Oct. 26, 2016
Good morning. I want to thank the staff for their hard work on these rules. Specifically, I would like to thank Anthony Barone, Jenny Reigel, Ivan Griswold and Sebastian Gomez in the Office of Small Business Policy. I also would like to thank Timothy White in the Division of Trading & Markets, Rachita Gullapalli in the Division of Economic Risk and Analysis, and Bryant Morris in the Office of General Counsel.
Today's rulemaking attempts to improve capital-raising opportunities for community-based companies. Historically, capital-raising that occurs within one state has been exempted from federal registration pursuant to Section 3(a)(11) of the Securities Act.[1] In 1974, the Commission adopted Rule 147 under the Securities Act to make it clear to issuers how and when they could rely on Section 3(a)(11) to conduct intrastate offerings.[2]
Today's rules seek to further enhance the fundraising options available to small and local businesses, which addresses a concern I have heard from companies around the country. Today's rules amend Rule 147, and create a new federal offering exemption known as Rule 147A. Hopefully, the updated safe harbor and new exemption before us today will foster opportunities and create new paths forward for such smaller firms, while still safeguarding investors.
At least, this is the theory. Like other experimental capital-raising rules, such as Regulation A+ and Regulation Crowdfunding, only time will tell how well the theory works in practice. Only time will tell whether we can relax capital-raising regulations, while also maintaining appropriate investor protections. So, while today's rules may provide smaller companies with additional funding opportunities, today's rules also raise some investor protection concerns.
For example, amended rule 147 and the new exemption under 147A do not contain a bad actor provision. Such bad actor disqualifications are a fundamental part of the new offering exemptions we have instituted under Regulation A, Regulation Crowdfunding, and Regulation D. These provisions serve as a check before an offering ever commences. They prohibit people who have committed fraud or engaged in other serious misconduct from being involved in an offering of securities pursuant to these exemptions from registration.
The North American Securities Administrators Association, which represents state regulators, specifically requested that bad actor disqualifications be included in these rules.[3] Additionally, while a majority of states and territories have some version of bad actor provisions, some states have not yet enacted such disqualifications.[4] Allowing bad actors to participate in such offerings not only undermines investor confidence, but also harms legitimate companies attempting to use these rules to raise capital. I supported and requested the inclusion of bad actor disqualifications in amended rule 147 and the new 147A for these reasons. Such provisions would serve as a floor for states, which they could choose to raise with state-specific bad actor disqualifications. Unfortunately, a majority of the Commission did not support this view.
In addition, unlike the proposed rule, the final rules do not contain a maximum offering limit. They do not provide a cap on the amount a single investor may contribute. They also significantly expand the safe harbor for integration.
Integration is a securities law doctrine geared toward preventing issuers from avoiding the registration of what, in reality, is a single public offering. A fundamental premise behind the securities laws is that an offer that is public in size and scope must be registered with the Commission, and subject to the requirements and protections of the Securities Act, unless the offer qualifies for an exemption from registration. The integration doctrine attempts to identify when seemingly separate exempt offers should be combined, and treated as a single, non-exempt offer that should be registered under Section 5 of the Securities Act.[5] The new safe harbor from integration in today's rules, together with some of the other provisions, raise questions as to whether the rules have sufficient guardrails to protect investors. In theory, this new integration framework may facilitate a young, local company's ability to move between alternative sources of funding, without fear that offerings will trigger a Section 5 violation. However, this new integration safe harbor may also facilitate evasion of our registration requirements, putting investors at greater risk.
Despite these concerns, all of the changes in today's rules are made with the view that our state regulators will be closely monitoring offerings under the amended rule and the new exemption. It is therefore, of the utmost importance, that we collaborate with our sister regulators in the states and share data and information about this new experimental regime on a regular basis. I am pleased to see that the staff has committed to study and report to the Commission in three years on how these new rules are working. This report will hopefully give us insight into the new features of Rules 147 and 147A, and how well they are working. In particular, this report will examine how the rules are being used, how they are being complied with, any incidences of fraud, and the effectiveness of state bad actor provisions. It will also determine whether state regulators could benefit from additional support in the form of a federal bad actor disqualification provision.
Finally, today's rules also repeal Rule 505, and amend Rule 504 of Regulation D to increase the maximum offering amount allowed from $1 million to $5 million in a twelve-month period. By raising the offering amounts, perhaps a greater number of companies may use the Rule 504 exemption to raise capital. Additionally, under the amended rules, Rule 504 offerings will also now be subject to the same bad actor provisions that are in the other exemptive provisions of Regulation D.[6]
Today's amendments to Rules 147 and 504 and the new exemption under Rule 147A are part of a suite of rules focused on providing options for smaller businesses seeking to raise capital. On balance, I think they are worth the experiment. However, by collecting, sharing, and examining data on how these new options are working in practice, we should be able to recalibrate these rules if the experiment is not working out as planned. Thank you.
[1] Section 3(a)(11) exempts from registration any security which is offered and sold only to persons resident within a state or territory by an issuer that is resident and doing business within or, if a corporation, incorporated by and doing business within, the same state or territory. See Securities Act of 1933 § 3(a)(11), 15 U.S.C. § 77c(a)(11).
[2] See 17 CFR 230.147.
[3]See Comment Letter from the North American Securities Administrators Association, Inc., January 11, 2016 at 9 available at https://www.sec.gov/comments/s7-22-15/s72215-22.pdf.
[4]For example, as of this date, at least five states either (1) do not have bad actor disqualification provisions or (2) have legislation pending, which would include bad actor disqualification provisions.
[5]The question of whether two or more seemingly distinct securities offerings should be combined or integrated because they constitute a single offer is at the core of the integration doctrine. The concept of integration was first introduced in 1933 and has been updated since that time. See SEC Rel. No. 33-97 (Dec. 28, 1933); SEC Rel. No. 33-4434 (Dec. 6, 1961); SEC Rel. No. 33-4552 (Nov. 6, 1962); see also, Adopting Release, Exemptions to Facilitate Intrastate and Regional Securities Offerings (Oct. 26, 2016) at fn. 181.
[6] See Rule 506(d) of Regulation D, 17 CFR 230.506(d).