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Editorial 10 MIN READ

The SEC's coming concept release on private-offering exemptions

Chairman Clayton has been telegraphing a harmonization review all spring, and the framework he is about to open up is the one every formation actually lives inside

The Editors
Staff, Incorporator.org
10 min read Updated
Contents 7 sections
  1. Why the review is happening now
  2. Regulation D, and why 506(b) still dominates
  3. Regulation A+ and the Tier 2 ceiling
  4. Regulation Crowdfunding, five years in
  5. Rule 147A, integration, and the quiet pieces
  6. What a founder should actually do about it in May 2019
  7. Sources

hairman Jay Clayton has spent the spring telling anyone who will listen that the SEC's private-offering exemption framework is due for a full review, and the Commission is expected to publish a concept release within weeks that opens the question formally. The private offering exemptions in play are the ones every venture financing, every crowdfunded raise, and every small-cap Reg A+ issuance actually runs through: Regulation D, Regulation A+, and Regulation Crowdfunding, with the intrastate Rule 147A stub around the edges.

This piece is a map of the framework as it stands on May 14, 2019, and the specific pressure points the release is expected to open for comment.

Why the review is happening now

Clayton flagged harmonization in his testimony to the House Financial Services Committee in June 2018 and returned to it repeatedly through early 2019, most recently in his April 8, 2019 remarks at the Equity Market Structure Advisory Committee. The theme is consistent. The current exemption patchwork grew up in pieces, under different statutory mandates and at different times: Regulation D in 1982, Rule 144A in 1990, the JOBS Act amendments in 2012 that added Rule 506(c) general solicitation and the Regulation Crowdfunding title, and the 2015 Regulation A+ rewrite that split the exemption into two tiers. Each piece solved a discrete problem. Together they form a map with overlapping borders, gaps, and pieces that contradict each other on integration and on who counts as eligible.

Clayton's stated goal is not deregulation for its own sake. It is to reduce the number of issuers who either (a) end up with a deal they cannot cleanly bring to market because two exemptions that should fit together do not, or (b) spend legal budget the size of a small offering figuring out which path to run. The SEC's Division of Corporation Finance has been collecting data on usage patterns for more than a year; the 2018 accredited-investor definition review was staged for exactly this purpose.

A concept release is not a rule proposal. It is a structured set of questions to the market, with no specific rule text, inviting comment for 60 to 90 days. What emerges from the comment file then drives the actual rulemaking, which typically shows up six to eighteen months later. This release is the starting line, not the finish.

Regulation D, and why 506(b) still dominates

Regulation D is the exemption that matters. In calendar year 2017, the most recent year for which the SEC's Analysis of Regulation D Offerings report is final, issuers raised roughly $1.7 trillion under Reg D, compared to roughly $1.5 trillion in registered offerings. Reg D is larger than the public markets by capital raised. Within Reg D, Rule 506 is responsible for the overwhelming majority of that volume, and within Rule 506, the old Rule 506(b) path still carries substantially more deal count than the 2013-vintage Rule 506(c).

Rule 506(b) allows a private placement to an unlimited number of accredited investors plus up to 35 non-accredited but "sophisticated" investors, with no general solicitation. Rule 506(c) allows general solicitation (the issuer can advertise) but restricts the offering to accredited investors only and requires the issuer to take reasonable steps to verify accredited status. The tradeoff sounds balanced on paper. In practice, 506(c) is used much less, because (i) the verification burden is friction that law firms and founders avoid when they can raise quietly, (ii) the accredited-only ceiling cuts off friends-and-family rounds that want to include a non-accredited early backer, and (iii) many funds' LPAs and side letters were drafted before 506(c) existed and reference 506 generally, which counsel reads conservatively as 506(b).

The concept release is expected to ask whether the 506(b) and 506(c) regimes should be consolidated, whether the general-solicitation ban in 506(b) has outlived its usefulness in an era where the term "general solicitation" is nearly undefinable on the internet, and whether the accredited-investor definition itself should be broadened to include people who demonstrate financial sophistication through credentials (Series 7, CFA) rather than just income and net worth. The accredited-investor thresholds currently sit at $200,000 in annual income ($300,000 joint) or $1 million in net worth excluding primary residence, under 17 CFR § 230.501(a). Those thresholds have not been indexed for inflation since 1982, a point Clayton has noted pointedly.

If you are forming now with any expectation of raising venture capital, you already live inside 506(b), even if your lawyer has not said the words. Related reading: C-corp vs S-corp: the 1202 question.

Regulation A+ and the Tier 2 ceiling

Regulation A+, introduced by the SEC's 2015 rewrite of the old Regulation A under Section 401 of the JOBS Act, splits into two tiers. Tier 1 permits offerings up to $20 million in a twelve-month period, but still requires state-level blue-sky review, which is what killed old Reg A and which Tier 1 does not meaningfully solve. Tier 2 permits offerings up to $50 million in a twelve-month period and preempts state registration under Section 18(b)(4)(D)(ii) of the Securities Act, which is the feature that makes the whole exemption usable. Tier 2 issuers file a qualified offering statement on Form 1-A, file ongoing reports (Form 1-K annual, Form 1-SA semi-annual, Form 1-U current), and can advertise and solicit generally.

Usage has been modest. SEC staff reports show roughly 100 to 150 Tier 2 qualifications per year since 2015, concentrated in real estate funds, consumer brands with a loyalty base they can convert into investors, and a small number of early-stage companies that used Reg A+ as an alternative to a traditional IPO. The two most-cited friction points are the $50 million ceiling (a real operating company that needs more than that is back in registration territory or back to Reg D) and the ongoing-reporting burden, which is lighter than full Exchange Act reporting but heavier than a 506(b) issuer faces.

