[Federal Register Volume 61, Number 91 (Thursday, May 9, 1996)]
[Rules and Regulations]
[Pages 21356-21359]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-11626]



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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 230

[Release No. 33-7285; File No. S7-15-95]
RIN 3235-AG51


Exemption for Certain California Limited Issues

AGENCY: Securities and Exchange Commission.

ACTION: Final rules.

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SUMMARY: In order to reduce regulatory burdens associated with certain 
offers and sales of securities, the Securities and Exchange Commission 
(``Commission'') today is adopting a new exemption from its 
registration requirements for limited offerings of up to $5 million 
that are exempt from qualification under a 1994 California state 
securities law.

EFFECTIVE DATE: The effective date of Rule 1001 and the amendment to 
Rule 144 will be effective June 10, 1996.

FOR FURTHER INFORMATION CONTACT: Richard K. Wulff, Office of Small 
Business Policy, Division of Corporation Finance, at (202) 942-2950 or 
James R. Budge, Office of Disclosure Policy, Division of Corporation 
Finance, at (202) 942-2910, 450 Fifth Street, N.W., Washington, D.C. 
20549.

SUPPLEMENTARY INFORMATION: The Commission today is adopting, as 
proposed, new Rule 1001 1 under Section 3(b) 2 of the 
Securities Act of 1933 (``Securities Act''). 3 The new rule 
exempts from the registration requirements of the Securities Act offers 
and sales up to $5 million that are exempt from state qualification 
under paragraph (n) of Section 25102 of the California Corporations 
Code. 4 Securities Act Rule 144 5 also has been amended to 
include securities issued in reliance upon Rule 1001 in the definition 
of ``restricted securities.''
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    \1\ The rule is being added as Regulation CE (for coordinated 
exemptions), 17 CFR 230.1001, rather than as Regulation CA, as 
proposed.
    \2\ 15 U.S.C. 77c(b).
    \3\ 15 U.S.C. 77a et seq.
    \4\ Cal. Corporations Code Section 25102(n).
    \5\ 17 CFR 230.144.
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I. Introduction

    In June 1995, pursuant to its authority to provide exemptions for 
small offerings under Section 3(b) of the Securities Act, the 
Commission proposed a new rule 6 designed to assist small 
businesses' capital raising ability by creating a federal exemption for 
offerings of up to $5 million 7 that meet the qualifications of a 
California exemption. The California law provides an exemption from 
state law registration for offerings made to specified classes of 
qualified purchasers that are similar, but not the same as, accredited 
investors under Regulation D.8 Certain methods of general 
solicitation are permitted under the California law.
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    \6\ Release No. 33-7185 (June 27, 1995) [60 FR 35638] 
(``proposing release'').
    \7\ This is the maximum dollar amount permitted under the 
Commission's Section 3(b) exemptive authority.
    \8\ 17 CFR 230.501-230.508.
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    The Commission received ten comment letters, which generally were 
supportive of the proposals.9 The Commission believes that the 
California exemption has the potential to facilitate small business 
capital raising. It is anticipated that the new rule will result in 
compliance cost savings for small businesses and others because 
qualifying issuers will be exempt from both state qualification and 
federal registration. At the same time, the exemption assures adequate 
protections to investors. Therefore, the Commission is exercising its 
exemptive authority in Section 3(b) to provide a parallel federal 
exemption for the California exemption by adopting new Rule 1001.
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    \9\ The letters and comment summary are available for inspection 
and copying in the Commission's public reference room. Refer to File 
No. S7-15-95.
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II. The California Exemption

