Exemptions from registration have long been a cornerstone of the U.S. federal securities laws that have helped facilitate capital formation among private companies. The line drawing required to effectuate these exemptions has evolved over time and requires a delicate balance of the tensions between investor protection and capital formation. In the last decade, significant legislative and regulatory developments have expanded access to capital for private companies, particularly early stage businesses.
Significantly, the Jumpstart Our Business Startups Act (JOBS Act), enacted April 5, 2012, effected profound changes to U.S. federal securities laws and ushered in sweeping changes for the conduct of IPOs, in addition to other accommodations for private and public companies. Under the JOBS Act, the Securities and Exchange Commission (SEC) allowed for general solicitation and general advertising in private placements conducted pursuant to Rule 506 under Regulation D (provided that all purchasers are “accredited investors”) and in Rule 144A placements (provided that all purchasers are qualified institutional buyers).
The JOBS Act also increased the number of record holders of a class of equity securities that triggers an issuer’s obligation to register and become a reporting company under the Securities Exchange Act of 1934 from 500 holders to either 2,000 persons or 500 persons who are not accredited investors (with some meaningful exclusions from these calculations, including certain recipients of employee equity grants). The JOBS Act also expanded the maximum size of Regulation A offerings (i.e., Reg A+) and created a new exemption from registration for “crowdfunding” by private U.S. companies. Collectively, these developments have significantly expanded access to capital, particularly for early stage private companies, through means not requiring a formal IPO registration process.
The impact of the JOBS Act extends beyond exempt offerings. Moving along the company lifecycle, the JOBS Act also created an “IPO on-ramp” that affords several accommodations for emerging growth companies, or “EGCs” (generally defined as companies with total annual gross revenues of less than $1.07 billion—increased from $1 billion in April 2017, and subject to further adjustment for inflation every five years), in the process of going public. These include accommodations for reduced financial statement, MD&A, and executive compensation disclosure.
More recently, in 2020, the SEC adopted a host of rule amendments designed “to harmonize, simplify, and improve the multilayer and overly complex exempt offering framework.” Those amendments acknowledged that “[f]or many small and medium-sized business[es], our exempt offering framework is the only viable channel for raising capital.” To that end, these amendments increased the offering limits for Regulation A+, Regulation Crowdfunding, and Rule 504 offerings. They also modified the definition of “accredited investor” to expand those eligible for inclusion in this investor status and established a new framework to make it easier for companies to make integration determinations when conducting private offerings in parallel or close in time.
Notwithstanding the evolution of the exemption framework, challenges remain, and the debate continues as to whether additional modifications are necessary to further enhance the current exemption framework. Some contend that navigating the myriad of available exemptions with differing requirements remains unduly challenging. Others have focused more on the funding sources available to entrepreneurs to take advantage of the existing exemption frameworks. For example, when considering trends in capital raising and access to capital, disparity between rural and urban locales is just one topic under discussion. Changes among state regulations of securities are also relevant considerations to this ecosystem and any future adjustments thereto at the federal level. Relatedly, as retail investors come ever into the fore of investing and the types of offered securities become more complex, some have expressed concern about the need for additional protections for these investors, including whether further modifications to the accredited investor definition, or other or different regulatory requirements, are merited.
Much has been done over the years to protect Main Street investors, and enforcement actions and commentary from the SEC have kept them a priority. Nevertheless, there are indeed risks, including those arising from “bad actors,” illustrating the need for continued enforcement in the private offering contexts, which includes its own challenges. In that same vein, the role of gatekeepers remains of critical importance and significant policy interest at the SEC and more broadly in Washington. Recent enforcement actions underscore this point.
Looking forward, these and other questions in the ever-changing environment for private companies will contribute to the evolving discussion around the federal regulation of securities and the future of the SEC and the exempt offering framework. Continued input from all stakeholders will be critically important to supporting the evolution of the exempt offering framework while preserving the core principles upon which it is grounded.
This article is based on a CLE program that took place during the ABA Business Law Section’s 2022 Hybrid Annual Meeting. To learn more about this topic, view the program as on-demand CLE, free for members, or watch the related video.
