a year) initiated by non-fund issuers, the share of Rule 504 offerings was slightly higher at approximately 7%. Similarly, considering only Regulation D offerings by non-fund issuers of up to $5 million (the maximum amount that an existing 347 In this regard, a study of one large crowdfunding platform revealed that relatively few companies on that platform operate in technology sectors that typically attract VC investment activity. See Ethan R. Mollick, The Dynamics of Crowdfunding: An Exploratory Study, J. BUS. VENT., January 2014 (1–16). 348 While there is a strong, positive correlation of the incidence of new Regulation D offerings with the economic conditions of the public market (see Section 4.2 of Unregistered Offerings White Paper), some of the decline in Rule 504 offerings during the early 2000s could also be attributed to the 1999 Commission decision to reinstate the ban on general solicitation in Rule 504 offerings. See Seed Capital Release and Release No. 34–69959 (July 10, 2013). Though the incidence of new Rule 506 offerings recovered in 2003 with improved conditions in the public markets, the number of new Rule 504 offerings remained well below the pre-2000 levels. 349 Data is not readily available for the period 2002–2008 during which Form D was a paper-based filing. The form became available electronically in March 2009. Since the data for year 2009 is only for the period April to December, the number of new Regulation D offerings shown is underestimated for 2009. 350 Based on staff analysis of Form D filings. See also Unregistered Offerings White Paper. asabaliauskas on DSK3SPTVN1PROD with RULES VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 E:\FR\FM\21NOR2.SGM 21NOR2 ER21NO16.000</GPH> ii. Rule 504 and Rule 505 Issuers Rules 504 and 505 of Regulation D provide exemptions from registration under Section 3(b)(1) of the Securities Act for small offerings where the Commission believes registration under the Securities Act is not necessary by reason of the small amount involved or the limited character of the public offering. An analysis of Form D filings indicates that reliance on these two exemptions has been declining over time. As shown in Figure 1, while offerings under Rule 506(b) of Regulation D grew significantly from 1993 to 2015, offerings under Rule 504 and Rule 505 in 2015 were approximately a quarter of 1993 levels. In addition, while offering activity under Rule 504 has been higher than under the Rule 505 exemption, the We anticipate that many potential issuers of securities under amended Rule 147 and new Rule 147A, particularly those utilizing the exemptions for intrastate crowdfunding, will continue to be small businesses, early stage firms and ‘‘idea’’ stage business ventures that have not yet commenced operations. Some of these issuers may lack business plans that are sufficiently developed to attract venture capitalists (VCs) or angel investors that invest in high risk ventures, or may not offer the profit potential or business model to attract such investors.347 83520 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations Rule 505 offering or amended Rule 504 offering can raise in a year), the share of the total amount raised for Rule 505 offerings was less than 2%. Table 2 presents data on the number of new Rule 504 and 505 offerings and amounts reported to be raised in these offerings during the period 2009– 2015.351 Since investment companies are excluded from using the two exemptions, issuers relying on Rules 504 and 505 are predominantly nonfund issuers.352 Form D data also indicates that the mean and median Rule 504 offering sizes during 2009– 2015 were approximately $0.5 million and $0.36 million, respectively, while the average and median Rule 505 offering sizes were approximately $1.90 million and $1.54 million, respectively. TABLE 2—RULE 504 AND RULE 505 CAPITAL RAISING ACTIVITY, 2009–2015 Number of offerings 353 Rule 504 2009 ................................................................................................................. 2010 ................................................................................................................. 2011 ................................................................................................................. 2012 ................................................................................................................. 2013 ................................................................................................................. 2014 ................................................................................................................. 2015 ................................................................................................................. 2009–2015 ....................................................................................................... Total amount raised ($ million) Rule 505 579 714 721 632 599 544 519 4,308 195 262 207 227 229 289 179 1,588 Rule 504 $91 131 113 109 97 94 84 719 Rule 505 $185 257 205 193 203 238 134 1,415 asabaliauskas on DSK3SPTVN1PROD with RULES Companies that file reports with the Commission under Section 12(b), Section 12(g) or Section 15(d) of the Exchange Act can use the Rule 505 exemption but not the Rule 504 exemption. Data from Form D filings indicates that approximately 10 of 278 unique Rule 505 issuers during 2014 and 8 of 163 unique Rule 505 issuers during 2015 were reporting companies.354 These reporting companies initiated 12 Rule 505 offerings during 2014 and 11 such offerings during 2015. The mean size of Rule 505 offerings by reporting companies was approximately $824,000 and the median size was approximately $200,000. Figure 2 shows the financial size of Rule 504 and Rule 505 issuers based on revenues or net asset value during the period 2009–2015.355 Of all the issuers that disclosed these metrics in their Form D filings (approximately 70% of all Rule 504 issuers and 80% of all Rule 505 issuers), more than three quarters of those offerings were initiated by issuers that had no revenues or had revenues or net asset values of less than $1 million. From this reported size, we believe that a vast majority of Rule 504 and Rule 505 issuers likely consist of startups and small businesses. These issuers’ small size is also consistent with their younger age, as measured by years since incorporation. Based on Form D filings, 51% of Rule 504 issuers and 62% of Rule 505 issuers initiated their offerings during the year of their incorporation or in the subsequent year. Another 14% of Rule 504 and Rule 505 issuers initiated their offerings between two and three years since incorporation.356 351 Id. This analysis uses the same assumptions and methodologies described in the Unregistered Offerings White Paper. 352 Non-fund issuers constituted 98% and 93% of all Rule 504 and Rule 505 offerings, respectively. In terms of amounts reported to be raised, non-fund issuers raised 96% and 76% of all amounts reported to be raised in Rule 504 offerings and Rule 505 offerings, respectively. Based on information in Form D filings, funds using the Rule 504 or Rule 505 exemption were not registered under the Investment Company Act. 353 Based on staff analysis of Form D filings. This analysis uses the same assumptions and methodologies described in the Unregistered Offerings White Paper. As noted in the Unregistered Offerings White Paper, some issuers in Regulation D offerings check multiple exemptions in their Form D filing. Under those circumstances, staff assigns the highest checked numerical exemption to the offering. While issuers in 4,308 offerings checked only the Rule 504 exemption and reported to raise $719 million during the period 2009–2015, issuers in an additional 1,224 offerings checked the Rule 504 exemption along with the Rule 505 and/ or the Rule 506 exemption and safe harbor. Similarly, issuers in 1,520 offerings checked only the Rule 505 exemption and reported to raise $1,399 million during 2009–2015; issuers in an additional 68 new offerings checked the Rule 504 and 505 exemptions; and issuers in 2,170 new offerings checked the Rule 505 exemption along with the Rule 506 exemption. 354 Based on staff analysis of Form D filings and Form 10–K filings made during 2014 and 2015. 355 Based on staff analysis of Form D filings. 356 Id. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations With regard to the geographical location of issuers, Form D filings indicate that during the period 2009– 2015, most Rule 504 and Rule 505 issuers had their principal place of business in California (22% and 21%), followed by Texas, New York, Florida, Colorado and Illinois; most were incorporated in Delaware (19%, 23%), 357 Id. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 E:\FR\FM\21NOR2.SGM 21NOR2 ER21NO16.002</GPH> years operate in the technology, real estate or other industry (Figure 3).357 ER21NO16.001</GPH> asabaliauskas on DSK3SPTVN1PROD with RULES Most Rule 504 and Rule 505 issuers that initiated offerings in the past seven 83521 83522 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations California (13%, 12%), Nevada and Texas. In addition, approximately 37% of Rule 504 offerings and 39% of Rule 505 offerings reported having different states of incorporation and principal places of business. While only approximately 2% of Rule 504 and Rule 505 offerings were initiated by foreignincorporated issuers, a larger number of issuers (4–5%) reported their principal place of business to be outside the United States. In addition, approximately 89% of issuers in the Rule 504 market and 93% of issuers in the Rule 505 market initiated only one offering. Approximately 83% of Rule 504 offerings and 79% of Rule 505 characteristics of investors in Rule 504 and Rule 505 offerings. Data in Table 3 below shows that more than 34,000 investors participated in new Rule 504 offerings initiated during the period 2009–2015, while almost 14,400 investors participated in new Rule 505 offerings initiated during the same period.359 An analysis of the same Form D filings indicates that, for new Rule 504 offerings that reported sales, the mean number of investors was approximately 11 and the median number of investors was approximately four. The mean and median number of investors in new Rule 505 offerings that reported sales was 12 and seven, respectively. offerings during the period 2009–2015 were equity offerings.358 b. Investors Currently, Rule 147 limits offers and sales to residents of the same state or territory as the issuer. While there are generally no limitations on who can invest in Rule 504 offerings, only accredited investors and up to 35 nonaccredited investors can participate in Rule 505 offerings. Although the Commission does not require a form to be filed in connection with Rule 147 offerings, and thus does not receive information concerning investors participating in these offerings, data from Form D filings provide some insights into the number and TABLE 3—NUMBER AND TYPE OF INVESTORS IN RULE 504 OFFERINGS, 2009–2015 360 Rule 504 Offerings Total investors Mean number of investors ......................................................... ......................................................... ......................................................... ......................................................... ......................................................... ......................................................... ......................................................... 4,004 5,427 5,512 6,295 5,573 3,996 3,398 34,205 11 2009 2010 2011 2012 2013 2014 2015 The presence of non-accredited investors was larger in Rule 504 offerings, where the number of nonaccredited investors is not limited, than in Rule 505 or Rule 506 offerings, where the number of non-accredited investors is limited to 35. Data in Table 3 above shows that issuers in approximately 57% of Rule 504 offerings and 41% of Rule 505 offerings during 2009–2015 reported having sold or intending to sell to non-accredited investors.361 Given existing investment limitations under state crowdfunding provisions, we believe that many investors affected by amended Rule 147 and new Rule 147A will likely be individual retail investors whose broad access to potentially riskier investment opportunities in early-stage ventures is asabaliauskas on DSK3SPTVN1PROD with RULES % Offerings with nonaccredited investors 9 10 11 13 13 10 9 2009–2015 ............................................... Rule 505 Offerings 358 Id. 359 Id. See also Unregistered Offerings White Paper. 360 Id. The data shown in the table represents offerings that reported sales to investors. 361 Form D data shows that Rule 504 offerings that involved non-accredited investors were, on average, smaller and had a fewer mean number of investors (8) than those offerings that involved only accredited investors (9). In contrast, Rule 505 offerings that indicated potential sales to non- VerDate Sep<11>2014 21:14 Nov 18, 2016 Jkt 241001 % Offerings with nonaccredited investors Total investors Mean number of investors 53 54 57 58 61 60 61 1,818 2,234 1,676 2,027 2,167 2,943 1,520 12 11 12 13 13 13 11 38 41 43 44 41 36 43 57 14,385 12 41 currently limited, either because they do not have the necessary accreditation or sophistication to invest in most private offerings, or because they do not have sufficient funds to participate as angel investors. Intrastate crowdfunding offerings may provide retail investors with additional investment opportunities, although the extent to which they invest in such offerings will likely depend on their view of the potential return on investment as well as the potential risks, including fraud. In contrast, larger, more sophisticated or well-funded investors may be less likely to invest in intrastate crowdfunding offerings. The relatively low offering amount limits, in-state investor residency requirements, and low investment limits for crowdfunding investors under state laws 362 may make these offerings less attractive for such investors, which include VCs and angel investors.363 While an intrastate crowdfunding offering can result in increased visibility for an issuer, it is likely that such investors will elect to invest in offerings relying on Rule 506, which are not subject to the investment limitations applicable to crowdfunding. accredited investors were, on average, larger and had a greater mean number of investors (11) than Rule 505 offerings that sold only to accredited investors (8). We note that since issuers do not file Form D at the close of the offering, the number of investors reported in initial Form D filings may be an underestimate (offerings reporting zero investors are included). 362 Most state crowdfunding provisions allow up to a $2 million offering size and a maximum investment of $10,000 by non-accredited investors. 363 An observer suggests that, unlike angels, VCs may be less interested in crowdfunding because, if VCs rely on crowdfunding sites for their deal flow, it would be difficult to justify charging a 2% management fee and 20% carried interest to their limited partners. See Ryan Caldbeck, Crowdfunding—Why Angels, Venture Capitalists And Private Equity Investors All May Benefit, Forbes, Aug. 7, 2013. PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 c. Intermediaries Issuers that undertake private offerings may use broker-dealers to help them with various aspects of the offering and to help ensure compliance with the ban on general solicitation and advertising that exists for most private offerings. Private offerings can also involve finders and investment advisers E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES who connect issuers with potential investors for a fee.364 We do not have information on the extent of intermediary use in Rule 147 offerings; however, an analysis of Form D filings indicates that intermediaries are used less frequently in Rule 504 offerings than in registered offerings. Approximately 20% of Rule 504 offerings and 29% of Rule 505 offerings reported using an intermediary during the period 2009–2015.365 The average commissions and fees paid by issuers that reported using an intermediary was approximately 6% of the offering amount for Rule 504 and 5.6% for Rule 505.366 Although we are unable to predict the potential use of broker-dealers, transfer agents,367 investment advisers and finders in private offerings as a result of the adoption of the final rules, data on the use of broker-dealers and finders in the Rule 506 market suggests that they do not currently play a large role in private offerings. Form D filings indicate that approximately 17% of Rule 506 offerings with an offering size up to $5 million, including 18% of such Rule 506 offerings initiated by non-fund issuers, used an intermediary during 2009–2015.368 The use of a brokerdealer or a finder increased with offering size, while the average percentage of the total fee declined with offering size.369 We base these estimates, however, only on available data from the Regulation D market. It is possible that issuers engaging in other types of unregistered offerings, for which data is not available to us, may 364 Depending on the nature and scope of their activities, these persons may need to be registered as broker-dealers or finders under state law. 365 Based on staff analysis of Form D filings. 366 Id. 367 Aside from their standard role in maintaining records of ownership of securities, transfer agents play an important role in private offerings that involve restricted securities, in which there may be limitations on resale of such securities for a certain period or to certain types of investors. In addition to ensuring compliance with such provisions, only a transfer agent can remove a restrictive legend from the security, which is done with the consent of the issuer. 368 Based on staff analysis of Form D filings. 369 Based on analysis of Form D filings for 2009– 2015, approximately 20% of all Rule 506 offerings reported using an intermediary. Further, intermediaries participated in approximately 16% of Rule 506 offerings of up to $1 million and 31% of offerings of more than $50 million during the period 2009–2015. The average total fee (commission plus finder fee) paid by issuers conducting offerings of up to $1 million was 6.2%, while the average total fee paid by issuers conducting offerings of more than $50 million was 1.9%. See also Section 5.3 in the Unregistered Offerings White Paper. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 use broker-dealers and finders more frequently or less frequently.370 2. Alternative Methods of Raising Up to $5 Million of Capital The potential economic impact of the final rules, including their effects on efficiency, competition and capital formation, will depend primarily on the extent of use of amended Rules 147 and 504 and new Rule 147A and how these methods compare to alternative sources of capital that startups and small businesses can utilize. As the amendments to Rule 504 would permit offerings up to $5 million by all types of issuers (other than investment companies, Exchange Act reporting companies and development stage companies), the analysis below discusses alternatives available for startups and small businesses to access up to $5 million in capital. Current state crowdfunding provisions, most of which require issuers to rely on Rule 147 for federal exemption, have offering limits of up to $4 million and most restrict private funds from utilizing the crowdfunding provisions. In addition, final Rules 147, 147A and 504 all exclude investment companies. Thus, our analysis below also includes a discussion of alternative sources for non-fund issuers to raise capital up to $5 million.371 Startups and small businesses can potentially access a variety of external financing sources in the capital markets through, for example, registered or unregistered offerings of debt, equity or hybrid securities and bank loans. Issuers seeking to raise capital must register the offer and sale of securities under the Securities Act or qualify for an exemption from registration under the federal securities laws. Registered offerings, however, are generally too 370 A number of states that have enacted crowdfunding provisions require that the offer and sale of securities by means of intrastate crowdfunding be conducted through a funding portal or a broker-dealer. Some intrastate crowdfunding provisions require the offering portals to be registered with the state or as a brokerdealer. Based on FOCUS Reports filed with the Commission, as of December 2015, there were 4,122 registered broker-dealers, with average total assets of approximately $0.98 billion per broker-dealer. The aggregate assets of these registered brokerdealers totaled approximately $4.1 trillion. See Regulation Crowdfunding Adopting Release for a more detailed discussion of intermediaries in crowdfunding offerings. 371 While offerings greater than $5 million that are registered or exempt under state law, subject to certain conditions, could be raised under amended Rule 147 or new Rule 147A, we believe that the impact of the final rules on larger offerings is not likely to be significant, given the local nature of offerings under these exemptions and current state regulations applicable for larger offerings. See Section V.B (discussing the impact of the final rules in detail). PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 83523 costly to be viable alternatives for startups and small businesses. Issuers conducting registered offerings incur a variety of fees and expenses related to registration and reporting requirements. Two surveys concluded that the average initial compliance cost associated with conducting an initial public offering is $2.5 million, followed by an ongoing compliance cost for public companies of $1.5 million per year.372 Moreover, issuers conducting registered offerings usually pay underwriter fees, which average approximately 7% for initial public offerings, approximately 5% for follow-on equity offerings and approximately 1–1.5% for public bond issuances.373 Hence, for a small issuer seeking to raise less than $5 million, a registered offering typically may not be economically feasible relative to options available under exempt offerings. 372 See IPO Task Force, Rebuilding the IPO OnRamp (Oct. 20, 2011), at 9, available at https:// www.sec.gov/info/smallbus/acsec/rebuilding_the_ ipo_on-ramp.pdf (‘‘IPO Task Force’’). The estimates should be interpreted with the caveat that most companies in the IPO Task Force surveys likely raised more than $1 million. The IPO Task Force surveys do not provide a breakdown of costs by offering size. However, compliance related costs of an initial public offering and subsequent compliance related costs of being a reporting company likely have a fixed cost component that would disproportionately affect smaller issuers. Title I of the JOBS Act provided certain accommodations to issuers that qualify as emerging growth companies (EGCs). According to a recent working paper, the underwriting, legal and accounting fees of EGC and non-EGC initial public offerings were similar (based on a time period from April 5, 2012 to April 30, 2015). For a median EGC initial public offering, gross spread comprised 7% of proceeds and accounting and legal fees comprised 2.4% of proceeds. See Susan Chaplinsky, Kathleen W. Hanley, and S. Katie Moon, ‘‘The JOBS Act and the Costs of Going Public,’’ working paper, October 4, 2015, available at https://papers.ssrn.com/sol3/Papers.cfm?abstract_ id=2492241, (‘‘Chaplinsky Study’’). 373 See, e.g., Hsuan-Chi Chen and Jay R. Ritter, ‘‘The Seven Percent Solution,’’ 55 J. Fin. 1105–1131 (2000); Mark Abrahamson, Tim Jenkinson, and Howard Jones, ‘‘Why Don’t U.S. Issuers Demand European Fees for IPOs?’’ 66 J. Fin. 2055–2082 (2011); Shane A. Corwin, ‘‘The Determinants of Underpricing for Seasoned Equity Offers,’’ 58 J. Fin. 2249–2279 (2003); Lily Hua Fang, ‘‘Investment Bank Reputation and the Price and Quality of Underwriting Services,’’ 60 J. Fin. 2729–2761 (2005); Rongbing Huang and Donghang Zhang, ‘‘Managing Underwriters and the Marketing of Seasoned Equity Offerings,’’ 46 J. Fin. Quant. Analysis 141–170 (2011); Stephen J. Brown, Bruce D. Grundy, Craig M. Lewis and Patrick Verwijmeren, ‘‘Convertibles and Hedge Funds as Distributors of Equity Exposure,’’ 25 Rev. Fin. Stud. 3077–3112 (2012). Recent studies that analyze IPOs by EGCs and non-EGCs find that the costs of raising capital through an IPO are similar pre- and post-JOBS Act. See, e.g., Michael Dambra, Laura Fields and Matthew Gustafson, ‘‘The JOBS Act and IPO Volume: Evidence that Disclosure Costs Affect the IPO Decision’’, 116 J. Fin. Econ.121–143 (2015); see also Chaplinsky Study. E:\FR\FM\21NOR2.SGM 21NOR2 83524 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations a. Exempt Offerings alternative methods of raising capital. For example, startups and small businesses could rely on current exemptions and safe harbors, such as Section 3(a)(11), Section 4(a)(2),374 Regulation A,375 Section 4(a)(6),376 and Rule 506 of Regulation D.377 For startups and small businesses that can potentially access capital under Rules 147, 504 and 505, offerings under other existing exemptions or safe harbors from registration may represent Each of these provisions, however, includes restrictions that may limit its suitability for startups and small businesses seeking to raise capital up to $5 million. Table 4 below lists the main requirements of these provisions. TABLE 4—OTHER PROVISIONS CURRENTLY AVAILABLE FOR CAPITAL RAISING Offering limit 378 Solicitation Issuer and investor requirements Filing requirement Restriction on resale Section 3(a)(11) ..... None ................................. All offerees must be resident in state. No 379 ................... None ................................. No general solicitation. All issuers and investors must be resident in state, and an issuer, if a corporation, must be incorporated in state; investment companies are excluded. Transactions by an issuer not involving any public offering 381. None ................................. Section 4(a)(2) ....... None ................................. Restricted securities. Regulation A .......... Tier 1: up to $20 million with $6 million limit on secondary sales by affiliates of the issuer; Tier 2: up to $50 million with $15 million limit on secondary sales by affiliates of the issuer. Testing the waters permitted both before and after filing the offering statement. U.S. or Canadian issuers, excluding investment companies, blank-check companies, reporting companies, and issuers of fractional undivided interests in oil or gas rights, or similar interests in other mineral rights 382. $1 million .......................... Allowed after Form C is filed and with limitations on advertising. Excludes foreign private issuers; investment limitations based on annual income and net worth. Rule 506(b) Regulation D. None ................................. No general solicitation. Rule 506(c) Regulation D. None ................................. General solicitation is permitted, subject to certain conditions 384. No issuer exclusion; unlimited accredited investors and up to 35 nonaccredited investors. No issuer exclusion; unlimited accredited investors; no non-accredited investors. File testing the waters materials, Form 1–A for Tier 1 and Tier 2 offerings; file annual, semiannual, and current reports for Tier 2 offerings; file exit report for Tier 1 offerings; and file exit report to suspend or terminate reporting for Tier 2 offerings. File Form C; reviewed financial statements required for offerings greater than $100,000; audited financial statements required for offerings greater than $500,000 (unless it is the first offering made pursuant to the exemption); file annual reports. File Form D ....................... No ........................ Section 4(a)(6) Regulation Crowdfunding 383. asabaliauskas on DSK3SPTVN1PROD with RULES Type of offering 374 Securities Act Section 4(a)(2) provides that the provisions of the Securities Act shall not apply to ‘‘transactions by an issuer not involving a public offering.’’ 375 Regulation A provides an exemption from registration for certain small issuances. The Commission recently adopted amendments to Regulation A that became effective on June 19, 2015. See 2015 Regulation A Release. 376 Regulation Crowdfunding provides an exemption from registration for small offerings up to $1 million sold within a twelve month period. The rules became effective on May 16, 2016. See Regulation Crowdfunding Adopting Release. 377 Rule 506(b) of Regulation D provides a nonexclusive safe harbor from registration for certain types of securities offerings. Rule 506(c) of Regulation D is an exemption from registration that the Commission adopted to implement Section 201(a) of the JOBS Act. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 File Form D ....................... 378 Aggregate offering limit on securities sold within a twelve-month period. 379 Although Section 3(a)(11) does not have explicit resale restrictions, the Commission has explained that ‘‘to give effect to the fundamental purpose of the exemption, it is necessary that the entire issue of securities shall be offered and sold to, and come to rest only in the hands of residents within the state.’’ See 1961 Release. State securities laws also may have specific resale restrictions. Rule 147 limits resales to persons residing in-state for a period of nine months after the last sale by the issuer. 380 See text accompanying notes 250, 251, 252, 253 and 254 above. 381 Section 4(a)(2) of the Securities Act provides a statutory exemption for ‘‘transactions by an issuer not involving any public offering.’’ See SEC v. Ralston Purina Co., 346 U.S. 119 (1953) (holding that an offering to those who are shown to be able PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 Blue sky law preemption and bad actor disqualification provisions State Law Preemption: No. Bad Actor Provisions: Required by the majority of states at the state level. 380 State Law Preemption: No. Bad Actor Provisions: No. State Law Preemption: Tier 1: No Tier 2: Yes. Bad Actor Provisions: Yes. 12-month resale State Law Prelimitation; resale emption: Yes. within one year Bad Actor Provito issuer and sions: Yes. certain investors. Restricted securities. Restricted securities. State Law Preemption: Yes. Bad Actor Provisions: Yes. State Law Preemption: Yes Bad Actor Provisions: Yes to fend for themselves is a transaction ‘‘not involving any public offering.’’) 382 The Regulation A exemption is also not available to companies that have been subject to any order of the Commission under Exchange Act Section 12(j) entered within the past five years, have not filed ongoing reports required by the regulation during the preceding two years, or are disqualified under the regulation’s ‘‘bad actor’’ disqualification rules. 383 See Table 6 below for a more detailed comparison between Regulation Crowdfunding and intrastate crowdfunding provisions. 384 General solicitation and general advertising is permitted under Rule 506(c). All purchasers must be accredited investors and the issuer must take reasonable steps to verify accredited investor status. E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations While we do not have data on offerings relying on an exemption under Section 3(a)(11) or Section 4(a)(2), data available from Regulation D and Regulation A filings allow us to gauge how frequently issuers seeking to raise up to $5 million rely on these provisions. Based on Form D filings from 2009 to 2015, a substantial number of issuers chose to raise capital by relying on Rule 506(b), even though their offering size would qualify under Rule 504 or Rule 505.385 As shown in the upper part of Table 5, most Regulation D issuers made offers for amounts of up to $1 million from 2009 to 2015. A large majority of offerings up to $5 million relied on the Rule 506(b) exemption. The lower part of Table 5 shows a similar pattern for the number of offerings by non-fund issuers. The overwhelming majority of nonfund issuers (approximately 73%) conducting offerings less than $5 83525 million were five years or younger, and 64% of such issuers were two years or younger, with a median age of approximately one year. More than 93% of the non-fund issuers that made Regulation D offerings of $5 million or less during this period were organized as either a corporation or a limited liability company. Almost 21% reported having no revenues, while approximately 20% had revenues of less than $5 million.386 TABLE 5—NUMBER OF REGULATION D AND REGULATION A OFFERINGS BY SIZE, 2009–2015 Offering size < = $1 million $1–$2.5 million $2.5–5 million $5–50 million > $50 million 4,224 592 35,688 1,233 ............................ 518 18,998 529 ........................ 432 16,107 512 ........................ ........................ 31,978 975 ........................ ........................ 14,726 268 Total ............................................................... Regulation A ................................................................ Non-fund offerings: Rule 504 ............................................................... Rule 505 ............................................................... Rule 506(b) ........................................................... Rule 506(c) ........................................................... 41,737 10 20,045 6 17,051 33 32,953 6 14,994 ........................ 4,143 568 32,095 1,007 ............................ 496 16,975 447 ........................ 378 13,866 472 ........................ ........................ 22,291 763 ........................ ........................ 3,375 153 Total ............................................................... 37,813 17,918 14,716 23,054 3,528 All offerings: Rule 504 ............................................................... Rule 505 ............................................................... Rule 506(b) ........................................................... Rule 506(c) ........................................................... Note: Data based on Form D filings for Regulation D offerings and Form 1–A filings for qualified Regulation A offerings from 2009 to 2015. We consider only new offerings and exclude offerings that do not report offering size and report amount sold as $0 on Form D. Data on Rule 506(c) offerings covers the period from September 23, 2013 (the date the rule became effective) to December 31, 2015. We also use the maximum amount indicated in Form 1–A to determine offering size for Regulation A offerings. asabaliauskas on DSK3SPTVN1PROD with RULES Table 5 also includes the number of Regulation A offerings by size. From 2009 to 2015, 49 issuers relied on Regulation A for offerings of up to $5 million.387 This data includes 17 offerings, of which 11 have offering sizes of up to $5 million, initiated subsequent to the effectiveness of amendments to Regulation A in June 2015. The amendments allow issuers to raise up to $50 million over a 12-month period and preempt state registration requirements for certain Regulation A offerings (Tier 2 offerings). As these amendments became effective only recently, more time is needed to assess how the changes in Regulation A will affect capital raising by small issuers.388 b. Regulation Crowdfunding The analysis above does not include data regarding securities-based crowdfunding transactions under the recently adopted Regulation Crowdfunding exemption. The new rules, which became effective on May 16, 2016, supplement the existing regulatory scheme of exemptions and safe harbors that are described above and provide start-ups and small businesses with an alternate source for raising capital through offerings exempt from registration under the Securities Act. As of September 30, 2016, approximately 114 offerings relying on the federal crowdfunding exemption filed a Form C with the Commission.389 Offerings pursuant to these rules are limited to a maximum amount of $1 million over a 12-month period and are subject to ongoing disclosure requirements. Securities issued pursuant to these rules can be sold to an unlimited number of investors (subject to specified investment limits), are freely tradable after one year, and can be offered and sold without state qualification or registration. Unlike intrastate crowdfunding provisions enacted at the state level, the new federal crowdfunding exemption allows interstate offerings, whereby an issuer can make offers and sell to investors in multiple states. Table 6 presents a comparison of the provisions of Regulation Crowdfunding and current intrastate crowdfunding provisions that rely on current Rule 147 for federal exemption. 385 See Unregistered Offerings White Paper. This tendency could, in part, be attributed to two features of Rule 506: preemption from state registration (‘‘blue sky’’) requirements and an unlimited offering amount. See also report from U.S. Government Accountability Office, Factors That May Affect Trends in Regulation A Offerings, GAO–12–839 (Jul. 3, 2012), available at https:// www.gao.gov/products/GAO-12-839. 386 These percentages could be higher because almost 55% of the issuers that conduct Regulation D offerings of $5 million or less declined to disclose the size of the offering. 387 We only consider offerings with offering statements that have been qualified by the Commission. For purposes of counting offerings, we exclude amendments or multiple 1–A filings by the same issuer in a given year. For purposes of determining the offering size for Regulation A offerings, we use the maximum amount indicated on the latest pre-qualification Form 1–A or amended Form 1–A. We reclassify two offerings that are dividend reinvestment plans with uncertain offering amounts as having the maximum permitted offering amount. 388 See 2015 Regulation A Adopting Release. 389 Based on Form C filings, as of September 30, 2016. Analysis of data reported in Form C and Form C–U filings indicates that the mean maximum offer size was approximately $643,150 and the mean amount reported to be raised per offering was $440,480. Based on filings of Form C–U as of September 30, 2016, 12 offerings were reported to be completed. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 E:\FR\FM\21NOR2.SGM 21NOR2 83526 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations TABLE 6—INTRASTATE CROWDFUNDING AND REGULATION CROWDFUNDING PROVISIONS Current Rule 147 + state level crowdfunding provisions 390 Investor Base .......... State Registration ... Issuer Incorporation/ Residency Limitations. Excluded Issuers .... Offering Size Limits Security Type .......... Audited Financials Requirement. General Solicitation Investment Limits .... Restrictions on Resale. Exemption from Section 12(g) Registration Requirements. Rule 147 requires that all investors reside in the state of the issuer. Exemption provided by state ................. Rule 147 requires issuer to be incorporated and ‘‘doing-business’’ in state. Investment companies are excluded under the federal exemption. Although not excluded under Rule 147, most state crowdfunding provisions also exclude Exchange Act reporting companies and blank check companies. Although not limited under Rule 147, state provisions limit between $250,000 and $4 million, depending on state. Mean (median) limit: $1.6 ($2) million. Although not limited under Rule 147, equity and debt permitted in some states; equity only in other states; any security in some other states. Although no requirements under Rule 147, most states require, if offer greater than $1 million. Rule 147 and states allow, but only to investors residing in state. No limits under Rule 147 ....................... $2,500–$10,000, depending on state, for non-accredited investors. None, in most states, for accredited investors. Rule 147 restricts interstate resales for nine months 391. None ...................................................... c. Private Debt Financing asabaliauskas on DSK3SPTVN1PROD with RULES While equity-based financing, including principal owner equity, accounts for a significant proportion of the total capital of a typical small business, other sources of capital for startups and small businesses include loans from commercial banks, finance companies and other financial institutions, business credit cards and credit lines.392 390 Information in this column is based on the provisions that are reflective of most states that have enacted crowdfunding provisions. See https:// www.nasaa.org/industry-resources/corporationfinance/instrastate-crowdfunding-resource-center/ intrastate-crowdfunding-directory/. 391 See 17 CFR 230.147(e). States may impose additional resale restrictions. 392 Using data from the 1993 Survey of Small Business Finance, one study indicates that financial institutions account for approximately 27% of small companies’ borrowings. See Allen N. Berger and VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 Regulation crowdfunding All investors, all states. Preemption of state registration. Excludes foreign private issuers. Exchange Act reporting companies, investment companies, pooled investment funds, and blank check companies. Up to $1 million. Any security. Required for offerings greater than $500,000 with the exception of first-time crowdfunding issuers offering more than $500,000 but not more than $1,000,000, who are permitted to provide financial statements reviewed by an independent accountant, unless the issuer has audited statements otherwise available. Reviewed financial statements are required for offerings greater than $100,000 but not more than $500,000, unless the issuer has audited statements otherwise available. Allowed after filing of Form C and subject to limitations on advertising. (a) the greater of $2,000 or 5% of the lesser of the investor’s annual income or net worth if either annual income or net worth is less than $100,000, or (b) 10% of the lesser of the investor’s annual income or net worth if both annual income and net worth are $100,000 or more, subject to investment cap of $100,000. 12-month resale limitation; resale within one year to issuer and certain investors. Conditional exemption, provided that the issuer is current in its ongoing annual reports required pursuant to Rule 202 of Regulation Crowdfunding, has total assets as of the end of its last fiscal year not in excess of $25 million, and has engaged the services of a transfer agent registered with the Commission pursuant to Section 17A of the Exchange Act. For example, a 2014 study reports that startups frequently resort to bank financing early in their lifecycle.393 The study finds that businesses rely heavily in the first year after formation on external debt sources such as bank Gregory F. Udell, The Economics of Small Business Finance: The Roles of Private Equity and Debt Markets in the Financial Growth Cycle, 22 J. Banking & Fin. 613 (1998). See also 1987, 1993, 1998 and 2003 Surveys of Small Business Finances, available at https://www.federalreserve.gov/pubs/ oss/oss3/nssbftoc.htm. The Survey of Small Business Finances was discontinued after 2003. Using data from the Kauffman Foundation Firm Surveys, one study finds that 44% of startups use loans from financial institutions. See Rebel A. Cole and Tatyana Sokolyk, How Do Start-Up Firms Finance Their Assets? Evidence from the Kauffman Firm Surveys (2012), available at https://papers.ssrn .com/sol3/papers.cfm?abstract_id=2028176. 393 See Alicia M. Robb, and David T. Robinson, 2014, The Capital Structure Decisions of New Firms, Review of Financial Studies 27(1), pp. 153– 179 (‘‘Robb Study’’). PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 financing, mostly in the form of personal and commercial bank loans, business credit cards, and credit lines.394 Another report shows a decline in cumulative bank lending to small businesses, which fell by $100 billion from 2008 to 2011.395 This report also shows that less than one-third of small businesses reported having a business bank loan by 2012. Similarly, an FDIC report shows that, as of December 2015, small business lending, specifically business loans of up to $1 million, by 394 See also NextSeed Letter. The Kauffman Foundation, 2013 State of Entrepreneurship Address (Feb. 5, 2013), available at https://www.kauffman.org/∼/media/kauffman_ org/research%20reports%20and%20covers/2013/ 02/soe%20report_2013pdf.pdf. The report cautions against prematurely concluding that banks are not lending enough to small businesses as the sample period of the study includes the most recent recession. 395 See E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES FDIC-insured depository institutions amounted to approximately $606 billion, which is 15% lower than the June 2008 level but 2% above December 31, 2014 level.396 An earlier study by Federal Reserve Board staff covering the prerecessionary period suggests that 60% of small businesses had outstanding credit in the form of a credit line, a loan or a capital lease.397 These loans were borrowed from two types of financial institutions: depository and nondepository institutions (e.g., finance companies, factoring or leasing companies).398 Lines of credit were the most widely used type of credit.399 Other types included mortgage loans, equipment loans, and motor vehicle loans.400 Small businesses may also receive funding from various loan guarantee programs of the Small Business Administration (‘‘SBA’’), which makes credit more accessible to small businesses by either lowering the interest rate of the loan or enabling a market-based loan that a lender would not be willing to provide, absent a guarantee.401 SBA loan programs include 7(a) loans,402 microloans 403 and Certified Development Company loans 396 We define small business loans to include commercial and industrial loans of up to $1 million and loans secured by nonfarm nonresidential properties and commercial and industrial loans of up to $1 million to U.S. addressees. See Federal Deposit Insurance Corporation, Statistics on Depository Institutions Report, available at https:// www2.fdic.gov/SDI/SOB/. 397 See Federal Reserve Board, Financial Services Used by Small Businesses: Evidence from the 2003 Survey of Small Business Finances (October 2006), available at https://www.federalreserve.gov/pubs/ bulletin/2006/smallbusiness/smallbusiness.pdf (‘‘2003 FRB Survey’’). 398 See Rebel Cole, What Do We Know About the Capital Structure of Privately Held Firms? Evidence from the Surveys of Small Business Finance (Working Paper) (Feb. 2013), available at https:// onlinelibrary.wiley.com/doi/10.1111/fima.12015/ epdf. 399 See 2003 FRB Survey, note 397 (estimating that 34% of small businesses use lines of credit). 400 Id. 401 Numerous states also offer a variety of small business financing programs, such as Capital Access Programs, collateral support programs and loan guarantee programs. These programs are eligible for support under the State Small Business Credit Initiative, available at https:// www.treasury.gov/resource-center/sb-programs/ Pages/ssbci.aspx. 402 15 U.S.C. 631 et seq. 7(a) loans provide small businesses with financing guarantees (up to $5 million) for a variety of general business purposes through participating lending institutions. 403 SBA also offers the Microloan program, which provides funds to specially designated intermediary lenders that administer the program for eligible borrowers. The maximum loan amount is $50,000, but the average is approximately $13,000. See Microloan Program, U.S. Small Business Administration, available at https://www.sba.gov/ content/microloan-program. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 (CDC loans).404 For example, in fiscal year 2015, the SBA supported approximately $33.2 billion in 7(a) and CDC loans, microloans and surety bonds distributed to approximately 61,000 small businesses.405 In addition, investments in high-growth small businesses through its Small Business Investment Company program increased from $5.5 billion in 2014 to $6.3 billion in 2015.406 SBA guaranteed loans, however, currently account for a relatively small share (20%) of the balances of small business loans outstanding.407 Borrowing from financial institutions is, however, relatively costly for many early-stage issuers and small businesses as they may have low revenues, irregular cash-flow projections, insufficient assets to offer as collateral, and high external monitoring costs.408 Many startups and small businesses may find loan requirements imposed by financial institutions difficult to meet and may not be able to rely on these institutions to secure funding. For example, financial institutions generally require a borrower to provide collateral and/or a guarantee,409 which startups, small businesses and their owners may not be able to provide. Collateral may also be required for loans guaranteed by the SBA. Other sources of debt financing for startups and small businesses include 404 15 U.S.C. 695 et seq. The CDC loans (up to $5.5 million) are made available through ‘‘certified development companies’’ or ‘‘CDCs,’’ typically structured with the SBA providing 40% of the total project costs, a participating lender covering up to 50% of the total project costs and the borrower contributing 10% of the project costs. 405 See U.S. Small Business Administration, Agency Financial Report: Fiscal Year 2015, available at https://www.sba.gov/sites/default/files/ aboutsbaarticle/Agency_Financial_Report_FY_ 2015.pdf. 406 Id. 407 As of the end of fiscal year 2015, the SBA guaranteed business loans outstanding (including 7(a) and CDC loans) equaled $118.8 billion. See SBA Agency Financial Report: Fiscal Year 2015. This comprises approximately 20% of the approximately $606 billion in outstanding small business loans for commercial real estate and commercial and industrial loans discussed above. In addition to loan guarantees, the SBA program portfolio also includes direct business loans, which are mainly microloans and disaster loans. 408 See Robb Study. 409 Approximately 92% of all small business debt to financial institutions is secured, and owners of the company guarantee about 52% of that debt. See Allen N. Berger and Gregory F. Udell, 1995, Relationship Lending and Lines of Credit in Small Firm Finance, Journal of Business 68(3), pp. 351– 381. Some studies of small business lending also document the creation of local captive markets with higher borrowing costs for small, informationally opaque companies as a result of strategic use of soft information by local lenders. See Sumit Agarwal and Robert Hauswald, 2010, Distance and Private Information in Lending, Review of Financial Studies 13(7), pp. 2757–2788. PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 83527 peer-to-peer and peer-to-business lending,410 microfinance,411 and other alternative online lending channels.412 According to some industry estimates, the global volume of ‘‘lending-based crowdfunding,’’ which includes peer-topeer lending to consumers and businesses, had risen to approximately $11.08 billion in 2014.413 Technology has facilitated the growth of alternative models of small business lending. According to one academic study,414 the outstanding portfolio balance of online alternative lenders has doubled every year, albeit this market represents less than $10 billion in outstanding loan capital. According to the 2015 Small Business Credit survey,415 20% of all 410 Such debt transactions are facilitated by online platforms that connect borrowers and lenders and potentially offer small businesses additional flexibility with regard to pricing, repayment schedules, collateral or guarantee requirements, and other terms. See Ian Galloway, Peer-to-Peer Lending and Community Development Finance, Federal Reserve Bank of San Francisco (Working Paper) (2009), available at https:// www.frbsf.org/publications/community/wpapers/ 2009/wp2009-06.pdf. 411 See Craig Churchill and Cheryl Frankiewicz, Making Microfinance Work: Managing for Improved Performance, Geneva International Labor Organization (2006). Microfinance consists of small, working capital loans provided by microfinance institutions that are invested in microenterprises or income-generating activities. According to one report, in fiscal year 2012, the U.S. microfinance industry was estimated to have disbursed $292.1 million across 36,936 microloans, with an estimated $427.6 million in outstanding microloans (across 45,744 in microloans). See FIELD at the Aspen Institute, U.S. Microenterprise Census Highlights, FY 2012, available at https://fieldus.org/ Publications/CensusHighlightsFY2012.pdf. 412 Several models of online small business lending have emerged: Online lenders raising capital from institutional investors and lending on their own account (e.g., short-term loan products similar to a merchant cash advance); peer-to-peer platforms; and ‘‘lender-agnostic’’ online marketplaces that facilitate small business borrower access to various loan products from traditional and alternative lenders, including term loans, lines of credit, merchant cash advances and factoring products,. See Karen Gordon Mills and Brayden McCarthy, The State of Small Business Lending: Credit Access during the Recovery and How Technology May Change the Game, Harvard Business School Working Paper 15–004 (2014), available at https://ssrn.com/abstract=2470523 (‘‘Mills Study’’). 413 See Massolution, 2015CF Crowdfunding Industry Report: Market Trends, Composition and Crowdfunding Platforms, available at https:// reports.crowdsourcing.org/ index.php?route=product/product&product_id=54 (‘‘Massolution 2015 Report’’) at 56. The Massolution 2015 Report refers to peer-to-peer lending to consumers and peer-to-business lending to small businesses as ‘‘lending based’’ crowdfunding. Our discussion refers to peer-to-peer lending more broadly in a sense synonymous with ‘‘lending-based’’ crowdfunding. 414 See Mills Study. 415 The survey was conducted by the Federal Reserve Banks of New York, Atlanta, Boston, Cleveland, Philadelphia, Richmond and St. Louis during 2015. It focused on credit access among E:\FR\FM\21NOR2.SGM Continued 21NOR2 83528 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations small businesses surveyed applied for credit with an online lender.416 Family and friends are also sources through which startups and small businesses can raise capital. This source of capital is usually available early in the lifecycle of a small business, before the business engages with arm’s-length, more formal funding channels.417 Among other things, family and friends may donate funds, loan funds or acquire an equity stake in the business. A recent study finds that most of the capital supplied to startups by friends and family is in the form of loans.418 Family and friends, however, may be able to provide only a limited amount of capital compared to more formal sources. We do not have data available on these financing sources that could allow us to quantify their magnitude or compare them to other current sources of capital. B. Analysis of Final Rules asabaliauskas on DSK3SPTVN1PROD with RULES 1. Broad Economic Considerations The final rules are intended to streamline and modernize the capital raising options available to startups and small businesses, including through the use of intrastate and regional securities offering provisions that have been enacted or could be enacted by various states, and thereby promote capital formation within the larger economy. Securities-based crowdfunding is a relatively new and evolving capital market that provides startups and small businesses an alternative mechanism of raising funds by selling small amounts of securities to a large number of investors using the Internet. Title III of the JOBS Act directed the Commission to establish rules for an exemption that would facilitate this market at the federal level. Around the same time, some states began enacting intrastate businesses with fewer than 500 employees in 26 states. The survey authors note that since the sample is not a random sample, results were reweighted for industry, age, size, and geography to reduce coverage bias. See 2015 Small Business Credit Survey: Report on Employer Firms, available at https://www.clevelandfed.org/communitydevelopment/small-business/about-the-joint-smallbusiness-credit-survey/2015-joint-small-businesscredit-survey.aspx. 416 Id. The survey also showed differences in the use of online lenders by type of borrower: 26% and 21% of small businesses that have been in business for less than 2 years and 3–5 years, respectively, applied for credit with online lenders. By comparison, 11% of small businesses with revenue between $1million-$10 million and 6% of small businesses with revenue greater than $10 million applied for credit to an online lender. Mature (older, higher revenue, greater number of employees) categories of small businesses were much more likely to apply for credit with bank lenders than with online lenders. 417 See Paul Gompers and Josh Lerner, The Venture Capital Cycle (MIT Press 2006). 418 See Robb Study, at 1219. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 crowdfunding statutes and rules that provide issuers with exemptions from state registration. Most intrastate crowdfunding provisions require issuers to comply with the requirements of Section 3(a)(11) and Rule 147, while three states currently provide issuers with the option of utilizing Rule 504 or another Regulation D exemption.419 By establishing new Rule 147A and modernizing the existing requirements under Rule 147, the final rules could facilitate capital formation through intrastate crowdfunded offerings as well as through other state registered or state exempt offerings. Raising the offering amount limit under amended Rule 504 from $1 million to $5 million may facilitate smaller offerings, including those registered or exempt from registration in a particular state, or regional offerings made pursuant to regional state coordinated review programs.420 Such programs, when implemented, may enable issuers relying on Rule 504 to register an offering in any one rather than in each of the several states where they conduct offers and sales, thereby saving them time and money. In light of the current infrequent use of the Rule 505 exemption and the increase in the maximum offering size under Rule 504 to $5 million, repealing Rule 505 will simplify the existing Securities Act exemptive framework without significantly diminishing issuers’ capital raising options. The amendments to Rule 147 and Rule 504 and the establishment of Rule 147A will remove or reduce certain impediments to capital raising identified by market participants and commenters.421 As discussed below, the effects of the final rules on capital formation will depend, first, on whether issuers that currently raise or plan to raise capital will choose to rely on the safe harbor and exemptions provided by amended Rules 147 and 504 and new Rule 147A in lieu of other methods of raising capital, such as Regulation 419 Maine’s provisions currently permit interstate crowdfunding utilizing the Rule 504 exemption and Mississippi and Vermont dually offer intrastate crowdfunding under Section 3(a)(11) and interstate crowdfunding under Rule 504. See NASAA Letter. 420 See https://www.nasaa.org/industry-resources/ corporation-finance/coordinated-review/. See also the ‘‘Reciprocal Crowdfunding Exemption’’ proposed by the Massachusetts Securities Division available at https://www.sec.state.ma.us/sct/crowd fundingreg/Reciprocal%20Crowdfunding%20 Exemption%20-%20MA.PDF. 421 See e.g., Transcript of Record at 78, SEC Advisory Committee on Small and Emerging Companies (June 3, 2015), available at https:// www.sec.gov/info/smallbus/acsec/acsec-minutes060315.pdf. See also 2015 Small Business Forum Recommendations; ABA Letter; CFIRA Letter; CrowdCheck Letter; Milken Letter. PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 Crowdfunding and Rule 506 of Regulation D. To assess the likely impact of the final rules on capital formation, we consider the features of amended Rules 147 and 504 and new Rule 147A that potentially could increase securities offerings by new issuers and by issuers that already rely on other private offering methods. Second, to the extent that securities offerings relying on the final rules provide capital raising options for issuers that currently do not have access to capital, the final rules could enhance the overall level of capital formation in the economy, in addition to any reallocation of demand for capital amongst the various capital raising methods that could arise from issuers changing such methods. Third, to the extent that states currently have residency and eligibility requirements that correspond to existing Rule 147, the impact of amended Rule 147 and new Rule 147A on capital formation will significantly depend on whether state law is amended to align with the final rules. Any changes to intrastate and regional securities offering provisions that may be enacted by states would, in turn, affect the expected use of amended Rules 147 and 504 and new Rule 147A. Currently, most intrastate crowdfunding provisions require issuers to rely on Rule 147 and Section 3(a)(11) for exemption from Securities Act registration. To the extent state law provisions are amended to allow these offerings to comply with amended Rule 147, new Rule 147A or amended Rule 504, the choice between these three exemptions could depend on issuers’ preferences with respect to general solicitation, target investor base, issuer incorporation and investor location. For example, while issuers relying on the amended Rule 147 safe harbor must be incorporated in the state where they seek to conduct an intrastate offering, there is no such restriction for issuers relying on the Rule 147A exemption. While both Rule 147 and Rule 147A offerings will be restricted to in-state investors, Rule 504 offerings will be available to investors in more than one state, thus facilitating regional offerings. At the same time, there is no limit on the maximum offering amount under amended Rule 147 or new Rule 147A, while amended Rule 504 limits the maximum amount that can be sold over a twelve-month period to $5 million. Finally, the impact of the final rules on aggregate capital formation also will depend on whether new investors are attracted to the Rule 147, Rule 147A and Rule 504 markets or whether investors reallocate existing capital among E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations various types of offering methods. If the final rules allow issuers to reach a category of potential investors significantly different from those that they can reach through other offering methods, or attract existing investors to invest a greater share of their wealth in primary offerings, then capital formation, in aggregate, could increase. On the other hand, if the final rules are viewed as substantially similar to alternate offering methods, investors with limited investment capital may simply reallocate their capital from other markets to the Rule 147, Rule 147A or Rule 504 markets. Investor demand for securities offered under the final rules could, in particular, depend on the extent to which expected risk, return and liquidity of the offered securities compare to what investors can obtain from securities in other exempt offerings and in registered offerings. Investor demand also will depend on whether state disclosure requirements are sufficient to enable investors to evaluate the aforementioned characteristics of offerings made pursuant to Rules 147, 147A or 504. For example, investors may be less willing to participate in offerings that are made in reliance on exemptions both from state and federal registration and that are subject to fewer disclosure requirements. For some investors, these concerns may be mitigated by other state and federal provisions, such as the amendment being adopted to disqualify certain bad actors from participation in Rule 504 offerings or the disclosure requirements for larger intrastate crowdfunding offerings under state law provisions.422 In sum, we believe that the potential use of Rules 147, 147A and 504 will depend largely on how issuers perceive the trade-off between the costs of compliance under federal provisions as well as state regulation, if any, and the benefits of access to non-accredited investors. For instance, relative to Regulation Crowdfunding, the extent to which issuers rely on Rules 147, 147A or 504 for intrastate crowdfunding offerings will depend on whether the benefits of a larger offering amount and fewer reporting requirements outweigh the costs of a more geographically limited investor base, compliance with issuer residency requirements and the potential for registration under Section 12(g) of the Exchange Act. In this regard, we believe a small, local business that serves local customers (e.g., a hair salon 422 See NASAA’s Intrastate Crowdfunding Resource Center, available at https://www.nasaa.org/ industry-resources/corporation-finance/instrastatecrowdfunding-resource-center/. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 or a pizza shop), rather than a scalable business like a technology start-up, is more likely to use intrastate crowdfunding than interstate crowdfunding.423 Compared to Rules 147, 147A and 504, other exemptions and safe harbors already being utilized could remain attractive to issuers. For example, offerings conducted pursuant to the exemption from registration under Rule 506(b) of Regulation D, which accounts for a significant amount of exempt offerings,424 are subject to limits on participation by nonaccredited investors. In contrast, issuers relying on Rules 147, 147A or 504 could generally sell securities to an unlimited number of non-accredited investors, which would allow for a more diffuse investor base. General solicitation is currently permitted under Rule 506(c) of Regulation D, and issuers relying on Rule 506(c) can more easily reach institutional and accredited investors, making it less necessary for them to seek capital from a broader non-accredited investor base, especially if trading platforms aimed at accredited investors in privately placed securities continue to develop.425 In addition, offerings under Rule 506(b) that are limited to accredited investors require only a notice filing with the Commission and have no specified disclosure requirements. Finally, relative to Regulation A, Rules 147, 147A and 504 will have fewer disclosure and other regulatory requirements at the federal level. However, unlike securities issued in reliance on Regulation A, which are freely tradable, securities issued under Rules 147, 147A and 504 could be less liquid due to their resale restrictions. Overall, the amendments to Rules 147, 147A and 504 could increase the aggregate amount of capital raised if used by issuers that have not previously conducted securities offerings. The net effect also will depend on whether investors find the rules’ investor protections to be sufficient to evaluate the expected return and risk of such offerings. As noted above, the final rules may have a limited impact on capital formation if they simply cause issuers to conduct, and investors to reallocate their participation across, different types of offerings. However, even redistribution among capital raising 423 See Nextseed Letter. discussion in Section V.2 above. 425 See e.g., NASDAQ Private Market overview, available at https://www.nasdaqprivatemarket.com/ market/overview (explaining that ‘‘NASDAQ Private Market’s affiliated marketplace is an electronic network of Member Broker-Dealers who provide accredited institutions and individual clients with access to the market. Companies use a private portal to enable approved parties to access certain information and transact in its securities.’’). 424 See PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 83529 methods will have a net positive effect on capital formation and allocative efficiency if it allows issuers to access capital at a lower cost. As the final rules are not currently in effect, data does not exist to estimate the effect of the final rules on the potential rate of substitution between alternative methods of raising capital and the overall expansion or decline in capital raising by potential issuers affected by the rules. However, we anticipate that the final rules, by lowering investor search costs and easing issuer eligibility requirements, will result in an increased use of the federal intrastate offering provisions, including for intrastate crowdfunding, as more states enact provisions facilitating such offerings. Similarly, we expect the final rules will increase the use of the Rule 504 exemption, especially by facilitating efforts among state securities regulators to implement regional coordinated review programs that will enable regional offerings. Although it is not possible to predict the extent of such increase or the type and size of issuers that will conduct intrastate and small regional offerings, the current number of businesses pursuing similar levels of financing through alternative capital raising methods, as discussed in the baseline analysis above, provide an upper bound for Rule 147, Rule 147A and Rule 504 usage.426 Nevertheless, the baseline data show that the potential number of issuers that might seek to offer and sell securities in reliance on Rules 147, 147A and 504 is large, particularly when compared to the current number of approximately 9,000 reporting companies.427 We recognize that the amendments to Rules 147 and 504 and new Rule 147A could raise investor protection concerns. For instance, as discussed in detail further in this section, allowing issuers with more geographically dispersed assets and revenues than currently permitted to rely on Rules 147 and 147A may raise concerns about reduced oversight by state securities regulators. We believe however, that the amended ‘‘doing business’’ tests along 426 We believe the numbers in the baseline analysis provide an upper bound because, unlike Rule 147 offerings, investors from multiple states are permitted to invest in Regulation D offerings, which attracts more issuers, especially those that want to raise larger amounts. Similarly, unlike Rule 504, Rule 506 provides state law preemption and permits unlimited offering amounts, which appears to make Rule 506 offerings more attractive for issuers. 427 See U.S. Securities and Exchange Commission, FY 2016 Congressional Budget Justification, 2016 Annual Performance Plan, FY 2014 Annual Performance Report, available at https://www.sec.gov/about/reports/secfy16congbu dgjust.pdf. E:\FR\FM\21NOR2.SGM 21NOR2 83530 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES with the principal place of business requirement are sufficient to provide assurance of the local nature of an issuer’s business operations.428 We also believe such concerns are mitigated by the continuing applicability of state regulatory requirements, which may impose additional eligibility conditions for issuers in these offerings, as well as the residency requirements for investors that remain under the final rules. Similarly, there could be concerns about not having an offering size limit at the federal level or not requiring a limit under state law if the issuer relies on a state exemption for an intrastate offering. In adopting existing Rules 147, 504 and 505, the Commission relied substantially upon state securities laws and regulations on the rationale that the size and/or local nature of smaller offerings conducted pursuant to these provisions does not warrant imposing extensive regulation at the federal level.429 The final rules preserve this approach by permitting state legislators and securities regulators to determine the specific additional rule requirements, if any, that should be mandated to regulate local offerings and provide additional investor protections. In this regard, the final rules provide greater flexibility to states in designing regulations that would work best for issuers and investors in their respective jurisdictions. We believe that such latitude could improve the efficiency of local capital markets and lead to competition between states in attracting issuers to locate to their jurisdictions. In addition to state regulations, the amendments to Rule 504 to disqualify certain bad actors from participation in Rule 504 offerings could help to address such investor protection concerns. We also note that the Commission will retain authority under the antifraud provisions of the federal securities laws to pursue enforcement action against issuers and other persons involved in such offerings.430 Nevertheless, if investors demand higher returns because of a perceived increase in the risk of fraud as a result of less extensive federal regulation, issuers may face a higher cost of capital. We are unable to predict if or how the final rules will affect the incidence of fraud in intrastate and Rule 504 offerings. 428 See also NASAA Letter and CFA Letter. Seed Capital Release and Rule 147 Adopting Release. See also, ABA Letter and NASAA Letter. 430 See, e.g., Seed Capital Release at note 20 and accompanying text (Rule 504 offerings are subject to Section 17 of the Securities Act [15 U.S.C. 77q(a), Section 10(b) of the Exchange Act [15 U.S.C. 78j(b) and Rule 10b–5 thereunder [17 CFR 240.10b–5]). 429 See VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 The impact of the repeal of Rule 505 will depend on the trade-offs that Rule 505 issuers and investors face when switching to alternate offering methods, predominantly other unregistered offerings. This will be contingent on whether issuers can raise the desired amount of capital at the same or lesser cost as under Rule 505 in a timely manner. For example, if issuers switch to offerings under Rule 506(b), they may only offer and sell to investors that are accredited or that, unlike in a Rule 505 offering, either alone or with a purchaser representative,431 are sophisticated (i.e., have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment). However, the possibility of raising unlimited amounts of capital and preemption from state blue sky laws may offset some of these concerns for potential issuers that subsequent to the repeal of Rule 505, would switch to a Rule 506 offering. In contrast, if issuers switch to offerings under amended Rule 504, they could replicate most characteristics of an offering under existing Rule 505 and receive some additional benefits, such as access to an unlimited number of non-accredited investors and the ability to engage in general solicitation in certain situations. However, reporting companies, albeit a small proportion of all Rule 505 issuers,432 are not permitted to utilize the Rule 504 exemption. As an alternative to Rule 505, issuers may also opt for a registered offering to raise capital. As noted above, a registered offering may not be economically feasible for small issuers relative to an exempt offering,433 but may provide a reasonable alternative for Rule 505 issuers that are reporting companies. Registered offerings, unlike Rule 505 or Rule 506(b) offerings, have benefits like providing investors with unrestricted securities, and providing issuers access to an unlimited number of non-accredited investors and investors who prefer offerings that have the protections of the registration process. On the other hand, the costs of 431 A purchaser representative is someone who is not an affiliate of the issuer but has such knowledge and experience in financial and business matters that he is capable of evaluating, alone, or together with other purchaser representatives of the purchaser, or together with the purchaser, the merits and risks of the prospective investment. See also Rule 501, Regulation D of Securities Act. 432 As discussed in Section IV(A)(1)(ii), the number of reporting companies that conducted a Rule 505 offering during 2014 and 2015 was 10 and 8, respectively. 433 See discussion in Section V(A(1)(c)(2) above. PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 registering an offering compared with costs of raising capital through an exempt offering, including Rule 505 or Rule 506(b) offerings, may also affect an issuer’s willingness to switch to a registered offering. Such costs include the costs of disclosure required for a registered offering relative to the disclosure required under Rule 505 or 506(b) when non-accredited investors are solicited,434 including any costs associated with Commission staff review of the registration statement. Recent regulatory changes to Form S–1 435 that permit forward incorporation by reference of certain information required under Exchange Act reporting requirements may have lowered the costs of registered offerings for eligible smaller reporting companies by eliminating the need to update information in the Form S–1 that has become stale or is incomplete through a post-effective amendment. Whether Rule 505 issuers, in particular those that are reporting companies, switch to a registered offering or another form of unregistered offering such as Rule 506 offering will depend on how they assess such costs of registration relative to the benefits like broader access to nonaccredited investors.436 The effect of the repeal of Rule 505 will also depend on investors’ willingness and ability to participate in an alternate unregistered offering, such as a Rule 504 or Rule 506 offering, or a registered offering. This willingness will rest on whether investors find disclosure requirements and investor protections in alternate markets to be sufficient, relative to the Rule 505 market, to evaluate the expected return and risk of such offerings. For example, it is possible that investor protection levels will be perceived to be lower in a Rule 506 offering as these offerings are preempted from state or Commission registration. In addition, ‘‘unsophisticated’’ non-accredited investors that may have been able to participate in a Rule 505 investment 434 The disclosure requirements under Rule 505 and Rule 506(b) for an Exchange Act reporting issuer that sells securities to a non-accredited investor are similar to the disclosure requirements for a registered offering under the Securities Act. See Rule 502(b)(2)(ii) of Regulation D. Note that if the Rule 505 or 506(b) offering is soliciting only accredited investors, there is no equivalent requirement for information being furnished. 435 See note 330 above. 436 See, e.g., Armando Gomes and Gordon Phillips, ‘‘Why Do Public Firms Issue Private and Public Securities?’’, J. FINAN. INTERMEDIATION, March 21, 2012 which find that choice of public versus private financing depends on asymmetric information, risk and market timing. See also Hsuan-Chi Chen, Na Dai, John Schatzberg, ‘‘The Choice of Equity Selling Mechanisms: PIPEs versus SEOs’’, J. CORP. FIN., August 21, 2009. E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations opportunity may not be able to participate in a Rule 506(b) offering without a purchaser representative and hence may find their set of investment opportunities reduced. Similarly, while more than 35 non-accredited investors (the maximum eligible to invest in a Rule 505 offering) will be able to participate in an offering under amended Rule 504, Rule 504 has fewer disclosure requirements at the federal level relative to a Rule 505 or 506 offering, which may raise potential investor protection concerns. Such concerns, however, may be offset by disclosure requirements imposed at the state level. Thus, the net impact on the overall level of investor protection will likely depend on the capital markets that substitute for the repealed Rule 505 market. Overall, the repeal of Rule 505 may not have a significant or any impact on capital formation if issuers can successfully find commensurate investor interest in an alternate unregistered or registered offering market. If issuers are not able to find an alternate exemption and raise sufficient amounts of capital, an outcome we believe is unlikely, overall capital formation in the economy and allocative efficiency of capital markets could slightly decline. In the sections below, we analyze in more detail the potential costs and benefits stemming from the specific amendments and new rule being adopted today, as well as their impact on efficiency, competition and capital formation, relative to the baseline discussed above. asabaliauskas on DSK3SPTVN1PROD with RULES 2. Analysis of Amendments to Existing Rule 147 and New Rule 147A The amendments to Rule 147 and new Rule 147A will modernize and expand the options available under federal law for exempt intrastate offerings by local companies, including offerings relying upon crowdfunding provisions under state securities laws. a. Retention of Existing Rule 147 The proposed amendments would have replaced the existing Rule 147 safe harbor with a new intrastate offering exemption. In contrast, the final rules amend Rule 147 and retain it as a safe harbor under Section 3(a)(11), while also establishing new Rule 147A pursuant to the Commission’s general exemptive authority under Section 28. Because most state crowdfunding provisions require issuers to comply with Section 3(a)(11) and Rule 147, retention of Rule 147 within the statutory parameters of Section 3(a)(11) will enable issuers to continue to rely VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 upon the existing safe harbor to conduct intrastate offerings until states update their laws or regulations to allow issuers to rely on new Rule 147A.437 This will help to ensure that intrastate offering activity is not adversely affected during the interim period or in states that do not amend their laws, and will thus provide greater certainty to market participants, including issuers and investors who participate in such intrastate offerings.438 Together, the amendments to Rule 147 and new Rule 147A seek to modernize federal regulation of intrastate offerings to comport with contemporary business practices and communications technology, while retaining the underlying intent of the rules to permit issuers to raise money from investors resident within the same state without registering the offering at the federal level. Amended Rule 147 will differ from new Rule 147A with respect to two provisions that are statutorily mandated by Section 3(a)(11). Under Section 3(a)(11), and by extension the safe harbor under Rule 147, offers can be made only to in-state residents and issuers are required to be incorporated in the state where they conduct the intrastate offering. The provisions of new Rule 147A will not include these two limitations; however, both Rule 147 and 147A will require an issuer to have its principal place of business within the state or territory of the offering. In the following sections, we first discuss the economic effects of not including the two statutory limitations contained in Rule 147 within new Rule 147A and then discuss the amendments that are substantially identical under Rules 147 and 147A. b. Distinguishing Provisions Under New Rule 147A i. Elimination of Restrictions on Manner of Offering Offers pursuant to current and amended Rule 147 must be limited to in-state residents.439 However, the provisions under new Rule 147A will allow an issuer to make offers to out-ofstate residents, as long as sales are made only to residents of the issuer’s state or territory.440 Both amended Rule 147 and new Rule 147A require issuers to 437 Most states that have enacted state crowdfunding provisions require issuers to comply with the provisions of Section 3(a)(11) and Rule 147. See note 30 above. 438 See, e.g., ABA Letter, NASAA Letter, CrowdCheck Letter, Guzik Letter, NextSeed Letter and the 2015 Small Business Forum Recommendations. 439 See Rule 147(b). 440 See Rule 147A(b). PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 83531 include prominent disclosures on all offering materials stating that sales will be made only to residents of the same state or territory as the issuer, while also disclosing that the securities are being sold in an unregistered offering and have resale restrictions for a six-month period.441 In addition, under both rules, states retain the flexibility to impose additional disclosure or other requirements related to offers and sales made in the intrastate offering. As Internet-based advertising is easily accessible across state lines, issuers relying on existing Rule 147 that choose to disseminate offering materials using online media could have a higher risk of being non-compliant unless they take additional and potentially costly precautions to restrict any advertising that can be viewed outside their state of incorporation. Eliminating manner of offering restrictions in Rule 147A will allow issuers to engage in broad-based solicitations, including on publicly accessible Web sites, in order to successfully locate potential in-state investors. For example, an issuer resident in New Jersey will be permitted under Rule 147A to advertise and disseminate offering information through online media to reach New Jersey residents, including those who may work and access the online solicitation while in New York. Thus, Rule 147A will provide issuers with the flexibility to utilize a wider array of options to advertise their offerings, allowing them to take advantage of modern communication technologies such as the Internet and other social media platforms to reach investors.442 In this regard, we expect Rule 147A to be particularly effective at facilitating statebased crowdfunding offerings that rely heavily on online platforms to bring issuers and investors together.443 Online advertising provides a lower cost and more efficient means of communicating with a more diffused base of prospective investors. Consequently, eliminating manner of offering restrictions in Rule 147A should result in lower search costs for Rule 147A issuers. The provisions may facilitate compliance with the rules’ requirements as issuers will not need to limit advertising or take additional precautions to ensure that only in-state residents view the offering. Under the final rules, issuers will be able to choose between utilizing Rule 147 and Rule 147A for intrastate offerings based on their preferences for communicating with investors. This 441 See 442 See Rules 147(f) and 147A(f). also ABA Letter, CFA Letter, Nextseed Letter. 443 See Massolution 2015 Report. E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES 83532 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations could enable a larger number of issuers to utilize intrastate offerings to meet their capital raising needs. To the extent issuers shift from another unregistered capital market to the Rule 147A market, capital formation may not increase but the allocative efficiency of capital markets could improve, if issuers are able to meet their capital raising needs more effectively and investors are better able to find investment opportunities that satisfy their financial objectives. We believe that eliminating the manner of offering restrictions in Rule 147A will attract a number of new issuers that previously could not avail themselves of lower-cost capital raising opportunities, such as intrastate crowdfunding, that primarily rely on online media to advertise the offering to large numbers of investors. Such improved access to cheaper capital raising methods may result in higher levels of capital formation in the economy. In addition, eliminating manner of offering restrictions in Rule 147A may result in a greater number of investors becoming aware of a larger and more diverse set of investment opportunities in private offerings, enabling them to diversify their investment portfolios and allocate their capital more efficiently. Further, broadly advertised offerings under Rule 147A may compete for potential investors more effectively with offerings where general solicitation is also permitted, such as Rule 504, Rule 506(c), and Regulation A offerings. The final rules could thus intensify competition among unregistered capital markets for attracting issuers that want to raise capital and investors that are looking for suitable investment opportunities. An increase in competition could change the number and type of market participants across various markets, which would impact the relative demand for and supply of capital in each of these markets. However, as issuers utilizing Rule 147A advertise more widely and freely, the likelihood of out-of-state investors purchasing into an intrastate offering could increase. The inclusion of legends and other mandatory disclosures may mitigate this concern and may provide a certain measure of investor protection, although out-of-state investors in their desire to participate in an attractive investment opportunity may overlook the legends or disclosures or may simply disregard them. While issuers are required to have a reasonable belief that all their purchasers are resident within the state and obtain a written representation from each purchaser as to his or her residence, the probability of circumventing the out-of-state sale restrictions by investors who VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 misrepresent their residency status could increase as out-of-state residents may view Internet-based advertising and become aware of Rule 147A offerings in another state. Likewise, there may be an increased probability that out-of-state purchasers will attempt to purchase in resale transactions that occur within the restricted period. However, due to inclusion of rule provisions such as the requirement of written representation by investors as to their residency status as well as requirements related to legends, transfer agent instructions and prominent disclosure about limitations on resales, we believe that such concerns may not be significantly higher than under amended Rule 147, which retains the restrictions related to manner of offerings. Allowing Internet-based advertising of Rule 147A offerings and the potential increased use of the intrastate offering exemptions could also impact the effectiveness of state oversight if regulators do not have adequate resources to monitor the manner in which these securities are marketed to the general public. Overall, we believe that the final rules will modernize existing regulations to reflect modern business practices and technological developments while maintaining appropriate investor protections. ii. Incorporation and Principal Place of Business Requirements New Rule 147A will eliminate the current requirements in Rule 147 for issuers to be incorporated and have their principal office in the state where an offering is being conducted. In order to establish sufficient in-state presence to be eligible to conduct an exempt intrastate offering, in lieu of such requirements, Rule 147A will require issuers to have their principal place of business in the state where an offering is conducted. The principal place of business will be defined as the location from which officers, partners or managers of the issuer primarily direct, control and coordinate the activities of the issuer.444 We believe that the elimination of the incorporation or organization in-state requirement in Rule 147A better comports with modern business practices and thereby will make it easier for a greater number of issuers to utilize 444 See Rule 147A(c)(1). Corporations, limited partnerships and trusts relying on amended Rule 147 will continue to be required to be organized or incorporated in the state where the offering is being conducted in order to establish in-state residency. Rule 147(c), however, will be amended by replacing the principal office requirement with a principal place of business requirement. We believe principal place of business is conceptually similar to principal office location. See Section II(A)(2). PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 the new exemption, relative to amended Rule 147. A significant number of public and private companies are incorporated in states other than the state in which their principal place of business is located, thereby precluding otherwise eligible issuers from utilizing Rule 147 to conduct an intrastate offering.445 Most of these companies have chosen to incorporate in jurisdictions where corporate laws are consistent with modern business practices or provide more flexibility.446 For example, according to one academic study, corporate laws affect company value, even after controlling for company size, diversification, profitability, investment opportunities and industry.447 Thus, companies may have strong incentives to select perceived favorable regimes, such as that of Delaware.448 These studies and industry practices indicate that companies’ choice of state of incorporation depends on the economic benefits derived from the regulatory environment in which the company is organized and not necessarily where the company operates most efficiently. Since the geographical location of investment and employment is aligned more closely with the principal place of business of a company than where it is incorporated, we believe replacing the current incorporation and residency requirements of current Rule 147 with a principal place of business requirement in Rule 147A will be sufficient to 445 For example, based on analysis of EDGAR filing data, 76% of Exchange Act reporting companies indicated, in their 2015 Form 10–K filings, that they had a separate state of principal executive office and state of incorporation. Analyzing by size (assets), more than two-thirds of the smallest 10% of reporting companies reported different states of incorporation and principal office. The practice of incorporating in different states extends beyond public companies to private and smaller companies. During 2009–2015, 37% of Rule 504 offerings and 39% in Rule 505 offerings indicated in their Form D filings that they had different states of incorporation and principal place of business. See baseline analysis in Section IV(A)(1)(ii). Form D data also indicates that approximately 65% of all Rule 506 offerings initiated during 2009–2015 reported different states of incorporation and operations. While smaller companies may be less likely than larger companies to have separate states of incorporation and principal places of business, Form D data indicates that a considerable number of small businesses are currently unable to meet the state of incorporation requirement in existing Rule 147. 446 See ABA Letter, CFA Letter, CrowdCheck Letter, Milken Letter. 447 Robert Daines, ‘‘Does Delaware Law Improve Firm Value?’’ J. Fin. Econ., Volume 62, Issue 3 (2001) at 525–558. 448 See Scott D. Dyreng, Bradley P. Lindsey, Jacob R. Thornock, ‘‘Exploring the Role Delaware Plays as a Domestic Tax Haven,’’ J. Fin. Econ., Volume 108, Issue 3, (2013) at 751–772 (explaining that Delaware’s tax laws play an economically important role in U.S. companies’ decision to locate in Delaware). E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations establish the in-state nature of the issuer’s business. Such a change will also be consistent with the objectives of the current intrastate offering exemption, while making it easier for more issuers to utilize the new exemption relative to the amended Rule 147 safe harbor under Section 3(a)(11). By not requiring issuers to be incorporated in-state, it may be possible for foreign incorporated issuers that have their principal place of business in a U.S. state to be able to access the Rule 147A capital market. This will create a uniform standard for companies that are operating locally, irrespective of their country or state of incorporation, to utilize the Rule 147A exemption. Form D filings for the period 2009–2015 reported that approximately 2.5% of Regulation D offerings (approximately 3,211 offerings) were initiated by issuers that were incorporated outside of the United States and had their principal place of business in a U.S. state. Allowing issuers to raise capital in the state in which it has its principal place of business, without regard to the jurisdiction of incorporation under new Rule 147A, could enable issuers to organize or incorporate in foreign jurisdictions with perceived advantages that may increase the financial viability of such issuers, especially for early stage companies. However, to the extent that it is more difficult to enforce securities and other relevant laws against such foreign organized or incorporated issuers, risks to investors in such issuers could increase. Overall, given the intrastate character of Rule 147A offerings, we do not think it likely that a significant number of foreign issuers will seek to utilize this exemption. Under Rule 147 and Rule 147A, issuers will be able to have a ‘‘principal place of business’’ within only one state or territory, and therefore the issuer will be able to conduct an intrastate (Rule 147 or Rule 147A) offering in only one state or territory. To mitigate the risk of issuers switching their principal place of business to a different state in order to conduct Rule 147 or Rule 147A offerings in multiple states, the final rules limit issuers that change their principal place of business from utilizing the exemption to conduct another intrastate offering in a different state for a period of six months from the date of last sale of securities under the prior Rule 147 or Rule 147A offering. These provisions will help to deter issuers from misusing the amended residency requirements to change their principal place of business in order to sell to residents in multiple states. The duration of this limitation is consistent VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 with the period for which resales to outof-state investors will be prohibited. To the extent a change in principal place of business to a new state is motivated by business or regulatory considerations, this amendment could affect the capital raising prospects of companies by requiring them to delay their subsequent intrastate offerings or seek to conduct an offering under another exemption. For example, certain start-ups and small businesses that could potentially relocate their principal place of business in pursuit of costs savings could be affected by the final rules. c. Common Requirements of Amended Rule 147 and New Rule 147A i. ‘‘Doing Business’’ In-State Tests Similar to the proposed amendments, the final rules will modify the current ‘‘doing business’’ in-state requirements in Rule 147 by requiring issuers to satisfy one of four specified tests. A similar requirement will be included in Rule 147A. The specified tests will include a new test whereby issuers can satisfy the ‘‘doing business’’ requirement if a majority of their employees are located in the offering state. Specifically, under amended Rule 147 and new Rule 147A, in order to be deemed ‘‘doing business’’ in a state, issuers will have to satisfy at least one of the following requirements: • 80% of the issuer’s consolidated assets are located within such state or territory; • 80% of the issuer’s consolidated gross revenues are derived from the operation of a business or of real property located in or from the rendering of services within such state or territory; • 80% of the net proceeds from the offering are intended to be used by the issuer, and are in fact used, in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services within such state or territory; or • A majority of the issuer’s employees are in such state or territory. The modifications to the existing ‘‘doing business’’ in-state tests will modernize the Rule 147 safe harbor and provide greater flexibility to potential issuers relying on Rules 147 and 147A to conduct intrastate offerings. This will ease issuer burden in complying with the provisions, while also better aligning the rules with modern business practices such that issuers will be able to use the test that best reflects the local nature of their business operations.449 449 See PO 00000 also CFA Letter. Frm 00041 Fmt 4701 Sfmt 4700 83533 Rule 147 currently requires issuers to satisfy all three ‘‘doing business’’ instate tests, which can be burdensome even for small businesses that have a strong nexus to one state. For example, for some startups and early stage ventures that are unable to access alternate methods of raising capital and therefore seek to rely on the intrastate offering exemption, the existing ‘‘doing business’’ tests, by restricting these issuers’ operations and capital investments substantially to one state may have adverse effects on their growth and viability. Moreover, in recent years new business models have emerged that may make satisfying all three tests ill-suited for issuers who would otherwise be able to rely on Rule 147 as a capital raising option. For example, businesses that use new technologies (e.g., e-businesses) to make their operations more efficient tend to be more geographically distributed in their operations or revenues than what is permitted under current Rule 147.450 According to an academic study, advances in computing and communications have fundamentally changed how information can be stored, distributed, modified or assimilated, which has enabled businesses to become more geographically dispersed and modular rather than centralized into discrete units.451 Similarly, the growth of modern technologies has made it easier for companies, through ecommerce and shared logistical networks, to reach a larger and more diffused customer base, leading to more dispersed revenue streams. Requiring an issuer to own a majority of its assets, invest most of the capital it raises, and obtain its revenue in one state could create inefficient constraints for startups and small businesses to operate and grow in the modern business environment. While the original intent of Section 3(a)(11) and Rule 147 was to ensure that investors and issuers are located in the same state so that they are potentially familiar with each other,452 current business practices of issuers, consumption habits of customers, and the set of available investment opportunities of investors have expanded greatly since Rule 147 450 Consider the example of an e-commerce company that invests in distribution facilities outside its state to meet the needs of customers who are resident outside that state. Under current requirements, such an issuer may be able to invest only a small part (less than 20%) of the capital raised in a Rule 147 offering outside its principal state of business to remain eligible for the exemption. See also NASAA Letter. 451 See Mohanbir Sawhney and Deval Parikh, ‘‘Where Value Lives in A Networked World,’’ Harvard Business Review (2001). 452 See Rule 147 Adopting Release. E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES 83534 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations was adopted in 1974. In view of these changes, we believe that the modifications to the ‘‘doing business’’ requirements in the final rules will provide issuers with greater flexibility in conducting intrastate offerings and help to eliminate potential uncertainty about the availability of intrastate offering exemptions. Compared to current Rule 147, the revised ‘‘doing business’’ requirements in the final rules will enable a greater number of companies to rely on Rule 147 or Rule 147A to raise capital through local offerings. Such new issuers could be those entities that are currently accessing capital through alternate means, or they could be issuers that could not previously raise sufficient amounts of capital in any market but would be able to use amended Rule 147 or new Rule 147A to meet their funding needs. In addition, to the extent raising capital in a Rule 147 or Rule 147A offering is less costly than raising capital using alternate means, issuers will benefit from such lower costs. Easier access to local capital may enable issuers to finance investment opportunities in a timely manner, thereby accelerating company growth and promoting state employment and economic growth. As more companies become eligible or are willing to raise capital pursuant to amended Rule 147 or new Rule 147A, the set of investment opportunities for investors will also increase in a corresponding manner, resulting in greater allocative efficiency and capital formation. These economic benefits generally depend on the extent to which increased use of the intrastate offering provisions, compared to current Rule 147, arises as a result of substitution out of other types of offerings. On one hand, if increased use of the intrastate offering provisions causes issuers and investors to migrate from other types of offerings as a result of marginally more attractive prospects for investment and capital raising, the aggregate increase in capital formation may not be significant but competition amongst types of private offerings will be higher.453 On the other hand, if amended Rule 147 or new Rule 147A attracts new issuers, capital formation levels will increase in the economy. We believe that, by facilitating intrastate crowdfunding, the final rules could provide new company growth and consequently lead to an overall increase in capital formation. Further, the final rules could lead to increased capital formation by 453 We note that issuers that meet current requirements under existing Rule 147 will also be eligible to rely on amended Rule 147 or Rule 147A. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 facilitating other state registered or exempt offerings, including those with amounts greater than what is allowed for intrastate crowdfunding offerings. However, since we do not have data on the existing use of Rule 147, we are unable to quantify or predict the extent of any increase in offering activity under amended Rule 147 or new Rule 147A. At the same time, if issuers with assets and operations dispersed over more than one state make use of amended Rule 147 or new Rule 147A, there may be concerns that state oversight of such issuers could weaken, with a consequent reduction in investor protection. We believe, however, that qualifying under any one of the four ‘‘doing business’’ in-state tests and requiring an issuer to have its principal place of business in the state, such that the officers and managers of the issuer primarily direct, control and coordinate the activities of the issuer in the state, will provide state regulators with a sufficient basis from which to monitor an issuer’s activities and enforce state securities laws for the protection of their residents.454 Further, state enforcement actions aimed at protecting in-state investors can extend to issuers whose assets are located beyond the boundaries of the state, which could potentially deter issuers from engaging in fraudulent intrastate offerings. Moreover, with the adoption of amendments to Rule 147 and new Rule 147A, state regulators may choose to amend their state regulations to comport with these provisions, which would allow them to consider any additional requirements, including qualification tests, for issuers to comply with state securities offerings regulations. Finally, we note that the high threshold levels specified in the final rules’ ‘‘doing business’’ tests may preclude certain issuers whose business models result in widely distributed operations (e.g., some e-commerce companies) from qualifying under any of the four tests and thus from relying on these intrastate offering provisions. Such issuers could rely on alternate capital raising methods such as Regulation Crowdfunding. To the extent these issuers are unable to raise the required capital through alternate methods, these provisions could adversely impact capital formation and investment opportunities for such firms. We believe, however, that the vast majority of issuers will be able to satisfy the ‘‘doing business’’ test requirements in order to qualify for local capitalraising. 454 See PO 00000 also CFA Letter and NASAA letter. Frm 00042 Fmt 4701 Sfmt 4700 ii. Reasonable Belief and Written Representation as to Purchaser Residency Status Amended Rule 147 and new Rule 147A include a reasonable belief standard for determining whether a purchaser is a state resident at the time of the sale of the securities. In a change from the proposed rules, the final rules will retain the requirement of current Rule 147 that an issuer obtain investor representations as to his or her residency status. The reasonable belief standard is conceptually consistent with similar requirements in Regulation D offerings and will provide greater certainty to issuers as to their compliance with the conditions of the exemption, potentially encouraging greater reliance on the final rules.455 Retaining the written representation requirement could constrain issuer flexibility if the requirement predisposes them to rely on particular modes of residency verification over others.456 It could also result in somewhat higher compliance costs for issuers. At the same time, the requirement could help to better ensure that issuers are selling to investors who are residents of the state in which the offering is being conducted. In this way, requiring a representation as to the purchaser’s residency may mitigate some of the investor protection concerns raised by commenters.457 While a formal representation of residency by itself is not sufficient to establish a reasonable belief that such purchasers are in-state residents, the representation requirement, together with the reasonable belief standard, may result in better compliance with the final rules, which would serve to increase investor protections. It is possible, however, that some issuers may consider a written representation to be dispositive of reasonable belief of investor’s residency status, which would increase the risk of issuers’ violating the final rules. As an alternative, we considered providing a safe harbor for determining purchaser’s residence, as requested by several commenters.458 A safe harbor could provide greater certainty for issuers as to their compliance with the rules’ provisions, potentially 455 See NASAA Letter. example, issuers may find it easier to obtain a proof of residency document directly from the purchaser along with a written representation, whereas they may have found it more efficient to rely on an alternate mode like third-party verification if a written representation was not required. 457 See CFA Letter, CrowdCheck Letter, NASAA Letter. 458 See CFIRA Letter; CrowdCheck Letter; Localstake Letter; WBA Letter. 456 For E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations encouraging greater use of the intrastate offering exemptions and enhancing capital formation. However, a safe harbor also could be viewed as an exclusive or a minimum standard that could restrict issuer choice of verification methods, and we believe that requiring issuers to consider the facts and circumstances of the offering and sale will best serve issuers’ compliance with the final rules. asabaliauskas on DSK3SPTVN1PROD with RULES iii. Residence of Entity Purchasers Amended Rule 147 and new Rule 147A define the residence of a purchaser that is a legal entity—such as a corporation, partnership, trust or other form of business organization—as the location where, at the time of the sale, the entity has its principal place of business. This definition will create consistency in defining the place of residence of entity investors with that of the issuer while also helping to ensure that investors are sufficiently local by nature. iv. Limitations on Resales Consistent with the proposal, amended Rule 147 and new Rule 147A will limit resales to in-state residents during a defined restricted period from the date of sale by the issuer. In a change from the proposed rules, this restricted period has been reduced from nine to six months. Current Rule 147 provides a restricted period of nine months, and the start date for the restricted period is from ‘‘date of last sale’’ rather than from the ‘‘date of sale’’ for the particular security in question. In addition, the issuers’ ability to rely on Rules 147 and 147A will not be conditioned on a purchaser’s compliance with the rules’ resale restrictions. Under the final rules, after expiration of the restricted period, investors will be able to sell their securities to out-of-state purchasers, even if the offering is not yet completed. While reducing the restricted period to six months may raise investor protection concerns, including concerns about increased probability that the securities will be purchased with an intention to distribute, we are persuaded by commenters that suggested a six-month period would be adequate to assure that the securities have come-to-rest in the state of issuance.459 In addition, state regulators will have the flexibility to impose additional transfer restrictions under amended Rule 147 or new Rule 147A, if warranted within their jurisdiction. Additional language in 459 See note 157. See also text accompanying notes 167 and 168. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 amended Rule 147(e) and new Rule 147A(e) that specifies that all re-sales during this six-month restricted period will be limited to the state or territory in which the issuer is a resident at the time of the sale of the security by the issuer will help to maintain the intrastate nature of the offering even if the issuer relocates its principal place of business to a different state. The final rules, by shortening the restricted period, will provide greater liquidity for Rule 147 and Rule 147A securities, making them more attractive to investors, which could lead to greater investor participation and an increase in the supply of capital available in intrastate offerings. Further, it could improve price discovery and lead to lower capital raising costs for issuers. Additionally, not conditioning the availability of amended Rule 147 or new Rule 147A on the issuer complying with the provisions relating to resale restrictions will provide greater certainty to issuers conducting an offering pursuant to these provisions. For example, issuers will not need to be concerned about potentially losing the exemption if the resale provisions are violated under circumstances that are beyond their control. At the same time, given that issuers will continue to be subject to other compliance requirements, such as in-state sales limitations, mandatory offeree and purchaser disclosures, and stop transfer instructions, as well as federal antifraud and civil liability provisions, we believe that the final rules will not reduce investor protections. Rule 147(f) and new Rule 147A(f) require disclosure of the resale restrictions to every offeree in the manner in which the offering is communicated. Compared to the requirements in current Rule 147, which require written disclosure of resale restrictions, these provisions will provide greater flexibility to issuers and ease compliance burdens in cases of oral offers, while potentially making it easier for investors to be made aware of the resale restrictions at the time an offer is made. This change will lower the regulatory burden for issuers, especially smaller issuers; however, where an offer is communicated other than in writing, it also may adversely impact the information provided to potential investors (offerees) because the investor may not receive such information in writing at the time an offering is initially made and being considered. To the extent that investors would be more likely to comprehend or heed written disclosures, these changes may adversely impact investor protection. This impact will be mitigated by the PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 83535 requirement to provide disclosure about resale restrictions, in writing, to every purchaser a reasonable period of time before the date of sale.460 Rule 147(f)(3) is also being amended to remove the requirement to disclose to offerees and purchasers the stop transfer instructions provided by an issuer to its transfer agent and the provisions of Rule 147(f)(2) regarding the issuance of new certificates during the resale period, which also will ease compliance burdens for issuers. These changes are not expected to adversely affect investor protection, since the information in question relates to technical aspects of the securities transfer process and does not address securities ownership rights as such. v. Integration The final rules, similar to the proposed rules, will expand the current Rule 147 integration safe harbor such that offers and sales pursuant to amended Rule 147 or Rule 147A will not be integrated with: (i) Any offers or sales of securities made prior to the commencement of the offering, (ii) any offers or sales made more than six months after the completion of the offering, or (iii) any subsequent offer or sale of securities that is either registered under the Securities Act, exempt from registration pursuant to Regulation A, Regulation S, Rule 701, or Section 4(a)(6), or made pursuant to an employee benefit plan. Compared to the integration safe harbor in current Rule 147, the expanded integration safe harbor in the final rules will provide issuers with greater certainty that they can engage in other exempt or registered offerings either prior to or near in time of an intrastate offering without risk of becoming ineligible to rely on Rule 147 or Rule 147A. Similarly, the addition of Section 4(a)(6) to the list of exempt offerings that will not be integrated with a Rule 147 or Rule 147A offering will provide certainty to issuers that they can conduct concurrent crowdfunding offerings as per the provisions of the respective exemptions. This flexibility and ensuing regulatory predictability will be especially beneficial for small issuers who likely face greater challenges in relying on a single financing option for raising sufficient capital. While the expanded scope of the integration safe harbor may raise concerns that an issuer could more easily structure a single transaction as a series of exempt offerings to avoid securities registration,461 the final rules 460 Id. 461 See E:\FR\FM\21NOR2.SGM NASAA Letter. 21NOR2 83536 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations provide for non-integration only to the extent that the issuer meets the requirements of each of the offering exemptions being used to raise capital.462 Furthermore, the final rules require an issuer to wait at least 30 calendar days between its last offer made to investors other than qualified institutional buyers or institutional accredited investors in reliance on Rule 147 or Rule 147A and the filing of a registration statement with the Commission, which will provide additional protection to investors in registered offerings who might otherwise be influenced by an earlier intrastate offering. Therefore, we do not believe that the adoption of the integration safe harbor will result in reduced investor protections. asabaliauskas on DSK3SPTVN1PROD with RULES vi. Intrastate Broker-Dealer Exemption and Additional Considerations We are also providing guidance regarding the use of the Internet by a person that seeks to rely on the intrastate broker-dealer exemption.463 Our guidance clarifies that a person whose business otherwise meets the requirements of the intrastate brokerdealer exemption should not cease to qualify for the exemption solely because it has a Web site that may be viewed by out-of-state persons, so long as the broker-dealer takes measures reasonably designed to ensure that its business remains exclusively intrastate. This guidance will provide greater certainty to market participants about intermediaries’ ability to participate in intrastate offerings that seek to raise capital via online media without having to register as a broker-dealer with the Commission. Such certainty may increase both the demand for and the supply of intermediaries in Rule 147 and Rule 147A offerings, which could facilitate a greater number of intrastate offerings, especially crowdfunding offerings. At the same time, despite the measures taken by broker-dealers that are reasonably designed to ensure that their businesses remain exclusively intrastate, the risk of non-compliance with the exemptions under Section 5 may somewhat increase for issuers if out-of-state investors, attracted by the intrastate broker’s Web site, invest in the offering through misrepresentations of their residency status. 462 See also note 177. Act Section 15(a)(1) exempts from broker-dealer registration requirements under Section 15(b) a broker-dealer whose business is exclusively intrastate and who does not use any facility of a national securities exchange. 463 Exchange VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 vii. Alternatives Considered The paragraphs below discuss major alternatives that we considered in addition to the alternatives discussed in the individual sub-sections above. (a) ‘‘Doing Business’’ Tests As an alternative to the ‘‘doing business’’ tests in the final rules, we considered lowering the percentage thresholds for the existing tests but retaining the requirement that all tests be satisfied. For example, compared with the current 80% threshold requirements, requiring issuers to have the majority of their assets, derive the majority of their revenue, and use the majority of their offering proceeds instate could better comport with modern business practices, provide greater flexibility and make it less burdensome for issuers to satisfy these requirements, while still providing some indicia of the in-state nature of the issuer’s business.464 Such a change would also provide a consistent standard for the ‘‘doing business’’ tests in Rule 147 and Rule 147A, aligning the current tests with the new majority employees test and tests from other rules that use a majority threshold for determining issuer status, such as the test for determining foreign private issuer status.465 In this way, such an alternative could encourage greater reliance on Rule 147 and Rule 147A and thereby promote additional capital formation through exempt intrastate offerings. However, lowering the percentage thresholds would necessarily weaken the required nexus between the issuer and the state contemplated by current Rule 147 and Section 3(a)(11). To the extent that such a change would result in less effective state regulation, there could be increased concerns that investor protections in exempt intrastate offerings may be reduced. As another alternative to the final rules, we considered eliminating the requirement to qualify under any of the ‘‘doing business’’ tests. This alternative would significantly ease the burden for potential issuers in complying with Rules 147 and 147A, while also modernizing the rules to better align them with current business practices. As described above, in recent years new business models have emerged that may make the eligibility tests ill-suited for relying on the intrastate exemptions as a capital raising option. In view of broad changes in modern business practices, the principal place of business requirement may be sufficiently 464 See, e.g., Milken Letter. Securities Act Rule 405 and Exchange Act Rule 3b–4. 465 See PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 effective in establishing the local nature of an offering pursuant to Rule 147 or Rule 147A for purposes of compliance with the ‘‘doing business’’ in-state requirement at the federal level. The alternative will enable a larger number of issuers to qualify under the intrastate exemptions, which could increase capital formation. Relative to the adopted approach, this alternative also could provide more flexibility to state regulators to enact their own eligibility and residency requirements that better suit the interests of issuers and investors in their state, rather than imposing a uniform approach at the federal level that may function more effectively in some states than others. However, eliminating the ‘‘doing business’’ tests could allow issuers with widely-dispersed operations over more than one state or even no business operations (besides having a principal place of business in-state) to make greater use of amended Rule 147 or new Rule 147A. Without sufficient local presence or an appropriate nexus with the issuer and the state, local oversight of such issuers could weaken, with a consequent decrease in investor protection. Although some of these concerns could be mitigated by continuing to restrict sales to in-state residents and the inclusion of the principal place of business requirement, as well as by the ability of states to extend their enforcement activities to issuers whose assets are located beyond state borders, we believe the approach we are adopting in the final rules will provide issuers with sufficient flexibility to satisfy these requirements, while maintaining important indicia of the in-state nature of the issuer’s business. As noted above, given the other changes we are adopting to modernize our exemptive framework for intrastate offerings, we believe it is appropriate to first observe how the updated doing business in-state requirements are used by issuers in practice before making any further changes (b) State Law Requirements and Additional Federal Restrictions In a change from the proposed rules, the final rules will not require that the offering be registered under state law or conducted pursuant to a state law exemption that limits the amount of securities an issuer may sell pursuant to amended Rule 147 or new Rule 147A and the amount of securities than can be purchased by an investor in the offering. These requirements, as proposed, could provide additional protections at the federal level and could mitigate investor protection concerns that may arise from E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations the modernization of the federal regulatory regime applicable to intrastate offerings. However, as noted by some commenters, conditioning the final rules on specified state law requirements would reduce the flexibility of state regulators to design rules that best conform to the requirements of issuers and investors in their states and, by imposing a uniform standard, could disadvantage certain jurisdictions relative to others.466 Such requirements could thus unduly restrict capital raising options of issuers, especially those issuers that sell primarily to accredited investors, and could also restrict legitimate state interests in permitting larger offerings within their jurisdictions that otherwise rely on the federal intrastate exemptions. We also note that the maximum amount that can be raised under existing intrastate crowdfunding provisions is less than the limit of $5 million that was proposed as a limit on certain intrastate offerings. Most of these states have also adopted provisions that impose investment limitations on investors. Thus, the protections provided by such limitations will remain available to investors in many intrastate crowdfunding offerings. States also retain the flexibility to enact additional measures under state law to strengthen issuer eligibility requirements for intrastate offerings. We recognize that conditioning the federal exemption on certain state law exemptions or requirements could raise concerns that the provisions will be utilized to conduct offerings in states that lack sufficient investor protection safeguards, leading to a ‘‘race-to-thebottom’’ between state legislators and regulators through significant easing of compliance provisions in order to attract more issuers. We believe, however, that such an outcome may be unlikely because state legislators and regulators have economic and reputational incentives to provide local issuers and investors with robust capital markets that are sustainable over the long run. Robust competition between states to enact securities laws that attract issuers to their territories would result in better regulations that promote effective functioning of local financial markets among the states, issuers and investors. We also considered excluding certain types of issuers from relying on Rule 466 See CFIRA Letter, Milken Letter, NASAA Letter, NextSeed letter. See also ABA Letter stating that such limits would be inconsistent ‘‘with Congressional intent that local offerings do not require federal regulation and are best left to be regulated by the states’’. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 147 or Rule 147A, since it is likely that intrastate offerings and, especially crowdfunded offerings, may have a large proportion of retail investors.467 Further, we also considered whether to extend bad actor disqualification provisions to these rules, similar to the provisions under Rule 506(d) of Regulation D.468 Such provisions could enhance investor protections and promote regulatory consistency with other unregistered offering exemptions. However, these provisions are already a feature of most state crowdfunding exemptions, and additional restrictions at the federal level could reduce states’ flexibility in enacting provisions that work best for their local jurisdictions. In this regard, we believe that states are well positioned to determine whether these or additional requirements are necessary in their jurisdictions. (c) Exemption From Section 12(g) Requirements Amended Rule 147 and new Rule 147A do not exempt securities issued in intrastate crowdfunding from reporting requirements under Section 12(g) of the Exchange Act.469 As crowdfunded offerings are purchased in small amounts by a relatively large number of investors, issuers using Rule 147 or Rule 147A for state crowdfunding offerings may exceed record holder thresholds that trigger registration requirements under Section 12(g). In contrast to intrastate crowdfunding offerings, securities issued under Regulation Crowdfunding do not count toward the record holder thresholds for triggering registration under Section 12(g), subject to certain conditions. This may place an additional regulatory burden on Rule 147 and Rule 147A issuers, making them less likely to initiate intrastate crowdfunding offerings. As an alternative to the final rules, an exemption from the registration requirements under Section 12(g) for intrastate crowdfunded offerings could encourage issuers to rely on Rule 147 or Rule 147A by allowing such issuers to delay registration, and thereby avoid the regulatory obligations of ongoing reporting requirements under the Exchange Act.470 However, as Rule 147 and Rule 147A issuers will not be required to submit financial reports on an ongoing basis, such a provision may result in less information about these issuers being available to the market to 467 See NASAA Letter. 468 Id. Section II.C. above. CFIRA Letter, CrowdCheck Letter, Guzik Letter, Milken Letter. See also 2015 Small Business Forum Recommendations. 83537 the possible detriment of existing and prospective investors. Such concerns are mitigated under Regulation Crowdfunding as issuers relying on that exemption are required to file ongoing financial reports with the Commission. Under Rule 147 and Rule 147A, however, issuers will not be subject to any federal ongoing reporting requirements, which could make the additional protections provided by registration under Section 12(g) especially beneficial to the issuers’ investors. 3. Analysis of Amendments to Rule 504 The final rules related to Rule 504 will increase the maximum aggregate amount that can be raised under a Rule 504 offering, in a 12-month period, from $1 million to $5 million and will disqualify certain bad actors from participation in Rule 504 offerings. Additionally, in order to account for the increase in the Rule 504 aggregate offering amount limitation, we are adopting technical amendments to the notes to Rule 504(b)(2) that will update the current illustrations in the rule regarding how the aggregate offering limitation is calculated in the event that an issuer sells securities in multiple offerings pursuant to Rule 504, within the same twelve-month period.471 All other provisions of current Rule 504 of Regulation D will remain unchanged. a. Increase in Maximum Aggregate Amount to $5 Million As shown in the baseline analysis above, use of Rule 504 offerings has been declining over the past decade, in absolute terms as well as relative to Rule 506 of Regulation D. Compared to Rule 504 offerings, Rule 506 offerings have the advantage of preemption from state registration. Thus, even though Rule 506(b) offerings, unlike Rule 504 offerings, are limited to accredited investors and up to 35 non-accredited investors, capital raising activity during the last two decades suggests that the benefits of state preemption outweigh unrestricted access to non-accredited investors. With the adoption of Rule 506(c), which allows for general solicitation, the comparative advantage of current Rule 504 has further diminished. The current $1 million maximum amount was set by the Commission in 1988 and was meant to provide ‘‘seed capital’’ for small and emerging businesses.472 Given the high costs of raising capital from public sources, the 469 See 470 See PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 471 See Notes 1 and 2 to Rule 504(b)(2), 17 CFR 230.504(b)(2). 472 See Seed Capital Release. E:\FR\FM\21NOR2.SGM 21NOR2 83538 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES unregistered offerings market has expanded significantly in the past twenty-five years. The growth of angel investors and VCs, who invest primarily through unregistered offerings, has also increased seed capital available for investment at the initial stages of a company. Angel investments in 2015 amounted to approximately $25 billion, and the average angel deal size was approximately $346,000.473 According to PWC MoneyTree, in 2008, U.S. VCs made $1.5 billion of seed investments in 440 companies.474 This represents an average seed investment of $3.5 million per company. While the involvement of VCs at the seed stage has been increasing over the years, it is reported that some angel investments at the seed stage have included investments as large as $2.5 million per entity.475 Given these changes, amending the Rule 504 offering size from $1 million to $5 million would better comport with market trends that indicate demand for larger seed capital infusions. Four parallel developments may further change the regulatory landscape surrounding existing Rule 504. First, the use of current Rule 504 could be diminished by interstate crowdfunding offerings pursuant to Regulation Crowdfunding, which allows issuers to raise up to $1 million over a 12-month period with unlimited access to nonaccredited investors, permits general solicitation, and provides preemption from state regulation and exemption from Exchange Act reporting, subject to certain conditions. Second, at least 34 states and the District of Columbia have enacted and several other states are in the process of enacting their own crowdfunding exemptions where the maximum amount that can be raised in a 12-month period ranges from $250,000 to $4 million, depending on the state (up to $2 million for all but three states). The maximum offering amounts for 473 According to a recent report, angel investments amounted to $24.6 billion in 2015, with approximately 71,100 entrepreneurial ventures receiving angel funding and approximately 304,930 active angel investors. Seed/startup stage investments accounted for approximately 28% of the $24.6 billion. See Jeffrey Sohl, The Angel Investor Market in 2015: A Buyer’s Market, Center for Venture Research, May 25, 2015, available at https://paulcollege.unh.edu/sites/ paulcollege.unh.edu/files/webform/ Full%20Year%202015%20Analysis%20Report.pdf. 474 See PricewaterhouseCoopers, Investment by Stage of Development, available at https:// www.pwcmoneytree.com/CurrentQuarter/BySoD. 475 See Fenwick & West Survey 2012 (March 2013), available at https://www.fenwick.com/ publications/Pages/Seed-Finance-Survey2012.aspx. The survey defines a ‘‘seed’’ financing as the first round of financing by a company in which the company raises between $250,000 and $2,500,000 and in which professional investors play a lead role. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 intrastate crowdfunding thus exceed the current offer limit under Rule 504. While most state crowdfunding exemptions require use of Rule 147, currently three states allow issuers to conduct intrastate crowdfunding under the Rule 504 exemption.476 Third, state regulators have been working to implement regional coordinated review programs in order to facilitate regional offerings that could potentially save issuers time and money. Additionally, at least one state is in the process of enacting reciprocal crowdfunding provisions, which may allow issuers to conduct regional crowdfunding offerings under state law.477 Since amended Rule 147 and new Rule 147A will be restricted to intrastate offerings, Rule 504 will be the most likely federal exemption that could be used for such regional offerings. Fourth, Tier 1 of amended Regulation A, which became effective in June 2015 and has similar eligibility criteria as Rule 504, allows offerings up to $20 million without any restrictions on resale of securities. In light of these developments, the increase in the maximum amount that can be raised in Rule 504 offerings to $5 million could help make this market more attractive for startups and small businesses while also facilitating intrastate and regional offerings greater than $1 million. A higher offering amount limit for Rule 504 offerings could increase the number of issuers that rely on the exemption.478 To the extent that amended Rule 504 permits issuers to raise larger amounts of capital at lower costs than other unregistered capital markets, the final rules could also lower issuer cost of capital and facilitate intrastate crowdfunding and the regional offerings market as it evolves. In addition to new issuers raising capital for the first time, it is likely that some issuers currently using other unregistered capital markets may shift to the amended Rule 504 market. Such potential trends would increase competition for supply of and demand for capital between the different unregistered markets, especially the exemptions pursuant to amended Rule 476 Maine’s provisions currently permit interstate crowdfunding utilizing the Rule 504 exemption, and Mississippi and Vermont dually offer intrastate crowdfunding under Section 3(a)(11) and interstate crowdfunding under Rule 504. See NASAA Letter. 477 See https://www.nasaa.org/industry-resources/ corporation-finance/coordinated-review/. See also, the ‘‘Reciprocal Crowdfunding Exemption’’ proposed by the Massachusetts Securities Division, available at https://www.sec.state.ma.us/sct/ crowdfundingreg/ Reciprocal%20Crowdfunding%20Exemption%20%20MA.PDF. 478 See CFA Letter, CFIRA Letter, NASAA Letter. PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 147, Rule 147A, Rule 506 of Regulation D, Regulation A, Regulation Crowdfunding, and Sections 4(a)(2) and 3(a)(11). Further, modernizing our exemptive scheme in order to provide issuers, and especially small businesses, with more viable options for capital raising could foster an environment that encourages new market participants with promising ventures to enter the capital markets, thereby enhancing the overall level of capital formation in the economy and investment opportunities. The amendments could also encourage new interstate and regional approaches to crowdfunding and other offering methods 479 and lead to greater coordination for regional review of capital raising options. Increasing the Rule 504 offering amount limit could also increase the number of investors (including nonaccredited investors) that can access such exempt offerings, thereby providing them with a wider array of investment opportunities to diversify their investment portfolios. This, in turn, could have positive effects on the supply of capital and the allocative efficiency of unregistered capital markets. To the extent that nonaccredited investors are less capable of evaluating investment opportunities than accredited investors,480 an increase in the number of Rule 504 offerings could raise investor protection concerns. A higher offering amount limit, together with a potential increase in the number of investors that can access Rule 504 offerings, may raise concerns about a potential increase in the incidence of fraud under the final rules. The Commission’s experience with the elimination of the prohibition against general solicitation for Rule 504 offerings in 1992 481 and its subsequent reinstatement in 1999 as a result of heightened fraudulent activity 482 illustrates the potential for fraud in the Rule 504 market. It should be noted, however, that in 1998 and 1999 the Commission concluded that the increase in fraud occurred because of rule provisions that permitted general solicitation of investors and free 479 Id. 480 See Staff of the U.S. Securities and Exchange Commission, Report on the Review of the Definition of ‘‘Accredited Investor’’ (Dec. 18, 2015) at 43–46 available at https://www.sec.gov/corpfin/ reportspubs/special-studies/review-definition-ofaccredited-investor-12–18–2015.pdf (describing criticisms of the current definition of accredited investor). 481 See Adoption of Small Business Initiatives, SEC Release No. 33–6949 (July 30, 1992). 482 See Seed Capital Release. E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES transferability of issued securities.483 As a result, under that regime, a nonreporting company was able to sell up to $1 million of unrestricted securities in a 12-month period and be subject only to the antifraud and civil liability provisions of the federal securities laws. In contrast, the final rules will only increase the aggregate offering amount limitation of Rule 504, thereby retaining existing restrictions on general solicitation and the restricted securities status of most offered securities. State registration requirements may also mitigate the risk for investor abuse in Rule 504 offerings. Enforcement cases over the past several years involving Rule 504 offerings could also raise concerns about the potential for increased incidence of fraud under the final rules. Most of these cases have involved promoters who engaged in secondary market sales of unrestricted securities that were previously issued in reliance on Rule 504(b)(1)(iii), defrauding investors and, in some cases, unsophisticated issuers.484 Securities issued in reliance on Rule 504(b)(1)(iii) are exempt from state registration, and issuers relying on the exemption are permitted to market the securities using general solicitation so long as sales are made only to accredited investors.485 We recognize 483 Id. See also Proposed Revision of Rule 504 of Regulation D, the ‘‘Seed Capital’’ Exemption, No. 33–7541 (May 21, 1998). As the Commission noted at the time it proposed to eliminate the unrestricted status of securities issued under Rule 504, securities issued in these Rule 504 offerings may have facilitated a number of fraudulent secondary transactions in the over-the-counter markets. The Commission also noted that these securities were issued by ‘‘microcap’’ companies, characterized by thin capitalization, low share prices and little or no analyst coverage. As the freely-tradable nature of the securities facilitated the fraudulent secondary transactions, the Commission proposed to ‘‘implement the same resale restrictions on securities issued in a Rule 504 transaction as apply to transactions under the other Regulation D exemptions,’’ in addition to reinstating the prohibition against general solicitation. Although the Commission recognized that resale restrictions would have ‘‘some impact upon small businesses trying to raise ‘seed capital’ in bona fide transactions,’’ it believed at the time that such restrictions were necessary so that ‘‘unscrupulous stock promoters will be less likely to use Rule 504 as the source of the freely tradable securities they need to facilitate their fraudulent activities in the secondary markets.’’ 484 See, e.g., SEC v. Stephen Czarnik, Case No. 10cv-745 (S.D.N.Y.), Litigation Release No. 21401 (Feb. 2, 2010); SEC v. Yossef Kahlon, a/k/a Jossef Kahlon and TJ Management Group, LLC, Case No. 4:12-cv-517 (E. D. Tex.) (Aug. 14, 2012). 485 The extent to which general solicitation may be used in connection with an offering conducted in reliance on Rule 504(b)(1)(iii) will depend on the specific state exemption being relied upon. In this regard, the NASAA Model Accredited Investor Exemption specifies that only a tombstone ad may be used in making a general solicitation. See Model Accredited Investor Exemption, available from the NASAA Web site at https://www.nasaa.org/wp- VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 that an increase in the maximum offering size could increase the risk of investor harm, at least in offerings that are exempt from state registration. Some of these concerns could be mitigated by the inclusion of bad actor disqualification provisions in Rule 504, as discussed below. b. Bad Actor Disqualification Provisions and Additional Amendments The amendments to Rule 504 will include bad actor disqualification provisions that are substantially similar to related provisions in Rule 506 of Regulation D. 486 Consistent with Rule 506(d), the final rules will require that the covered person’s status be assessed at the time of the sale of securities. As in Rule 506(d), the disqualification provisions will not preclude the participation of bad actors whose disqualifying events occurred prior to the effective date of the final rules, which could expose investors to risks that arise when bad actors are associated with an offering. However, similar to Rule 506(e), issuers will be required to disclose bad actor disqualifying events that occurred prior to the effectiveness of the final rules. The risks to investors from participation of covered persons who otherwise would be disqualified may therefore be partly mitigated as investors will have access to relevant information that could inform their investment decisions. Disclosure of prior bad actor disqualifying events may make it more difficult for issuers to attract investors, and as a result, issuers may experience a similar impact to being disqualified. Some Rule 504 issuers may accordingly choose to exclude involvement by prior bad actors to avoid such disclosures. We expect that the bad actor disqualification provisions could help reduce the potential for fraud in these types of offerings and thus strengthen investor protection.487 If disqualification standards lower the risk premium associated with the risk of fraud due to the presence of bad actors in securities offerings, they could also reduce the cost of capital for issuers that rely on the amended Rule 504 exemption. In addition, the requirement that issuers determine whether any covered persons are subject to disqualification might reduce the need for investors to conduct their own due diligence on such persons and could therefore increase efficiency. While content/uploads/2011/07/24-Model_Accredited_ Investor_Exemption.pdf. 486 See Rule 506(d) of Regulation D, 17 CFR 230.506(d). 487 See also ABA Letter, CFA Letter. PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 83539 fraud can still occur without prior incidence of disqualification on the part of the issuer or covered persons, these provisions could mitigate some of the concerns relating to incidence of fraud in offerings pursuant to amended Rule 504, including offerings subject to regional coordinated review programs that could be registered in one jurisdiction but offered and sold in multiple other jurisdictions. The disqualification provisions could also impose costs on issuers and covered persons. Issuers that are disqualified from using amended Rule 504 may experience an increased cost of capital or a reduced availability of capital, which could have negative effects on capital formation. Similarly, other covered persons may experience reductions in revenue or market share (for market intermediaries) or demotion or termination of employment or other limitations on career advancement (for individuals) as a result of disqualification from Rule 504 offerings. In addition, issuers may incur costs and transactional delays related to seeking disqualification waivers from the Commission and replacing personnel or avoiding the participation of covered persons who are subject to disqualifying events. Issuers also might incur costs to restructure their share ownership to avoid beneficial ownership of 20% or more of the issuer’s outstanding voting equity securities by individuals subject to disqualification. The final rules will provide, by reference to Rule 506(d), a reasonable care exception, similar to other exemptions and safe harbors under Regulation D. A reasonable care exception could facilitate capital formation by encouraging issuers to proceed with Rule 504 offerings in situations in which issuers otherwise might have been deterred from relying on Rule 504 if they risked potential liability under Section 5 of the Securities Act for unknown disqualifying events. At the same time, this exception also could increase the potential for fraud, compared with an alternative of not providing a reasonable care exception, by limiting issuers’ incentives to determine whether bad actors are involved with their offerings. We also recognize that some issuers might incur costs associated with conducting and documenting their factual inquiry into possible disqualifications. The rule’s flexibility with respect to the nature and extent of the factual inquiry required could allow an issuer to tailor its factual inquiry as appropriate to its particular circumstances, thereby potentially limiting costs. Finally, we note that E:\FR\FM\21NOR2.SGM 21NOR2 83540 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations extending the disqualification provisions to Rule 504 will create a more consistent regulatory regime under Regulation D that will simplify due diligence requirements and thereby benefit issuers and investors that participate in different types of exempt offerings.488 The amendment to Rule 504(b)(2) will update the current illustrations of how the aggregate offering limitation is calculated in the event that an issuer sells securities in multiple offerings pursuant to Rule 504 within the same twelve-month period. By enabling market participants to calculate more easily the amounts permitted to be sold, this amendment will facilitate issuer compliance with the increased aggregate offering limitation. asabaliauskas on DSK3SPTVN1PROD with RULES c. Alternatives Considered As an alternative to the final rules, we considered raising the offering limit under Rule 504 to an amount less than $5 million. For example, adjusted for inflation, the $1 million in 1988 would equate to approximately $2 million today.489 Additionally, offering amount limits under various state crowdfunding provisions generally are set around $2 million for most jurisdictions, with $4 million being the highest offering limit in one state. Increasing the maximum Rule 504 offering to an amount less than $5 million could help alleviate concerns about a decrease in investor protection from unlimited access to non-accredited investors. At the same time, this alternative could limit the use of Rule 504 as a capital raising option for issuers. We also considered increasing the maximum offering limit under amended Rule 504 to an amount greater than $5 million. For example, we could align the maximum offering limit to that of the Tier 1 offer limit ($20 million) under amended Regulation A. This could allow for more cost-effective state registration, while also providing a competitive alternative to eligible issuers in Tier 1 of the Regulation A market. However, unlike the Regulation A market, non-accredited investors have no investment limits under the Rule 504 provisions. Moreover, enforcement cases over the past several years have highlighted instances of fraud in Rule 504(b)(1)(iii) offerings.490 A higher maximum offering amount may thus 488 See NASAA Letter. 489 Annual inflation rates (1988–2015) based on consumer price index data, for all urban consumers, obtained from the Bureau of Labor Statistics. See https://data.bls.gov/cgi-bin/surveymost?cu. 490 See note 484 and related discussion above. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 lead to greater investor protection concerns. In light of concerns about potential abuses involving securities issued in reliance on Rule 504(b)(1)(iii),491 we considered, as an alternative, to impose resale restrictions on such securities. This could increase investor protection by helping to ensure that securities initially sold pursuant to the exemption are only resold by initial purchasers after the passage of a specified time period. However, these restrictions would reduce the liquidity of Rule 504(b)(1)(iii) securities, which could increase the cost of capital for issuers seeking to raise capital in reliance on this rule provision. At the same time, increasing investor protection through resale restrictions could attract somewhat greater investor interest and lower the expected risk premium, which would mitigate, to some extent, the higher costs arising from less liquid securities. We note that states are free to enact additional restrictions in such offerings if they deem them necessary or appropriate. Additionally, Rule 504 could be amended to include additional mandatory disclosures, or other requirements, to address investor protection concerns arising from the increase in the maximum offering size. While such additional requirements could mitigate some of these concerns, they would also increase the compliance obligations for Rule 504 issuers and may also overlap with similar requirements under state law in the jurisdiction in which such Rule 504 offering is registered. 4. Analysis of Repeal of Rule 505 The final rules also eliminate the exemption under Rule 505 of Regulation D. Rule 505, like Rule 504, was created under Section 3(b)(1) of the Securities Act to exempt offerings of up to $5 million over a 12-month period. As discussed in the baseline analysis, reliance on Rule 505 is much less frequent than even Rule 504 and has declined steadily in the past 15–20 years in terms of the number of new offerings and the amount of capital raised.492 We believe that amended Rule 504, by allowing offerings up to $5 million, will 491 Id. 492 During the period 2009–2015, there were 1,588 new offerings of less than or equal to $5 million by non-fund issuers that relied on Rule 505 compared to 64,862 such offerings that relied on Rule 506. Including offerings in which the issuer checked both the Rule 505 and Rule 506 exemptions on the Form D (2,170 new offerings), the proportion of Rule 505 offerings in Regulation D offerings rises from 2% to 5.3%. See Section V.A.2 and Table 5. PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 likely further diminish the utility of current Rule 505 for issuers that are currently eligible to use both exemptions because Rule 504 provides access to an unlimited number of nonaccredited investors and restricted access to general solicitation.493 Other exemptions from registration may also provide an alternative to Rule 505 offerings. For example, Rule 506(b) enables issuers to raise unlimited amounts of capital along with providing preemption from state registration, although being limited to 35 nonaccredited investors who need to be sophisticated, either individually or through a purchaser representative. Similarly, while Regulation A offerings have greater disclosure requirements, they may be sold to non-accredited investors and have the added benefit of unrestricted resales of securities. We recognize that reporting companies that are potential Rule 505 issuers may find it relatively harder to shift to another type of unregistered offering as they are excluded from using Rule 504, Regulation A and Regulation Crowdfunding. Such issuers, however, constitute a small proportion of current Rule 505 issuers and, absent disqualifying bad actor events, could likely avail themselves of Rule 506. Alternatively, Rule 505 issuers, particularly those that are reporting companies, could also raise capital through a registered offering if they seek investment from non-accredited investors and investors who prefer securities issued through registered offerings. In view of recent changes to Form S–1 494 and the availability of shelf registration to eligible reporting issuers, the costs of raising capital through a registered offering for issuers that are reporting companies, may be comparable to costs of a Rule 505 offering that solicits non-accredited investors and requires registration under state regulations. Whether Rule 505 issuers, particularly those that are reporting companies, switch to an unregistered offering such as a Rule 506 offering or a registered offering will depend on how these issuers assess the costs of registration relative to benefits such as broader access to non-accredited investors and investors who prefer securities issued through registered offerings.495 The impact of the elimination of Rule 505 will depend on whether issuers are 493 Unlike offerings conducted pursuant to Rule 506, Rule 504 and Rule 505 offerings are subject to state securities law registration and qualification requirements. 494 See note 435 above. 495 See discussion in Section V(B)(1) and note 436. E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations able to access alternate capital markets and raise the desired amount of capital at a comparable cost and in a timely manner, as they would in the current Rule 505 market. To the extent that issuers are not able to raise sufficient or any amount of capital in such alternate markets, overall capital formation in the economy and allocative efficiency of capital markets could decline. We believe that Rule 505 issuers likely will be able to shift to other exemptions or alternately to follow-on registered offerings in case of issuers that are reporting companies, at little or no additional cost. In the short term, the repeal likely will increase competition amongst markets for attracting potential Rule 505 issuers and investors, but in the long-run, it may decrease the overall level of competition amongst the various capital markets to attract new issuers and investors. As discussed above, the impact on efficiency, competition and capital formation of the repeal of Rule 505 also will depend on investor willingness and ability to purchase in an alternate unregistered capital market. For example, unsophisticated investors that may be eligible to purchase in a Rule 505 offering may not be able to purchase in a Rule 506 offering and hence may find their set of investment opportunities reduced. Further, as Rule 506 offerings are preempted from state registration, potential Rule 505 investors may be reluctant to purchase in a Rule 506 offering once Rule 505 is repealed, due to investor protection concerns. Similarly, Rule 504 offerings are subject to fewer investor disclosure requirements at the federal level, relative to a Rule 505 offering, that could also raise potential investor protection concerns. The net impact on the overall level of investor participation could thus depend on the type of offering that primarily substitutes for the repealed Rule 505 market. Overall, we believe that the repeal of Rule 505 will not have a significant impact or any impact on capital formation because issuers will likely be successful at finding commensurate capital supply in an alternate unregistered capital market. Repeal of Rule 505 will streamline the existing exemptive framework to provide a clearer and less complex set of rules and regulations for the issuer to choose among. As an alternative to the repeal of Rule 505, we considered increasing the maximum amount that can be raised over a period of 12 months to a higher amount. For example, adjusting for inflation, $5 million in 1988 would VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 equate to approximately $10 million today. Retention of Rule 505 with a higher offering limit would allow issuers (in contrast to Rule 506) to access to up to 35 non-accredited investors without having to ensure that these investors are sophisticated investors. It would also allow reporting companies (in contrast to Rule 504) to avail themselves of the exemption for raising capital. However, we believe that in view of the widespread use of Rule 506 and the decreased use of Rule 505 in capital formation in the Regulation D market, a higher ceiling is not likely to increase reliance on the exemption. VI. Paperwork Reduction Act A. Rules 147(f)(1)(iii) and 147A(f)(1)(iii) Rule 147 and new Rule 147A contain ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act of 1995 (‘‘PRA’’).496 Specifically, Rules 147(f)(1)(iii) and 147A(f)(1)(iii) each contain a provision requiring issuers relying on the rules to ‘‘obtain a written representation from each purchaser as to his or her residence.’’ There are two titles for these collection of information requirements. The first title is: ‘‘Rule 147(f)(1)(iii) Written Representation as to Purchaser Residency,’’ a new collection of information. The second title is: ‘‘Rule 147A(f)(1)(iii) Written Representation as to Purchaser Residency,’’ a new collection of information. We are requesting comment on these collection of information requirements in this adopting release, and intend to submit these requirements to the Office of Management and Budget (‘‘OMB’’) for review in accordance with the PRA and its implementing regulations.497 If approved, responses to the new collection of information requirement would be mandatory for issuers seeking to rely upon the rules to conduct exempt intrastate offerings. An agency may not sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. In the Proposing Release, we solicited comment on our proposal to eliminate the requirement in Rule 147(f)(1)(iii) to obtain a written representation as to the 496 44 U.S.C. 3501 et seq. the Proposing Release, we did not submit a PRA analysis because we proposed to eliminate the written representation requirement in Rule 147(f)(1)(iii), and our other proposed amendments to Rule 147 did not contain a ‘‘collection of information’’ requirement within the meaning of the PRA. At this time, we do not have any comments regarding overall burden estimates for the final rules. This release is requesting such comments. 497 In PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 83541 purchaser’s residency. In response to comments received, we have decided not to eliminate the requirement and are adopting an identical requirement in new Rule 147A(f)(1)(iii) under the Securities Act.498 Both Rule 147(f)(1)(iii) and new Rule 147A(f)(1)(iii) will require the issuer to obtain from the purchaser a written representation as to the purchaser’s residency. The representation is not required to be presented in any particular format, although it must be in writing. Representations obtained by the issuer are not required to be kept confidential, and there is no mandatory retention period. The hours and costs to the issuer and purchaser associated with preparing, furnishing, obtaining and collecting these written representations constitute paperwork burdens and costs imposed by these collection of information requirements. The required written representation by the purchaser as to his or her residence is identical under both Rule 147(f)(1)(iii) and new Rule 147A(f)(1)(iii). Similarly, both rules define the residence of the purchaser in the same manner. If the purchaser is a corporation, partnership, limited liability company, trust or another form of business organization, it shall be deemed to be a resident of the territory or state if, at the time of the offer and sale to it, it has its principal place of business within such territory or state. Principal place of business is defined as the territory or state in which the officers, partners or managers of the entity primarily direct, control and coordinate the activities of the entity. If the purchaser is an individual, such person shall be deemed to be a resident of the territory or state if such person has, at the time of the offer and sale, his or her principal residence in the territory or state.499 We expect that the determination of a purchaser’s residence will be easiest for natural persons.500 This determination may be more difficult for purchasers who have more than one place of residence. We also expect this determination to be more difficult for purchasers who are legal entities, such as corporations, partnerships, limited liability companies and trusts which will have to undertake a factual inquiry to determine in what state or territory their ‘‘principal place of business’’ is located. We anticipate that the requirement for issuers to obtain a written 498 See text accompanying notes 119, 120, and 121 above. 499 See Rules 147(d) and 147A(d). 500 See Section II.B.2(c) above. E:\FR\FM\21NOR2.SGM 21NOR2 83542 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES representation from each purchaser as to his or her residence, as required under Rule 147(f)(1)(iii) and Rule 147A(f)(1)(iii), will result in a burden and cost to issuers to meet these requirements in order to sell securities in an exempt intrastate offering. For purposes of the PRA, for each of Rule 147 and Rule 147A, we estimate that the total annual paperwork burden for all affected issuers arising from this collection of information requirement will be approximately 175 hours of issuer (company) personnel time and approximately $70,000 for the services of outside professionals at an average cost of $400 per hour. Similarly, we anticipate that the written representation required by purchasers, including the obligation to determinate the state or territory of their residence, as required under Rule 147(f)(1)(iii) and Rule 147A(f)(1)(iii), will result in a burden incurred by purchasers in order to purchase securities in an exempt intrastate offering. For purposes of the PRA, for each of Rule 147 and Rule 147A, we estimate that the total annual paperwork burden for all affected purchasers arising from this collection of information requirements will be approximately 1,750 hours of purchaser time and no cost incurred for the services of outside professionals. In deriving our estimates, we assume that: • Approximately 700 issuers 501 will conduct a Rule 147 and Rule 147A offering each year, respectively, and each issuer will spend an average of fifteen minutes to obtain and collect the written representation from each purchaser in the offering as to his or her state or territory of residence; • Each of the approximately 700 issuers will retain outside professional firms to spend an average of fifteen minutes helping the issuer comply with this requirement to obtain and collect the written statement of residency from each purchaser in the offering at an average cost of $400 per hour; • Each Rule 147 and Rule 147A offering will have an average of approximately 10 purchasers of securities, resulting in approximately 501 We rely upon the number of offerings under Rules 504 and 505 of Regulation D for the year ended December 31, 2015 as a proxy for the average annual number of offerings under Rule 147 and new Rule 147A. Based on staff analysis of Form D filings, there were 519 new Form D filings reporting reliance on Rule 504 and 179 new Form D filings reporting reliance on Rule 505 in 2015. See Figure 1 in Section V.A.1, above. For purposes of these PRA estimates, we estimate that an average of 700 issuers will conduct a Rule 147 and new Rule 147A offering each year, respectively. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 7,000 purchasers per year for each exemption; and • Each purchaser in a Rule 147 and Rule 147A offering will spend an average of approximately fifteen minutes preparing a written statement of residency to provide to the issuer and will incur no cost for the services of outside professionals to satisfy this requirement. Since Rule 147 does not require the issuer to file any type of notice form with the Commission, it is difficult to determine accurately the number of Rule 147 offerings conducted annually or estimate the annual number of offerings that will be made in reliance on the updated rule and the new Rule 147A exemption. As a result, we are using the number of offerings made in reliance on the exemptions in Rules 504 and 505 of Regulation D for the year ended December 31, 2015 as a proxy to estimate the average annual number of Rule 147 offerings, given that both Rule 147 and Rules 504 and 505 provide exemptions to Securities Act registration designed to facilitate smaller issuers raising seed capital. Given that Rule 147A is very similar to Rule 147, as amended, we are using this same methodology and estimate for the number of offerings under newly adopted Rule 147A. It is also difficult to provide any standardized estimates of the burdens and costs involved for the issuer to obtain and collect these written statements of purchaser residency. We expect, however, that the burdens and costs to issuers may be higher or lower depending on the size of the offering and the number of purchasers acquiring securities in the offering, which may, in turn, be affected by the state or territory where the offering occurs. These estimates include the time and cost to the issuer to implement a system to obtain and collect the written statements of residency by purchasers in their offerings, including the preparation of written materials, such as subscription agreements or questionnaires to potential purchasers. These estimates also include the time and cost incurred by an issuer’s inhouse and outside counsel and executive officers of collecting these written statements received from purchasers in their offerings. In deriving our estimates, we recognize that these burdens and costs will likely vary among issuers based on the size of their offerings and the number of purchasers acquiring securities in their offerings. We believe that some issuers will experience burdens and costs in excess of these estimated averages and other issuers PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 may experience less than these estimated average burdens and costs. Similarly, it is difficult to provide any standardized estimates of the burdens and costs to purchasers in determining their state or territory of residence and preparing their related written statements of residency to the issuer. We expect, however, that the burden to purchasers may be higher or lower depending on whether the purchaser is a natural person or legal entity, and, if a legal entity, the extent of the entity’s activities in other states or territories. If a legal entity, we realize there may be a wide range of management structures, involving management teams potentially residing in multiple states or territories, thereby complicating the determination of the purchaser’s principal place of business. These estimates include the time and cost to the purchaser to determine the purchaser’s state or territory of residence and prepare a written statement of residency for the issuer. In the case of purchasers who are legal entities, these estimates also include the time and cost incurred by purchasers’ in-house counsel and executive officers to undertake a factual inquiry to determine the state or territory of the purchaser’s principal place of business. In deriving our estimates, we recognize that the burdens and costs will likely vary between natural person and legal entity purchasers. In the case of purchasers who are legal entities, these burdens and costs will be based on a number of factors, including the location and structure of their management teams. We believe that some natural person and legal entity purchasers will experience burdens and costs in excess of our estimated averages, and that others may experience burdens and costs less than our estimated averages. Request for Comment We request comment on our approach and the accuracy of the current estimates. Pursuant to 44 U.S.C. 3506(c)(2)(A), the Commission solicits comments to: (1) Evaluate whether the collections of information are necessary for the proper performance of the functions of the agency, including whether the information will have practical utility; (2) evaluate the accuracy of the Commission’s estimate of the burden of the collections of information; (3) determine whether there are ways to enhance the quality, utility and clarity of the information to be collected; and (4) evaluate whether there are ways to minimize the burden of the collections of information on those who are required to respond, E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations including through the use of automated collection techniques or other forms of information technology. Persons submitting comments on the collection of information requirements should direct the comments to the Commission by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/final.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number S7– 22–15 on the subject line; or • Use the Federal eRulemaking Portal (https://www.regulations.gov). Follow the instructions for submitting comments. Paper Comments • Send paper comments to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. Comments should be received on or before: January 20, 2017. Comments submitted in response to this document will be summarized and/or included in the request for OMB approval of this information collection; they also will become a matter of public record. B. Amendments to Rule 504 of Regulation D The amendments to Rule 504 of Regulation D contain ‘‘collection of information’’ requirements within the meaning of the PRA. There are two titles for the collection of information requirements contemplated by the amendments. The first title is: ‘‘Form D’’ (OMB Control No. 3235–0076), an existing collection of information.502 The second title is: ‘‘Regulation D Rule 504(b)(3) Felons and Other Bad Actors Disclosure Statement,’’ (OMB Control No. 3235–0746), a new collection of information. Although the amendments to Rule 504 do not alter the information requirements set forth in Form D, the amendments are expected to increase the number of new Form D filings made pursuant to Regulation D. Additionally, the mandatory bad actor disclosure provisions that will be required under Rule 504 contain ‘‘collection of information’’ requirements within the meaning of the PRA. We published a notice requesting comment on these collection of information requirements in the Proposing Release, and we submitted the proposed amendments to the Office of Management and Budget (‘‘OMB’’) for review and approval in accordance with the PRA and its implementing regulations.503 While several commenters provided qualitative comments on the possible costs of the proposed amendments, we did not receive comments on our PRA analysis and thus are adopting our estimates substantially as proposed, except as otherwise noted herein. The information collection requirements related to the filing of Form D with the Commission are mandatory to the extent that an issuer elects to make an offering of securities in reliance on the relevant exemption. Responses are not confidential, and there is no mandatory retention period for the information disclosed. The hours and costs associated with preparing and filing forms and retaining records constitute reporting and cost burdens imposed by the collection of information requirements. We applied for an OMB control number for the proposed new collection of information in accordance with 44 U.S.C. 3507(j) and 5 CFR 1320.13, and OMB assigned a control number to the new collection, as specified above. Responses to the new collection of information will be mandatory for issuers raising capital under Rule 504 of Regulation D. Form D (OMB Control No. 3235–0076) The Form D filing is required for issuers as a notice of sales without registration under the Securities Act based on a claim of exemption under 83543 Regulation D or Section 4(a)(5) of the Securities Act. The Form D must include basic information about the issuer, certain related persons, and the offering. This information is used by the Commission to observe use of the Regulation D exemptions and safe harbor. As the amendments are not altering the information requirements of Form D, the amendments will not affect the paperwork burden of the form, and the burden for responding to the collection of information in Form D will be the same as before the amendments to Form D. However, we estimate that the amendments to increase the aggregate amount of securities that may be offered and sold in any 12-month period in reliance on Rule 504 will increase the number of Form D filings that are made with the Commission. We do not believe this increase will be materially offset by a decrease in the number of Form D filings that are made with the Commission attributable to our repeal of Rule 505 of Regulation D. The table below shows the current total annual compliance burden, in hours and in costs, of the collection of information pursuant to Form D. For purposes of the PRA, we estimate that, over a three-year period, the average burden estimate will be four hours per Form D. Our burden estimate represents the average burden for all issuers. This burden is reflected as a one hour burden of preparation on the company and a cost of $1,200 per filing. In deriving these estimates, we assume that 25% of the burden of preparation is carried by the issuer internally and that 75% of the burden of preparation is carried by outside professionals retained by the issuer at an average cost of $400 per hour. The portion of the burden carried by outside professionals is reflected as a cost, while the portion of the burden carried by the issuer internally is reflected in hours. TABLE 1—ESTIMATED PAPERWORK BURDEN UNDER FORM D, PRE-AMENDMENT TO RULE 504 Number of responses asabaliauskas on DSK3SPTVN1PROD with RULES Total burden hours Internal issuer time External professional time Professional costs (A) 504 Form D ......................................... Burden hours/form (B) (C) = (A)*(B) (D) (E) (F) = (E)*$400 25,900 4 103,600 25,900 77,700 $31,080,000 502 Form D was adopted pursuant to Sections 2(a)(15), 3(b), 4(a)(2), 19(a) and 19(c)(3) of the Securities Act, 15 U.S.C. 77b(a)(15), 77c(b), 77d(a)(2), 77s(a) and 77s(c)(3). 503 44 U.S.C. 3507(d); 5 CFR 1320.11. VerDate Sep<11>2014 21:14 Nov 18, 2016 Jkt 241001 504 Although the number of responses for Form D is reported as 21,824 in the OMB’s Inventory of Currently Approved Information Collections, available at https://www.reginfo.gov/public/do/PRA Main;jsessionid=D37174B5F6F9148DB767D63DF 6983A65, we have prepared a new estimate based on the historical trend of the annual number of new PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 Form D filings. Based on an average increase of approximately 1,515 new Form D filings per year over the past six years, we believe that the average number of new Form D filings in each of the next three years will be approximately 25,884, or 25,900 rounded to the nearest hundredth. E:\FR\FM\21NOR2.SGM 21NOR2 83544 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations For the year ended 2015, there were 22,854 new Form D filings. The annual number of new Form D filings rose from 13,764 in 2009 to 22,854 in 2015, an average increase of approximately 1,515 Form D filings per year, or approximately 9%. Assuming the number of Form D filings continues to increase by 1,515 filings per year for each of the next three years, the average number of Form D filings in each of the next three years would be approximately 25,900. We estimate that the amendments to Rule 504 will result in a much smaller annual increase in the number of new Form D filings than the average annual increase that has occurred over the past six years. To estimate how the amendments to Rule 504 will impact the number of new Form D filings, we used as a reference point the impact of a past rule change on the market for Regulation D offerings. In 1997, the Commission amended Rule 144(d) under the Securities Act 505 to reduce the holding period for restricted securities from two years to one year,506 thereby increasing the attractiveness of Regulation D offerings to investors and to issuers. Prior to amending Rule 144(d), there were 10,341 Form D filings in 1996, which was followed by a 20% increase in the number of Form D filings in each of the subsequent three calendar years, reaching 17,830 by 1999. Although it is not possible to predict with any degree of certainty the increase in the number of Rule 504 offerings following the amendments, we estimate for purposes of the PRA that there will be a similar 20% increase over the number of new Form D offerings that relied on either Rule 504 or 505 in 2015 after the amendments become effective.507 In 2015, there were 519 new Form D filings reporting reliance on Rule 504 and 179 new Form D filings reporting reliance on Rule 505.508 We estimate that there will be approximately 100 new Form D filings in each of the next three years attributable to the amendments.509 Based on these increases, we estimate that the total annual compliance burden of the collection of information requirements for issuers making Form D filings after amending Rule 504 to increase the aggregate offering amount from $1 million to $5 million will be 26,000 hours of issuer personnel time and $31,200,000 for the services of outside professionals. TABLE 2—ESTIMATED PAPERWORK BURDEN UNDER FORM D, POST-AMENDMENT TO RULE 504 Number of responses Burden hours/form Total burden hours Internal issuer time External professional time Professional costs (A) 510 (B) (C) = (A)*(B) (D) (E) (F) = (E) * $400 26,000 4 104,000 26,000 78,000 $31,200,000 Form D ..................................................... Regulation D Rule 504(b)(3) Felons and Other Bad Actors Disclosure Statement (OMB Control No. 3235–0746) Under the amendments, Rule 504 will disqualify issuers from reliance on Rule 504 if such issuer would be subject to disqualification under Rule 506(d) of Regulation D.511 Consistent with the requirements of Rule 506(e), the amendments require the issuer in a Rule 504 offering to furnish to each purchaser, a reasonable time prior to sale, a written description of any disqualifying events that occurred before effectiveness of the amendments and within the time periods described in the list of disqualification events set forth in Rule 506(d)(1) of Regulation D,512 for the issuer or any other 505 17 CFR 230.144(d). SEC Rel. No. 33–7390 (Feb. 20, 1997) [62 FR 9242]. 507 We include the number of new Form D filings that rely on Rule 505 in these estimates since we are repealing Rule 505, which has provided an alternative Regulation D exemption available for both non-reporting and reporting issuers under the Exchange Act. Rule 505 has a maximum offering limitation of no more than $5 million in a twelve month period. We believe that issuers who are nonreporting under the Exchange Act that have previously relied upon Rule 505 will rely upon Rule 504 upon effectiveness of the amendments, which will raise the maximum offering limitation under Rule 504 from $1 million to $5 million. Reporting issuers under the Exchange Act, who would have otherwise relied upon Rule 505, will now have to rely upon Rule 506 of Regulation D, asabaliauskas on DSK3SPTVN1PROD with RULES 506 See VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 ‘‘covered person’’ associated with the offering. For purposes of the mandatory disclosure provision described in the note to Rule 504(b)(3),513 issuers will be required to ascertain whether any disclosures are required in respect of covered persons involved in their offerings, prepare any required disclosures and furnish them to purchasers. The disclosure required to be furnished to investors does not involve submission of a form filed with the Commission and is not required to be presented in any particular format, although it must be in writing. The hours and costs associated with preparing and furnishing the required disclosure to investors in the offering constitute reporting and cost burdens imposed by the collection of information. The disclosure or paperwork burden imposed on issuers appears in an instruction to Rule 504(b)(3) and pertains to events that occurred before effectiveness of the final rules but which would have triggered disqualification had they occurred after effectiveness. Issuers relying on Rule 504 will be required to furnish disclosure of any relevant past events that would have triggered disqualification under Rule 504(b)(3) that relate to the issuer or any other covered person. If there are any such events, a disclosure statement will be required to be furnished, a reasonable time before sale, to all purchasers in the offering. The disclosure requirement will serve to protect purchasers by once the repeal of Rule 505 becomes effective, since Rule 504 is unavailable to reporting issuers. 508 Only 10 of the 179 new Form D filings that reported reliance on Rule 505 in 2015 were filed by reporting issuers under the Exchange Act. The remaining 169 new Form D filings were filed by non-reporting issuers. 509 We estimate the number of new Form D filings attributable to the amendments over the next three years, as follows: 698 new Form D filings in 2015 relying on either Rules 504 or 505, less 10 new Form D filings made by reporting issuers under Rule 505 in 2015, multiplied by 20%, equals 138. Rounding 138 to the nearest hundredth provides an estimate of 100 new Form D filings attributable to the amendments. 510 The information in this column is not based on the number of responses for Form D of 21,824, as reported in the OMB’s Inventory of Currently Approved Information Collections, but rather on a new estimate of the average number of new Form D filings in each of the next three years. We prepared this estimate based on the historical trend of the annual number of new Form D filings. See text accompanying note 503 above. Based on an average increase of approximately 1,515 new Form D filings per year over the past six years, we estimate that the number of new Form D filings after the amendment to Rule 504 would be the average number of new Form D filings we estimate in each of the next three years of 25,900, plus the additional 100 filings we estimate would be filed as a result of the amendment to Rule 504. 511 See Rule 504(b)(3); see also 17 CFR 230.506(d). 512 17 CFR 230.506(d)(1). 513 See Note to Rule 504(b)(3). PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations ensuring that they receive information about any covered persons that were subject to such disqualifying events. The disclosure requirement will not apply to triggering events occurring after the effective date of the amendments, because those events will result in disqualification from reliance on Rule 504 (absent a waiver or other exception provided in Rule 506(d)), rather than any disclosure obligation. The steps that issuers take to comply with the disclosure requirement are expected to mirror the steps they would take to determine whether they are disqualified from relying on Rule 504. For purposes of estimating burdens and costs, we have assumed that issuers planning or conducting a Rule 504 offering will undertake a factual inquiry to determine whether they are subject to any disqualification in order to utilize the reasonable care provisions set forth in Rule 506(d)(2)(iv). Disqualification and mandatory disclosure will be triggered by the same types of events in respect of the same covered persons, with disqualification arising from triggering events occurring after the adoption and effectiveness of the amendments and mandatory disclosure applicable to events occurring before that date. Therefore, we expect that the factual inquiry process for the disclosure statement requirement will impose a limited incremental burden on issuers. The burdens and costs may vary depending on the size of the issuer and the circumstances of the particular Rule 504 offering. We do not anticipate that it will generally be necessary for any issuer or any compensated solicitor to make inquiry of any covered individual with respect to ascertaining the existence of events that require disclosure more than once, because the period to be covered by the inquiry will end with the effective date of the new disqualification rules. However, issuers may incur additional burden and costs for each Rule 504 offering due to changes in management or intermediaries, other changes to the group of covered persons or if questions arise about the accuracy of previous responses. We anticipate that the Regulation D Rule 504(b)(3) Felons and Other Bad Actors Disclosure Statement will result in an incremental increase in the burdens and costs for issuers that rely on the Rule 504 exemption. For purposes of the PRA, we estimate the total annual increase in paperwork burden for all affected Rule 504 issuers to comply with our collection of information requirements will be approximately 880 hours of company VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 personnel time and approximately $9,600 for the services of outside professionals. These estimates include the incremental time and cost of conducting a factual inquiry to determine whether the Rule 504 issuers have any covered persons with past disqualifying events. The estimates also include the cost of preparing a disclosure statement that issuers will be required to furnish to each purchaser a reasonable time prior to sale. In deriving our estimates, consistent with those assumptions used in the PRA analysis for the Rule 506 bad actor disqualification provisions,514 we assume that: • Approximately 800 issuers 515 relying on Rule 504 of Regulation D will spend on average one additional hour to conduct a factual inquiry to determine whether any covered persons had a disqualifying event that occurred before the effective date of the amendments; and • On the basis of the factual inquiry, approximately eight issuers (or approximately 1%) will spend ten hours to prepare a disclosure statement describing matters that would have triggered disqualification under Rule 504(b)(3) of Regulation D had they occurred on or after the effective date of the amendments; and • For purposes of the Rule 504(b)(3) disclosure statement, approximately eight issuers will retain outside professional firms to spend three hours on disclosure preparation at an average cost of $400 per hour. The increase in burdens and costs associated with conducting a factual inquiry for the disclosure statement requirement should be minimal given that issuers are likely to conduct 514 See SEC Rel. No. 33–9414 (July 10, 2013). on staff analysis of Form D filings, there were 519 new Form D filings reporting reliance on Rule 504 and 179 new Form D filings reporting reliance on Rule 505 in 2015. See Figure 1 in Section V.A.1, above. Of the 179 new Form D filings reporting reliance on Rule 505 in 2015, 10 new Form D filings were made by reporting issuers under the Exchange Act and 169 new Form D filings were made by non-reporting issuers under the Exchange Act. For purposes of the PRA estimates, and based on the data provided for Rule 504 and Rule 505 offerings in 2015, we assume that approximately 800 issuers would file a Form D indicating reliance on Rule 504 after the effectiveness of the amendments to Rule 504 (calculated as follows: 519 new Rule 504 filings and 169 new Rule 505 filings by non-reporting issuers in 2015, rounded to the nearest hundredth, or 700 new Form D filings, plus 100 additional new Form D filings attributable to the amendments to Rule 504). This figure includes non-reporting issuers under the Exchange Act that, before adoption of amendments to Rule 504, would have conducted offerings pursuant to Rule 505, but that after adoption of the amendments to Rule 504 and repeal of Rule 505 will likely conduct their offerings pursuant to Rule 504. 515 Based PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 83545 simultaneously a similar factual inquiry for purposes of determining disqualification from Rule 504. It is difficult to provide any standardized estimates of the costs involved with the factual inquiry. There is no central repository that aggregates information from all federal and state courts and regulators that would be relevant in determining whether a covered person has a disqualifying event in his or her past. In this regard, we are currently unable to estimate the burdens and costs for issuers in a verifiable way. We expect, however, that the costs to issuers may be higher or lower depending on the size of the issuer and the number and roles of covered persons. We realize there may be a wide range of issuer sizes, management structures, and offering participants associated with Rule 504 offerings and that different issuers may develop a variety of different factual inquiry procedures. Where the issuer or any covered person will be subject to an event covered by Rule 504(b)(3) that existed before the effective date of these rules, the issuer will be required to prepare disclosure for each relevant Rule 504 offering. The estimates include the time and the cost of data gathering systems, the time and cost of preparing and reviewing disclosure by in-house and outside counsel and executive officers, and the time and cost of delivering or furnishing documents and retaining records. Issuers conducting ongoing or continuous offerings may need to update their factual inquiry and disclosure as necessary to address additional covered persons. The annual incremental paperwork burden, therefore, depends on an issuer’s Rule 504 offering activity and the changes in covered persons from offering to offering. For example, some issuers may only conduct one Rule 504 offering during a year while other issuers may have multiple, separate Rule 504 offerings during the course of the same year involving different financial intermediaries, newly hired executive officers or new 20% shareholders, any of which will result in a different group of covered persons. In deriving our estimates, we recognize that the burdens will likely vary among individual companies based on a number of factors, including the size and complexity of their organizations. We believe that some companies will experience costs in excess of this estimated average and other companies may experience less than the estimated average costs. E:\FR\FM\21NOR2.SGM 21NOR2 83546 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES VII. Final Regulatory Flexibility Act Analysis The Regulatory Flexibility Act (‘‘RFA’’) 516 requires the Commission, in promulgating rules under Section 553 of the Administrative Procedure Act,517 to consider the impact of those rules on small entities. The Commission has prepared this Final Regulatory Flexibility Analysis (‘‘FRFA’’) in accordance with Section 604 of the RFA.518 This FRFA relates to the amendments to Rules 147 and 504, new Rule 147A and the repeal of Rule 505, all of which rules are under the Securities Act. An Initial Regulatory Flexibility Analysis (IRFA) was prepared in accordance with the RFA and included in the Proposing Release. A. Need for the Rules The amendments to Rule 147 are designed to modernize the safe harbor, consistent with the Section 3(a)(11) exemption from registration for intrastate securities offerings. New Rule 147A, which will be similar to amended Rule 147 but will have no restriction on offers and will allow issuers to be incorporated or organized out-of-state, establishes a new Securities Act exemption for intrastate offerings of securities by local companies. Together, the amendments to Rule 147 and new Rule 147A are designed to facilitate capital formation by making it easier to engage in exempt intrastate offerings while maintaining appropriate protections for investors who purchase securities in these offerings. The amendments to Rule 504 are designed to facilitate capital formation by increasing the flexibility of state securities regulators to implement regional coordinated review programs that will facilitate regional offerings. The amendments to Rule 504 will raise the aggregate amount of securities an issuer may offer and sell in any 12month period from $1 million to $5 million and disqualify certain bad actors from participating in Rule 504 offerings. We believe that raising the aggregate offering limitation and disqualifying certain bad actors will maximize the flexibility of state securities regulators to implement regional coordinated review programs and provide for greater consistency across Regulation D. We believe our amendment to Rule 504 to increase its aggregate offering ceiling from $1 million to $5 million will significantly diminish the utility of Rule 505 of Regulation D, and we are therefore repealing that rule. 516 5 U.S.C. 601 et seq. U.S.C. 553. 518 5 U.S.C. 604. 517 5 VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 B. Significant Issues Raised by Public Comments In the Proposing Release, we requested comment on all aspects of the IRFA, including the number of small entities that would be affected by the proposed amendments, the existence or nature of the potential impact of the proposals on small entities discussed in the analysis, and how to quantify the impact of the proposed amendments. We did not receive any comments specifically addressing the IRFA. We did, however, receive comments from members of the public on matters that could potentially impact small entities. These comments are discussed at length by topic in the corresponding subsections of Sections II. and III. above. Many commenters recommended making changes to the proposed rules that, in their view, would make the exemptions a more viable capital raising option for smaller issuers. Numerous commenters supported 519 the proposal to eliminate the Rule 147 limitation on offers to in-state residents while continuing to require that all sales be made to in-state residents. However, many commenters also supported 520 and the 2015 Small Business Forum recommended 521 retaining Rule 147 as a safe harbor under Section 3(a)(11), while adopting a substantially similar new exemption pursuant to the Commission’s general exemptive authority under Section 28 as an alternative to the Section 3(a)(11) exemption for companies that are conducting an intrastate offering. Many commenters opposed any limits at the federal level on offering size or investment size,522 and the 2015 Small Business Forum recommended permitting the states to set their own limits as appropriate.523 In addition, 519 ABA Letter; City of Adrian Letter; Bishop Letter; Brelion Letter; CFA Letter; CFIRA Letter; CrowdCheck Letter; CrwdCorp Letter; Ely Letter; Guzik Letter; Love Letter; MacDougall Letter; Milken Letter; NASAA Letter; Newcomer Letter; NextSeed Letter; Pearl Letter; Terdal Letter; Wolff Letter; Zeoli Letter. See also Congressional Letter (expressing general support for the proposed amendments to Rule 147). 520 ABA Letter; City of Adrian Letter; Bishop Letter; California Bar Letter; CFIRA Letter; Congressional Letter; CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA Letter; NextSeed Letter; Pearl Letter; Wallin Letter; Orloff Letter; Zeoli Letter. No commenters supported eliminating Rule 147 as a safe harbor under Section 3(a)(11). 521 See 2015 Small Business Forum Recommendations. 522 ABA Letter; Campbell Letter; CFIRA Letter; Congressional Letter; CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA Letter; NextSeed Letter; WBA Letter. 523 See 2015 Small Business Forum Recommendations. PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 several commenters supported 524 and the 2015 Small Business Forum recommended 525 exempting securities issued in reliance upon Rule 147 from the reporting requirements of Section 12(g) of the Exchange Act. Several commenters also supported interpreting the intrastate broker-dealer exemption under the Exchange Act to include intermediaries whose activities are limited to facilitating intrastate offerings using the Internet.526 Amended Rule 147 and new Rule 147 take into account some of the suggestions by commenters and the recommendations of the 2015 Small Business Forum on ways to make the intrastate offering exemptions more useful for small entities. For example, the final rules retain Rule 147 as a safe harbor under Section 3(a)(11), while adopting a substantially similar new exemption pursuant to the Commission’s general exemptive authority under Section 28 as an alternative to the Section 3(a)(11) exemption for companies that are conducting an intrastate offering. As described above, the final rules will modernize existing Rule 147 and maintain a consistent approach across the two intrastate offering provisions, where possible. Also, given the comments received, the recommendations of the 2015 Small Business Forum and the local intrastate nature of the exemptions, amended Rule 147 and new Rule 147A will not contain any limits at the federal level on offering size or investment size. As noted in Section II.C above, however, we are not persuaded that securities issued in reliance upon Rule 147 or Rule 147A should be exempt from the reporting requirements of Section 12(g) of the Exchange Act. Given the lack of ongoing reporting requirements under these rules, we believe that the Section 12(g) record holder and asset thresholds continue to provide an important baseline above which issuers should generally be subject to the disclosure obligations of the Exchange Act. As the shareholder base and total assets of these issuers grow, we believe that the additional protections that will be provided by registration under Section 12(g) are necessary and appropriate. Additionally, as noted in Section II.B.2.c above, in response to the request by several commenters to interpret the intrastate broker-dealer exemption 524 CFIRA Letter; CrowdCheck Letter; Guzik Letter; Milken Letter; City of Adrian Letter. 525 See 2015 Small Business Forum Recommendations. 526 NASAA Letter; NextSeed Letter; WBA Letter. E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations under the Exchange Act to include intermediaries whose activities are limited to facilitating intrastate offerings using the Internet,527 we are providing guidance that a broker-dealer whose business otherwise meets the requirements of the intrastate brokerdealer exemption should not cease to qualify for the intrastate broker-dealer exemption solely because it has a Web site that may be viewed by out-of-state persons, so long as the broker-dealer takes measures reasonably designed to ensure that its business remains exclusively intrastate. A few commenters also recommended changes to Rules 504 and 505 that, in their view, would make the exemptions a more viable capital raising option for smaller issuers. Two commenters suggested 528 and the 2015 Small Business Forum recommended 529 that the Rule 504 offering amount limit be increased to $10 million. In addition, one commenter suggested 530 and the 2015 Small Business Forum recommended 531 that securities sold under Rule 504 be exempt from the requirements of Section 12(g). For Rule 505, one commenter suggested that the Commission consider changes to Rule 505 to facilitate very small offerings by early stage companies, such as a simple debt-only offering exemption for smaller issuers.532 Another commenter noted that, if the proposed changes to Rule 504 are adopted, Rule 505 would be substantially similar to Rule 504, making Rule 505 unnecessary, unless the Commission increases the aggregate offering amount that may be raised under Rule 505 in any twelve-month period.533 As supported by many commenters, the final amendments to Rule 504 will increase the offering amount limit from $1 million to $5 million.534 We believe that the $5 million threshold will facilitate issuers’ ability to raise capital, while remaining within the statutory requirements of Section 3(b)(1). As noted in Section III.B above, although two commenters and the 2015 Small Business Forum recommended that the Commission increase the Rule 504 527 NASAA Letter; NextSeed Letter; WBA Letter. Letter; CFIRA Letter. 529 See 2015 Small Business Forum Recommendations. 530 Milken Letter. 531 See 2015 Small Business Forum Recommendations. 532 Milken Letter. 533 ABA Letter. This commenter recommended, for example, that the offering amount limit could be raised from $5 million to $10 million or some larger amount, thereby preserving Rule 505 as a viable alternative exemption. 534 ABA Letter; CFA Letter; CFIRA Letter; CrowdCheck Letter; Milken Letter; NASAA Letter. asabaliauskas on DSK3SPTVN1PROD with RULES 528 CrowdCheck VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 offering amount limit to $10 million, we are not exceeding the maximum offering amount permitted under Section 3(b)(1). Although, as several commenters noted, we could use our exemptive authority under Section 28 of the Securities Act to raise the maximum offering amount above $5 million,535 in accord with the suggestion of one of those commenters,536 we believe it appropriate to first observe market activity under a new maximum offering amount of $5 million before raising the Rule 504 offering limit any higher. As noted in Section III.B above, we are not persuaded that securities issued in reliance upon Rule 504 should be exempt from the reporting requirements of Section 12(g) of the Exchange Act. Similar to Rules 147 and 147A, given the lack of ongoing reporting requirements under Rule 504, we believe that the Section 12(g) record holder and asset thresholds continue to provide an important baseline above which issuers should generally be subject to the disclosure obligations of the Exchange Act. As the shareholder base and total assets of these companies grow, we believe that the additional protections that will be provided by registration under Section 12(g) are necessary and appropriate. After considering the comments, we are repealing Rule 505. As discussed in Section III.C, amending Rule 504 to increase the aggregate offering amount limit from $1 million to $5 million may further reduce the incentives to use Rule 505 by issuers contemplating an exempt offering. We also believe that, even if we were to raise the Rule 505 aggregate offering amount limit from $5 million to $10 million, or some higher amount, such a higher limit would not increase the utility of the Rule 505 exemption as compared to Rule 506 which has no limit, given the historically diminished utility of Rule 505 as compared to Rule 506.537 Further, although Rule 505 provides issuers the ability to sell securities to up to 35 non-accredited investors without having to make a finding, as in Rule 506(b)(2)(ii), that such persons have the knowledge and experience in financial matters that they are capable of evaluating the merits and risks of the prospective investment, 538 this provision does not appear to have historically resulted in the Rule 505 Letter; Milken Letter. Letter (‘‘If the increase to $5 million is adopted, after there is experience with the use and operation of new Rule 504, the Commission may wish to consider using its exemption authority under Section 28 to increase the dollar limitation amount that may be offered under Rule 204.’’). 537 See note 22 above. 538 Cf. 17 CFR 230.506(b)(2)(ii). 83547 exemption being widely utilized.539 We will continue to evaluate whether we should replace Rule 505 with a substantially different exemption with new criteria, such as an exemption limited to a very small aggregate offering amount by early stage companies, or an exemption limited only to ‘‘simple debt securities’’ with very modest compliance requirements. In the light of the changes discussed above, we believe that the final rules provide smaller issuers with an appropriately tailored regulatory regime that takes into account the needs of small entities to have viable intrastate capital formation options, while maintaining appropriate investor protections. C. Small Entities Subject to the Rules For purposes of the RFA, under our rules, an issuer, other than an investment company, is a ‘‘small business’’ or ‘‘small organization’’ if it has total assets of $5 million or less as of the end of its most recent fiscal year and is engaged or proposing to engage in an offering of securities which does not exceed $5 million.540 For purposes of the RFA, an investment company is a small entity if it, together with other investment companies in the same group of related investment companies, has net assets of $50 million or less as of the end of its most recent fiscal year.541 While we lack data on the number and size of Rule 147 offerings or the type of issuers currently relying on the Rule 147 safe harbor, the nature of the eligibility requirements and other restrictions of the rule lead us to believe that it is used by U.S. incorporated entities that are likely small businesses seeking to raise small amounts of capital locally without incurring the costs of registering with the Commission. Currently, most states that have enacted crowdfunding provisions require issuers that intend to conduct intrastate crowdfunding offerings to rely upon Rule 147. Since December 2011, when the first state crowdfunding provision was enacted, 179 state crowdfunding offerings have been reported to be filed with the respective state regulators.542 Of these offerings, 166 were reported to be approved or cleared, as of June 20, 535 ABA 536 ABA PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 539 See Unregistered Offerings White Paper. CFR 230.157. 541 17 CFR 270.0–10(a). 542 Based on estimates provided by NASAA in a meeting with staff of the SEC Division of Corporation Finance on July 20, 2016, available athttps://www.sec.gov/comments/s7-22-15/s7221532.pdf. 540 17 E:\FR\FM\21NOR2.SGM 21NOR2 83548 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations 2016.543 We expect that almost all of the entities conducting these offerings were small issuers. It is difficult to predict the number of small entities that will use amended Rule 147 and new Rule 147A due to the many variables included in the amendments. Nevertheless, we believe that the final rules will increase the overall number of offerings relying on the intrastate exemptions due to the ability to make out-of-state offers under Rule 147A, the expanded number of issuers that will be eligible to use the intrastate exemptions due to the lack of an in-state incorporation requirement in Rule 147A and the modernized ‘‘doing business’’ requirements of Rules 147 and 147A, and other significant changes summarized in Section II above. The amendments to Rule 504 will affect small issuers that rely on this exemption from Securities Act registration. All issuers that sell securities in reliance on Regulation D are required to file a Form D with the Commission reporting the transaction. For the year ended December 31, 2015, 20,736 issuers made 22,854 new Form D filings, and of these Form D filings, 493 issuers relied on the Rule 504 exemption. Based on the information reported by issuers on Form D, we estimate that there were 269 small issuers 544 relying on the Rule 504 exemption in 2015. This number likely underestimates the actual number of small issuers relying on the Rule 504 exemption, however, because 41% of issuers that are not pooled investment funds and 38% of issuers that are pooled investment funds declined to report their amount of revenues or assets on their Form D filed with the Commission. It is difficult to predict the number of small entities that will use amended Rule 504 due to the variables included in the amendments. Nevertheless, we believe that the final rules for Rule 504 will increase the overall number of offerings relying on the exemption due to the increase in the offering amount limit from $1 million to $5 million, as summarized in Section III above. The repeal of Rule 505 will affect small issuers that rely on this exemption from Securities Act registration. For the asabaliauskas on DSK3SPTVN1PROD with RULES 543 Id. 544 Of this number, 265 of these issuers are not pooled investment funds, and 4 are pooled investment funds. We also note that issuers that are not pooled investment funds disclose only revenues on Form D, and not total assets. To estimate the number of small issuers, for non-pooled investment funds, we have included issuers that disclosed up to $5 million in revenues, including those with no revenues, and for pooled investment funds, we have included issuers that disclosed up to $5 million in net asset value, including those with no asset value. VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 year ended December 31, 2015, of the 20,736 issuers that made new Form D filings, 163 issuers relied on the Rule 505 exemption. Based on the information reported by issuers on Form D, we estimate that there were 112 small issuers 545 relying on the Rule 505 exemption in 2015. This number likely underestimates the actual number of small issuers relying on the Rule 504 exemption, however, because 25% of issuers that are not pooled investment funds and 38% of issuers that are pooled investment funds declined to report their amount of revenues or assets on their Form D filed with the Commission. D. Projected Reporting, Recordkeeping and Other Compliance Requirements Amended Rule 147 and new Rule 147A will not impose any reporting or recordkeeping requirements, but will require that issuers conducting offerings in reliance on these rules make certain specific disclosures to each offeree and purchaser in the offering. These disclosures will be made to each offeree in the manner in which any such offer is communicated and to each purchaser of a security in writing. Amended Rule 147 and new Rule 147A will also require that issuers place a specific legend on the certificate or other document evidencing the securities that are being offered in reliance on the rules. In order to comply with Rules 147(d) and 147A(d), sales of securities must be made only to residents of the state or territory in which the issuer has its residence or who the issuer reasonably believes, at the time of sale, are residents of the state or territory in which the issuer has its residence. In light of the comments received on the proposal, Rules 147 and 147A will include a requirement that issuers obtain a written representation from each purchaser as to his or her residence.546 This written representation, however, will not be sufficient, by itself, to establish reasonable belief. In addition to the written representation, an issuer will need to consider other facts and circumstances. 545 Of this number, 107 are not pooled investment funds, and 5 are pooled investment funds. We also note that issuers that are not pooled investment funds disclose only revenues on Form D and not total assets. To estimate the number of small issuers, for non-pooled investment funds, we have included issuers that disclosed up to $5 million in revenues, including those with no revenues, and for pooled investment funds, we have included issuers that disclosed up to $5 million in net asset value, including those with no asset value. 546 See Rules 147(f)(1)(iii) and 147A(f)(1)(iii). PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 The amendments to Rule 504 will increase the aggregate offering ceiling from $1 million to $5 million and disqualify certain bad actors from participating in Rule 504 offerings. Issuers will need to comply with all the current requirements of Rule 504, including the filing of a Form D.547 Also, as is the case under current Rule 504, issuers relying on the rule that wish to engage in general solicitation and issue freely tradable securities may also be required to register their offering with at least one state regulator. The amendments to Rule 504 will also impose a disclosure requirement with respect to bad actor disqualifying events that occurred before the effective date of the disqualification provisions and that would have triggered disqualification had they occurred after that date.548 Such disclosure will be required to be in writing and furnished to each purchaser a reasonable time prior to sale. There no prescribed format for such disclosure. In addition, we assume that issuers will exercise reasonable care to ascertain whether a disqualification exists with respect to any covered person and document their exercise of reasonable care. The steps undertaken by issuers to exercise reasonable care may vary with the circumstances. In addition, issuers will have to prepare any necessary disclosure about preexisting events. We expect that the costs of compliance will vary depending on the size and nature of the offering but will generally be lower for small entities than for larger ones because of the relative simplicity of their organizational structures and securities offerings and the generally smaller numbers of individuals and entities involved. E. Agency Action To Minimize Effect on Small Entities The Regulatory Flexibility Act directs us to consider significant alternatives that would accomplish the stated objectives of our amendments, while minimizing any significant adverse impact on small entities. Specifically, we considered the following alternatives: (1) Establishing different compliance or reporting requirements or timetables that take into account the resources available to small entities; (2) clarifying, consolidating or simplifying compliance and reporting requirements for small entities under the rule; (3) using performance rather than design 547 Rule 503 requires an issuer relying on any exemption under Regulation D to file a Form D within 15 calendar days after the first sale of securities in the offering. 548 See Rule 504(b)(3). E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations standards; and (4) exempting small entities from coverage of all or part of the amendments. With respect to clarification, consolidation and simplification of the final rules’ compliance and reporting requirements for small entities, amended Rule 147 and new Rule 147A do not impose any new reporting requirements. To the extent the final rules may be considered to create a new compliance requirement to have a reasonable belief that a prospective purchaser is a resident of the state or territory in which the issuer is a resident, including a requirement that issuers obtain a written representation from each purchaser as to his or her residence (as currently required in Rule 147), the precise steps necessary to meet the ‘‘reasonable belief’’ requirement will vary according to the circumstances, and this flexible standard will be applicable to all issuers, regardless of size. Overall, the final rules are designed to streamline and modernize the rule for all issuers, both large and small. In connection with amended Rule 147 and new Rule 147A, we do not think it feasible or appropriate to establish different compliance or reporting requirements or timetables for small entities. The final rules are designed to facilitate access to capital for both large and small issuers, but particularly smaller issuers who may satisfy their financing needs by limiting the sales of their securities only to residents of the state or territory in which the issuers are resident. The final rules do not contain any reporting standards and the compliance requirements they do include are minimal and designed with the limited resources of smaller issuers in mind. Similarly, we do not believe it is necessary to clarify, consolidate or simplify reporting or compliance requirements for small entities as the final rules contain more streamlined requirements for all issuers, both large and small. For example, the rules simplify the ‘‘doing business’’ in-state determination by amending the current requirements in Rule 147 so that an issuer’s ability to rely on the safe harbor will be based on its ability to satisfy updated and modernized issuer requirements, while continuing to require issuers to have an in-state presence sufficient to justify reliance on the Section 3(a)(11) exemption. New Rule 147A includes similar modernized ‘‘doing business’’ in-state requirements. With respect to using performance rather than design standards, we note that the final rules establish a ‘‘reasonable belief’’ standard for the determination of a prospective VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 purchaser’s residency status, which we believe is a performance standard. Although the final rules will require a written representation from investors, the rules recognize that reasonable belief can be established in a variety of ways (e.g., through pre-existing knowledge of the purchaser, obtaining supporting documentation, or using other appropriate methods). We believe that the use of a performance standard accommodates different types of offerings and purchasers without imposing overly burdensome methods that may be ill-suited or unnecessary to a particular offering or purchaser, given the facts and circumstances. With respect to exempting small entities from amended Rule 147 and new Rule 147A, we believe such an approach would increase, rather than decrease, their regulatory burden. The final rules are designed to facilitate an issuer’s access to capital, regardless of the size of the issuer. We have endeavored throughout these rules to minimize the regulatory burden on all issuers, including small entities, while meeting our regulatory objectives. In connection with our amendments to Rule 504 of Regulation D, we do not think it is feasible or appropriate to establish different compliance or reporting requirements or timetables for small entities. Our amendments are intended to facilitate issuers’ access to capital and are particularly designed for smaller issuers who are not subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act and who are offering no more than $5 million of their securities in any twelve month period. The amendments also exclude felons and other ‘‘bad actors’’ from involvement in Rule 504 offerings, which we believe could benefit small issuers by increasing investor protection and trust in such offerings. Increased investor trust could potentially reduce the cost of capital and create greater opportunities for small businesses to raise capital. With respect to clarification, consolidation and simplification of the compliance and reporting requirements for small entities, the amendments to Rule 504 do not impose any new reporting requirements. To the extent the amendments may be considered to create a new compliance requirement to exercise reasonable care to ascertain whether a disqualification exists with respect to any offering and to furnish a written description of preexisting triggering events, the precise steps necessary to meet that requirement will vary according to the circumstances. In general, we believe the requirement will more easily be met by small entities PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 83549 than by larger ones because we believe that their structures and securities offerings would be generally less complex and involve fewer participants. With respect to the use of performance or design standards, we note that the ‘‘reasonable care’’ exception is a performance standard. With respect to exempting small entities from coverage of these amendments, we believe that such an approach would increase, rather than decrease, their regulatory burden. Regulation D was designed, in part, to provide exemptive relief for smaller issuers. Furthermore, exempting small entities from Rule 504’s bad actor provisions could result in a decrease in investor protection and trust in this small offerings market, thereby potentially increasing the issuer’s cost of capital. We have endeavored to minimize the regulatory burden on all issuers, including small entities, while meeting our regulatory objectives, and have included a ‘‘reasonable care’’ exception and waiver authority for the Commission to provide additional flexibility with respect to the application of these amendments. VIII. Statutory Basis and Text of Final Amendments The amendments contained in this release are being adopted under the authority set forth in Sections 3(b)(1), 19 and 28 of the Securities Act of 1933, as amended, Sections 12, 13, 15, 23(a) and 36 of the Securities Exchange Act of 1934, Section 38(a) of the Investment Company Act of 1940 and Section 211(a) of the Investment Advisers Act. List of Subjects 17 CFR Part 200 Administrative practice and procedure, Authority delegations (Government agencies), Organization and functions (Government agencies). 17 CFR 230, 239, 240, 249, 270 and 275 Reporting and recordkeeping requirements, Securities. Text of Final Amendments For the reasons set out above, the Commission is amending Title 17, chapter II of the Code of Federal Regulations, as follows: PART 200—ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND REQUESTS Subpart A—Organization and Program Management 1. The authority citation for Part 200, Subpart A, continues to read, in part as follows: ■ E:\FR\FM\21NOR2.SGM 21NOR2 83550 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations Authority: 15 U.S.C. 77c, 77o, 77s, 77z–3, 77sss, 78d, 78d–1, 78d–2, 78o–4, 78w, 78ll(d), 78mm, 80a–37, 80b–11, 7202, and 7211 et seq., unless otherwise noted. * * * § 200.30–1 * * [Amended] 2. Amend § 200.30–1 by: a. In paragraph (a)(7), removing the references to ‘‘4(3)’’, ‘‘4(3)(b)’’ and ‘‘77d(3)(B)’’ and adding in their places ‘‘4(a)(3)’’, ‘‘4(a)(3)(B)’’ and ‘‘77d(a)(3)(B)’’ respectively; and ■ b. In paragraph (c), removing the reference to ‘‘§§ 230.505(b)(2)(iii)(C)’’ and adding in its place ‘‘§§ 230.504(b)(3)’’. ■ ■ PART 230—GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933 3. The authority citation for part 230 continues to read in part as follows: ■ Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 77s, 77z–3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o–7 note, 78t, 78w, 78ll(d), 78mm, 80a–8, 80a–24, 80a– 28, 80a–29, 80a–30, and 80a–37, and Public Law 112–106, sec. 201(a), sec. 401, 126 Stat. 313 (2012), unless otherwise noted. * * * * * 4. § 230.147 is revised to read as follows: ■ asabaliauskas on DSK3SPTVN1PROD with RULES § 230.147 Intrastate offers and sales. (a) This section shall not raise any presumption that the exemption provided by section 3(a)(11) of the Act (15 U.S.C. 77c(a)(11)) is not available for transactions by an issuer which do not satisfy all of the provisions of this section. (b) Manner of offers and sales. An issuer, or any person acting on behalf of the issuer, shall be deemed to conduct an offering in compliance with section 3(a)(11) of the Act (15 U.S.C. 77c(a)(11)), where offers and sales are made only to persons resident within the same state or territory in which the issuer is resident and doing business, within the meaning of section 3(a)(11) of the Act, so long as the issuer complies with the provisions of paragraphs (c), (d), and (f) through (h) of this section. (c) Nature of the issuer. The issuer of the securities shall at the time of any offers and sales be a person resident and doing business within the state or territory in which all of the offers and sales are made. (1) The issuer shall be deemed to be a resident of the state or territory in which: (i) It is incorporated or organized, and it has its principal place of business, if a corporation, limited partnership, trust or other form of business organization VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 that is organized under state or territorial law. The issuer shall be deemed to have its principal place of business in a state or territory in which the officers, partners or managers of the issuer primarily direct, control and coordinate the activities of the issuer; (ii) It has its principal place of business, as defined in paragraph (c)(1)(i) of this section, if a general partnership or other form of business organization that is not organized under any state or territorial law; (iii) Such person’s principal residence is located, if an individual. Instruction to paragraph (c)(1): An issuer that has previously conducted an intrastate offering pursuant to this section (§ 230.147) or Rule 147A (§ 230.147A) may not conduct another intrastate offering pursuant to this section (§ 230.147) in a different state or territory, until the expiration of the time period specified in paragraph (e) of this section (§ 230.147(e)) or paragraph (e) of Rule 147A (§ 230.147A(e)), calculated on the basis of the date of the last sale in such offering. (2) The issuer shall be deemed to be doing business within a state or territory if the issuer satisfies at least one of the following requirements: (i) The issuer derived at least 80% of its consolidated gross revenues from the operation of a business or of real property located in or from the rendering of services within such state or territory; Instruction to paragraph (c)(2)(i): Revenues must be calculated based on the issuer’s most recent fiscal year, if the first offer of securities pursuant to this section is made during the first six months of the issuer’s current fiscal year, and based on the first six months of the issuer’s current fiscal year or during the twelve-month fiscal period ending with such six-month period, if the first offer of securities pursuant to this section is made during the last six months of the issuer’s current fiscal year. (ii) The issuer had at the end of its most recent semi-annual fiscal period prior to an initial offer of securities in any offering or subsequent offering pursuant to this section, at least 80% of its assets and those of its subsidiaries on a consolidated basis located within such state or territory; (iii) The issuer intends to use and uses at least 80% of the net proceeds to the issuer from sales made pursuant to this section (§ 230.147) in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services within such state or territory; or PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 (iv) A majority of the issuer’s employees are based in such state or territory. (d) Residence of offerees and purchasers. Offers and sales of securities pursuant to this section (§ 230.147) shall be made only to residents of the state or territory in which the issuer is resident, as determined pursuant to paragraph (c) of this section, or who the issuer reasonably believes, at the time of the offer and sale, are residents of the state or territory in which the issuer is resident. For purposes of determining the residence of offerees and purchasers: (1) A corporation, partnership, limited liability company, trust or other form of business organization shall be deemed to be a resident of a state or territory if, at the time of the offer and sale to it, it has its principal place of business, as defined in paragraph (c)(1)(i) of this section, within such state or territory. Instruction to paragraph (d)(1): A trust that is not deemed by the law of the state or territory of its creation to be a separate legal entity is deemed to be a resident of each state or territory in which its trustee is, or trustees are, resident. (2) Individuals shall be deemed to be residents of a state or territory if such individuals have, at the time of the offer and sale to them, their principal residence in the state or territory. (3) A corporation, partnership, trust or other form of business organization, which is organized for the specific purpose of acquiring securities offered pursuant to this section (§ 230.147), shall not be a resident of a state or territory unless all of the beneficial owners of such organization are residents of such state or territory. Instruction to paragraph (d): Obtaining a written representation from purchasers of in-state residency status will not, without more, be sufficient to establish a reasonable belief that such purchasers are in-state residents. (e) Limitation on resales. For a period of six months from the date of the sale by the issuer of a security pursuant to this section (§ 230.147), any resale of such security shall be made only to persons resident within the state or territory in which the issuer was resident, as determined pursuant to paragraph (c) of this section, at the time of the sale of the security by the issuer. Instruction to paragraph (e): In the case of convertible securities, resales of either the convertible security, or if it is converted, the underlying security, could be made during the period described in paragraph (e) only to persons resident within such state or territory. For purposes of this paragraph E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations (e), a conversion in reliance on section 3(a)(9) of the Act (15 U.S.C. 77c(a)(9)) does not begin a new period. (f) Precautions against interstate sales. (1) The issuer shall, in connection with any securities sold by it pursuant to this section: (i) Place a prominent legend on the certificate or other document evidencing the security stating that: ‘‘Offers and sales of these securities were made under an exemption from registration and have not been registered under the Securities Act of 1933. For a period of six months from the date of the sale by the issuer of these securities, any resale of these securities (or the underlying securities in the case of convertible securities) shall be made only to persons resident within the state or territory of [identify the name of the state or territory in which the issuer was resident at the time of the sale of the securities by the issuer].’’; (ii) Issue stop transfer instructions to the issuer’s transfer agent, if any, with respect to the securities, or, if the issuer transfers its own securities, make a notation in the appropriate records of the issuer; and (iii) Obtain a written representation from each purchaser as to his or her residence. (2) The issuer shall, in connection with the issuance of new certificates for any of the securities that are sold pursuant to this section (§ 230.147) that are presented for transfer during the time period specified in paragraph (e), take the steps required by paragraphs (f)(1)(i) and (ii) of this section. (3) The issuer shall, at the time of any offer or sale by it of a security pursuant to this section (§ 230.147), prominently disclose to each offeree in the manner in which any such offer is communicated and to each purchaser of such security in writing a reasonable period of time before the date of sale, the following: ‘‘Sales will be made only to residents of [identify the name of the state or territory in which the issuer was resident at the time of the sale of the securities by the issuer]. Offers and sales of these securities are made under an exemption from registration and have not been registered under the Securities Act of 1933. For a period of six months from the date of the sale by the issuer of the securities, any resale of the securities (or the underlying securities in the case of convertible securities) shall be made only to persons resident within the state or territory of [identify the name of the state or territory in which the issuer was resident at the time of the sale of the securities by the issuer].’’ VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 (g) Integration with other offerings. Offers or sales made in reliance on this section will not be integrated with: (1) Offers or sales of securities made prior to the commencement of offers and sales of securities pursuant to this section (§ 230.147); or (2) Offers or sales made after completion of offers and sales of securities pursuant to this section (§ 230.147) that are: (i) Registered under the Act, except as provided in paragraph (h) of this section (§ 230.147); (ii) Exempt from registration under Regulation A (§§ 230.251 through 230.263); (iii) Exempt from registration under Rule 701 (§ 230.701); (iv) Made pursuant to an employee benefit plan; (v) Exempt from registration under Regulation S (§§ 230.901 through 230.905); (vi) Exempt from registration under section 4(a)(6) of the Act (15 U.S.C. 77d(a)(6)); or (vii) Made more than six months after the completion of an offering conducted pursuant to this section (§ 230.147). Instruction to paragraph (g): If none of the safe harbors applies, whether subsequent offers and sales of securities will be integrated with any securities offered or sold pursuant to this section (§ 230.147) will depend on the particular facts and circumstances. (h) Offerings limited to qualified institutional buyers and institutional accredited investors. Where an issuer decides to register an offering under the Act after making offers in reliance on this section (§ 230.147) limited only to qualified institutional buyers and institutional accredited investors referenced in section 5(d) of the Act, such offers will not be subject to integration with any subsequent registered offering. If the issuer makes offers in reliance on this section (§ 230.147) to persons other than qualified institutional buyers and institutional accredited investors referenced in section 5(d) of the Act, such offers will not be subject to integration if the issuer (and any underwriter, broker, dealer, or agent used by the issuer in connection with the proposed offering) waits at least 30 calendar days between the last such offer made in reliance on this section (§ 230.147) and the filing of the registration statement with the Commission. ■ 5. Add § 230.147A to read as follows: § 230.147A Intrastate sales exemption. (a) Scope of the exemption. Offers and sales by or on behalf of an issuer of its PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 83551 securities made in accordance with this section (§ 230.147A) are exempt from section 5 of the Act (15 U.S.C. 77e). This exemption is not available to an issuer that is an investment company registered or required to be registered under the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.). (b) Manner of offers and sales. An issuer, or any person acting on behalf of the issuer, may rely on this exemption to make offers and sales using any form of general solicitation and general advertising, so long as the issuer complies with the provisions of paragraphs (c), (d), and (f) through (h) of this section. (c) Nature of the issuer. The issuer of the securities shall at the time of any offers and sales be a person resident and doing business within the state or territory in which all of the sales are made. (1) The issuer shall be deemed to be a resident of the state or territory in which it has its principal place of business. The issuer shall be deemed to have its principal place of business in a state or territory in which the officers, partners or managers of the issuer primarily direct, control and coordinate the activities of the issuer. (2) The issuer shall be deemed to be doing business within a state or territory if the issuer satisfies at least one of the following requirements: (i) The issuer derived at least 80% of its consolidated gross revenues from the operation of a business or of real property located in or from the rendering of services within such state or territory; Instruction to paragraph (c)(2)(i): Revenues must be calculated based on the issuer’s most recent fiscal year, if the first offer of securities pursuant to this section is made during the first six months of the issuer’s current fiscal year, and based on the first six months of the issuer’s current fiscal year or during the twelve-month fiscal period ending with such six-month period, if the first offer of securities pursuant to this section is made during the last six months of the issuer’s current fiscal year. (ii) The issuer had at the end of its most recent semi-annual fiscal period prior to an initial offer of securities in any offering or subsequent offering pursuant to this section, at least 80% of its assets and those of its subsidiaries on a consolidated basis located within such state or territory; (iii) The issuer intends to use and uses at least 80% of the net proceeds to the issuer from sales made pursuant to this section (§ 230.147A) in connection with the operation of a business or of E:\FR\FM\21NOR2.SGM 21NOR2 asabaliauskas on DSK3SPTVN1PROD with RULES 83552 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations real property, the purchase of real property located in, or the rendering of services within such state or territory; or (iv) A majority of the issuer’s employees are based in such state or territory. Instruction to paragraph (c): An issuer that has previously conducted an intrastate offering pursuant to this section (§ 230.147A) or Rule 147 (§ 230.147) may not conduct another intrastate offering pursuant to this section (§ 230.147A) in a different state or territory, until the expiration of the time period specified in paragraph (e) of this section (§ 230.147A(e)) or paragraph (e) of Rule 147 (§ 230.147(e)), calculated on the basis of the date of the last sale in such offering. (d) Residence of purchasers. Sales of securities pursuant to this section (§ 230.147A) shall be made only to residents of the state or territory in which the issuer is resident, as determined pursuant to paragraph (c) of this section, or who the issuer reasonably believes, at the time of sale, are residents of the state or territory in which the issuer is resident. For purposes of determining the residence of purchasers: (1) A corporation, partnership, limited liability company, trust or other form of business organization shall be deemed to be a resident of a state or territory if, at the time of sale to it, it has its principal place of business, as defined in paragraph (c)(1) of this section, within such state or territory. Instruction to paragraph (d)(1): A trust that is not deemed by the law of the state or territory of its creation to be a separate legal entity is deemed to be a resident of each state or territory in which its trustee is, or trustees are, resident. (2) Individuals shall be deemed to be residents of a state or territory if such individuals have, at the time of sale to them, their principal residence in the state or territory. (3) A corporation, partnership, trust or other form of business organization, which is organized for the specific purpose of acquiring securities offered pursuant to this section (§ 230.147A), shall not be a resident of a state or territory unless all of the beneficial owners of such organization are residents of such state or territory. Instruction to paragraph (d): Obtaining a written representation from purchasers of in-state residency status will not, without more, be sufficient to establish a reasonable belief that such purchasers are in-state residents. (e) Limitation on resales. For a period of six months from the date of the sale by the issuer of a security pursuant to VerDate Sep<11>2014 20:30 Nov 18, 2016 Jkt 241001 this section (§ 230.147A), any resale of such security shall be made only to persons resident within the state or territory in which the issuer was resident, as determined pursuant to paragraph (c) of this section, at the time of the sale of the security by the issuer. Instruction to paragraph (e): In the case of convertible securities, resales of either the convertible security, or if it is converted, the underlying security, could be made during the period described in paragraph (e) only to persons resident within such state or territory. For purposes of this paragraph (e), a conversion in reliance on section 3(a)(9) of the Act (15 U.S.C. 77c(a)(9)) does not begin a new period. (f) Precautions against interstate sales. (1) The issuer shall, in connection with any securities sold by it pursuant to this section: (i) Place a prominent legend on the certificate or other document evidencing the security stating that: ‘‘Offers and sales of these securities were made under an exemption from registration and have not been registered under the Securities Act of 1933. For a period of six months from the date of the sale by the issuer of these securities, any resale of these securities (or the underlying securities in the case of convertible securities) shall be made only to persons resident within the state or territory of [identify the name of the state or territory in which the issuer was resident at the time of the sale of the securities by the issuer].’’; (ii) Issue stop transfer instructions to the issuer’s transfer agent, if any, with respect to the securities, or, if the issuer transfers its own securities, make a notation in the appropriate records of the issuer; and (iii) Obtain a written representation from each purchaser as to his or her residence. (2) The issuer shall, in connection with the issuance of new certificates for any of the securities that are sold pursuant to this section (§ 230.147A) that are presented for transfer during the time period specified in paragraph (e), take the steps required by paragraphs (f)(1)(i) and (ii) of this section. (3) The issuer shall, at the time of any offer or sale by it of a security pursuant to this section (§ 230.147A), prominently disclose to each offeree in the manner in which any such offer is communicated and to each purchaser of such security in writing a reasonable period of time before the date of sale, the following: ‘‘Sales will be made only to residents of the state or territory of [identify the name of the state or territory in which the issuer was resident at the time of the sale of the PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 securities by the issuer]. Offers and sales of these securities are made under an exemption from registration and have not been registered under the Securities Act of 1933. For a period of six months from the date of the sale by the issuer of the securities, any resale of the securities (or the underlying securities in the case of convertible securities) shall be made only to persons resident within the state or territory of [identify the name of the state or territory in which the issuer was resident at the time of the sale of the securities by the issuer].’’ (g) Integration with other offerings. Offers or sales made in reliance on this section will not be integrated with: (1) Offers or sales of securities made prior to the commencement of offers and sales of securities pursuant to this section (§ 230.147A); or (2) Offers or sales of securities made after completion of offers and sales of securities pursuant to this section (§ 230.147A) that are: (i) Registered under the Act, except as provided in paragraph (h) of this section (§ 230.147A); (ii) Exempt from registration under Regulation A (§§ 230.251 through 230.263); (iii) Exempt from registration under Rule 701 (§ 230.701); (iv) Made pursuant to an employee benefit plan; (v) Exempt from registration under Regulation S (§§ 230.901 through 230.905); (vi) Exempt from registration under section 4(a)(6) of the Act (15 U.S.C. 77d(a)(6)); or (vii) Made more than six months after the completion of an offering conducted pursuant to this section (§ 230.147A). Instruction to paragraph (g): If none of the safe harbors applies, whether subsequent offers and sales of securities will be integrated with any securities offered or sold pursuant to this section (§ 230.147A) will depend on the particular facts and circumstances. (h) Offerings limited to qualified institutional buyers and institutional accredited investors. Where an issuer decides to register an offering under the Act after making offers in reliance on this section (§ 230.147A) limited only to qualified institutional buyers and institutional accredited investors referenced in section 5(d) of the Act, such offers will not be subject to integration with any subsequent registered offering. If the issuer makes offers in reliance on this section (§ 230.147A) to persons other than qualified institutional buyers and institutional accredited investors referenced in section 5(d) of the Act, E:\FR\FM\21NOR2.SGM 21NOR2 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations such offers will not be subject to integration if the issuer (and any underwriter, broker, dealer, or agent used by the issuer in connection with the proposed offering) waits at least 30 calendar days between the last such offer made in reliance on this section (§ 230.147A) and the filing of the registration statement with the Commission. § 230.501 [Amended] 6. Amend § 230.501 paragraph (e) introductory text by removing the reference to ‘‘§§ 230.505(b) and 230.506(b)’’ and adding in its place ‘‘§ 230.506(b)’’. ■ § 230.502 [Amended] 7. Amend § 230.502 by: a. In paragraph (b)(1), removing the reference to ‘‘§ 230.505 or’’; ■ b. In paragraph (b)(2)(iv), removing the reference to ‘‘§ 230.505 or’’; ■ c. In paragraph (b)(2)(v), removing the reference to ‘‘§ 230.505 or’’; and ■ d. In paragraph (b)(2)(vii), removing the reference to ‘‘§ 230.505 or’’; ■ ■ § 230.503 [Amended] 8. Amend § 230.503 paragraph (a)(1) by removing the comma after ‘‘§ 230.504’’ and the reference to ‘‘§ 230.505,’’. ■ 9. In § 230.504, the section heading and paragraph (b)(2) are revised, and paragraph (b)(3) is added, to read as follows: ■ asabaliauskas on DSK3SPTVN1PROD with RULES 20:30 Nov 18, 2016 Jkt 241001 [Removed and Reserved] 10. § 230.505 is removed and reserved. ■ § 230.507 [Amended] 11. Amend § 230.507 by: a. In the section heading, removing the comma after ‘‘§§ 230.504’’ and the reference to ‘‘230.505’’; and ■ b. In paragraph (a), removing the reference to ‘‘§ 230.505,’’ and adding in its place ‘‘§ 230.504’’ and removing the reference to ‘‘§ 230.505.’’ ■ ■ [Amended] 12. Amend § 230.508 by: a. In paragraph (a) introductory text, removing the comma after ‘‘§ 230.504’’ and the reference to ‘‘§ 230.505’’; ■ b. In paragraph (a)(2), removing the comma after ‘‘§ 230.504’’ and the reference to ‘‘paragraphs (b)(2)(i) and (ii) of § 230.505’’: ■ c. In paragraph (a)(3), removing the comma after ‘‘§ 230.504’’ and the reference to ‘‘§ 230.505’’; and ■ d. In paragraph (b), removing the comma after ‘‘§ 230.504’’ and the reference to ‘‘§ 230.505.’’ ■ ■ * * * * (b) * * * (2) The aggregate offering price for an offering of securities under this § 230.504, as defined in § 230.501(c), shall not exceed $5,000,000, less the aggregate offering price for all securities sold within the twelve months before the start of and during the offering of securities under this § 230.504, in violation of section 5(a) of the Securities Act. Instruction to paragraph (b)(2): If a transaction under § 230.504 fails to meet the limitation on the aggregate offering price, it does not affect the availability of this § 230.504 for the other transactions considered in applying such limitation. For example, if an issuer sold $5,000,000 of its securities on January 1, 2014 under this § 230.504 and an additional $500,000 of its securities on July 1, 2014, this § 230.504 would not be available for the later sale, but would still be applicable to the January 1, 2014 sale. VerDate Sep<11>2014 § 230.505 § 230.508 § 230.504 Exemption for limited offerings and sales of securities not exceeding $5,000,000. * (3) Disqualifications. No exemption under this section shall be available for the securities of any issuer if such issuer would be subject to disqualification under § 230.506(d) on or after January 20, 2017; provided that disclosure of prior ‘‘bad actor’’ events shall be required in accordance with § 230.506(e). Instruction to paragraph (b)(3): For purposes of disclosure of prior ‘‘bad actor’’ events pursuant to § 230.506(e), an issuer shall furnish to each purchaser, a reasonable time prior to sale, a description in writing of any matters that would have triggered disqualification under this paragraph (b)(3) but occurred before January 20, 2017. PART 239—FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933 13. The authority citation for part 239 continues to read, in part, as follows: ■ 83553 b. In paragraph (a)(1), removing the comma after ‘‘§ 230.504’’ and the reference to ‘‘§ 230.505,’’; and removing the reference to ‘‘4(5)’’ and adding in its place ‘‘4(a)(5)’’; and ■ c. Amend Form D (referenced in § 239.500) by: ■ i. In Item 6, removing the phrase ‘‘Rule 505’’ and the appropriate check box; ■ ii. Under ‘‘Signature and Submission,’’ replace the third paragraph under ‘‘Terms of Submission’’ with the following sentence: ‘‘Certifying that, if the issuer is claiming a Regulation D exemption for the offering, the issuer is not disqualified from relying on Rule 504 or Rule 506 for one of the reasons stated in Rule 504(b)(3) or Rule 506(d). ’’ ■ (Note: The text of Form D does not, and the amendments will not, appear in the Code of Federal Regulations.) PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934 15. The authority citation for Part 240 continues to read, in part, as follows: ■ Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f, 78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, 78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q, 78q–1, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b–3, 80b– 4, 80b–11, 7201 et. seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and Pub. L. 111–203, 939A, 124 Stat. 1376, (2010), unless otherwise noted. * * * § 240.15g–9 * * [Amended] 16. Amend § 240.15g–9 paragraph (c)(2) by removing the reference to ‘‘230.505 or’’; and removing the reference to ‘‘4(2)’’ and adding in its place ‘‘4(a)(2)’’. ■ PART 249—FORMS, SECURITIES EXCHANGE ACT OF 1934 17. The authority citation for part 249 continues to read, in part, as follows: ■ Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s, 77z–2, 77z–3, 77sss, 78c, 78l, 78m, 78n, 78o(d), 78o–7 note, 78u–5, 78w(a), 78ll, 78mm, 80a–2(a), 80a–3, 80a–8, 80a–9, 80a– 10, 80a–13, 80a–24, 80a–26, 80a–29, 80a–30, 80a–37, and Sec. 71003 and Sec. 84001, Pub. L. 114–94, 129 Stat. 1312, unless otherwise noted. Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C. 5461 et seq.; 18 U.S.C. 1350; Sec. 953(b), Public Law 111–203, 124 Stat. 1904; Sec. 102(a)(3), Public Law 112–106, 126 Stat. 309 (2012); Sec. 107, Public Law 112–106, 126 Stat. 313 (2012), and Sec. 72001, Public Law 114–94, 129 Stat. 1312 (2015), unless otherwise noted. * * * § 239.500 * * * 14. Amend § 239.500 by: a. In the section heading, removing the reference to ‘‘4(5)’’ and adding in its place ‘‘4(a)(5)’’; Frm 00061 Fmt 4701 * § 249.308 [Amended] ■ ■ PO 00000 * Sfmt 4700 * * [Amended] 18. Amend the Instruction to Item 9.01 in Form 8–K (referenced in § 249.308) by removing the phrase ‘‘Rules 505 and 506 of Regulation D (17 ■ E:\FR\FM\21NOR2.SGM 21NOR2 83554 Federal Register / Vol. 81, No. 224 / Monday, November 21, 2016 / Rules and Regulations § 270.17j–1 CFR 230.505 and’’ and adding in its place ‘‘Rule 506 of Regulation D (17 CFR’’. [Amended] 20. Amend § 270.17j–1 paragraph (a)(8) by removing the references to ‘‘4(2)’’, ‘‘4(5)’’, ‘‘77d(2)’’ and ‘‘77d(5)’’ and adding in their places ‘‘4(a)(2)’’, ‘‘4(a)(5)’’, ‘‘77d(a)(2)’’ and ‘‘77d(a)(5)’’, respectively; and removing the comma after ‘‘rule 504’’, the reference to ‘‘rule 505,’’, the comma after ‘‘230.504’’ and the reference to ‘‘230.505,’’. ■ (Note: The text of Form 8–K does not, and the amendments will not, appear in the Code of Federal Regulations.) PART 270—RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940 19. The authority citation for Part 270 continues to read in part as follows: PART 275—RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940 Authority: 15 U.S.C. 80a–1 et seq., 80a– 34(d), 80a–37, and 80a–39, unless otherwise noted. ■ ■ asabaliauskas on DSK3SPTVN1PROD with RULES * * * VerDate Sep<11>2014 * * 20:30 Nov 18, 2016 21. The authority citation for Part 275 continues to read in part as follows: Authority: 15 U.S.C. 80b–2(a)(11)(G), 80b– 2(a)(11)(H), 80b–2(a)(17), 80b–3, 80b–4, 80b– Jkt 241001 PO 00000 Frm 00062 Fmt 4701 Sfmt 9990 4a, 80b–6(4), 80b–6a, and 80b–11, unless otherwise noted. * * * § 275.204A–1 * * [Amended] 22. Amend § 275.204A–1 paragraph (e)(7) by removing the references to ‘‘4(2)’’, ‘‘4(5)’’, ‘‘77d(2)’’ and ‘‘77d(5)’’ and adding in their places ‘‘4(a)(2)’’, ‘‘4(a)(5)’’, ‘‘77d(a)(2)’’ and ‘‘77d(a)(5)’’, respectively; and removing the comma after ‘‘230.504’’ and the reference to ‘‘230.505,’’. ■ Dated: October 26, 2016. By the Commission. Brent J. Fields, Secretary. [FR Doc. 2016–26348 Filed 11–18–16; 8:45 am] BILLING CODE 8011–01–P E:\FR\FM\21NOR2.SGM 21NOR2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 81, Number 224 (Monday, November 21, 2016)]
[Rules and Regulations]
[Pages 83494-83554]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-26348]