    On September 26, 1994, an exemption from the issuer transactions 
qualification provisions of the California Corporations Code became 
effective.10 The provision was specifically designed ``to 
facilitate the ability of small companies to raise capital to finance 
their growth.'' 11
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    \10\ Chapter 828, Statutes of 1994 (Senate Bill 1951--Killea), 
adding subdivision (n) to Corporations Code Section 25102.
    \11\ Section 3, Senate Bill 1951.
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    The exemption generally is limited to issuers that are California 
corporations or any other form of business entity organized in that 
state, including partnerships and trusts. In addition, non-California 
organized businesses may use the exemption if they can attribute more 
than 50 percent of property, payroll and sales to California and if 
more than 50 percent of outstanding voting securities of the issuer are 
held of record by persons having addresses in California. It is not 
available for offerings relating to a rollup transaction, nor may it be 
used by ``blind pool'' issuers or investment companies subject to the 
Investment Company Act of 1940 (the ``Investment Company Act''). 
12
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    \12\ 15 U.S.C. 80a-1 et seq.
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    Sales under the exemption must be effected only to qualified 
purchasers who buy for investment purposes and not for redistribution. 
A qualified purchaser is defined as:
     Designated professional or institutional purchasers or 
persons affiliated with the issuer; 13
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    \13\ Officers and directors of corporate issuers (or persons 
performing similar duties); general partners and trustees, where the 
issuer is a partnership or a trust; small business investment 
companies; business development companies subject to the Investment 
Company Act; private venture capital companies exempted from the 
Investment Advisers Act of 1940 [15 U.S.C. 80b-1 et seq.]; entities 
comprised of accredited investors; banks; savings and loan 
associations; insurance companies; Investment Company Act companies; 
non-issuer pension or profit-sharing trusts; and, organizations 
(corporations, business trusts or partnerships) described in Section 
501(c)(3) of the Internal Revenue Code [26 U.S.C. 501(c)(3)] with 
assets of more than $5 million. Individuals with a net worth of $1 
million or annual income of more than $200,000 also are qualified 
purchasers under the California exemption. All these persons would 
qualify as ``accredited investors'' under Rule 501(a) [17 CFR 
230.501(a)].
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     Certain relatives residing with qualified purchasers;
     Promoters;
     Any person purchasing more than $150,000 of securities in 
the offering; 14
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    \14\ These persons must also satisfy one of the following 
additional suitability standards: (1) They must have, alone or with 
the assistance of a professional advisor, the capacity to protect 
their own interests; (2) they must have the ability to bear the 
economic risk of the investment; or (3) the investment must not 
exceed 10 percent of the person's net worth. These criteria also 
apply to individuals who have a net worth of over $1 million or 
annual income exceeding $200,000.
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     Entities whose equity owners are limited to officers, 
directors and any affiliate of the issuer;
     Reporting companies under the Securities Exchange Act of 
1934 (the ``Exchange Act''), 15 if the transaction

[[Page 21357]]

