Reg A and Reg D: Evolving Securities

Exemptions for Private Placement OfferingsNavigating Regulation A+, the FAST ACT, Rule 506 (c), and Accredited Investors: Recent SEC

Guidance and the HALOS Act

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Hannah Flint, Attorney, Hunton Andrews Kurth LLP, Washington, D.C.

Scott H. Kimpel, Partner, Hunton Andrews Kurth LLP, Washington, D.C.

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Hannah Flinthflint@huntonak.com

Scott H. Kimpelskimpel@huntonak.com

Regulation A and Regulation D: Evolving SecuritiesExemptions for Private Placement Offerings

May 8, 2019

Agenda

• Overview of Securities Act of 1933

• Regulation D offering exemption

• Regulation A+ offerings

• Private Resales of Securities

• ICOs and Token Offerings

6

Securities Act of 1933 in Brief

• Section 5: Every offer and sale of “securities” must either be registered with the SEC or exempt from registration

– “Securities” includes stocks, bonds, “investment contracts” and various other financial instruments

• Section 3: Provides a narrow list of discrete securities that are exempt from the 1933 Act

• Section 4: Provides that the provisions of Section 5 do not apply to certain enumerated transactions

7

Securities Act: Section 4

• 4(a)(1) – Transactions by any person other than an issuer, underwriter, or dealer.

• 4(a)(2) – Transactions by an issuer not involving any public offering.

• 4(a)(3) – Transactions by a dealer (including an underwriter no longer acting as such in respect of a security), with certain exceptions.

• 4(a)(4) – Brokers’ transactions executed upon customers’ orders on any exchange or in the over-the-counter market but not the solicitation of such orders.

• 4(a)(5) – Transactions involving offers or sales by an issuer solely to accredited investors, if the aggregate offering price does not exceed $5 million, if there is no advertising or public solicitation, and if the issuer files notice with the SEC.

• 4(a)(6) – Transactions involving an offer and sale if the aggregate amount over a 12-month period does not exceed $1 million, with certain other conditions (Crowdfunding).

• 4(a)(7) – Transactions in which each purchaser is an accredited investor, involves no general solicitation, and certain information requirements are met (among other requirements) – designed to ease resale of securities in private companies in limited amounts.

8

Securities Act: Key Questions

• Who Can You Sell To?

– Sophisticated Investors vs. Retail

– Accredited Investors

• Individual Investors

– $1 million net worth (exclusive of primary residence) or $200,000 annual income ($300,000 for married couples)

• Entities

• $5 million total assets

• Not “formed for the purpose”

9

Securities Act: Key Questions

• How Can You Sell?

– Broadly, to strangers

– General solicitation or advertising

• Print media, broadcast, internet

• Mass mailings, seminars

• Social media

– Narrowly, through pre-existing relationships

– Primary Offering vs. Resale

10

Securities Act: Key Questions

• Interaction with state “blue sky” laws

– States retain right to regulate securities unless federal law provides preemption

– Preemption for “covered securities” under NSMIA

– Onerous merit review process

• Transferability of Securities

– Rule 144: securities acquired in a transaction not involving a public offering

– Holding periods

– Issuer information requirements

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Public Offering

• Pros

– May be widely marketed and sold

– No restrictions on offerees and investors

– Results in a freely tradeable security (no Rule 144 restrictions)

• Cons

– SEC registration process can be time-consuming and cumbersome

– Preparation of an IPO is expensive

– Going public results in ongoing reporting requirement and associated compliance burden

12

Private Offering

• Pros

– Avoids time and cost of SEC review

– Avoids ongoing reporting and compliance obligations

• Cons

– Potential limits on universe of offerees

– Results in “restricted” securities under Rule 144

– Securities may be priced with illiquidity discount

13

Regulation D

• Rule 500 – Notes on the Use of Reg D

• Rule 501 – Definitions

• Rule 502 – General Conditions to Be Met (Integration, Information Requirements, Limitation on Manner of Offering, and Limitations on Resale)

• Rule 503 – Filing of Notice of Sales

• Requires the electronic filing (via EDGAR) of a notice on Form D with the SEC within 15 days

• Rule 504 – Exemption for Limited Offerings and Sales of Securities Not Exceeding $5 million (“Seed Capital”)