[[Page 83493]]

Vol. 81

Monday,

No. 224

November 21, 2016

Part IV

Securities and Exchange Commission

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17 CFR Parts 200, 230, 239, et al.

Exemptions To Facilitate Intrastate and Regional Securities Offerings;
Final Rule

Federal Register / Vol. 81 , No. 224 / Monday, November 21, 2016 /
Rules and Regulations

[[Page 83494]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 200, 230, 239, 240, 249, 270 and 275

[Release Nos. 33-10238; 34-79161; File No. S7-22-15]
RIN 3235-AL80

Exemptions To Facilitate Intrastate and Regional Securities
Offerings

AGENCY: Securities and Exchange Commission.

ACTION: Final rules.

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SUMMARY: We are adopting amendments to modernize Rule 147 under the
Securities Act of 1933, which provides a safe harbor for compliance
with the Section 3(a)(11) exemption from registration for intrastate
securities offerings. We are also establishing a new intrastate
offering exemption under the Securities Act, designated Rule 147A,
which will be similar to amended Rule 147, but will have no restriction
on offers and will allow issuers to be incorporated or organized
outside of the state in which the intrastate offering is conducted
provided certain conditions are met. The amendments to Rule 147 and new
Rule 147A are designed to facilitate capital formation, including
through offerings relying upon intrastate crowdfunding provisions under
state securities laws, while maintaining appropriate investor
protections and providing state securities regulators with the
flexibility to add additional investor protections they deem
appropriate for offerings within their state.
We also are adopting amendments to Rule 504 of Regulation D under
the Securities Act to facilitate issuers' capital raising efforts and
provide additional investor protections. The amendments to Rule 504
will increase the aggregate amount of securities that may be offered
and sold in any twelve-month period from $1 million to $5 million and
disqualify certain bad actors from participation in Rule 504 offerings.
In light of these amendments to Rule 504, we are also repealing Rule
505.

DATES: Effective date: Revised 17 CFR 230.147 (Rule 147) and new 17 CFR
230.147A (Rule 147A) will be effective on April 20, 2017. The
amendments to 17 CFR 230.504 (Rule 504) and 17 CFR 200.30-1 (Rule 30-1)
will be effective on January 20, 2017. The removal of 17 CFR 230.505
(Rule 505) will be effective on May 22, 2017. All other amendments in
this rule will be effective on May 22, 2017.
Comment date: Comments regarding the collection of information
requirements within the meaning of the Paperwork Reduction Act of 1995
should be received on or before January 20, 2017.

ADDRESSES: Persons submitting comments on the collection of information
requirements should direct the comments to the Commission by any of the
following methods:

Electronic Comments

Use the Commission's Internet comment form (https://www.sec.gov/rules/final.shtml); or
Send an email to rule-comments@sec.gov. Please include
File Number S7-22-15 on the subject line; or
Use the Federal eRulemaking Portal (https://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

Send paper comments to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE., Washington, DC
20549-1090.

FOR FURTHER INFORMATION CONTACT: With regard to the final rules,
Anthony G. Barone, Special Counsel, Jenny Riegel, Special Counsel, or
Ivan Griswold, Attorney-Advisor, Division of Corporation Finance, at
(202) 551-3460, and with regard to guidance on broker-dealer
registration, Timothy J. White, Senior Special Counsel, Division of
Trading and Markets, at (202) 551-5550, U.S. Securities and Exchange
Commission, 100 F Street NE., Washington, DC 20549-3628.

SUPPLEMENTARY INFORMATION: We are adopting new Rule 147A and are
adopting amendments to Rule 147 \1\ and Rule 504 \2\ of Regulation D
\3\ under the Securities Act of 1933 (the ``Securities Act'').\4\ We
are repealing Rule 505 \5\ of Regulation D.
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\1\ 17 CFR 230.147.
\2\ 17 CFR 230.504.
\3\ 17 CFR 230.500 through 230.508.
\4\ 15 U.S.C. 77a et seq.
\5\ 17 CFR 230.505.
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Table of Contents

I. Introduction and Background
II. Amendments to Rule 147 and New Rule 147A
A. Explanation of Amendments to Rule 147 and New Rule 147A
1. Manner of Offering
2. Elimination of Residence Requirement for Issuers
B. Common Requirements of the Amendments to Rule 147 and New
Rule 147A
1. Requirements for Issuers ``Doing Business'' In-State
2. Reasonable Belief as to Purchaser Residency Status
3. Residence of Entity Purchasers
4. Limitation on Resales
5. Integration
6. Disclosures to Investors
7. State Law Requirements
C. Additional Considerations
1. Notice Filings
2. Intrastate Broker Dealer Exemption
3. Section 12(g) Registration
4. Exclusion of Investment Companies
5. Trust Indenture Act
6. Other Requirements
III. Amendments to Rules 504 and 505 of Regulation D
A. Overview of Rules 504 and 505
B. Amendments to Rule 504
C. Repeal of Rule 505
IV. Other Matters
V. Economic Analysis
A. Baseline
1. Current Market Participants
2. Alternative Methods of Raising up to $5 Million of Capital
B. Analysis of Final Rules
1. Broad Economic Considerations
2. Analysis of Amendments to Existing Rule 147 and New Rule 147A
3. Analysis of Amendments to Rule 504
4. Analysis of Repeal of Rule 505
VI. Paperwork Reduction Act
A. Rules 147(f)(1)(iii) and 147A(f)(1)(iii)
B. Amendments to Rule 504 of Regulation D
VII. Final Regulatory Flexibility Act Analysis
VIII. Statutory Basis and Text of Final Amendments

I. Introduction and Background

On October 30, 2015, we proposed amendments to Rule 147 and Rule
504 under the Securities Act to assist smaller companies with capital
formation consistent with other public policy goals, including investor
protection.\6\ In developing final rules, we considered recommendations
by the Advisory Committee on Small and Emerging Companies (``ACSEC'')
\7\ and the most recent SEC Government-Business Forum on Small Business

[[Page 83495]]

Capital Formation (``Small Business Forum'') \8\ and comment letters
received on the Proposing Release.\9\ Today we are amending Rule 147
and establishing a new Securities Act exemption, designated Rule 147A.
We are also amending Rule 504 of Regulation D. We believe the final
rules will facilitate capital formation by smaller companies by
increasing the utility of the current Securities Act exemptive
framework for smaller offerings while maintaining appropriate
protections for investors. The final rules complement recent efforts by
the U.S. Congress,\10\ state legislatures,\11\ and state securities
regulators \12\ to modernize existing federal and state securities laws
and regulations to assist smaller companies with capital formation. We
believe our amendment to Rule 504 to increase its aggregate offering
ceiling from $1 million to $5 million will significantly diminish the
utility of Rule 505 and we are therefore repealing that rule.
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\6\ See SEC Rel. No. 33-9973 [80 FR 69786] (Nov. 10, 2015)
(``Proposing Release'').
\7\ See Recommendation to the Commission by the Advisory
Committee on Small and Emerging Companies to Modernize Rule 147
under the Securities Act of 1933 (Sept. 23, 2015) (``2015 ACSEC
Recommendation''), available at https://www.sec.gov/info/smallbus/acsec/acsec-recommendation-modernize-rule-147.pdf. The Commission
established the ACSEC in 2011 with the objective of providing the
Commission with advice on its rules, regulations and policies with
regard to its mission of protecting investors, maintaining fair,
orderly and efficient markets and facilitating capital formation, as
they relate to: (1) Capital raising by emerging privately-held small
businesses (emerging companies) and publicly traded companies with
less than $250 million in public market capitalization (smaller
public companies) through securities offerings, including private
and limited offerings and initial and other public offerings; (2)
trading in the securities of emerging companies and smaller public
companies; and (3) public reporting and corporate governance
requirements of emerging companies and smaller public companies.
Advisory Committee on Small and Emerging Companies, SEC Rel. No. 33-
9258 (Sept. 12, 2011) [76 FR 57769 (Sept. 16, 2011)].
\8\ See Final Report of the 2015 SEC Government Business Forum
on Small Business Capital Formation (April 2016) (``2015 Small
Business Forum Recommendations''), available at https://www.sec.gov/info/smallbus/gbfor34.pdf. The Small Business Investment Incentive
Act of 1980 directed the Commission to conduct an annual government-
business forum to undertake an ongoing review of the financing
problems of small businesses. 15 U.S.C. 80c-1. The Small Business
Forum has met annually since 1982 to provide a platform to highlight
perceived unnecessary impediments to small business capital
formation and address whether they can be eliminated or reduced.
Each forum seeks to develop recommendations for government and
private action to improve the environment for small business capital
formation, consistent with other public policy goals, including
investor protection. Information about the Small Business Forum is
available at https://www.sec.gov/info/smallbus/sbforum.shtml.
\9\ The comment letters received in response to the Proposing
Release are available at https://www.sec.gov/comments/s7-22-15/s72215.shtml.
\10\ Congress enacted the Jumpstart Our Business Startups Act of
2012 (``JOBS Act''), which was signed into law by President Obama on
April 5, 2012. Public Law 112-106, 126 Stat. 306. Pursuant to Title
II of the JOBS Act, the Commission adopted new paragraph (c) of Rule
506 of Regulation D, removing the prohibition on general
solicitation or general advertising for securities offerings relying
on Rule 506. See SEC Rel. No. 33-9415 (July 10, 2013). Pursuant to
Title IV of the JOBS Act, the Commission amended Regulation A in
order to permit issuers to raise up to $50 million annually. See SEC
Rel. No. 33-9741 (Mar. 25, 2015) (``2015 Regulation A Release'').
Pursuant to Title III of the JOBS Act, the Commission adopted rules
permitting companies to use the Internet to offer and sell
securities through crowdfunding (``Regulation Crowdfunding''). See
SEC Rel. No. 33-9974 (Oct. 30, 2015) (``Regulation Crowdfunding
Adopting Release''). Congress also enacted the Fixing America's
Surface Transportation Act of 2015 (``FAST Act''), which was signed
into law by President Obama on December 4, 2015. Public Law 114-94,
Sec 129 Stat. 1312 (2015). The FAST Act includes several amendments
to the federal securities laws, including a new exemption to Section
4 of the Securities Act for secondary sales of securities that are
purchased by an accredited investor, among other requirements
(Section 76001), and changes to facilitate initial public offerings
by emerging growth companies (Sections 71001 through 71003).
\11\ See, e.g., Ala. Code Sec. 8-6-11 (2014); Ariz. Rev. Stat.
Ann. Sec. 44-1844 (2015); Colo. Rev. Stat. Sec. 11-51-304(6)
(2014); Fla. Stat. Sec. 571.021, 517.061, 517.0611, 517.12,
517.121, 517.161, 626.9911; Ind. Code Sec. 6-3.1-24-14 (2014); Ky.
Rev. Stat. Ann. Sec. 292.410-292.415 (2015); Me. Rev. Stat. Ann.
tit. 32, Sec. 16304, sub-Sec. 6-a (2014).
\12\ See, e.g., D.C. Mun Regs. tit. 26-B, Sec. 250 (2014); Ga.
Comp. R. & Regs. 590-4-08 (2011); Idaho Code Ann. Sec. 30-14-203
(providing an exemption by order on a case-by-case basis); Kan.
Admin. Regs. Sec. 81-5-21 (2011).
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Consistent with commenters' suggestions \13\ and the
recommendations of the 2015 Small Business Forum,\14\ we are retaining
and modernizing Rule 147 under the Securities Act as a safe harbor for
intrastate offerings exempt from registration pursuant to Securities
Act Section 3(a)(11). These amendments will modernize the safe harbor,
while keeping within the statutory parameters of Section 3(a)(11), so
that issuers may continue to rely upon the rule for offerings pursuant
to state law exemptions, including crowdfunding provisions, that are
conditioned upon compliance with Section 3(a)(11) and Rule 147.
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\13\ Letter from David M. Lynn, Chair, Federal Regulation of
Securities Committee, Business Law Section, American Bar
Association, April 8, 2016 (``ABA Letter''); Letter from Christopher
D. Miller, Economic and Downtown Development Director, City of
Adrian, Michigan, January 8, 2016 (``City of Adrian Letter'');
Letter from Keith Paul Bishop, Former California Commissioner of
Corporations, December 30, 2015 (``Bishop Letter''); Letter from
Deborah L. Gunny and Cathryn S. Gawne, Co-Chairs, Corporations
Committee, Business Law Section, State Bar of California, January 8,
2016 (``California Bar Letter''); Letter from Kim Wales, CEO, Wales
Capital, and Executive Board Member, CrowdFund Intermediary
Regulatory Advocates, January 11, 2016 (``CFIRA Letter''); Letter
from Reps. Tom Emmer, Gwen Moore, Patrick McHenry, John Carney,
Scott Garrett, Denny Heck, Randy Neugebauer, Terri Sewell, Luke
Messer, Keith Ellison, Peter T. King, Robert Hurt, Robert Pittenger,
Roger Williams and Stephen Fincher, U.S. House of Representatives,
October 7, 2016 (``Congressional Letter''); Letter from Sara Hanks,
CEO, CrowdCheck, Inc., January 2, 2016 (``CrowdCheck Letter'');
Letter from Samuel S. Guzik, Securities Attorney, Guzik Associates,
January 18, 2016 (``Guzik Letter''); Letter from Brian Knight,
Associate Director, Financial Policy, and Staci Warden, Executive
Director; Center for Financial Markets, Milken Institute, January
11, 2016 (``Milken Letter''); Letter from Judith M. Shaw, President,
North American Securities Administrators Association, Inc.
(``NASAA'') and Maine Securities Administrator, January 11, 2016
(``NASAA Letter''); Letter from Youngro Lee, Esq., Co-founder/CEO,
NextSeed TX LLC, January 7, 2016 (``NextSeed Letter''); Letter from
Amy E. Pearl, Founder and Executive Director, Hatch Innovation Inc.,
January 10, 2016 (``Pearl Letter''); Letter from Joe M. Wallin,
Attorney, January 11, 2016 (``Wallin Letter''); Letter from Kristin
Wolff, January 11, 2016 (``Wolff Letter''); Letter from Howard
Orloff, CMO, ZacksInvest, November 19, 2015 (``Orloff Letter'');
Letter from Anthony J. Zeoli, Partner, Freeborn & Peters LLP,
November 5, 2016 (``Zeoli Letter''). No commenters supported the
proposed elimination of Rule 147 as a safe harbor under Section
3(a)(11).
\14\ See 2015 Small Business Forum Recommendations.
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Securities Act Section 3(a)(11) provides an exemption from
registration under the Securities Act for ``[a]ny security which is
part of an issue offered and sold only to persons resident within a
single State or Territory, where the issuer of such security is a
person resident and doing business within, or, if a corporation,
incorporated by and doing business within, such State or Territory.''
\15\ In 1974, the Commission adopted Rule 147 under the Securities Act
to provide objective standards for local businesses seeking to rely on
Section 3(a)(11).\16\ The Rule 147 safe harbor was intended to provide
assurances that the intrastate offering exemption would be used for the
purpose Congress intended in enacting Section 3(a)(11), namely the
local financing of companies by investors within the company's state or
territory.\17\ Rule 147 reflects this Congressional intent and
generally relies upon state regulation to effectively protect
investors.
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\15\ 15 U.S.C. 77c(a)(11).
\16\ See SEC Rel. No. 33-5450 (Jan. 7, 1974) [39 FR 2353 (Jan.
21, 1974)] (``Rule 147 Adopting Release''). See also SEC Rel. No.
33-5349 (Jan. 8, 1973) [38 FR 2468 (Jan. 26, 1973)] (``Rule 147
Proposing Release'').
\17\ See Rule 147 Adopting Release. See also H.R. Rep. No. 73-
85, at 6-7 (1933), H.R. Rep. No. 73-1838, at 40-41 (1934) (Conf.
Rep.) and SEC Rel. No. 33-4434, at 4 (Dec. 6, 1961) [26 FR 11896
(Dec. 13, 1961)] (``1961 Release'').
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Notwithstanding the importance of these limitations, due to
developments in modern business practices and communications technology
in the years since Rule 147 was adopted, we have determined that it is
necessary to update the requirements of Rule 147 to ensure its
continued utility.\18\ We are also establishing a new intrastate
offering exemption under the Securities Act, designated Rule 147A, that
will further accommodate modern business practices and communications
technology and provide an alternative means for smaller companies to
raise capital locally.
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\18\ The Commission has not amended Rule 147 since its adoption,
other than in 2013 when the Commission adopted technical amendments
to Rules 145, 147, 152 and 155 to update references to Section 4(2)
of the Securities Act, which was renumbered as Section 4(a)(2) by
Section 201(c) of the JOBS Act, Public Law 112-106, sec. 201(c), 126
Stat. 306, 314 (Apr. 5, 2012). See SEC Rel. No. 33-9414 [78 FR
44730] (July 10, 2013). See also ABA Letter; Milken Letter.
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We are adopting new Rule 147A pursuant to our general exemptive
authority under Section 28 of the Securities Act,\19\ and therefore,
new

[[Page 83496]]

Rule 147A will not be subject to the statutory limitations of Section
3(a)(11). Accordingly, Rule 147A will have no restriction on offers,
but will require that all sales be made only to residents of the
issuer's state or territory to ensure the intrastate nature of the
exemption. Rule 147A also will not require issuers to be incorporated
or organized in the same state or territory where the offering occurs
so long as issuers can demonstrate the in-state nature of their
business, which we believe will expand the number of businesses that
will be able to seek intrastate financing under Rule 147A, as compared
to amended Rule 147. Certain provisions of existing Rule 147 concerning
legends and mandatory disclosures to purchasers and prospective
purchasers will apply to offerings conducted pursuant to amended Rule
147 and Rule 147A.\20\
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\19\ 15 U.S.C. 77z-3. For the reasons discussed throughout this
release, we find that the Rule 147A exemption being adopted today is
necessary and appropriate in the public interest and consistent with
the protection of investors.
\20\ See Rules 147(f) and 147A(f).
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As in current Rule 147, nothing in either amended Rule 147 or new
Rule 147A will obviate the need for compliance with any applicable
state law relating to the offer and sale of securities. Thus, states
will retain the flexibility to adopt requirements that are consistent
with their respective interests in facilitating capital formation and
protecting their resident investors in intrastate securities offerings,
including the authority to impose additional disclosure requirements
regarding offers and sales made to persons within their state or
territory, or the authority to limit the ability of certain bad actors
from relying on applicable state exemptions. In addition, both federal
and state antifraud provisions will continue to apply to offers and
sales made pursuant to amended Rule 147 and new Rule 147A.
The staff will seek to collaborate with state regulators in
gathering information about intrastate crowdfunding offerings and,
based on the sharing of this information and other relevant inputs, the
staff will undertake to study and submit a report to the Commission, no
later than three years following the effective date of amended Rule 147
and new Rule 147A, on capital formation and investor protection in
offerings under these rules. The report will include, but not be
limited to, a review of information about:
(1) The use of amended Rule 147 and new Rule 147A;
(2) repeat use by the same issuers of amended Rule 147 or new Rule
147A;
(3) the use by issuers of alternative federal offering exemptions
concurrently or close in time to an offer or sale under amended Rule
147 or new Rule 147A;
(4) fraud associated with, or issuer non-compliance with provisions
of, amended Rule 147 or new Rule 147A;
(5) the role of intrastate broker-dealers and other intermediaries
in offerings conducted pursuant to amended Rule 147 or new Rule 147A;
and
(6) the application of state bad actor disqualification provisions
in offerings conducted pursuant to amended Rule 147 or new Rule 147A to
inform whether the Commission should consider including bad actor
disqualification provisions in amended Rule 147 and new Rule 147A.
We also are amending Rule 504 of Regulation D under the Securities
Act to increase the aggregate amount of securities that may be offered
and sold pursuant to Rule 504 in any twelve-month period from $1
million to $5 million and to disqualify certain bad actors from
participation in Rule 504 offerings. The higher offering ceiling amount
will promote capital formation by increasing the flexibility of state
securities regulators to implement coordinated review programs to
facilitate regional offerings.\21\ The bad actor disqualification
provisions will provide for greater consistency across Regulation D. We
believe these amendments to Rule 504 will significantly diminish the
utility of Rule 505, which historically has been little utilized in
comparison to Rule 506 of Regulation D.\22\ We, therefore, are
repealing Rule 505.
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\21\ The state registration of securities offerings under
coordinated review programs is an example of the efforts being
undertaken by states to streamline the state registration process
for issuers seeking to undertake multi-state registrations. These
programs establish uniform review standards and are designed to
expedite the registration process, thereby potentially saving
issuers time and money. Participation in such programs is voluntary.
The states have created coordinated review protocols for equity,
small company and franchise offerings; direct participation program
securities; and for certain offerings of securities pursuant to
Regulation A. More information on coordinated review programs is
available at https://www.nasaa.org/industry-resources/corporation-finance/coordinated-review/.
\22\ For the period 2009 through 2015, 132,091 Forms D were
filed. Of these Forms D, 3,758 reported an offering made in reliance
upon Rule 505 of Regulation D, representing approximately 3% of all
offerings made in reliance upon Regulation D and 5% of all
Regulation D offerings raising less than $5 million. During this
time period, 1,548 Forms D reported reliance only on Rule 505, and
2,210 Forms D reported reliance on Rule 505 and another Regulation D
exemption. By contrast, for the period 2009 through 2015, 5,532
filings reported an offering made in reliance upon Rule 504,
representing approximately 4% of all offerings made in reliance upon
Regulation D and 13% of all Regulation D offerings raising less than
$1 million. During this time period, 4,308 Forms D reported reliance
only on Rule 504, and 1,224 Forms D reported reliance on Rule 504
and another Regulation D exemption. All other Form D filings during
this period reported an offering made in reliance on Rule 506.
---------------------------------------------------------------------------

