Final Rules
We are adopting an investment limitation for Tier 2 offerings in the final rules, with minor modifications from the proposed rules. We believe that the investment limitation serves as an important investor protection and may help to mitigate the risk that with the increased annual offering limitation provided in Section 3(b)(2) comes a risk of commensurately greater investor losses. We do not believe that the limitation is needed for accredited investors because investors that qualify as accredited under our rules satisfy certain criteria that suggest they are capable of protecting themselves in transactions that are exempt from registration under the Securities Act.145 We also do not believe that the limitation is necessary for investments in securities that will be listed on a national securities exchange upon qualification because of the issuer listing requirements and the potential liquidity that exchanges provide to investors that seek to reduce their holdings. These both are important investor protections that help to mitigate concerns
143 MCS Letter.
144 Cornell Clinic Letter.
145 See Rule 501(a) of Regulation D, 17 CFR 230.501(a); see also SEC v. Ralston Purina Co., 346 U.S. 119 (1953).
about the magnitude of loss that could potentially result from an investor purchasing a large amount of securities in a single offering.
Under the final rules, the investment limitations for purchasers in Tier 2 offerings will not apply to purchasers who qualify as accredited investors under Rule 501 of Regulation D.146 Further, investment limitations in a Tier 2 offering will not apply to the sale of securities that will be listed on a national securities exchange upon qualification since such issuers will be required to meet the listing standards of a national securities exchange147 and become subject to ongoing Exchange Act reporting, resulting in additional investor protections.
In response to questions raised by commenters, we are clarifying that non- accredited, non-natural persons are subject to the investment limitation and should calculate the limitation based on no more than 10% of the greater of the purchaser’s revenue or net assets (as of the purchaser’s most recent fiscal year end).148
Non-accredited, natural persons must calculate the investment limitations on the basis of
146 See Rule 252(c)(2). Under Rule 501, natural persons are accredited investors if: (i) their income exceeds $200,000 in each of the two most recent years (or $300,000 in joint income with a person’s spouse), and they reasonably expect to reach the same income level in the current year;
they serve as executives or directors of the issuer; or (iii) their net worth exceeds $1,000,000 (individual or jointly with a spouse), excluding the value of their primary residence. Certain enumerated entities that satisfy an asset-based test also qualify as accredited investors, while others, including regulated entities such as banks and registered investment companies, are not subject to the asset test. See 17 CFR 230.501. The accredited investor definition is intended to encompass those individuals and entities “whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.” See, e.g., Rel. No. 33-6683 (Jan. 16, 1987) [52 FR 3015] (Regulation D Revisions; Exemption for Certain Employee Benefit Plans).
147 National securities exchanges impose certain requirements on issuers, in addition to those generally required by the Commission, in order for an issuer’s securities to be approved for listing. See discussion of listing requirements for, and additional investor protections associated with, national securities exchanges in Section II.E.3.c. below; see also fns. 721, 722 below.
148 Rule 251(d)(2)(i)(C)(1).
10% of the greater of the purchaser’s annual income or net worth (determined as provided in Rule 501 of Regulation D).149
If the investor is purchasing securities that are convertible into, or exercisable or exchangeable for, other securities, if such securities are exercisable within a year or otherwise are being qualified, the investment limitation will include the aggregate conversion, exercise, or exchange price of such securities, in addition to the purchase price.150 We believe this is an appropriate calculation because it is consistent with the
offering limit calculation for the respective tiers151 and because it applies investment
limitations to reasonably foreseeable investment decisions (i.e., those involving securities exercisable within a year or otherwise qualified by the issuer) while reducing the risk that issuers may seek to sell large amounts of securities that are convertible, exercisable or exchangeable into other securities in the near term at a low cost in an effort to avoid the 10% limitation.
As proposed, we are adopting final rules that require issuers to notify investors of the investment limitations.152 Issuers may rely on a representation of compliance with the investment limitation from the investor, unless the issuer knew at the time of sale that any such representation was untrue.153 As we noted in the Proposing Release, we are cognizant of the privacy issues and practical difficulties associated with verifying
149 Rule 251(d)(2)(i)(C)(2). See Securities Act Rule 501(a)(5) [17 CFR 230.501(a)(5)] (net worth).
Consistent with this rule, the calculation of a natural person’s net worth for purposes of the investment limit excludes the value of the primary residence of such person.