involves the acquisition of all of an issuer's capital stock for 
investment;
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    \15\ 15 U.S.C. 78a et seq.
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     A natural person whose net worth exceeds $500,000, or a 
natural person whose net worth exceeds $250,000 if such purchaser's 
annual income exceeds $100,000--in either case the transaction must 
involve:
    (a) Only a one-class voting stock (or preferred establishing the 
same voting rights),
    (b) An amount limited to no more than 10 percent of the purchaser's 
net worth, and
    (c) A purchaser able to protect his or her own interests (alone or 
with the help of a professional advisor); 16
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    \16\ This provision states that each such natural person, by 
reason of his or her business or financial experience, or the 
business or financial experience of his or her professional advisor 
(who is unaffiliated with and who is not compensated, directly or 
indirectly, by the issuer), can be reasonably assumed to have the 
capacity to protect his or her interests in connection with the 
transaction. The California Department of Corporations has indicated 
that qualified investors under this rubric must have business or 
financial experience or rely on a professional advisor. Release No. 
94-C (September 27, 1994).
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     Pension and profit sharing trusts, as well as 401(k) plans 
17 and Individual Retirement Accounts of individual qualified 
purchasers.
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    \17\ 26 U.S.C 401(k).
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    Issuers must provide certain purchasers who are natural persons 
18 a disclosure document as specified in Rule 502 of Regulation D 
19 five days prior to any sale or commitment to purchase.
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    \18\ This delivery requirement is limited to those natural 
persons designated as qualified purchasers because their net worth 
exceeds $500,000, or whose net worth exceeds $250,000 where there is 
an annual income of $100,000.
    \19\ 17 CFR 230.502(b)(2).
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    Offers, oral or written, are generally limited to qualified 
purchasers. However, the law does permit general announcements of a 
proposed offering to be widely published and circulated, so long as 
they contain only specified information. 20 This general 
announcement process is modeled on the ``test the waters'' concept 
being used by several of the states 21 and by the Commission in 
connection with Regulation A.
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    \20\ The California provision limits the content of the general 
announcement to the following items: the issuer's identity; the full 
title of the securities being offered; the suitability standards of 
prospective investors; a statement that no money is being sought or 
will be accepted, that an indication of interest involves no 
commitment to purchase and that under certain circumstances a 
disclosure document will be provided prior to purchase; and the 
name, address and telephone number of a person who can provide 
further information about the offering. Only the following 
additional information may be included at the issuer's option: a 
brief description of the business, its geographical location and the 
offering price or method of determination.
    \21\ See CCH NASAA Reports Sec. 7036. Arizona, Colorado, Kansas, 
Massachusetts, Oregon, Pennsylvania, Vermont, Virginia and 
Washington currently are participating in a pilot program in this 
regard, and Indiana has proposed entering this pilot program as 
well.
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    A notice must be filed with the California Corporations 
Commissioner at the initial offer of securities or with the publication 
of a general announcement of proposed offering, whichever comes first, 
accompanied by a $600 filing fee. A second filing is required within 10 
business days after the close or abandonment of the offering, and in no 
case later than 210 days after the filing of the initial notice.

III. Regulation CE and Rule 1001

A. Need for a New Exemption

    The California exemption combines a form of general solicitation 
using a ``test the waters'' concept with a qualified purchaser concept 
derived in part from the Uniform Limited Offering Exemption (``ULOE''), 
22 an official policy guideline of the North American Securities 
Administrators Association, Inc. (``NASAA'') 23 that was adopted 
in coordination with the Commission's adoption of Regulation D. 24 
California's exemption does not fit well within any current federal 
exemption, other than Rule 504, 25 which is limited to $1 million, 
or potentially the intrastate offering exemption. 26 Rules 505 and 
506 of Regulation D prohibit general solicitations; moreover, 
California's definition of qualified purchasers is broader than 
Regulation D's. The intrastate offering exemption is available only for 
those offerings by issuers incorporated and doing business in 
California.
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    \22\ See CCH NASAA Reports Sec. 6201.
    \23\ NASAA is an association of securities commissioners from 
each of the 50 states, the District of Columbia, Puerto Rico, Mexico 
and several of the Canadian provinces.
    \24\ State statutes and rules based on NASAA's ULOE exempt 
offers or sales of securities made in compliance with Rules 501-503, 
505 and/or 506 of Regulation D [17 CFR 230.501-230.503, 230.505 and 
230.506 respectively], including the prohibition of general 
solicitations found in Rule 502(c).
    \25\ 17 CFR 230.504.
    \26\ Securities Act Section 3(a)(11) [15 U.S.C. 77c(a)(11)] and 
Rule 147 [17 CFR 230.147].
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    The Commission does not believe that these differences need to be 
an impediment to the ability of small businesses to take full advantage 
of the California exemption. While the qualified purchaser definition 
differs somewhat from the accredited investor definition for 
individuals, the California law includes additional suitability 
standards. Moreover, the general announcement of proposed offering is 
subject to significant limitation, thereby protecting against abuse of 
the procedure. The provisions of the California law are consistent with 
investor protection and the public interest, and therefore warrant the 
Commission's full exercise of its exemptive authority under Section 
3(b).