II. Amendments to Rule 147 and New Rule 147A

A. Explanation of Amendments to Rule 147 and New Rule 147A

Numerous commenters \23\ and the 2015 Small Business Forum \24\
recommended retaining Rule 147 as a safe harbor under Section 3(a)(11).
Many of these commenters also recommended adopting a substantially
similar new exemption pursuant to the Commission's general exemptive
authority under Section 28 as an alternative to the Section 3(a)(11)
exemption and safe harbor for companies that wish to conduct intrastate
offerings under slightly broader conditions than contemplated by
Section 3(a)(11). After considering the comments, we are amending Rule
147 to modernize the rule to incorporate most of our proposed
amendments, except for the two proposed amendments that do not fit
within the statutory limits of Section 3(a)(11)--allowing issuers to
make offers accessible to out-of-state residents and to be incorporated
out-of-state. These two provisions are the distinguishing features of
the new Rule 147A exemption that we are establishing pursuant to our
general exemptive authority under Section 28. Aside from these two
provisions, the remaining provisions of new Rule 147A are substantively
the same as the provisions of amended Rule 147.
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\23\ ABA Letter; City of Adrian Letter; Bishop Letter;
California Bar Letter; CFIRA Letter; Congressional Letter;
CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA Letter;
NextSeed Letter; Pearl Letter; Wallin Letter; Wolff Letter; Orloff
Letter; Zeoli Letter. No commenters supported the proposed
elimination of Rule 147 as a safe harbor under Section 3(a)(11).
\24\ 2015 Small Business Forum Recommendations.
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1. Manner of Offering
a. Proposed Amendments
Rule 147, as proposed, would have required issuers to limit sales
to in-state residents, but would no longer have limited offers by the
issuer to in-state residents.\25\ Accordingly, under our proposal,
amended Rule 147 would have permitted issuers to engage in general
solicitation and general advertising that could reach out-of-state
residents in order to locate potential in-state investors using any
form of mass media, including unrestricted, publicly-available Internet
Web sites, to advertise their offerings, so long as all sales of

[[Page 83497]]

securities so offered were made to residents of the state or territory
in which the issuer has its principal place of business. In the
Proposing Release, the Commission noted that market participants and
commenters have indicated that the combined effect of the statutory
limitation on offers in Section 3(a)(11) and the prescriptive threshold
requirements of Rule 147 unduly limits the availability of the
exemption for local companies that would otherwise conduct intrastate
offerings.\26\
---------------------------------------------------------------------------

\25\ See proposed Rule 147(d).
\26\ See Proposing Release at text accompanying note 18.
---------------------------------------------------------------------------

Given that proposed Rule 147 would have allowed offers to be made
to or be accessible by out-of-state residents, including advertising
offers on publicly-available Internet Web sites, the proposal would
have required an issuer to include a prominent disclosure on all
offering materials used in connection with a Rule 147 offering stating
that sales will be made only to residents of the same state or
territory as the issuer.\27\ This proposed disclosure requirement was
intended to advise investors who are not residents of the state in
which sales are being made that the intrastate offering would be
unavailable to them.
---------------------------------------------------------------------------

\27\ See proposed Rule 147(f)(3).
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As proposed, Rule 147 would no longer have remained a safe harbor
for conducting a valid intrastate exempt offering under Section
3(a)(11). An issuer that attempted to comply with Rule 147, as proposed
to be amended, but failed to do so, could rely on any other available
exemption. Failure to satisfy the requirements of Rule 147, as proposed
to be amended, however, would also have likely resulted in a failure to
satisfy the statutory requirements for the intrastate offering
exemption under Section 3(a)(11), since the requirements of Section
3(a)(11) would be more restrictive than under Rule 147, as proposed to
be amended.
b. Comments on Proposed Amendments
All commenters that addressed the issue expressed support for
eliminating the limitation on offers to in-state residents while
continuing to require that all sales be made to in-state residents.\28\
Many of these commenters also expressed support for retaining existing
Rule 147 as a safe harbor under Section 3(a)(11), in order to allow
issuers to take advantage of existing state crowdfunding
provisions.\29\ As explained by one commenter, if the Commission
eliminated the Rule 147 safe harbor, state legislative and/or
rulemaking action would be required, since almost all of the state
crowdfunding exemptions are premised on the offering qualifying under
Section 3(a)(11) and its Rule 147 safe harbor.\30\ The commenter noted
that eliminating the Rule 147 safe harbor would leave these state
crowdfunding exemptions unavailable until states modified their
exemptions to accommodate the removal of Rule 147 as a safe harbor to
Section 3(a)(11).\31\ In order to avoid this problem, some commenters
recommended that the Commission interpret Section 3(a)(11) and Rule 147
to allow for offers to be viewed by out-of-state residents.\32\ A few
of these commenters stated that Section 3(a)(11) should be interpreted
to allow for offers to be viewed by out-of-state residents, so long as
such offers indicate that they are being made to residents of a single
state.\33\
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\28\ ABA Letter; NASAA Letter; Letter from Kurt N. Schacht, CFA,
Managing Director, Standards and Advocacy, and Linda L. Rittenhouse,
Director, Capital Markets Policy, CFA Institute, January 11, 2016
(``CFA Letter''); CrowdCheck Letter; CFIRA Letter; Guzik Letter;
NextSeed Letter; Milken Letter; Zeoli Letter; Bishop Letter; Wolff
Letter; City of Adrian Letter; Pearl Letter; Finn Terdal, Technology
Coordinator, Hatch Innovation, January 11, 2016 (``Terdal Letter'');
Letter from Simon R. Love, Managing Director, Hatch Lab, January 11,
2016 (``Love Letter''); Letter from John MacDougall, Founder & CEO,
MacDougall & Sons Bat Co. Inc., January 10, 2016 (``MacDougall
Letter''); Letter from Erin Ely, January 10, 2016 (``Ely Letter'');
Letter from Jim Newcomer, Ph.D., 4mation Advisers, January 10, 2016
(``Newcomer Letter''); Brandon P. Romano, Content Director, Brelion,
LLC, January 6, 2016 (``Brelion Letter''); Letter from Sean
Shepherd, CrwdCorp LLC, December 30, 2015 (``CrwdCorp Letter''). See
also Congressional Letter (expressing general support for the
proposed amendments to Rule 147).
\29\ See ABA Letter; CFIRA Letter; Congressional Letter;
CrowdCheck Letter; NASAA Letter; California Bar Letter; Guzik
Letter; Milken Letter; NextSeed Letter; Zeoli Letter; Bishop Letter;
Wolff Letter; Pearl Letter; City of Adrian Letter; Orloff Letter;
Wallin Letter.
\30\ NASAA Letter. According to the NASAA Letter, as of January
2016, of the 29 states plus the District of Columbia that adopted or
were finalizing rulemaking implementing crowdfunding exemptions, 29
were premised on the offering qualifying under Section 3(a)(11) and
its Rule 147 safe harbor: Alabama, Arizona, Colorado, District of
Columbia, Georgia, Florida, Idaho, Illinois, Indiana, Iowa, Kansas,
Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota,
Mississippi, Montana, Nebraska, New Jersey, New Mexico, Oregon,
South Carolina, Tennessee, Texas, Vermont, Virginia, Washington, and
Wisconsin. As of January 2016, the exemptions were effective in 27
of the 30 jurisdictions: Minnesota and New Jersey were finalizing
rulemaking, and New Mexico was working on draft regulations. Of the
states with state crowdfunding exemptions, only Iowa and Vermont do
not explicitly reference Rule 147, and Maine relies on Rule 504
rather than Section 3(a)(11).
\31\ Id.
\32\ ABA Letter; Guzik Letter; Zeoli Letter; Milken Letter;
Pearl Letter.
\33\ ABA Letter; Guzik Letter; Zeoli Letter.
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One commenter also noted that issuers currently rely on Section
3(a)(11) and Rule 147 to conduct forms of intrastate offerings other
than pursuant to state crowdfunding provisions.\34\ In the view of this
commenter, removal of Rule 147 as a safe harbor under Section 3(a)(11)
would also present problems for these exempt offerings, thereby
severely restricting other local capital raising options.\35\
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\34\ NASAA Letter. For example, issuers may rely upon Section
3(a)(11) and Rule 147 for offerings registered under state
securities laws, or pursuant to exemptions from state registration
other than state crowdfunding provisions.
\35\ Id.
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Although commenters overwhelmingly supported retaining existing
Rule 147 as a safe harbor to Section 3(a)(11), many commenters also
supported adopting a substantially similar new exemption under the
Commission's general exemptive authority under Section 28 for companies
that conduct an intrastate offering but may not qualify for the Section
3(a)(11) exemption.\36\ Similarly, the 2015 Small Business Forum
recommended that the Commission take a ``side-by-side'' approach in
introducing a new Rule 147--as it did with Rule 506 and Regulation A
\37\--keeping old Rule 147 in place as a safe harbor under Section
3(a)(11) (but amending it to the extent permissible given the statutory
limitations of Section 3(a)(11)) while also adopting a new
exemption.\38\ Several commenters stated that establishing a new
exemption under Section 28, in addition to retaining existing Rule 147,
would afford the states time to amend their existing state crowdfunding
provisions, as well as to adopt new state crowdfunding provisions.\39\
One commenter supported leaving the existing Rule 147 as a safe harbor
to Section 3(a)(11) while adopting the proposed new exemption as new
Rule 505.\40\
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\36\ ABA Letter; City of Adrian Letter; Bishop Letter;
California Bar Letter; CFIRA Letter; Congressional Letter;
CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA Letter;
NextSeed Letter; Pearl Letter; Wallin Letter; Orloff Letter; Zeoli
Letter.
\37\ For example, pursuant to Title II of the JOBS Act, the
Commission adopted the Rule 506(c) exemption that permits an issuer
to engage in general solicitation under certain circumstances while
retaining Rule 506(b) as a safe harbor, which prohibits general
solicitation. Pursuant to Title IV of the JOBS Act, the Commission
also adopted Tier 1 and Tier 2 categories under Regulation A.
\38\ 2015 Small Business Forum Recommendations.
\39\ See, e.g., Pearl Letter; Orloff Letter.
\40\ Orloff Letter.
---------------------------------------------------------------------------

Several commenters supported our proposal to require prominent
disclosure on all offering materials used in connection with a Rule 147
offering stating that sales will be made only to residents of the same
state or territory as

[[Page 83498]]

the issuer.\41\ One commenter supported the proposed prominent
disclosure requirement, but only to the extent it is required on all
general solicitation and advertising materials.\42\ Two other
commenters noted that appropriate accommodations should be made to
permit use of space-constrained social media communications such as
Twitter.\43\ Two commenters noted that the Commission's efforts to
modernize these requirements should preserve state authority over
intrastate offerings, including the authority to impose additional
disclosure requirements.\44\
---------------------------------------------------------------------------

\41\ CFA Letter; CFIRA Letter; CrowdCheck Letter; NASAA Letter.
\42\ NASAA Letter.
\43\ CFIRA Letter; CrowdCheck Letter.
\44\ Congressional Letter; NASAA Letter.
---------------------------------------------------------------------------

c. Final Rules
After considering these comments and the recommendations of the
2015 Small Business Forum, we are adopting new Rule 147A to allow
issuers to make offers accessible to out-of-state residents, so long as
sales are limited to in-state residents. We are also retaining amended
Rule 147 as a safe harbor under Section 3(a)(11) to preserve the
continued availability of existing state exemptive provisions that are
specifically conditioned upon issuer reliance on Section 3(a)(11) and
Rule 147. Issuers relying on amended Rule 147 as a safe harbor under
Section 3(a)(11) must continue to limit all offers and sales to in-
state residents.\45\
---------------------------------------------------------------------------

\45\ See Rule 147(b).
---------------------------------------------------------------------------

We believe offers made over the Internet that can be viewed by a
significant number of out-of-state residents are not consistent with
Section 3(a)(11) and Rule 147, even if such offers include prominent
disclosure stating that sales will be made only to residents of the
same state or territory as the issuer.\46\ When Section 3(a)(11) was
enacted in 1934, Congress noted, among other things, that ``a person
who comes within the purpose of the exemption, but happens to use a
newspaper for the circulation of his advertising literature, which
newspaper is transmitted in interstate commerce, does not thereby lose
the benefits of the exemption.'' \47\ Further, in 1937 the Commission
released guidance on the nature of the Section 3(a)(11) exemption in
the form of a letter from the Commission's General Counsel.\48\ The
letter stated that securities exempt from registration pursuant to
Section 3(a)(11) ``may be made the subject of general newspaper
advertisement (provided the advertisement is appropriately limited to
indicate that offers to purchase are solicited only from, and sales
will be made only to, residents of the particular state involved).''
\49\ In its 1961 Release, the Commission explained that in order ``[t]o
give effect to the fundamental purpose of the exemption, it is
necessary that the entire issue of securities shall be offered and sold
to, and come to rest only in the hands of residents within the state.
If any part of the issue is offered or sold to a non-resident, the
exemption is unavailable not only for the securities so sold, but for
all securities forming a part of the issue, including those sold to
residents.'' \50\ We do not read the legislative history for Section
3(a)(11) and the prior Commission statements as envisioning widespread
out-of-state offers, but rather as recognition that some media of
communication, such as a local newspaper or periodical, could only be
imperfectly targeted to residents of a particular state. The Internet,
however, is not similarly targeted to residents of a particular state,
making it difficult for issuers to keep the distribution of such offers
local in nature.
---------------------------------------------------------------------------

\46\ Cf. ABA Letter; Guzik Letter; Zeoli Letter; Milken Letter;
Pearl Letter.
\47\ See H.R. Rep. No. 73-1838, at 40-41 (1934) (Conf. Rep.).
Section 3(a)(11) initially was enacted as Securities Act Section
5(c). When Congress enacted the Securities Exchange Act of 1934, it
also amended the Securities Act, including revising and
redesignating Section 5(c) as Section 3(a)(11).
\48\ See SEC Rel. No. 33-1459 (May 29, 1937) [11 FR 10958 (Sept.
27, 1946)] (``1937 Letter of General Counsel'').
\49\ Id.
\50\ 1961 Release; see also 1937 Letter of General Counsel
(stating that Section 3(a)(11) is ``limited to cases in which the
entire issue of securities is offered and sold exclusively to
residents of the state in question'').
---------------------------------------------------------------------------

Given the foregoing, we believe that the most appropriate means to
permit the offer and sale of securities on Internet Web sites, or using
any other form of mass media likely to reach significant numbers of
out-of-state residents, is to adopt a new intrastate offering exemption
pursuant to the Commission's general exemptive authority under Section
28. Accordingly, new Rule 147A will require issuers to limit sales to
in-state residents, but will not limit offers by the issuer to in-state
residents. New Rule 147A thereby will permit issuers to engage in
general solicitation and general advertising of their offerings, using
any form of mass media, including unrestricted, publicly-available
Internet Web sites, so long as sales of securities so offered are made
only to residents of the state or territory in which the issuer is
resident.
Consistent with the proposal, both Rule 147A and amended Rule 147
will require issuers to include prominent disclosure with all offering
materials stating that sales will be made only to residents of the same
state or territory as the issuer.\51\ We believe this disclosure will
help alert potential investors that only residents of the state in
which the issuer is located are eligible to participate in the
offering. Nothing in this disclosure requirement, however, will prevent
state authorities from imposing additional disclosure requirements or
other requirements on offers or sales made to persons within their
states.
---------------------------------------------------------------------------

\51\ See Rules 147(f)(3) and 147A(f)(3).
---------------------------------------------------------------------------

Two commenters noted that appropriate accommodations should be made
to permit use of space-constrained social media communications such as
Twitter.\52\ To accommodate space-constrained social media
communication, when offering materials are distributed through a
communications medium that has technological limitations on the number
of characters or amount of text that may be included in the
communication and including the required statements in their entirety,
together with the other information, would cause the communication to
exceed the limit on the number of characters or amount of text, an
issuer could satisfy the disclosure requirement by including an active
hyperlink to the required disclosure that otherwise would be required
by the rules.The communication should prominently convey, through
introductory language, that required information is provided through
the hyperlink. We believe this guidance will accommodate advancements
in social media, while still providing potential investors with the
disclosure required by the rules. Where an electronic communication is
capable of including the entirety of the required disclosure, along
with the other information, without exceeding the applicable limit on
the number of characters or amount of text, the use of a hyperlink to
the required statements should not be used.
---------------------------------------------------------------------------

\52\ CFIRA Letter; CrowdCheck Letter.
---------------------------------------------------------------------------

2. Elimination of Residence Requirement for Issuers
a. Proposed Amendments
For corporations, limited partnerships, trusts, or other forms of
business organizations, we proposed to eliminate the current
requirement in Rule 147 that limits the availability of the rule to
issuers incorporated or

[[Page 83499]]

organized in the state in which an offering takes place. Our proposed
amendments would have expanded the universe of eligible issuers by
eliminating the current ``residence'' requirement, while continuing to
require that an issuer have a sufficient in-state presence determined
by the location of the issuer's principal place of business.\53\
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\53\ See proposed Rule 147(c)(1). See also discussion on
principal place of business in Section II.B.1 below, and the related
discussion of the proposed requirement that an issuer satisfy at
least one of four threshold requirements in order to help ensure the
in-state nature of its business.
---------------------------------------------------------------------------

The proposed amendments also would have replaced the current rule's
``principal office'' \54\ requirements for an issuer with a ``principal
place of business'' requirement.\55\ The proposed rule defined the term
``principal place of business'' to mean the location from which the
officers, partners, or managers of the issuer primarily direct, control
and coordinate the activities of the issuer.\56\ As noted in the
Proposing Release, an issuer would have been able to have a ``principal
place of business'' within only one state or territory and would have
therefore been able to conduct an offering pursuant to amended Rule 147
only within that particular state or territory. We also proposed to
restrict the ability of an issuer that has changed its principal place
of business from conducting an intrastate offering in a different state
for a period of nine months from the date of the last sale in the prior
state,\57\ which was consistent with the duration of the resale
limitation period specified in proposed Rule 147(e).\58\
---------------------------------------------------------------------------

\54\ See 17 CFR 230.147(c)(1)(ii) and 17 CFR 230.147(c)(2)(iv).
\55\ See proposed Rule 147(c)(1).
\56\ See proposed Rule 147(c)(1).
\57\ See Note 1 to proposed Rule 147(c)(1).
\58\ See proposed Rule 147(e) (proposing to limit resales of a
given security purchased in an offering pursuant to Rule 147 to out-
of-state residents for a nine-month period from the date such
security is sold by the issuer).
---------------------------------------------------------------------------

b. Comments on Proposed Amendments
Commenters were divided on the proposal to eliminate the
requirement in Rule 147 that entities be incorporated or organized
under the laws of the state or territory in which the offering takes
place. Several commenters supported eliminating this requirement and
stated that the jurisdiction of entity formation should not affect the
ability of an issuer to be considered resident for purposes of an
intrastate offering and that there are valid business reasons for
incorporating or organizing in states, such as Delaware, which do not
detract from an issuer's connection to the state in which its principal
place of business is located.\59\ Other commenters opposed eliminating
the requirement that entities be incorporated or organized under the
laws of the state in which the offering takes place,\60\ and some of
these commenters stated that the intrastate exemption should promote
state and local economic development goals in addition to capital
formation--goals that, in their view, would be curtailed in the absence
of an in-state organization requirement.\61\
---------------------------------------------------------------------------

\59\ See Bishop Letter (``The application of state securities
laws is not dependent upon the state of incorporation or
organization of the issuer. Rather, the application of these laws
depends upon whether an offer or sale is being made within the
state.''); CFIRA Letter; CFA Letter (the proposed approach
``continues the issuer-state connection through the actual business
activities and employment aspects that accompany a principal place
of business and recognizes the lack of connection between state of
incorporation and actual business activities.''); CrowdCheck Letter;
NASAA Letter; NextSeed Letter.
\60\ Love Letter; MacDougall Letter; Newcomer Letter; Pearl
Letter; Wolff Letter.
\61\ Love Letter (``If the company is incorporated in the state
where sales occur, it is another way to encourage local funds to be
retained locally''); MacDougall Letter (stating that incorporating
out of state to avoid state taxes ``goes against the `spirit' of the
law and sends the wrong message''); Pearl Letter (``intrastate laws
are focused on state economic development in addition to capital
formation for entrepreneurs and financial return for investors, and
therefore the retention of capital within the state is a necessary
component of the successful spread of benefits''); Wolff Letter
(stating that local investing confers benefits that extend beyond
financial return and seeks to encourage the spread of such social,
economic, and other benefits while lifting the restriction on state
incorporation entirely changes the nature of the intrastate
crowdfunding).
---------------------------------------------------------------------------

Commenters also were divided on replacing the current in-state
organization requirement in Rule 147(c)(1) with a principal place of
business requirement. While two commenters viewed the principal place
of business standard along with a ``doing business'' test as
sufficiently demonstrating the in-state nature of an issuer's
business,\62\ two other commenters opposed the proposed principal place
of business requirement.\63\ One commenter noted that the
jurisdictional reach of state securities laws is independent of whether
an issuer is conducting any business within the state and indicated
that a state's jurisdiction is established by the offer or sale of a
security within the state.\64\ Another commenter stated that the
principal place of business requirement is ``anti-competitive in nature
and disruptive in spurring economic growth for small businesses.'' \65\
---------------------------------------------------------------------------

\62\ NASAA Letter; NextSeed Letter.
\63\ Bishop Letter; Letter from David L. Sjursen, CEO & Founder,
Exante Regulatory Compliance Consultants Inc., December 2, 2015
(``Exante Letter'').
\64\ Bishop Letter (``[T]he Commission's proposed `presence'
requirements would not augment California's ability to enforce its
securities laws for the protection of resident investors as assumed
by the Commission. If a state believes that its existing
qualification or exemption requirements inadequately protect
offerees and purchasers, it can amend those requirements. . . . [I]t
is far more logical to require only that the issuer be organized in
the state or territory or qualified to transact intrastate business
in the state or territory'').
\65\ Exante Letter.USGPO Galley End:?>
---------------------------------------------------------------------------

Several commenters supported the proposed nine-month waiting period
until the offering comes to rest, consistent with the requirements of
proposed Rule 147(e), before an issuer may change its principal place
of business to another state or territory and make a subsequent
offering of securities in that new state or territory in reliance on
proposed Rule 147.\66\ No commenters opposed the proposed waiting
period.
---------------------------------------------------------------------------

\66\ CFIRA Letter; CrowdCheck Letter; NASAA Letter.
---------------------------------------------------------------------------

c. Final Rules
We are adopting changes to the residency requirements for issuers
conducting exempt intrastate offerings largely as proposed, but with
certain modifications to reflect our decision to retain existing Rule
147 as a safe harbor to the Section 3(a)(11) exemption. Since we are
retaining Rule 147 as a safe harbor and since Section 3(a)(11)
expressly requires that if the issuer is a corporation that it be
``incorporated by and doing business within, such state or territory,''
we are not eliminating the ``residence'' requirement in current
paragraph (c)(1) of Rule 147, as proposed. Instead, we are retaining
the requirement that an issuer shall be deemed a resident of a state or
territory in which it is incorporated or organized for issuers that are
incorporated or organized under state or territorial law, such as
corporations, limited partnerships and trusts.
In addition, for consistency between the provisions of Rule 147 and
new Rule 147A,\67\ throughout amended Rule 147, we are replacing the
``principal office'' requirement with the proposed ``principal place of
business'' requirement.\68\ Instead of ``principal

[[Page 83500]]

office,'' amended Rule 147 and new Rule 147A will refer to the term
``principal place of business'' to mean the location from which the
officers, partners, or managers of the issuer primarily direct, control
and coordinate the activities of the issuer.\69\ We do not expect this
change will significantly alter the scope of existing Rule 147 as we
believe ``principal place of business'' is conceptually similar to
principal office location.
---------------------------------------------------------------------------

\67\ See Rules 147(c)(1), 147(d)(1), 147A(c)(1) and 147A(d)(1).
The principal place of business definition is consistent with the
use of that term in Exchange Act Rule 3a71-3, 17 CFR 240.3a71-3, for
cross-border security based swap dealing activity, and the use of
the term ``principal office and place of business'' in Investment
Advisers Act Rule 203A-3(c), 17 CFR 275.203A-3(c).
\68\ For example, as proposed, we are amending paragraph (d)(1)
of Rule 147 to replace the ``principal office'' requirement with
``principal place of business.'' See also Section II.B.3 below
discussing the use of the ``principal place of business'' standard
for the residence of entity purchasers.
\69\ See Rules 147(c)(1), 147(d)(1), 147A(c)(1) and 147A(d)(1).
---------------------------------------------------------------------------

Under amended Rule 147, issuers that are incorporated or organized
under state or territorial law will be deemed a ``resident'' of a
particular state or territory in which they are both incorporated or
organized and have their ``principal place of business.'' \70\
Specifically, the ``principal office'' requirement contained in current
Rule 147(c)(2)(iv) \71\ will be updated and replaced with the
``principal place of business'' requirement in amended Rule
147(c)(1)(i). Similarly, issuers that are general partnerships, or in
the form of another business organization not organized under any state
or territorial law, shall be deemed to be a ``resident'' of the state
or territory in which they have their ``principal place of business.''
\72\
---------------------------------------------------------------------------

\70\ See 17 CFR 230.147(c)(1)(i).
\71\ See 17 CFR 230.147(c)(1)(iv).
\72\ See 17 CFR 230.147(c)(1)(ii).
---------------------------------------------------------------------------

Consistent with the proposal, new Rule 147A(c)(1) will rely solely
on the principal place of business requirement to determine the state
or territory in which the issuer shall be deemed a ``resident,'' not
only for corporate issuers, but for all issuers, including issuers that
are not organized under any state or territorial law, such as general
partnerships.\73\ Although commenters were divided on whether to retain
the requirement that entities be incorporated or organized under the
laws of the state in which the offering takes place, we continue to
believe that using a principal place of business requirement in lieu of
an in-state formation requirement to establish the issuer's residency
is more consistent with modern business practices in which issuers are
permitted to incorporate or organize in states other than the state or
territory of their principal place of business, for example, to take
advantage of well-established bodies of corporate or partnership
law.\74\ We continue to believe that, outside the statutory
requirements of Section 3(a)(11), the jurisdiction of entity formation
should not affect the ability of an issuer to be considered
``resident'' for purposes of an intrastate offering exemption at the
federal level. While we recognize that some commenters supported
retaining an in-state formation requirement as a means of ensuring that
the economic and social benefits of the offering remain within the
state, the objectives of our rulemaking in this area are more broadly
focused on facilitating capital formation by small businesses.\75\ We
believe that retaining an in-state formation requirement in new Rule
147A would be unnecessarily restrictive and limit the usefulness of the
exemption, potentially to the detriment of local economic development.
---------------------------------------------------------------------------

\73\ See note 56 above.
\74\ For example, data provided by issuers in Form D filings
with the Commission indicates that approximately 37% of Rule 504
offerings and 39% of Rule 505 offerings indicated in their Form D
filings that they had different states of incorporation and
principal places of business. Form D data also indicates that
approximately 65% of all Rule 506 offerings initiated during 2009-
2015 reported different states of incorporation and operations. See
discussion in Section V.B.2.b.ii below.
\75\ See e.g., Rule 147 Adopting Release at text accompanying
note 2.
---------------------------------------------------------------------------

We are, however, retaining the proposed principal place of business
requirement, despite the views of several commenters that such a
requirement is unnecessary or inappropriate.\76\ Although, as noted by
one commenter, the jurisdictional reach of state securities laws is
independent of whether an issuer is conducting any business within the
state since a state's jurisdiction is established by the offer or sale
of a security within the state,\77\ we believe that states will have a
particular interest in regulating intrastate offerings for the
protection of investors where there is a meaningful nexus between the
state, issuers and investors.
---------------------------------------------------------------------------

\76\ Bishop Letter; Exante Letter.
\77\ Bishop Letter.
---------------------------------------------------------------------------

To ensure an appropriate connection between the state, issuers and
investors, amended Rule 147(d) and Rule 147A(d) will require an issuer
to be a resident of the same state where purchasers are resident or
where the issuer reasonably believes they are resident.\78\ Viewed
together, paragraphs (c) and (d) of each of Rules 147 and 147A help to
ensure the local intrastate character of the offering by requiring that
both issuers and purchasers reside and have their principal place of
business (for purchasers, the principal place of business requirement
only applies to purchasers who are legal entities) \79\ in the same
state or territory where the offering takes place.
---------------------------------------------------------------------------

\78\ See Rule 147A(c)(1).
\79\ Under both amended Rule 147(d)(2) and Rule 147A(d)(2), the
residence of an individual (natural person) is determined by the
state or territory in which his or her principal residence is
located at the time of the offer and sale to the individual.
---------------------------------------------------------------------------

For situations where an issuer changes its principal place of
business to another state after conducting an intrastate offering in
reliance on Rule 147 or Rule 147A, we are adopting provisions in both
rules that limit the ability of an issuer to conduct a subsequent
intrastate offering pursuant to Rule 147 or Rule 147A until such time
as securities sold in reliance on the exemption in the prior state have
come to rest in that state.\80\ This is consistent with the view that
securities sold in an intrastate offering in one state should have to
come to rest within such state before purchasers may resell their
securities to out-of-state residents.\81\ Accordingly, both rules
provide that issuers who have previously conducted an intrastate
offering pursuant to Rule 147 or Rule 147A will not be able to conduct
another subsequent intrastate offering pursuant to either rule in a
different state for a period of six months from the date of the last
sale in the prior state, which is consistent with the duration of the
resale limitation period specified in our amendments to Rule 147(e) and
new Rule 147A(e).\82\ The use of a six-month period is a change from
the proposed nine-month period, and aligns these provisions with
changes being made to amended Rule 147(e) and new Rule 147A(e),
consistent with commenters' suggestions to reduce the nine-month resale
limitation period to six months.\83\
---------------------------------------------------------------------------

\80\ See Rules 147(e) and 147A(e).
\81\ See 1961 Release at 4.
\82\ See Instruction to paragraph (c)(1) of Rule 147 and
Instruction to paragraph (c)(1) of Rule 147A.
\83\ See Section II.B.4.c below.
---------------------------------------------------------------------------

B. Common Requirements of the Amendments to Rule 147 and New Rule 147A

Our amendments to Rule 147 and the provisions of new Rule 147A are
substantially identical, except that, as discussed above, new Rule 147A
allows an issuer to make offers accessible to out-of-state residents
and to be incorporated or organized out-of-state.\84\ Under the rules
we adopt today, both amended Rule 147 and new Rule 147A will include
the following provisions:
---------------------------------------------------------------------------

\84\ See Sections II.A.1and II.A.2 above.
---------------------------------------------------------------------------

A requirement that the issuer satisfy at least one ``doing
business'' requirement that will demonstrate the in-state nature of the
issuer's business.

[[Page 83501]]

A new ``reasonable belief'' standard for issuers to rely
upon in determining the residence of the purchaser at the time of the
sale of securities.
A requirement that issuers obtain a written representation
from each purchaser as to his or her residency.
The residence of a purchaser that is a non-natural person,
such as a corporation, partnership, trust or other form of business
organization, will be defined as the location where, at the time of the
sale, the entity has its ``principal place of business.''
A limit on resales to persons resident within the state or
territory of the offering for a period of six months from the date of
the sale by the issuer to the purchaser of a security sold pursuant to
the exemption.
An integration safe harbor that will include any prior
offers or sales of securities by the issuer, as well as certain
subsequent offers or sales of securities by the issuer occurring after
the completion of the offering.
Disclosure requirements, including legend requirements, to
offerees and purchasers about the limits on resales.
1. Requirements for Issuers ``Doing Business'' In-State
a. Proposed Amendments
Under the proposed rules, an issuer would be required to meet at
least one of the following requirements in order to be considered
``doing business'' in-state:
The issuer derived at least 80% of its consolidated gross
revenues from the operation of a business or of real property located
in or from the rendering of services within such state or territory;
\85\
---------------------------------------------------------------------------

\85\ See proposed Rule 147(c)(2)(i) and related notes to the
rule indicating how and when an issuer would calculate its revenue
for purposes of compliance with the proposed rule, based on when the
first offer of securities is made pursuant to the exemption.
---------------------------------------------------------------------------

The issuer had at the end of its most recent semi-annual
fiscal period prior to the first offer of securities pursuant to the
exemption, at least 80% of its consolidated assets located within such
state or territory; \86\
---------------------------------------------------------------------------

\86\ See proposed Rule 147(c)(2)(ii).
---------------------------------------------------------------------------

The issuer intends to use and uses at least 80% of the net
proceeds to the issuer from sales made pursuant to the exemption in
connection with the operation of a business or of real property, the
purchase of real property located in, or the rendering of services
within such state or territory; \87\ or
---------------------------------------------------------------------------

\87\ See proposed Rule 147(c)(2)(iii).
---------------------------------------------------------------------------

A majority of the issuer's employees are based in such
state or territory.\88\
---------------------------------------------------------------------------

\88\ See proposed Rule 147(c)(2)(iv).
---------------------------------------------------------------------------

b. Comments on the Proposed Amendments
Several commenters supported our proposed amendments to the current
``doing business'' requirements in Rule 147(c)(2).\89\ One commenter
specifically favored the proposed disjunctive approach, requiring an
issuer to satisfy one of four threshold tests, thereby enabling
different types of issuers (e.g., a brick-and-mortar business versus an
online business) to confirm local residency and demonstrate the in-
state nature of their business.\90\ Another commenter, although noting
that the proposed requirements and thresholds appropriately reflect
characteristics that are in keeping with establishing a local presence,
was concerned that having to meet only one requirement may not
establish the local connection of the issuer to the state to the degree
anticipated by Section 3(a)(11) and encouraged a close review of this
issue in a Commission study.\91\
---------------------------------------------------------------------------

\89\ CFA Letter; CFIRA Letter; CrowdCheck Letter; NASAA Letter.
\90\ NASAA Letter.
\91\ CFA Letter (``If the Commission determines to adopt the
proposed approach, however, we encourage a close review in the study
the Commission intends to undertake within three years of the
adoption of the amendments.''). See note 106.
---------------------------------------------------------------------------

Two commenters supported our proposed amendment to the ``doing
business'' test to add an alternative threshold requirement based on
the location of a majority of an issuer's employees.\92\ Several
commenters supported using this additional criterion, but with
different percentage thresholds.\93\ Some of these commenters
recommended requiring that at least 80% of the issuer's employees be
based in the state,\94\ while another commenter supported requiring
that at least 75% of the issuer's employees be based in the state.\95\
---------------------------------------------------------------------------

\92\ Milken Letter; NASAA Letter.
\93\ Ely Letter; MacDougall Letter; Pearl Letter; Terdal Letter;
Wolff Letter.
\94\ Ely Letter; MacDougall Letter; Pearl Letter; Terdal Letter.
\95\ Wolff Letter.
---------------------------------------------------------------------------

Several commenters opposed our proposed ``doing business''
requirements in favor of alternative standards.\96\ For example, some
of these commenters supported the use of five alternative criteria in
order for an issuer to be deemed a ``state business,'' specifically:
the issuer's main office be located in-state, and at least 80% of the
funds raised be used in-state, work is done in-state, employees live
in-state and owners reside in-state.\97\ Another commenter supported
generally these same criteria, but using 75% thresholds as opposed to
80% thresholds.\98\ Other commenters recommended a more flexible
standard that would move away from the strict 80% thresholds in favor
of majority requirements that would harmonize the current ``doing
business'' tests with the proposed test for number of employees.\99\
Finally, another commenter suggested a periodic review by the
Commission to evaluate the 80% thresholds to determine whether the
exemption succeeds in facilitating the goal of small business capital
formation while protecting investors.\100\
---------------------------------------------------------------------------

\96\ Ely Letter; MacDougall Letter; Pearl Letter; Terdal Letter.
\97\ Ely Letter; MacDougall Letter; Pearl Letter (recommending
that an issuer be required to satisfy ``at least three'' of these
five criteria or from an alternative ``reasonable list''). Cf.
Terdal Letter (``A more appropriate test of a ``local company''
would be one that has at least 80% of the employees' wages paid in
state, or perhaps 80% of the work (i.e. manufacturing, producing,
brewing, etc.) be done in state.'').
\98\ Wolff Letter (recommending 75% thresholds for use of funds,
work done in-state, and number of employees residing in-state but
that the rules require only a majority of the owners' primary
residences be located in-state).
\99\ Milken Letter (stating that the requirement for a precise
80% threshold ``can be confusing and difficult for issuers to
assess. Additionally, the high and precise threshold can exclude
issuers that rationally should qualify.''); Pearl Letter.
\100\ NASAA Letter.
---------------------------------------------------------------------------

c. Final Rules
After considering the comments, we are adopting, as proposed,
updated and modernized ``doing business'' requirements in Rule 147 and
new Rule 147A to comport with contemporary small business
practices.\101\ We believe these updated requirements will expand the
universe of issuers that may rely on Section 3(a)(11) and the amended
Rule 147 safe harbor, as well as new Rule 147A, to conduct exempt
intrastate offerings, while continuing to require issuers to have an
in-state presence sufficient to justify reliance on these provisions.
Given the increasing ``interstate'' nature of small business
activities, we believe it has become increasingly difficult for
companies, even smaller companies that are physically located within a
single state or territory, to satisfy the issuer ``doing business''
requirements of current Rule 147(c)(2).\102\ Accordingly, we believe
these issuer ``doing business'' requirements, identical for both
amended Rule 147 and new Rule 147A, will provide issuers with greater
flexibility in conducting intrastate offerings and expand the
availability of

[[Page 83502]]

these two intrastate offering provisions.\103\
---------------------------------------------------------------------------

\101\ See Rules 147(c)(2) and 147A(c)(2).
\102\ See discussion in Section II.A.2 above.
\103\ See, e.g., Transcript of Record 82-91, SEC Advisory
Committee on Small and Emerging Companies (June 3, 2015).
---------------------------------------------------------------------------

As proposed, we are adopting amendments to Rule 147(c)(2) and
including provisions in new Rule 147A(c)(2) that will provide issuers
with greater flexibility to satisfy the current ``doing business''
requirements by adding an alternative test based on the location of a
majority of the issuer's employees while retaining the three 80%
threshold tests in current Rule 147(c)(2).\104\ Furthermore, while the
substance of the three 80% threshold requirements of current Rule
147(c)(2) is being retained in the final rules, compliance with any one
of the 80% threshold requirements (or the additional test based on the
majority of employees) will be sufficient to demonstrate the in-state
nature of the issuer's business, as proposed. This is a change from
current Rule 147(c)(2), which requires issuers to satisfy all three 80%
threshold requirements.
---------------------------------------------------------------------------

\104\ See Rules 147(c)(2) and 147A(c)(2).
---------------------------------------------------------------------------

We recognize that commenters had various alternative views on these
requirements. While some commenters sought to require issuers to meet
additional criteria, other commenters sought to lower the percentage
thresholds in the criteria to ease the issuer requirements. We believe
that the approach we are adopting in the final rules will provide
issuers with additional flexibility to satisfy the requirements, while
continuing to function as meaningful indicia of the in-state nature of
the issuer's business. In light of the fact that issuers will need to
meet only one of the threshold tests, we are not changing the current
80% threshold tests to a majority requirement as one commenter
suggested.\105\ We believe it is appropriate to first observe how the
updated doing business in-state requirements are used by issuers in
practice before making any further changes.\106\ Except as discussed
below, we also are not adopting alternative criteria for the doing
business in-state requirements, as suggested by several
commenters.\107\ We believe the existing criteria have generally served
states, issuers and investors well by being easy to understand and
apply, and when updated as discussed above, will appropriately reflect
characteristics in keeping with a local business presence.\108\
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\105\ See Milken Letter.
\106\ As we indicated in the Proposing Release, we expect the
staff to undertake to study and submit a report to the Commission no
later than three years following the effective date of the final
rules on whether this new framework appropriately provides
assurances that an issuer is doing business in the state in which
the offering takes place.
\107\ See Ely Letter; MacDougall Letter; Pearl Letter; Terdal
Letter.
\108\ See CFA Letter.
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We are also making certain technical revisions to the three current
80% thresholds, as proposed, that we believe will simplify the
structure and application of the rules.\109\ In light of our amendments
to require issuers to satisfy only one of the threshold tests, we are
eliminating the current provision in Rule 147(c)(2)(i)(B), which does
not apply the revenue test to issuers with less than $5,000 in revenue
during the prior fiscal year.\110\ While this accommodation may be
reasonable in the context of the current conjunctive 80% threshold
requirements of Rule 147(c)(2), we do not believe it is necessary under
the new disjunctive approach that we are adopting in these rules.
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\109\ For example, in order to streamline the presentation of
Rule 147(c)(2), we are re-designating current Rule 147(c)(2)(i)(A)-
(B), 17 CFR 230.147(c)(2)(i)(A)-(B), which includes instructions on
how to calculate revenue under Rule 147(c)(2)(i), as Instruction to
paragraph (c)(2)(i) of Rule 147. Similarly, Rule 147A will also
include an instruction on how to calculate revenue under Rule
147A(c)(2)(i).
\110\ 17 CFR 230.147(c)(2)(i)(B).
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Consistent with the proposal, and as supported by commenters, we
are adding an alternative requirement to the three modified 80%
threshold requirements. This requirement, which relates to the location
of a majority of the issuer's employees, will provide an additional
method by which an issuer may demonstrate that it conducts in-state
business sufficient to justify reliance on either Rule 147 or new Rule
147A. For these purposes, we are permitting an issuer to satisfy the
``doing business'' requirements by having a majority of its employees
based in such state or territory.\111\ An employee would be based in
the same state or territory of the issuer for purposes of this test if
such employee is based out of offices located within such state or
territory.\112\ For example, if an employee provides services in the
Maryland, Virginia and Washington, DC metro area out of the offices of
a company in Maryland, the employee would be based in Maryland for
purposes of this test. While some commenters suggested different
thresholds for the employee test (ranging from 75% to 80%), we believe
that using a majority of the employees test provides a standard that
more accurately captures the increasingly flexible ways that companies
structure and conduct their business operations, while still requiring
that more employees be located in-state than elsewhere. Current
workforce trends, such as telecommuting, whereby employees often work
in a different geographical location from their employer, suggest that
flexibility is particularly needed in this area. We believe adding this
criterion to expand upon the current doing business requirements in
Rule 147(c)(2) will provide additional flexibility to issuers by making
these requirements more consistent with modern business practices,
especially in light of the different roles employees play within
smaller companies and the different locations in which employees carry
out such roles, while still providing important indicia of the in-state
nature of an issuer's business.
---------------------------------------------------------------------------

\111\ See Rules 147(c)(2)(iv) and 147A(c)(2)(iv).
\112\ The state or territory in which an employee is based may,
or may not, be the same state or territory in which the employee
resides.
---------------------------------------------------------------------------

2. Reasonable Belief as to Purchaser Residency Status
a. Proposed Amendments
Consistent with the requirements in Regulation D,\113\ we proposed
to add a reasonable belief standard to the issuer's determination as to
the residence of the purchaser at the time of the sale of the
securities.\114\ As proposed, an issuer would satisfy the requirement
that the purchaser in the offering be a resident of the same state or
territory as the issuer's principal place of business by either the
existence of the fact that the purchaser is a resident of the
applicable state or territory, or by establishing that the issuer had a
reasonable belief that the purchaser of the securities in the offering
was a resident of such state or territory.\115\ We also proposed to
eliminate the requirement in current Rule 147 that issuers obtain a
written representation from each purchaser as to his or her residence,
as we believed this requirement may be unnecessary in light of the
proposed reasonable belief standard.\116\
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\113\ Rule 501(a) of Regulation D includes in the definition of
``accredited investor,'' persons who come within the enumerated
categories of the rule, or who the issuer reasonably believes come
within any of such categories, at the time of sale to such person.
17 CFR 230.501(a).
\114\ See proposed Rule 147(d).
\115\ Id.
\116\ 17 CFR 230.147(f)(1)(iii).
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b. Comments on the Proposed Amendments
Several commenters supported the proposal to include a reasonable
belief standard.\117\ One of these commenters

[[Page 83503]]

stated that a reasonable belief standard will provide more certainty
for issuers about the availability of the exemption and increase its
utility without sacrificing investor protection.\118\
---------------------------------------------------------------------------

\117\ ABA Letter; City of Adrian Letter; CFA Letter; NASAA
Letter.
\118\ NASAA Letter.
---------------------------------------------------------------------------

Commenters were divided on whether to eliminate the requirement to
obtain a written representation from the purchaser as to his or her
residence, with two commenters supporting the proposed elimination of
the requirement \119\ and two commenters opposing it.\120\ Commenters
opposing elimination of the requirement stated that the written
representation should not be the sole indication of residency under a
facts and circumstances exercise, but asserted that it is a useful
indication of residency.\121\
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\119\ CFIRA Letter; CrowdCheck Letter.
\120\ CFA Letter; NASAA Letter.
\121\ NASAA Letter (``this requirement should remain in place
but may be construed as evidence of, but not be dispositive of, a
reasonable belief of purchaser residency.'').
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Several commenters requested that the Commission provide a safe
harbor for determining an individual purchaser's residence, based upon
certain objective criteria.\122\ Two of those commenters supported the
creation of a non-exclusive safe harbor setting out the means by which
a reasonable belief may be established, including the circumstances in
which an issuer may rely on the steps taken by a third-party, such as a
service provider or intermediary.\123\ Another of those commenters
stated that Commission staff should work with the states to standardize
requirements for determining state of residency for purposes of
investor participation in an offering to help ensure compliance with
the residency requirement.\124\ In addition, the 2015 Small Business
Forum recommended that the Commission create a safe harbor for
determining the ``place of business'' of a non-natural person investor
in Rule 147 offerings, which could be as simple as a self-certification
as to its place of business.\125\
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\122\ CFIRA Letter; CrowdCheck Letter; Letter from Brandon
Smith, Managing Principal, Localstake Marketplace LLC, November 17,
2015 (``Localstake Letter''); Letter from Rose Oswald-Poels,
President/CEO, Wisconsin Bankers Association, January 8, 2016 (``WBA
Letter'').
\123\ CFIRA Letter; CrowdCheck Letter.
\124\ Localstake Letter.
\125\ See 2015 Small Business Forum Recommendations.
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c. Final Rules
Consistent with the proposal, and with the determination of
accredited investor status under Regulation D,\126\ we are adopting
amendments to Rule 147 and a provision in new Rule 147A that will
include a reasonable belief standard for the issuer's determination as
to the residence of the purchaser at the time of the sale of the
securities.\127\ Under the final rules, an issuer will satisfy the
requirement that the purchaser in the offering be a resident of the
same state or territory in which the issuer is resident by either the
existence of the fact that the purchaser is a resident of the
applicable state or territory, or by establishing that the issuer had a
reasonable belief that the purchaser of the securities in the offering
was a resident of such state or territory.\128\ Under current Rule
147(d), regardless of the efforts an issuer takes to determine that
potential investors are residents of the state in which the issuer is
resident, the exemption is lost for the entire offering if securities
are offered or sold to just one investor that was not in fact a
resident of such state. We continue to believe that permitting issuers
to sell on the basis of a reasonable belief of a purchaser's in-state
residency status will increase the utility of amended Rule 147 and new
Rule 147A by providing issuers with additional certainty about the
availability of the exemption under Section 3(a)(11) or new Rule 147A
while still providing appropriate investor protections.\129\
---------------------------------------------------------------------------

\126\ See note 113 above.
\127\ See Rules 147(d) and 147A(d).
\128\ Id.
\129\ The burden will continue to be on the issuer to establish
that the purchaser is an in-state resident or that the issuer had a
reasonable belief as to residency. Otherwise, the sale to a non-
resident purchaser would preclude reliance on amended Rule 147 or
new Rule 147A.
---------------------------------------------------------------------------

In a change from the proposal, both amended Rule 147 and new Rule
147A will include a requirement that issuers obtain a written
representation from each purchaser as to his or her residence.\130\ We
are persuaded by those commenters who stated that this requirement
should be retained and considered as evidence of, but not be
dispositive of, the purchaser's residency. In the context of Section
3(a)(11), the Commission has previously indicated that ``[t]he mere
obtaining of formal representations of residence . . . should not be
relied upon without more as establishing the availability of the
exemption.'' \131\ Whether an issuer has formed a reasonable belief
that the prospective purchaser is an in-state resident will be
determined on the basis of all facts and circumstances. Obtaining a
written representation from purchasers of in-state residency status
will not, without more, be sufficient to establish a reasonable belief
that such purchasers are in-state residents.\132\
---------------------------------------------------------------------------

\130\ See Rules 147(f)(1)(iii) and 147A(f)(1)(iii).
\131\ See 1961 Release at 3.
\132\ See Instruction to paragraph (d) of Rule 147 and
Instruction to paragraph (d) of Rule 147A.
---------------------------------------------------------------------------

In addition to the written representation, other facts and
circumstances could include, but will not be limited to, for example, a
pre-existing relationship between the issuer and the prospective
purchaser that provides the issuer with sufficient knowledge about the
prospective purchaser's principal residence or principal place of
business so as to enable the issuer to have a reasonable basis to
believe that the prospective purchaser is an in-state resident. An
issuer may also consider other facts and circumstances when
establishing the residency of a prospective purchaser, such as evidence
of the home address of the prospective purchaser, as documented by a
recently dated utility bill, pay-stub, information contained in state
or federal tax returns, any documentation issued by a federal, state,
or local government authority, such as a driver's license or
identification card, or a public or private database that the issuer
has determined is reasonably reliable, including credit bureau
databases, directory listings, and public records.
While a few commenters \133\ and the 2015 Small Business Forum
recommended that the Commission provide a safe harbor for determining a
purchaser's residence, including the circumstances in which a
reasonable belief may be established, we are not doing so in the final
rules. Our rules do not provide a safe harbor for the reasonable belief
determination made under Rule 501(a) of Regulation D for exempt
offerings, and we do not believe that the determinations required for
amended Rule 147 and new Rule 147A present a more compelling case for
having such a provision. In addition, we are concerned that a safe
harbor could be viewed as an exclusive or minimum standard. We believe
that requiring issuers to consider the facts and circumstances in order
to establish a reasonable basis to believe that the purchaser is a
resident of the same state or territory in which the issuer is resident
is appropriate and will provide sufficient certainty for issuers
seeking to satisfy the requirements of the exemption. Commission staff
will consider available information on issuer compliance with the
``reasonable belief'' standards in connection with the study

[[Page 83504]]

of amended Rule 147 and new Rule 147A.\134\
---------------------------------------------------------------------------

\133\ CFIRA Letter; CrowdCheck Letter; Localstake Letter; WBA
Letter.
\134\ See Section I above.
---------------------------------------------------------------------------

3. Residence of Entity Purchasers
a. Proposed Amendments
We proposed to define the residence of a purchaser that is a legal
entity, such as a corporation, partnership, trust or other form of
business organization, as the location where, at the time of the sale,
the entity has its principal place of business.\135\ For these
purposes, we also proposed to define a purchaser's ``principal place of
business,'' consistent with the proposed definition for issuer
eligibility purposes, as the location in which the officers, partners,
or managers of the entity primarily direct, control and coordinate its
activities.\136\
---------------------------------------------------------------------------

\135\ See proposed Rule 147(d). Under the current rule, an
entity is a resident of the state or territory where the entity has
its ``principal office.'' Current Rule 147 does not define
``principal office.'' 17 CFR 230.147(c)(2)(iv).
\136\ See proposed Rule 147(c)(1).
---------------------------------------------------------------------------

b. Comments on the Proposed Amendments
Two commenters supported the proposed amendments to replace the
``principal office'' requirement for entity purchasers with the
``principal place of business'' standard, consistent with the standard
for issuers.\137\ One commenter suggested that the Commission clarify
how the residency of non-business trusts should be determined.\138\
---------------------------------------------------------------------------

\137\ NASAA Letter; NextSeed Letter.
\138\ Bishop Letter (recommending that Rule 147(d)(1) be amended
to add: ``A trust that is not deemed by the law of the state or
territory of its creation to be a separate legal entity is deemed to
be a resident of each state or territory in which its trustee is, or
trustees are, resident.'').
---------------------------------------------------------------------------

c. Final Rules
Consistent with the proposal, we are adopting amendments to Rule
147 and a provision in new Rule 147A that will define the residence of
a purchaser that is a legal entity, such as a corporation, partnership,
trust or other form of business organization, as the location where, at
the time of the sale, the entity has its principal place of
business.\139\ The final rules define a purchaser's ``principal place
of business,'' consistent with the definition for determining issuer
residency contained in paragraph (c)(1) of Rules 147 and 147A, as the
location in which the officers, partners, or managers of the entity
primarily direct, control and coordinate its activities.\140\ In
addition, as suggested by one commenter, \141\ we are adding an
instruction to the requirement as to the residency of the purchaser
stating that a trust that is not deemed by the law of the state or
territory of its creation to be a separate legal entity should be
deemed to be a resident of each state or territory in which its trustee
is, or trustees are, resident.\142\
---------------------------------------------------------------------------

\139\ See Rules 147(d) and 147A(d).
\140\ See Rules 147(c)(1), 147(d)(1), 147A(c)(1) and 147A(d)(1).
\141\ Bishop Letter.
\142\ See Instruction 1 to paragraph (d)(1) of Rule 147 and
Instruction 1 to paragraph (d)(1) of Rule 147A.
---------------------------------------------------------------------------

4. Limitation on Resales
a. Proposed Amendments
We proposed to amend the limitation on resales in Rule 147(e) to
provide that for a period of nine months from the date of the sale by
the issuer of a security sold pursuant to this rule, any resale by a
purchaser would need to be made only to residents within the
purchaser's state or territory of residence.\143\ In contrast, Rule
147(e) currently requires that during the period in which securities
are offered and sold in reliance on the intrastate offering exemption,
and for a period of nine months from the date of the last sale by the
issuer of such securities, all resales of any securities sold in the
offering shall only be made to persons resident within the state or
territory of which the issuer is a resident. In the Proposing Release,
we explained that the determination as to when a given purchase of
securities in an intrastate offering has come to rest in-state depends
less on a defined period of time after the final sale by the issuer in
such offering than it does on whether a resident purchaser has taken
the securities ``without a view to further distribution or resale to
non-residents.'' \144\ In this regard, we believed that a time-based
limitation on potential resales to non-residents that relates back to
the date of the purchase by a resident investor from the issuer would
more precisely address the concern regarding out-of-state resales.
---------------------------------------------------------------------------

\143\ Proposed Rule 147(e).
\144\ See Proposing Release, at text accompanying note 87.
---------------------------------------------------------------------------

We also proposed to amend Rule 147(b) so that an issuer's ability
to rely on Rule 147 would no longer be conditioned on a purchaser's
compliance with Rule 147(e).\145\ We believed that this proposed
amendment to the application of Rule 147(e), as it relates to Rule
147(b), would increase the utility of the exemption by eliminating the
uncertainty created in the offering process for issuers under the
current rules. As proposed, issuers would remain subject to
requirements relating to, for example, in-state sales limitations,
legends, stop transfer instructions for transfer agents, and offeree
and purchaser disclosures in order to satisfy the exemption at the
federal level. In addition, issuers would continue to be subject to the
antifraud and civil liability provisions of the federal securities
laws, as well as state securities law requirements. Lastly, although we
did not propose to amend our rules to provide that securities issued
under amended Rule 147 be considered ``restricted securities'' under
Rule 144(a)(3), \146\ we requested comments on this question.
---------------------------------------------------------------------------

\145\ See proposed Rule 147(b). As proposed, current Rule 147(a)
would be re-designated as Rule 147(b).
\146\ 17 CFR 230.144(a)(3).
---------------------------------------------------------------------------

b. Comments on the Proposed Amendments
Several commenters supported the proposed change to the limitation
on resales by resident purchasers to non-residents based on the date of
sale by the issuer to the relevant purchaser rather than based on the
date when the offering terminates.\147\ Commenters, however, had
differing views on the length of the holding period from the date of
sale. Two commenters supported a nine-month holding period from the
date of sale.\148\ One of these commenters reasoned that this period
sufficiently demonstrates the purchase was for investment without an
intent to distribute out-of-state or avoid registration.\149\ Two other
commenters stated that a period of six months is adequate to establish
that securities have ``come to rest'' in a state.\150\ Those commenters
noted that a nine-month period does not exist in any other securities
law requirements, so the potential exists for confusion. One commenter
recommended that the Commission clarify that bona fide gifts are not
subject to the limitation on resales out-of-state, and that a donee is
deemed to have acquired the securities when they were acquired by the
donor.\151\
---------------------------------------------------------------------------

\147\ CFA Letter; CFIRA Letter; CrowdCheck Letter; NASAA Letter.
\148\ CFA Letter; NASAA Letter.
\149\ NASAA Letter.
\150\ CrowdCheck Letter; CFIRA Letter. These commenters stated
that allowing a six-month period, by analogy to parts of Rule 144,
is more appropriate.
\151\ Bishop Letter.
---------------------------------------------------------------------------

Commenters were divided on whether securities issued under amended
Rule 147 should be considered ``restricted securities'' under Rule
144(a)(3). One commenter stated that securities issued under amended
Rule 147 should be considered ``restricted securities'' under Rule
144(a)(3).\152\ Two other

[[Page 83505]]

commenters stated that the securities should not be treated as
``restricted securities'' under Rule 144(a)(3), noting that the
``coming to rest'' in-state purpose of the nine-month restriction is
sufficiently distinct from the policy considerations underlying Rule
144.\153\
---------------------------------------------------------------------------

\152\ NASAA Letter.
\153\ CFIRA Letter; CrowdCheck Letter.
---------------------------------------------------------------------------

In addition, several commenters supported no longer conditioning
the availability of the exemption on purchaser compliance with Rule
147(e).\154\ One of those commenters reasoned that if an issuer takes
reasonable steps to comply with the limitations on resale, the issuer
should not lose the original exemption if a purchaser does not comply
with the resale restrictions at a later date.\155\
---------------------------------------------------------------------------

\154\ CFIRA Letter; CrowdCheck Letter; NASAA Letter.
\155\ NASAA Letter.
---------------------------------------------------------------------------

c. Final Rules
After considering the comments, we are adopting a requirement in
amended Rule 147 and new Rule 147A providing that for a period of six
months from the date of the sale of the security by the issuer any
resale of the security shall be made only to persons resident within
the state or territory in which the issuer was resident at the time of
the sale of the security by the issuer.\156\ We are persuaded by those
commenters that indicated that a period of six months is adequate to
establish that securities sold in an intrastate offering have ``come to
rest'' in a state by analogizing to provisions of Rule 144, in which a
six-month holding period is deemed sufficient to establish a requisite
investment intent.\157\ In this regard, given the use of a six-month
resale restriction in the Rule 144 context, we believe that a similar
resale restriction in the intrastate offering context should provide
adequate assurance that the securities will come to rest in-state.\158\
---------------------------------------------------------------------------

\156\ Rules 147(e) and 147A(e).
\157\ See CFIRA Letter and CrowdCheck Letter. Rule 144 provides
a safe-harbor from being deemed a ``statutory underwriter'' under
Section 2(a)(11) of the Securities Act. Specifically, Rule
144(d)(1)(i) requires a six-month holding period for restricted
securities sold by issuers reporting under the Exchange Act in order
for a purchaser to resell such securities and not be deemed an
underwriter.
\158\ In such circumstances, resales of securities that were
initially purchased in an intrastate offering must themselves be
registered or exempt from registration pursuant to any state
securities laws where such resale takes place.
---------------------------------------------------------------------------

We note that bona fide gifts are not subject to the limitation on
resales in amended Rule 147 or new Rule 147A.\159\ Since bona fide
gifts are not transactions for value, they require no investment
decision by the donee and thus do not involve the sale of a security
subject to regulation under the Securities Act.\160\ However, we note
that subsequent resales of donated securities are subject to the resale
restrictions regardless of the state in which the holder of the donated
securities resides. To address bona fide gifts of securities to out-of-
state donees, as well as the resales of securities that were wrongfully
sold to out-of-state purchasers, within the six month re-sale
limitation period, we are revising our proposed resale limitation to
focus on the state or territory in which the issuer was resident, as
opposed to where the last purchaser of the securities may have resided.
Accordingly, the resale limitation in the final rules limits resales to
``persons resident within the state or territory in which the issuer
was resident . . . at the time of the sale of the security by the
issuer'' as opposed to limiting resales to ``persons resident within
the purchaser's state or territory of residence,'' as proposed. We
believe this revision will address situations in which purchasers in
the offering subsequently gift or wrongfully sell their securities to
out-of-state residents who then wish to resell their securities within
the six month limitation of paragraph (e). This change to the rules
makes clear that the six-month limitation on resales applies to all
holders of the securities, including holders subsequent to the original
purchaser, whether they received the shares as a gift, donation, or by
purchase.\161\
---------------------------------------------------------------------------

\159\ See Bishop Letter.
\160\ Section 2(a)(3) of the Securities Act defines ``sale'' or
``sell'' to ``include every contract of sale or disposition of a
security or interest in a security, for value.'' A lack of monetary
consideration, however, does not always mean that there was not a
sale or offer for sale for purposes of Section 5. See, e.g., Capital
General Corporation, 54 SEC Docket 1714, 1728-29 (July 23, 1993)
(Capital General's ``gifting'' of securities constituted a sale
because it was a disposition for value, the ``value'' arising ``by
virtue of the creation of a public market for the issuer's
securities.''). See also SEC v. Harwyn Industries Corp., 326 F.
Supp. 943 (S.D.N.Y. 1971).
\161\ See Rules 147(e) and 147A(e).
---------------------------------------------------------------------------

As proposed, the resale limitation period for both amended Rule
147(e) and new Rule 147A(e) will relate back to the date of purchase by
a resident investor from the issuer, in contrast to current Rule 147(e)
that does not start the resale limitation period until the offering has
terminated (i.e., until all offers and sales have ceased).\162\ We
continue to believe that a time-based limitation on potential resales
to non-residents of securities purchased in an intrastate offering that
relates back to the date of purchase by a resident investor from the
issuer would more precisely address the concern regarding out-of-state
resales.
---------------------------------------------------------------------------

\162\ The resale limitation period may end on different dates
for different purchasers if the issuer sold shares on multiple
dates.
---------------------------------------------------------------------------

In light of our revision to the resale limitation to focus on the
state where the issuer is a resident, we are including additional
language in amended Rule 147(e) and new Rule 147A(e) to specify that
all re-sales during this six month resale limitation period will be
restricted to the state or territory in which the issuer was a resident
at the time of the sale of the security by the issuer to a purchaser.
Accordingly, if an issuer were to change its state or territory of
residence during the six month resale limitation period, all resales
would, nevertheless, continue to be limited to the state or territory
in which the issuer resided at the time of the original sale of
securities in reliance upon either Rule 147 or Rule 147A. We believe
this additional language will preserve the intent of the proposed
resale restriction--to help ensure that the securities offered pursuant
to an intrastate offering exemption have come to rest within the state
of the offering before being resold.
As proposed, an issuer's ability to rely on the respective rules
will not be conditioned on a purchaser's compliance with Rule 147(e)
and Rule 147A(e).\163\ As discussed in the Proposing Release, the
application of current Rule 147(e) in the overall scheme of the safe
harbor can cause uncertainty for issuers. We continue to believe that
removing the condition on purchaser compliance with Rule 147(e) will
increase the utility of the exemption by eliminating the uncertainty
created in the offering process for issuers under the current rules. As
one commenter noted, if an issuer takes reasonable steps to comply with
the limitations on resale, it should not lose the availability of the
exemption due to a purchaser not complying with the resale
limitations.\164\ We continue to believe that eliminating this
uncertainty should not result in an increased risk of issuer non-
compliance with the rules, because issuers will remain subject to
requirements relating to, for example, in-state sales limitations,
legends, stop transfer instructions for transfer agents, and offeree
and purchaser disclosures, in order to satisfy the exemption at the
federal level.\165\ In addition, issuers will

[[Page 83506]]

continue to be subject to the antifraud and civil liability provisions
of the federal securities laws, as well as state securities law
requirements.
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\163\ See Rules 147(b) and 147A(b). Current Rule 147(a) would be
re-designated as Rule 147(b).
\164\ NASAA Letter.
\165\ Commission staff will seek to review information gathered
by state regulators on issuer compliance with the legend
requirements in amended Rule 147(f) and new Rule 147A(f) as part of
the study of amended Rule 147 and new Rule 147A. See Section I.
---------------------------------------------------------------------------

Lastly, while one commenter believed that securities issued under
amended Rule 147 should be considered ``restricted securities'' under
Rule 144(a)(3), \166\ we believe that limiting the resale of these
securities only to persons resident within the same state or territory
in which the issuer is a resident for a period of six months from the
date of the sale of the security by the issuer to the purchaser is
sufficient to assure that the offering has come to rest in the state or
territory in which the issuer resides and thereby preserve the local
character of the offering. We note that states are free to impose any
additional requirements they believe are necessary to protect the
residents of their states, including imposing further transfer
restrictions on securities issued under amended Rule 147 or new Rule
147A similar to that required under Rule 144(a)(3). In addition,
persons reselling securities will need to consider whether they could
be an ``underwriter'' if they acquired the securities with a view to
``distribution'' or if they are participating in a ``distribution.''
\167\ A seller that complies with the conditions of the Rule 144 safe
harbor will not be deemed to be an underwriter.\168\
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\166\ Id.
\167\ See Section 4(a)(1) of the Securities Act (exempting from
registration ``transactions by any person other than an issuer,
underwriter, or dealer'') and Section 2(a)(11) of the Securities Act
(defining the term ``underwriter''). 15 U.S.C. 77d(a)(1) and 15
U.S.C. 77b(a)(11).
\168\ 17 CFR 230.144.
---------------------------------------------------------------------------

5. Integration
a. Proposed Amendments
The proposed Rule 147 integration safe harbor would include any
prior offers or sales of securities by the issuer, as well as certain
subsequent offers or sales of securities by the issuer occurring within
six months after the completion of an offering exempted by Rule 147. As
proposed, offers and sales made pursuant to Rule 147 would not be
integrated with:
Prior offers or sales of securities; or
Subsequent offers or sales of securities that are:
Registered under the Act, except as provided in proposed
paragraph (h) of Rule 147;
Exempt from registration under Regulation A (17 CFR
230.251 et seq.);
Exempt from registration under Rule 701 (17 CFR 230.701);
Made pursuant to an employee benefit plan;
Exempt from registration under Regulation S (17 CFR
230.901 through 230.905);
Exempt from registration under Section 4(a)(6) of the Act
(15 U.S.C. 77d(a)(6)); or
Made more than six months after the completion of an
offering conducted pursuant to this rule.\169\
---------------------------------------------------------------------------

\169\ See proposed Rule 147(g).
---------------------------------------------------------------------------

b. Comments on the Proposed Amendments
One commenter supported including registered offers and sales and
certain other exempt offerings occurring within six months after
completion of the offering in the integration safe harbor, as
proposed.\170\ The same commenter did not support providing a safe
harbor for any and all prior offers or sales of securities by the
issuer, as proposed in paragraph (g)(1) of the amended rule, and
instead recommended restricting the safe harbor to cover only offers
and sales of securities that take place before the six-month period
immediately preceding the Rule 147 offering.\171\ While acknowledging
that the proposed integration safe harbor is consistent with the
integration safe harbor in Rule 251(c) of Regulation A, the commenter
distinguished Regulation A from Rule 147 by noting that ``Regulation A
is a quasi-registration subject to regulatory oversight by the
Commission and the states while a Rule 147 offering may be exempt at
both the federal and state level.'' In determining an integration safe
harbor model to follow, the commenter indicated it would be better to
look to Rule 502(a) of Regulation D, which limits the safe harbor for
private offerings to offers and sales occurring either six months
before, or six months after, a Regulation D offering.\172\
---------------------------------------------------------------------------

\170\ NASAA Letter.
\171\ Id.
\172\ Id. Rule 502(a) provides that ``Offers and sales that are
made more than six months before the start of a Regulation D
offering or are made more than six months after completion of a
Regulation D offering will not be considered part of that Regulation
D offering, so long as during those six month periods there are no
offers or sales of securities by or for the issuer that are of the
same or a similar class as those offered or sold under Regulation D,
other than those offers or sales of securities under an employee
benefit plan as defined in Rule 405 under the Act.'' 17 CFR
230.502(a).
---------------------------------------------------------------------------

On the other hand, two commenters believed that Rule 147 offerings
should not be integrated with any other exempt offerings.\173\ One of
these commenters recommended that Rule 147 contain language expressly
stating that an offering made in reliance on Rule 147 will not be
integrated with another exempt offering made concurrently, provided
that each offering meets the requirements of the claimed
exemption.\174\
---------------------------------------------------------------------------

\173\ NextSeed Letter; Localstake Letter.
\174\ NextSeed Letter.
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c. Final Rules
After considering the comments, we are adopting amendments to the
integration safe harbor under Rule 147 and providing an identical
integration safe harbor provision in new Rule 147A, substantially as
proposed. The integration safe harbor will cover any prior offers or
sales of securities by the issuer, as well as certain subsequent offers
or sales of securities by the issuer occurring after the completion of
an offering pursuant to Rule 147 or Rule 147A, as applicable.
Accordingly, offers and sales made pursuant to Rules 147 and 147A will
not be integrated with:
Offers or sales of securities made prior to the
commencement of offers and sales of securities pursuant to Rules 147 or
147A; or
Offers or sales of securities made after completion of
offers and sales pursuant to Rules 147 or 147A that are:
Registered under the Securities Act, except as provided in
Rule 147(h) or Rule 147A(h);
Exempt from registration under Regulation A (17 CFR
230.251 et seq.);
Exempt from registration under Rule 701 (17 CFR 230.701);
Made pursuant to an employee benefit plan;
Exempt from registration under Regulation S (17 CFR
230.901 through 230.905);
Exempt from registration under Section 4(a)(6) of the Act
(15 U.S.C. 77d(a)(6)); or
Made more than six months after the completion of an
offering conducted pursuant to Rules 147 or 147A.\175\
---------------------------------------------------------------------------

\175\ See Rules 147(g) and 147A(g).
---------------------------------------------------------------------------

As discussed in the Proposing Release, integration safe harbors
provide issuers, particularly smaller issuers whose capital needs often
change, with greater certainty about their eligibility to comply with
an exemption from Securities Act registration.\176\ Consistent with the
proposal and the approach taken in Rule 251(c) of Regulation A, the
safe harbor from integration provided by Rule 147(g) and Rule 147A(g)
will expressly provide that any offer or sale made in reliance on the
respective rules will not be integrated with any other offer or sale
made either before the commencement of, or more than six

[[Page 83507]]

months after the completion of, the respective intrastate offerings
under either Rule 147 or Rule 147A. For transactions that fall within
the scope of the safe harbor, issuers will not have to conduct an
integration analysis of the terms of any offering being conducted under
the other specified provisions in order to determine whether the two
offerings would be treated as one for purposes of qualifying for either
exemption.\177\ While one commenter recommended that the Commission
adopt a safe harbor more closely aligned with the provisions of Rule
502(a) of Regulation D,\178\ we believe the integration safe harbor in
Rule 251(c) of Regulation A is more consistent with the Commission's
post-JOBS Act approach to integration that has evolved since the
adoption of Regulation D in 1982 to better articulate the principles
underlying the integration doctrine in light of current offering
practices and developments in information and communication
technology.\179\ As we explained in the Proposing Release, we believe
that our approach to integration will provide issuers with greater
certainty as to the availability of an exemption for a given offering
and increase consistency in the application of the integration doctrine
among the exemptive rules available to smaller issuers, while
preserving important investor protections provided in each
exemption.\180\
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\176\ See Proposing Release at Section II.B.4.d. (Integration);
see also 2015 Regulation A Release at Section II.B.5. (Integration).
\177\ The issuer will, however, need to comply with the
requirements of each exemption that it is relying upon. For example,
an offering made pursuant to Rule 506(b) will not be integrated with
a subsequent offering pursuant to Rule 147A, but the issuer will
need to comply with the requirements of each rule, including the
limitation on general solicitation for offers made pursuant to Rule
506(b).
\178\ NASAA Letter.
\179\ See also, Regulation Crowdfunding Adopting Release.
\180\ See Proposing Release at text accompanying note 103. See
also Rule 251(c) of Regulation A [17 CFR 230.251(c)]; Rule 701 [17
CFR 230.701]. Each exemption is designed based on a particular type
of offer and investor, with corresponding requirements that must be
satisfied.
---------------------------------------------------------------------------

