Section 3(a)11 Exemption
Section 3(a)(11) of the Securities Act is generally known as the “intrastate offering exemption.” This federal exemption seeks to facilitate the financing of local business operations. Section 3(a)(11) concerns State-specific securities that meet certain exemption requirements. In order to qualify for the intrastate offering exemption at the federal level, a business must: (1) be organized in the State where it is offering the securities, (2) carry out a significant amount of its business in that State and, (3) make offers and sales only to residents of that State.
The Section 3(a)(11) intrastate offering exemption does not limit the size of the offering or the number of purchasers. However, a company utilizing this exemption must determine the residence of each offeree and purchaser. If any of the securities are offered or sold to even one out-of-state person, this federal exemption may be lost. Without a perfected exemption, the company or offeror may be in violation of the Securities Act. The Section 3(a)(11) exemption is attractive to issuers because it allows for an unlimited number of investors; an unlimited amount of raised capital and the ability to generate investors through general solicitation under the applicable State law.
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 Securities and Exchange Commission (SEC) defers to State securities regulators to regulate the sale under Section3(a)11. 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 the rule, then you will be presumed to be in compliance with the rule.
Rule 147 & Rule 147A
In an effort to minimize the uncertainty surrounding the scope of Section 3(a)(11), the SEC promulgated Rule 147 as a safe harbor. Rule 147 provides objective standards that an issuer can rely on to meet the requirements of federally exempt State-specific offers. Rule 147, as amended has the following requirements: (1) the company must be organized in the State where it offers and sells securities, (2) the company must have its “principal place of business” in-state and satisfy at least one “doing business” requirement that demonstrates the in-state nature of the company’s business, (3) offers and sales of securities can only be made to in-state residents or persons who the company reasonably believes are in-state residents and (4) the company obtains a written representation from each purchaser providing the residency of that purchaser.
In order to be considered “doing business: in-state the issuer must derive at least 80 percent of its consolidated gross revenues from the operation of a business or of real property located in-state or from the tendering of services in-state. The issuer can meet the requirement if the issuer intends to use and uses at least 8 percent 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 the rendering of services in-state. An issuer can also meet the requirement if the majority of the issuer’s employees are based in-state.
The Rule 147 safe harbor was intended to provide assurances that the intrastate offering exemption would be used for the purposes Congress intended in enacting Section 3(a)(11), namely the encouragement of local financing of issuers by investors within the issuer’s State or territory. Under Rule 147, States retain the flexibility to adopt requirements that are consistent with their respective interests in facilitating capital formation and protecting their resident investors in intrastate securities offerings, including the authority to impose additional disclosure requirements for offers and sales made to persons within their State or territory, and the authority to limit the ability of certain bad actors to rely on applicable State exemptions.
Securities purchased in an offering under Rule 147 impose a limit on resales on the issuer. The securities can only be resold to persons residing in-state for a period of six months from the date of the sale by the issuer to the purchaser. Issuers must disclose these limitations on resale to offerees and purchasers and include appropriate legends on the certificate or document evidencing the security.
Rule 147A is an intrastate offering exemption adopted by the Commission in 2016 that seeks to accommodate modern business practices and communications technology while still providing an alternative means for small issuers to raise capital locally, including through offerings relying on intrastate crowdfunding provisions. Rule 147A is substantially identical to Rule 147. However, Rule 147A has a few differences, including, allowing offers to be accessible to out-of-state residents, so long as sales are only made to in-state residents. Rule 147A also permits a company to be incorporated or organized out-of-state, so long as the company has its “principal place of business” in-state and satisfies at least one “doing business” requirement that demonstrates the in-state nature of the company’s business.
As shown, federal SEC Rule 147 places limitations on both offerings and sales of securities, which 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.
Issuers conducting an offering pursuant to Rule 147 or Rule 147A are not required to file any information with or pay any fees to the SEC. Issuers, however, must comply with State securities laws and regulations in the State in which securities are offered or sold. Each state’s securities laws have their own registration requirements and exemptions to registration requirements. Issuers wishing to obtain information should contact the state securities regulator in the State in which they intend to offer or sell securities for further guidance on compliance with State law requirements.
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 that govern interstate securities offerings. The changes to Rule 147 and the addition of Rule 147A allows companies flexibility for companies not only to determine where to incorporate their businesses, but also in the way they structure their securities financings.
If you would like to learn more about the federal intrastate securities exemptions that may be available to you, schedule a consultation with us today.
*with edits by Elizabeth L. Carter, Esq., Managing Attorney