THE MODERNIZED RULE 147 AND NEW RULE 147A

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1 THE MODERNIZED RULE 147 AND NEW RULE 147A An analysis of the potential market response to the SEC s attempt to revive and modernize the Intrastate Offering Exemption. By: Sarah Aboukhair

2 INTRODUCTION A recent challenge facing the SEC and state and federal legislators: modernizing its approaches to fundraising and capital formation because of the intrusion of the Internet into securities transactions. This is particularly relevant for Securities Act exemptions.

3 SECURITIES ACT EXEMPTIONS If an issuer uses an instrument that classifies as a security (or if there is any doubt that the instrument is a security), it is prudent for the issuer to (i) register the security under 5 of the Securities Act of 1933 or (ii) qualify and perfect an exemption from registration, or (iii) for the instrument to be an exempt security class. Restrictions on offers to sell and solicitations of sale.

4 RESUSCITATION OF THE INTRASTATE OFFERING EXEMPTION The SEC unanimously adopted amendments to Rule 147 and adopted the new Rule 147A under its general exemptive authority under Section 28. The first amendment to Rule 147 since its initial implementation in 1974 Policy: to help facilitate capital formation for smaller companies, while simultaneously protecting investors and allowing state securities regulators to customize their individual protections.

5 SECTION 3(A)(11) BRIEF OVERVIEW Exemption from registration under Section 5 for [a]ny security which is 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 resident and doing business within, or, if a corporation, incorporated by and doing business within, such State or Territory.

6 ADOPTION OF THE FORMER RULE 147 The SEC adopted Rule 147 in 1974 The intended purpose: to provide more clarity and objective guidelines for local issuers who wanted to engage in an exempted securities transaction under Section 3(a)(11) If an issuer satisfies Rule 147, then it also satisfies the Section 3(a)(11) statutory exemption.

7 ISSUES WITH RULE 147 Viewed as one of the easiest exemptions to violate and destroy. Any offer to a non-resident (whether a good faith mistake or intentional) purportedly invalidates the entire offering under the exemption for the issuer. This is exacerbated by the use of the Internet.

8 THE COMMISSION S RESPONSE The Solution: to resuscitate and amend the exemption to better accommodate the current climate of the financial and securities markets. The Means: modernizing Rule 147 and adopting the new Rule 147A. The Purpose: to facilitate capital formation while maintaining appropriate investor protections and providing state securities regulators with the flexibility to add additional investor protections they deem appropriate for offerings within their state. The Impact: remains to be seen.

9 OVERVIEW: THE MODERNIZED RULE 147 Because of the statutory underpinnings of Section 3(a)(11), the Commission could not amend the manner-of-offering limitations under Rule 147. Rule 147 remains under Section 3(a)(11) to allow issuers to continue to rely on current state law exemptions from registration that are conditioned on compliance with Rule 147 and Section 3(a)(11). Big picture: modernized Rule 147 is to serve as a placeholder until Rule 147A becomes more widespread.

10 OVERVIEW: THE NEW RULE 147A Adopted under the Commission s Section 28 general exemptive authority under the Securities Act of Under Section 28, the Commission may exempt a transaction from regulation to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors. Because Rule 147A is adopted via Section 28 and not Section 3(a)(11), the Commission had far more flexibility to alter the rule so that it directly addresses issuer concerns.

11 INTRASTATE OFFERING EXEMPTION SAFE HARBORS THE PROVISIONS Former Rule 147 v. Amended Rule 147 v. New Rule 147A Manner of Offering Sales Issuer Residency Doing Business Reasonable Belief standard Resales *Note: non-exhaustive list

12 MANNER OF OFFERING Former Rule 147 Amended Rule 147 New Rule 147A All offers must be made ONLY to residents within the same state or territory where the issuer is resident and doing business. All offers must be made ONLY to residents within the same state or territory where the issuer is resident and doing business. There is no limitation on offers. Offers may be made to in-state and/or out-ofstate residents.

13 ISSUER RESIDENCY Former Rule 147 Amended Rule 147 New Rule 147A The issuer must be incorporated or organized and shall be operational ( principal office ) in the offering state or territory. The issuer must be incorporated or organized and shall have its principal place of business in the offering state or territory. No incorporation requirement. The offering state must be the issuer s principal place of business.

14 DOING BUSINESS REQUIREMENT Former Rule 147 Amended Rule 147 New Rule 147A The issuer must prove that (i) 80% of its revenue is from the offering state, (ii) 80% of its assets is located in the offering state, and (iii) 80% of the proceeds from the offering will be used for business operations in the offering state. The issuer must prove ONE of the following: that (i) 80% of its revenue is from the offering state, or (ii) 80% of its assets is located in the offering state, or (iii) 80% of the proceeds from the offering will be used on business operations in the offering state, or (iv) that a majority of the issuer s employees are based in the offering state.

15 REASONABLE BELIEF STANDARD Former Rule 147 Amended Rule 147 New Rule 147A There is no reasonable belief standard for the issuer. If any offer or sale is made to any single non-resident, the entire exemption may be void. An issuer satisfies the requirement that the purchaser must be resident of the offering state or territory either by the fact that the purchaser is a resident of that state, or by showing the issuer had a reasonable belief that the purchaser was a resident of the applicable state. Issuers must obtain a written representation from each purchaser as to his or her residence.

16 RESALES Former Rule 147 Amended Rule 147 New Rule 147A Starting from when the issuer begins the offering until nine months after the date of the last sale of a security, all resales of any securities from that offering may only be made to residents within the state or territory of which the issuer is a resident. For six months after the date of the sale to the purchaser by the issuer, the purchaser may only resale the security to residents within the state or territory in which the issuer was a resident at the time of the sale of the security by the issuer.

17 OTHER FAVORABLE PROVISIONS IN THE FINAL RULES No limitation on the amount of capital an issuer can raise through a Rule 147 or 147A offering No limitation on the number of offers No restrictions on the sophistication of the offerees or purchasers No restriction on how issuers must advertise the offerings

18 HURDLES FACING RULE 147 AND 147A Will issuers will even use 147 or 147A over alternative means of raising capital? Will states will amend their intrastate crowdfunding legislation to align with the new Rule 147A?

19 NEWLY AMENDED RULE 504 OF REG. D VERSUS RULE 147 AND 147A Advantage of Rule 504: the offering does not have to be conducted within a single state, but is regional in nature. Disadvantage of Rule 504: should the issuer conduct a regional offering, the issuer becomes subject to rules and regulations of more than one state.

20 RULE 506 OF REG. D VERSUS RULE 147 AND147A Rule 506(b) is an issuer favorite for small offerings. From , issuers conducted 70,793 offerings (most of which were conducted only to accredited investors) to raise up to $5 million or less. Preempts state blue sky laws. If all purchasers are accredited investors, the issuer is not required to furnish any information. However, Rule 147 and 147A have their advantages.

21 STATES MUST AMEND THEIR LEGISLATION TO ALIGN WITH THE NEW RULE 147A Problem: most state securities laws have intrastate crowdfunding provisions that require issuers to comply with Rule 147 and Section 3(a)(11) to be eligible for the exemption, and are thus unable to use Rule 147A. Proposed Amendment: Securities offered in reliance on the exemption by this section must also meet the requirements of the federal exemption for intrastate offerings in the Securities Act of 1933, 3(a)(11), and Securities Exchange Commission Rule 147, or, the requirements of the federal exemption for intrastate offerings in Securities Exchange Commission Rule 147A.

22 CONCLUSION