The bright-line integration safe harbor we are adopting in amended
Rule 147(g) and new Rule 147A(g) will assist issuers, particularly
smaller issuers, in analyzing certain transactions, but will not
address the issue of potential offers or sales that occur concurrently
with, or close in time after, a Rule 147 or 147A offering. There is no
presumption that offerings outside the integration safe harbors should
be integrated. Rather, whether concurrent or subsequent offers and
sales of securities will be integrated with any securities offered or
sold pursuant to amended Rule 147 or new Rule 147A will depend on the
particular facts and circumstances, including whether each offering
complies with the requirements of the exemption that is being relied
upon for the particular offering.\181\ For example, an issuer
conducting a concurrent exempt offering for which general solicitation
is not permitted will need to be satisfied that purchasers in that
offering were not solicited by means of the offering made in reliance
on Rule 147 or new Rule 147A.\182\ If an offer fails to comply with the
requirements of the exemption, and the offer is not registered and no
other exemption is available, that offer would be in violation of
Section 5 of the Securities Act.
---------------------------------------------------------------------------

\181\ The integration concept was first articulated by the
Commission in 1933 and was further developed in two interpretive
releases issued in the 1960s. See SEC Rel. No. 33-97 (Dec. 28,
1933); SEC Rel. No. 33-4434 (Dec. 6, 1961); SEC Rel. No. 33-4552
(Nov. 6, 1962). The interpretive releases stated that determining
whether a particular securities offering should be integrated with
another offering requires an analysis of the specific facts and
circumstances of the offerings. The Commission identified five
factors to consider in making the determination of whether the
offerings should be integrated. See SEC Rel. No. 33-4552 (Nov. 6,
1962). See also Rule 502(a) of Regulation D. More recently, the
Commission has provided additional guidance to help issuers evaluate
whether two offerings should be integrated. In 2007, the Commission
provided a framework for analyzing how an issuer can conduct
simultaneous registered and private offerings. See SEC Release No.
33-8828 (Aug. 3, 2007) [72 FR 45116 (Aug. 10, 2007)]. In 2015, when
implementing provisions of the JOBS Act, the Commission applied this
framework to concurrent exempt offerings, including situations where
one offering permits general solicitation and the other does not.
See 2015 Regulation A Release at Section II.B.5 and Regulation
Crowdfunding Adopting Release at Section II.A.1.c. In those
releases, the Commission noted that an offering made pursuant to
Regulation A or Regulation Crowdfunding should not be integrated
with another exempt offering made by the issuer, provided that each
offering complies with the requirements of the exemption that is
being relied upon for the particular offering. Id.
\182\ For a concurrent offering under Rule 506(b), purchasers in
the Rule 506(b) offering could not be solicited by means of a
general solicitation under Rule 147 or new Rule 147A. The issuer
would need an alternative means of establishing how purchasers in
the Rule 506(b) offering were solicited. For example, the issuer may
have had a preexisting substantive relationship with such
purchasers. Otherwise, the solicitation conducted in connection with
the Rule 147 or Rule 147A offering would very likely preclude
reliance on Rule 506(b). See also SEC Rel. No. 33-8828 (Aug. 3,
2007) [72 FR 45116 (Aug. 10, 2007)].
---------------------------------------------------------------------------

Amended Rule 147, as a safe harbor under Section 3(a)(11), will
continue to prohibit out-of-state offers to any person not residing in
the same state or territory in which the issuer is resident.
Accordingly, an issuer conducting a concurrent exempt offering for
which general solicitation is permitted across state lines would be
unlikely to comply with the in-state offer restriction in Rule
147(b).\183\ For example, issuers relying on amended Rule 147 will not
be able to conduct a concurrent Regulation Crowdfunding offering, since
by its nature a Regulation Crowdfunding offering would involve a
multistate offer due to the offering terms being made publicly
available from an intermediary's online platform.\184\
---------------------------------------------------------------------------

\183\ See Rule 147(b).
\184\ For the same reasons, issuers will not be able to rely on
amended Rule 147 and conduct concurrent Regulation A offerings or
registered public offerings.
---------------------------------------------------------------------------

An issuer relying on the new Rule 147A exemption, which permits
multi-state offers, may conduct a concurrent exempt offering for which
general solicitation is permitted, so long as the issuer complies with
the legend and disclosure requirements of Rule 147A(f), as well as any
additional restrictions on the general solicitation required by the
other exemption concurrently being relied upon by the issuer. For
example, the limitations imposed on advertising the terms of the
offering pursuant to Rule 204 of Regulation Crowdfunding would limit
the issuer's general solicitation in a concurrent offering made
pursuant to Rule 147A. Similarly, an issuer conducting a concurrent
Rule 506(c) offering could not include in its Rule 506(c) general
solicitation materials an advertisement of a concurrent Rule 147A
offering, unless that advertisement also included the disclosure
required by, and otherwise complied with, paragraph (f) of Rule
147A.\185\
---------------------------------------------------------------------------

\185\ See Rule 147A(f); see also discussion in Section II.A.1.
---------------------------------------------------------------------------

As discussed in the Proposing Release, we are mindful of the risk
that offers made pursuant to an exemption shortly before a registration
statement is filed could be viewed as conditioning the market for that
registered offering. Accordingly, final Rules 147 and 147A will exclude
from the safe harbor any such offer made to persons other than
qualified institutional buyers and institutional accredited investors
within the 30-day period before a registration statement is filed with
the Commission.\186\ Commission staff expects to review issuer
compliance with the expanded integration safe harbor as part of the
study of amended Rule 147 and new Rule 147A.\187\
---------------------------------------------------------------------------

\186\ See Rules 147(h) and 147A(h). In such circumstances,
whether an offer made within the thirty-day period before the filing
of a registration statement constitutes an impermissible offer for
purpose of Securities Act Section 5(c) will be based on the facts
and circumstances of such offer.
\187\ See Section I above.
---------------------------------------------------------------------------

6. Disclosures to Investors
a. Proposed Amendments
We proposed to retain the substance of the disclosure requirements
of

[[Page 83508]]

current Rule 147(f)(3), in modified form. As proposed, Rule 147(f)(3)
would require issuers to make specified disclosures to offerees and
purchasers about the limitations on resale contained in proposed Rule
147(e) and to include the legend set forth in proposed Rule
147(f)(1)(i) on the certificate or other document evidencing the
offered security. Although the disclosure should be prominently
disclosed to each offeree and purchaser at the time any offer or sale
is made by the issuer to such person, the proposed amendments would no
longer require that such disclosure be made in writing in all
instances. Instead, the proposed amendments would require issuers to
provide the required disclosure to offerees in the same manner in which
an offer is communicated, while continuing to require written
disclosure to all purchasers. In addition, the proposed amendments
would no longer require issuers to disclose to offerees and purchasers
the stop transfer instructions provided by an issuer to its transfer
agent \188\ or the provisions of Rule 147(f)(2) regarding the issuance
of new certificates during the Rule 147(e) resale period.\189\
---------------------------------------------------------------------------

\188\ See 17 CFR 230.147(f)(1)(ii).
\189\ See 17 CFR 230.147(f)(2).
---------------------------------------------------------------------------

b. Comments on the Proposed Amendments
Two commenters supported the proposal to include in the text of the
amended rule the specific language of the required disclosure.\190\
These commenters also stated that all offerees and purchasers should
continue to receive written disclosures, rather than, as proposed,
permitting offerees to receive oral disclosures if the offer is
communicated orally.\191\
---------------------------------------------------------------------------

\190\ CFA Letter; NASAA Letter.
\191\ Id.
---------------------------------------------------------------------------

c. Final Rules
After considering the comments, we are adopting amendments to Rule
147 and a provision in new Rule 147A that will require issuers to make
specified disclosures to offerees and purchasers about the limitations
on resale contained in Rules 147(e) and 147A(e), respectively. Issuers
will also be required to meet the legend requirement of Rules
147(f)(1)(i) and 147A(f)(1)(i), respectively. Although the disclosure
should be prominently disclosed to each offeree and purchaser at the
time any offer or sale is made by the issuer to such person, consistent
with the proposal, the amendment and new rule will not require that
such disclosure be made in writing in all instances.
While two commenters recommended that we require issuers to provide
all offerees written disclosures, rather than permitting offerees to
receive oral disclosures if the offer is communicated orally,\192\ we
are not adopting that requirement in our rules. We believe the approach
we are adopting--requiring issuers to provide the disclosure to
offerees in the same manner in which an offer is communicated--will
provide appropriate flexibility to issuers in the conduct of their
offerings and avoid potential confusion as to when, for example, an
oral offer must be followed up with a written disclosure.\193\
Requiring the disclosure to be made orally if the offer is made orally
also will help ensure that the investor receives the required
disclosure when most relevant (i.e., immediately upon learning about
the offer). Furthermore, we believe our amendments to Rule 147(f)(3)
and the provision in new Rule 147A(f)(3) will maintain appropriate
investor protections, especially in light of the new provision
requiring issuers to provide written disclosure to all purchasers
within a reasonable period of time before the date of sale. We note
that this requirement to provide written disclosure a reasonable period
of time before the date of sale is consistent with the disclosure
delivery requirements of Regulation D and Rule 701.\194\ Finally, while
we are not adopting commenters' suggestions to require that written
disclosure be provided to all offerees, nothing in our rules prevents
state regulators, that deem it necessary and appropriate, from
requiring such written disclosures for offers to residents within their
states. State regulators are in a position to tailor any such rules to
their local capital markets in a manner that addresses capital market
practices and investor protection measures they deem appropriate for
offers and sales to residents of their state.
---------------------------------------------------------------------------

\192\ Id.
\193\ In addition, it may not be possible for an issuer to
provide written disclosures to all offerees. For example, an issuer
conducting an offer over the radio would not be able to provide the
written disclosures to everyone listening to the offer on the radio
as it would not know the identity of each of the offerees.
\194\ See e.g., Rules 501(i)(4) and 502(b)(1) of Regulation D
and Rule 701(e).
---------------------------------------------------------------------------

Consistent with the proposal, issuers will also be required to
satisfy the legend requirement in Rules 147(f)(1)(i) and 147A(f)(1)(i),
respectively. However, issuers will not be required to disclose to
offerees and purchasers the stop transfer instructions provided by an
issuer to its transfer agent \195\ or the provisions of Rules 147(f)(2)
and 147A(f)(2), respectively, regarding the issuance of new
certificates during the resale period.\196\ Although issuers will have
to comply with these transfer agent instruction requirements,\197\ we
continue to believe that requiring issuers to disclose information
regarding such requirements to offerees and purchasers at the time of
the offer and/or sale will not enhance the disclosure requirements
under Rules 147(e), 147A(e), 147(f)(1) or 147A(f)(1), and we therefore
are eliminating the disclosure requirements related to stop transfer
instructions and the issuance of new certificates from Rule 147 and not
including them in new Rule 147A.\198\
---------------------------------------------------------------------------

\195\ See 17 CFR 230.147(f)(1)(ii).
\196\ See 17 CFR 230.147(f)(2). Additionally, as discussed in
Section II.B.1 above, we are requiring issuers in offerings
conducted pursuant to Rule 147 or Rule 147A to disclose to each
offeree in the manner in which any offer is communicated and to each
purchaser of a security in writing that sales will be made only to
residents of the same state or territory as the issuer. See Rules
147(f)(3) and 147A(f)(3).
\197\ See Rules 147(f)(1)(ii), 147(f)(2), 147A(f)(1)(ii) and
147A(f)(2).
\198\ See Rules 147(f)(3) and 147A(f)(3).
---------------------------------------------------------------------------

Finally, in order for the required disclosure to offerees and
purchasers under amended Rule 147(f) and new Rule 147A(f) to be as
clear as possible, and consistent with our revisions to make the
issuer's state of residency the focus of the relevant resale
restrictions, we are adding a requirement that the issuer identify in
this disclosure the particular state or territory in which the issuer
was resident at the time of the original sale of the security. Since a
small business may change the location of its residence and principal
activities within the six-month resale limitation period provided for
in amended Rule 147(e) and new Rule 147A(e), we believe this
information, which should be readily available to the issuer, will
assist purchasers in understanding the implications of the applicable
resale restrictions.
7. State Law Requirements
a. Proposed Amendments
We proposed to limit the availability of Rule 147 to issuers that
have registered an offering in the state in which all of the purchasers
are resident or that conduct the offering pursuant to an exemption from
state law registration in such state that limits the amount of
securities an issuer may sell pursuant to such exemption to no more
than $5 million in a twelvemonth period and that limits the amount of
securities an investor can purchase in any such offering.\199\ In the
Proposing Release, we expressed our preliminary view that, in light of
the other proposed changes to

[[Page 83509]]

Rule 147, including a maximum offering amount limitation and investment
limitations in the rule would provide investors with additional
protection and would be consistent with existing state law crowdfunding
provisions.\200\
---------------------------------------------------------------------------

\199\ See proposed Rule 147(a).
\200\ See Proposing Release.
---------------------------------------------------------------------------

b. Comments on the Proposed Amendments
All commenters that addressed the issue opposed any limits at the
federal level on offering size or investment size.\201\ In general,
these commenters preferred that any limits be imposed through the state
legislative and/or rulemaking process, which they stated may be better
situated to making a determination about specific limits.\202\
Commenters also stated that the requirements are unnecessary at the
federal level since these are local offerings where only the individual
state's residents are involved.\203\ One of these commenters noted the
potential disparate impact on larger versus smaller states with
different resident populations and gross domestic products.\204\
Another of these commenters noted that, in addition to the regulation
of these offerings at the state level, to the extent federal regulatory
oversight is deemed necessary, these offerings are also subject to the
Commission's powers to enforce the antifraud provisions of Section
10(b) of the Exchange Act and Rule 10b-5 thereunder.\205\ Another of
these commenters stated that the baseline cost of the proposed federal
requirements may prevent state policy makers from adding investor
protection provisions that the states consider to be more effective due
to the cumulative compliance burden.\206\ In addition, the 2015 Small
Business Forum recommended that the Commission remove the $5 million
limit in the proposal, permitting the states to set their own limits as
appropriate.\207\
---------------------------------------------------------------------------

\201\ See ABA Letter; Letter from Rutheford B. Campbell, Jr.,
Spears-Gilbert Professor of Law, University of Kentucky College of
Law, March 30, 2016 (``Campbell Letter''); CFIRA Letter;
Congressional Letter (``the states are better positioned to
determine offering and investment caps that best meet their local
population and business needs''); CrowdCheck Letter; Guzik Letter;
Milken Letter; NASAA Letter; NextSeed Letter; WBA Letter.
\202\ See, e.g., ABA Letter; Campbell Letter; CFIRA Letter;
Congressional Letter; CrowdCheck Letter; Guzik Letter; NASAA Letter;
WBA Letter.
\203\ ABA Letter; Campbell Letter; CFIRA Letter; CrowdCheck
Letter; Guzik Letter; Milken Letter; NASAA Letter; NextSeed Letter;
WBA Letter.
\204\ NASAA Letter.
\205\ Guzik Letter.
\206\ Milken Letter.
\207\ See 2015 Small Business Forum Recommendations.
---------------------------------------------------------------------------

A few commenters stated that, if the proposed limits were retained,
any limit on the amount a company can raise under Rule 147 should be
indexed for inflation,\208\ with one of these commenters suggesting an
automatic, periodic review of any such limits.\209\ One commenter
strongly encouraged the Commission to raise the offering limit
significantly.\210\ Two commenters believed that, if the proposed
limits were retained, Rule 147 should be amended to require that the
offering, not the state exemption, be limited to no more than $5
million in order to allow issuers to rely upon existing state law
exemptions.\211\ One of these commenters also suggested that, if the
proposed investment limits were retained, the Commission should
establish them as direct requirements of amended Rule 147 and should
only apply them to non-accredited investors.\212\
---------------------------------------------------------------------------

\208\ ABA Letter; NASAA Letter; Milken Letter.
\209\ NASAA Letter.
\210\ WBA Letter.
\211\ Bishop Letter; WBA Letter.
\212\ WBA Letter.
---------------------------------------------------------------------------

c. Final Rules
Given the comments received, the recommendations of the 2015 Small
Business Forum and the intrastate nature of the offerings, we are not
limiting amended Rule 147 and new Rule 147A to offerings that either
are registered in the state where all of the purchasers are resident or
that are conducted pursuant to an exemption from state law registration
in a state that limits the amount of securities an issuer may sell
pursuant to such exemption to no more than $5 million in a twelve-month
period and that limits the amount of securities an investor can
purchase in any such offering. Consistent with the policy underlying
Section 3(a)(11), we believe it appropriate that the resident investor
protections in intrastate offerings primarily flow from the
requirements of state securities law. For example, as with the federal
securities laws, states generally require an issuer to register an
offering with appropriate state authorities when offers or sales of
securities are made to their residents, unless the state has adopted,
by rule or statute, an exemption from registration. As noted in the
Proposing Release, of the states that have adopted and/or enacted
crowdfunding provisions that require an issuer to comply with Rule 147,
either alone or in conjunction with Section 3(a)(11), no state has
adopted and/or enacted a crowdfunding provision with an aggregate
offering amount that exceeds $5 million.\213\ Additionally, almost all
of these states have adopted provisions that impose investment
limitations on investors.
---------------------------------------------------------------------------

\213\ See https://www.nasaa.org/industry-resources/corporation-finance/instrastate-crowdfunding-resource-center/intrastate-crowdfunding-directory/. Illinois is the only state with a
crowdfunding provision allowing for a maximum aggregate offering
amount up to $5 million in a twelve-month period. All other states
that have adopted some form of a state-based crowdfunding provision
limit the aggregate offering amount to between $1 million and $2.5
million. See Illinois House Bill 3429, Sec. 4.T. (2015), available
at https://legiscan.com/IL/text/HB3429/id/1257029.
---------------------------------------------------------------------------

In light of these existing limitations in state exemptions and the
fact that all commenters opposed our proposed limits at the federal
level on offering size and investment size, we are not adopting the
proposed federal limits on state exemptions. As commenters noted,
states can decide whether to adopt requirements not specifically
contemplated by the federal requirements that are consistent with their
respective interests in facilitating capital formation and protecting
their resident investors in intrastate securities offerings within
their jurisdiction.\214\ If any states determine to amend their
statutes and/or rules to require compliance with new Rule 147A, those
states can consider whether any additional requirements should be
adopted at the state level given their interest in regulating local
offerings within their jurisdiction. Moreover, in addition to state
securities law requirements, issuers will continue to be subject to the
antifraud and civil liability provisions of the federal securities
laws.
---------------------------------------------------------------------------

\214\ States currently employ this approach to varying degrees
in their respective state crowdfunding statutes. See, e.g., D.C.
Mun. Regs. tit. 26-B, Sec. 250 (2014) (escrow required until
minimum offering amount satisfied), Ind. Code Sec. 6-3.1-24-14
(2014) (funding portal required).
---------------------------------------------------------------------------

C. Additional Considerations

In addition to soliciting specific comments on the proposals, we
also solicited general comments, including additional or different
revisions to the rules and other matters that may impact the proposals.
1. Notice Filings
Commenters were divided on whether to require issuers utilizing the
exemption to make a notice filing with the Commission. While one
commenter specifically stated that additional federal administrative
obligations, such as new minimum disclosure or delivery requirements,
registration and/or additional filings with the Commission, should not
be imposed on issuers for

[[Page 83510]]

conducting intrastate crowdfunding,\215\ another commenter recommended
that the Commission require issuers utilizing Rule 147 to file a notice
with the Commission, but (similar to Regulation D) the exemption should
not be conditioned on the filing.\216\ Given the local intrastate
nature of the exemptions, we continue to believe that the limited
benefits of a notice filing with the Commission would not justify the
costs and burdens on issuers to add such a requirement. We note,
however, that states could make a notice filing (at the state level) a
condition to any state law exemption.\217\ In this regard, we note that
a vast majority of intrastate crowdfunding provisions require a notice
filing with a state regulator.\218\ Commission staff will seek to
collaborate with state regulators to consider filing data in connection
with the study of amended Rule 147 and new Rule 147A.\219\
---------------------------------------------------------------------------

\215\ NextSeed Letter.
\216\ Campbell Letter.
\217\ See NASAA Letter.
\218\ E.g., Alabama, Arizona, Colorado, Delaware, Florida,
Georgia, Idaho, Illinois, Iowa, Indiana, Kansas, Kentucky, Maine,
Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Montana,
Nebraska, New Mexico, North Carolina, Oregon, South Carolina,
Tennessee, Texas, Vermont, Washington, West Virginia, Wisconsin,
Wyoming and the District of Columbia. Other states have pending
legislation that would require notice filings for intrastate
crowdfunded offerings, e.g., California, Hawaii, Missouri, Nevada,
and New Hampshire.
\219\ See Section I above.
---------------------------------------------------------------------------

2. Intrastate Broker Dealer Exemption
Exchange Act Section 15(a)(1) exempts from broker-dealer
registration requirements under Section 15(b) a broker-dealer whose
business is exclusively intrastate and who does not use any facility of
a national securities exchange (``intrastate broker-dealer
exemption'').\220\ Several commenters supported interpreting the
intrastate broker-dealer exemption under the Exchange Act to include
intermediaries whose activities are limited to facilitating intrastate
offerings using the Internet.\221\ One commenter was concerned that
intrastate intermediaries operating exclusively online may not qualify
for the intrastate exemption from registration if they post information
on the Internet and it is accessed by out-of-state residents.\222\ The
commenter, therefore, suggested that the Commission clarify that an
entity will not relinquish its ability to rely on the intrastate
broker-dealer exemption solely because it has a web presence, as long
as it continues to operate and conduct sales intrastate.\223\ Two
commenters similarly suggested that intrastate intermediaries should be
able to rely on the intrastate broker-dealer exemption from broker-
dealer registration if they use the Internet to facilitate offerings
being conducted in reliance on Rule 147.\224\
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\220\ Under Section 15(a)(1) of the Exchange Act, it is
generally unlawful for any broker or dealer to use any means or
instrumentality of interstate commerce to effect any transaction in,
or to induce or attempt to induce the purchase or sale of, any
security (other than an exempt security) unless the broker or dealer
is registered with the Commission. Section 15(a)(1) provides an
exemption from registration for ``a broker or dealer whose business
is exclusively intrastate and who does not make use of any facility
of a national securities exchange.''
\221\ See NASAA Letter; NextSeed Letter; WBA Letter. The
commenters were focused, in particular, on intermediaries that
facilitate intrastate crowdfunding offerings using the Internet.
\222\ NASAA Letter. This commenter noted that an SEC staff Guide
to Broker-Dealer Registration indicates that information posted on
the Internet that is accessible by persons in another state would be
considered an interstate offer of securities and would require
federal broker-dealer registration. See id. See also Guide to
Broker-Dealer Registration, Division of Trading and Markets, U.S.
Securities and Exchange Commission (Apr. 2008), available at https://www.sec.gov/divisions/marketreg/bdguide.htm. The Commission has not
previously spoken to this issue, and the guidance in this release is
intended to take into account modern business practices of broker-
dealers and clarify the permissibility of the use of the Internet by
broker-dealers relying on the intrastate broker-dealer exemption. To
the extent the staff guidance is inconsistent, it is superseded.
\223\ See NASAA Letter. The commenter also suggested that
intrastate broker-dealers be permitted to advertise and use the
Internet without having to register with the Commission so long as
they used certain disclaimers. Id.
\224\ NextSeed Letter (``[S]tate crowdfunding intermediaries
should be permitted to use the internet to facilitate intrastate
crowdfunding offerings pursuant to Rule 147 and still be able to
rely on the intrastate broker-dealer exemption.''); WBA Letter (``If
crowdfunding offerings conducted in accordance with amended Rule 147
are intrastate in nature, then state crowdfunding portals which
exclusively host such offerings should be deemed to conduct
`exclusively intrastate' business under [Section] 15(a)(1).'').
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We agree with the commenters that it would be helpful to provide
guidance regarding the use of the Internet by a person that seeks to
rely on the intrastate broker-dealer exemption.\225\ In providing this
guidance, we are seeking to take into account the contemporary business
practices of broker-dealers, which have evolved over the years to
include as a routine matter the use of the Internet as an essential
tool in conducting business. As noted elsewhere, the actions we are
taking today are intended to facilitate capital formation, while
maintaining appropriate investor protections. We believe that a broker-
dealer whose business otherwise meets the requirements of the
intrastate broker-dealer exemption should not cease to qualify for the
intrastate broker-dealer exemption solely because it has a Web site
that may be viewed by out-of-state persons, so long as the broker-
dealer takes measures reasonably designed to ensure that its business
remains exclusively intrastate.\226\ The use of disclaimers clearly
indicating that the broker-dealer's business is exclusively intrastate
and that the broker-dealer can only act for or with, and provide
broker-dealer services to, a person in its state could be one means
reasonably designed to ensure that the broker-dealer's business remains
exclusively intrastate so long as the broker-dealer does not provide
brokerage services to a person that indicates that it is, or that the
broker-dealer has reason to believe is, not within the broker-dealer's
state of residence.\227\ These measures are not

[[Page 83511]]

intended to be exclusive. A broker-dealer could adopt other measures
reasonably designed to ensure that it does not provide brokerage
services to persons that are not within the same state as the broker-
dealer. We do not believe, however, that an intermediary's business
would be ``exclusively intrastate'' if it sold securities or provided
any other brokerage services to a person that indicates that it is, or
that the broker-dealer has reason to believe is, not within the broker-
dealer's state of residence.\228\ We believe that this guidance will
facilitate capital formation by smaller companies while maintaining
appropriate protections for investors.\229\ This guidance also is
consistent with, and will further, the goal of modernizing our rules to
comport with contemporary business practices.
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\225\ Although commenters focused on broker-dealers who
facilitate intrastate crowdfunding offerings, we are providing more
general guidance not limited to offerings relying upon intrastate
crowdfunding provisions under state law.
\226\ As noted, Section 15(a)(1) of the Exchange Act provides an
exemption from registration for ``a broker or dealer whose business
is exclusively intrastate.'' Our guidance today is intended to
provide clarity regarding when a broker-dealer's business will be
``exclusively intrastate'' in connection with its use of the
Internet. As discussed in this section of this release, a broker-
dealer with a Web site that may be viewed by an out-of-state person
may still be able to rely on the intrastate exemption if the broker-
dealer implements measures reasonably designed to ensure that its
business remains exclusively intrastate. This guidance is separate
and apart from the question of whether a security may be offered and
sold on the broker-dealer's Web site in reliance on an exemption
from registration under Section 5 of the Securities Act. In this
regard, we note that an offer in the context of the Securities Act
has generally been defined broadly, and the considerations involved
in determining whether an offer includes an impermissible general
solicitation are necessarily distinct from the considerations as to
whether a broker-dealer's activities occur exclusively within a
single state. Therefore, a broker-dealer facilitating an offering
pursuant to an exemption from registration under the Securities Act
should be careful not to engage in activity that would compromise
the issuer's ability to rely on the applicable exemption to
Securities Act Section 5. See, e.g., Rules 147 and 147A, including
paragraphs (d) and (f) and the Instruction to paragraph (d).
\227\ This guidance is consistent with the concepts articulated
in prior Commission guidance for foreign broker-dealers. See
Interpretation: Re: Use of Internet Web sites to Offer Securities,
Solicit Securities Transactions, or Advertise Investment Services
Offshore, SEC Rel. No. 33-7516 (Mar. 23, 1998) (``Offshore
Interpretation''). In the Offshore Interpretation, the Commission
stated that it would not consider a foreign broker-dealer's
advertising on an Internet Web site to constitute an attempt to
induce a securities transaction with U.S. persons if the foreign
broker-dealer takes measures reasonably designed to ensure that it
does not effect securities transactions with U.S. persons as a
result of its Internet activities. The Commission further stated
that, as applied in the broker-dealer context, a foreign broker-
dealer generally would be considered to have taken measures
reasonably designed to ensure it does not effect securities
transactions with U.S. persons as a result of its Internet
activities if it: (i) Posts a prominent disclaimer on the Web site
either affirmatively delineating the countries in which the broker-
dealer's services are available, or stating that the services are
not available to U.S. persons; and (ii) refuses to provide brokerage
services to any potential customer that the broker-dealer has reason
to believe is, or that indicates that it is, a U.S. person, based on
residence, mailing address, payment method, or other grounds.
\228\ See, e.g., In the Matter of Professional Investors, Inc.,
37 SE.C. 173, 175-176 (1956) (indicating that a broker-dealer that
effected transactions on national securities exchanges for its
customers and its own account and, as an underwriter, sold stock on
behalf of an out-of-state issuer no longer had an exclusively
intrastate business and the intrastate exemption from registration
as a broker-dealer was therefore not available); Peoples Securities
Company, 39 SE.C. 641, 652-653 (1960) (stating that a broker-
dealer's business was not exclusively intrastate based on its
interstate activities, which included sales of securities to out-of-
state residents), aff'd sub nom. Peoples Securities Co. v. SE.C.,
289 F.2d 268 (C.A. 5, 1961).
\229\ Commission staff expects to consider the role of
intrastate broker-dealers and other intermediaries in offerings
under amended Rule 147 or new Rule 147A in connection with its
study. See Section I above.
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3. Section 12(g) Registration
Several commenters recommended exempting securities issued in
reliance upon Rule 147 from the reporting requirements of Section 12(g)
of the Exchange Act.\230\ Most of these commenters asserted that the
Rule 147 exemption would be of limited utility if the securities were
not exempted from Section 12(g).\231\ In addition, the 2015 Small
Business Forum recommended that the Commission provide a permanent
exemption from Section 12(g) registration under the Exchange Act for
securities sold in a Rule 147 offering.\232\ As amended by the JOBS
Act, Section 12(g) requires, among other things, that an issuer with
total assets exceeding $10,000,000 and a class of securities held of
record by either 2,000 persons or 500 persons who are not accredited
investors to register such class of securities with the
Commission.\233\
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\230\ CFIRA Letter; CrowdCheck Letter; Guzik Letter; Milken
Letter; City of Adrian Letter.
\231\ CFIRA Letter; CrowdCheck Letter; Guzik Letter; City of
Adrian Letter.
\232\ See 2015 Small Business Forum Recommendations.
\233\ See Section 501 of the JOBS Act. See also 17 CFR 240.12g-
1. In the case of an issuer that is a bank, a savings and loan
holding company or a bank holding company, Exchange Act Section
12(g)(1)(B) (15 U.S.C. 78l(g)(1)(B)) requires, among other things,
that the issuer, if it has total assets exceeding $10,000,000 and a
class of securities held of record by 2,000 persons, register such
class of securities with the Commission. See Section 601 of the JOBS
Act and Section 85001 of the FAST Act. See also 17 CFR 240.12g-1.
---------------------------------------------------------------------------

Section 12(g) was originally enacted by Congress as a way to ensure
that purchasers of over-the-counter securities about which there was
little or no information, but which had a significant shareholder base,
were provided with ongoing information about their investment.\234\
Unlike Tier 2 offerings under Regulation A \235\ or Regulation
Crowdfunding,\236\ where the Commission provided conditional exemptions
from registration under Section 12(g), issuers that utilize the
exemptions under amended Rule 147 or new Rule 147A will not be required
to comply with ongoing reporting requirements. Given the lack of
ongoing reporting requirements, we believe that the Section 12(g)
record holder and asset thresholds continue to provide an important
baseline above which issuers should generally be subject to the
disclosure obligations of the Exchange Act. As the shareholder base of
these issuers and their total assets grow, we believe that the
additional protections that will be provided by registration under
Section 12(g) are necessary and appropriate.
---------------------------------------------------------------------------

\234\ See generally Report of the Special Study of Securities
Markets of the Securities and Exchange Commission, House Document
No. 95, House Committee on Interstate and Foreign Commerce, 88th
Cong., 1st Sess. (1963), at 60-62.
\235\ See 2015 Regulation A Release at Section II.B.6.
\236\ See Regulation Crowdfunding Adopting Release at Section
II.E.4.
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4. Exclusion of Investment Companies
In the proposing release, we asked whether we should leave existing
Rule 147 in place and unchanged as a safe harbor under Section 3(a)(11)
while adopting the proposed revisions to Rule 147 as a new rule, and if
so, whether we should make any additional changes to the proposed rule.
One commenter that recommended retaining the existing Rule 147 safe
harbor and adopting a new exemption also recommended that the new
exemption exclude investment companies subject to the Investment
Company Act of 1940 (the ``Investment Company Act''),\237\ including
private equity funds, from relying upon Rule 147.\238\ Under Section
24(d) of the Investment Company Act,\239\ the Section 3(a)(11)
exemption is not available for an investment company registered or
required to be registered under the Investment Company Act.\240\ Since
we are retaining Rule 147 as a safe harbor under Section 3(a)(11), Rule
147 will continue to be unavailable for an investment company
registered or required to be registered under the Investment Company
Act. To provide a consistent treatment between Rule 147 and new Rule
147A, we are specifically excluding an issuer that is an investment
company registered or required to be registered under the Investment
Company Act from relying on Rule 147A.\241\ As described above, the
final rules maintain a consistent approach across the two intrastate
offering exemptions, where possible, including with respect to issuer
eligibility. In addition, this same commenter also recommended
excluding other types of issuers from Rule 147.\242\ Since these other
types of issuers are not excluded from existing Rule 147 and because we
believe that, absent specific Congressional direction or evidence of
abuse, the states should have the discretion to determine whether any
additional restrictions are appropriate for offerings conducted
exclusively within their jurisdiction, we

[[Page 83512]]

are not amending Rule 147 or including a provision in Rule 147A to
exclude other types of issuers from these provisions.
---------------------------------------------------------------------------

\237\ 15 U.S.C. 80a-1 et seq.
\238\ NASAA Letter.
\239\ 15 U.S.C. 80a-24(d).
\240\ See 1961 Release at note 1.
\241\ See Rule 147A(a). Investment companies are companies that
are registered or required to be registered under the Investment
Company Act. 15 U.S.C. 80a-1 et seq. Private funds (including
private equity funds and other pooled investment vehicles) generally
rely on the exclusions from the definition of ``investment company''
in Sections 3(c)(1) or 3(c)(7) of the Investment Company Act. See 15
U.S.C. 80a-3(c). Private funds are precluded from relying on either
of these exclusions if they make a public offering of their
securities. Id. Accordingly, if such a private fund engaged in a
public offering of its securities, that private fund would no longer
be able to rely on the applicable exclusion under Section 3(c)(1) or
(7) and thus would be required to be registered under the Investment
Company Act, unless another exclusion or exemption is available. As
a result, the private fund would be an ``investment company'' for
purposes of Section 24(d) and would be excluded from the Section
3(a)(11) exemption and safe harbor of existing Rule 147.
\242\ Specifically, NASAA also recommended excluding the
following types of issuers from the exemption: holding companies
(i.e., companies whose principal purpose is owning stock in, or
supervising the management of, other companies); blind pools;
commodity pools; public companies reporting under the Exchange Act;
and blank check companies (i.e., development stage companies that
either have no specific business plan or purpose or have indicated
that their business plan is to engage in a merger or acquisition
with an unidentified company or companies or other entity or
person).
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5. Trust Indenture Act
Two commenters supported exempting securities issued in reliance
upon Rule 147, as proposed to be amended, from the Trust Indenture Act
of 1939.\243\ Rule 147 offerings are exempt from the Trust Indenture
Act pursuant to Section 304(a)(4) which exempts any security issued in
reliance on Section 3(a)(11) of the Securities Act.\244\ Since the
Trust Indenture Act applies to any debt security sold through the use
of the mails or interstate commerce, including debt securities sold in
transactions that are exempt from Securities Act registration, the
issuance of a debt security under new Rule 147A, as a new exemption not
under Section 3(a)(11), raises questions about the applicability of the
Trust Indenture Act. We note, however, that Trust Indenture Act Section
304(a)(8) \245\ and Rule 4a-1 \246\ provide an exemption for the
issuance of up to $50 million of debt securities without an indenture
in any 12-month period. Given the existing exemption for up to $50
million of debt securities, we do not believe that a specific exemption
from the requirements of the Trust Indenture Act for offerings of debt
securities under Rule 147A is necessary at this time.
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\243\ NextSeed Letter; WBA Letter.
\244\ 15 U.S.C. 77ddd(a)(4).
\245\ 15 U.S.C. 77ddd(a)(8).
\246\ 17 CFR 260.4a-1.
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6. Other Requirements
Two commenters recommended that the Commission work with the states
to encourage, or amend Rule 147 in a way that encourages, issuers to
use any U.S. escrow agent, as opposed to using only escrow agents
registered in the state of the offering, which is often a requirement
of state law.\247\ Another commenter recommended amending Rule 147 to
include bad actor disqualification provisions similar to those set
forth under Rule 506(d).\248\
---------------------------------------------------------------------------

\247\ City of Adrian Letter; Localstake Letter.
\248\ NASAA Letter.
---------------------------------------------------------------------------

As noted elsewhere, the amendments we are adopting today are
intended to facilitate capital formation, while maintaining appropriate
investor protections and providing state securities regulators with the
flexibility to add additional investor protections they deem
appropriate for offerings within their state. Moreover, a broad
consensus of commenters opposed additional requirements for exempt
intrastate offerings beyond those currently contemplated by our
rules.\249\ State legislatures and/or securities regulators have a
significant interest in intrastate offerings made to their residents
and therefore may wish to impose, and are uniquely positioned to
determine, additional requirements they deem necessary or appropriate
for the protection of their residents. Consistent with our approach to
other aspects of the final rules, we believe it is appropriate in these
circumstances to defer to the states regarding which, if any, of the
additional provisions recommended by commenters should supplement the
federal rules. In this regard, we note that bad actor disqualification
provisions are a feature of most state crowdfunding exemptions.\250\ In
addition, a majority of states have adopted the Uniform Limited
Offering Exemption (``ULOE''), or a variant of that uniform
exemption.\251\ The ULOE includes a bad actor disqualification
provision.\252\ Other state exemptions include bad actor
disqualification provisions,\253\ and the small corporate offering
registration (``SCOR'') program \254\ also contemplates
disqualification of an issuer or any of its officers, directors,
principal stockholders or promoters because of prior violations of the
securities laws. We believe that state and federal regulators share an
interest in collaborative efforts that facilitate capital formation and
investor protection. Accordingly, Commission staff will seek to
collaborate with state regulators to review data on the application of
state bad actor disqualification provisions in offerings conducted
pursuant to amended Rule 147 or new Rule 147A to inform whether the
Commission should consider including bad actor disqualification
provisions in Rules 147 and 147A.\255\
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\249\ See Section II.B.7 above.
\250\ See NASAA Letter. See, e.g., Alabama, Arizona, Colorado,
Florida, Georgia, Idaho, Illinois, Iowa, Indiana, Kansas, Kentucky,
Maine, Maryland, Massachusetts, Michigan, Mississippi, Montana,
Nebraska, New Jersey, New Mexico, North Carolina, Oregon, South
Carolina, Tennessee, Texas, Vermont, Washington, Wisconsin and the
District of Columbia.
\251\ See, e.g., Alabama, Arizona, Colorado, Georgia, Illinois,
Iowa, Kansas, Louisiana, Massachusetts, Maryland, Mississippi,
Nebraska, New Hampshire, New Mexico, North Carolina, North Dakota,
Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Utah,
Vermont, Virginia, Washington, West Virginia, Wisconsin, Wyoming and
the District of Columbia. The Uniform Limited Offering Exemption was
adopted by NASAA in 1983 and again in 1989 (available from the NASAA
Web site at https://www.nasaa.org/wp-content/uploads/2011/07/UNIFORM-LIMITED-OFFERING-EXEMPTION.pdf).
\252\ See Section 1.B of the ULOE.
\253\ See, e.g., the Model Accredited Investor Exemption
(available from the NASAA Web site at https://www.nasaa.org/wp-content/uploads/2011/07/24-Model_Accredited_Investor_Exemption.pdf),
as well as other state exemptions such as the Small Issuer Exemption
in Pennsylvania, 10 Pa. Code Sec. 203.187, and the Small Offering
Exemption in Washington, WAC 460-44A-504.
\254\ Forty-three states, the District of Columbia and the
Commonwealth of Puerto Rico have adopted some form of the SCOR
program or recognize the filing of Form U-7 (also referred to as
uniform limited offering registration (``ULOR'')). See CCH Blue Sky
Law Reporter, Blue Sky Findings Lists, Small Corporate Offering
Registration Program and Form U-7, ] 6461 (2016). SCOR and Form U-7
were developed by NASAA as a registration format for companies
registering securities under state securities laws when relying upon
an exemption from Securities Act registration, including Rule 504. A
company may not use the SCOR Form to offer and sell its securities
if the company or any of its officers, directors, principal
stockholders or promoters are disqualified because of prior
violations of the securities laws. A company also may not use
salespersons who are disqualified because of prior violations of the
securities laws. See SCOR Overview, available from the NASAA Web
site at https://www.nasaa.org/industry-resources/corporation-finance/scor-overview/.
\255\ See Section I above.
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III. Amendments to Rules 504 and 505 of Regulation D

A. Overview of Rules 504 and 505

Rule 504 \256\ of Regulation D provides issuers with an exemption
from registration for offers and sales of up to $1 million of
securities in a twelve-month period, provided that the issuer is not:
---------------------------------------------------------------------------

\256\ 17 CFR 230.504.
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Subject to reporting pursuant to Section 13 or 15(d) of
the Exchange Act; \257\
---------------------------------------------------------------------------

\257\ 17 CFR 230.504(a)(1).
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an investment company; \258\ or
---------------------------------------------------------------------------

\258\ 17 CFR 230.504(a)(2).
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a development stage company that either has no specific
business plan or purpose or that has indicated that its business plan
is to engage in a merger or acquisition with an unidentified company or
companies (``blank check company'').\259\
---------------------------------------------------------------------------

\259\ 17 CFR 230.504(a)(3).
---------------------------------------------------------------------------

Additionally, Rule 504 imposes certain conditions, including
limitations on the use of general solicitation or general advertising
in the offering and the restricted status of securities issued pursuant
to the exemption, with limited exceptions for offers and sales made:
Exclusively in one or more states that provide for the
registration of the securities, and require the public filing and
delivery to investors of a substantive disclosure document before sale,
and are made in accordance with state law requirements;
in one or more states that have no provision for the
registration of the securities or the public filing or delivery

[[Page 83513]]

of a disclosure document before sale, if the securities have been
registered in at least one state that provides for such registration,
public filing and delivery before sale, offers and sales are made in
that state in accordance with such provisions, and the disclosure
document is delivered before sale to all purchasers (including those in
the states that have no such procedure); or
exclusively according to state law exemptions from
registration that permit general solicitation and general advertising
so long as sales are made only to ``accredited investors'' as defined
in Rule 501(a) of Regulation D.\260\
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\260\ 17 CFR 230.504(b)(1). State exemptions of this nature
include those based upon the ``Model Accredited Investor
Exemption,'' which was adopted by NASAA in 1997. CCH NASAA Reporter
Para. 361. Generally, the model rule exempts offers and sales of
securities from state registration requirements, if among other
matters, the securities are sold only to persons who are, or are
reasonably believed to be, ``accredited investors'' as defined in
Rule 501(a) of Regulation D, 17 CFR 230.501(a). The model rule
restricts transfer of the securities for 12 months after issuance
except to other accredited investors or if registered. General
solicitations by any means under that provision are generally
limited to a type of ``tombstone'' ad. See Model Accredited Investor
Exemption, available from the NASAA Web site at https://www.nasaa.org/wp-content/uploads/2011/07/24-Model_Accredited_Investor_Exemption.pdf.
---------------------------------------------------------------------------

Rule 504, together with Rules 505 and 506, comprise the Securities
Act exemptions and safe harbor in Regulation D.\261\ Regulation D
offerings are exempt from the registration requirements of the
Securities Act. Offerings conducted pursuant to Rule 504 or Rule 505,
however, must be registered in each state in which they are offered or
sold unless an exemption to state registration is available under state
securities laws.\262\ The vast majority of states have adopted a
uniform registration form for offerings relying upon Rule 504.\263\ One
state, however, recently adopted a form of state-based crowdfunding
that permits the use of general solicitation but has provided for an
abbreviated state registration procedure where, in addition to
following various state-specific requirements for registration, an
issuer also complies with Rule 504 of Regulation D.\264\ Additionally,
offerings conducted pursuant to Rules 505 and 506 are subject to bad
actor disqualification provisions, while offerings conducted pursuant
to Rule 504 are not subject to such provisions.\265\
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\261\ 17 CFR 230.500 through 508. Rules 501 through 503 contain
definitions, conditions, and other provisions that apply generally
throughout Regulation D. Rules 504, 505 and 506(c) are exemptions
from registration under the Securities Act, while Rule 506(b) is a
``safe harbor'' for compliance with the non-public offering
exemption in Section 4(a)(2) of the Securities Act. Rule 507
disqualifies issuers from relying on Regulation D, under certain
circumstances, for failure to file a Form D notice. Rule 508
provides a safe harbor for certain insignificant deviations from a
term, condition, or requirement of Regulation D.
\262\ Section 18(b)(4)(D) of the Securities Act provides
``covered security'' status to all securities sold in transactions
exempt from registration under Commission rules promulgated under
Section 4(a)(2), which includes Rule 506 of Regulation D. Covered
security status under Section 18 provides for the preemption of
state securities laws registration and qualification requirements
for offerings of such securities. In comparison, securities issued
pursuant to either Rules 504 or 505 are not covered securities as
these two exemptions are adopted pursuant to the Commission's
authority under Section 3(b)(1) of the Securities Act.
\263\ See note 254 above.
\264\ Of the 34 states and the District of Columbia that have
adopted intrastate crowdfunding provisions, only Maine allows an
issuer to rely upon Rule 504 of Regulation D where the issuer is
required to file with the Maine securities regulator in an
abbreviated registration procedure. See Me. Rev. Stat. tit. 32,
Sec. 16304(6-A)(D) (2013).
\265\ See Rule 505(b)(2)(iii), 17 CFR 230.505(b)(2)(iii), and
Rule 506(d), 17 CFR 230.506(d), of Regulation D.
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B. Amendments to Rule 504

1. Proposed Amendments to Rule 504
In an effort to facilitate capital formation, including
facilitating the development of comprehensive regional coordinated
review programs at the state level, and enhance investor protection, we
proposed to increase the aggregate amount of securities that may be
offered and sold in any twelve-month period pursuant to Rule 504 from
$1 million to $5 million and to disqualify certain bad actors from
participation in Rule 504 offerings. We further proposed a technical
amendment to Rules 504 and 505 to account for the re-designation of
Securities Act Section 3(b) as Section 3(b)(1) that occurred as a
result of the enactment of the JOBS Act in 2012.\266\ Additionally, to
account for the proposed increase in the Rule 504 aggregate offering
amount limitation, we proposed technical amendments to the notes to
Rule 504(b)(2) that would update the current illustrations in the rule
regarding how the aggregate offering limitation is calculated in the
event that an issuer sells securities pursuant to Rule 504 and Rule 505
within the same twelve-month period.\267\
---------------------------------------------------------------------------

\266\ Public Law 112-106, 126 Stat. 306.
\267\ See proposed Notes 1 and 2 to Rule 504(b)(2). See also 17
CFR 230.504(b)(2).
---------------------------------------------------------------------------

2. Comments on the Proposed Amendments to Rule 504
Many commenters supported, and no commenters opposed, increasing
the Rule 504 offering amount limit from $1 million to $5 million.\268\
These commenters stated that increasing the offering amount limit will
allow more small businesses to use this capital raising tool, better
satisfying the needs of these businesses for capital formation and
helping to facilitate multi-state offerings.\269\ Several commenters
stated that Rule 504 is currently being underutilized, in part, due to
the low offering amount limit of $1 million and the erosion of the
dollar's value due to inflation since the offering amount limit was
last raised in 1988 from $500,000 to $1 million.\270\ As Rule 504
allows issuers to conduct an offering in multiple states and provides
an opportunity for states to coordinate a regional review of the
offering, commenters stated that an increase in the Rule 504 offering
amount limit will encourage new interstate, regional approaches to
crowdfunding and other small business offerings and will provide
greater utility to a regional review of those offerings.\271\ Two
commenters stated that the offering amount limit should be increased to
$10 million in order to offset the significant compliance costs
involved in state registration and review.\272\ In addition, the 2015
Small Business Forum recommended that the Commission increase the
proposed limit on Rule 504 to $10 million, permitting the states to set
their own limit as appropriate.\273\ Another commenter stated that Rule
504 should be automatically indexed for inflation in order to preserve
the utility of the rule from the erosion of the dollar's value in real
terms.\274\ Two commenters stated the Commission should use its general
exemptive

[[Page 83514]]

authority under Section 28 for future increases in the Rule 504
offering limitation.\275\ Several commenters also supported, and no
commenters opposed, amending Rule 504 to include bad actor
disqualification provisions to provide a more uniform set of bad actor
triggering events across Regulation D.\276\
---------------------------------------------------------------------------

\268\ ABA Letter; CFA Letter; CFIRA Letter; CrowdCheck Letter;
Milken Letter; NASAA Letter.
\269\ Id.
\270\ ABA Letter; Milken Letter; NASAA Letter.
\271\ NASAA Letter (``Maine currently permits interstate
crowdfunding under the federal exemption in Rule 504 and Mississippi
and Vermont dually offer intrastate crowdfunding under Section
3(a)(11) and interstate crowdfunding under Rule 504. Many other
states are presently exploring a dual option for crowdfunding,
including additional regional review programs under Rule 504.'').
See also CFA Letter.
\272\ CrowdCheck Letter (``Having recently gone through the
coordinated review process in the context of a Regulation A
offering, we believe that the compliance cost involved in state
registration and review is significant, and Rule 504 will only be of
interest to issuers if they can raise enough capital to offset this
burden.''); CFIRA Letter.
\273\ See 2015 Small Business Forum Recommendations.
\274\ Milken Letter (``Rule 504's current obsolescence is
largely a result of the erosion of the dollar's value in real terms
. . . Indexing would place Rule 504 in a similar position to
Regulation Crowdfunding offerings where, under Section 4A(h)(1) of
the 1933 Act the annual dollar amount is to be adjusted for
inflation at least every five years.'').
\275\ ABA Letter; Milken Letter.
\276\ ABA Letter; CFA Letter (``It not only clarifies the
applicability to new Rule 504 offering limits, but also provides
consistency across Regulation D.''); CFIRA Letter; CrowdCheck
Letter; NASAA Letter (``We also strongly support a more uniform set
of bad actor triggering events across Regulation D . . . as this
would align with bad actor disqualification provisions already
included in state crowdfunding exemptions.'').
---------------------------------------------------------------------------

In response to our solicitation for comment on whether to repeal
Rule 504(b)(1)(iii) or amend the rule to place limitations on resale,
one commenter recommended that the Commission not repeal or amend Rule
504(b)(1)(iii), but retain this provision to provide an environment
that ``allow[s] the states to experiment'' and innovate in a manner
that may prove useful for state and federal policy makers.\277\ Rule
504(b)(1)(iii) provides an exemption from registration for offers and
sales of securities that are conducted ``according to state law
exemptions from registration that permit general solicitation and
general advertising so long as sales are made only to `accredited
investors' as defined in Rule 501(a).'' Securities sold without
registration in reliance on this provision are not subject to the
limitations on resale established in Rule 502(d) and, as such, are not
``restricted securities'' for purposes of Rule 144(a)(3)(ii). Another
commenter indicated that ``the Commission should consider amending Rule
504 to permit resales of securities issued in Rule 504 `public
offerings' in states where the offering complies with exemptions that
permit general solicitation or advertising and that require
dissemination of a state law compliant disclosure document.'' \278\
---------------------------------------------------------------------------

\277\ Milken Letter (noting that this approach ``will allow for
innovation in a tightly controlled environment that may prove useful
for other state and federal policy makers.'').
\278\ ABA Letter.
---------------------------------------------------------------------------

One commenter recommended that the Commission exempt securities
sold under Rule 147 and 504 from the requirements of Section 12(g) of
the Securities Exchange Act of 1934.\279\ In addition, the 2015 Small
Business Forum recommended that the Commission provide a permanent
exemption from Section 12(g) registration under the Exchange Act for
securities sold in a Rule 504 offering.\280\
---------------------------------------------------------------------------

\279\ Milken Letter (``Given the expected local nature of Rule
147 offerings and the likelihood that they will be made to the
general public for relatively small amounts, it is very possible
that small companies making even modest offerings would accrue
sufficient numbers of non-accredited investors to be forced to
register with the Commission.'').
\280\ See 2015 Small Business Forum Recommendations.
---------------------------------------------------------------------------

3. Final Amendments to Rule 504
The amendments that we are adopting to Rule 504 will raise the
aggregate amount of securities an issuer may offer and sell in any
twelve-month period from $1 million to $5 million, which is the maximum
statutorily allowed under Section 3(b)(1).\281\ The Commission has not
raised the 12-month aggregate offering amount limit in Rule 504 since
1988, when the Commission increased the original Rule 504 offering
amount limit of $500,000 to $1 million.\282\ Adjusted for inflation,
the $1 million limit in 1988 would equate to approximately $2 million
today.\283\ We believe the $5 million limit will facilitate issuers'
ability to raise capital. We also believe that our amendments to
increase the aggregate offering amount limit in Rule 504 to $5 million
may bolster efforts among the states to enter into, or revise existing,
regional coordinated review programs that are designed to increase
efficiencies associated with the registration of securities offerings
in multiple jurisdictions without increasing risks to investors.
Increasing the aggregate offering amount limit from $1 million to $5
million will also increase the flexibility of state securities
regulators to set their own limits and to consider whether any
additional requirements should be implemented at the state level.
---------------------------------------------------------------------------

\281\ Rules 504 and 505 were adopted pursuant to the
Commission's small issues exemptive authority under Section 3(b)(1)
of the Securities Act, which gives the Commission authority to adopt
an exemption for offerings not exceeding $5 million where the
Commission believes registration under the Securities Act is not
necessary by reason of the small amount involved or the limited
character of the public offering.
\282\ See SEC Rel. No. 33-6758 (Mar. 3, 1988) [53 FR 7870 (Mar.
10, 1988)].
\283\ Annual inflation rates (1988-2015) based on consumer price
index data, for all urban consumers, obtained from the Bureau of
Labor Statistics.
---------------------------------------------------------------------------

Although two commenters and the 2015 Small Business Forum
recommended that the Commission increase the Rule 504 offering amount
limit to $10 million, we are not exceeding the maximum offering amount
permitted under Section 3(b)(1). Although, as several commenters noted,
we could use our exemptive authority under Section 28 of the Securities
Act to raise the maximum offering amount above $5 million,\284\ in
accord with the suggestion of one of those commenters,\285\ we believe
it appropriate to first observe market activity under a new maximum
offering amount of $5 million before raising the Rule 504 offering
limit higher.
---------------------------------------------------------------------------

\284\ ABA Letter; Milken Letter.
\285\ ABA Letter (``If the increase to $5 million is adopted,
after there is experience with the use and operation of new Rule
504, the Commission may wish to consider using its exemption
authority under Section 28 to increase the dollar limitation amount
that may be offered under Rule 504.'').
---------------------------------------------------------------------------

In conjunction with our increase to the Rule 504 aggregate offering
amount limit, we are also adopting provisions that will disqualify
certain bad actors from participation in offerings conducted pursuant
to the exemption.\286\ We believe that the disqualification provisions
that we are adopting, which are substantially similar to related
provisions in Rule 506 of Regulation D,\287\ will create a more
consistent regulatory regime across Regulation D and provide additional
protections to investors in Rule 504 offerings.
---------------------------------------------------------------------------

\286\ See Rule 504(b)(3).
\287\ See 17 CFR 230.506(d). See also Rule 262 of Regulation A,
17 CFR 230.262, and Rule 505(b)(2)(iii) of Regulation D, 17 CFR
230.505(b)(2)(iii).
---------------------------------------------------------------------------

The Rule 504 disqualification provisions will be implemented by
reference to the disqualification provisions of Rule 506 of Regulation
D.\288\ We believe that creating a uniform set of bad actor triggering
events across the various exemptions from Securities Act registration
should simplify due diligence, particularly for issuers that may engage
in different types of exempt offerings. In accordance with the views of
several commenters,\289\ the bad actor triggering events for Rule 504
will be substantially similar to existing provisions in Regulation
D,\290\ Regulation A,\291\ and Regulation Crowdfunding \292\ and will
apply to the issuer and other covered persons (such as underwriters,
placement agents, and the directors, officers and significant
shareholders of the issuer). Consistent with the Commission's treatment
of disqualification in Rule 506(e),\293\ disqualification will only
occur for triggering events that occur after effectiveness of any
amendments, but disclosure will be required for triggering

[[Page 83515]]

events that pre-date effectiveness of any amendments.\294\
---------------------------------------------------------------------------

\288\ See Rule 504(b)(3), referencing the disqualification
provisions of Rule 506(d), 17 CFR 230.506(d), and Instruction to
paragraph (b)(3) of Rule 504, referencing the disclosure provisions
of Rule 506(e), 17 CFR 230.506(e).
\289\ CFA Letter; NASAA Letter.
\290\ See Rules 505(b)(2)(iii) and 506(d) of Regulation D, 17
CFR 230.505(b)(2)(iii), 230.506(d).
\291\ See Rule 262 of Regulation A, 17 CFR 230.262.
\292\ See Rule 503 of Regulation Crowdfunding, 17 CFR 227.503.
\293\ See 17 CFR 230.506(e).
\294\ See Rule 504(b)(3).
---------------------------------------------------------------------------

We also sought public comment on whether additional changes to Rule
504 should be adopted in the final amendments. In particular, in
conjunction with the increase in the Rule 504 offering amount limit, we
contemplated amending the calculation of the aggregate offering limit
in Rule 504(b)(2). Currently, this rule requires issuers to aggregate
all securities sold within the preceding 12 months in any transaction
that is exempt under Section 3(b) or in violation of Section 5(a) of
the Securities Act for purposes of computing the aggregate offering
amount under Rule 504.\295\ This rule also includes illustrations of
how the aggregate offering limit is calculated in the event that an
issuer sells securities pursuant to Rule 504 and Rule 505 within the
same twelve-month period.\296\
---------------------------------------------------------------------------

\295\ 17 CFR 230.504(b)(2); see also 17 CFR 230.505(b)(2).
\296\ See 17 CFR 230.504(b)(2).
---------------------------------------------------------------------------

When the current aggregation provisions in Rules 504 and 505 were
originally adopted in Rule 505's predecessor, Rule 242, the Commission
noted that aggregating offering amounts across offerings conducted
pursuant to Section 3(b) was intended to ``limit the potential for the
issuer to raise large sums by circumventing the registration provisions
of the Securities Act through multiple offerings pursuant to Section
3(b).'' \297\ In the intervening years, however, in implementing
Congressional mandates,\298\ the Commission has increased the number of
exemptive provisions available to issuers, particularly smaller
issuers, to raise large sums of capital in a more cost-effective manner
in offerings that are exempt from registration, while continuing to
provide appropriate safeguards for investors.\299\ Therefore, we sought
comment on whether the current requirements for Rule 504(b)(2), as they
relate to the aggregation of offering proceeds across all offerings
that are conducted pursuant to Securities Act Section 3(b)(1), should
be retained in the amendments.\300\
---------------------------------------------------------------------------

\297\ SEC Rel. No. 33-6180 (Jan. 17, 1980). This provision was
subsequently carried over into Rule 505 and incorporated into Rule
504 when Regulation D was adopted by the Commission in 1982. See SEC
Rel. No. 33-6389 (Mar. 8, 1982); SEC Rel. No. 33-6339 (Aug. 7,
1981).
\298\ See JOBS Act, Public Law 112-106, 126 Stat. 306.
\299\ See, e.g., Regulation A, 17 CFR 230.251 et seq., providing
non-Exchange Act reporting companies with the option to raise up to
$20 million annually pursuant to the requirements of Tier 1 and up
to $50 million annually pursuant to the requirements of Tier 2.
\300\ We are referring to Section 3(b)(1) instead of Section
3(b), due to the changes that occurred as a result of the Securities
Act amendments in Title IV of the JOBS Act.
---------------------------------------------------------------------------

Although no commenters responded to our request for comment on this
issue, in light of our repeal today of Rule 505, which is the only
other existing exemption in Regulation D promulgated under Section
3(b)(1), we are amending Rule 504(b)(2) to omit any reference to the
aggregation of offering proceeds across all offerings that are
conducted pursuant to Section 3(b) of the Securities Act.
Correspondingly, we are also deleting the related note under Rule
504(b)(2) illustrating how the aggregate offering amount limitation is
calculated in the event that an issuer sells securities pursuant to
Rule 504 and Rule 505 within the same twelve-month period.
We are also adopting a further technical amendment to the second
note to Rule 504(b)(2), as proposed. Specifically, we are updating the
illustration of how the aggregate offering amount limitation is
calculated to account for the increase to the Rule 504 aggregate
offering amount limitation from $1 million to $5 million.\301\
---------------------------------------------------------------------------

\301\ See Instruction to paragraph (b)(2) to Rule 504.
---------------------------------------------------------------------------

One commenter \302\ and the 2015 Small Business Forum recommended
that the Commission provide an exemption from Section 12(g)
registration under the Exchange Act for securities sold in a Rule 504
offering.\303\ As discussed above, Section 12(g) requires, among other
things, that an issuer with total assets exceeding $10,000,000 and a
class of securities held of record by either 2,000 persons, or 500
persons who are not accredited investors, register such class of
securities with the Commission.\304\ Unlike Tier 2 offerings under
Regulation A \305\ or Regulation Crowdfunding,\306\ where the
Commission provided conditional exemptions from registration under
Section 12(g), issuers that utilize the exemptions under amended Rule
504 will not be required to comply with ongoing reporting requirements.
Given the lack of ongoing reporting requirements under Rule 504, we
believe that the Section 12(g) record holder and asset thresholds
continue to provide an important baseline above which issuers should
generally be subject to the disclosure obligations of the Exchange Act.
As the shareholder base of these companies and their total assets grow,
we believe that the additional protections that will be provided by
registration under Section 12(g) are necessary and appropriate.
---------------------------------------------------------------------------

\302\ Milken Letter.
\303\ See 2015 Small Business Forum Recommendations.
\304\ See note 233 above.
\305\ See 17 CFR part 251. See also 2015 Regulation A Release at
Section II.B.6.
\306\ See 17 CFR 227.100. See also Regulation Crowdfunding
Adopting Release at Section II.E.4.
---------------------------------------------------------------------------

Another commenter recommended that the Commission amend Rule 504 to
permit the resale of securities issued in Rule 504 ``public offerings''
in states where the offering complies with exemptions that permit
general solicitation or advertising and that require a public filing
and delivery of a state law compliant disclosure document before any
sales to purchasers.\307\ As discussed above, Rule 504 currently
permits the resale of securities issued in Rule 504 offerings that
involve general solicitation or advertising where either the offering
is registered in one or more states and one or more states require the
dissemination of a state-approved disclosure document or the offering
is exempt but sales are only made to accredited investors.\308\
Consistent with the limitations on resales in other Securities Act
exemptions that permit general solicitation or advertising, such as
Rule 506(c) and Regulation Crowdfunding, we have concerns with
expanding the ability to issue freely tradable securities under Rule
504 to offerings that permit general solicitation or advertising to
non-accredited investors without state registration. Further, we
believe that the additional protections that will be provided by the
limitations on resale for securities offered and sold in these
transactions, which are directed primarily to non-accredited
investors,\309\ are necessary and appropriate given that these
offerings are not registered at either the state or federal level.
---------------------------------------------------------------------------

\307\ ABA Letter.
\308\ See 17 CFR 230.504(b).
\309\ In contrast, general solicitation or advertising is
permitted under Rule 506(c), so long as the issuer limits all sales
exclusively to accredited investors and the issuer takes reasonable
steps to verify that the investor is an accredited investor.
---------------------------------------------------------------------------

C. Repeal of Rule 505

In light of the proposed amendments to Rule 504, we solicited
comments on whether we should repeal Rule 505 as an exemption from
registration. Rule 505 is used far less frequently than Rule 506,\310\
and in the Proposing Release, we noted that an increase in the Rule 504
offering amount limit from $1 million to $5 million could further
diminish its utility.\311\
---------------------------------------------------------------------------

\310\ See note 22 above. See also Table 5 in Section V.A.2.a
below.
\311\ See Proposing Release at Section III.C.

---------------------------------------------------------------------------

[[Page 83516]]

1. Comments on Repealing Rule 505
Three commenters responded to our request for comment on Rule 505.
One commenter recommended that the Commission review the Rule 505
exemption ``to consider whether modifications may and/or should be made
to modernize the exemption; for example, reviewing the aggregate
offering amount or information requirements.'' \312\ This commenter
strongly opposed, however, replacing Rule 505 with a new Securities Act
exemption providing ``covered security status'' under Section 18 of the
Securities Act to securities issued in reliance on the new
exemption.\313\ This commenter cautioned ``against considering a new
framework for Rule 505 that is contrary to the rule's original intent
and purpose--to be a coordinated federal-state exemption and `to
achieve a uniform system of federal-state limited offering exemptions
that facilitates capital formation consistent with the protection of
investors.' '' \314\
---------------------------------------------------------------------------

\312\ NASAA Letter.
\313\ Id. (opposing extension of covered security status ``by
either enacting a new `safe harbor' pursuant to Securities Act
Section 4(a)(2) or by defining purchasers of securities issued in an
offering pursuant to the exemption as `qualified purchaser,'
pursuant to Securities Act Section 18(b)(3).'')
\314\ Id. (``In 1983, NASAA adopted a model exemption, the
Uniform Limited Offering Exemption (``ULOE''), designed to provide
an exemption at the state level for offerings that are exempt at the
federal level under Rules 505 and 506 of Regulation D.'').
---------------------------------------------------------------------------

Another commenter stated that changes to Rule 505 aimed at
facilitating very small offerings by early stage companies merit
further consideration.\315\ This commenter also recommended that the
Commission consider ``whether an exempt, simple debt-only offering is
feasible and could be made cost-efficient for smaller issuers.'' \316\
According to this commenter, the Commission should explore whether an
exemption focused on simple debt securities could serve the needs of
small businesses and investors, especially since the unique nature of
simple debt securities may warrant more modest and easier compliance
requirements, while not sacrificing investor protections, as compared
to an exemption that permits both debt and equity offerings.\317\
---------------------------------------------------------------------------

\315\ Milken Letter.
\316\ Id.
\317\ Id. In commenting on the proposed amendments to Rule 147,
one commenter noted that small businesses are likely to seek debt
financing more frequently than equity offerings. See Nextseed Letter
(``equity offerings are more likely to be attractive to technology-
based, high growth companies that cannot financially support debt
obligations,'' as compared to ``Main Street'' businesses (e.g.,
local restaurants operated by friends and families) that are
inherently local in nature seeking to raise not millions of dollars,
but much smaller amounts of capital that traditional lenders are
increasingly reluctant to fund).
---------------------------------------------------------------------------

Finally, another commenter stated that, if the proposed changes to
Rule 504 are adopted, Rule 505 would be substantially similar to Rule
504, making Rule 505 unnecessary, unless the Commission increases the
aggregate offering amount that may be raised under Rule 505 in any
twelve-month period.\318\ This commenter recommended, for example, that
the ceiling could be raised from $5 million to $10 million or some
larger amount, thereby preserving Rule 505 as a viable alternative
exemption. Despite its infrequent use, the commenter noted that Rule
505 serves the purpose of permitting issuers to sell to up to 35 non-
accredited investors without having to be satisfied that these
investors meet a financial sophistication test.\319\
---------------------------------------------------------------------------

\318\ ABA Letter.
\319\ Id. In contrast, issuers relying upon Rule 506(b) may sell
to up to 35 non-accredited investors, but each non-accredited
investor must satisfy a financial sophistication test set forth in
Rule 506(b)(2)(ii).
---------------------------------------------------------------------------

2. Repeal of Rule 505
After considering these comments, we are repealing Rule 505. After
the effective date of the repeal of Rule 505, issuers will no longer be
able to make offers and sales of securities in reliance on Rule 505. We
believe that amending Rule 504 to increase the aggregate offering
amount from $1 million to $5 million will further reduce the incentives
to use Rule 505 by issuers contemplating an exempt offering. We also
believe that, even if we were to raise the Rule 505 aggregate offering
amount limit from $5 million to $10 million, or some higher amount,
such a higher limit would not increase the utility of the Rule 505
exemption as compared to Rule 506, which has no limit, given the
historical use of Rule 505 as compared to Rule 506. Further, although
Rule 505 provides issuers the ability to sell securities to up to 35
non-accredited investors without having to make a finding, as in Rule
506(b)(2)(ii), that such persons have the knowledge and experience in
financial matters that they are capable of evaluating the merits and
risks of the prospective investment,\320\ this provision does not
appear to have historically resulted in the Rule 505 exemption being
widely utilized.\321\
---------------------------------------------------------------------------

\320\ Cf., 17 CFR 230.506(b)(2)(ii).
\321\ For the period 2009-2015, there were a total of 1,542 Rule
505 offerings. During this same time period, there were a total of
70,793 Rule 506(b) offerings of $5 million or less. See Table 5 in
Section V.A.2.b below. See also Scott Bauguess, Rachita Gullapalli
and Vladimir Ivanov, ``Capital Raising in the U.S.: An Analysis of
the Market for Unregistered Securities Offerings, 2009-2014''
(October 2015) (``Unregistered Offerings White Paper''), available
at https://www.sec.gov/dera/staff-papers/white-papers/unregistered-offering10-2015.pdf.
---------------------------------------------------------------------------

We believe the flexibility of the requirements of Rule 504, as
amended today, as well as the availability of Rule 506(b) and Rule
506(c) will continue to fulfill the original objectives of Regulation D
to achieve uniformity between state and federal exemptions in order to
facilitate capital formation consistent with the protection of
investors.\322\ Amended Rule 504 will be available only to non-
reporting issuers \323\ that are not investment companies \324\ or
development stage companies \325\ for offerings of up to $5 million in
a twelve-month period and will permit general solicitation and the
issuance of unrestricted securities in certain limited situations.\326\
Rule 506(b) and 506(c) are available to all issuers without any
aggregate offering amount limitations. Rule 506(b) prohibits general
solicitation and limits sales to no more than 35 non-accredited
investors.\327\ Rule 506(c) permits general solicitation where all
purchasers of the securities are accredited investors and the issuer
takes reasonable steps to verify that the purchasers are accredited
investors.\328\ Securities issued pursuant to Rules 506(b) and 506(c)
are deemed restricted securities.\329\ Reporting issuers also can
register the offer and sale of securities on Form S-1, for which the
Commission recently promulgated rules permitting forward incorporation
by reference.\330\
---------------------------------------------------------------------------

\322\ See SEC Rel. No. 33-7644 (Feb. 25, 1999) [64 FR 11090
(Mar. 8, 1999)] (``Seed Capital Release'') at text accompanying note
4. See also Release No. 33-6389 (Mar. 8, 1982) [47 FR 11251]
(Regulation D adopting release).
\323\ See Rule 504(a)(1).
\324\ See Rule 504(a)(2).
\325\ See Rule 504(a)(3).
\326\ See Rule 504(b)(1).
\327\ See 17 CFR 230.506(b)(2).
\328\ See 17 CFR 230.506(c).
\329\ See 17 CFR 230.506(b)(2) and 17 CFR 230.502(d).
\330\ See SEC Release No. 33-10003 [81 FR 2743] (Jan. 19, 2016)
(revising Form S-1 to permit a smaller reporting company to
incorporate by reference into its registration statement any
documents filed by the issuer subsequent to the effective date of
the registration statement). The information delivery requirements
under Rule 505 for an Exchange Act reporting issuer that sells
securities to a non-accredited investor are similar to the
disclosure requirements for a registered offering under the
Securities Act. See Rule 502(b)(2)(ii).
---------------------------------------------------------------------------

IV. Other Matters

If any of the provisions of these rules, or the application thereof
to any person or circumstance, is held to be invalid,

[[Page 83517]]

such invalidity shall not affect other provisions or application of
such provisions to other persons or circumstances that can be given
effect without the invalid provision or application.

V. Economic Analysis

This section analyzes the expected economic effects of the final
rules relative to the current baseline, which is the regulatory
framework and state of the market \331\ in existence today, including
current provisions available to potential issuers to raise capital up
to $5 million. We are mindful of the costs imposed by, and the benefits
obtained from, the final rules. Relative to this baseline, our analysis
considers the anticipated benefits and costs for market participants
affected by the final rules as well as the impact of the final rules on
efficiency, competition and capital formation.\332\ We also analyze the
potential benefits and costs stemming from alternatives to the final
rules that we considered. Many of the benefits and costs discussed
below are difficult to quantify, especially when analyzing the likely
effects of the final rules on efficiency, competition and capital
formation. For example, it is difficult to precisely estimate the
extent to which amended Rule 147 and new Rule 147A will promote future
reliance by issuers on these provisions, or the extent to which future
use of amended Rule 147 and new Rule 147A will affect the use of other
offering methods. Similarly, it is difficult to quantify the effect of
the final rules on investor protection. Therefore, much of the
discussion in this section is qualitative in nature. However, where
possible, we have attempted to quantify the expected effects of the
final rules.
---------------------------------------------------------------------------

\331\ The term ``market'' as used throughout this economic
analysis refers to capital markets in general, and where discussed
in the context of a specific rule, relates to the provisions of the
relevant exemption or safe harbor. We refer, for example, to the
Rule 147 safe harbor and Rule 504 exemption as the Rule 147 and Rule
504 markets because each of those rules' provisions prescribe
requirements that determine who can participate and how the
participants (issuers/investors/intermediaries) can engage in
transactions under each exemption. Participants face different
trade-offs when choosing between the markets created by each of the
exemptions and safe harbors.
\332\ Securities Act Section 2(b) and Exchange Act Section 3(f)
direct us, when engaging in rulemaking that requires us to consider
or determine whether an action is necessary or appropriate in the
public interest, to consider, in addition to the protection of
investors, whether the action will promote efficiency, competition,
and capital formation. See 15 U.S.C. 77b(b) and 15 U.S.C. 78c(f). In
addition, Exchange Act Section 23(a)(2) requires us, when adopting
rules, to consider the impact that any new rule would have on
competition. See 15 U.S.C. 78w(a)(2)
---------------------------------------------------------------------------

A. Baseline

The final rules will modernize Rule 147, a safe harbor under
Section 3(a)(11), and establish new Rule 147A in order to facilitate
intrastate offerings, including intrastate crowdfunded offerings under
state securities laws. We also are amending Rule 504 of Regulation D to
raise the aggregate amount that can be raised during a twelve-month
period from $1 million as established in 1988, to $5 million and to
disqualify certain bad actors from participating in Rule 504 offerings.
In light of the amendments to Rule 504, we are also repealing Rule 505,
an alternate exemption available under Regulation D for offerings of up
to $5 million during a twelve-month period.
The final rules will primarily impact the financing market for
startups and small businesses.\333\ The baseline for our economic
analysis--including the baseline for our consideration of the effects
of the final rules on efficiency, competition and capital formation--is
the regulatory framework and market structure in existence today in
which startups and small businesses seeking to raise capital through
securities offerings must register the offer and sale of securities
under the Securities Act, unless they can rely on an existing exemption
from registration under the federal securities laws.
---------------------------------------------------------------------------

\333\ According to the Longitudinal Business Database of the
U.S. Census Bureau, there were more than 6.7 million active
establishments in the U.S., of which approximately 5.5 million had
fewer than 500 paid employees and approximately 5.2 million had less
than 100 paid employees. See U.S. Department of Commerce, United
States Census Bureau, Business Dynamics Statistics, Data: Firm
Characteristics (2013), available at https://www.census.gov/ces/dataproducts/bds/data_firm.html.
---------------------------------------------------------------------------

In addition to a description of the type and number of issuers that
currently offer and sell securities in reliance on Rules 147, 504 and
505, our analysis includes a description of the types of investors who
purchase or may consider purchasing such securities and a discussion of
the role of intermediaries in such offerings. Table 1 summarizes the
main characteristics of Rules 147, 504 and 505.

