Direct Public Offerings and the SEC's Recent Changes to Rule 147

Ice cream magnates, Ben Cohen and Jerry Greenfield, remained true to their adopted state's roots in 1984 when they raised more than $750,000 in a direct public offering ("DPO") entirely from residents of the state of Vermont. DPO's allow small or local companies to raise investment capital apart from the strict registration requirements of federal and state securities laws.  Crowdfunding seems like a new thing, but as Amy Cortese pointed out in an article entitled “Old-School Crowdfunding: Meet the Direct Public Offering”, crowdfunding has been around in the form of direct public offerings for a quite a while.

There are multiple ways to conduct a DPO, but Ben & Jerry's relied on the intrastate offering exemption of Rule 147, which limits the offering to residents of a single state.  Recently-adopted changes to Rule 147 by the Securities Exchange Commission (SEC) have loosened some of that Rule's restrictions and opened Rule 147 to more prospective issuers.  The changes not only modify Rule 147 to adapt to changes in technology and business practices, but also implement a new Rule 147A which accommodates offers accessible to out-of-state residents and companies that are incorporated or organized out-of-state.

Under its prior formulation, issuers could not advertise their offering outside of their state. With the new amendments, the eventual purchasers still must only be made to residents of the state of the issuer’s principal place of business, but the offering itself could be advertised to out-of-state residents as well.  Because information is so pervasive now and certain types of media, such as the internet, easily crosses state lines, this change helps modernize the old Rule 147.

One of the more significant changes in the new Rules is the new "reasonable belief" standard. Under this new standard, an issuer is within the safe harbor standards if the investor is in fact a resident of the state where the issuer maintains its principal place of business, or if the issuer has established a reasonable belief that the participant was a resident of that state. The Rules require issuers to procure a written statement from participants as to their residency status in the target state, but “reasonable belief” extends beyond that.  The issuer must either have a pre-existing relationship with the investor that leads the issuer to know that the investor is a resident or obtain evidence of the investor’s residence (such as through recent bills, pay stubs, tax returns, or id cards).  The standard is a similar one to the “reasonable steps” verification required in Rule 506(c) offerings, the most commonly used method to crowdfund.

The new and Amended Rules also include shorter holding restrictions before securities purchased in a Rule 147 offering can be resold outside of the target state. Under the new Rules, for a six month period after purchase, investors may only resell securities to residents of the target state. All securities offered pursuant to a Rule 147 offering must include a legend that recites this resale limitation.

In recognition of the diverse geography of many small businesses and startups, the new Rules provide guidelines to determine where an issuer maintains its principal place of business. Those guidelines specify that an issuer's principal place of business is the location from which its officers, partners, or managers direct, control, and coordinate its activities.  An issuer may only have a principal place of business in a single state.

The new and amended Rules do not specifically mention crowdfunding, but they make it easier for issuers to solicit and advertise offerings outside of the boundaries of a target state. Previously, issuers could not generally solicit or advertise for a Rule 147 offerings in a manner that exposed the offering to out-of-state residents. An issuer can now engage in general solicitation and advertisements that reach out-of-state residents to locate potential in-state investors. Issuers can use any form of mass media for those solicitations and advertisements, including publicly available crowdfunding websites.

The new amendments and provisions in Rule 147 and Rule 147A expand the scope of the safe harbor, but they do not altogether remove standard securities registration laws and requirements. Issuers remain obligated to assure their compliance with those laws.