150 See note to Rule 251(d)(2)(i).
151 See discussion in Section II.B.3.c. above.
152 See paragraph (a)(5) to Part II of Form 1-A.
153 Rule 251(d)(2)(i)(D). Similarly, issuers may also rely on representations of investor compliance with the investment limitations from participating broker-dealers, unless the issuer knew at the time of sale that any such representation was untrue.
individual income and net worth and, therefore, are not requiring investors to disclose personal information to issuers in order to verify compliance.154
Some commenters suggested requiring an issuer to have a reasonable belief that it can rely on an investor’s representation of compliance with the investment limitations or to take reasonable steps to verify compliance, while other commenters suggested we establish consequences for issuers (and intermediaries, when applicable) if an investor failed to comply with the limitations.155 At the same time, many commenters supported the proposed approach, noting the low compliance costs and the certainty it would provide issuers and their intermediaries.156 We believe that the rules, as adopted, will limit potential losses for non-accredited investors with respect to individual offerings, while providing certainty to, and lower compliance costs for, issuers and intermediaries.
We do not believe that additional requirements for issuers and their intermediaries, such as requiring issuers to take reasonable steps to verify an investors’ compliance with the investment limitations, are necessary to protect investors in light of the total package of investor protections included in the final rules for Tier 2 offerings.157 We believe that additional requirements, like the ones suggested by some commenters, may have an unintended consequence of dissuading issuers from selling to non- accredited investors in Tier 2 offerings by increasing compliance uncertainties and
154 See Proposing Release, at Section II.B.4.
155 See fn. 140-144 above.
156 See fn. 137 above.
157 For example, the final rules include limitations on issuer eligibility, bad actor disqualification provisions, a requirement that offering statements must be qualified by the Commission, narrative and financial disclosure requirements, which for Tier 2 offerings must include audited financial statements on an initial and annual basis, as well as annual, semiannual, and current event reporting.
obligations. We are therefore not adopting any additional compliance requirements with respect to investment limitations in the final rules.
While many commenters urged the Commission to eliminate or provide less restrictive investment limitations in the final rules,158 we believe that these requirements, as proposed and adopted, usefully augment other requirements for, and investor protections applicable to, Tier 2 offerings. As we noted in the Proposing Release,
Title IV of the JOBS Act mandates certain investor protections159 and suggests that the Commission consider others as part of its Section 3(b)(2) rulemaking.160 Congress recognized in Section 3(b)(2) that investor protections beyond those expressly provided
in Title IV of the JOBS Act may be necessary in the revised regulation. To that end, Section 3(b)(2)(G) indicates that the Commission may include in the expanded exemption “such other terms, conditions, or requirements . . . necessary in the public interest and for the protection of investors . . . .” Limiting the amount of securities that a non-accredited investor can purchase in a particular Tier 2 offering (other than a Tier 2 offering of securities listed on a national securities exchange) should help to mitigate concerns that such investors may not be able to absorb the potential loss of the investment and is consistent with the authority granted to the Commission in
158 See fn. 122 above.
159 See Section 3(b)(2)(D) (expressly providing for Section 12(a)(2) liability for any person offering or selling Section 3(b)(2) securities); Section 3(b)(2)(F) (requiring issuers to file audited financial statements with the Commission annually).
160 See Section 3(b)(2)(G) (inviting the Commission to consider, among other things, requiring audited financial statements in the offering statement and implementing bad actor disqualification provisions); Section 3(b)(4) (inviting the Commission to consider implementing ongoing reporting requirements).
Section 3(b)(2).161 We further believe that setting the investment limitation at 10% of the greater of such investor’s net worth/net assets and annual income/revenue, as opposed to some other percentage (e.g., 5% or 20%), is generally consistent with similar maximum investment limitations placed on investors in Title III of the JOBS Act and will help to set a loss limitation standard in such offerings.162
Despite the suggestions of some commenters,163 we do not believe that further distinctions as to the applicability of investment limitations are appropriate among investors that do not qualify as accredited investors. On the contrary, we believe that the regulatory distinctions among accredited and non-accredited investors and the familiarity many market participants have with such terms will help to ease compliance with, and determinations about the applicability of, the investment limitations and will avoid unnecessary complexity associated with other, additional distinctions.
Integration