Intrastate Securities Offerings Under 3(a)(11) and Rule 147 & 147a
As we’ve discussed previously, the Securities and Exchange Commission (SEC) is the governmental body responsible for the regulation and enforcement of federal securities laws that govern both interstate securities offerings and intrastate securities offerings. These laws are detailed in, among others, the Securities Exchange Act of 1933. The SEC is primarily concerned with regulating securities transactions that take place on a large scale (generally interstate), and so the ‘33 Act provides for an exemption from registration for intrastate securities offerings. Today’s post discusses the federal exemption for intrastate securities offerings under Rule 3(a)(11).
For purposes of this post, when we refer to “selling securities” we’re generally referring to companies raising investments under either equity or debt instruments. Here’s a prior post that discusses a more precise definition of “securities.”
SECTION 3(a)(11): The Intrastate Securities Offer Exemption
The SEC created several rules that make certain sales of securities “exempt” from registration requirements. The federal intrastate securities offering exemption is found in Section 3(a)(11) of the Securities Act. Section 3(a)(11) exempts “any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within, or, if a corporation, incorporated by and doing business within, such State or Territory.”
When a company is only offering and selling securities within a single state and does a majority of its business within that same state, the SEC defers to state securities regulators to regulate the sale. To avoid conflicts between state and federal law concerning these sales, the SEC has adopted a “safe harbor” rule to clearly lay out the requirements needed for an issuer to qualify for protection under Section 3(a)(11). (A “safe harbor” refers to a type of rule that if you follow the steps in rule then you will by default be considered in compliance with the rule.)
The safe harbor referred to in 3(a)(11) is Rule 147. If complied with, Rule 147 ensures eligibility for the intrastate securities offering exemption. Congress recently amended Rule 147 and created Rule 147a to further accommodate modern business practices and the use of large-scale communication technology.
RULE 147: THE SAFE HARBOR
In order to conduct intrastate securities offerings under the Rule 147 safe harbor, issuers (that is, companies offering equity or debt) must meet the following requirements:
- Companies must limit all offers and sales to in-state residents, or people the company reasonably believes are in-state residents;
- The company’s “principal place of business” and activities are in-state;
- The company must satisfy at least one out of four additional requirements to be considered “doing business” in-state (see below for those requirements)
- The company is organized in-state; and
- Any securities offered or sold must include a disclaimer stating that the securities have not been registered, and set limitations on resale.
“Doing Business” In-state
To satisfy the requirements under Rule 147, companies must satisfy at least one of the following requirements (in addition to those above) in order to be deemed “doing business” in-state:
- The company received at least 80% of its consolidated gross revenues from the operation of a business or of real property located in-state or from the providing services in-state;
- The company had at least 80% of its consolidated assets located in-state (measured at the end of its most recent semi-annual fiscal period);
- The company intends to use and uses at least 80% of the net proceeds from the offering towards the operation of a business or of real property in-state, the purchase of real property located in-state, or providing services in-state; or
- A majority of the issuer’s employees are based in-state.
RULE 147a: Congress’ Update to “Modernize” Rule 147
The two primary differences between Rule 147 and Rule 147a are in the manner of the offering and the residence requirement for companies.
Manner of Intrastate Securities Offering:
Rule 147 places limitations on both offerings and sales of securities. Both must be made only to in-state residents. However, congress, recognizing the changes in technology, loosened the limitations for Rule 147a. Rule 147a allows issuers to make offers to out-of-state residents, so long as the actual sales remain limited to in-state residents. This allows issuers to use the internet (and other technology that facilitates reaching a larger audience quickly) when advertising their offers. Under Rule 147, companies ran into a real risk of not complying with the exemption if they used the internet because of the strong likelihood that the offer would be seen by potential investors that were not in-state.
Residence Requirement for Intrastate Securities Issuers:
Rule 147 requires that companies be incorporated or organized and have their “principal place of business” in a state in order to be considered a resident of the particular state. Rule 147a only requires that the “principal place of business” be in the state to determine residency. In recent decades there has been a push by companies to incorporate in states other than the one where they do a majority of their business, primarily to take advantage of favorable corporate laws. This shift made meeting the requirements of Rule 147 difficult. Through Rule 147a, Congress made it easier for these companies to utilize the intrastate exemption.
Why should startups and entrepreneurs care about the intrastate securities offering exemption and rule 147?
The federal intrastate securities offering exemption makes it simpler for companies to raise money from “local” investors, and it reduces the costs and administrative hassle of the securities regulations governing interstate securities offerings. The changes to Rule 147 and the addition of Rule 147a allows companies flexibility not only to determine where to incorporate their businesses, but also in the way they structure their securities financings.