B. The Exemption

    New Rule 1001 provides that offers and sales of securities, in 
amounts of up to $5 million, that are exempt from registration under 
the California securities law pursuant to paragraph (n) of section 
25102 of the California Corporations Code 27 are exempt from the 
registration requirements of Section 5 of the Securities Act, pursuant 
to Section 3(b) of that Act.28 All issuers that qualify for the 
state exemption can rely on the Rule 1001 exemption.29 Issuers 
should look to the state of California for interpretations relating to 
who qualifies for the exemption, since any person who lawfully relies 
on the state exemption also could rely on its federal counterpart. 
Commenters who spoke to the issue supported the Commission's proposal 
not to impose additional qualifying standards.
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    \27\ One commenter expressed the view that the Commission should 
key the exemption to section 25102(n) as it existed at the time it 
originally became effective. The Commission has determined to adopt 
Rule 1001 as proposed in order to allow California flexibility to 
address concerns relating to its exemption without fear of losing 
the federal counterpart. Nevertheless, the Commission will monitor 
future changes to the California exemption to assure that the 
investor protections are not diminished in a fashion that would 
warrant modification of the federal exemption.
    \28\ Rule 1001(a). While the transactions would not be subject 
to registration under Section 5, the antifraud provisions of the 
federal securities laws would continue to be applicable to all 
exempt transactions. See preliminary note 1 to Rule 1001. Rule 1001 
would provide an exemption only for the transactions in which the 
securities are offered or sold by the issuer; it is not an exemption 
for the securities themselves.
    \29\ As noted above, California law precludes reliance on the 
exemption in connection with investment company, blind pool or roll-
up offerings; thus, the Rule 1001 exemption also would be 
unavailable in those cases.
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    As in the proposal, the final rule does not require issuers to 
notify the Commission when they rely on the California exemption in 
view of the notification provisions of the California law.

C. Computation of $5 million amount

    Rule 1001 exempts offerings up to $5 million, the maximum allowed 
under Section 3(b).30 The $5 million limit will apply on an 
offering-by-offering basis.31

[[Page 21358]]

Commenters supported this approach, which differs from that applied in 
other Section 3(b) rules, where an annual dollar limit for the 
aggregate of various Section 3(b) offers has been used.32
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    \30\ Where a transaction involves non-cash consideration, the 
amount of the offering would be calculated as provided under 
California law.
    \31\ Standard integration analysis concepts would apply. See 
Release No. 33-4552 (November 7, 1962) [27 FR 11316]. These concepts 
are currently under review in connection with the work of the Task 
Force on Disclosure Simplification and the Advisory Committee on the 
Capital Formation and Regulatory Processes. See notes 37 and 37, 
below.
    \32\ See, e.g., Rule 251(b) [17 CFR 230.251(b)], Rule 504(b)(2) 
[17 CFR 230.504(b)(2)] and Rule 505(b)(2)(i) [17 CFR 
230.505(b)(2)(i)].
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D. Resale limitations

    The new exemption provides that purchasers in the exempt 
transaction receive ``restricted securities.'' 33 Consequently, 
purchasers must either register subsequent resales of the securities or 
have an exemption for such sales. Categorizing the securities offered 
and sold pursuant to Rule 1001 as ``restricted'' is consistent with the 
California exemption, since the latter requires an investment intent on 
the part of purchasers in the offering, and such shares could not be 
resold under California law without qualification or some other 
exemption under such law. In addition, the treatment is consistent with 
other federal exemptions, the availability of which depends on the 
sophistication, wealth or institutional character of the 
investor.34
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    \33\ Rule 1001(c) and amendment to Rule 144.
    \34\ See, e.g., Section 4(6) of the Exchange Act [15 U.S.C. 
78d(6)] and Securities Act Rule 506.
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IV. Other Matters Addressed in the Proposing Release

