Testing the Waters with Rule 241
The Securities Act of 1933 (“Act”) regulates securities transactions that involve interstate commerce. Unless your securities are registered with The Securities and Exchange Commission (“SEC”) or are exempt from registration, it is unlawful for you to offer or sell securities.
What is an Offer?
- § 2(a)(3) of the Act defines “offer” as “every attempt to offer or dispose of,” or “any solicitation of an offer to buy” a security.
The SEC and the Courts have largely construed the term “offer” broadly to “g[o] beyond the common law concept of an offer.” 1 Whether or not an “offer” as defined by § 2(a)(3) actually invites acceptance such that there will be a formation of a binding contract is not dispositive as to whether the statutory definition has been triggered. 2 For example, advertisements made in advance of an offering of securities that have yet to be issued will be deemed to be an offer because it has the “effect of conditioning the public mind or arousing public interest” in such securities. 3 In other words, offer can cover broad swaths of activities including promotional actions, materials, or appearances related to the sale of securities. For example, an offer could take the form of a positively biased research report or radio interview about the company’s condition.
Here are various activities that fall within the definition of “offer,” including but not limited to:
- Advertisements including (television ads, newspaper ads, online ads, and other forms of marketing material).
- Cold calls to potential investors.
- One-on-one conversations about certain offering of securities.
- Pitching to investors at seminars or networking events.
- Receiving indications of interests for a proposed offering of securities.
- Paying a publication to release glowing reports for your company.
Notwithstanding this general principle, there are statutory and regulatory carveouts that allow for certain types of “offers” that have historically existed to accommodate the practicalities of the securities market while maintaining the core legislative intent of the Act.
Some of the carveouts include:
- Research reports by a broker-dealer about an emerging growth company 4 that is about to launch its Initial Public Offering (“IPO”).
- Tombstone Advertisement which includes: (1) identifying information of the issuer including the type of business the issuer is engaged in, (2) title, amount, and price of securities being offered, (3) brief description of the intended use of proceeds of the offering, (4) type of underwriting (firm commitment, best efforts, Dutch auction), (5) names of the underwriter (usually an investment bank), and inter alia.
- Preliminary prospectus if the issuer has filed a registration statement.
How does this apply to the private placement world?
All issuers of securities have an interest in gauging the marketplace’s appetite for their securities, particularly startups. The issuer must determine whether its securities are marketable and whether it is worth the time, money, and effort to initiate an offering, given the cost.
Prior to the SEC’s enactment of the amended rules in November 2020, there was a ban on general solicitations of interest absent an exception provided by a rule. For example, if the issuer offered securities pursuant to Rule 506(c) of Regulation D, then the issuer could generally solicit or generally advertise its offering. However, the issuer was required to identify the applicable exemption with the necessary disclosures (this was usually done in the PPM). The issuer could not generally advertise or solicit indications of interest without first claiming an available exemption and following its conditions. Things have changed for the better.
Testing the Waters
Effective March 15, 2021, Rule 241 allows an issuer to “communicate orally or in writing to determine whether there is any interest in a contemplated offering of securities exempt from registration.” Naturally, there are conditions that must be met and there are always caveats in the law:
- The offering of securities being considered must be made pursuant to an exemption from registration, even if the issuer has not determined the specific exemption. (This exemption is unavailable to issuers who are looking to register their securities and offer them to the public or in an IPO).
- The issuer neither accepts nor solicits any money.
- Issuer must state certain disclaimers in its communications.
- (Example of a disclaimer [Lawyers absolutely revel in writing disclaimers. I know I do.]:
“This communication is not an offer or sale of securities; no money or consideration is being solicited or will be accepted. The issuer has yet to determine a specific exemption from registration of its securities from any subsequent offer or sale of securities, and a person’s indication of interests is not a binding obligation or commitment to purchase of such securities.”
- The antifraud provisions of securities laws, such as § 10b and Rule 10b-5 of the Exchange Act of 1934 still apply to communications exempted under Rule 241. In other words, don’t lie, steal, or cheat in your communications. Full and truthful disclosure is the best policy.
- The integration rules apply if someone tries to use Rule 241 as a means to skirt around prohibitions from general solicitations pursuant to an exemption from registration. For example, if the subsequent offering is made pursuant to Rule 506(b) which prevents general solicitation, then unless the issuer can show that it has a substantive relationship prior to commencement of the 506(b) offering, the SEC could deem the communications made under Rule 241 as being part of the 506(b) offering, thus breaching the conditions of the available exemption from registration.
Rule 206, specifically available for Crowdfunding offerings, tracks the language of Rule 241 and generally has the same conditions and requirements.
Rule 148 allows for an issuer to participate in a seminar or meeting sponsored by educational institutions, nonprofits, State or local government agencies, angel investor group, or incubator or accelerator groups, without its communications being deemed to have generally advertised or generally solicited. This is subject to conditions laid out in the Rule.
Would You, If You Could?
Issuers can now gauge the market (do “Due Diligence”) to determine interests in their securities before going through the arduous and expensive process of offering securities, subject to conditions laid out in the available exemption as stated.
This blog post is for general educational purposes and is not to be construed as legal advice. Please consult an attorney.
- Diskin v. Lomasney Co., 452 F.2d 871 (2d Cir. 1971).
- Compare with Restatement (Second) of Contracts, § 24 (A generally accepted principle of contract law is that an offer invites acceptance, and such acceptance forms a binding contract between parties.)
- Securities Act Release No. 33-3844 (October 8, 1957).
- As defined in § 2(a)(19) to be an issuer that has total gross revenues of less than $1 billion, inter alia.