2020 was a year of surprises that brought with it sweeping changes to seemingly every facet of life. The realm of securities regulation was no exception. Securities and Exchange (SEC) Chairman Jay Clayton stepped down at the end of the year, but not before pushing through broad reforms targeted at making it easier for private securities issuers to effectively raise money. In particular, the SEC introduced three noteworthy changes that are likely to have drastic, long-term impacts on virtually every business and individual looking to raise funds via the exempt offering of securities.

1) SEC Amends the Definition of “Accredited Investor” in Rule 501(a)

Rule 501(a), which sets forth the criteria for determining if an investor qualifies as an “accredited” investor, has remained largely unchanged for many years and has been solely based on the financial condition of the prospective investors (i.e. whether they meet certain net worth or income thresholds). The process by which the SEC qualifies an accredited investor is important because all exempt securities offerings rely in large part on the investment of accredited investors. The most common exempt offering in the marketplace, a Rule 506(b) offering under Regulation D, restricts the sale of securities to only accredited investors and a very limited number of investors who, traditionally, were obligated to meet certain “sophistication” requirements.

To increase the pool of accredited investors available to private issuers, the SEC has recently created a new accredited investor class that permits natural persons to qualify based on certain professional qualifications or credentials. While this new class of accredited investor is currently limited to holders of Series 7, Series 65 and Series 82 licenses, the SEC has strongly hinted that it intends to expand this definition via future orders – perhaps  to CPAs, attorneys, certified financial planners, and others. The SEC’s new rule also clarifies that LLCs with $5M in assets, and family offices with at least $5M in assets from “family clients,” can also now automatically meet the accredited definition criteria set forth in Rule 501(a). These updates went into effect Oct. 25, 2020.

This is a welcome change, as it unlocks funds of a large group of people clearly capable of weighing the risks of investing in private issuers. The change also creates new considerations when drafting offering documents that should be discussed with competent securities counsel.

2) SEC Introduces Formal Finder Exemption

The topic of finders has long been a problem in the world of private placements. Historically, issuers were forced to rely solely on their pre-existing network of potential investors; retain the services of a broker dealer who often consumed substantial portions of investments in fees; or bear the risk of utilizing the services of finders, while relying on a complicated and inconsistent framework of SEC opinion letters and ever-evolving informal guidance documents. In sharp contrast, the SEC has proposed a new formal finders’ exemption that will allow finders to assist businesses access capital with clear, safe harbors. On the most basic level, all finders must  i) be a natural person, ii) not be subject to regulatory reporting, iii) assist with an exempt offering only, iv) only help engage accredited investors, v) not participate in general solicitation, vi) not be an “associated person” of a broker dealer or otherwise be subject to securities licensing regulations, vii) not be a “bad actor,” viii) not be engaged in the resale or structuring of the offering, ix) not provide financing or advise investors or analyze the merits of the offering; and vii) appear in a written agreement with the issuer outlining the compensation and services rendered.

Provided these preliminary conditions are met, finders are then sorted into two categories of finders: Tier 1 finders are limited to referring investors to a single capital-raising transaction by a single issuer within a 12-month period and would be prohibited from communicating with prospective investors about the issuer. They are limited to providing contact information and facilitating introductions. Tier 2 finders may discuss the offering and its materials and coordinate meetings between investors and issuers. They may also screen and contact potential investors, rather than simply provide them with contact information. The SEC is still finalizing the proposed regulations for finders, but these changes are expected to go live shortly. These changes will have a profound effect on the ability of businesses to utilize finder services but will also require new finder relationship agreements that will necessitate careful drafting and appear substantially different from past arrangements.

3) SEC Modifies Exemption Limits

Perhaps the most drastic change was the SEC’s increase in offering limits for exempt offerings that permit general solicitation. Most notably, Regulation Crowdfunding, which has become a popular way of raising funds from non-accredited investors, saw a nearly five-times increase in its offering limit (from $1.07 million to $5 million). The Tier 2 Regulation A offering limit increased from $50 million to $75 million; and the Rule 504 offering limit increased from $5 million to $10 million. Furthermore, the SEC has revamped its integration analysis, providing more guidance about the point at which multiple offerings are considered integrated (bad) versus independently offered (good). These changes went into effect Jan. 1, 2021, and we expect to see many more small businesses and issuers leverage these changes going forward. Consequently, now is an excellent time to consider a Regulation Crowdfunding or Regulation A offering.

Despite all the challenges that 2020 brought to small businesses, the recent bevy of changes at the SEC are an encouraging sign that the Commission is actively looking for ways to assist small issuers access capital. The securities attorneys at Parsons Behle & Latimer are available to discuss these and many other changes with you and determine how you can leverage them to help raise capital during 2021 and beyond.

To learn more about this or related issues, contact Adam Ott by calling 801.536.6910 or send an email to aott@parsonsbehle.com