A. Exemptions for Other States

    The Commission proposed to provide the same exemption for each 
state that enacts a transaction exemption incorporating the same 
standards used by California. To date, the Commission has not received 
any request from a state other than California seeking its own 
exemption. The Commission reiterates its desire to cooperate with the 
states and repeats its position that it will create an exemption for 
any state that adopts an exemption incorporating the same standards 
used by California. Separate consideration for a federal exemption will 
be given to states that adopt other similar exemptions that protect the 
public interest.35
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    \35\ Three commenters supported this approach. Two commenters, 
however, believed that the Commission should not proceed on a state-
by-state basis; rather, it should take a broader approach by 
creating a federal exemption that the individual states could then 
use to fashion their own coordinated exemptions. The Commission will 
consider this suggestion, together with others put forward by 
commenters with respect to facilitating small business capital 
formation, in connection with future rulemaking projects.
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B. General Solicitation under Regulation D and ULOE

    While not included as a rule proposal, the Commission indicated in 
the proposing release that it was considering whether amendments to 
Regulation D should be proposed that would facilitate better use of the 
exemptions by revising or eliminating the prohibition against general 
solicitation for Rule 505 and 506 offerings. This question was prompted 
in part by the approach in the California exemption that allows a form 
of general solicitation followed by sales only to qualified purchasers. 
Comment also was sought as to whether the Commission should consult 
with the states and NASAA about modifying ULOE, which also prohibits 
general solicitations in these offerings.
    A number of commenters supported relaxing the general solicitation 
prohibition, believing that it would enhance the utility of Rule 505 
and 506 offerings. The Commission has determined to proceed with 
adoption of the California exemption at this time while deferring 
action on the general solicitation question with respect to other 
exemptions, since Section 3(b) does not prohibit general solicitation 
for offerings exempt thereunder. However, these comments will be 
considered in connection with future initiatives undertaken by the 
Commission as it evaluates the reports of the Task Force on Disclosure 
Simplification 36 and the Advisory Committee on the Capital 
Formation and Regulatory Processes.37 The work of both of these 
groups has been dedicated to reassessing and reforming the federal 
securities disclosure regime where necessary and appropriate in the 
public interest and consistent with investor protection.
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    \36\ The Task Force on Disclosure Simplification was organized 
in August 1995 to review forms and rules relating to capital-raising 
transactions, periodic reporting pursuant to the Exchange Act, proxy 
solicitations, and tender offers and beneficial ownership reports 
under the Williams Act. Its goal was to identify where the 
disclosure process could be simplified and, consistent with investor 
protection, to make regulation of capital formation more efficient. 
Following a seven-month review, the Task Force completed its report, 
including a number of recommendations, which the Commission 
authorized for publication on March 5, 1996. This report is 
available for inspection and copying at the Commission's public 
reference room. It also is available through the Commission's 
Internet web site [http://www.sec.gov].
    \37\ The Securities and Exchange Commission Advisory Committee 
on the Capital Formation and Regulatory Processes was established in 
February 1995. See Release No. 33-7135 (February 17, 1995) [60 FR 
9415]. The objective of the Committee is to assist the Commission in 
evaluating the efficiency of the regulatory process relating to 
public offerings of securities, secondary market trading and 
corporate reporting. The Committee's focus has been the development 
of a company registration system for adoption by the Commission, 
which would allow eligible companies to offer and sell securities 
relying on a more company-focused, as opposed to transaction-
focused, system. The Committee plans to issue a report containing 
its recommendations in the near future.
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V. Cost-Benefit Analysis

    The Commission solicited comments to aid in its evaluation of the 
costs and benefits that would result from the proposed exemption. It 
was expected that compliance burdens would decrease with respect to 
issuers who qualify for the proposed exemption, inasmuch as they would 
be able to raise up to $5 million in capital without the burden and 
expense of compliance with the registration and reporting requirements 
of the federal securities laws. Commenters supported that view, 
indicating that the exemption would be beneficial to small business by 
reducing their capital raising expenses without reducing investor 
protection. Consequently, the Commission has determined to adopt the 
rule as proposed.

