Almost a year ago, the SEC proposed certain amendments to the current Rule 147 which were intended to help foster, and increase the viability of, Intrastate crowdfunding. While little has been heard about these amendments since their release (except from Intrastate proponents like me of course), over the last week the stars seemed to have aligned themselves and we may actually see these important amendments being approved by the SEC as early as next week … with a couple, extremely important modifications, we hope….
Generally speaking, Rule 147 and Section 3(a)(11) of the Securities Act of 1933 (the “Act”) are the basis for “intrastate crowdfunding.” Technically, Rule 147 is a “safe harbor” under Section 3(a)(11) which provides an exemption from registration (emphasis added) for “any security which is a 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 residing and doing business within, or, if a corporation, incorporated by and doing business within such state or territory.” Essentially under this safe harbor, a securities offering that takes place completely within one state is exempt from federal registration. The problem with Rule 147 is that it has not substantively changed since its adoption in 1974 and does not mesh well with today’s global and internet based society.
As a quick summary, the SEC’s proposed amendments to Rule 147 provide for:
- Eliminating the restriction on “offers” being made only within a state. Currently Rule 147 does not permit Issuers to use any form of general solicitation/advertising to promote their offering which could potentially reach, or be seen by, out-of-state residents. Under the proposed amendments, this restriction would be entirely eliminated. While Rule 147, as amended, would still require that that offered securities be sold only to residents within the Issuer’s state, the Issuer would be permitted 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 websites, to advertise their offerings.”
- Eliminating the Strict Residency Requirement for Issuers. Rule 147 currently requires Issuers to be incorporated/organized/formed in the state in which the intrastate offering is conducted. In recognizing that companies are often incorporated/organized/formed in states such as Delaware or Nevada for certain business or liability purposes while actually operating in another state, the SEC’s proposed amendments would eliminate this current “residence” requirement and replace it with a “principal place of business” standard. As proposed, an Issuer’s “principal place of business” would be the “location from which the officers, partners, or managers of the issuer primarily direct, control and coordinate the activities of the issuer.”
- Modifying the “Doing Business” Requirement Test. The current iteration of Rule 147 includes three threshold tests (commonly referred to as the 80/80/80 test), each of which must be satisfied by the Issuer in order for it to be considered “doing business” in a particular state. Unfortunately, in today’s internet based society, meeting any one of these tests can be extremely difficult to satisfy, let alone all of them. Under the proposed amendments, the three existing thresholds tests would remain. However, a fourth, more general threshold test would be added and an Issuer would only be required to satisfy one, not all, of the stated tests.
- Certain additional positive amendments. The proposed amendments to Rule 147 also include positive changes related to the rules governing the integration of Rule 147 offerings, the verification of investor residency status, and the resale and holding period restrictions. Each of these proposed amendments is intended to simplify/clarify the current rules in order to make compliance with Rule 147 significantly easier for both Issuers and investors.
While the SEC’s proposed amendments would go a long way in modernizing the currently outdated Rule 147, there is one proposed provision which, if made effective, would make the beneficial amendments above completely moot for Issuers in most states. The provision at issue is the SEC’s proposal to make Rule 147 function as a separate exemption from registration under the Act rather than as a “safe harbor” under Section 3(a)(11) of the Act. Without getting into a full on discussion on the issue, most current state-based crowdfunding statutes require compliance with both Section 3(a)(11) and Rule 147. If the SEC elects treat Rule 147 as a separate exemption and not a “safe harbor” of 3(a)(11), compliance with both statutes would be effectively impossible. Hence, Issuers in most states would not be able to utilize the improved Rule 147 provisions discussed above (at least not without an amendment of the respective state crowdfunding statutes) making them effectively moot;. As the author of the Illinois’ intrastate crowdfunding law, I sent one of the first (if not the first) comment letters to the SEC on this issue. Since then, multiple other advocates (including the NASAA and even members of Congress as discussed below) have come forward to contest the issue and to petition the SEC to maintain Rule 147 as a “safe harbor.”
For a detailed discussion on each of the proposed modifications, as well as the “safe harbor” issue, see “SEC Proposes Sweeping Amendments To Rule 147 To Facilitate Intrastate Crowdfunding – Why They May All Be Moot.”
