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ANALYSIS: Six Questions on the SEC’s Review of Private Offerings

Nov. 4, 2019, 12:01 PM

The SEC will take a long, hard look at its exempt offerings in 2020. Chairman Jay Clayton stressed in a 2018 speech the need for a top-to-bottom review of the agency’s private offering rules to ensure that the provisions are “rational, accessible, and effective.” The Commission published a concept release in June 2019, aiming to harmonize the hodgepodge of offering exemptions. Comments on the concept release are now in. The topics put forth by the SEC for comment are far-reaching and wide-ranging, and could generate significant changes in how companies raise money away from the public markets. Below are six questions to watch in the new year.

1. Should Regulation Begin at Offer or Sale?

Where is the SEC looking? One of the first areas dates back to the adoption of the Securities Act itself. Section 5 of the Securities Act requires either registration or an exemption before any person may lawfully sell or offer to sell any security. Does it make sense to start the regulatory clock at the point of an offer, when investors are constantly bombarded with communications that could easily fit into the statutory definition of an offer?

2. Should Communication Restrictions Be Eased?

Some exemptive provisions (Rule 506(c), for example) allow offers with limited communications restrictions. The SEC will look at whether this ability to communicate with investors with few restrictions should be expanded across the exemptive framework. A key question for the Commission to examine next year would be to determine what investor protections would be necessary or beneficial in such a framework.

3. Should Markets Provide More Retail Opportunities?

Another area that will certainly generate controversy in 2020 is whether retail investors should be allowed greater exposure to early-stage issuers through pooled investment funds. The Commission noted that there are potential advantages for retail investment in growth-stage issuers through a pooled investment fund, including the ability to have an interest in a diversified portfolio that can reduce risk relative to the risk of holding a security of a single issuer. Securities offered in exempt transactions may also have returns that are less correlated to the public markets.

The release, while not laying out any particular roadmap to such a result, indicated an openness to increased retail access to private funds that invest in exempt offerings, including hedge funds, private equity funds and venture capital funds, and hedge funds. Any movement in this area could, however, generate significant pushback from investor and consumer protection advocates.

4. Should the SEC Encourage Capital Formation Through Underused Exemptions?

The SEC also wanted market participants to discuss underused exemptions, such as crowdfunding, Rule 504 and the intrastate offerings provisions. For example, according to the concept release, in 2018, issuers raised more than $1.7 trillion under Rule 506, while Rule 504 offerings netted only $2 billion. Crowdfunding generated significant initial excitement upon its rollout, but the results so far have been underwhelming. In addition, the SEC asked if the intrastate exemptions under Rule 147 and 147A appropriately address capital formation and investor protection considerations for in-state offerings.

5. How Can the SEC Simplify Integration Questions?

The release also discussed the integration of offers in a series of exempt transactions. The SEC first published its “five factor test” guidance in 1962, and has offered interpretive guidance throughout the years. The SEC staff has not been particularly consistent in interpreting integration guidance over the years.

Exemptive rulemakings, such as Regulation D and “Regulation A+,” have also included integration safe harbors. Will 2020 see the Commission articulate one integration doctrine that would apply to all exempt offerings? If so, what will that framework look like? Will we bid adieu to the five factor test, now in its sixth decade of existence? Would one consistent integration doctrine facilitate capital-raising by making it easier for issuers to transition from one exemption to another and, ultimately, to a registered offering? Will current investor protections be adequate under one integration doctrine for all exempt offerings?

6. Where Do the Resale Markets Go from Here?

Finally, 2020 may see significant changes to the restrictions on the secondary trading of securities initially issued in exempt offerings. Restricted securities can yield a more stable shareholder base with less investor turnover, but smaller issuers may have difficulty attracting capital in the absence of available liquidity options. Will relaxed restrictions on resale still afford sufficient consumer protection?

Read about other trends our analysts are following as part of our Bloomberg Law 2020 series.