VI. Final Regulatory Flexibility Analysis

    A final regulatory flexibility analysis has been prepared in 
accordance with 5 U.S.C. 604 concerning the adoption of Rule 1001 
exemption and the amendment to Rule 144. A copy of the analysis may be 
obtained by contacting James R. Budge, Office of Disclosure Policy, 
Division of Corporation Finance, at (202) 942-2910, U.S. Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

VII. Statutory Basis for the Rules

    Regulation CE, Rule 1001 and the amendment to Rule 144 are adopted 
pursuant to Sections 3(b) and 19 of the Securities Act.

List of Subjects in 17 CFR Part 230

    Registration requirements, Securities.

Text of the Amendments

    In accordance with the foregoing, Title 17, Chapter II of the Code 
of Federal Regulations is amended as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    1. The authority citation for Part 230 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77s, 77sss, 78c, 
78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 89a-29, 80a-30, and 
80a-37, unless otherwise noted.

* * * * *

[[Page 21359]]

    2. By amending Sec. 230.144 by removing the period at the end of 
paragraph (a)(3)(iv) and adding ``; or'' in its place and by adding 
paragraph (a)(3)(v), to read as follows:


Sec. 230.144  Persons deemed not to be engaged in a distribution and 
therefore not underwriters.

* * * * *
    (a) * * *
    (3) * * *
    (v) Securities acquired from the issuer that are subject to the 
resale limitations of Regulation CE (Sec. 230.1001).
* * * * *
    3. By adding a new undesignated center heading and Sec. 230.1001, 
to read as follows:

Regulation CE--Coordinated Exemptions for Certain Issues of Securities 
Exempt Under State Law


Sec. 230.1001  Exemption for transactions exempt from qualification 
under Sec. 25102(n) of the California Corporations Code.

    Preliminary Notes: (1) Nothing in this section is intended to be 
or should be construed as in any way relieving issuers or persons 
acting on behalf of issuers from providing disclosure to prospective 
investors necessary to satisfy the antifraud provisions of the 
federal securities laws. This section only provides an exemption 
from the registration requirements of the Securities Act of 1933 
(``the Act'') [15 U.S.C. 77a et seq.].
    (2) Nothing in this section obviates the need to comply with any 
applicable state law relating to the offer and sales of securities.
    (3) Attempted compliance with this section does not act as an 
exclusive election; the issuer also can claim the availability of 
any other applicable exemption.
    (4) This exemption is not available to any issuer for any 
transaction which, while in technical compliance with the provision 
of this section, is part of a plan or scheme to evade the 
registration provisions of the Act. In such cases, registration 
under the Act is required.

    (a) Exemption. Offers and sales of securities that satisfy the 
conditions of paragraph (n) of Sec. 25102 of the California 
Corporations Code, and paragraph (b) of this section, shall be exempt 
from the provisions of Section 5 of the Securities Act of 1933 by 
virtue of Section 3(b) of that Act.
    (b) Limitation on and computation of offering price. The sum of all 
cash and other consideration to be received for the securities shall 
not exceed $5,000,000, less the aggregate offering price for all other 
securities sold in the same offering of securities, whether pursuant to 
this or another exemption.
    (c) Resale limitations. Securities issued pursuant to this 
Sec. 230.1001 are deemed to be ``restricted securities'' as defined in 
Securities Act Rule 144 [Sec. 230.144]. Resales of such securities must 
be made in compliance with the registration requirements of the Act or 
an exemption therefrom.

    Dated: May 1, 1996.

    By the Commission.
Jonathan G. Katz,
Secretary.
[FR Doc. 96-11626 Filed 5-8-96; 8:45 am]
BILLING CODE 8010-01-P