The Path Is Clear For Change
It’s no surprise that the North American Securities Administrator Association (NASAA) is in support of the proposed amendments as they will go a long way toward furthering the use of state-level crowdfunding exemptions. What is a pleasant surprise, however, is the recent support of the amendments from a bipartisan contingent of members of the Congress. In an effort led by Representatives Tom Emmer and Gewn Moore, on October 7th fifteen members of Congress from both sides of the aisle issued a letter to SEC Chair Mary Jo White in support of the proposed amendments. While Congressional support is fantastic in general, the specific language of the letter is of particular interest.
While overwhelmingly in support of the SEC’s proposed amendments, the letter leaves little doubt as to what the Congressional group is requesting from the SEC. Most notably, the letter includes the following paragraph:
Specifically, we request that the Commission amend Rule 147 as a safe harbor under Section 3(a)(11) of the Securities Act of 1993, to avoid state legislatures from having to amend their existing crowdfunding statutes. Furthermore, we believe that the states are better positioned to determine offering and investor caps that best meet their local population and business needs. We therefore respectfully request that the SEC not limit the availability of the exemption to a state exemption with a $5 million offering cap as proposed, but instead allow such limitations to be determined under state law. We also strongly encourage the Commission to maintain important investor protections in any new exemption, including preserving all existing state authority.
The Congressional group could have easily crafted the letter to be in general support of the proposed amendments, leaving the specifics up to the SEC, but it seems they wanted to leave little to the SEC’s imagination. It is also clear that the group intends there to be a general deference to the respective state authorities in implementing intrastate regulations, something they have been reluctant to specify in the past (e.g. in connection with Regulation A+ oversight).
Overall the language of the letter reflects a general alignment between the recommendations of group members and those of NASAA who have been advocating the same positions for almost a year. This alignment is made all the more evident by the statements of Mike Rothman, NASAA President, in a press release (which was also made on October 7th) commending the congressional letter and indicating NASAA’s full support of the SEC’s proposed rule changes:
NASAA has strongly supported the SEC’s efforts to modernize Rules 147 and 504, and we are encouraged to see members of Congress, led by Rep. Tom Emmer (R-MN) and Rep. Gwen Moore (D-WI), weigh in to support the SEC’s important proposed actions. These key changes will benefit small and local businesses conducting intrastate crowdfunding and regional securities offerings to raise capital, while maintaining important investor protections.
The Stage Is Set
Whatever NASAA and the Congressional group did, it certainly got the attention of the SEC. On October 19th, a mere 12 days after the date of the congressional letter, the SEC announced that it will hold an open meeting on Wednesday, October 26th, to consider, among other things, whether to adopt the proposed amendments. With the majority of the proposed amendments garnering support across the board, the only foreseeable issues are the “safe harbor” treatment and the proposed maximum offering limitation.
The offering limit is one thing. It is arbitrary and, given the criticisms to date, most likely will not be incorporated. The “safe harbor” issue however, is another matter. Without getting into an intellectual debate on the issue, allowing Rule 147 (as amended) to remain a “safe harbor” under Section 3(a)(11) of the Securities Act requires the SEC to analyze and interpret the congressional intent in enacting Section 3(a)(11) and whether the proposed changes fit the current iteration of that intent. While this may have given Chair White and the SEC reason to pause in the past, I believe the recent congressional letter gives them clear support in continuing the “safe harbor” treatment of the amended Rule 147.
While we will ultimately have to wait until the 28th to see how the SEC will act, all signs point to the SEC’s adoption of the proposed amendments with the continued “safe harbor” treatment of Rule 147 and without the proposed offering limitation. If this happens, intrastate crowdfunding will become an extremely viable, and in many ways preferable, capital raising option for many small and emerging companies.
Anthony Zeoli is a Senior Contributor for Crowdfund Insider. He is a Partner at the law firm of Freeborn in the Corporate Practice Group. He is an experienced transactional attorney with a national practice specializing in the areas of securities, commercial finance, real estate and general corporate law. Anthony recently drafted the bill to allow for an intrastate crowdfunding exemption in Illinois.