[[Page 83518]]

Table 1--Main Characteristics of Existing Rules 147, 504 and 505
--------------------------------------------------------------------------------------------------------------------------------------------------------
Blue sky law
Issuer and preemption and
Type of offering Offering limit \334\ Solicitation investor Filing requirement Restriction on bad actor
requirements resale disqualification
provisions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Rule 147...................... None.................. Only intrastate All issuers must None................. Interstate State Law
solicitation. be incorporated resales are Preemption: No.
and ``doing restricted for Bad Actor
business'' in nine months Provisions:
state. Statutory from the later Required by the
exemption of the last majority of
excludes sale in, or the states at the
investment completion of, state
companies. All the offering level.\336\
investors must \335\.
be residents in
state.
Rule 504 Regulation D......... $1 million............ General Excludes File Form D.......... Restricted, State Law
solicitation investment unless offering Preemption: No.
permitted in companies, blank- is within Bad Actor
specified check companies, specified Provisions:
circumstances and Exchange Act circumstances Required by the
\337\. reporting \338\. majority of
companies. states at the
state
level.\339\
Rule 505 Regulation D......... $5 million............ No general Excludes File Form D.......... Restricted State Law
solicitation. investment securities. Preemption: No.
companies. Bad Actor
Unlimited Provisions: Yes.
accredited
investors and up
to 35 non-
accredited
investors.
--------------------------------------------------------------------------------------------------------------------------------------------------------

1. Current Market Participants
---------------------------------------------------------------------------

\334\ Aggregate offering limit on securities sold within a 12-
month period.
\335\ See 17 CFR 230.147(e). Additional resale restrictions may
apply under state securities laws.
\336\ See text accompanying notes 250, 251, 252, 253 and 254
above.
\337\ No general solicitation or advertising is permitted unless
the offering is registered in a state requiring the use of a
substantive disclosure document or sold under a state exemption that
permits general solicitation or advertising so long as sales are
made only to accredited investors. See Rule 504(b).
\338\ Restricted unless the offering is registered in a state
requiring the use of a substantive disclosure document or sold under
a state exemption limiting sales only to accredited investors. See
Rule 504(b).
\339\ See text accompanying notes 250, 251, 252, 253 and 254
above.
---------------------------------------------------------------------------

The final rules that amend existing Rules 147 and 504, establish
new Rule 147A, and repeal Rule 505 will primarily affect securities
issuers, particularly startups and small businesses, that rely on
unregistered offerings under these and other provisions or safe harbors
to raise capital, as well as accredited and non-accredited investors
who participate in unregistered offerings.
a. Issuers
i. Rule 147 Issuers
Under current Rule 147, there is no limit on the amount of capital
that can be raised. Since the Section 3(a)(11) exemption is not
available for an investment company registered or required to be
registered under the Investment Company Act,\340\ the existing Rule 147
safe harbor is also not available to these issuers. Current Rule 147
has no other restrictions on the type of issuers that may rely on the
safe harbor. However, there are in-state residency and eligibility
requirements that an issuer must satisfy in order to rely on Rule 147.
Eligible issuers are those that are incorporated or organized in-state,
have their ``principal office'' in-state, and can satisfy three 80%
threshold requirements concerning their revenues, assets and use of net
proceeds.
---------------------------------------------------------------------------

\340\ See 15 U.S.C. 80a-24(d) and 1961 Release at note 1.
---------------------------------------------------------------------------

While we lack data on the number and size of Rule 147 offerings
\341\ or the type of issuers currently relying on the Rule 147 safe
harbor, the nature of the eligibility requirements and other
restrictions of the rule lead us to believe that it is used by U.S.
incorporated entities that are likely small businesses seeking to raise
small amounts of capital locally without incurring the costs of
registering with the Commission.
---------------------------------------------------------------------------

\341\ Unlike Regulation D, which requires the filing of a Form
D, Rule 147 does not require any filing with the Commission, and we
thus have no source of reliable data about the prevalence and scope
of Rule 147 offerings. Commission staff will seek to collaborate
with state regulators in gathering information for the study of
amended Rule 147 and new Rule 147A. See Section I above.
---------------------------------------------------------------------------

Currently, most of the states that have enacted crowdfunding
provisions require issuers that intend to conduct intrastate
crowdfunding offerings to use Rule 147.\342\ Based on information from
NASAA,\343\ as of May 20, 2016, 34 states and the District of Columbia
have enacted crowdfunding provisions, and more states are expected to
promulgate similar provisions in the near future. Since December 2011,
when the first state (Kansas) enacted its crowdfunding provisions, 179
state crowdfunding offerings have been reported to be filed with the
respective state regulator.\344\ Of these offerings, 166 were reported
to be approved or cleared, as of July 2016.\345\
---------------------------------------------------------------------------

\342\ See https://www.nasaa.org/industry-resources/corporation-finance/instrastate-crowdfunding-resource-center/intrastate-crowdfunding-directory/.
\343\ See NASAA's Intrastate Crowdfunding Resource Center at
https://www.nasaa.org/industry-resources/corporation-finance/instrastate-crowdfunding-resource-center/. See also https://www.nasaa.org/industry-resources/corporation-finance/instrastate-crowdfunding-resource-center/intrastate-crowdfunding-directory/.
\344\ See Slide Presentation on ``NASAA Intrastate Crowdfunding
Update,'' NASAA July 18, 2016 available at https://nasaa.cdn.s3.amazonaws.com/wp-content/uploads/2014/12/Intrastate-Crowdfunding-Slides-7-18-16.pdf.
\345\ Id. Most of the early approved or cleared offerings were
in Georgia, Michigan, Oregon, Kansas and Indiana. See Slide
Presentation on ``Intrastate Equity Crowdfunding'' by Anya Coverman,
Deputy Director of Policy, NASAA at the SEC Government Business
Forum on Small Business Capital Formation, November 19, 2015
available at https://www.sec.gov/info/smallbus/sbforum119015-coverman-presentation.pdf.
---------------------------------------------------------------------------

Given that investment companies are statutorily restricted from
relying on Section 3(a)(11) \346\ and that almost all the enacted state
crowdfunding provisions currently exclude reporting companies, we
expect that issuers that rely on Rule 147 are likely operating
companies (``non-fund issuers'') that are not reporting under the
Exchange Act. As stated above, information on the size of these issuers
is not available. Data from NASAA shows that most issuers are from
various industries including agriculture, manufacturing, business
services, retail, entertainment, and technology.
---------------------------------------------------------------------------

\346\ See also note 241 above.

---------------------------------------------------------------------------

[[Page 83519]]

We anticipate that many potential issuers of securities under
amended Rule 147 and new Rule 147A, particularly those utilizing the
exemptions for intrastate crowdfunding, will continue to be small
businesses, early stage firms and ``idea'' stage business ventures that
have not yet commenced operations. Some of these issuers may lack
business plans that are sufficiently developed to attract venture
capitalists (VCs) or angel investors that invest in high risk ventures,
or may not offer the profit potential or business model to attract such
investors.\347\
---------------------------------------------------------------------------

\347\ In this regard, a study of one large crowdfunding platform
revealed that relatively few companies on that platform operate in
technology sectors that typically attract VC investment activity.
See Ethan R. Mollick, The Dynamics of Crowdfunding: An Exploratory
Study, J. BUS. VENT., January 2014 (1-16).
---------------------------------------------------------------------------

ii. Rule 504 and Rule 505 Issuers
Rules 504 and 505 of Regulation D provide exemptions from
registration under Section 3(b)(1) of the Securities Act for small
offerings where the Commission believes registration under the
Securities Act is not necessary by reason of the small amount involved
or the limited character of the public offering. An analysis of Form D
filings indicates that reliance on these two exemptions has been
declining over time. As shown in Figure 1, while offerings under Rule
506(b) of Regulation D grew significantly from 1993 to 2015, offerings
under Rule 504 and Rule 505 in 2015 were approximately a quarter of
1993 levels. In addition, while offering activity under Rule 504 has
been higher than under the Rule 505 exemption, the number of new Rule
504 offerings peaked in 1999, with 3,402 new offerings initiated, and
steeply declined afterward.\348\ Compared to the early 1990s when Rule
504 offerings constituted approximately 28% of all new Regulation D
offerings, the proportion of Rule 504 offerings between 2009 and 2015
ranged between 3% and 4% of all new Regulation D offerings. The number
of new Rule 505 offerings peaked in 1996 at 1,124 (12% of all new
Regulation D offerings), and during 2015, less than 1% of all new
Regulation D offerings claimed the Rule 505 exemption.
---------------------------------------------------------------------------

\348\ While there is a strong, positive correlation of the
incidence of new Regulation D offerings with the economic conditions
of the public market (see Section 4.2 of Unregistered Offerings
White Paper), some of the decline in Rule 504 offerings during the
early 2000s could also be attributed to the 1999 Commission decision
to reinstate the ban on general solicitation in Rule 504 offerings.
See Seed Capital Release and Release No. 34-69959 (July 10, 2013).
Though the incidence of new Rule 506 offerings recovered in 2003
with improved conditions in the public markets, the number of new
Rule 504 offerings remained well below the pre-2000 levels.
[GRAPHIC] [TIFF OMITTED] TR21NO16.000

The current limited use of the Rule 504 and Rule 505 exemptions and
the predominance of Rule 506, especially Rule 506(b), are also evident
when we consider the total amount raised in offerings under each of
these exemptions. Overall, capital formation in the Rule 504 and Rule
505 markets individually constituted approximately 0.1% of the capital
raised in all Regulation D offerings initiated during 2009-2015.\350\
Considering only Regulation D offerings of up to $1 million (the
maximum amount that a Rule 504 offering can raise in a year) initiated
by non-fund issuers, the share of Rule 504 offerings was slightly
higher at approximately 7%. Similarly, considering only Regulation D
offerings by non-fund issuers of up to $5 million (the maximum amount
that an existing

[[Page 83520]]

Rule 505 offering or amended Rule 504 offering can raise in a year),
the share of the total amount raised for Rule 505 offerings was less
than 2%.
---------------------------------------------------------------------------

\349\ Data is not readily available for the period 2002-2008
during which Form D was a paper-based filing. The form became
available electronically in March 2009. Since the data for year 2009
is only for the period April to December, the number of new
Regulation D offerings shown is underestimated for 2009.
\350\ Based on staff analysis of Form D filings. See also
Unregistered Offerings White Paper.
---------------------------------------------------------------------------

Table 2 presents data on the number of new Rule 504 and 505
offerings and amounts reported to be raised in these offerings during
the period 2009-2015.\351\ Since investment companies are excluded from
using the two exemptions, issuers relying on Rules 504 and 505 are
predominantly non-fund issuers.\352\ Form D data also indicates that
the mean and median Rule 504 offering sizes during 2009-2015 were
approximately $0.5 million and $0.36 million, respectively, while the
average and median Rule 505 offering sizes were approximately $1.90
million and $1.54 million, respectively.
---------------------------------------------------------------------------

\351\ Id. This analysis uses the same assumptions and
methodologies described in the Unregistered Offerings White Paper.
\352\ Non-fund issuers constituted 98% and 93% of all Rule 504
and Rule 505 offerings, respectively. In terms of amounts reported
to be raised, non-fund issuers raised 96% and 76% of all amounts
reported to be raised in Rule 504 offerings and Rule 505 offerings,
respectively. Based on information in Form D filings, funds using
the Rule 504 or Rule 505 exemption were not registered under the
Investment Company Act.

Table 2--Rule 504 and Rule 505 Capital Raising Activity, 2009-2015
----------------------------------------------------------------------------------------------------------------
Number of offerings \353\ Total amount raised ($
-------------------------------- million)
-------------------------------
Rule 504 Rule 505 Rule 504 Rule 505
----------------------------------------------------------------------------------------------------------------
2009............................................ 579 195 $91 $185
2010............................................ 714 262 131 257
2011............................................ 721 207 113 205
2012............................................ 632 227 109 193
2013............................................ 599 229 97 203
2014............................................ 544 289 94 238
2015............................................ 519 179 84 134
2009-2015....................................... 4,308 1,588 719 1,415
----------------------------------------------------------------------------------------------------------------

Companies that file reports with the Commission under Section
12(b), Section 12(g) or Section 15(d) of the Exchange Act can use the
Rule 505 exemption but not the Rule 504 exemption. Data from Form D
filings indicates that approximately 10 of 278 unique Rule 505 issuers
during 2014 and 8 of 163 unique Rule 505 issuers during 2015 were
reporting companies.\354\ These reporting companies initiated 12 Rule
505 offerings during 2014 and 11 such offerings during 2015. The mean
size of Rule 505 offerings by reporting companies was approximately
$824,000 and the median size was approximately $200,000.
---------------------------------------------------------------------------

\353\ Based on staff analysis of Form D filings. This analysis
uses the same assumptions and methodologies described in the
Unregistered Offerings White Paper. As noted in the Unregistered
Offerings White Paper, some issuers in Regulation D offerings check
multiple exemptions in their Form D filing. Under those
circumstances, staff assigns the highest checked numerical exemption
to the offering. While issuers in 4,308 offerings checked only the
Rule 504 exemption and reported to raise $719 million during the
period 2009-2015, issuers in an additional 1,224 offerings checked
the Rule 504 exemption along with the Rule 505 and/or the Rule 506
exemption and safe harbor. Similarly, issuers in 1,520 offerings
checked only the Rule 505 exemption and reported to raise $1,399
million during 2009-2015; issuers in an additional 68 new offerings
checked the Rule 504 and 505 exemptions; and issuers in 2,170 new
offerings checked the Rule 505 exemption along with the Rule 506
exemption.
\354\ Based on staff analysis of Form D filings and Form 10-K
filings made during 2014 and 2015.
---------------------------------------------------------------------------

Figure 2 shows the financial size of Rule 504 and Rule 505 issuers
based on revenues or net asset value during the period 2009-2015.\355\
Of all the issuers that disclosed these metrics in their Form D filings
(approximately 70% of all Rule 504 issuers and 80% of all Rule 505
issuers), more than three quarters of those offerings were initiated by
issuers that had no revenues or had revenues or net asset values of
less than $1 million. From this reported size, we believe that a vast
majority of Rule 504 and Rule 505 issuers likely consist of startups
and small businesses. These issuers' small size is also consistent with
their younger age, as measured by years since incorporation. Based on
Form D filings, 51% of Rule 504 issuers and 62% of Rule 505 issuers
initiated their offerings during the year of their incorporation or in
the subsequent year. Another 14% of Rule 504 and Rule 505 issuers
initiated their offerings between two and three years since
incorporation.\356\
---------------------------------------------------------------------------

\355\ Based on staff analysis of Form D filings.
\356\ Id.

---------------------------------------------------------------------------

[[Page 83521]]

[GRAPHIC] [TIFF OMITTED] TR21NO16.001

Most Rule 504 and Rule 505 issuers that initiated offerings in the
past seven years operate in the technology, real estate or other
industry (Figure 3).\357\
---------------------------------------------------------------------------

\357\ Id.
[GRAPHIC] [TIFF OMITTED] TR21NO16.002

With regard to the geographical location of issuers, Form D filings
indicate that during the period 2009-2015, most Rule 504 and Rule 505
issuers had their principal place of business in California (22% and
21%), followed by Texas, New York, Florida, Colorado and Illinois; most
were incorporated in Delaware (19%, 23%),

[[Page 83522]]

California (13%, 12%), Nevada and Texas. In addition, approximately 37%
of Rule 504 offerings and 39% of Rule 505 offerings reported having
different states of incorporation and principal places of business.
While only approximately 2% of Rule 504 and Rule 505 offerings were
initiated by foreign-incorporated issuers, a larger number of issuers
(4-5%) reported their principal place of business to be outside the
United States. In addition, approximately 89% of issuers in the Rule
504 market and 93% of issuers in the Rule 505 market initiated only one
offering. Approximately 83% of Rule 504 offerings and 79% of Rule 505
offerings during the period 2009-2015 were equity offerings.\358\
---------------------------------------------------------------------------

\358\ Id.
---------------------------------------------------------------------------

b. Investors
Currently, Rule 147 limits offers and sales to residents of the
same state or territory as the issuer. While there are generally no
limitations on who can invest in Rule 504 offerings, only accredited
investors and up to 35 non-accredited investors can participate in Rule
505 offerings. Although the Commission does not require a form to be
filed in connection with Rule 147 offerings, and thus does not receive
information concerning investors participating in these offerings, data
from Form D filings provide some insights into the number and
characteristics of investors in Rule 504 and Rule 505 offerings.
Data in Table 3 below shows that more than 34,000 investors
participated in new Rule 504 offerings initiated during the period
2009-2015, while almost 14,400 investors participated in new Rule 505
offerings initiated during the same period.\359\ An analysis of the
same Form D filings indicates that, for new Rule 504 offerings that
reported sales, the mean number of investors was approximately 11 and
the median number of investors was approximately four. The mean and
median number of investors in new Rule 505 offerings that reported
sales was 12 and seven, respectively.
---------------------------------------------------------------------------

\359\ Id. See also Unregistered Offerings White Paper.

Table 3--Number and Type of Investors in Rule 504 Offerings, 2009-2015 \360\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Rule 504 Offerings Rule 505 Offerings
------------------------------------------------------------------------------------------------
% Offerings % Offerings
Total Mean number of with non- Total Mean number of with non-
investors investors accredited investors investors accredited
investors investors
--------------------------------------------------------------------------------------------------------------------------------------------------------
2009................................................... 4,004 9 53 1,818 12 38
2010................................................... 5,427 10 54 2,234 11 41
2011................................................... 5,512 11 57 1,676 12 43
2012................................................... 6,295 13 58 2,027 13 44
2013................................................... 5,573 13 61 2,167 13 41
2014................................................... 3,996 10 60 2,943 13 36
2015................................................... 3,398 9 61 1,520 11 43
rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrr
2009-2015.............................................. 34,205 11 57 14,385 12 41
--------------------------------------------------------------------------------------------------------------------------------------------------------

The presence of non-accredited investors was larger in Rule 504
offerings, where the number of non-accredited investors is not limited,
than in Rule 505 or Rule 506 offerings, where the number of non-
accredited investors is limited to 35. Data in Table 3 above shows that
issuers in approximately 57% of Rule 504 offerings and 41% of Rule 505
offerings during 2009-2015 reported having sold or intending to sell to
non-accredited investors.\361\
---------------------------------------------------------------------------

\360\ Id. The data shown in the table represents offerings that
reported sales to investors.
\361\ Form D data shows that Rule 504 offerings that involved
non-accredited investors were, on average, smaller and had a fewer
mean number of investors (8) than those offerings that involved only
accredited investors (9). In contrast, Rule 505 offerings that
indicated potential sales to non-accredited investors were, on
average, larger and had a greater mean number of investors (11) than
Rule 505 offerings that sold only to accredited investors (8). We
note that since issuers do not file Form D at the close of the
offering, the number of investors reported in initial Form D filings
may be an underestimate (offerings reporting zero investors are
included).
---------------------------------------------------------------------------

Given existing investment limitations under state crowdfunding
provisions, we believe that many investors affected by amended Rule 147
and new Rule 147A will likely be individual retail investors whose
broad access to potentially riskier investment opportunities in early-
stage ventures is currently limited, either because they do not have
the necessary accreditation or sophistication to invest in most private
offerings, or because they do not have sufficient funds to participate
as angel investors. Intrastate crowdfunding offerings may provide
retail investors with additional investment opportunities, although the
extent to which they invest in such offerings will likely depend on
their view of the potential return on investment as well as the
potential risks, including fraud.
In contrast, larger, more sophisticated or well-funded investors
may be less likely to invest in intrastate crowdfunding offerings. The
relatively low offering amount limits, in-state investor residency
requirements, and low investment limits for crowdfunding investors
under state laws \362\ may make these offerings less attractive for
such investors, which include VCs and angel investors.\363\ While an
intrastate crowdfunding offering can result in increased visibility for
an issuer, it is likely that such investors will elect to invest in
offerings relying on Rule 506, which are not subject to the investment
limitations applicable to crowdfunding.
---------------------------------------------------------------------------

\362\ Most state crowdfunding provisions allow up to a $2
million offering size and a maximum investment of $10,000 by non-
accredited investors.
\363\ An observer suggests that, unlike angels, VCs may be less
interested in crowdfunding because, if VCs rely on crowdfunding
sites for their deal flow, it would be difficult to justify charging
a 2% management fee and 20% carried interest to their limited
partners. See Ryan Caldbeck, Crowdfunding--Why Angels, Venture
Capitalists And Private Equity Investors All May Benefit, Forbes,
Aug. 7, 2013.
---------------------------------------------------------------------------

c. Intermediaries
Issuers that undertake private offerings may use broker-dealers to
help them with various aspects of the offering and to help ensure
compliance with the ban on general solicitation and advertising that
exists for most private offerings. Private offerings can also involve
finders and investment advisers

[[Page 83523]]

who connect issuers with potential investors for a fee.\364\ We do not
have information on the extent of intermediary use in Rule 147
offerings; however, an analysis of Form D filings indicates that
intermediaries are used less frequently in Rule 504 offerings than in
registered offerings. Approximately 20% of Rule 504 offerings and 29%
of Rule 505 offerings reported using an intermediary during the period
2009-2015.\365\ The average commissions and fees paid by issuers that
reported using an intermediary was approximately 6% of the offering
amount for Rule 504 and 5.6% for Rule 505.\366\
---------------------------------------------------------------------------

\364\ Depending on the nature and scope of their activities,
these persons may need to be registered as broker-dealers or finders
under state law.
\365\ Based on staff analysis of Form D filings.
\366\ Id.
---------------------------------------------------------------------------

Although we are unable to predict the potential use of broker-
dealers, transfer agents,\367\ investment advisers and finders in
private offerings as a result of the adoption of the final rules, data
on the use of broker-dealers and finders in the Rule 506 market
suggests that they do not currently play a large role in private
offerings. Form D filings indicate that approximately 17% of Rule 506
offerings with an offering size up to $5 million, including 18% of such
Rule 506 offerings initiated by non-fund issuers, used an intermediary
during 2009-2015.\368\ The use of a broker-dealer or a finder increased
with offering size, while the average percentage of the total fee
declined with offering size.\369\ We base these estimates, however,
only on available data from the Regulation D market. It is possible
that issuers engaging in other types of unregistered offerings, for
which data is not available to us, may use broker-dealers and finders
more frequently or less frequently.\370\
---------------------------------------------------------------------------

\367\ Aside from their standard role in maintaining records of
ownership of securities, transfer agents play an important role in
private offerings that involve restricted securities, in which there
may be limitations on resale of such securities for a certain period
or to certain types of investors. In addition to ensuring compliance
with such provisions, only a transfer agent can remove a restrictive
legend from the security, which is done with the consent of the
issuer.
\368\ Based on staff analysis of Form D filings.
\369\ Based on analysis of Form D filings for 2009-2015,
approximately 20% of all Rule 506 offerings reported using an
intermediary. Further, intermediaries participated in approximately
16% of Rule 506 offerings of up to $1 million and 31% of offerings
of more than $50 million during the period 2009-2015. The average
total fee (commission plus finder fee) paid by issuers conducting
offerings of up to $1 million was 6.2%, while the average total fee
paid by issuers conducting offerings of more than $50 million was
1.9%. See also Section 5.3 in the Unregistered Offerings White
Paper.
\370\ A number of states that have enacted crowdfunding
provisions require that the offer and sale of securities by means of
intrastate crowdfunding be conducted through a funding portal or a
broker-dealer. Some intrastate crowdfunding provisions require the
offering portals to be registered with the state or as a broker-
dealer. Based on FOCUS Reports filed with the Commission, as of
December 2015, there were 4,122 registered broker-dealers, with
average total assets of approximately $0.98 billion per broker-
dealer. The aggregate assets of these registered broker-dealers
totaled approximately $4.1 trillion. See Regulation Crowdfunding
Adopting Release for a more detailed discussion of intermediaries in
crowdfunding offerings.
---------------------------------------------------------------------------

2. Alternative Methods of Raising Up to $5 Million of Capital
The potential economic impact of the final rules, including their
effects on efficiency, competition and capital formation, will depend
primarily on the extent of use of amended Rules 147 and 504 and new
Rule 147A and how these methods compare to alternative sources of
capital that startups and small businesses can utilize.
As the amendments to Rule 504 would permit offerings up to $5
million by all types of issuers (other than investment companies,
Exchange Act reporting companies and development stage companies), the
analysis below discusses alternatives available for startups and small
businesses to access up to $5 million in capital. Current state
crowdfunding provisions, most of which require issuers to rely on Rule
147 for federal exemption, have offering limits of up to $4 million and
most restrict private funds from utilizing the crowdfunding provisions.
In addition, final Rules 147, 147A and 504 all exclude investment
companies. Thus, our analysis below also includes a discussion of
alternative sources for non-fund issuers to raise capital up to $5
million.\371\
---------------------------------------------------------------------------

\371\ While offerings greater than $5 million that are
registered or exempt under state law, subject to certain conditions,
could be raised under amended Rule 147 or new Rule 147A, we believe
that the impact of the final rules on larger offerings is not likely
to be significant, given the local nature of offerings under these
exemptions and current state regulations applicable for larger
offerings. See Section V.B (discussing the impact of the final rules
in detail).
---------------------------------------------------------------------------

Startups and small businesses can potentially access a variety of
external financing sources in the capital markets through, for example,
registered or unregistered offerings of debt, equity or hybrid
securities and bank loans. Issuers seeking to raise capital must
register the offer and sale of securities under the Securities Act or
qualify for an exemption from registration under the federal securities
laws. Registered offerings, however, are generally too costly to be
viable alternatives for startups and small businesses. Issuers
conducting registered offerings incur a variety of fees and expenses
related to registration and reporting requirements. Two surveys
concluded that the average initial compliance cost associated with
conducting an initial public offering is $2.5 million, followed by an
ongoing compliance cost for public companies of $1.5 million per
year.\372\ Moreover, issuers conducting registered offerings usually
pay underwriter fees, which average approximately 7% for initial public
offerings, approximately 5% for follow-on equity offerings and
approximately 1-1.5% for public bond issuances.\373\ Hence, for a small
issuer seeking to raise less than $5 million, a registered offering
typically may not be economically feasible relative to options
available under exempt offerings.
---------------------------------------------------------------------------

\372\ See IPO Task Force, Rebuilding the IPO On-Ramp (Oct. 20,
2011), at 9, available at https://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdf (``IPO Task Force''). The estimates
should be interpreted with the caveat that most companies in the IPO
Task Force surveys likely raised more than $1 million. The IPO Task
Force surveys do not provide a breakdown of costs by offering size.
However, compliance related costs of an initial public offering and
subsequent compliance related costs of being a reporting company
likely have a fixed cost component that would disproportionately
affect smaller issuers.
Title I of the JOBS Act provided certain accommodations to
issuers that qualify as emerging growth companies (EGCs). According
to a recent working paper, the underwriting, legal and accounting
fees of EGC and non-EGC initial public offerings were similar (based
on a time period from April 5, 2012 to April 30, 2015). For a median
EGC initial public offering, gross spread comprised 7% of proceeds
and accounting and legal fees comprised 2.4% of proceeds. See Susan
Chaplinsky, Kathleen W. Hanley, and S. Katie Moon, ``The JOBS Act
and the Costs of Going Public,'' working paper, October 4, 2015,
available at https://papers.ssrn.com/sol3/Papers.cfm?abstract_id=2492241, (``Chaplinsky Study'').
\373\ See, e.g., Hsuan-Chi Chen and Jay R. Ritter, ``The Seven
Percent Solution,'' 55 J. Fin. 1105-1131 (2000); Mark Abrahamson,
Tim Jenkinson, and Howard Jones, ``Why Don't U.S. Issuers Demand
European Fees for IPOs?'' 66 J. Fin. 2055-2082 (2011); Shane A.
Corwin, ``The Determinants of Underpricing for Seasoned Equity
Offers,'' 58 J. Fin. 2249-2279 (2003); Lily Hua Fang, ``Investment
Bank Reputation and the Price and Quality of Underwriting
Services,'' 60 J. Fin. 2729-2761 (2005); Rongbing Huang and Donghang
Zhang, ``Managing Underwriters and the Marketing of Seasoned Equity
Offerings,'' 46 J. Fin. Quant. Analysis 141-170 (2011); Stephen J.
Brown, Bruce D. Grundy, Craig M. Lewis and Patrick Verwijmeren,
``Convertibles and Hedge Funds as Distributors of Equity Exposure,''
25 Rev. Fin. Stud. 3077-3112 (2012).
Recent studies that analyze IPOs by EGCs and non-EGCs find that
the costs of raising capital through an IPO are similar pre- and
post-JOBS Act. See, e.g., Michael Dambra, Laura Fields and Matthew
Gustafson, ``The JOBS Act and IPO Volume: Evidence that Disclosure
Costs Affect the IPO Decision'', 116 J. Fin. Econ.121-143 (2015);
see also Chaplinsky Study.

---------------------------------------------------------------------------

[[Page 83524]]

a. Exempt Offerings
For startups and small businesses that can potentially access
capital under Rules 147, 504 and 505, offerings under other existing
exemptions or safe harbors from registration may represent alternative
methods of raising capital. For example, startups and small businesses
could rely on current exemptions and safe harbors, such as Section
3(a)(11), Section 4(a)(2),\374\ Regulation A,\375\ Section
4(a)(6),\376\ and Rule 506 of Regulation D.\377\
---------------------------------------------------------------------------

\374\ Securities Act Section 4(a)(2) provides that the
provisions of the Securities Act shall not apply to ``transactions
by an issuer not involving a public offering.''
\375\ Regulation A provides an exemption from registration for
certain small issuances. The Commission recently adopted amendments
to Regulation A that became effective on June 19, 2015. See 2015
Regulation A Release.
\376\ Regulation Crowdfunding provides an exemption from
registration for small offerings up to $1 million sold within a
twelve month period. The rules became effective on May 16, 2016. See
Regulation Crowdfunding Adopting Release.
\377\ Rule 506(b) of Regulation D provides a nonexclusive safe
harbor from registration for certain types of securities offerings.
Rule 506(c) of Regulation D is an exemption from registration that
the Commission adopted to implement Section 201(a) of the JOBS Act.
---------------------------------------------------------------------------

Each of these provisions, however, includes restrictions that may
limit its suitability for startups and small businesses seeking to
raise capital up to $5 million. Table 4 below lists the main
requirements of these provisions.
---------------------------------------------------------------------------

\378\ Aggregate offering limit on securities sold within a
twelve-month period.
\379\ Although Section 3(a)(11) does not have explicit resale
restrictions, the Commission has explained that ``to give effect to
the fundamental purpose of the exemption, it is necessary that the
entire issue of securities shall be offered and sold to, and come to
rest only in the hands of residents within the state.'' See 1961
Release. State securities laws also may have specific resale
restrictions. Rule 147 limits resales to persons residing in-state
for a period of nine months after the last sale by the issuer.
\380\ See text accompanying notes 250, 251, 252, 253 and 254
above.
\381\ Section 4(a)(2) of the Securities Act provides a statutory
exemption for ``transactions by an issuer not involving any public
offering.'' See SEC v. Ralston Purina Co., 346 U.S. 119 (1953)
(holding that an offering to those who are shown to be able to fend
for themselves is a transaction ``not involving any public
offering.'')
\382\ The Regulation A exemption is also not available to
companies that have been subject to any order of the Commission
under Exchange Act Section 12(j) entered within the past five years,
have not filed ongoing reports required by the regulation during the
preceding two years, or are disqualified under the regulation's
``bad actor'' disqualification rules.
\383\ See Table 6 below for a more detailed comparison between
Regulation Crowdfunding and intrastate crowdfunding provisions.
\384\ General solicitation and general advertising is permitted
under Rule 506(c). All purchasers must be accredited investors and
the issuer must take reasonable steps to verify accredited investor
status.

Table 4--Other Provisions Currently Available for Capital Raising
--------------------------------------------------------------------------------------------------------------------------------------------------------
Blue sky law
preemption and bad
Type of offering Offering limit Solicitation Issuer and investor Filing requirement Restriction on actor
\378\ requirements resale disqualification
provisions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Section 3(a)(11)......... None............... All offerees must All issuers and None............... No \379\........... State Law
be resident in investors must be Preemption: No.
state. resident in state, Bad Actor
and an issuer, if Provisions:
a corporation, Required by the
must be majority of states
incorporated in at the state level.
state; investment \380\
companies are
excluded.
Section 4(a)(2).......... None............... No general Transactions by an None............... Restricted State Law
solicitation. issuer not securities. Preemption: No.
involving any Bad Actor
public offering Provisions: No.
\381\.
Regulation A............. Tier 1: up to $20 Testing the waters U.S. or Canadian File testing the No................. State Law
million with $6 permitted both issuers, excluding waters materials, Preemption: Tier 1:
million limit on before and after investment Form 1-A for Tier No Tier 2: Yes.
secondary sales by filing the companies, blank- 1 and Tier 2 Bad Actor
affiliates of the offering statement. check companies, offerings; file Provisions: Yes.
issuer; Tier 2: up reporting annual, semi-
to $50 million companies, and annual, and
with $15 million issuers of current reports
limit on secondary fractional for Tier 2
sales by undivided offerings; file
affiliates of the interests in oil exit report for
issuer. or gas rights, or Tier 1 offerings;
similar interests and file exit
in other mineral report to suspend
rights \382\. or terminate
reporting for Tier
2 offerings.
Section 4(a)(6) $1 million......... Allowed after Form Excludes foreign File Form C; 12-month resale State Law
Regulation Crowdfunding C is filed and private issuers; reviewed financial limitation; resale Preemption: Yes.
\383\. with limitations investment statements within one year to Bad Actor
on advertising. limitations based required for issuer and certain Provisions: Yes.
on annual income offerings greater investors.
and net worth. than $100,000;
audited financial
statements
required for
offerings greater
than $500,000
(unless it is the
first offering
made pursuant to
the exemption);
file annual
reports.
Rule 506(b) Regulation D. None............... No general No issuer File Form D........ Restricted State Law
solicitation. exclusion; securities. Preemption: Yes.
unlimited Bad Actor
accredited Provisions: Yes.
investors and up
to 35 non-
accredited
investors.
Rule 506(c) Regulation D. None............... General No issuer File Form D........ Restricted State Law
solicitation is exclusion; securities. Preemption: Yes
permitted, subject unlimited Bad Actor
to certain accredited Provisions: Yes
conditions \384\. investors; no non-
accredited
investors.
--------------------------------------------------------------------------------------------------------------------------------------------------------

[[Page 83525]]

While we do not have data on offerings relying on an exemption
under Section 3(a)(11) or Section 4(a)(2), data available from
Regulation D and Regulation A filings allow us to gauge how frequently
issuers seeking to raise up to $5 million rely on these provisions.
Based on Form D filings from 2009 to 2015, a substantial number of
issuers chose to raise capital by relying on Rule 506(b), even though
their offering size would qualify under Rule 504 or Rule 505.\385\ As
shown in the upper part of Table 5, most Regulation D issuers made
offers for amounts of up to $1 million from 2009 to 2015. A large
majority of offerings up to $5 million relied on the Rule 506(b)
exemption. The lower part of Table 5 shows a similar pattern for the
number of offerings by non-fund issuers.
---------------------------------------------------------------------------

\385\ See Unregistered Offerings White Paper. This tendency
could, in part, be attributed to two features of Rule 506:
preemption from state registration (``blue sky'') requirements and
an unlimited offering amount. See also report from U.S. Government
Accountability Office, Factors That May Affect Trends in Regulation
A Offerings, GAO-12-839 (Jul. 3, 2012), available at https://www.gao.gov/products/GAO-12-839.
---------------------------------------------------------------------------

The overwhelming majority of non-fund issuers (approximately 73%)
conducting offerings less than $5 million were five years or younger,
and 64% of such issuers were two years or younger, with a median age of
approximately one year. More than 93% of the non-fund issuers that made
Regulation D offerings of $5 million or less during this period were
organized as either a corporation or a limited liability company.
Almost 21% reported having no revenues, while approximately 20% had
revenues of less than $5 million.\386\
---------------------------------------------------------------------------

\386\ These percentages could be higher because almost 55% of
the issuers that conduct Regulation D offerings of $5 million or
less declined to disclose the size of the offering.

Table 5--Number of Regulation D and Regulation A Offerings By Size, 2009-2015
----------------------------------------------------------------------------------------------------------------
Offering size
-----------------------------------------------------------------------------------
< = $1 million $1-$2.5 million $2.5-5 million $5-50 million > $50 million
----------------------------------------------------------------------------------------------------------------
All offerings:
Rule 504................ 4,224 ................ .............. .............. ..............
Rule 505................ 592 518 432 .............. ..............
Rule 506(b)............. 35,688 18,998 16,107 31,978 14,726
Rule 506(c)............. 1,233 529 512 975 268
-----------------------------------------------------------------------------------
Total............... 41,737 20,045 17,051 32,953 14,994
Regulation A................ 10 6 33 6 ..............
Non-fund offerings:
Rule 504................ 4,143 ................ .............. .............. ..............
Rule 505................ 568 496 378 .............. ..............
Rule 506(b)............. 32,095 16,975 13,866 22,291 3,375
Rule 506(c)............. 1,007 447 472 763 153
-----------------------------------------------------------------------------------
Total............... 37,813 17,918 14,716 23,054 3,528
----------------------------------------------------------------------------------------------------------------
Note: Data based on Form D filings for Regulation D offerings and Form 1-A filings for qualified Regulation A
offerings from 2009 to 2015. We consider only new offerings and exclude offerings that do not report offering
size and report amount sold as $0 on Form D. Data on Rule 506(c) offerings covers the period from September
23, 2013 (the date the rule became effective) to December 31, 2015. We also use the maximum amount indicated
in Form 1-A to determine offering size for Regulation A offerings.

Table 5 also includes the number of Regulation A offerings by size.
From 2009 to 2015, 49 issuers relied on Regulation A for offerings of
up to $5 million.\387\ This data includes 17 offerings, of which 11
have offering sizes of up to $5 million, initiated subsequent to the
effectiveness of amendments to Regulation A in June 2015. The
amendments allow issuers to raise up to $50 million over a 12-month
period and preempt state registration requirements for certain
Regulation A offerings (Tier 2 offerings). As these amendments became
effective only recently, more time is needed to assess how the changes
in Regulation A will affect capital raising by small issuers.\388\
---------------------------------------------------------------------------

\387\ We only consider offerings with offering statements that
have been qualified by the Commission. For purposes of counting
offerings, we exclude amendments or multiple 1-A filings by the same
issuer in a given year. For purposes of determining the offering
size for Regulation A offerings, we use the maximum amount indicated
on the latest pre-qualification Form 1-A or amended Form 1-A. We
reclassify two offerings that are dividend reinvestment plans with
uncertain offering amounts as having the maximum permitted offering
amount.
\388\ See 2015 Regulation A Adopting Release.
---------------------------------------------------------------------------

b. Regulation Crowdfunding
The analysis above does not include data regarding securities-based
crowdfunding transactions under the recently adopted Regulation
Crowdfunding exemption. The new rules, which became effective on May
16, 2016, supplement the existing regulatory scheme of exemptions and
safe harbors that are described above and provide start-ups and small
businesses with an alternate source for raising capital through
offerings exempt from registration under the Securities Act. As of
September 30, 2016, approximately 114 offerings relying on the federal
crowdfunding exemption filed a Form C with the Commission.\389\
---------------------------------------------------------------------------

\389\ Based on Form C filings, as of September 30, 2016.
Analysis of data reported in Form C and Form C-U filings indicates
that the mean maximum offer size was approximately $643,150 and the
mean amount reported to be raised per offering was $440,480. Based
on filings of Form C-U as of September 30, 2016, 12 offerings were
reported to be completed.
---------------------------------------------------------------------------

Offerings pursuant to these rules are limited to a maximum amount
of $1 million over a 12-month period and are subject to ongoing
disclosure requirements. Securities issued pursuant to these rules can
be sold to an unlimited number of investors (subject to specified
investment limits), are freely tradable after one year, and can be
offered and sold without state qualification or registration. Unlike
intrastate crowdfunding provisions enacted at the state level, the new
federal crowdfunding exemption allows interstate offerings, whereby an
issuer can make offers and sell to investors in multiple states. Table
6 presents a comparison of the provisions of Regulation Crowdfunding
and current intrastate crowdfunding provisions that rely on current
Rule 147 for federal exemption.

[[Page 83526]]

Table 6--Intrastate Crowdfunding and Regulation Crowdfunding Provisions
------------------------------------------------------------------------
Current Rule 147
+ state level Regulation
crowdfunding crowdfunding
provisions \390\
------------------------------------------------------------------------
Investor Base................. Rule 147 requires All investors, all
that all states.
investors reside
in the state of
the issuer.
State Registration............ Exemption Preemption of state
provided by registration.
state.
Issuer Incorporation/Residency Rule 147 requires Excludes foreign
Limitations. issuer to be private issuers.
incorporated and
``doing-
business'' in
state.
Excluded Issuers.............. Investment Exchange Act
companies are reporting companies,
excluded under investment
the federal companies, pooled
exemption. investment funds,
Although not and blank check
excluded under companies.
Rule 147, most
state
crowdfunding
provisions also
exclude Exchange
Act reporting
companies and
blank check
companies.
Offering Size Limits.......... Although not Up to $1 million.
limited under
Rule 147, state
provisions limit
between $250,000
and $4 million,
depending on
state. Mean
(median) limit:
$1.6 ($2)
million.
Security Type................. Although not Any security.
limited under
Rule 147, equity
and debt
permitted in
some states;
equity only in
other states;
any security in
some other
states.
Audited Financials Requirement Although no Required for
requirements offerings greater
under Rule 147, than $500,000 with
most states the exception of
require, if first-time
offer greater crowdfunding issuers
than $1 million. offering more than
$500,000 but not
more than
$1,000,000, who are
permitted to provide
financial statements
reviewed by an
independent
accountant, unless
the issuer has
audited statements
otherwise available.
Reviewed financial
statements are
required for
offerings greater
than $100,000 but
not more than
$500,000, unless the
issuer has audited
statements otherwise
available.
General Solicitation.......... Rule 147 and Allowed after filing
states allow, of Form C and
but only to subject to
investors limitations on
residing in advertising.
state.
Investment Limits............. No limits under (a) the greater of
Rule 147. $2,000 or 5% of the
$2,500-$10,000, lesser of the
depending on investor's annual
state, for non- income or net worth
accredited if either annual
investors. income or net worth
None, in most is less than
states, for $100,000, or (b) 10%
accredited of the lesser of the
investors. investor's annual
income or net worth
if both annual
income and net worth
are $100,000 or
more, subject to
investment cap of
$100,000.
Restrictions on Resale........ Rule 147 12-month resale
restricts limitation; resale
interstate within one year to
resales for nine issuer and certain
months \391\. investors.
Exemption from Section 12(g) None............. Conditional
Registration Requirements. exemption, provided
that the issuer is
current in its
ongoing annual
reports required
pursuant to Rule 202
of Regulation
Crowdfunding, has
total assets as of
the end of its last
fiscal year not in
excess of $25
million, and has
engaged the services
of a transfer agent
registered with the
Commission pursuant
to Section 17A of
the Exchange Act.
------------------------------------------------------------------------

c. Private Debt Financing
---------------------------------------------------------------------------

\390\ Information in this column is based on the provisions that
are reflective of most states that have enacted crowdfunding
provisions. See https://www.nasaa.org/industry-resources/corporation-finance/instrastate-crowdfunding-resource-center/intrastate-crowdfunding-directory/.
\391\ See 17 CFR 230.147(e). States may impose additional resale
restrictions.
---------------------------------------------------------------------------

While equity-based financing, including principal owner equity,
accounts for a significant proportion of the total capital of a typical
small business, other sources of capital for startups and small
businesses include loans from commercial banks, finance companies and
other financial institutions, business credit cards and credit
lines.\392\
---------------------------------------------------------------------------

\392\ Using data from the 1993 Survey of Small Business Finance,
one study indicates that financial institutions account for
approximately 27% of small companies' borrowings. See Allen N.
Berger and Gregory F. Udell, The Economics of Small Business
Finance: The Roles of Private Equity and Debt Markets in the
Financial Growth Cycle, 22 J. Banking & Fin. 613 (1998). See also
1987, 1993, 1998 and 2003 Surveys of Small Business Finances,
available at https://www.federalreserve.gov/pubs/oss/oss3/nssbftoc.htm. The Survey of Small Business Finances was discontinued
after 2003. Using data from the Kauffman Foundation Firm Surveys,
one study finds that 44% of startups use loans from financial
institutions. See Rebel A. Cole and Tatyana Sokolyk, How Do Start-Up
Firms Finance Their Assets? Evidence from the Kauffman Firm Surveys
(2012), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2028176.
---------------------------------------------------------------------------

For example, a 2014 study reports that startups frequently resort
to bank financing early in their lifecycle.\393\ The study finds that
businesses rely heavily in the first year after formation on external
debt sources such as bank financing, mostly in the form of personal and
commercial bank loans, business credit cards, and credit lines.\394\
Another report shows a decline in cumulative bank lending to small
businesses, which fell by $100 billion from 2008 to 2011.\395\ This
report also shows that less than one-third of small businesses reported
having a business bank loan by 2012. Similarly, an FDIC report shows
that, as of December 2015, small business lending, specifically
business loans of up to $1 million, by

[[Page 83527]]

FDIC-insured depository institutions amounted to approximately $606
billion, which is 15% lower than the June 2008 level but 2% above
December 31, 2014 level.\396\
---------------------------------------------------------------------------

\393\ See Alicia M. Robb, and David T. Robinson, 2014, The
Capital Structure Decisions of New Firms, Review of Financial
Studies 27(1), pp. 153-179 (``Robb Study'').
\394\ See also NextSeed Letter.
\395\ See The Kauffman Foundation, 2013 State of
Entrepreneurship Address (Feb. 5, 2013), available at https://
www.kauffman.org/~/media/kauffman_org/
research%20reports%20and%20covers/2013/02/soe%20report_2013pdf.pdf.
The report cautions against prematurely concluding that banks are
not lending enough to small businesses as the sample period of the
study includes the most recent recession.
\396\ We define small business loans to include commercial and
industrial loans of up to $1 million and loans secured by nonfarm
nonresidential properties and commercial and industrial loans of up
to $1 million to U.S. addressees. See Federal Deposit Insurance
Corporation, Statistics on Depository Institutions Report, available
at https://www2.fdic.gov/SDI/SOB/.
---------------------------------------------------------------------------

An earlier study by Federal Reserve Board staff covering the pre-
recessionary period suggests that 60% of small businesses had
outstanding credit in the form of a credit line, a loan or a capital
lease.\397\ These loans were borrowed from two types of financial
institutions: depository and non-depository institutions (e.g., finance
companies, factoring or leasing companies).\398\ Lines of credit were
the most widely used type of credit.\399\ Other types included mortgage
loans, equipment loans, and motor vehicle loans.\400\
---------------------------------------------------------------------------

\397\ See Federal Reserve Board, Financial Services Used by
Small Businesses: Evidence from the 2003 Survey of Small Business
Finances (October 2006), available at https://www.federalreserve.gov/pubs/bulletin/2006/smallbusiness/smallbusiness.pdf (``2003 FRB
Survey'').
\398\ See Rebel Cole, What Do We Know About the Capital
Structure of Privately Held Firms? Evidence from the Surveys of
Small Business Finance (Working Paper) (Feb. 2013), available at
https://onlinelibrary.wiley.com/doi/10.1111/fima.12015/epdf.
\399\ See 2003 FRB Survey, note 397 (estimating that 34% of
small businesses use lines of credit).
\400\ Id.
---------------------------------------------------------------------------

Small businesses may also receive funding from various loan
guarantee programs of the Small Business Administration (``SBA''),
which makes credit more accessible to small businesses by either
lowering the interest rate of the loan or enabling a market-based loan
that a lender would not be willing to provide, absent a guarantee.\401\
SBA loan programs include 7(a) loans,\402\ microloans \403\ and
Certified Development Company loans (CDC loans).\404\ For example, in
fiscal year 2015, the SBA supported approximately $33.2 billion in 7(a)
and CDC loans, microloans and surety bonds distributed to approximately
61,000 small businesses.\405\ In addition, investments in high-growth
small businesses through its Small Business Investment Company program
increased from $5.5 billion in 2014 to $6.3 billion in 2015.\406\ SBA
guaranteed loans, however, currently account for a relatively small
share (20%) of the balances of small business loans outstanding.\407\
---------------------------------------------------------------------------

\401\ Numerous states also offer a variety of small business
financing programs, such as Capital Access Programs, collateral
support programs and loan guarantee programs. These programs are
eligible for support under the State Small Business Credit
Initiative, available at https://www.treasury.gov/resource-center/sb-programs/Pages/ssbci.aspx.
\402\ 15 U.S.C. 631 et seq. 7(a) loans provide small businesses
with financing guarantees (up to $5 million) for a variety of
general business purposes through participating lending
institutions.
\403\ SBA also offers the Microloan program, which provides
funds to specially designated intermediary lenders that administer
the program for eligible borrowers. The maximum loan amount is
$50,000, but the average is approximately $13,000. See Microloan
Program, U.S. Small Business Administration, available at https://www.sba.gov/content/microloan-program.
\404\ 15 U.S.C. 695 et seq. The CDC loans (up to $5.5 million)
are made available through ``certified development companies'' or
``CDCs,'' typically structured with the SBA providing 40% of the
total project costs, a participating lender covering up to 50% of
the total project costs and the borrower contributing 10% of the
project costs.
\405\ See U.S. Small Business Administration, Agency Financial
Report: Fiscal Year 2015, available at https://www.sba.gov/sites/default/files/aboutsbaarticle/Agency_Financial_Report_FY_2015.pdf.
\406\ Id.
\407\ As of the end of fiscal year 2015, the SBA guaranteed
business loans outstanding (including 7(a) and CDC loans) equaled
$118.8 billion. See SBA Agency Financial Report: Fiscal Year 2015.
This comprises approximately 20% of the approximately $606 billion
in outstanding small business loans for commercial real estate and
commercial and industrial loans discussed above. In addition to loan
guarantees, the SBA program portfolio also includes direct business
loans, which are mainly microloans and disaster loans.
---------------------------------------------------------------------------

Borrowing from financial institutions is, however, relatively
costly for many early-stage issuers and small businesses as they may
have low revenues, irregular cash-flow projections, insufficient assets
to offer as collateral, and high external monitoring costs.\408\ Many
startups and small businesses may find loan requirements imposed by
financial institutions difficult to meet and may not be able to rely on
these institutions to secure funding. For example, financial
institutions generally require a borrower to provide collateral and/or
a guarantee,\409\ which startups, small businesses and their owners may
not be able to provide. Collateral may also be required for loans
guaranteed by the SBA.
---------------------------------------------------------------------------

\408\ See Robb Study.
\409\ Approximately 92% of all small business debt to financial
institutions is secured, and owners of the company guarantee about
52% of that debt. See Allen N. Berger and Gregory F. Udell, 1995,
Relationship Lending and Lines of Credit in Small Firm Finance,
Journal of Business 68(3), pp. 351-381. Some studies of small
business lending also document the creation of local captive markets
with higher borrowing costs for small, informationally opaque
companies as a result of strategic use of soft information by local
lenders. See Sumit Agarwal and Robert Hauswald, 2010, Distance and
Private Information in Lending, Review of Financial Studies 13(7),
pp. 2757-2788.
---------------------------------------------------------------------------

Other sources of debt financing for startups and small businesses
include peer-to-peer and peer-to-business lending,\410\
microfinance,\411\ and other alternative online lending channels.\412\
According to some industry estimates, the global volume of ``lending-
based crowdfunding,'' which includes peer-to-peer lending to consumers
and businesses, had risen to approximately $11.08 billion in 2014.\413\
Technology has facilitated the growth of alternative models of small
business lending. According to one academic study,\414\ the outstanding
portfolio balance of online alternative lenders has doubled every year,
albeit this market represents less than $10 billion in outstanding loan
capital. According to the 2015 Small Business Credit survey,\415\ 20%
of all

[[Page 83528]]

small businesses surveyed applied for credit with an online
lender.\416\
---------------------------------------------------------------------------

\410\ Such debt transactions are facilitated by online platforms
that connect borrowers and lenders and potentially offer small
businesses additional flexibility with regard to pricing, repayment
schedules, collateral or guarantee requirements, and other terms.
See Ian Galloway, Peer-to-Peer Lending and Community Development
Finance, Federal Reserve Bank of San Francisco (Working Paper)
(2009), available at https://www.frbsf.org/publications/community/wpapers/2009/wp2009-06.pdf.
\411\ See Craig Churchill and Cheryl Frankiewicz, Making
Microfinance Work: Managing for Improved Performance, Geneva
International Labor Organization (2006). Microfinance consists of
small, working capital loans provided by microfinance institutions
that are invested in microenterprises or income-generating
activities. According to one report, in fiscal year 2012, the U.S.
microfinance industry was estimated to have disbursed $292.1 million
across 36,936 microloans, with an estimated $427.6 million in
outstanding microloans (across 45,744 in microloans). See FIELD at
the Aspen Institute, U.S. Microenterprise Census Highlights, FY
2012, available at https://fieldus.org/Publications/CensusHighlightsFY2012.pdf.
\412\ Several models of online small business lending have
emerged: Online lenders raising capital from institutional investors
and lending on their own account (e.g., short-term loan products
similar to a merchant cash advance); peer-to-peer platforms; and
``lender[hyphen]agnostic'' online marketplaces that facilitate small
business borrower access to various loan products from traditional
and alternative lenders, including term loans, lines of credit,
merchant cash advances and factoring products,. See Karen Gordon
Mills and Brayden McCarthy, The State of Small Business Lending:
Credit Access during the Recovery and How Technology May Change the
Game, Harvard Business School Working Paper 15-004 (2014), available
at https://ssrn.com/abstract=2470523 (``Mills Study'').
\413\ See Massolution, 2015CF Crowdfunding Industry Report:
Market Trends, Composition and Crowdfunding Platforms, available at
https://reports.crowdsourcing.org/index.php?route=product/product&product_id=54 (``Massolution 2015 Report'') at 56. The
Massolution 2015 Report refers to peer-to-peer lending to consumers
and peer-to-business lending to small businesses as ``lending
based'' crowdfunding. Our discussion refers to peer-to-peer lending
more broadly in a sense synonymous with ``lending-based''
crowdfunding.
\414\ See Mills Study.
\415\ The survey was conducted by the Federal Reserve Banks of
New York, Atlanta, Boston, Cleveland, Philadelphia, Richmond and St.
Louis during 2015. It focused on credit access among businesses with
fewer than 500 employees in 26 states. The survey authors note that
since the sample is not a random sample, results were reweighted for
industry, age, size, and geography to reduce coverage bias. See 2015
Small Business Credit Survey: Report on Employer Firms, available at
https://www.clevelandfed.org/community-development/small-business/about-the-joint-small-business-credit-survey/2015-joint-small-business-credit-survey.aspx.
\416\ Id. The survey also showed differences in the use of
online lenders by type of borrower: 26% and 21% of small businesses
that have been in business for less than 2 years and 3-5 years,
respectively, applied for credit with online lenders. By comparison,
11% of small businesses with revenue between $1million-$10 million
and 6% of small businesses with revenue greater than $10 million
applied for credit to an online lender. Mature (older, higher
revenue, greater number of employees) categories of small businesses
were much more likely to apply for credit with bank lenders than
with online lenders.
---------------------------------------------------------------------------

Family and friends are also sources through which startups and
small businesses can raise capital. This source of capital is usually
available early in the lifecycle of a small business, before the
business engages with arm's-length, more formal funding channels.\417\
Among other things, family and friends may donate funds, loan funds or
acquire an equity stake in the business. A recent study finds that most
of the capital supplied to startups by friends and family is in the
form of loans.\418\ Family and friends, however, may be able to provide
only a limited amount of capital compared to more formal sources. We do
not have data available on these financing sources that could allow us
to quantify their magnitude or compare them to other current sources of
capital.
---------------------------------------------------------------------------

\417\ See Paul Gompers and Josh Lerner, The Venture Capital
Cycle (MIT Press 2006).
\418\ See Robb Study, at 1219.
---------------------------------------------------------------------------

B. Analysis of Final Rules

1. Broad Economic Considerations
The final rules are intended to streamline and modernize the
capital raising options available to startups and small businesses,
including through the use of intrastate and regional securities
offering provisions that have been enacted or could be enacted by
various states, and thereby promote capital formation within the larger
economy.
Securities-based crowdfunding is a relatively new and evolving
capital market that provides startups and small businesses an
alternative mechanism of raising funds by selling small amounts of
securities to a large number of investors using the Internet. Title III
of the JOBS Act directed the Commission to establish rules for an
exemption that would facilitate this market at the federal level.
Around the same time, some states began enacting intrastate
crowdfunding statutes and rules that provide issuers with exemptions
from state registration. Most intrastate crowdfunding provisions
require issuers to comply with the requirements of Section 3(a)(11) and
Rule 147, while three states currently provide issuers with the option
of utilizing Rule 504 or another Regulation D exemption.\419\
---------------------------------------------------------------------------

\419\ Maine's provisions currently permit interstate
crowdfunding utilizing the Rule 504 exemption and Mississippi and
Vermont dually offer intrastate crowdfunding under Section 3(a)(11)
and interstate crowdfunding under Rule 504. See NASAA Letter.
---------------------------------------------------------------------------

By establishing new Rule 147A and modernizing the existing
requirements under Rule 147, the final rules could facilitate capital
formation through intrastate crowdfunded offerings as well as through
other state registered or state exempt offerings. Raising the offering
amount limit under amended Rule 504 from $1 million to $5 million may
facilitate smaller offerings, including those registered or exempt from
registration in a particular state, or regional offerings made pursuant
to regional state coordinated review programs.\420\ Such programs, when
implemented, may enable issuers relying on Rule 504 to register an
offering in any one rather than in each of the several states where
they conduct offers and sales, thereby saving them time and money. In
light of the current infrequent use of the Rule 505 exemption and the
increase in the maximum offering size under Rule 504 to $5 million,
repealing Rule 505 will simplify the existing Securities Act exemptive
framework without significantly diminishing issuers' capital raising
options.
---------------------------------------------------------------------------

\420\ See https://www.nasaa.org/industry-resources/corporation-finance/coordinated-review/. See also the ``Reciprocal Crowdfunding
Exemption'' proposed by the Massachusetts Securities Division
available at https://www.sec.state.ma.us/sct/crowdfundingreg/Reciprocal%20Crowdfunding%20Exemption%20-%20MA.PDF.
---------------------------------------------------------------------------

The amendments to Rule 147 and Rule 504 and the establishment of
Rule 147A will remove or reduce certain impediments to capital raising
identified by market participants and commenters.\421\ As discussed
below, the effects of the final rules on capital formation will depend,
first, on whether issuers that currently raise or plan to raise capital
will choose to rely on the safe harbor and exemptions provided by
amended Rules 147 and 504 and new Rule 147A in lieu of other methods of
raising capital, such as Regulation Crowdfunding and Rule 506 of
Regulation D. To assess the likely impact of the final rules on capital
formation, we consider the features of amended Rules 147 and 504 and
new Rule 147A that potentially could increase securities offerings by
new issuers and by issuers that already rely on other private offering
methods.
---------------------------------------------------------------------------

\421\ See e.g., Transcript of Record at 78, SEC Advisory
Committee on Small and Emerging Companies (June 3, 2015), available
at https://www.sec.gov/info/smallbus/acsec/acsec-minutes-060315.pdf.
See also 2015 Small Business Forum Recommendations; ABA Letter;
CFIRA Letter; CrowdCheck Letter; Milken Letter.
---------------------------------------------------------------------------

Second, to the extent that securities offerings relying on the
final rules provide capital raising options for issuers that currently
do not have access to capital, the final rules could enhance the
overall level of capital formation in the economy, in addition to any
reallocation of demand for capital amongst the various capital raising
methods that could arise from issuers changing such methods.
Third, to the extent that states currently have residency and
eligibility requirements that correspond to existing Rule 147, the
impact of amended Rule 147 and new Rule 147A on capital formation will
significantly depend on whether state law is amended to align with the
final rules. Any changes to intrastate and regional securities offering
provisions that may be enacted by states would, in turn, affect the
expected use of amended Rules 147 and 504 and new Rule 147A. Currently,
most intrastate crowdfunding provisions require issuers to rely on Rule
147 and Section 3(a)(11) for exemption from Securities Act
registration. To the extent state law provisions are amended to allow
these offerings to comply with amended Rule 147, new Rule 147A or
amended Rule 504, the choice between these three exemptions could
depend on issuers' preferences with respect to general solicitation,
target investor base, issuer incorporation and investor location. For
example, while issuers relying on the amended Rule 147 safe harbor must
be incorporated in the state where they seek to conduct an intrastate
offering, there is no such restriction for issuers relying on the Rule
147A exemption. While both Rule 147 and Rule 147A offerings will be
restricted to in-state investors, Rule 504 offerings will be available
to investors in more than one state, thus facilitating regional
offerings. At the same time, there is no limit on the maximum offering
amount under amended Rule 147 or new Rule 147A, while amended Rule 504
limits the maximum amount that can be sold over a twelve-month period
to $5 million.
Finally, the impact of the final rules on aggregate capital
formation also will depend on whether new investors are attracted to
the Rule 147, Rule 147A and Rule 504 markets or whether investors
reallocate existing capital among

[[Page 83529]]

various types of offering methods. If the final rules allow issuers to
reach a category of potential investors significantly different from
those that they can reach through other offering methods, or attract
existing investors to invest a greater share of their wealth in primary
offerings, then capital formation, in aggregate, could increase. On the
other hand, if the final rules are viewed as substantially similar to
alternate offering methods, investors with limited investment capital
may simply reallocate their capital from other markets to the Rule 147,
Rule 147A or Rule 504 markets. Investor demand for securities offered
under the final rules could, in particular, depend on the extent to
which expected risk, return and liquidity of the offered securities
compare to what investors can obtain from securities in other exempt
offerings and in registered offerings.
Investor demand also will depend on whether state disclosure
requirements are sufficient to enable investors to evaluate the
aforementioned characteristics of offerings made pursuant to Rules 147,
147A or 504. For example, investors may be less willing to participate
in offerings that are made in reliance on exemptions both from state
and federal registration and that are subject to fewer disclosure
requirements. For some investors, these concerns may be mitigated by
other state and federal provisions, such as the amendment being adopted
to disqualify certain bad actors from participation in Rule 504
offerings or the disclosure requirements for larger intrastate
crowdfunding offerings under state law provisions.\422\
---------------------------------------------------------------------------

\422\ See NASAA's Intrastate Crowdfunding Resource Center,
available at https://www.nasaa.org/industry-resources/corporation-finance/instrastate-crowdfunding-resource-center/.
---------------------------------------------------------------------------

In sum, we believe that the potential use of Rules 147, 147A and
504 will depend largely on how issuers perceive the trade-off between
the costs of compliance under federal provisions as well as state
regulation, if any, and the benefits of access to non-accredited
investors. For instance, relative to Regulation Crowdfunding, the
extent to which issuers rely on Rules 147, 147A or 504 for intrastate
crowdfunding offerings will depend on whether the benefits of a larger
offering amount and fewer reporting requirements outweigh the costs of
a more geographically limited investor base, compliance with issuer
residency requirements and the potential for registration under Section
12(g) of the Exchange Act. In this regard, we believe a small, local
business that serves local customers (e.g., a hair salon or a pizza
shop), rather than a scalable business like a technology start-up, is
more likely to use intrastate crowdfunding than interstate
crowdfunding.\423\ Compared to Rules 147, 147A and 504, other
exemptions and safe harbors already being utilized could remain
attractive to issuers. For example, offerings conducted pursuant to the
exemption from registration under Rule 506(b) of Regulation D, which
accounts for a significant amount of exempt offerings,\424\ are subject
to limits on participation by non-accredited investors. In contrast,
issuers relying on Rules 147, 147A or 504 could generally sell
securities to an unlimited number of non-accredited investors, which
would allow for a more diffuse investor base. General solicitation is
currently permitted under Rule 506(c) of Regulation D, and issuers
relying on Rule 506(c) can more easily reach institutional and
accredited investors, making it less necessary for them to seek capital
from a broader non-accredited investor base, especially if trading
platforms aimed at accredited investors in privately placed securities
continue to develop.\425\ In addition, offerings under Rule 506(b) that
are limited to accredited investors require only a notice filing with
the Commission and have no specified disclosure requirements. Finally,
relative to Regulation A, Rules 147, 147A and 504 will have fewer
disclosure and other regulatory requirements at the federal level.
However, unlike securities issued in reliance on Regulation A, which
are freely tradable, securities issued under Rules 147, 147A and 504
could be less liquid due to their resale restrictions.
---------------------------------------------------------------------------

\423\ See Nextseed Letter.
\424\ See discussion in Section V.2 above.
\425\ See e.g., NASDAQ Private Market overview, available at
https://www.nasdaqprivatemarket.com/market/overview (explaining that
``NASDAQ Private Market's affiliated marketplace is an electronic
network of Member Broker-Dealers who provide accredited institutions
and individual clients with access to the market. Companies use a
private portal to enable approved parties to access certain
information and transact in its securities.'').
---------------------------------------------------------------------------

Overall, the amendments to Rules 147, 147A and 504 could increase
the aggregate amount of capital raised if used by issuers that have not
previously conducted securities offerings. The net effect also will
depend on whether investors find the rules' investor protections to be
sufficient to evaluate the expected return and risk of such offerings.
As noted above, the final rules may have a limited impact on capital
formation if they simply cause issuers to conduct, and investors to
reallocate their participation across, different types of offerings.
However, even redistribution among capital raising methods will have a
net positive effect on capital formation and allocative efficiency if
it allows issuers to access capital at a lower cost.
As the final rules are not currently in effect, data does not exist
to estimate the effect of the final rules on the potential rate of
substitution between alternative methods of raising capital and the
overall expansion or decline in capital raising by potential issuers
affected by the rules. However, we anticipate that the final rules, by
lowering investor search costs and easing issuer eligibility
requirements, will result in an increased use of the federal intrastate
offering provisions, including for intrastate crowdfunding, as more
states enact provisions facilitating such offerings. Similarly, we
expect the final rules will increase the use of the Rule 504 exemption,
especially by facilitating efforts among state securities regulators to
implement regional coordinated review programs that will enable
regional offerings. Although it is not possible to predict the extent
of such increase or the type and size of issuers that will conduct
intrastate and small regional offerings, the current number of
businesses pursuing similar levels of financing through alternative
capital raising methods, as discussed in the baseline analysis above,
provide an upper bound for Rule 147, Rule 147A and Rule 504 usage.\426\
Nevertheless, the baseline data show that the potential number of
issuers that might seek to offer and sell securities in reliance on
Rules 147, 147A and 504 is large, particularly when compared to the
current number of approximately 9,000 reporting companies.\427\
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\426\ We believe the numbers in the baseline analysis provide an
upper bound because, unlike Rule 147 offerings, investors from
multiple states are permitted to invest in Regulation D offerings,
which attracts more issuers, especially those that want to raise
larger amounts. Similarly, unlike Rule 504, Rule 506 provides state
law preemption and permits unlimited offering amounts, which appears
to make Rule 506 offerings more attractive for issuers.
\427\ See U.S. Securities and Exchange Commission, FY 2016
Congressional Budget Justification, 2016 Annual Performance Plan, FY
2014 Annual Performance Report, available at https://www.sec.gov/about/reports/secfy16congbudgjust.pdf.
---------------------------------------------------------------------------

We recognize that the amendments to Rules 147 and 504 and new Rule
147A could raise investor protection concerns. For instance, as
discussed in detail further in this section, allowing issuers with more
geographically dispersed assets and revenues than currently permitted
to rely on Rules 147 and 147A may raise concerns about reduced
oversight by state securities regulators. We believe however, that the
amended ``doing business'' tests along

[[Page 83530]]

with the principal place of business requirement are sufficient to
provide assurance of the local nature of an issuer's business
operations.\428\ We also believe such concerns are mitigated by the
continuing applicability of state regulatory requirements, which may
impose additional eligibility conditions for issuers in these
offerings, as well as the residency requirements for investors that
remain under the final rules.
---------------------------------------------------------------------------

\428\ See also NASAA Letter and CFA Letter.
---------------------------------------------------------------------------

Similarly, there could be concerns about not having an offering
size limit at the federal level or not requiring a limit under state
law if the issuer relies on a state exemption for an intrastate
offering. In adopting existing Rules 147, 504 and 505, the Commission
relied substantially upon state securities laws and regulations on the
rationale that the size and/or local nature of smaller offerings
conducted pursuant to these provisions does not warrant imposing
extensive regulation at the federal level.\429\ The final rules
preserve this approach by permitting state legislators and securities
regulators to determine the specific additional rule requirements, if
any, that should be mandated to regulate local offerings and provide
additional investor protections. In this regard, the final rules
provide greater flexibility to states in designing regulations that
would work best for issuers and investors in their respective
jurisdictions. We believe that such latitude could improve the
efficiency of local capital markets and lead to competition between
states in attracting issuers to locate to their jurisdictions.
---------------------------------------------------------------------------

\429\ See Seed Capital Release and Rule 147 Adopting Release.
See also, ABA Letter and NASAA Letter.
---------------------------------------------------------------------------

In addition to state regulations, the amendments to Rule 504 to
disqualify certain bad actors from participation in Rule 504 offerings
could help to address such investor protection concerns. We also note
that the Commission will retain authority under the antifraud
provisions of the federal securities laws to pursue enforcement action
against issuers and other persons involved in such offerings.\430\
Nevertheless, if investors demand higher returns because of a perceived
increase in the risk of fraud as a result of less extensive federal
regulation, issuers may face a higher cost of capital. We are unable to
predict if or how the final rules will affect the incidence of fraud in
intrastate and Rule 504 offerings.
---------------------------------------------------------------------------

\430\ See, e.g., Seed Capital Release at note 20 and
accompanying text (Rule 504 offerings are subject to Section 17 of
the Securities Act [15 U.S.C. 77q(a), Section 10(b) of the Exchange
Act [15 U.S.C. 78j(b) and Rule 10b-5 thereunder [17 CFR 240.10b-5]).
---------------------------------------------------------------------------

The impact of the repeal of Rule 505 will depend on the trade-offs
that Rule 505 issuers and investors face when switching to alternate
offering methods, predominantly other unregistered offerings. This will
be contingent on whether issuers can raise the desired amount of
capital at the same or lesser cost as under Rule 505 in a timely
manner.
For example, if issuers switch to offerings under Rule 506(b), they
may only offer and sell to investors that are accredited or that,
unlike in a Rule 505 offering, either alone or with a purchaser
representative,\431\ are sophisticated (i.e., have sufficient knowledge
and experience in financial and business matters to make them capable
of evaluating the merits and risks of the prospective investment).
However, the possibility of raising unlimited amounts of capital and
preemption from state blue sky laws may offset some of these concerns
for potential issuers that subsequent to the repeal of Rule 505, would
switch to a Rule 506 offering. In contrast, if issuers switch to
offerings under amended Rule 504, they could replicate most
characteristics of an offering under existing Rule 505 and receive some
additional benefits, such as access to an unlimited number of non-
accredited investors and the ability to engage in general solicitation
in certain situations. However, reporting companies, albeit a small
proportion of all Rule 505 issuers,\432\ are not permitted to utilize
the Rule 504 exemption.
---------------------------------------------------------------------------