The concept release is expected to ask whether the Tier 2 ceiling should be lifted to $75 million or $100 million, which is the number operating companies and their counsel have been pushing in comment letters since 2017. It is also expected to ask whether Reg A+ should be opened to Exchange Act reporting companies, which are currently excluded; that exclusion was a deliberate choice in 2015 to keep the exemption focused on non-reporting issuers, but it has meant that a company that goes public via Tier 2 cannot re-use the exemption once it is a reporting company, which creates a cliff. Expect a question on integration with concurrent Reg D offerings as well.

Regulation Crowdfunding, five years in

Regulation Crowdfunding took effect on May 16, 2016, and permits an issuer to raise up to $1,070,000 in a twelve-month period from the general public, including non-accredited investors, through an SEC-registered funding portal or broker-dealer. The $1,070,000 limit is an inflation-adjusted figure updated by the SEC under Section 4A(h) of the Securities Act; it was originally $1 million in the statute and was raised to its current number by SEC rule on April 12, 2017. Per- investor limits cap non-accredited participation at the greater of $2,200 or 5 percent of the lesser of annual income or net worth (for investors below $107,000 on both), and 10 percent up to a $107,000 aggregate cap for those above.

The caps are the entire story. Issuer-side practitioners argue the $1,070,000 ceiling is too low to make the offering's fixed legal and portal-fee cost (typically $10,000 to $30,000 per raise) worth the effort for any company that can raise the same money through a 506(b) friends-and-family round. Portal operators (Republic, StartEngine, Wefunder, SeedInvest) have argued the ceiling should be raised to $5 million, and have pushed for the ability to do "testing the waters" before filing Form C. Investor advocates have pushed back on both, on the grounds that the exemption was designed for small retail capital and that raising the cap converts it into something closer to a mini-Reg A.

The concept release is expected to ask whether the Reg CF ceiling should move, whether the per-investor caps should be recalibrated, whether testing the waters should be permitted pre-filing (it is currently not, for Reg CF specifically), and whether special-purpose vehicles should be allowed so that a larger pool of small investors can be aggregated into a single position on the cap table rather than landing as dozens of line items that complicate later rounds. The last point is the one founders care about most. A Reg CF round that puts 150 retail investors directly on the cap table is a round that makes the next VC's diligence harder, and many funds ask for a clean-up merger before they will invest.

Rule 147A, integration, and the quiet pieces

Two quieter pieces will almost certainly appear in the release and matter to specific issuers.

Rule 147A, adopted by the SEC in October 2016, is the modernized intrastate exemption. It permits an in-state offering to in-state residents without federal registration, but unlike old Rule 147, it does not require that 80 percent of the issuer's business be in-state and it permits general solicitation (including via the internet) so long as sales are limited to in-state residents. 147A has been used mostly for real-estate offerings in states with their own crowdfunding regimes layered on top. Expect the release to ask whether the federal intrastate framework still makes sense as a separate track, or whether its function should fold into Reg CF.

Integration is the other quiet piece, and it is the one that bites issuers who run two exemptions in sequence. The integration doctrine asks whether two offerings by the same issuer, close in time, should be collapsed and treated as one offering for exemption purposes. The current framework is a mess: Rule 502(a) of Regulation D contains a five-factor integration test and a six-month safe harbor, Rule 251(c) of Regulation A contains its own integration rule, Rule 152 has its own overlay, and Reg CF has its own. A Reg CF round followed 45 days later by a 506(c) round is a question nobody wants to answer cleanly. The release is expected to propose consolidating into a single integration framework, likely around a 30-day cooling-off concept that treats non-overlapping offerings as independent regardless of exemption choice. This is the technical change with the largest practical effect for founders running parallel or sequential raises.

What a founder should actually do about it in May 2019

The concept release, when it lands, will be a set of questions. Nothing in the current framework changes the day it publishes. The exemption elected for a round closing this quarter is the same exemption that will be available in August. The 506(b) private placement with accredited investors remains the default for anything that looks like venture financing. Reg A+ Tier 2 remains an option for companies with a retail investor base and a willingness to build out a qualified offering statement. Reg CF remains useful for under-seven-figure raises where the marketing value of the campaign itself is part of the point.

The decision worth revisiting is whether a company that plans to raise in 2020 should delay a non-urgent filing by a few months to benefit from whatever emerges. The honest answer is no. Rules out of a concept release arrive eighteen months to two years after the release, on average; the 2015 Reg A+ rewrite itself took roughly three years from the JOBS Act's directive to final rules. If the round closes this summer, close it on the framework that exists. If the round closes in 2021, the framework may genuinely be different, and the comment file is worth reading when it opens.

What is worth doing right now is filing a comment letter if you have used any of these exemptions and found a specific friction point. The comment files on SEC concept releases are read. The 2015 Reg A+ final rules incorporated commenter-specific language on state preemption that had not appeared in the original proposal. Founders do not typically file comment letters. Their lawyers do, and their portals do, and the result is a comment file that skews toward intermediaries rather than issuers. A letter from an operating founder who actually ran a Reg CF round and hit the cap, or ran a 506(b) and wished the sophisticated-investor count were higher, carries weight.

The larger point is that the exemption framework is the thing every private-company formation actually sits inside, even when the founder has never read a line of it. The review that is about to open is the first full look at that framework since the JOBS Act. Whatever comes out of it will shape the default path for the next decade of private capital.

Sources

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