PROPOSED CHANGES TO SEC RULE 504 AND RULE 147 (Part 2)

Proposed Amendments to Rule 147.  Importantly, Rule 147 was initially adopted to implement the statutory intrastate exemption found in 1933 Act, §3(a)(11).  As proposed to be modified in Rel. 33-9973, Rule 147 goes beyond §3(a)(11) and would, therefore, be adopted under the SEC’s exemptive authority found in § 28 of the 1933 Act. 

• The proposed amendments to Rule 147 would permit an issuer to engage in any form of general solicitation or general advertising, including the use of publicly accessible Internet websites, to offer and sell its securities, so long as all sales occur within the same state or territory in which the issuer’s principal place of business is located.   

• The proposed rules also require that the offering be registered in the state in which all of the purchasers are resident, or be conducted 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 twelve-month period and imposes an investment limitation on investors. This is designed to fit within the state-adopted crowdfunding exemptions, such as the Colorado Crowdfunding Act.  

• The proposed amendments would also define an issuer’s principal place of business (as opposed to its “principal office” as defined in current Rule 147) as the location in which the officers, partners, or managers of the issuer primarily direct, control, and coordinate the activities of the issuer. 
  • To establish its “principal place of business”, the issuer must satisfy at least one of four threshold requirements regarding the in-state nature of the issuer’s business.  Under existing Rule 147, the issuer must satisfy EACH of the 80% factors, and the fourth alternative factor (a majority of employees in such state) is not included.    
    • 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; or 
    • 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; or
    • 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; or 
    • a majority of the issuer’s employees are based in such state or territory. 
  • Under the proposed amendments, issuers that have changed their principal place of business after making sales in an intrastate offering pursuant to proposed Rule 147 would not be able to conduct an intrastate offering pursuant to proposed Rule 147 in another state for a period of nine months from the date of the last sale in the prior state.  This is consistent with the duration of the resale limitation period specified in existing Rule 147(f) and in proposed Rule 147(e). 
  • As defined, an issuer would only be able to have a “principal place of business” within a single state or territory and would therefore only be able to conduct an offering pursuant to amended Rule 147 within that state or territory. Further, as proposed, the provisions of Rule 147 regarding legends and mandatory disclosures to purchasers and prospective purchasers would be retained. 
  • Importantly, under the proposed rules, the issuer’s place of organization (which is important under Rule 147) is no longer relevant to the question of the issuer’s “principal office.” 

Conclusion.  The crowdfunding rules have been described in numerous articles and speeches as facilitating capital formation for small businesses while continuing to protect investors as required by federal and state securities laws.  A brief look at the crowdfunding rules adopted in Colorado (and elsewhere) and Regulation Crowdfunding adopted by the SEC makes it clear that investor protection was paramount in the regulators’ concerns.  Ease of use by small businesses does not appear to have been a priority.  This is consistent with the opinion of SEC Commissioner Michael Piwowar who voted against adoption of the proposed rules, saying: 

• “[M]any traps for the unwary are hidden in the regulations, creating potential nightmares for small business owners that fail to place regulatory compliance at the top of their business plans.” 

Issuers must understand that crowdfunding offerings will not be inexpensive under federal Reg CF or Colorado law.  If successfully completed many costs will be ongoing.  If unsuccessful, the issuers will still have costs that are independent of the funds raised that will have to be paid. 

The proposed amendments to Rules 504 and 147 may make those offerings even more attractive than previously for capital formation by small business issuers, and may make crowdfunding under the Colorado Crowdfunding Act or Reg CF moot.