\431\ A purchaser representative is someone who is not an
affiliate of the issuer but has such knowledge and experience in
financial and business matters that he is capable of evaluating,
alone, or together with other purchaser representatives of the
purchaser, or together with the purchaser, the merits and risks of
the prospective investment. See also Rule 501, Regulation D of
Securities Act.
\432\ As discussed in Section IV(A)(1)(ii), the number of
reporting companies that conducted a Rule 505 offering during 2014
and 2015 was 10 and 8, respectively.
---------------------------------------------------------------------------

As an alternative to Rule 505, issuers may also opt for a
registered offering to raise capital. As noted above, a registered
offering may not be economically feasible for small issuers relative to
an exempt offering,\433\ but may provide a reasonable alternative for
Rule 505 issuers that are reporting companies. Registered offerings,
unlike Rule 505 or Rule 506(b) offerings, have benefits like providing
investors with unrestricted securities, and providing issuers access to
an unlimited number of non-accredited investors and investors who
prefer offerings that have the protections of the registration process.
On the other hand, the costs of registering an offering compared with
costs of raising capital through an exempt offering, including Rule 505
or Rule 506(b) offerings, may also affect an issuer's willingness to
switch to a registered offering. Such costs include the costs of
disclosure required for a registered offering relative to the
disclosure required under Rule 505 or 506(b) when non-accredited
investors are solicited,\434\ including any costs associated with
Commission staff review of the registration statement. Recent
regulatory changes to Form S-1 \435\ that permit forward incorporation
by reference of certain information required under Exchange Act
reporting requirements may have lowered the costs of registered
offerings for eligible smaller reporting companies by eliminating the
need to update information in the Form S-1 that has become stale or is
incomplete through a post-effective amendment. Whether Rule 505
issuers, in particular those that are reporting companies, switch to a
registered offering or another form of unregistered offering such as
Rule 506 offering will depend on how they assess such costs of
registration relative to the benefits like broader access to non-
accredited investors.\436\
---------------------------------------------------------------------------

\433\ See discussion in Section V(A(1)(c)(2) above.
\434\ The disclosure requirements under Rule 505 and Rule 506(b)
for an Exchange Act reporting issuer that sells securities to a non-
accredited investor are similar to the disclosure requirements for a
registered offering under the Securities Act. See Rule 502(b)(2)(ii)
of Regulation D. Note that if the Rule 505 or 506(b) offering is
soliciting only accredited investors, there is no equivalent
requirement for information being furnished.
\435\ See note 330 above.
\436\ See, e.g., Armando Gomes and Gordon Phillips, ``Why Do
Public Firms Issue Private and Public Securities?'', J. FINAN.
INTERMEDIATION, March 21, 2012 which find that choice of public
versus private financing depends on asymmetric information, risk and
market timing. See also Hsuan-Chi Chen, Na Dai, John Schatzberg,
``The Choice of Equity Selling Mechanisms: PIPEs versus SEOs'', J.
CORP. FIN., August 21, 2009.
---------------------------------------------------------------------------

The effect of the repeal of Rule 505 will also depend on investors'
willingness and ability to participate in an alternate unregistered
offering, such as a Rule 504 or Rule 506 offering, or a registered
offering. This willingness will rest on whether investors find
disclosure requirements and investor protections in alternate markets
to be sufficient, relative to the Rule 505 market, to evaluate the
expected return and risk of such offerings. For example, it is possible
that investor protection levels will be perceived to be lower in a Rule
506 offering as these offerings are preempted from state or Commission
registration. In addition, ``unsophisticated'' non-accredited investors
that may have been able to participate in a Rule 505 investment

[[Page 83531]]

opportunity may not be able to participate in a Rule 506(b) offering
without a purchaser representative and hence may find their set of
investment opportunities reduced. Similarly, while more than 35 non-
accredited investors (the maximum eligible to invest in a Rule 505
offering) will be able to participate in an offering under amended Rule
504, Rule 504 has fewer disclosure requirements at the federal level
relative to a Rule 505 or 506 offering, which may raise potential
investor protection concerns. Such concerns, however, may be offset by
disclosure requirements imposed at the state level. Thus, the net
impact on the overall level of investor protection will likely depend
on the capital markets that substitute for the repealed Rule 505
market.
Overall, the repeal of Rule 505 may not have a significant or any
impact on capital formation if issuers can successfully find
commensurate investor interest in an alternate unregistered or
registered offering market. If issuers are not able to find an
alternate exemption and raise sufficient amounts of capital, an outcome
we believe is unlikely, overall capital formation in the economy and
allocative efficiency of capital markets could slightly decline.
In the sections below, we analyze in more detail the potential
costs and benefits stemming from the specific amendments and new rule
being adopted today, as well as their impact on efficiency, competition
and capital formation, relative to the baseline discussed above.
2. Analysis of Amendments to Existing Rule 147 and New Rule 147A
The amendments to Rule 147 and new Rule 147A will modernize and
expand the options available under federal law for exempt intrastate
offerings by local companies, including offerings relying upon
crowdfunding provisions under state securities laws.
a. Retention of Existing Rule 147
The proposed amendments would have replaced the existing Rule 147
safe harbor with a new intrastate offering exemption. In contrast, the
final rules amend Rule 147 and retain it as a safe harbor under Section
3(a)(11), while also establishing new Rule 147A pursuant to the
Commission's general exemptive authority under Section 28. Because most
state crowdfunding provisions require issuers to comply with Section
3(a)(11) and Rule 147, retention of Rule 147 within the statutory
parameters of Section 3(a)(11) will enable issuers to continue to rely
upon the existing safe harbor to conduct intrastate offerings until
states update their laws or regulations to allow issuers to rely on new
Rule 147A.\437\ This will help to ensure that intrastate offering
activity is not adversely affected during the interim period or in
states that do not amend their laws, and will thus provide greater
certainty to market participants, including issuers and investors who
participate in such intrastate offerings.\438\ Together, the amendments
to Rule 147 and new Rule 147A seek to modernize federal regulation of
intrastate offerings to comport with contemporary business practices
and communications technology, while retaining the underlying intent of
the rules to permit issuers to raise money from investors resident
within the same state without registering the offering at the federal
level.
---------------------------------------------------------------------------

\437\ Most states that have enacted state crowdfunding
provisions require issuers to comply with the provisions of Section
3(a)(11) and Rule 147. See note 30 above.
\438\ See, e.g., ABA Letter, NASAA Letter, CrowdCheck Letter,
Guzik Letter, NextSeed Letter and the 2015 Small Business Forum
Recommendations.
---------------------------------------------------------------------------

Amended Rule 147 will differ from new Rule 147A with respect to two
provisions that are statutorily mandated by Section 3(a)(11). Under
Section 3(a)(11), and by extension the safe harbor under Rule 147,
offers can be made only to in-state residents and issuers are required
to be incorporated in the state where they conduct the intrastate
offering. The provisions of new Rule 147A will not include these two
limitations; however, both Rule 147 and 147A will require an issuer to
have its principal place of business within the state or territory of
the offering. In the following sections, we first discuss the economic
effects of not including the two statutory limitations contained in
Rule 147 within new Rule 147A and then discuss the amendments that are
substantially identical under Rules 147 and 147A.
b. Distinguishing Provisions Under New Rule 147A
i. Elimination of Restrictions on Manner of Offering
Offers pursuant to current and amended Rule 147 must be limited to
in-state residents.\439\ However, the provisions under new Rule 147A
will allow an issuer to make offers to out-of-state residents, as long
as sales are made only to residents of the issuer's state or
territory.\440\ Both amended Rule 147 and new Rule 147A require issuers
to include prominent disclosures on all offering materials stating that
sales will be made only to residents of the same state or territory as
the issuer, while also disclosing that the securities are being sold in
an unregistered offering and have resale restrictions for a six-month
period.\441\ In addition, under both rules, states retain the
flexibility to impose additional disclosure or other requirements
related to offers and sales made in the intrastate offering. As
Internet-based advertising is easily accessible across state lines,
issuers relying on existing Rule 147 that choose to disseminate
offering materials using online media could have a higher risk of being
non-compliant unless they take additional and potentially costly
precautions to restrict any advertising that can be viewed outside
their state of incorporation. Eliminating manner of offering
restrictions in Rule 147A will allow issuers to engage in broad-based
solicitations, including on publicly accessible Web sites, in order to
successfully locate potential in-state investors. For example, an
issuer resident in New Jersey will be permitted under Rule 147A to
advertise and disseminate offering information through online media to
reach New Jersey residents, including those who may work and access the
online solicitation while in New York. Thus, Rule 147A will provide
issuers with the flexibility to utilize a wider array of options to
advertise their offerings, allowing them to take advantage of modern
communication technologies such as the Internet and other social media
platforms to reach investors.\442\ In this regard, we expect Rule 147A
to be particularly effective at facilitating state-based crowdfunding
offerings that rely heavily on online platforms to bring issuers and
investors together.\443\ Online advertising provides a lower cost and
more efficient means of communicating with a more diffused base of
prospective investors. Consequently, eliminating manner of offering
restrictions in Rule 147A should result in lower search costs for Rule
147A issuers. The provisions may facilitate compliance with the rules'
requirements as issuers will not need to limit advertising or take
additional precautions to ensure that only in-state residents view the
offering.
---------------------------------------------------------------------------

\439\ See Rule 147(b).
\440\ See Rule 147A(b).
\441\ See Rules 147(f) and 147A(f).
\442\ See also ABA Letter, CFA Letter, Nextseed Letter.
\443\ See Massolution 2015 Report.
---------------------------------------------------------------------------

Under the final rules, issuers will be able to choose between
utilizing Rule 147 and Rule 147A for intrastate offerings based on
their preferences for communicating with investors. This

[[Page 83532]]

could enable a larger number of issuers to utilize intrastate offerings
to meet their capital raising needs. To the extent issuers shift from
another unregistered capital market to the Rule 147A market, capital
formation may not increase but the allocative efficiency of capital
markets could improve, if issuers are able to meet their capital
raising needs more effectively and investors are better able to find
investment opportunities that satisfy their financial objectives. We
believe that eliminating the manner of offering restrictions in Rule
147A will attract a number of new issuers that previously could not
avail themselves of lower-cost capital raising opportunities, such as
intrastate crowdfunding, that primarily rely on online media to
advertise the offering to large numbers of investors. Such improved
access to cheaper capital raising methods may result in higher levels
of capital formation in the economy.
In addition, eliminating manner of offering restrictions in Rule
147A may result in a greater number of investors becoming aware of a
larger and more diverse set of investment opportunities in private
offerings, enabling them to diversify their investment portfolios and
allocate their capital more efficiently. Further, broadly advertised
offerings under Rule 147A may compete for potential investors more
effectively with offerings where general solicitation is also
permitted, such as Rule 504, Rule 506(c), and Regulation A offerings.
The final rules could thus intensify competition among unregistered
capital markets for attracting issuers that want to raise capital and
investors that are looking for suitable investment opportunities. An
increase in competition could change the number and type of market
participants across various markets, which would impact the relative
demand for and supply of capital in each of these markets.
However, as issuers utilizing Rule 147A advertise more widely and
freely, the likelihood of out-of-state investors purchasing into an
intrastate offering could increase. The inclusion of legends and other
mandatory disclosures may mitigate this concern and may provide a
certain measure of investor protection, although out-of-state investors
in their desire to participate in an attractive investment opportunity
may overlook the legends or disclosures or may simply disregard them.
While issuers are required to have a reasonable belief that all their
purchasers are resident within the state and obtain a written
representation from each purchaser as to his or her residence, the
probability of circumventing the out-of-state sale restrictions by
investors who misrepresent their residency status could increase as
out-of-state residents may view Internet-based advertising and become
aware of Rule 147A offerings in another state. Likewise, there may be
an increased probability that out-of-state purchasers will attempt to
purchase in resale transactions that occur within the restricted
period. However, due to inclusion of rule provisions such as the
requirement of written representation by investors as to their
residency status as well as requirements related to legends, transfer
agent instructions and prominent disclosure about limitations on
resales, we believe that such concerns may not be significantly higher
than under amended Rule 147, which retains the restrictions related to
manner of offerings. Allowing Internet-based advertising of Rule 147A
offerings and the potential increased use of the intrastate offering
exemptions could also impact the effectiveness of state oversight if
regulators do not have adequate resources to monitor the manner in
which these securities are marketed to the general public. Overall, we
believe that the final rules will modernize existing regulations to
reflect modern business practices and technological developments while
maintaining appropriate investor protections.
ii. Incorporation and Principal Place of Business Requirements
New Rule 147A will eliminate the current requirements in Rule 147
for issuers to be incorporated and have their principal office in the
state where an offering is being conducted. In order to establish
sufficient in-state presence to be eligible to conduct an exempt
intrastate offering, in lieu of such requirements, Rule 147A will
require issuers to have their principal place of business in the state
where an offering is conducted. The principal place of business will be
defined as the location from which officers, partners or managers of
the issuer primarily direct, control and coordinate the activities of
the issuer.\444\
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\444\ See Rule 147A(c)(1). Corporations, limited partnerships
and trusts relying on amended Rule 147 will continue to be required
to be organized or incorporated in the state where the offering is
being conducted in order to establish in-state residency. Rule
147(c), however, will be amended by replacing the principal office
requirement with a principal place of business requirement. We
believe principal place of business is conceptually similar to
principal office location. See Section II(A)(2).
---------------------------------------------------------------------------

We believe that the elimination of the incorporation or
organization in-state requirement in Rule 147A better comports with
modern business practices and thereby will make it easier for a greater
number of issuers to utilize the new exemption, relative to amended
Rule 147. A significant number of public and private companies are
incorporated in states other than the state in which their principal
place of business is located, thereby precluding otherwise eligible
issuers from utilizing Rule 147 to conduct an intrastate offering.\445\
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\445\ For example, based on analysis of EDGAR filing data, 76%
of Exchange Act reporting companies indicated, in their 2015 Form
10-K filings, that they had a separate state of principal executive
office and state of incorporation. Analyzing by size (assets), more
than two-thirds of the smallest 10% of reporting companies reported
different states of incorporation and principal office. The practice
of incorporating in different states extends beyond public companies
to private and smaller companies. During 2009-2015, 37% of Rule 504
offerings and 39% in Rule 505 offerings indicated in their Form D
filings that they had different states of incorporation and
principal place of business. See baseline analysis in Section
IV(A)(1)(ii). Form D data also indicates that approximately 65% of
all Rule 506 offerings initiated during 2009-2015 reported different
states of incorporation and operations. While smaller companies may
be less likely than larger companies to have separate states of
incorporation and principal places of business, Form D data
indicates that a considerable number of small businesses are
currently unable to meet the state of incorporation requirement in
existing Rule 147.
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Most of these companies have chosen to incorporate in jurisdictions
where corporate laws are consistent with modern business practices or
provide more flexibility.\446\ For example, according to one academic
study, corporate laws affect company value, even after controlling for
company size, diversification, profitability, investment opportunities
and industry.\447\ Thus, companies may have strong incentives to select
perceived favorable regimes, such as that of Delaware.\448\ These
studies and industry practices indicate that companies' choice of state
of incorporation depends on the economic benefits derived from the
regulatory environment in which the company is organized and not
necessarily where the company operates most efficiently.
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\446\ See ABA Letter, CFA Letter, CrowdCheck Letter, Milken
Letter.
\447\ Robert Daines, ``Does Delaware Law Improve Firm Value?''
J. Fin. Econ., Volume 62, Issue 3 (2001) at 525-558.
\448\ See Scott D. Dyreng, Bradley P. Lindsey, Jacob R.
Thornock, ``Exploring the Role Delaware Plays as a Domestic Tax
Haven,'' J. Fin. Econ., Volume 108, Issue 3, (2013) at 751-772
(explaining that Delaware's tax laws play an economically important
role in U.S. companies' decision to locate in Delaware).
---------------------------------------------------------------------------

Since the geographical location of investment and employment is
aligned more closely with the principal place of business of a company
than where it is incorporated, we believe replacing the current
incorporation and residency requirements of current Rule 147 with a
principal place of business requirement in Rule 147A will be sufficient
to

[[Page 83533]]

establish the in-state nature of the issuer's business. Such a change
will also be consistent with the objectives of the current intrastate
offering exemption, while making it easier for more issuers to utilize
the new exemption relative to the amended Rule 147 safe harbor under
Section 3(a)(11).
By not requiring issuers to be incorporated in-state, it may be
possible for foreign incorporated issuers that have their principal
place of business in a U.S. state to be able to access the Rule 147A
capital market. This will create a uniform standard for companies that
are operating locally, irrespective of their country or state of
incorporation, to utilize the Rule 147A exemption. Form D filings for
the period 2009-2015 reported that approximately 2.5% of Regulation D
offerings (approximately 3,211 offerings) were initiated by issuers
that were incorporated outside of the United States and had their
principal place of business in a U.S. state. Allowing issuers to raise
capital in the state in which it has its principal place of business,
without regard to the jurisdiction of incorporation under new Rule
147A, could enable issuers to organize or incorporate in foreign
jurisdictions with perceived advantages that may increase the financial
viability of such issuers, especially for early stage companies.
However, to the extent that it is more difficult to enforce securities
and other relevant laws against such foreign organized or incorporated
issuers, risks to investors in such issuers could increase. Overall,
given the intrastate character of Rule 147A offerings, we do not think
it likely that a significant number of foreign issuers will seek to
utilize this exemption.
Under Rule 147 and Rule 147A, issuers will be able to have a
``principal place of business'' within only one state or territory, and
therefore the issuer will be able to conduct an intrastate (Rule 147 or
Rule 147A) offering in only one state or territory. To mitigate the
risk of issuers switching their principal place of business to a
different state in order to conduct Rule 147 or Rule 147A offerings in
multiple states, the final rules limit issuers that change their
principal place of business from utilizing the exemption to conduct
another intrastate offering in a different state for a period of six
months from the date of last sale of securities under the prior Rule
147 or Rule 147A offering. These provisions will help to deter issuers
from misusing the amended residency requirements to change their
principal place of business in order to sell to residents in multiple
states. The duration of this limitation is consistent with the period
for which resales to out-of-state investors will be prohibited.
To the extent a change in principal place of business to a new
state is motivated by business or regulatory considerations, this
amendment could affect the capital raising prospects of companies by
requiring them to delay their subsequent intrastate offerings or seek
to conduct an offering under another exemption. For example, certain
start-ups and small businesses that could potentially relocate their
principal place of business in pursuit of costs savings could be
affected by the final rules.
c. Common Requirements of Amended Rule 147 and New Rule 147A
i. ``Doing Business'' In-State Tests
Similar to the proposed amendments, the final rules will modify the
current ``doing business'' in-state requirements in Rule 147 by
requiring issuers to satisfy one of four specified tests. A similar
requirement will be included in Rule 147A. The specified tests will
include a new test whereby issuers can satisfy the ``doing business''
requirement if a majority of their employees are located in the
offering state. Specifically, under amended Rule 147 and new Rule 147A,
in order to be deemed ``doing business'' in a state, issuers will have
to satisfy at least one of the following requirements:
80% of the issuer's consolidated assets are located within
such state or territory;
80% of the issuer's consolidated gross revenues are
derived from the operation of a business or of real property located in
or from the rendering of services within such state or territory;
80% of the net proceeds from the offering are intended to
be used by the issuer, and are in fact used, in connection with the
operation of a business or of real property, the purchase of real
property located in, or the rendering of services within such state or
territory; or
A majority of the issuer's employees are in such state or
territory.
The modifications to the existing ``doing business'' in-state tests
will modernize the Rule 147 safe harbor and provide greater flexibility
to potential issuers relying on Rules 147 and 147A to conduct
intrastate offerings. This will ease issuer burden in complying with
the provisions, while also better aligning the rules with modern
business practices such that issuers will be able to use the test that
best reflects the local nature of their business operations.\449\
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\449\ See also CFA Letter.
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Rule 147 currently requires issuers to satisfy all three ``doing
business'' in-state tests, which can be burdensome even for small
businesses that have a strong nexus to one state. For example, for some
startups and early stage ventures that are unable to access alternate
methods of raising capital and therefore seek to rely on the intrastate
offering exemption, the existing ``doing business'' tests, by
restricting these issuers' operations and capital investments
substantially to one state may have adverse effects on their growth and
viability. Moreover, in recent years new business models have emerged
that may make satisfying all three tests ill-suited for issuers who
would otherwise be able to rely on Rule 147 as a capital raising
option. For example, businesses that use new technologies (e.g., e-
businesses) to make their operations more efficient tend to be more
geographically distributed in their operations or revenues than what is
permitted under current Rule 147.\450\ According to an academic study,
advances in computing and communications have fundamentally changed how
information can be stored, distributed, modified or assimilated, which
has enabled businesses to become more geographically dispersed and
modular rather than centralized into discrete units.\451\ Similarly,
the growth of modern technologies has made it easier for companies,
through e-commerce and shared logistical networks, to reach a larger
and more diffused customer base, leading to more dispersed revenue
streams.
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\450\ Consider the example of an e-commerce company that invests
in distribution facilities outside its state to meet the needs of
customers who are resident outside that state. Under current
requirements, such an issuer may be able to invest only a small part
(less than 20%) of the capital raised in a Rule 147 offering outside
its principal state of business to remain eligible for the
exemption. See also NASAA Letter.
\451\ See Mohanbir Sawhney and Deval Parikh, ``Where Value Lives
in A Networked World,'' Harvard Business Review (2001).
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Requiring an issuer to own a majority of its assets, invest most of
the capital it raises, and obtain its revenue in one state could create
inefficient constraints for startups and small businesses to operate
and grow in the modern business environment. While the original intent
of Section 3(a)(11) and Rule 147 was to ensure that investors and
issuers are located in the same state so that they are potentially
familiar with each other,\452\ current business practices of issuers,
consumption habits of customers, and the set of available investment
opportunities of investors have expanded greatly since Rule 147

[[Page 83534]]

was adopted in 1974. In view of these changes, we believe that the
modifications to the ``doing business'' requirements in the final rules
will provide issuers with greater flexibility in conducting intrastate
offerings and help to eliminate potential uncertainty about the
availability of intrastate offering exemptions.
---------------------------------------------------------------------------

\452\ See Rule 147 Adopting Release.
---------------------------------------------------------------------------

Compared to current Rule 147, the revised ``doing business''
requirements in the final rules will enable a greater number of
companies to rely on Rule 147 or Rule 147A to raise capital through
local offerings. Such new issuers could be those entities that are
currently accessing capital through alternate means, or they could be
issuers that could not previously raise sufficient amounts of capital
in any market but would be able to use amended Rule 147 or new Rule
147A to meet their funding needs. In addition, to the extent raising
capital in a Rule 147 or Rule 147A offering is less costly than raising
capital using alternate means, issuers will benefit from such lower
costs. Easier access to local capital may enable issuers to finance
investment opportunities in a timely manner, thereby accelerating
company growth and promoting state employment and economic growth.
As more companies become eligible or are willing to raise capital
pursuant to amended Rule 147 or new Rule 147A, the set of investment
opportunities for investors will also increase in a corresponding
manner, resulting in greater allocative efficiency and capital
formation. These economic benefits generally depend on the extent to
which increased use of the intrastate offering provisions, compared to
current Rule 147, arises as a result of substitution out of other types
of offerings. On one hand, if increased use of the intrastate offering
provisions causes issuers and investors to migrate from other types of
offerings as a result of marginally more attractive prospects for
investment and capital raising, the aggregate increase in capital
formation may not be significant but competition amongst types of
private offerings will be higher.\453\ On the other hand, if amended
Rule 147 or new Rule 147A attracts new issuers, capital formation
levels will increase in the economy. We believe that, by facilitating
intrastate crowdfunding, the final rules could provide new company
growth and consequently lead to an overall increase in capital
formation. Further, the final rules could lead to increased capital
formation by facilitating other state registered or exempt offerings,
including those with amounts greater than what is allowed for
intrastate crowdfunding offerings. However, since we do not have data
on the existing use of Rule 147, we are unable to quantify or predict
the extent of any increase in offering activity under amended Rule 147
or new Rule 147A.
---------------------------------------------------------------------------

\453\ We note that issuers that meet current requirements under
existing Rule 147 will also be eligible to rely on amended Rule 147
or Rule 147A.
---------------------------------------------------------------------------

At the same time, if issuers with assets and operations dispersed
over more than one state make use of amended Rule 147 or new Rule 147A,
there may be concerns that state oversight of such issuers could
weaken, with a consequent reduction in investor protection. We believe,
however, that qualifying under any one of the four ``doing business''
in-state tests and requiring an issuer to have its principal place of
business in the state, such that the officers and managers of the
issuer primarily direct, control and coordinate the activities of the
issuer in the state, will provide state regulators with a sufficient
basis from which to monitor an issuer's activities and enforce state
securities laws for the protection of their residents.\454\ Further,
state enforcement actions aimed at protecting in-state investors can
extend to issuers whose assets are located beyond the boundaries of the
state, which could potentially deter issuers from engaging in
fraudulent intrastate offerings. Moreover, with the adoption of
amendments to Rule 147 and new Rule 147A, state regulators may choose
to amend their state regulations to comport with these provisions,
which would allow them to consider any additional requirements,
including qualification tests, for issuers to comply with state
securities offerings regulations.
---------------------------------------------------------------------------

\454\ See also CFA Letter and NASAA letter.
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Finally, we note that the high threshold levels specified in the
final rules' ``doing business'' tests may preclude certain issuers
whose business models result in widely distributed operations (e.g.,
some e-commerce companies) from qualifying under any of the four tests
and thus from relying on these intrastate offering provisions. Such
issuers could rely on alternate capital raising methods such as
Regulation Crowdfunding. To the extent these issuers are unable to
raise the required capital through alternate methods, these provisions
could adversely impact capital formation and investment opportunities
for such firms. We believe, however, that the vast majority of issuers
will be able to satisfy the ``doing business'' test requirements in
order to qualify for local capital-raising.
ii. Reasonable Belief and Written Representation as to Purchaser
Residency Status
Amended Rule 147 and new Rule 147A include a reasonable belief
standard for determining whether a purchaser is a state resident at the
time of the sale of the securities. In a change from the proposed
rules, the final rules will retain the requirement of current Rule 147
that an issuer obtain investor representations as to his or her
residency status. The reasonable belief standard is conceptually
consistent with similar requirements in Regulation D offerings and will
provide greater certainty to issuers as to their compliance with the
conditions of the exemption, potentially encouraging greater reliance
on the final rules.\455\
---------------------------------------------------------------------------

\455\ See NASAA Letter.
---------------------------------------------------------------------------

Retaining the written representation requirement could constrain
issuer flexibility if the requirement predisposes them to rely on
particular modes of residency verification over others.\456\ It could
also result in somewhat higher compliance costs for issuers. At the
same time, the requirement could help to better ensure that issuers are
selling to investors who are residents of the state in which the
offering is being conducted. In this way, requiring a representation as
to the purchaser's residency may mitigate some of the investor
protection concerns raised by commenters.\457\ While a formal
representation of residency by itself is not sufficient to establish a
reasonable belief that such purchasers are in-state residents, the
representation requirement, together with the reasonable belief
standard, may result in better compliance with the final rules, which
would serve to increase investor protections. It is possible, however,
that some issuers may consider a written representation to be
dispositive of reasonable belief of investor's residency status, which
would increase the risk of issuers' violating the final rules.
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\456\ For example, issuers may find it easier to obtain a proof
of residency document directly from the purchaser along with a
written representation, whereas they may have found it more
efficient to rely on an alternate mode like third-party verification
if a written representation was not required.
\457\ See CFA Letter, CrowdCheck Letter, NASAA Letter.
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As an alternative, we considered providing a safe harbor for
determining purchaser's residence, as requested by several
commenters.\458\ A safe harbor could provide greater certainty for
issuers as to their compliance with the rules' provisions, potentially

[[Page 83535]]

encouraging greater use of the intrastate offering exemptions and
enhancing capital formation. However, a safe harbor also could be
viewed as an exclusive or a minimum standard that could restrict issuer
choice of verification methods, and we believe that requiring issuers
to consider the facts and circumstances of the offering and sale will
best serve issuers' compliance with the final rules.
---------------------------------------------------------------------------

\458\ See CFIRA Letter; CrowdCheck Letter; Localstake Letter;
WBA Letter.
---------------------------------------------------------------------------

iii. Residence of Entity Purchasers
Amended Rule 147 and new Rule 147A define the residence of a
purchaser that is a legal entity--such as a corporation, partnership,
trust or other form of business organization--as the location where, at
the time of the sale, the entity has its principal place of business.
This definition will create consistency in defining the place of
residence of entity investors with that of the issuer while also
helping to ensure that investors are sufficiently local by nature.
iv. Limitations on Resales
Consistent with the proposal, amended Rule 147 and new Rule 147A
will limit resales to in-state residents during a defined restricted
period from the date of sale by the issuer. In a change from the
proposed rules, this restricted period has been reduced from nine to
six months. Current Rule 147 provides a restricted period of nine
months, and the start date for the restricted period is from ``date of
last sale'' rather than from the ``date of sale'' for the particular
security in question. In addition, the issuers' ability to rely on
Rules 147 and 147A will not be conditioned on a purchaser's compliance
with the rules' resale restrictions.
Under the final rules, after expiration of the restricted period,
investors will be able to sell their securities to out-of-state
purchasers, even if the offering is not yet completed. While reducing
the restricted period to six months may raise investor protection
concerns, including concerns about increased probability that the
securities will be purchased with an intention to distribute, we are
persuaded by commenters that suggested a six-month period would be
adequate to assure that the securities have come-to-rest in the state
of issuance.\459\ In addition, state regulators will have the
flexibility to impose additional transfer restrictions under amended
Rule 147 or new Rule 147A, if warranted within their jurisdiction.
Additional language in amended Rule 147(e) and new Rule 147A(e) that
specifies that all re-sales during this six-month restricted period
will be limited to the state or territory in which the issuer is a
resident at the time of the sale of the security by the issuer will
help to maintain the intrastate nature of the offering even if the
issuer relocates its principal place of business to a different state.
The final rules, by shortening the restricted period, will provide
greater liquidity for Rule 147 and Rule 147A securities, making them
more attractive to investors, which could lead to greater investor
participation and an increase in the supply of capital available in
intrastate offerings. Further, it could improve price discovery and
lead to lower capital raising costs for issuers.
---------------------------------------------------------------------------

\459\ See note 157. See also text accompanying notes 167 and
168.
---------------------------------------------------------------------------

Additionally, not conditioning the availability of amended Rule 147
or new Rule 147A on the issuer complying with the provisions relating
to resale restrictions will provide greater certainty to issuers
conducting an offering pursuant to these provisions. For example,
issuers will not need to be concerned about potentially losing the
exemption if the resale provisions are violated under circumstances
that are beyond their control. At the same time, given that issuers
will continue to be subject to other compliance requirements, such as
in-state sales limitations, mandatory offeree and purchaser
disclosures, and stop transfer instructions, as well as federal
antifraud and civil liability provisions, we believe that the final
rules will not reduce investor protections.
Rule 147(f) and new Rule 147A(f) require disclosure of the resale
restrictions to every offeree in the manner in which the offering is
communicated. Compared to the requirements in current Rule 147, which
require written disclosure of resale restrictions, these provisions
will provide greater flexibility to issuers and ease compliance burdens
in cases of oral offers, while potentially making it easier for
investors to be made aware of the resale restrictions at the time an
offer is made. This change will lower the regulatory burden for
issuers, especially smaller issuers; however, where an offer is
communicated other than in writing, it also may adversely impact the
information provided to potential investors (offerees) because the
investor may not receive such information in writing at the time an
offering is initially made and being considered. To the extent that
investors would be more likely to comprehend or heed written
disclosures, these changes may adversely impact investor protection.
This impact will be mitigated by the requirement to provide disclosure
about resale restrictions, in writing, to every purchaser a reasonable
period of time before the date of sale.\460\
---------------------------------------------------------------------------

\460\ Id.
---------------------------------------------------------------------------

Rule 147(f)(3) is also being amended to remove the requirement to
disclose to offerees and purchasers the stop transfer instructions
provided by an issuer to its transfer agent and the provisions of Rule
147(f)(2) regarding the issuance of new certificates during the resale
period, which also will ease compliance burdens for issuers. These
changes are not expected to adversely affect investor protection, since
the information in question relates to technical aspects of the
securities transfer process and does not address securities ownership
rights as such.
v. Integration
The final rules, similar to the proposed rules, will expand the
current Rule 147 integration safe harbor such that offers and sales
pursuant to amended Rule 147 or Rule 147A will not be integrated with:
(i) Any offers or sales of securities made prior to the commencement of
the offering, (ii) any offers or sales made more than six months after
the completion of the offering, or (iii) any subsequent offer or sale
of securities that is either registered under the Securities Act,
exempt from registration pursuant to Regulation A, Regulation S, Rule
701, or Section 4(a)(6), or made pursuant to an employee benefit plan.
Compared to the integration safe harbor in current Rule 147, the
expanded integration safe harbor in the final rules will provide
issuers with greater certainty that they can engage in other exempt or
registered offerings either prior to or near in time of an intrastate
offering without risk of becoming ineligible to rely on Rule 147 or
Rule 147A. Similarly, the addition of Section 4(a)(6) to the list of
exempt offerings that will not be integrated with a Rule 147 or Rule
147A offering will provide certainty to issuers that they can conduct
concurrent crowdfunding offerings as per the provisions of the
respective exemptions. This flexibility and ensuing regulatory
predictability will be especially beneficial for small issuers who
likely face greater challenges in relying on a single financing option
for raising sufficient capital. While the expanded scope of the
integration safe harbor may raise concerns that an issuer could more
easily structure a single transaction as a series of exempt offerings
to avoid securities registration,\461\ the final rules

[[Page 83536]]

provide for non-integration only to the extent that the issuer meets
the requirements of each of the offering exemptions being used to raise
capital.\462\ Furthermore, the final rules require an issuer to wait at
least 30 calendar days between its last offer made to investors other
than qualified institutional buyers or institutional accredited
investors in reliance on Rule 147 or Rule 147A and the filing of a
registration statement with the Commission, which will provide
additional protection to investors in registered offerings who might
otherwise be influenced by an earlier intrastate offering. Therefore,
we do not believe that the adoption of the integration safe harbor will
result in reduced investor protections.
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\461\ See NASAA Letter.
\462\ See also note 177.
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vi. Intrastate Broker-Dealer Exemption and Additional Considerations
We are also providing guidance regarding the use of the Internet by
a person that seeks to rely on the intrastate broker-dealer
exemption.\463\ Our guidance clarifies that a person whose business
otherwise meets the requirements of the intrastate broker-dealer
exemption should not cease to qualify for the exemption solely because
it has a Web site that may be viewed by out-of-state persons, so long
as the broker-dealer takes measures reasonably designed to ensure that
its business remains exclusively intrastate. This guidance will provide
greater certainty to market participants about intermediaries' ability
to participate in intrastate offerings that seek to raise capital via
online media without having to register as a broker-dealer with the
Commission. Such certainty may increase both the demand for and the
supply of intermediaries in Rule 147 and Rule 147A offerings, which
could facilitate a greater number of intrastate offerings, especially
crowdfunding offerings. At the same time, despite the measures taken by
broker-dealers that are reasonably designed to ensure that their
businesses remain exclusively intrastate, the risk of non-compliance
with the exemptions under Section 5 may somewhat increase for issuers
if out-of-state investors, attracted by the intrastate broker's Web
site, invest in the offering through misrepresentations of their
residency status.
---------------------------------------------------------------------------

\463\ Exchange Act Section 15(a)(1) exempts from broker-dealer
registration requirements under Section 15(b) a broker-dealer whose
business is exclusively intrastate and who does not use any facility
of a national securities exchange.
---------------------------------------------------------------------------

vii. Alternatives Considered
The paragraphs below discuss major alternatives that we considered
in addition to the alternatives discussed in the individual sub-
sections above.
(a) ``Doing Business'' Tests
As an alternative to the ``doing business'' tests in the final
rules, we considered lowering the percentage thresholds for the
existing tests but retaining the requirement that all tests be
satisfied. For example, compared with the current 80% threshold
requirements, requiring issuers to have the majority of their assets,
derive the majority of their revenue, and use the majority of their
offering proceeds in-state could better comport with modern business
practices, provide greater flexibility and make it less burdensome for
issuers to satisfy these requirements, while still providing some
indicia of the in-state nature of the issuer's business.\464\ Such a
change would also provide a consistent standard for the ``doing
business'' tests in Rule 147 and Rule 147A, aligning the current tests
with the new majority employees test and tests from other rules that
use a majority threshold for determining issuer status, such as the
test for determining foreign private issuer status.\465\ In this way,
such an alternative could encourage greater reliance on Rule 147 and
Rule 147A and thereby promote additional capital formation through
exempt intrastate offerings. However, lowering the percentage
thresholds would necessarily weaken the required nexus between the
issuer and the state contemplated by current Rule 147 and Section
3(a)(11). To the extent that such a change would result in less
effective state regulation, there could be increased concerns that
investor protections in exempt intrastate offerings may be reduced.
---------------------------------------------------------------------------

\464\ See, e.g., Milken Letter.
\465\ See Securities Act Rule 405 and Exchange Act Rule 3b-4.
---------------------------------------------------------------------------

As another alternative to the final rules, we considered
eliminating the requirement to qualify under any of the ``doing
business'' tests. This alternative would significantly ease the burden
for potential issuers in complying with Rules 147 and 147A, while also
modernizing the rules to better align them with current business
practices. As described above, in recent years new business models have
emerged that may make the eligibility tests ill-suited for relying on
the intrastate exemptions as a capital raising option. In view of broad
changes in modern business practices, the principal place of business
requirement may be sufficiently effective in establishing the local
nature of an offering pursuant to Rule 147 or Rule 147A for purposes of
compliance with the ``doing business'' in-state requirement at the
federal level. The alternative will enable a larger number of issuers
to qualify under the intrastate exemptions, which could increase
capital formation. Relative to the adopted approach, this alternative
also could provide more flexibility to state regulators to enact their
own eligibility and residency requirements that better suit the
interests of issuers and investors in their state, rather than imposing
a uniform approach at the federal level that may function more
effectively in some states than others.
However, eliminating the ``doing business'' tests could allow
issuers with widely-dispersed operations over more than one state or
even no business operations (besides having a principal place of
business in-state) to make greater use of amended Rule 147 or new Rule
147A. Without sufficient local presence or an appropriate nexus with
the issuer and the state, local oversight of such issuers could weaken,
with a consequent decrease in investor protection. Although some of
these concerns could be mitigated by continuing to restrict sales to
in-state residents and the inclusion of the principal place of business
requirement, as well as by the ability of states to extend their
enforcement activities to issuers whose assets are located beyond state
borders, we believe the approach we are adopting in the final rules
will provide issuers with sufficient flexibility to satisfy these
requirements, while maintaining important indicia of the in-state
nature of the issuer's business. As noted above, given the other
changes we are adopting to modernize our exemptive framework for
intrastate offerings, we believe it is appropriate to first observe how
the updated doing business in-state requirements are used by issuers in
practice before making any further changes
(b) State Law Requirements and Additional Federal Restrictions
In a change from the proposed rules, the final rules will not
require that the offering be registered under state law or conducted
pursuant to a state law exemption that limits the amount of securities
an issuer may sell pursuant to amended Rule 147 or new Rule 147A and
the amount of securities than can be purchased by an investor in the
offering. These requirements, as proposed, could provide additional
protections at the federal level and could mitigate investor protection
concerns that may arise from

[[Page 83537]]

the modernization of the federal regulatory regime applicable to
intrastate offerings. However, as noted by some commenters,
conditioning the final rules on specified state law requirements would
reduce the flexibility of state regulators to design rules that best
conform to the requirements of issuers and investors in their states
and, by imposing a uniform standard, could disadvantage certain
jurisdictions relative to others.\466\ Such requirements could thus
unduly restrict capital raising options of issuers, especially those
issuers that sell primarily to accredited investors, and could also
restrict legitimate state interests in permitting larger offerings
within their jurisdictions that otherwise rely on the federal
intrastate exemptions.
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\466\ See CFIRA Letter, Milken Letter, NASAA Letter, NextSeed
letter. See also ABA Letter stating that such limits would be
inconsistent ``with Congressional intent that local offerings do not
require federal regulation and are best left to be regulated by the
states''.
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We also note that the maximum amount that can be raised under
existing intrastate crowdfunding provisions is less than the limit of
$5 million that was proposed as a limit on certain intrastate
offerings. Most of these states have also adopted provisions that
impose investment limitations on investors. Thus, the protections
provided by such limitations will remain available to investors in many
intrastate crowdfunding offerings. States also retain the flexibility
to enact additional measures under state law to strengthen issuer
eligibility requirements for intrastate offerings.
We recognize that conditioning the federal exemption on certain
state law exemptions or requirements could raise concerns that the
provisions will be utilized to conduct offerings in states that lack
sufficient investor protection safeguards, leading to a ``race-to-the-
bottom'' between state legislators and regulators through significant
easing of compliance provisions in order to attract more issuers. We
believe, however, that such an outcome may be unlikely because state
legislators and regulators have economic and reputational incentives to
provide local issuers and investors with robust capital markets that
are sustainable over the long run. Robust competition between states to
enact securities laws that attract issuers to their territories would
result in better regulations that promote effective functioning of
local financial markets among the states, issuers and investors.
We also considered excluding certain types of issuers from relying
on Rule 147 or Rule 147A, since it is likely that intrastate offerings
and, especially crowdfunded offerings, may have a large proportion of
retail investors.\467\ Further, we also considered whether to extend
bad actor disqualification provisions to these rules, similar to the
provisions under Rule 506(d) of Regulation D.\468\ Such provisions
could enhance investor protections and promote regulatory consistency
with other unregistered offering exemptions. However, these provisions
are already a feature of most state crowdfunding exemptions, and
additional restrictions at the federal level could reduce states'
flexibility in enacting provisions that work best for their local
jurisdictions. In this regard, we believe that states are well
positioned to determine whether these or additional requirements are
necessary in their jurisdictions.
---------------------------------------------------------------------------

\467\ See NASAA Letter.
\468\ Id.
---------------------------------------------------------------------------

(c) Exemption From Section 12(g) Requirements
Amended Rule 147 and new Rule 147A do not exempt securities issued
in intrastate crowdfunding from reporting requirements under Section
12(g) of the Exchange Act.\469\ As crowdfunded offerings are purchased
in small amounts by a relatively large number of investors, issuers
using Rule 147 or Rule 147A for state crowdfunding offerings may exceed
record holder thresholds that trigger registration requirements under
Section 12(g). In contrast to intrastate crowdfunding offerings,
securities issued under Regulation Crowdfunding do not count toward the
record holder thresholds for triggering registration under Section
12(g), subject to certain conditions. This may place an additional
regulatory burden on Rule 147 and Rule 147A issuers, making them less
likely to initiate intrastate crowdfunding offerings. As an alternative
to the final rules, an exemption from the registration requirements
under Section 12(g) for intrastate crowdfunded offerings could
encourage issuers to rely on Rule 147 or Rule 147A by allowing such
issuers to delay registration, and thereby avoid the regulatory
obligations of ongoing reporting requirements under the Exchange
Act.\470\ However, as Rule 147 and Rule 147A issuers will not be
required to submit financial reports on an ongoing basis, such a
provision may result in less information about these issuers being
available to the market to the possible detriment of existing and
prospective investors. Such concerns are mitigated under Regulation
Crowdfunding as issuers relying on that exemption are required to file
ongoing financial reports with the Commission. Under Rule 147 and Rule
147A, however, issuers will not be subject to any federal ongoing
reporting requirements, which could make the additional protections
provided by registration under Section 12(g) especially beneficial to
the issuers' investors.
---------------------------------------------------------------------------

\469\ See Section II.C. above.
\470\ See CFIRA Letter, CrowdCheck Letter, Guzik Letter, Milken
Letter. See also 2015 Small Business Forum Recommendations.
---------------------------------------------------------------------------

3. Analysis of Amendments to Rule 504
The final rules related to Rule 504 will increase the maximum
aggregate amount that can be raised under a Rule 504 offering, in a 12-
month period, from $1 million to $5 million and will disqualify certain
bad actors from participation in Rule 504 offerings. Additionally, in
order to account for the increase in the Rule 504 aggregate offering
amount limitation, we are adopting technical amendments to the notes to
Rule 504(b)(2) that will update the current illustrations in the rule
regarding how the aggregate offering limitation is calculated in the
event that an issuer sells securities in multiple offerings pursuant to
Rule 504, within the same twelve-month period.\471\ All other
provisions of current Rule 504 of Regulation D will remain unchanged.
---------------------------------------------------------------------------

\471\ See Notes 1 and 2 to Rule 504(b)(2), 17 CFR 230.504(b)(2).
---------------------------------------------------------------------------

a. Increase in Maximum Aggregate Amount to $5 Million
As shown in the baseline analysis above, use of Rule 504 offerings
has been declining over the past decade, in absolute terms as well as
relative to Rule 506 of Regulation D. Compared to Rule 504 offerings,
Rule 506 offerings have the advantage of preemption from state
registration. Thus, even though Rule 506(b) offerings, unlike Rule 504
offerings, are limited to accredited investors and up to 35 non-
accredited investors, capital raising activity during the last two
decades suggests that the benefits of state preemption outweigh
unrestricted access to non-accredited investors. With the adoption of
Rule 506(c), which allows for general solicitation, the comparative
advantage of current Rule 504 has further diminished.
The current $1 million maximum amount was set by the Commission in
1988 and was meant to provide ``seed capital'' for small and emerging
businesses.\472\ Given the high costs of raising capital from public
sources, the

[[Page 83538]]

unregistered offerings market has expanded significantly in the past
twenty-five years. The growth of angel investors and VCs, who invest
primarily through unregistered offerings, has also increased seed
capital available for investment at the initial stages of a company.
Angel investments in 2015 amounted to approximately $25 billion, and
the average angel deal size was approximately $346,000.\473\ According
to PWC MoneyTree, in 2008, U.S. VCs made $1.5 billion of seed
investments in 440 companies.\474\ This represents an average seed
investment of $3.5 million per company. While the involvement of VCs at
the seed stage has been increasing over the years, it is reported that
some angel investments at the seed stage have included investments as
large as $2.5 million per entity.\475\ Given these changes, amending
the Rule 504 offering size from $1 million to $5 million would better
comport with market trends that indicate demand for larger seed capital
infusions.
---------------------------------------------------------------------------

\472\ See Seed Capital Release.
\473\ According to a recent report, angel investments amounted
to $24.6 billion in 2015, with approximately 71,100 entrepreneurial
ventures receiving angel funding and approximately 304,930 active
angel investors. Seed/startup stage investments accounted for
approximately 28% of the $24.6 billion. See Jeffrey Sohl, The Angel
Investor Market in 2015: A Buyer's Market, Center for Venture
Research, May 25, 2015, available at https://paulcollege.unh.edu/sites/paulcollege.unh.edu/files/webform/Full%20Year%202015%20Analysis%20Report.pdf.
\474\ See PricewaterhouseCoopers, Investment by Stage of
Development, available at https://www.pwcmoneytree.com/CurrentQuarter/BySoD.
\475\ See Fenwick & West Survey 2012 (March 2013), available at
https://www.fenwick.com/publications/Pages/Seed-Finance-Survey-2012.aspx. The survey defines a ``seed'' financing as the first
round of financing by a company in which the company raises between
$250,000 and $2,500,000 and in which professional investors play a
lead role.
---------------------------------------------------------------------------

Four parallel developments may further change the regulatory
landscape surrounding existing Rule 504. First, the use of current Rule
504 could be diminished by interstate crowdfunding offerings pursuant
to Regulation Crowdfunding, which allows issuers to raise up to $1
million over a 12-month period with unlimited access to non-accredited
investors, permits general solicitation, and provides preemption from
state regulation and exemption from Exchange Act reporting, subject to
certain conditions. Second, at least 34 states and the District of
Columbia have enacted and several other states are in the process of
enacting their own crowdfunding exemptions where the maximum amount
that can be raised in a 12-month period ranges from $250,000 to $4
million, depending on the state (up to $2 million for all but three
states). The maximum offering amounts for intrastate crowdfunding thus
exceed the current offer limit under Rule 504. While most state
crowdfunding exemptions require use of Rule 147, currently three states
allow issuers to conduct intrastate crowdfunding under the Rule 504
exemption.\476\ Third, state regulators have been working to implement
regional coordinated review programs in order to facilitate regional
offerings that could potentially save issuers time and money.
Additionally, at least one state is in the process of enacting
reciprocal crowdfunding provisions, which may allow issuers to conduct
regional crowdfunding offerings under state law.\477\ Since amended
Rule 147 and new Rule 147A will be restricted to intrastate offerings,
Rule 504 will be the most likely federal exemption that could be used
for such regional offerings. Fourth, Tier 1 of amended Regulation A,
which became effective in June 2015 and has similar eligibility
criteria as Rule 504, allows offerings up to $20 million without any
restrictions on resale of securities. In light of these developments,
the increase in the maximum amount that can be raised in Rule 504
offerings to $5 million could help make this market more attractive for
startups and small businesses while also facilitating intrastate and
regional offerings greater than $1 million.
---------------------------------------------------------------------------

\476\ Maine's provisions currently permit interstate
crowdfunding utilizing the Rule 504 exemption, and Mississippi and
Vermont dually offer intrastate crowdfunding under Section 3(a)(11)
and interstate crowdfunding under Rule 504. See NASAA Letter.
\477\ See https://www.nasaa.org/industry-resources/corporation-finance/coordinated-review/. See also, the ``Reciprocal Crowdfunding
Exemption'' proposed by the Massachusetts Securities Division,
available at https://www.sec.state.ma.us/sct/crowdfundingreg/Reciprocal%20Crowdfunding%20Exemption%20-%20MA.PDF.
---------------------------------------------------------------------------

A higher offering amount limit for Rule 504 offerings could
increase the number of issuers that rely on the exemption.\478\ To the
extent that amended Rule 504 permits issuers to raise larger amounts of
capital at lower costs than other unregistered capital markets, the
final rules could also lower issuer cost of capital and facilitate
intrastate crowdfunding and the regional offerings market as it
evolves. In addition to new issuers raising capital for the first time,
it is likely that some issuers currently using other unregistered
capital markets may shift to the amended Rule 504 market. Such
potential trends would increase competition for supply of and demand
for capital between the different unregistered markets, especially the
exemptions pursuant to amended Rule 147, Rule 147A, Rule 506 of
Regulation D, Regulation A, Regulation Crowdfunding, and Sections
4(a)(2) and 3(a)(11). Further, modernizing our exemptive scheme in
order to provide issuers, and especially small businesses, with more
viable options for capital raising could foster an environment that
encourages new market participants with promising ventures to enter the
capital markets, thereby enhancing the overall level of capital
formation in the economy and investment opportunities. The amendments
could also encourage new interstate and regional approaches to
crowdfunding and other offering methods \479\ and lead to greater
coordination for regional review of capital raising options.
---------------------------------------------------------------------------

\478\ See CFA Letter, CFIRA Letter, NASAA Letter.
\479\ Id.
---------------------------------------------------------------------------

Increasing the Rule 504 offering amount limit could also increase
the number of investors (including non-accredited investors) that can
access such exempt offerings, thereby providing them with a wider array
of investment opportunities to diversify their investment portfolios.
This, in turn, could have positive effects on the supply of capital and
the allocative efficiency of unregistered capital markets. To the
extent that non-accredited investors are less capable of evaluating
investment opportunities than accredited investors,\480\ an increase in
the number of Rule 504 offerings could raise investor protection
concerns.
---------------------------------------------------------------------------

\480\ See Staff of the U.S. Securities and Exchange Commission,
Report on the Review of the Definition of ``Accredited Investor''
(Dec. 18, 2015) at 43-46 available at https://www.sec.gov/corpfin/reportspubs/special-studies/review-definition-of-accredited-investor-12-18-2015.pdf (describing criticisms of the current
definition of accredited investor).
---------------------------------------------------------------------------

A higher offering amount limit, together with a potential increase
in the number of investors that can access Rule 504 offerings, may
raise concerns about a potential increase in the incidence of fraud
under the final rules. The Commission's experience with the elimination
of the prohibition against general solicitation for Rule 504 offerings
in 1992 \481\ and its subsequent reinstatement in 1999 as a result of
heightened fraudulent activity \482\ illustrates the potential for
fraud in the Rule 504 market. It should be noted, however, that in 1998
and 1999 the Commission concluded that the increase in fraud occurred
because of rule provisions that permitted general solicitation of
investors and free

[[Page 83539]]

transferability of issued securities.\483\ As a result, under that
regime, a non-reporting company was able to sell up to $1 million of
unrestricted securities in a 12-month period and be subject only to the
antifraud and civil liability provisions of the federal securities
laws. In contrast, the final rules will only increase the aggregate
offering amount limitation of Rule 504, thereby retaining existing
restrictions on general solicitation and the restricted securities
status of most offered securities. State registration requirements may
also mitigate the risk for investor abuse in Rule 504 offerings.
---------------------------------------------------------------------------

\481\ See Adoption of Small Business Initiatives, SEC Release
No. 33-6949 (July 30, 1992).
\482\ See Seed Capital Release.
\483\ Id. See also Proposed Revision of Rule 504 of Regulation
D, the ``Seed Capital'' Exemption, No. 33-7541 (May 21, 1998). As
the Commission noted at the time it proposed to eliminate the
unrestricted status of securities issued under Rule 504, securities
issued in these Rule 504 offerings may have facilitated a number of
fraudulent secondary transactions in the over-the-counter markets.
The Commission also noted that these securities were issued by
``microcap'' companies, characterized by thin capitalization, low
share prices and little or no analyst coverage. As the freely-
tradable nature of the securities facilitated the fraudulent
secondary transactions, the Commission proposed to ``implement the
same resale restrictions on securities issued in a Rule 504
transaction as apply to transactions under the other Regulation D
exemptions,'' in addition to reinstating the prohibition against
general solicitation. Although the Commission recognized that resale
restrictions would have ``some impact upon small businesses trying
to raise `seed capital' in bona fide transactions,'' it believed at
the time that such restrictions were necessary so that
``unscrupulous stock promoters will be less likely to use Rule 504
as the source of the freely tradable securities they need to
facilitate their fraudulent activities in the secondary markets.''
---------------------------------------------------------------------------

Enforcement cases over the past several years involving Rule 504
offerings could also raise concerns about the potential for increased
incidence of fraud under the final rules. Most of these cases have
involved promoters who engaged in secondary market sales of
unrestricted securities that were previously issued in reliance on Rule
504(b)(1)(iii), defrauding investors and, in some cases,
unsophisticated issuers.\484\ Securities issued in reliance on Rule
504(b)(1)(iii) are exempt from state registration, and issuers relying
on the exemption are permitted to market the securities using general
solicitation so long as sales are made only to accredited
investors.\485\ We recognize that an increase in the maximum offering
size could increase the risk of investor harm, at least in offerings
that are exempt from state registration. Some of these concerns could
be mitigated by the inclusion of bad actor disqualification provisions
in Rule 504, as discussed below.
---------------------------------------------------------------------------

\484\ See, e.g., SEC v. Stephen Czarnik, Case No. 10-cv-745
(S.D.N.Y.), Litigation Release No. 21401 (Feb. 2, 2010); SEC v.
Yossef Kahlon, a/k/a Jossef Kahlon and TJ Management Group, LLC,
Case No. 4:12-cv-517 (E. D. Tex.) (Aug. 14, 2012).
\485\ The extent to which general solicitation may be used in
connection with an offering conducted in reliance on Rule
504(b)(1)(iii) will depend on the specific state exemption being
relied upon. In this regard, the NASAA Model Accredited Investor
Exemption specifies that only a tombstone ad may be used in making a
general solicitation. See Model Accredited Investor Exemption,
available from the NASAA Web site at https://www.nasaa.org/wp-content/uploads/2011/07/24-Model_Accredited_Investor_Exemption.pdf.
---------------------------------------------------------------------------

b. Bad Actor Disqualification Provisions and Additional Amendments
The amendments to Rule 504 will include bad actor disqualification
provisions that are substantially similar to related provisions in Rule
506 of Regulation D. \486\ Consistent with Rule 506(d), the final rules
will require that the covered person's status be assessed at the time
of the sale of securities. As in Rule 506(d), the disqualification
provisions will not preclude the participation of bad actors whose
disqualifying events occurred prior to the effective date of the final
rules, which could expose investors to risks that arise when bad actors
are associated with an offering. However, similar to Rule 506(e),
issuers will be required to disclose bad actor disqualifying events
that occurred prior to the effectiveness of the final rules. The risks
to investors from participation of covered persons who otherwise would
be disqualified may therefore be partly mitigated as investors will
have access to relevant information that could inform their investment
decisions. Disclosure of prior bad actor disqualifying events may make
it more difficult for issuers to attract investors, and as a result,
issuers may experience a similar impact to being disqualified. Some
Rule 504 issuers may accordingly choose to exclude involvement by prior
bad actors to avoid such disclosures.
---------------------------------------------------------------------------

\486\ See Rule 506(d) of Regulation D, 17 CFR 230.506(d).
---------------------------------------------------------------------------

We expect that the bad actor disqualification provisions could help
reduce the potential for fraud in these types of offerings and thus
strengthen investor protection.\487\ If disqualification standards
lower the risk premium associated with the risk of fraud due to the
presence of bad actors in securities offerings, they could also reduce
the cost of capital for issuers that rely on the amended Rule 504
exemption. In addition, the requirement that issuers determine whether
any covered persons are subject to disqualification might reduce the
need for investors to conduct their own due diligence on such persons
and could therefore increase efficiency. While fraud can still occur
without prior incidence of disqualification on the part of the issuer
or covered persons, these provisions could mitigate some of the
concerns relating to incidence of fraud in offerings pursuant to
amended Rule 504, including offerings subject to regional coordinated
review programs that could be registered in one jurisdiction but
offered and sold in multiple other jurisdictions.
---------------------------------------------------------------------------

\487\ See also ABA Letter, CFA Letter.
---------------------------------------------------------------------------

The disqualification provisions could also impose costs on issuers
and covered persons. Issuers that are disqualified from using amended
Rule 504 may experience an increased cost of capital or a reduced
availability of capital, which could have negative effects on capital
formation. Similarly, other covered persons may experience reductions
in revenue or market share (for market intermediaries) or demotion or
termination of employment or other limitations on career advancement
(for individuals) as a result of disqualification from Rule 504
offerings. In addition, issuers may incur costs and transactional
delays related to seeking disqualification waivers from the Commission
and replacing personnel or avoiding the participation of covered
persons who are subject to disqualifying events. Issuers also might
incur costs to restructure their share ownership to avoid beneficial
ownership of 20% or more of the issuer's outstanding voting equity
securities by individuals subject to disqualification.
The final rules will provide, by reference to Rule 506(d), a
reasonable care exception, similar to other exemptions and safe harbors
under Regulation D. A reasonable care exception could facilitate
capital formation by encouraging issuers to proceed with Rule 504
offerings in situations in which issuers otherwise might have been
deterred from relying on Rule 504 if they risked potential liability
under Section 5 of the Securities Act for unknown disqualifying events.
At the same time, this exception also could increase the potential for
fraud, compared with an alternative of not providing a reasonable care
exception, by limiting issuers' incentives to determine whether bad
actors are involved with their offerings. We also recognize that some
issuers might incur costs associated with conducting and documenting
their factual inquiry into possible disqualifications. The rule's
flexibility with respect to the nature and extent of the factual
inquiry required could allow an issuer to tailor its factual inquiry as
appropriate to its particular circumstances, thereby potentially
limiting costs. Finally, we note that

[[Page 83540]]

extending the disqualification provisions to Rule 504 will create a
more consistent regulatory regime under Regulation D that will simplify
due diligence requirements and thereby benefit issuers and investors
that participate in different types of exempt offerings.\488\
---------------------------------------------------------------------------

\488\ See NASAA Letter.
---------------------------------------------------------------------------

The amendment to Rule 504(b)(2) will update the current
illustrations of how the aggregate offering limitation is calculated in
the event that an issuer sells securities in multiple offerings
pursuant to Rule 504 within the same twelve-month period. By enabling
market participants to calculate more easily the amounts permitted to
be sold, this amendment will facilitate issuer compliance with the
increased aggregate offering limitation.
c. Alternatives Considered
As an alternative to the final rules, we considered raising the
offering limit under Rule 504 to an amount less than $5 million. For
example, adjusted for inflation, the $1 million in 1988 would equate to
approximately $2 million today.\489\ Additionally, offering amount
limits under various state crowdfunding provisions generally are set
around $2 million for most jurisdictions, with $4 million being the
highest offering limit in one state. Increasing the maximum Rule 504
offering to an amount less than $5 million could help alleviate
concerns about a decrease in investor protection from unlimited access
to non-accredited investors. At the same time, this alternative could
limit the use of Rule 504 as a capital raising option for issuers.
---------------------------------------------------------------------------

\489\ Annual inflation rates (1988-2015) based on consumer price
index data, for all urban consumers, obtained from the Bureau of
Labor Statistics. See https://data.bls.gov/cgi-bin/surveymost?cu.
---------------------------------------------------------------------------

We also considered increasing the maximum offering limit under
amended Rule 504 to an amount greater than $5 million. For example, we
could align the maximum offering limit to that of the Tier 1 offer
limit ($20 million) under amended Regulation A. This could allow for
more cost-effective state registration, while also providing a
competitive alternative to eligible issuers in Tier 1 of the Regulation
A market. However, unlike the Regulation A market, non-accredited
investors have no investment limits under the Rule 504 provisions.
Moreover, enforcement cases over the past several years have
highlighted instances of fraud in Rule 504(b)(1)(iii) offerings.\490\ A
higher maximum offering amount may thus lead to greater investor
protection concerns.
---------------------------------------------------------------------------

\490\ See note 484 and related discussion above.
---------------------------------------------------------------------------

In light of concerns about potential abuses involving securities
issued in reliance on Rule 504(b)(1)(iii),\491\ we considered, as an
alternative, to impose resale restrictions on such securities. This
could increase investor protection by helping to ensure that securities
initially sold pursuant to the exemption are only resold by initial
purchasers after the passage of a specified time period. However, these
restrictions would reduce the liquidity of Rule 504(b)(1)(iii)
securities, which could increase the cost of capital for issuers
seeking to raise capital in reliance on this rule provision. At the
same time, increasing investor protection through resale restrictions
could attract somewhat greater investor interest and lower the expected
risk premium, which would mitigate, to some extent, the higher costs
arising from less liquid securities. We note that states are free to
enact additional restrictions in such offerings if they deem them
necessary or appropriate.
---------------------------------------------------------------------------

\491\ Id.
---------------------------------------------------------------------------

Additionally, Rule 504 could be amended to include additional
mandatory disclosures, or other requirements, to address investor
protection concerns arising from the increase in the maximum offering
size. While such additional requirements could mitigate some of these
concerns, they would also increase the compliance obligations for Rule
504 issuers and may also overlap with similar requirements under state
law in the jurisdiction in which such Rule 504 offering is registered.
4. Analysis of Repeal of Rule 505
The final rules also eliminate the exemption under Rule 505 of
Regulation D. Rule 505, like Rule 504, was created under Section
3(b)(1) of the Securities Act to exempt offerings of up to $5 million
over a 12-month period. As discussed in the baseline analysis, reliance
on Rule 505 is much less frequent than even Rule 504 and has declined
steadily in the past 15-20 years in terms of the number of new
offerings and the amount of capital raised.\492\
---------------------------------------------------------------------------

\492\ During the period 2009-2015, there were 1,588 new
offerings of less than or equal to $5 million by non-fund issuers
that relied on Rule 505 compared to 64,862 such offerings that
relied on Rule 506. Including offerings in which the issuer checked
both the Rule 505 and Rule 506 exemptions on the Form D (2,170 new
offerings), the proportion of Rule 505 offerings in Regulation D
offerings rises from 2% to 5.3%. See Section V.A.2 and Table 5.
---------------------------------------------------------------------------

We believe that amended Rule 504, by allowing offerings up to $5
million, will likely further diminish the utility of current Rule 505
for issuers that are currently eligible to use both exemptions because
Rule 504 provides access to an unlimited number of non-accredited
investors and restricted access to general solicitation.\493\ Other
exemptions from registration may also provide an alternative to Rule
505 offerings. For example, Rule 506(b) enables issuers to raise
unlimited amounts of capital along with providing preemption from state
registration, although being limited to 35 non-accredited investors who
need to be sophisticated, either individually or through a purchaser
representative. Similarly, while Regulation A offerings have greater
disclosure requirements, they may be sold to non-accredited investors
and have the added benefit of unrestricted resales of securities. We
recognize that reporting companies that are potential Rule 505 issuers
may find it relatively harder to shift to another type of unregistered
offering as they are excluded from using Rule 504, Regulation A and
Regulation Crowdfunding. Such issuers, however, constitute a small
proportion of current Rule 505 issuers and, absent disqualifying bad
actor events, could likely avail themselves of Rule 506. Alternatively,
Rule 505 issuers, particularly those that are reporting companies,
could also raise capital through a registered offering if they seek
investment from non-accredited investors and investors who prefer
securities issued through registered offerings. In view of recent
changes to Form S-1 \494\ and the availability of shelf registration to
eligible reporting issuers, the costs of raising capital through a
registered offering for issuers that are reporting companies, may be
comparable to costs of a Rule 505 offering that solicits non-accredited
investors and requires registration under state regulations. Whether
Rule 505 issuers, particularly those that are reporting companies,
switch to an unregistered offering such as a Rule 506 offering or a
registered offering will depend on how these issuers assess the costs
of registration relative to benefits such as broader access to non-
accredited investors and investors who prefer securities issued through
registered offerings.\495\
---------------------------------------------------------------------------

\493\ Unlike offerings conducted pursuant to Rule 506, Rule 504
and Rule 505 offerings are subject to state securities law
registration and qualification requirements.
\494\ See note 435 above.
\495\ See discussion in Section V(B)(1) and note 436.
---------------------------------------------------------------------------

The impact of the elimination of Rule 505 will depend on whether
issuers are

[[Page 83541]]

able to access alternate capital markets and raise the desired amount
of capital at a comparable cost and in a timely manner, as they would
in the current Rule 505 market. To the extent that issuers are not able
to raise sufficient or any amount of capital in such alternate markets,
overall capital formation in the economy and allocative efficiency of
capital markets could decline. We believe that Rule 505 issuers likely
will be able to shift to other exemptions or alternately to follow-on
registered offerings in case of issuers that are reporting companies,
at little or no additional cost. In the short term, the repeal likely
will increase competition amongst markets for attracting potential Rule
505 issuers and investors, but in the long-run, it may decrease the
overall level of competition amongst the various capital markets to
attract new issuers and investors.
As discussed above, the impact on efficiency, competition and
capital formation of the repeal of Rule 505 also will depend on
investor willingness and ability to purchase in an alternate
unregistered capital market. For example, unsophisticated investors
that may be eligible to purchase in a Rule 505 offering may not be able
to purchase in a Rule 506 offering and hence may find their set of
investment opportunities reduced. Further, as Rule 506 offerings are
preempted from state registration, potential Rule 505 investors may be
reluctant to purchase in a Rule 506 offering once Rule 505 is repealed,
due to investor protection concerns. Similarly, Rule 504 offerings are
subject to fewer investor disclosure requirements at the federal level,
relative to a Rule 505 offering, that could also raise potential
investor protection concerns. The net impact on the overall level of
investor participation could thus depend on the type of offering that
primarily substitutes for the repealed Rule 505 market.
Overall, we believe that the repeal of Rule 505 will not have a
significant impact or any impact on capital formation because issuers
will likely be successful at finding commensurate capital supply in an
alternate unregistered capital market. Repeal of Rule 505 will
streamline the existing exemptive framework to provide a clearer and
less complex set of rules and regulations for the issuer to choose
among.
As an alternative to the repeal of Rule 505, we considered
increasing the maximum amount that can be raised over a period of 12
months to a higher amount. For example, adjusting for inflation, $5
million in 1988 would equate to approximately $10 million today.
Retention of Rule 505 with a higher offering limit would allow issuers
(in contrast to Rule 506) to access to up to 35 non-accredited
investors without having to ensure that these investors are
sophisticated investors. It would also allow reporting companies (in
contrast to Rule 504) to avail themselves of the exemption for raising
capital. However, we believe that in view of the widespread use of Rule
506 and the decreased use of Rule 505 in capital formation in the
Regulation D market, a higher ceiling is not likely to increase
reliance on the exemption.

VI. Paperwork Reduction Act

A. Rules 147(f)(1)(iii) and 147A(f)(1)(iii)

Rule 147 and new Rule 147A contain ``collection of information''
requirements within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\496\ Specifically, Rules 147(f)(1)(iii) and 147A(f)(1)(iii)
each contain a provision requiring issuers relying on the rules to
``obtain a written representation from each purchaser as to his or her
residence.'' There are two titles for these collection of information
requirements. The first title is: ``Rule 147(f)(1)(iii) Written
Representation as to Purchaser Residency,'' a new collection of
information. The second title is: ``Rule 147A(f)(1)(iii) Written
Representation as to Purchaser Residency,'' a new collection of
information. We are requesting comment on these collection of
information requirements in this adopting release, and intend to submit
these requirements to the Office of Management and Budget (``OMB'') for
review in accordance with the PRA and its implementing
regulations.\497\ If approved, responses to the new collection of
information requirement would be mandatory for issuers seeking to rely
upon the rules to conduct exempt intrastate offerings. An agency may
not sponsor, and a person is not required to respond to, a collection
of information unless it displays a currently valid OMB control number.
---------------------------------------------------------------------------

\496\ 44 U.S.C. 3501 et seq.
\497\ In the Proposing Release, we did not submit a PRA analysis
because we proposed to eliminate the written representation
requirement in Rule 147(f)(1)(iii), and our other proposed
amendments to Rule 147 did not contain a ``collection of
information'' requirement within the meaning of the PRA. At this
time, we do not have any comments regarding overall burden estimates
for the final rules. This release is requesting such comments.
---------------------------------------------------------------------------

In the Proposing Release, we solicited comment on our proposal to
eliminate the requirement in Rule 147(f)(1)(iii) to obtain a written
representation as to the purchaser's residency. In response to comments
received, we have decided not to eliminate the requirement and are
adopting an identical requirement in new Rule 147A(f)(1)(iii) under the
Securities Act.\498\
---------------------------------------------------------------------------

\498\ See text accompanying notes 119, 120, and 121 above.
---------------------------------------------------------------------------

Both Rule 147(f)(1)(iii) and new Rule 147A(f)(1)(iii) will require
the issuer to obtain from the purchaser a written representation as to
the purchaser's residency. The representation is not required to be
presented in any particular format, although it must be in writing.
Representations obtained by the issuer are not required to be kept
confidential, and there is no mandatory retention period. The hours and
costs to the issuer and purchaser associated with preparing,
furnishing, obtaining and collecting these written representations
constitute paperwork burdens and costs imposed by these collection of
information requirements.
The required written representation by the purchaser as to his or
her residence is identical under both Rule 147(f)(1)(iii) and new Rule
147A(f)(1)(iii). Similarly, both rules define the residence of the
purchaser in the same manner. If the purchaser is a corporation,
partnership, limited liability company, trust or another form of
business organization, it shall be deemed to be a resident of the
territory or state if, at the time of the offer and sale to it, it has
its principal place of business within such territory or state.
Principal place of business is defined as the territory or state in
which the officers, partners or managers of the entity primarily
direct, control and coordinate the activities of the entity. If the
purchaser is an individual, such person shall be deemed to be a
resident of the territory or state if such person has, at the time of
the offer and sale, his or her principal residence in the territory or
state.\499\
---------------------------------------------------------------------------

\499\ See Rules 147(d) and 147A(d).
---------------------------------------------------------------------------

We expect that the determination of a purchaser's residence will be
easiest for natural persons.\500\ This determination may be more
difficult for purchasers who have more than one place of residence. We
also expect this determination to be more difficult for purchasers who
are legal entities, such as corporations, partnerships, limited
liability companies and trusts which will have to undertake a factual
inquiry to determine in what state or territory their ``principal place
of business'' is located.
---------------------------------------------------------------------------

\500\ See Section II.B.2(c) above.
---------------------------------------------------------------------------

We anticipate that the requirement for issuers to obtain a written

[[Page 83542]]

representation from each purchaser as to his or her residence, as
required under Rule 147(f)(1)(iii) and Rule 147A(f)(1)(iii), will
result in a burden and cost to issuers to meet these requirements in
order to sell securities in an exempt intrastate offering. For purposes
of the PRA, for each of Rule 147 and Rule 147A, we estimate that the
total annual paperwork burden for all affected issuers arising from
this collection of information requirement will be approximately 175
hours of issuer (company) personnel time and approximately $70,000 for
the services of outside professionals at an average cost of $400 per
hour.
Similarly, we anticipate that the written representation required
by purchasers, including the obligation to determinate the state or
territory of their residence, as required under Rule 147(f)(1)(iii) and
Rule 147A(f)(1)(iii), will result in a burden incurred by purchasers in
order to purchase securities in an exempt intrastate offering. For
purposes of the PRA, for each of Rule 147 and Rule 147A, we estimate
that the total annual paperwork burden for all affected purchasers
arising from this collection of information requirements will be
approximately 1,750 hours of purchaser time and no cost incurred for
the services of outside professionals.
In deriving our estimates, we assume that:
Approximately 700 issuers \501\ will conduct a Rule 147
and Rule 147A offering each year, respectively, and each issuer will
spend an average of fifteen minutes to obtain and collect the written
representation from each purchaser in the offering as to his or her
state or territory of residence;
---------------------------------------------------------------------------

\501\ We rely upon the number of offerings under Rules 504 and
505 of Regulation D for the year ended December 31, 2015 as a proxy
for the average annual number of offerings under Rule 147 and new
Rule 147A. Based on staff analysis of Form D filings, there were 519
new Form D filings reporting reliance on Rule 504 and 179 new Form D
filings reporting reliance on Rule 505 in 2015. See Figure 1 in
Section V.A.1, above. For purposes of these PRA estimates, we
estimate that an average of 700 issuers will conduct a Rule 147 and
new Rule 147A offering each year, respectively.
---------------------------------------------------------------------------

Each of the approximately 700 issuers will retain outside
professional firms to spend an average of fifteen minutes helping the
issuer comply with this requirement to obtain and collect the written
statement of residency from each purchaser in the offering at an
average cost of $400 per hour;
Each Rule 147 and Rule 147A offering will have an average
of approximately 10 purchasers of securities, resulting in
approximately 7,000 purchasers per year for each exemption; and
Each purchaser in a Rule 147 and Rule 147A offering will
spend an average of approximately fifteen minutes preparing a written
statement of residency to provide to the issuer and will incur no cost
for the services of outside professionals to satisfy this requirement.
Since Rule 147 does not require the issuer to file any type of
notice form with the Commission, it is difficult to determine
accurately the number of Rule 147 offerings conducted annually or
estimate the annual number of offerings that will be made in reliance
on the updated rule and the new Rule 147A exemption. As a result, we
are using the number of offerings made in reliance on the exemptions in
Rules 504 and 505 of Regulation D for the year ended December 31, 2015
as a proxy to estimate the average annual number of Rule 147 offerings,
given that both Rule 147 and Rules 504 and 505 provide exemptions to
Securities Act registration designed to facilitate smaller issuers
raising seed capital. Given that Rule 147A is very similar to Rule 147,
as amended, we are using this same methodology and estimate for the
number of offerings under newly adopted Rule 147A.
It is also difficult to provide any standardized estimates of the
burdens and costs involved for the issuer to obtain and collect these
written statements of purchaser residency. We expect, however, that the
burdens and costs to issuers may be higher or lower depending on the
size of the offering and the number of purchasers acquiring securities
in the offering, which may, in turn, be affected by the state or
territory where the offering occurs.
These estimates include the time and cost to the issuer to
implement a system to obtain and collect the written statements of
residency by purchasers in their offerings, including the preparation
of written materials, such as subscription agreements or questionnaires
to potential purchasers. These estimates also include the time and cost
incurred by an issuer's in-house and outside counsel and executive
officers of collecting these written statements received from
purchasers in their offerings.
In deriving our estimates, we recognize that these burdens and
costs will likely vary among issuers based on the size of their
offerings and the number of purchasers acquiring securities in their
offerings. We believe that some issuers will experience burdens and
costs in excess of these estimated averages and other issuers may
experience less than these estimated average burdens and costs.
Similarly, it is difficult to provide any standardized estimates of
the burdens and costs to purchasers in determining their state or
territory of residence and preparing their related written statements
of residency to the issuer. We expect, however, that the burden to
purchasers may be higher or lower depending on whether the purchaser is
a natural person or legal entity, and, if a legal entity, the extent of
the entity's activities in other states or territories. If a legal
entity, we realize there may be a wide range of management structures,
involving management teams potentially residing in multiple states or
territories, thereby complicating the determination of the purchaser's
principal place of business.
These estimates include the time and cost to the purchaser to
determine the purchaser's state or territory of residence and prepare a
written statement of residency for the issuer. In the case of
purchasers who are legal entities, these estimates also include the
time and cost incurred by purchasers' in-house counsel and executive
officers to undertake a factual inquiry to determine the state or
territory of the purchaser's principal place of business.
In deriving our estimates, we recognize that the burdens and costs
will likely vary between natural person and legal entity purchasers. In
the case of purchasers who are legal entities, these burdens and costs
will be based on a number of factors, including the location and
structure of their management teams. We believe that some natural
person and legal entity purchasers will experience burdens and costs in
excess of our estimated averages, and that others may experience
burdens and costs less than our estimated averages.
Request for Comment
We request comment on our approach and the accuracy of the current
estimates. Pursuant to 44 U.S.C. 3506(c)(2)(A), the Commission solicits
comments to: (1) Evaluate whether the collections of information are
necessary for the proper performance of the functions of the agency,
including whether the information will have practical utility; (2)
evaluate the accuracy of the Commission's estimate of the burden of the
collections of information; (3) determine whether there are ways to
enhance the quality, utility and clarity of the information to be
collected; and (4) evaluate whether there are ways to minimize the
burden of the collections of information on those who are required to
respond,

[[Page 83543]]

including through the use of automated collection techniques or other
forms of information technology.
Persons submitting comments on the collection of information
requirements should direct the comments to the Commission by any of the
following methods:

Electronic Comments

Paper Comments

Send paper comments to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE., Washington, DC
20549-1090.