• Rule 505 – Repealed (formerly an exemption for offers and sales not exceeding $ 5 million)

• Rule 506 – Exemption for Limited Offers and Sales Without Regard to Dollar Amount of Offering

• Rule 507 – Disqualifying Provisions Relating to Exemptions Under Rule 504 and 506 (“Bad Actor” Provisions)

• Rule 508 – Insignificant Deviations from a Term, Condition or Requirement of Regulation D

14

Rule 504

• Limited to $5 million within prior 12 months

• Limited to non-reporting companies

• No general solicitation or advertising, unless permitted by state law (very few do)

• Unlimited number of investors

• No required disclosure (though disclosure often advisable)

• Restricted securities: Rule 144 restrictions apply

• Bad actor restrictions

• Form D filing requirement

• NO BLUE SKY PREEMPTION

15

Rule 506(b)

• No cap on amount

• No general solicitation or advertising

• Unlimited number of accredited investors

• Up to 35 “sophisticated” non-accredited investors

• Disclosure to non-accredited investors

• Restricted securities

• Bad actor restrictions

• Limited confirmation of accredited investors’ status

• Rule 144 restrictions apply

• Form D filing requirement

• Limited blue sky preemption: notice filings and fees

16

Rule 506(c)

• No cap on amount

• General solicitations and advertising are permitted

• Restricted securities

• All purchasers must be accredited investors

• Issuer must take “reasonable steps” to verify accredited investor status.

• Bad actor restrictions

• Rule 144 restrictions apply

• Form D

• Limited blue sky preemption: notice filings and fees

• Most recent DERA Study (August 2018) indicates 506(c) accounted for only 4% of Regulation D offerings

17

Rule 506(c): Investor Verification

• Principles-based method:

– Nature of purchaser/type of AI

– Amount and type of information available

– Nature of the offering

• Manner of solicitation

• Terms and minimum investment amount

• Safe harbor method:

– Tax forms

– Bank statements, tax assessments and U.S. credit reports

– Gatekeepers, such as brokers, accountants and attorneys

– Previous investors

• Staff guidance on technical questions

18

Section 4(a)(2)

• Reg D offers a safe harbor, but offerings are sometimes

effected in reliance on statute itself and related case law

• No general solicitation permitted

• Typically marketed only to small group of institutional

investors who purchase for investment purposes, with no

view to resale

• Rule 144 restrictions apply

• No SEC filing required

• NO BLUE SKY PREEMPTION

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Integration

• Separate sales of securities within 6 months may be viewed as one “integrated” transaction

• Five factor test:

• Whether the sales are part of a single plan of financing;

• Whether the sales involve issuance of the same class of securities;

• Whether the sales have been made at or about the same time;

• Whether the same type of consideration is being received; and

• Whether the sales are being made for the same general purpose

• Advertising from a 506(c) offering may impede a later 4(a)(2) private placement or traditional Rule 506(b) offering

• Rescission and SEC sanctions are possible consequences

• More likely, issuer would be forced to delay the next round

20

Old Regulation A

• Prior to 2012, “Scaled Registration” provision

• Key Terms:

– Up to $5 million per year

– Robust offering circular

– “Qualification” - SEC review and comment process

– General solicitations and advertising permitted

– Retail investors permitted without limit

– Unrestricted securities

– Audited financials not required

– No ongoing reporting requirements

– STRICT LIABILITY under Section 12

– NO BLUE SKY PREEMPTION

21

Old Regulation A

• Tremendously unpopular

• 19 Regulation A offerings between 2009 and 2012

– 27,500 Regulation D offerings of $5 million or less

– 373 Registered Offerings of $5 million or less

• Why?

– Costly and inefficient

– More attractive options, mainly Regulation D

– NO BLUE SKY PREEMPTION

– Market liquidity was an illusion

22

Regulation A+: Overview

• JOBS Act replacement for Regulation A

• Effective June 2015

• Two Tiers

– Tier One: Currently up to $20 million per year

– Tier Two: Currently up to $50 million per year

– Offerings under $20 million can choose either tier

• Requirements and benefits differ by tier

23

Regulation A+: Tier One

• Overview

– Currently up to $20 million

– Otherwise very similar to old Regulation A

• Key Provisions:

– Offering Circular: informal, Q&A format permitted

– SEC review and comment process

– General solicitations permitted

– Retail investors permitted without limit

– Unrestricted securities: no Rule 144 restrictions

– Audited financials not required

– No ongoing reporting requirements

– STRICT LIABILITY under Section 12 of the Securities Act

– NO BLUE SKY PREEMPTION

24

Regulation A+: Tier Two

• Overview

– Currently $50 million limit

– Otherwise, very close to full registration

• Key Provisions

– Robust, S-1 equivalent offering circular

– SEC review and comment process

– General solicitations permitted

– Retail investors subject to personal volume limitations

– Unrestricted securities: no Rule 144 restrictions

– Audited financials required

– Ongoing periodic and current reporting

– STRICT LIABILITY of the Securities Act

– FULL BLUE SKY PREEMPTION

25

Regulation A+: Tier Two

• Investor volume limit

– Applies to investors who are not accredited

– Per offering limit equal to the greater of:

• 10% of the investor’s net worth

• 10% of the investor’s annual income

• Ongoing reporting

26

Resale Exemption: “Section 4(a)(1½)”

• Regulation D and Regulation A only available to an issuer

• Investors wishing to resell on their own need another exemption

• Relies on elements of Section 4(a)(1) and Section 4(a)(2)

• Developed over time by securities professionals and discussed in case law; SEC informally recognizes it

• Requirements:

– Sophisticated investors (e.g., accredited investors) who would have been eligible to purchase such securities directly from the issuer

– Comply with rules typically prescribed for Section 4(a)(2) or Regulation D private placements by issuers

• Restrictions vary based on issuer, nature of investors, and size of the offering

27

Resale Exemption: Rule 144A

• Resale is made only to a Qualified Institutional Buyer (QIB) (e.g., insurance company, mutual fund) with $100 million in investments

• Seller must take reasonable steps to ensure that purchaser is aware that seller may rely on the exemption offered by Rule 144A

• The securities (1) when issued, were not of the same class of securities listed on a national securities exchange or quoted on a U.S. automated inter-dealer quotation system, and (2) are not securities of an open-end investment company, unit investment trust or face-amount certificate company required to be registered under the Investment Company Act

• If issuer is not a public reporting company (or exempt foreign issuer or foreign government), holders and prospective buyers have the right to obtain certain “reasonably current” information about issuer

28

Resale Exemption: Section 4(a)(7)

• Fixing America’s Surface Transportation Act (the “FAST Act”) of 2015 adds Section 4(a)(7)

• Creates nonexclusive safe harbor for private resales akin to the “Section 4(a)(1½)” exemption

– Similar to Rule 506 of Regulation D operating as a safe harbor for Section 4(a)(2) exemption

• Exemption available for private resales of restricted securities to “accredited investors”

• No general solicitation or advertising

• Certain information concerning the issuer and the transaction must be provided to the purchaser

29

Cryptocurrency

• IRS definition of “virtual currency”: A digital representation of value that functions as a medium of exchange, a unit of account, or a store of value.

▪ In some environments, it operates like ‘real’ currency, but it does not have legal tender status in the U.S.

▪ Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency.

• Bitcoin is one example of a convertible virtual currency.

• Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.

30

SEC Howey Test for “Investment Contract”

• Howey’s orange groves (1946)

• Test for “Investment Contract”

▪ an investment of money;

▪ in a common enterprise;

▪ with a reasonable expectation of profits;

▪ to be derived from the entrepreneurial or managerial efforts of others

• SEC’s DAO Report and Staff Guidance

• Excludes Bitcoin and Ether

31

Initial Coin Offerings

• ICO: enterprise seeks to raise capital by selling a “coin” (sometimes called a “token”)

– Coin gives purchaser some future right in the business or other benefit

– Ownership reflected electronically in smart contract

– Utility Token debate

• If a security, must register or have an exemption

• Munchee enforcement action

– Compare to Airfox and Paragon Coin enforcement actions

• Airdrops

– Tomahawk Exploration and “Free Stock” cases

• Tokenizing Assets and Security Token Offerings

32

Other Common Exemptions

• Intrastate Offerings under Rule 147 and Rule 147A

• Offshore Offerings under Regulation S

• Regulation CF (Crowd Funding)

• Offerings under Section 1145 of the Bankruptcy Code

33

Questions?

34