Comments should be received on or before: January 20, 2017. Comments
submitted in response to this document will be summarized and/or
included in the request for OMB approval of this information
collection; they also will become a matter of public record.

B. Amendments to Rule 504 of Regulation D

The amendments to Rule 504 of Regulation D contain ``collection of
information'' requirements within the meaning of the PRA. There are two
titles for the collection of information requirements contemplated by
the amendments. The first title is: ``Form D'' (OMB Control No. 3235-
0076), an existing collection of information.\502\ The second title is:
``Regulation D Rule 504(b)(3) Felons and Other Bad Actors Disclosure
Statement,'' (OMB Control No. 3235-0746), a new collection of
information. Although the amendments to Rule 504 do not alter the
information requirements set forth in Form D, the amendments are
expected to increase the number of new Form D filings made pursuant to
Regulation D. Additionally, the mandatory bad actor disclosure
provisions that will be required under Rule 504 contain ``collection of
information'' requirements within the meaning of the PRA. We published
a notice requesting comment on these collection of information
requirements in the Proposing Release, and we submitted the proposed
amendments to the Office of Management and Budget (``OMB'') for review
and approval in accordance with the PRA and its implementing
regulations.\503\ While several commenters provided qualitative
comments on the possible costs of the proposed amendments, we did not
receive comments on our PRA analysis and thus are adopting our
estimates substantially as proposed, except as otherwise noted herein.
---------------------------------------------------------------------------

\502\ Form D was adopted pursuant to Sections 2(a)(15), 3(b),
4(a)(2), 19(a) and 19(c)(3) of the Securities Act, 15 U.S.C.
77b(a)(15), 77c(b), 77d(a)(2), 77s(a) and 77s(c)(3).
\503\ 44 U.S.C. 3507(d); 5 CFR 1320.11.
---------------------------------------------------------------------------

The information collection requirements related to the filing of
Form D with the Commission are mandatory to the extent that an issuer
elects to make an offering of securities in reliance on the relevant
exemption. Responses are not confidential, and there is no mandatory
retention period for the information disclosed. The hours and costs
associated with preparing and filing forms and retaining records
constitute reporting and cost burdens imposed by the collection of
information requirements. We applied for an OMB control number for the
proposed new collection of information in accordance with 44 U.S.C.
3507(j) and 5 CFR 1320.13, and OMB assigned a control number to the new
collection, as specified above. Responses to the new collection of
information will be mandatory for issuers raising capital under Rule
504 of Regulation D.
Form D (OMB Control No. 3235-0076)
The Form D filing is required for issuers as a notice of sales
without registration under the Securities Act based on a claim of
exemption under Regulation D or Section 4(a)(5) of the Securities Act.
The Form D must include basic information about the issuer, certain
related persons, and the offering. This information is used by the
Commission to observe use of the Regulation D exemptions and safe
harbor.
As the amendments are not altering the information requirements of
Form D, the amendments will not affect the paperwork burden of the
form, and the burden for responding to the collection of information in
Form D will be the same as before the amendments to Form D. However, we
estimate that the amendments to increase the aggregate amount of
securities that may be offered and sold in any 12-month period in
reliance on Rule 504 will increase the number of Form D filings that
are made with the Commission. We do not believe this increase will be
materially offset by a decrease in the number of Form D filings that
are made with the Commission attributable to our repeal of Rule 505 of
Regulation D.
The table below shows the current total annual compliance burden,
in hours and in costs, of the collection of information pursuant to
Form D. For purposes of the PRA, we estimate that, over a three-year
period, the average burden estimate will be four hours per Form D. Our
burden estimate represents the average burden for all issuers. This
burden is reflected as a one hour burden of preparation on the company
and a cost of $1,200 per filing. In deriving these estimates, we assume
that 25% of the burden of preparation is carried by the issuer
internally and that 75% of the burden of preparation is carried by
outside professionals retained by the issuer at an average cost of $400
per hour. The portion of the burden carried by outside professionals is
reflected as a cost, while the portion of the burden carried by the
issuer internally is reflected in hours.

Table 1--Estimated Paperwork Burden Under Form D, Pre-Amendment to Rule 504
--------------------------------------------------------------------------------------------------------------------------------------------------------
External
Number of Burden hours/ Total burden hours Internal issuer professional Professional costs
responses form time time
(A) \504\ (B) (C) = (A)*(B) (D) (E) (F) = (E)*$400
--------------------------------------------------------------------------------------------------------------------------------------------------------
Form D...................................... 25,900 4 103,600 25,900 77,700 $31,080,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

[[Page 83544]]

For the year ended 2015, there were 22,854 new Form D filings. The
annual number of new Form D filings rose from 13,764 in 2009 to 22,854
in 2015, an average increase of approximately 1,515 Form D filings per
year, or approximately 9%. Assuming the number of Form D filings
continues to increase by 1,515 filings per year for each of the next
three years, the average number of Form D filings in each of the next
three years would be approximately 25,900.
---------------------------------------------------------------------------

\504\ Although the number of responses for Form D is reported as
21,824 in the OMB's Inventory of Currently Approved Information
Collections, available at https://www.reginfo.gov/public/do/PRAMain;jsessionid=D37174B5F6F9148DB767D63DF6983A65, we have
prepared a new estimate based on the historical trend of the annual
number of new Form D filings. Based on an average increase of
approximately 1,515 new Form D filings per year over the past six
years, we believe that the average number of new Form D filings in
each of the next three years will be approximately 25,884, or 25,900
rounded to the nearest hundredth.
---------------------------------------------------------------------------

We estimate that the amendments to Rule 504 will result in a much
smaller annual increase in the number of new Form D filings than the
average annual increase that has occurred over the past six years. To
estimate how the amendments to Rule 504 will impact the number of new
Form D filings, we used as a reference point the impact of a past rule
change on the market for Regulation D offerings. In 1997, the
Commission amended Rule 144(d) under the Securities Act \505\ to reduce
the holding period for restricted securities from two years to one
year,\506\ thereby increasing the attractiveness of Regulation D
offerings to investors and to issuers. Prior to amending Rule 144(d),
there were 10,341 Form D filings in 1996, which was followed by a 20%
increase in the number of Form D filings in each of the subsequent
three calendar years, reaching 17,830 by 1999. Although it is not
possible to predict with any degree of certainty the increase in the
number of Rule 504 offerings following the amendments, we estimate for
purposes of the PRA that there will be a similar 20% increase over the
number of new Form D offerings that relied on either Rule 504 or 505 in
2015 after the amendments become effective.\507\ In 2015, there were
519 new Form D filings reporting reliance on Rule 504 and 179 new Form
D filings reporting reliance on Rule 505.\508\ We estimate that there
will be approximately 100 new Form D filings in each of the next three
years attributable to the amendments.\509\
---------------------------------------------------------------------------

\505\ 17 CFR 230.144(d).
\506\ See SEC Rel. No. 33-7390 (Feb. 20, 1997) [62 FR 9242].
\507\ We include the number of new Form D filings that rely on
Rule 505 in these estimates since we are repealing Rule 505, which
has provided an alternative Regulation D exemption available for
both non-reporting and reporting issuers under the Exchange Act.
Rule 505 has a maximum offering limitation of no more than $5
million in a twelve month period. We believe that issuers who are
non-reporting under the Exchange Act that have previously relied
upon Rule 505 will rely upon Rule 504 upon effectiveness of the
amendments, which will raise the maximum offering limitation under
Rule 504 from $1 million to $5 million. Reporting issuers under the
Exchange Act, who would have otherwise relied upon Rule 505, will
now have to rely upon Rule 506 of Regulation D, once the repeal of
Rule 505 becomes effective, since Rule 504 is unavailable to
reporting issuers.
\508\ Only 10 of the 179 new Form D filings that reported
reliance on Rule 505 in 2015 were filed by reporting issuers under
the Exchange Act. The remaining 169 new Form D filings were filed by
non-reporting issuers.
\509\ We estimate the number of new Form D filings attributable
to the amendments over the next three years, as follows: 698 new
Form D filings in 2015 relying on either Rules 504 or 505, less 10
new Form D filings made by reporting issuers under Rule 505 in 2015,
multiplied by 20%, equals 138. Rounding 138 to the nearest hundredth
provides an estimate of 100 new Form D filings attributable to the
amendments.
---------------------------------------------------------------------------

Based on these increases, we estimate that the total annual
compliance burden of the collection of information requirements for
issuers making Form D filings after amending Rule 504 to increase the
aggregate offering amount from $1 million to $5 million will be 26,000
hours of issuer personnel time and $31,200,000 for the services of
outside professionals.

Table 2--Estimated Paperwork Burden Under Form D, Post-Amendment to Rule 504
--------------------------------------------------------------------------------------------------------------------------------------------------------
External
Number of Burden hours/ Total burden Internal issuer professional Professional
responses form hours time time costs
(A) \510\ (B) (C) = (A)*(B) (D) (E) (F) = (E) *
$400

rForm D........................................... 26,000 4 104,000 26,000 78,000 $31,200,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

Regulation D Rule 504(b)(3) Felons and Other Bad Actors Disclosure
Statement (OMB Control No. 3235-0746)
Under the amendments, Rule 504 will disqualify issuers from
reliance on Rule 504 if such issuer would be subject to
disqualification under Rule 506(d) of Regulation D.\511\ Consistent
with the requirements of Rule 506(e), the amendments require the issuer
in a Rule 504 offering to furnish to each purchaser, a reasonable time
prior to sale, a written description of any disqualifying events that
occurred before effectiveness of the amendments and within the time
periods described in the list of disqualification events set forth in
Rule 506(d)(1) of Regulation D,\512\ for the issuer or any other
``covered person'' associated with the offering. For purposes of the
mandatory disclosure provision described in the note to Rule
504(b)(3),\513\ issuers will be required to ascertain whether any
disclosures are required in respect of covered persons involved in
their offerings, prepare any required disclosures and furnish them to
purchasers.
---------------------------------------------------------------------------

\510\ The information in this column is not based on the number
of responses for Form D of 21,824, as reported in the OMB's
Inventory of Currently Approved Information Collections, but rather
on a new estimate of the average number of new Form D filings in
each of the next three years. We prepared this estimate based on the
historical trend of the annual number of new Form D filings. See
text accompanying note 503 above. Based on an average increase of
approximately 1,515 new Form D filings per year over the past six
years, we estimate that the number of new Form D filings after the
amendment to Rule 504 would be the average number of new Form D
filings we estimate in each of the next three years of 25,900, plus
the additional 100 filings we estimate would be filed as a result of
the amendment to Rule 504.
\511\ See Rule 504(b)(3); see also 17 CFR 230.506(d).
\512\ 17 CFR 230.506(d)(1).
\513\ See Note to Rule 504(b)(3).
---------------------------------------------------------------------------

The disclosure required to be furnished to investors does not
involve submission of a form filed with the Commission and is not
required to be presented in any particular format, although it must be
in writing. The hours and costs associated with preparing and
furnishing the required disclosure to investors in the offering
constitute reporting and cost burdens imposed by the collection of
information.
The disclosure or paperwork burden imposed on issuers appears in an
instruction to Rule 504(b)(3) and pertains to events that occurred
before effectiveness of the final rules but which would have triggered
disqualification had they occurred after effectiveness. Issuers relying
on Rule 504 will be required to furnish disclosure of any relevant past
events that would have triggered disqualification under Rule 504(b)(3)
that relate to the issuer or any other covered person. If there are any
such events, a disclosure statement will be required to be furnished, a
reasonable time before sale, to all purchasers in the offering. The
disclosure requirement will serve to protect purchasers by

[[Page 83545]]

ensuring that they receive information about any covered persons that
were subject to such disqualifying events.
The disclosure requirement will not apply to triggering events
occurring after the effective date of the amendments, because those
events will result in disqualification from reliance on Rule 504
(absent a waiver or other exception provided in Rule 506(d)), rather
than any disclosure obligation.
The steps that issuers take to comply with the disclosure
requirement are expected to mirror the steps they would take to
determine whether they are disqualified from relying on Rule 504. For
purposes of estimating burdens and costs, we have assumed that issuers
planning or conducting a Rule 504 offering will undertake a factual
inquiry to determine whether they are subject to any disqualification
in order to utilize the reasonable care provisions set forth in Rule
506(d)(2)(iv). Disqualification and mandatory disclosure will be
triggered by the same types of events in respect of the same covered
persons, with disqualification arising from triggering events occurring
after the adoption and effectiveness of the amendments and mandatory
disclosure applicable to events occurring before that date. Therefore,
we expect that the factual inquiry process for the disclosure statement
requirement will impose a limited incremental burden on issuers.
The burdens and costs may vary depending on the size of the issuer
and the circumstances of the particular Rule 504 offering. We do not
anticipate that it will generally be necessary for any issuer or any
compensated solicitor to make inquiry of any covered individual with
respect to ascertaining the existence of events that require disclosure
more than once, because the period to be covered by the inquiry will
end with the effective date of the new disqualification rules. However,
issuers may incur additional burden and costs for each Rule 504
offering due to changes in management or intermediaries, other changes
to the group of covered persons or if questions arise about the
accuracy of previous responses.
We anticipate that the Regulation D Rule 504(b)(3) Felons and Other
Bad Actors Disclosure Statement will result in an incremental increase
in the burdens and costs for issuers that rely on the Rule 504
exemption. For purposes of the PRA, we estimate the total annual
increase in paperwork burden for all affected Rule 504 issuers to
comply with our collection of information requirements will be
approximately 880 hours of company personnel time and approximately
$9,600 for the services of outside professionals. These estimates
include the incremental time and cost of conducting a factual inquiry
to determine whether the Rule 504 issuers have any covered persons with
past disqualifying events. The estimates also include the cost of
preparing a disclosure statement that issuers will be required to
furnish to each purchaser a reasonable time prior to sale.
In deriving our estimates, consistent with those assumptions used
in the PRA analysis for the Rule 506 bad actor disqualification
provisions,\514\ we assume that:
---------------------------------------------------------------------------

\514\ See SEC Rel. No. 33-9414 (July 10, 2013).
---------------------------------------------------------------------------

Approximately 800 issuers \515\ relying on Rule 504 of
Regulation D will spend on average one additional hour to conduct a
factual inquiry to determine whether any covered persons had a
disqualifying event that occurred before the effective date of the
amendments; and
---------------------------------------------------------------------------

\515\ Based on staff analysis of Form D filings, there were 519
new Form D filings reporting reliance on Rule 504 and 179 new Form D
filings reporting reliance on Rule 505 in 2015. See Figure 1 in
Section V.A.1, above. Of the 179 new Form D filings reporting
reliance on Rule 505 in 2015, 10 new Form D filings were made by
reporting issuers under the Exchange Act and 169 new Form D filings
were made by non-reporting issuers under the Exchange Act. For
purposes of the PRA estimates, and based on the data provided for
Rule 504 and Rule 505 offerings in 2015, we assume that
approximately 800 issuers would file a Form D indicating reliance on
Rule 504 after the effectiveness of the amendments to Rule 504
(calculated as follows: 519 new Rule 504 filings and 169 new Rule
505 filings by non-reporting issuers in 2015, rounded to the nearest
hundredth, or 700 new Form D filings, plus 100 additional new Form D
filings attributable to the amendments to Rule 504). This figure
includes non-reporting issuers under the Exchange Act that, before
adoption of amendments to Rule 504, would have conducted offerings
pursuant to Rule 505, but that after adoption of the amendments to
Rule 504 and repeal of Rule 505 will likely conduct their offerings
pursuant to Rule 504.
---------------------------------------------------------------------------

On the basis of the factual inquiry, approximately eight
issuers (or approximately 1%) will spend ten hours to prepare a
disclosure statement describing matters that would have triggered
disqualification under Rule 504(b)(3) of Regulation D had they occurred
on or after the effective date of the amendments; and
For purposes of the Rule 504(b)(3) disclosure statement,
approximately eight issuers will retain outside professional firms to
spend three hours on disclosure preparation at an average cost of $400
per hour.
The increase in burdens and costs associated with conducting a
factual inquiry for the disclosure statement requirement should be
minimal given that issuers are likely to conduct simultaneously a
similar factual inquiry for purposes of determining disqualification
from Rule 504.
It is difficult to provide any standardized estimates of the costs
involved with the factual inquiry. There is no central repository that
aggregates information from all federal and state courts and regulators
that would be relevant in determining whether a covered person has a
disqualifying event in his or her past. In this regard, we are
currently unable to estimate the burdens and costs for issuers in a
verifiable way. We expect, however, that the costs to issuers may be
higher or lower depending on the size of the issuer and the number and
roles of covered persons. We realize there may be a wide range of
issuer sizes, management structures, and offering participants
associated with Rule 504 offerings and that different issuers may
develop a variety of different factual inquiry procedures.
Where the issuer or any covered person will be subject to an event
covered by Rule 504(b)(3) that existed before the effective date of
these rules, the issuer will be required to prepare disclosure for each
relevant Rule 504 offering. The estimates include the time and the cost
of data gathering systems, the time and cost of preparing and reviewing
disclosure by in-house and outside counsel and executive officers, and
the time and cost of delivering or furnishing documents and retaining
records.
Issuers conducting ongoing or continuous offerings may need to
update their factual inquiry and disclosure as necessary to address
additional covered persons. The annual incremental paperwork burden,
therefore, depends on an issuer's Rule 504 offering activity and the
changes in covered persons from offering to offering. For example, some
issuers may only conduct one Rule 504 offering during a year while
other issuers may have multiple, separate Rule 504 offerings during the
course of the same year involving different financial intermediaries,
newly hired executive officers or new 20% shareholders, any of which
will result in a different group of covered persons. In deriving our
estimates, we recognize that the burdens will likely vary among
individual companies based on a number of factors, including the size
and complexity of their organizations. We believe that some companies
will experience costs in excess of this estimated average and other
companies may experience less than the estimated average costs.

[[Page 83546]]

VII. Final Regulatory Flexibility Act Analysis

The Regulatory Flexibility Act (``RFA'') \516\ requires the
Commission, in promulgating rules under Section 553 of the
Administrative Procedure Act,\517\ to consider the impact of those
rules on small entities. The Commission has prepared this Final
Regulatory Flexibility Analysis (``FRFA'') in accordance with Section
604 of the RFA.\518\ This FRFA relates to the amendments to Rules 147
and 504, new Rule 147A and the repeal of Rule 505, all of which rules
are under the Securities Act. An Initial Regulatory Flexibility
Analysis (IRFA) was prepared in accordance with the RFA and included in
the Proposing Release.
---------------------------------------------------------------------------

\516\ 5 U.S.C. 601 et seq.
\517\ 5 U.S.C. 553.
\518\ 5 U.S.C. 604.
---------------------------------------------------------------------------

A. Need for the Rules

The amendments to Rule 147 are designed to modernize the safe
harbor, consistent with the Section 3(a)(11) exemption from
registration for intrastate securities offerings. New Rule 147A, which
will be similar to amended Rule 147 but will have no restriction on
offers and will allow issuers to be incorporated or organized out-of-
state, establishes a new Securities Act exemption for intrastate
offerings of securities by local companies. Together, the amendments to
Rule 147 and new Rule 147A are designed to facilitate capital formation
by making it easier to engage in exempt intrastate offerings while
maintaining appropriate protections for investors who purchase
securities in these offerings.
The amendments to Rule 504 are designed to facilitate capital
formation by increasing the flexibility of state securities regulators
to implement regional coordinated review programs that will facilitate
regional offerings. The amendments to Rule 504 will raise the aggregate
amount of securities an issuer may offer and sell in any 12-month
period from $1 million to $5 million and disqualify certain bad actors
from participating in Rule 504 offerings. We believe that raising the
aggregate offering limitation and disqualifying certain bad actors will
maximize the flexibility of state securities regulators to implement
regional coordinated review programs and provide for greater
consistency across Regulation D. We believe our amendment to Rule 504
to increase its aggregate offering ceiling from $1 million to $5
million will significantly diminish the utility of Rule 505 of
Regulation D, and we are therefore repealing that rule.

B. Significant Issues Raised by Public Comments

In the Proposing Release, we requested comment on all aspects of
the IRFA, including the number of small entities that would be affected
by the proposed amendments, the existence or nature of the potential
impact of the proposals on small entities discussed in the analysis,
and how to quantify the impact of the proposed amendments. We did not
receive any comments specifically addressing the IRFA. We did, however,
receive comments from members of the public on matters that could
potentially impact small entities. These comments are discussed at
length by topic in the corresponding subsections of Sections II. and
III. above.
Many commenters recommended making changes to the proposed rules
that, in their view, would make the exemptions a more viable capital
raising option for smaller issuers. Numerous commenters supported \519\
the proposal to eliminate the Rule 147 limitation on offers to in-state
residents while continuing to require that all sales be made to in-
state residents. However, many commenters also supported \520\ and the
2015 Small Business Forum recommended \521\ retaining Rule 147 as a
safe harbor under Section 3(a)(11), while adopting a substantially
similar new exemption pursuant to the Commission's general exemptive
authority under Section 28 as an alternative to the Section 3(a)(11)
exemption for companies that are conducting an intrastate offering.
Many commenters opposed any limits at the federal level on offering
size or investment size,\522\ and the 2015 Small Business Forum
recommended permitting the states to set their own limits as
appropriate.\523\ In addition, several commenters supported \524\ and
the 2015 Small Business Forum recommended \525\ exempting securities
issued in reliance upon Rule 147 from the reporting requirements of
Section 12(g) of the Exchange Act. Several commenters also supported
interpreting the intrastate broker-dealer exemption under the Exchange
Act to include intermediaries whose activities are limited to
facilitating intrastate offerings using the Internet.\526\
---------------------------------------------------------------------------

\519\ ABA Letter; City of Adrian Letter; Bishop Letter; Brelion
Letter; CFA Letter; CFIRA Letter; CrowdCheck Letter; CrwdCorp
Letter; Ely Letter; Guzik Letter; Love Letter; MacDougall Letter;
Milken Letter; NASAA Letter; Newcomer Letter; NextSeed Letter; Pearl
Letter; Terdal Letter; Wolff Letter; Zeoli Letter. See also
Congressional Letter (expressing general support for the proposed
amendments to Rule 147).
\520\ ABA Letter; City of Adrian Letter; Bishop Letter;
California Bar Letter; CFIRA Letter; Congressional Letter;
CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA Letter;
NextSeed Letter; Pearl Letter; Wallin Letter; Orloff Letter; Zeoli
Letter. No commenters supported eliminating Rule 147 as a safe
harbor under Section 3(a)(11).
\521\ See 2015 Small Business Forum Recommendations.
\522\ ABA Letter; Campbell Letter; CFIRA Letter; Congressional
Letter; CrowdCheck Letter; Guzik Letter; Milken Letter; NASAA
Letter; NextSeed Letter; WBA Letter.
\523\ See 2015 Small Business Forum Recommendations.
\524\ CFIRA Letter; CrowdCheck Letter; Guzik Letter; Milken
Letter; City of Adrian Letter.
\525\ See 2015 Small Business Forum Recommendations.
\526\ NASAA Letter; NextSeed Letter; WBA Letter.
---------------------------------------------------------------------------

Amended Rule 147 and new Rule 147 take into account some of the
suggestions by commenters and the recommendations of the 2015 Small
Business Forum on ways to make the intrastate offering exemptions more
useful for small entities. For example, the final rules retain Rule 147
as a safe harbor under Section 3(a)(11), while adopting a substantially
similar new exemption pursuant to the Commission's general exemptive
authority under Section 28 as an alternative to the Section 3(a)(11)
exemption for companies that are conducting an intrastate offering. As
described above, the final rules will modernize existing Rule 147 and
maintain a consistent approach across the two intrastate offering
provisions, where possible. Also, given the comments received, the
recommendations of the 2015 Small Business Forum and the local
intrastate nature of the exemptions, amended Rule 147 and new Rule 147A
will not contain any limits at the federal level on offering size or
investment size.
As noted in Section II.C above, however, we are not persuaded that
securities issued in reliance upon Rule 147 or Rule 147A should be
exempt from the reporting requirements of Section 12(g) of the Exchange
Act. Given the lack of ongoing reporting requirements under these
rules, we believe that the Section 12(g) record holder and asset
thresholds continue to provide an important baseline above which
issuers should generally be subject to the disclosure obligations of
the Exchange Act. As the shareholder base and total assets of these
issuers grow, we believe that the additional protections that will be
provided by registration under Section 12(g) are necessary and
appropriate.
Additionally, as noted in Section II.B.2.c above, in response to
the request by several commenters to interpret the intrastate broker-
dealer exemption

[[Page 83547]]

under the Exchange Act to include intermediaries whose activities are
limited to facilitating intrastate offerings using the Internet,\527\
we are providing guidance that a broker-dealer whose business otherwise
meets the requirements of the intrastate broker-dealer exemption should
not cease to qualify for the intrastate broker-dealer exemption solely
because it has a Web site that may be viewed by out-of-state persons,
so long as the broker-dealer takes measures reasonably designed to
ensure that its business remains exclusively intrastate.
---------------------------------------------------------------------------

\527\ NASAA Letter; NextSeed Letter; WBA Letter.
---------------------------------------------------------------------------

A few commenters also recommended changes to Rules 504 and 505
that, in their view, would make the exemptions a more viable capital
raising option for smaller issuers. Two commenters suggested \528\ and
the 2015 Small Business Forum recommended \529\ that the Rule 504
offering amount limit be increased to $10 million. In addition, one
commenter suggested \530\ and the 2015 Small Business Forum recommended
\531\ that securities sold under Rule 504 be exempt from the
requirements of Section 12(g). For Rule 505, one commenter suggested
that the Commission consider changes to Rule 505 to facilitate very
small offerings by early stage companies, such as a simple debt-only
offering exemption for smaller issuers.\532\ Another commenter noted
that, if the proposed changes to Rule 504 are adopted, Rule 505 would
be substantially similar to Rule 504, making Rule 505 unnecessary,
unless the Commission increases the aggregate offering amount that may
be raised under Rule 505 in any twelve-month period.\533\
---------------------------------------------------------------------------

\528\ CrowdCheck Letter; CFIRA Letter.
\529\ See 2015 Small Business Forum Recommendations.
\530\ Milken Letter.
\531\ See 2015 Small Business Forum Recommendations.
\532\ Milken Letter.
\533\ ABA Letter. This commenter recommended, for example, that
the offering amount limit could be raised from $5 million to $10
million or some larger amount, thereby preserving Rule 505 as a
viable alternative exemption.
---------------------------------------------------------------------------

As supported by many commenters, the final amendments to Rule 504
will increase the offering amount limit from $1 million to $5
million.\534\ We believe that the $5 million threshold will facilitate
issuers' ability to raise capital, while remaining within the statutory
requirements of Section 3(b)(1). As noted in Section III.B above,
although two commenters and the 2015 Small Business Forum recommended
that the Commission increase the Rule 504 offering amount limit to $10
million, we are not exceeding the maximum offering amount permitted
under Section 3(b)(1). Although, as several commenters noted, we could
use our exemptive authority under Section 28 of the Securities Act to
raise the maximum offering amount above $5 million,\535\ in accord with
the suggestion of one of those commenters,\536\ we believe it
appropriate to first observe market activity under a new maximum
offering amount of $5 million before raising the Rule 504 offering
limit any higher.
---------------------------------------------------------------------------

\534\ ABA Letter; CFA Letter; CFIRA Letter; CrowdCheck Letter;
Milken Letter; NASAA Letter.
\535\ ABA Letter; Milken Letter.
\536\ ABA Letter (``If the increase to $5 million is adopted,
after there is experience with the use and operation of new Rule
504, the Commission may wish to consider using its exemption
authority under Section 28 to increase the dollar limitation amount
that may be offered under Rule 204.'').
---------------------------------------------------------------------------

As noted in Section III.B above, we are not persuaded that
securities issued in reliance upon Rule 504 should be exempt from the
reporting requirements of Section 12(g) of the Exchange Act. Similar to
Rules 147 and 147A, given the lack of ongoing reporting requirements
under Rule 504, we believe that the Section 12(g) record holder and
asset thresholds continue to provide an important baseline above which
issuers should generally be subject to the disclosure obligations of
the Exchange Act. As the shareholder base and total assets of these
companies grow, we believe that the additional protections that will be
provided by registration under Section 12(g) are necessary and
appropriate.
After considering the comments, we are repealing Rule 505. As
discussed in Section III.C, amending Rule 504 to increase the aggregate
offering amount limit from $1 million to $5 million may further reduce
the incentives to use Rule 505 by issuers contemplating an exempt
offering. We also believe that, even if we were to raise the Rule 505
aggregate offering amount limit from $5 million to $10 million, or some
higher amount, such a higher limit would not increase the utility of
the Rule 505 exemption as compared to Rule 506 which has no limit,
given the historically diminished utility of Rule 505 as compared to
Rule 506.\537\ Further, although Rule 505 provides issuers the ability
to sell securities to up to 35 non-accredited investors without having
to make a finding, as in Rule 506(b)(2)(ii), that such persons have the
knowledge and experience in financial matters that they are capable of
evaluating the merits and risks of the prospective investment, \538\
this provision does not appear to have historically resulted in the
Rule 505 exemption being widely utilized.\539\ We will continue to
evaluate whether we should replace Rule 505 with a substantially
different exemption with new criteria, such as an exemption limited to
a very small aggregate offering amount by early stage companies, or an
exemption limited only to ``simple debt securities'' with very modest
compliance requirements.
---------------------------------------------------------------------------

\537\ See note 22 above.
\538\ Cf. 17 CFR 230.506(b)(2)(ii).
\539\ See Unregistered Offerings White Paper.
---------------------------------------------------------------------------

In the light of the changes discussed above, we believe that the
final rules provide smaller issuers with an appropriately tailored
regulatory regime that takes into account the needs of small entities
to have viable intrastate capital formation options, while maintaining
appropriate investor protections.

C. Small Entities Subject to the Rules

For purposes of the RFA, under our rules, an issuer, other than an
investment company, is a ``small business'' or ``small organization''
if it has total assets of $5 million or less as of the end of its most
recent fiscal year and is engaged or proposing to engage in an offering
of securities which does not exceed $5 million.\540\ For purposes of
the RFA, an investment company is a small entity if it, together with
other investment companies in the same group of related investment
companies, has net assets of $50 million or less as of the end of its
most recent fiscal year.\541\
---------------------------------------------------------------------------

\540\ 17 CFR 230.157.
\541\ 17 CFR 270.0-10(a).
---------------------------------------------------------------------------

While we lack data on the number and size of Rule 147 offerings or
the type of issuers currently relying on the Rule 147 safe harbor, the
nature of the eligibility requirements and other restrictions of the
rule lead us to believe that it is used by U.S. incorporated entities
that are likely small businesses seeking to raise small amounts of
capital locally without incurring the costs of registering with the
Commission. Currently, most states that have enacted crowdfunding
provisions require issuers that intend to conduct intrastate
crowdfunding offerings to rely upon Rule 147. Since December 2011, when
the first state crowdfunding provision was enacted, 179 state
crowdfunding offerings have been reported to be filed with the
respective state regulators.\542\ Of these offerings, 166 were reported
to be approved or cleared, as of June 20,

[[Page 83548]]

2016.\543\ We expect that almost all of the entities conducting these
offerings were small issuers.
---------------------------------------------------------------------------

\542\ Based on estimates provided by NASAA in a meeting with
staff of the SEC Division of Corporation Finance on July 20, 2016,
available athttps://www.sec.gov/comments/s7-22-15/s72215-32.pdf.
\543\ Id.
---------------------------------------------------------------------------

It is difficult to predict the number of small entities that will
use amended Rule 147 and new Rule 147A due to the many variables
included in the amendments. Nevertheless, we believe that the final
rules will increase the overall number of offerings relying on the
intrastate exemptions due to the ability to make out-of-state offers
under Rule 147A, the expanded number of issuers that will be eligible
to use the intrastate exemptions due to the lack of an in-state
incorporation requirement in Rule 147A and the modernized ``doing
business'' requirements of Rules 147 and 147A, and other significant
changes summarized in Section II above.
The amendments to Rule 504 will affect small issuers that rely on
this exemption from Securities Act registration. All issuers that sell
securities in reliance on Regulation D are required to file a Form D
with the Commission reporting the transaction. For the year ended
December 31, 2015, 20,736 issuers made 22,854 new Form D filings, and
of these Form D filings, 493 issuers relied on the Rule 504 exemption.
Based on the information reported by issuers on Form D, we estimate
that there were 269 small issuers \544\ relying on the Rule 504
exemption in 2015. This number likely underestimates the actual number
of small issuers relying on the Rule 504 exemption, however, because
41% of issuers that are not pooled investment funds and 38% of issuers
that are pooled investment funds declined to report their amount of
revenues or assets on their Form D filed with the Commission.
---------------------------------------------------------------------------

\544\ Of this number, 265 of these issuers are not pooled
investment funds, and 4 are pooled investment funds. We also note
that issuers that are not pooled investment funds disclose only
revenues on Form D, and not total assets. To estimate the number of
small issuers, for non-pooled investment funds, we have included
issuers that disclosed up to $5 million in revenues, including those
with no revenues, and for pooled investment funds, we have included
issuers that disclosed up to $5 million in net asset value,
including those with no asset value.
---------------------------------------------------------------------------

It is difficult to predict the number of small entities that will
use amended Rule 504 due to the variables included in the amendments.
Nevertheless, we believe that the final rules for Rule 504 will
increase the overall number of offerings relying on the exemption due
to the increase in the offering amount limit from $1 million to $5
million, as summarized in Section III above.
The repeal of Rule 505 will affect small issuers that rely on this
exemption from Securities Act registration. For the year ended December
31, 2015, of the 20,736 issuers that made new Form D filings, 163
issuers relied on the Rule 505 exemption. Based on the information
reported by issuers on Form D, we estimate that there were 112 small
issuers \545\ relying on the Rule 505 exemption in 2015. This number
likely underestimates the actual number of small issuers relying on the
Rule 504 exemption, however, because 25% of issuers that are not pooled
investment funds and 38% of issuers that are pooled investment funds
declined to report their amount of revenues or assets on their Form D
filed with the Commission.
---------------------------------------------------------------------------

\545\ Of this number, 107 are not pooled investment funds, and 5
are pooled investment funds. We also note that issuers that are not
pooled investment funds disclose only revenues on Form D and not
total assets. To estimate the number of small issuers, for non-
pooled investment funds, we have included issuers that disclosed up
to $5 million in revenues, including those with no revenues, and for
pooled investment funds, we have included issuers that disclosed up
to $5 million in net asset value, including those with no asset
value.
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping and Other Compliance Requirements

Amended Rule 147 and new Rule 147A will not impose any reporting or
recordkeeping requirements, but will require that issuers conducting
offerings in reliance on these rules make certain specific disclosures
to each offeree and purchaser in the offering. These disclosures will
be made to each offeree in the manner in which any such offer is
communicated and to each purchaser of a security in writing. Amended
Rule 147 and new Rule 147A will also require that issuers place a
specific legend on the certificate or other document evidencing the
securities that are being offered in reliance on the rules.
In order to comply with Rules 147(d) and 147A(d), sales of
securities must be made only to residents of the state or territory in
which the issuer has its residence or who the issuer reasonably
believes, at the time of sale, are residents of the state or territory
in which the issuer has its residence. In light of the comments
received on the proposal, Rules 147 and 147A will include a requirement
that issuers obtain a written representation from each purchaser as to
his or her residence.\546\ This written representation, however, will
not be sufficient, by itself, to establish reasonable belief. In
addition to the written representation, an issuer will need to consider
other facts and circumstances.
---------------------------------------------------------------------------

\546\ See Rules 147(f)(1)(iii) and 147A(f)(1)(iii).
---------------------------------------------------------------------------

The amendments to Rule 504 will increase the aggregate offering
ceiling from $1 million to $5 million and disqualify certain bad actors
from participating in Rule 504 offerings. Issuers will need to comply
with all the current requirements of Rule 504, including the filing of
a Form D.\547\ Also, as is the case under current Rule 504, issuers
relying on the rule that wish to engage in general solicitation and
issue freely tradable securities may also be required to register their
offering with at least one state regulator. The amendments to Rule 504
will also impose a disclosure requirement with respect to bad actor
disqualifying events that occurred before the effective date of the
disqualification provisions and that would have triggered
disqualification had they occurred after that date.\548\ Such
disclosure will be required to be in writing and furnished to each
purchaser a reasonable time prior to sale. There no prescribed format
for such disclosure.
---------------------------------------------------------------------------

\547\ Rule 503 requires an issuer relying on any exemption under
Regulation D to file a Form D within 15 calendar days after the
first sale of securities in the offering.
\548\ See Rule 504(b)(3).
---------------------------------------------------------------------------

In addition, we assume that issuers will exercise reasonable care
to ascertain whether a disqualification exists with respect to any
covered person and document their exercise of reasonable care. The
steps undertaken by issuers to exercise reasonable care may vary with
the circumstances. In addition, issuers will have to prepare any
necessary disclosure about preexisting events. We expect that the costs
of compliance will vary depending on the size and nature of the
offering but will generally be lower for small entities than for larger
ones because of the relative simplicity of their organizational
structures and securities offerings and the generally smaller numbers
of individuals and entities involved.

E. Agency Action To Minimize Effect on Small Entities

The Regulatory Flexibility Act directs us to consider significant
alternatives that would accomplish the stated objectives of our
amendments, while minimizing any significant adverse impact on small
entities. Specifically, we considered the following alternatives: (1)
Establishing different compliance or reporting requirements or
timetables that take into account the resources available to small
entities; (2) clarifying, consolidating or simplifying compliance and
reporting requirements for small entities under the rule; (3) using
performance rather than design

[[Page 83549]]

standards; and (4) exempting small entities from coverage of all or
part of the amendments.
With respect to clarification, consolidation and simplification of
the final rules' compliance and reporting requirements for small
entities, amended Rule 147 and new Rule 147A do not impose any new
reporting requirements. To the extent the final rules may be considered
to create a new compliance requirement to have a reasonable belief that
a prospective purchaser is a resident of the state or territory in
which the issuer is a resident, including a requirement that issuers
obtain a written representation from each purchaser as to his or her
residence (as currently required in Rule 147), the precise steps
necessary to meet the ``reasonable belief'' requirement will vary
according to the circumstances, and this flexible standard will be
applicable to all issuers, regardless of size. Overall, the final rules
are designed to streamline and modernize the rule for all issuers, both
large and small.
In connection with amended Rule 147 and new Rule 147A, we do not
think it feasible or appropriate to establish different compliance or
reporting requirements or timetables for small entities. The final
rules are designed to facilitate access to capital for both large and
small issuers, but particularly smaller issuers who may satisfy their
financing needs by limiting the sales of their securities only to
residents of the state or territory in which the issuers are resident.
The final rules do not contain any reporting standards and the
compliance requirements they do include are minimal and designed with
the limited resources of smaller issuers in mind. Similarly, we do not
believe it is necessary to clarify, consolidate or simplify reporting
or compliance requirements for small entities as the final rules
contain more streamlined requirements for all issuers, both large and
small. For example, the rules simplify the ``doing business'' in-state
determination by amending the current requirements in Rule 147 so that
an issuer's ability to rely on the safe harbor will be based on its
ability to satisfy updated and modernized issuer requirements, while
continuing to require issuers to have an in-state presence sufficient
to justify reliance on the Section 3(a)(11) exemption. New Rule 147A
includes similar modernized ``doing business'' in-state requirements.
With respect to using performance rather than design standards, we note
that the final rules establish a ``reasonable belief'' standard for the
determination of a prospective purchaser's residency status, which we
believe is a performance standard. Although the final rules will
require a written representation from investors, the rules recognize
that reasonable belief can be established in a variety of ways (e.g.,
through pre-existing knowledge of the purchaser, obtaining supporting
documentation, or using other appropriate methods). We believe that the
use of a performance standard accommodates different types of offerings
and purchasers without imposing overly burdensome methods that may be
ill-suited or unnecessary to a particular offering or purchaser, given
the facts and circumstances.
With respect to exempting small entities from amended Rule 147 and
new Rule 147A, we believe such an approach would increase, rather than
decrease, their regulatory burden. The final rules are designed to
facilitate an issuer's access to capital, regardless of the size of the
issuer. We have endeavored throughout these rules to minimize the
regulatory burden on all issuers, including small entities, while
meeting our regulatory objectives.
In connection with our amendments to Rule 504 of Regulation D, we
do not think it is feasible or appropriate to establish different
compliance or reporting requirements or timetables for small entities.
Our amendments are intended to facilitate issuers' access to capital
and are particularly designed for smaller issuers who are not subject
to the reporting requirements of Section 13 or 15(d) of the Exchange
Act and who are offering no more than $5 million of their securities in
any twelve month period. The amendments also exclude felons and other
``bad actors'' from involvement in Rule 504 offerings, which we believe
could benefit small issuers by increasing investor protection and trust
in such offerings. Increased investor trust could potentially reduce
the cost of capital and create greater opportunities for small
businesses to raise capital.
With respect to clarification, consolidation and simplification of
the compliance and reporting requirements for small entities, the
amendments to Rule 504 do not impose any new reporting requirements. To
the extent the amendments may be considered to create a new compliance
requirement to exercise reasonable care to ascertain whether a
disqualification exists with respect to any offering and to furnish a
written description of preexisting triggering events, the precise steps
necessary to meet that requirement will vary according to the
circumstances. In general, we believe the requirement will more easily
be met by small entities than by larger ones because we believe that
their structures and securities offerings would be generally less
complex and involve fewer participants.
With respect to the use of performance or design standards, we note
that the ``reasonable care'' exception is a performance standard. With
respect to exempting small entities from coverage of these amendments,
we believe that such an approach would increase, rather than decrease,
their regulatory burden. Regulation D was designed, in part, to provide
exemptive relief for smaller issuers. Furthermore, exempting small
entities from Rule 504's bad actor provisions could result in a
decrease in investor protection and trust in this small offerings
market, thereby potentially increasing the issuer's cost of capital. We
have endeavored to minimize the regulatory burden on all issuers,
including small entities, while meeting our regulatory objectives, and
have included a ``reasonable care'' exception and waiver authority for
the Commission to provide additional flexibility with respect to the
application of these amendments.

VIII. Statutory Basis and Text of Final Amendments

The amendments contained in this release are being adopted under
the authority set forth in Sections 3(b)(1), 19 and 28 of the
Securities Act of 1933, as amended, Sections 12, 13, 15, 23(a) and 36
of the Securities Exchange Act of 1934, Section 38(a) of the Investment
Company Act of 1940 and Section 211(a) of the Investment Advisers Act.

List of Subjects

17 CFR Part 200

Administrative practice and procedure, Authority delegations
(Government agencies), Organization and functions (Government
agencies).

17 CFR 230, 239, 240, 249, 270 and 275

Reporting and recordkeeping requirements, Securities.

Text of Final Amendments

For the reasons set out above, the Commission is amending Title 17,
chapter II of the Code of Federal Regulations, as follows:

PART 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND
REQUESTS

Subpart A--Organization and Program Management

0
1. The authority citation for Part 200, Subpart A, continues to read,
in part as follows:

[[Page 83550]]

Authority: 15 U.S.C. 77c, 77o, 77s, 77z-3, 77sss, 78d, 78d-1,
78d-2, 78o-4, 78w, 78ll(d), 78mm, 80a-37, 80b-11, 7202, and 7211 et
seq., unless otherwise noted.
* * * * *

Sec. 200.30-1 [Amended]

0
2. Amend Sec. 200.30-1 by:
0
a. In paragraph (a)(7), removing the references to ``4(3)'',
``4(3)(b)'' and ``77d(3)(B)'' and adding in their places ``4(a)(3)'',
``4(a)(3)(B)'' and ``77d(a)(3)(B)'' respectively; and
0
b. In paragraph (c), removing the reference to ``Sec. Sec.
230.505(b)(2)(iii)(C)'' and adding in its place ``Sec. Sec.
230.504(b)(3)''.

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

0
3. The authority citation for part 230 continues to read in part as
follows:

Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h,
77j, 77r, 77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o-
7 note, 78t, 78w, 78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-
30, and 80a-37, and Public Law 112-106, sec. 201(a), sec. 401, 126
Stat. 313 (2012), unless otherwise noted.
* * * * *

0
4. Sec. 230.147 is revised to read as follows:

Sec. 230.147 Intrastate offers and sales.

(a) This section shall not raise any presumption that the exemption
provided by section 3(a)(11) of the Act (15 U.S.C. 77c(a)(11)) is not
available for transactions by an issuer which do not satisfy all of the
provisions of this section.
(b) Manner of offers and sales. An issuer, or any person acting on
behalf of the issuer, shall be deemed to conduct an offering in
compliance with section 3(a)(11) of the Act (15 U.S.C. 77c(a)(11)),
where offers and sales are made only to persons resident within the
same state or territory in which the issuer is resident and doing
business, within the meaning of section 3(a)(11) of the Act, so long as
the issuer complies with the provisions of paragraphs (c), (d), and (f)
through (h) of this section.
(c) Nature of the issuer. The issuer of the securities shall at the
time of any offers and sales be a person resident and doing business
within the state or territory in which all of the offers and sales are
made.
(1) The issuer shall be deemed to be a resident of the state or
territory in which:
(i) It is incorporated or organized, and it has its principal place
of business, if a corporation, limited partnership, trust or other form
of business organization that is organized under state or territorial
law. The issuer shall be deemed to have its principal place of business
in a state or territory in which the officers, partners or managers of
the issuer primarily direct, control and coordinate the activities of
the issuer;
(ii) It has its principal place of business, as defined in
paragraph (c)(1)(i) of this section, if a general partnership or other
form of business organization that is not organized under any state or
territorial law;
(iii) Such person's principal residence is located, if an
individual.
Instruction to paragraph (c)(1): An issuer that has previously
conducted an intrastate offering pursuant to this section (Sec.
230.147) or Rule 147A (Sec. 230.147A) may not conduct another
intrastate offering pursuant to this section (Sec. 230.147) in a
different state or territory, until the expiration of the time period
specified in paragraph (e) of this section (Sec. 230.147(e)) or
paragraph (e) of Rule 147A (Sec. 230.147A(e)), calculated on the basis
of the date of the last sale in such offering.
(2) The issuer shall be deemed to be doing business within a state
or territory if the issuer satisfies at least one of the following
requirements:
(i) The issuer derived at least 80% of its consolidated gross
revenues from the operation of a business or of real property located
in or from the rendering of services within such state or territory;
Instruction to paragraph (c)(2)(i): Revenues must be calculated
based on the issuer's most recent fiscal year, if the first offer of
securities pursuant to this section is made during the first six months
of the issuer's current fiscal year, and based on the first six months
of the issuer's current fiscal year or during the twelve-month fiscal
period ending with such six-month period, if the first offer of
securities pursuant to this section is made during the last six months
of the issuer's current fiscal year.
(ii) The issuer had at the end of its most recent semi-annual
fiscal period prior to an initial offer of securities in any offering
or subsequent offering pursuant to this section, at least 80% of its
assets and those of its subsidiaries on a consolidated basis located
within such state or territory;
(iii) The issuer intends to use and uses at least 80% of the net
proceeds to the issuer from sales made pursuant to this section (Sec.
230.147) in connection with the operation of a business or of real
property, the purchase of real property located in, or the rendering of
services within such state or territory; or
(iv) A majority of the issuer's employees are based in such state
or territory.
(d) Residence of offerees and purchasers. Offers and sales of
securities pursuant to this section (Sec. 230.147) shall be made only
to residents of the state or territory in which the issuer is resident,
as determined pursuant to paragraph (c) of this section, or who the
issuer reasonably believes, at the time of the offer and sale, are
residents of the state or territory in which the issuer is resident.
For purposes of determining the residence of offerees and purchasers:
(1) A corporation, partnership, limited liability company, trust or
other form of business organization shall be deemed to be a resident of
a state or territory if, at the time of the offer and sale to it, it
has its principal place of business, as defined in paragraph (c)(1)(i)
of this section, within such state or territory.
Instruction to paragraph (d)(1): A trust that is not deemed by the
law of the state or territory of its creation to be a separate legal
entity is deemed to be a resident of each state or territory in which
its trustee is, or trustees are, resident.
(2) Individuals shall be deemed to be residents of a state or
territory if such individuals have, at the time of the offer and sale
to them, their principal residence in the state or territory.
(3) A corporation, partnership, trust or other form of business
organization, which is organized for the specific purpose of acquiring
securities offered pursuant to this section (Sec. 230.147), shall not
be a resident of a state or territory unless all of the beneficial
owners of such organization are residents of such state or territory.
Instruction to paragraph (d): Obtaining a written representation
from purchasers of in-state residency status will not, without more, be
sufficient to establish a reasonable belief that such purchasers are
in-state residents.
(e) Limitation on resales. For a period of six months from the date
of the sale by the issuer of a security pursuant to this section (Sec.
230.147), any resale of such security shall be made only to persons
resident within the state or territory in which the issuer was
resident, as determined pursuant to paragraph (c) of this section, at
the time of the sale of the security by the issuer.
Instruction to paragraph (e): In the case of convertible
securities, resales of either the convertible security, or if it is
converted, the underlying security, could be made during the period
described in paragraph (e) only to persons resident within such state
or territory. For purposes of this paragraph

[[Page 83551]]

(e), a conversion in reliance on section 3(a)(9) of the Act (15 U.S.C.
77c(a)(9)) does not begin a new period.
(f) Precautions against interstate sales. (1) The issuer shall, in
connection with any securities sold by it pursuant to this section:
(i) Place a prominent legend on the certificate or other document
evidencing the security stating that: ``Offers and sales of these
securities were made under an exemption from registration and have not
been registered under the Securities Act of 1933. For a period of six
months from the date of the sale by the issuer of these securities, any
resale of these securities (or the underlying securities in the case of
convertible securities) shall be made only to persons resident within
the state or territory of [identify the name of the state or territory
in which the issuer was resident at the time of the sale of the
securities by the issuer].'';
(ii) Issue stop transfer instructions to the issuer's transfer
agent, if any, with respect to the securities, or, if the issuer
transfers its own securities, make a notation in the appropriate
records of the issuer; and
(iii) Obtain a written representation from each purchaser as to his
or her residence.
(2) The issuer shall, in connection with the issuance of new
certificates for any of the securities that are sold pursuant to this
section (Sec. 230.147) that are presented for transfer during the time
period specified in paragraph (e), take the steps required by
paragraphs (f)(1)(i) and (ii) of this section.
(3) The issuer shall, at the time of any offer or sale by it of a
security pursuant to this section (Sec. 230.147), prominently disclose
to each offeree in the manner in which any such offer is communicated
and to each purchaser of such security in writing a reasonable period
of time before the date of sale, the following: ``Sales will be made
only to residents of [identify the name of the state or territory in
which the issuer was resident at the time of the sale of the securities
by the issuer]. Offers and sales of these securities are made under an
exemption from registration and have not been registered under the
Securities Act of 1933. For a period of six months from the date of the
sale by the issuer of the securities, any resale of the securities (or
the underlying securities in the case of convertible securities) shall
be made only to persons resident within the state or territory of
[identify the name of the state or territory in which the issuer was
resident at the time of the sale of the securities by the issuer].''
(g) Integration with other offerings. Offers or sales made in
reliance on this section will not be integrated with:
(1) Offers or sales of securities made prior to the commencement of
offers and sales of securities pursuant to this section (Sec.
230.147); or
(2) Offers or sales made after completion of offers and sales of
securities pursuant to this section (Sec. 230.147) that are:
(i) Registered under the Act, except as provided in paragraph (h)
of this section (Sec. 230.147);
(ii) Exempt from registration under Regulation A (Sec. Sec.
230.251 through 230.263);
(iii) Exempt from registration under Rule 701 (Sec. 230.701);
(iv) Made pursuant to an employee benefit plan;
(v) Exempt from registration under Regulation S (Sec. Sec. 230.901
through 230.905);
(vi) Exempt from registration under section 4(a)(6) of the Act (15
U.S.C. 77d(a)(6)); or
(vii) Made more than six months after the completion of an offering
conducted pursuant to this section (Sec. 230.147).
Instruction to paragraph (g): If none of the safe harbors applies,
whether subsequent offers and sales of securities will be integrated
with any securities offered or sold pursuant to this section (Sec.
230.147) will depend on the particular facts and circumstances.
(h) Offerings limited to qualified institutional buyers and
institutional accredited investors. Where an issuer decides to register
an offering under the Act after making offers in reliance on this
section (Sec. 230.147) limited only to qualified institutional buyers
and institutional accredited investors referenced in section 5(d) of
the Act, such offers will not be subject to integration with any
subsequent registered offering. If the issuer makes offers in reliance
on this section (Sec. 230.147) to persons other than qualified
institutional buyers and institutional accredited investors referenced
in section 5(d) of the Act, such offers will not be subject to
integration if the issuer (and any underwriter, broker, dealer, or
agent used by the issuer in connection with the proposed offering)
waits at least 30 calendar days between the last such offer made in
reliance on this section (Sec. 230.147) and the filing of the
registration statement with the Commission.

0
5. Add Sec. 230.147A to read as follows:

Sec. 230.147A Intrastate sales exemption.

(a) Scope of the exemption. Offers and sales by or on behalf of an
issuer of its securities made in accordance with this section (Sec.
230.147A) are exempt from section 5 of the Act (15 U.S.C. 77e). This
exemption is not available to an issuer that is an investment company
registered or required to be registered under the Investment Company
Act of 1940 (15 U.S.C. 80a-1 et seq.).
(b) Manner of offers and sales. An issuer, or any person acting on
behalf of the issuer, may rely on this exemption to make offers and
sales using any form of general solicitation and general advertising,
so long as the issuer complies with the provisions of paragraphs (c),
(d), and (f) through (h) of this section.
(c) Nature of the issuer. The issuer of the securities shall at the
time of any offers and sales be a person resident and doing business
within the state or territory in which all of the sales are made.
(1) The issuer shall be deemed to be a resident of the state or
territory in which it has its principal place of business. The issuer
shall be deemed to have its principal place of business in a state or
territory in which the officers, partners or managers of the issuer
primarily direct, control and coordinate the activities of the issuer.
(2) The issuer shall be deemed to be doing business within a state
or territory if the issuer satisfies at least one of the following
requirements:
(i) The issuer derived at least 80% of its consolidated gross
revenues from the operation of a business or of real property located
in or from the rendering of services within such state or territory;
Instruction to paragraph (c)(2)(i): Revenues must be calculated
based on the issuer's most recent fiscal year, if the first offer of
securities pursuant to this section is made during the first six months
of the issuer's current fiscal year, and based on the first six months
of the issuer's current fiscal year or during the twelve-month fiscal
period ending with such six-month period, if the first offer of
securities pursuant to this section is made during the last six months
of the issuer's current fiscal year.
(ii) The issuer had at the end of its most recent semi-annual
fiscal period prior to an initial offer of securities in any offering
or subsequent offering pursuant to this section, at least 80% of its
assets and those of its subsidiaries on a consolidated basis located
within such state or territory;
(iii) The issuer intends to use and uses at least 80% of the net
proceeds to the issuer from sales made pursuant to this section (Sec.
230.147A) in connection with the operation of a business or of

[[Page 83552]]

real property, the purchase of real property located in, or the
rendering of services within such state or territory; or
(iv) A majority of the issuer's employees are based in such state
or territory.
Instruction to paragraph (c): An issuer that has previously
conducted an intrastate offering pursuant to this section (Sec.
230.147A) or Rule 147 (Sec. 230.147) may not conduct another
intrastate offering pursuant to this section (Sec. 230.147A) in a
different state or territory, until the expiration of the time period
specified in paragraph (e) of this section (Sec. 230.147A(e)) or
paragraph (e) of Rule 147 (Sec. 230.147(e)), calculated on the basis
of the date of the last sale in such offering.
(d) Residence of purchasers. Sales of securities pursuant to this
section (Sec. 230.147A) shall be made only to residents of the state
or territory in which the issuer is resident, as determined pursuant to
paragraph (c) of this section, or who the issuer reasonably believes,
at the time of sale, are residents of the state or territory in which
the issuer is resident. For purposes of determining the residence of
purchasers:
(1) A corporation, partnership, limited liability company, trust or
other form of business organization shall be deemed to be a resident of
a state or territory if, at the time of sale to it, it has its
principal place of business, as defined in paragraph (c)(1) of this
section, within such state or territory.
Instruction to paragraph (d)(1): A trust that is not deemed by the
law of the state or territory of its creation to be a separate legal
entity is deemed to be a resident of each state or territory in which
its trustee is, or trustees are, resident.
(2) Individuals shall be deemed to be residents of a state or
territory if such individuals have, at the time of sale to them, their
principal residence in the state or territory.
(3) A corporation, partnership, trust or other form of business
organization, which is organized for the specific purpose of acquiring
securities offered pursuant to this section (Sec. 230.147A), shall not
be a resident of a state or territory unless all of the beneficial
owners of such organization are residents of such state or territory.
Instruction to paragraph (d): Obtaining a written representation
from purchasers of in-state residency status will not, without more, be
sufficient to establish a reasonable belief that such purchasers are
in-state residents.
(e) Limitation on resales. For a period of six months from the date
of the sale by the issuer of a security pursuant to this section (Sec.
230.147A), any resale of such security shall be made only to persons
resident within the state or territory in which the issuer was
resident, as determined pursuant to paragraph (c) of this section, at
the time of the sale of the security by the issuer.
Instruction to paragraph (e): In the case of convertible
securities, resales of either the convertible security, or if it is
converted, the underlying security, could be made during the period
described in paragraph (e) only to persons resident within such state
or territory. For purposes of this paragraph (e), a conversion in
reliance on section 3(a)(9) of the Act (15 U.S.C. 77c(a)(9)) does not
begin a new period.
(f) Precautions against interstate sales. (1) The issuer shall, in
connection with any securities sold by it pursuant to this section:
(i) Place a prominent legend on the certificate or other document
evidencing the security stating that: ``Offers and sales of these
securities were made under an exemption from registration and have not
been registered under the Securities Act of 1933. For a period of six
months from the date of the sale by the issuer of these securities, any
resale of these securities (or the underlying securities in the case of
convertible securities) shall be made only to persons resident within
the state or territory of [identify the name of the state or territory
in which the issuer was resident at the time of the sale of the
securities by the issuer].'';
(ii) Issue stop transfer instructions to the issuer's transfer
agent, if any, with respect to the securities, or, if the issuer
transfers its own securities, make a notation in the appropriate
records of the issuer; and
(iii) Obtain a written representation from each purchaser as to his
or her residence.
(2) The issuer shall, in connection with the issuance of new
certificates for any of the securities that are sold pursuant to this
section (Sec. 230.147A) that are presented for transfer during the
time period specified in paragraph (e), take the steps required by
paragraphs (f)(1)(i) and (ii) of this section.
(3) The issuer shall, at the time of any offer or sale by it of a
security pursuant to this section (Sec. 230.147A), prominently
disclose to each offeree in the manner in which any such offer is
communicated and to each purchaser of such security in writing a
reasonable period of time before the date of sale, the following:
``Sales will be made only to residents of the state or territory of
[identify the name of the state or territory in which the issuer was
resident at the time of the sale of the securities by the issuer].
Offers and sales of these securities are made under an exemption from
registration and have not been registered under the Securities Act of
1933. For a period of six months from the date of the sale by the
issuer of the securities, any resale of the securities (or the
underlying securities in the case of convertible securities) shall be
made only to persons resident within the state or territory of
[identify the name of the state or territory in which the issuer was
resident at the time of the sale of the securities by the issuer].''
(g) Integration with other offerings. Offers or sales made in
reliance on this section will not be integrated with:
(1) Offers or sales of securities made prior to the commencement of
offers and sales of securities pursuant to this section (Sec.
230.147A); or
(2) Offers or sales of securities made after completion of offers
and sales of securities pursuant to this section (Sec. 230.147A) that
are:
(i) Registered under the Act, except as provided in paragraph (h)
of this section (Sec. 230.147A);
(ii) Exempt from registration under Regulation A (Sec. Sec.
230.251 through 230.263);
(iii) Exempt from registration under Rule 701 (Sec. 230.701);
(iv) Made pursuant to an employee benefit plan;
(v) Exempt from registration under Regulation S (Sec. Sec. 230.901
through 230.905);
(vi) Exempt from registration under section 4(a)(6) of the Act (15
U.S.C. 77d(a)(6)); or
(vii) Made more than six months after the completion of an offering
conducted pursuant to this section (Sec. 230.147A).
Instruction to paragraph (g): If none of the safe harbors applies,
whether subsequent offers and sales of securities will be integrated
with any securities offered or sold pursuant to this section (Sec.
230.147A) will depend on the particular facts and circumstances.
(h) Offerings limited to qualified institutional buyers and
institutional accredited investors. Where an issuer decides to register
an offering under the Act after making offers in reliance on this
section (Sec. 230.147A) limited only to qualified institutional buyers
and institutional accredited investors referenced in section 5(d) of
the Act, such offers will not be subject to integration with any
subsequent registered offering. If the issuer makes offers in reliance
on this section (Sec. 230.147A) to persons other than qualified
institutional buyers and institutional accredited investors referenced
in section 5(d) of the Act,

[[Page 83553]]

such offers will not be subject to integration if the issuer (and any
underwriter, broker, dealer, or agent used by the issuer in connection
with the proposed offering) waits at least 30 calendar days between the
last such offer made in reliance on this section (Sec. 230.147A) and
the filing of the registration statement with the Commission.

Sec. 230.501 [Amended]

0
6. Amend Sec. 230.501 paragraph (e) introductory text by removing the
reference to ``Sec. Sec. 230.505(b) and 230.506(b)'' and adding in its
place ``Sec. 230.506(b)''.

Sec. 230.502 [Amended]

0
7. Amend Sec. 230.502 by:
0
a. In paragraph (b)(1), removing the reference to ``Sec. 230.505 or'';
0
b. In paragraph (b)(2)(iv), removing the reference to ``Sec. 230.505
or'';
0
c. In paragraph (b)(2)(v), removing the reference to ``Sec. 230.505
or''; and
0
d. In paragraph (b)(2)(vii), removing the reference to ``Sec. 230.505
or'';

Sec. 230.503 [Amended]

0
8. Amend Sec. 230.503 paragraph (a)(1) by removing the comma after
``Sec. 230.504'' and the reference to ``Sec. 230.505,''.

0
9. In Sec. 230.504, the section heading and paragraph (b)(2) are
revised, and paragraph (b)(3) is added, to read as follows:

Sec. 230.504 Exemption for limited offerings and sales of securities
not exceeding $5,000,000.

* * * * *
(b) * * *
(2) The aggregate offering price for an offering of securities
under this Sec. 230.504, as defined in Sec. 230.501(c), shall not
exceed $5,000,000, less the aggregate offering price for all securities
sold within the twelve months before the start of and during the
offering of securities under this Sec. 230.504, in violation of
section 5(a) of the Securities Act.
Instruction to paragraph (b)(2): If a transaction under Sec.
230.504 fails to meet the limitation on the aggregate offering price,
it does not affect the availability of this Sec. 230.504 for the other
transactions considered in applying such limitation. For example, if an
issuer sold $5,000,000 of its securities on January 1, 2014 under this
Sec. 230.504 and an additional $500,000 of its securities on July 1,
2014, this Sec. 230.504 would not be available for the later sale, but
would still be applicable to the January 1, 2014 sale.
(3) Disqualifications. No exemption under this section shall be
available for the securities of any issuer if such issuer would be
subject to disqualification under Sec. 230.506(d) on or after January
20, 2017; provided that disclosure of prior ``bad actor'' events shall
be required in accordance with Sec. 230.506(e).
Instruction to paragraph (b)(3): For purposes of disclosure of
prior ``bad actor'' events pursuant to Sec. 230.506(e), an issuer
shall furnish to each purchaser, a reasonable time prior to sale, a
description in writing of any matters that would have triggered
disqualification under this paragraph (b)(3) but occurred before
January 20, 2017.

Sec. 230.505 [Removed and Reserved]

0
10. Sec. 230.505 is removed and reserved.

Sec. 230.507 [Amended]

0
11. Amend Sec. 230.507 by:
0
a. In the section heading, removing the comma after ``Sec. Sec.
230.504'' and the reference to ``230.505''; and
0
b. In paragraph (a), removing the reference to ``Sec. 230.505,'' and
adding in its place ``Sec. 230.504'' and removing the reference to
``Sec. 230.505.''

Sec. 230.508 [Amended]

0
12. Amend Sec. 230.508 by:
0
a. In paragraph (a) introductory text, removing the comma after ``Sec.
230.504'' and the reference to ``Sec. 230.505'';
0
b. In paragraph (a)(2), removing the comma after ``Sec. 230.504'' and
the reference to ``paragraphs (b)(2)(i) and (ii) of Sec. 230.505'':
0
c. In paragraph (a)(3), removing the comma after ``Sec. 230.504'' and
the reference to ``Sec. 230.505''; and
0
d. In paragraph (b), removing the comma after ``Sec. 230.504'' and the
reference to ``Sec. 230.505.''

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

0
13. The authority citation for part 239 continues to read, in part, as
follows:

Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-
3, 77sss, 78c, 78l, 78m, 78n, 78o(d), 78o-7 note, 78u-5, 78w(a),
78ll, 78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24,
80a-26, 80a-29, 80a-30, 80a-37, and Sec. 71003 and Sec. 84001, Pub.
L. 114-94, 129 Stat. 1312, unless otherwise noted.
* * * * *

Sec. 239.500 [Amended]

0
14. Amend Sec. 239.500 by:
0
a. In the section heading, removing the reference to ``4(5)'' and
adding in its place ``4(a)(5)'';
0
b. In paragraph (a)(1), removing the comma after ``Sec. 230.504'' and
the reference to ``Sec. 230.505,''; and removing the reference to
``4(5)'' and adding in its place ``4(a)(5)''; and
0
c. Amend Form D (referenced in Sec. 239.500) by:
0
i. In Item 6, removing the phrase ``Rule 505'' and the appropriate
check box;
0
ii. Under ``Signature and Submission,'' replace the third paragraph
under ``Terms of Submission'' with the following sentence: ``Certifying
that, if the issuer is claiming a Regulation D exemption for the
offering, the issuer is not disqualified from relying on Rule 504 or
Rule 506 for one of the reasons stated in Rule 504(b)(3) or Rule
506(d). ''

(Note: The text of Form D does not, and the amendments will not,
appear in the Code of Federal Regulations.)

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934

0
15. The authority citation for Part 240 continues to read, in part, as
follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et. seq., and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and
Pub. L. 111-203, 939A, 124 Stat. 1376, (2010), unless otherwise
noted.
* * * * *

Sec. 240.15g-9 [Amended]

0
16. Amend Sec. 240.15g-9 paragraph (c)(2) by removing the reference to
``230.505 or''; and removing the reference to ``4(2)'' and adding in
its place ``4(a)(2)''.

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

0
17. The authority citation for part 249 continues to read, in part, as
follows:

Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C.
5461 et seq.; 18 U.S.C. 1350; Sec. 953(b), Public Law 111-203, 124
Stat. 1904; Sec. 102(a)(3), Public Law 112-106, 126 Stat. 309
(2012); Sec. 107, Public Law 112-106, 126 Stat. 313 (2012), and Sec.
72001, Public Law 114-94, 129 Stat. 1312 (2015), unless otherwise
noted.
* * * * *

Sec. 249.308 [Amended]

0
18. Amend the Instruction to Item 9.01 in Form 8-K (referenced in Sec.
249.308) by removing the phrase ``Rules 505 and 506 of Regulation D (17

[[Page 83554]]

CFR 230.505 and'' and adding in its place ``Rule 506 of Regulation D
(17 CFR''.

(Note: The text of Form 8-K does not, and the amendments will not,
appear in the Code of Federal Regulations.)

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

0
19. The authority citation for Part 270 continues to read in part as
follows:

Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted.
* * * * *

Sec. 270.17j-1 [Amended]

0
20. Amend Sec. 270.17j-1 paragraph (a)(8) by removing the references
to ``4(2)'', ``4(5)'', ``77d(2)'' and ``77d(5)'' and adding in their
places ``4(a)(2)'', ``4(a)(5)'', ``77d(a)(2)'' and ``77d(a)(5)'',
respectively; and removing the comma after ``rule 504'', the reference
to ``rule 505,'', the comma after ``230.504'' and the reference to
``230.505,''.

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

0
21. The authority citation for Part 275 continues to read in part as
follows:

Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(11)(H), 80b-
2(a)(17), 80b-3, 80b-4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless
otherwise noted.
* * * * *

Sec. 275.204A-1 [Amended]

0
22. Amend Sec. 275.204A-1 paragraph (e)(7) by removing the references
to ``4(2)'', ``4(5)'', ``77d(2)'' and ``77d(5)'' and adding in their
places ``4(a)(2)'', ``4(a)(5)'', ``77d(a)(2)'' and ``77d(a)(5)'',
respectively; and removing the comma after ``230.504'' and the
reference to ``230.505,''.

Dated: October 26, 2016.

By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2016-26348 Filed 11-18-16; 8:45 am]
BILLING CODE 8011-01-P

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