These are uncertain times. Even before the world-wide COVID-19 pandemic, companies seeking to raise capital in the cannabis industry were facing challenges. However, some experts and insiders I’m hearing from are bullishly predicting that investors with dry powder will increasingly deploy capital for investment purposes. Other informed contacts are less optimistic, with forecasts painting a more negative outlook on the macro level. As is often the case, both perspectives could turn out to be correct. Regardless, now, more than ever, with no accurate crystal ball in hand, it is critical for cannabis companies pursuing funding to be able to take comfort that they are properly navigating securities regulations.
This latest installment of my series on fundraising outlines at a very high level some of the most popular securities exemptions from registering securities. Subsequent posts in this series will examine a number of these common exemptions in greater detail.
Under the federal securities laws, a company may not offer or sell securities unless the offering has been registered with the U.S. Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933, as amended (the “Securities Act”) or an exemption from registration is available. A securities offering that is exempt from registration is sometimes referred to as a private placement or an unregistered offering. Most privately-held cannabis companies are offering unregistered securities as part of a private placement.
Unregistered offerings will normally include capitalized legends placed on the offering documents and on the certificates or other instruments that represent the securities. These legends will likely appear familiar to those involved in private placements of securities. The legends will state that the offering has not been registered with the SEC and the securities are subject to certain restrictions on their transfer.
Generally, the most common exemptions from registration under the Securities Act are found in Regulation D. By far the most popular exemption relied upon in private offerings, Rule 506 (both (b) and (c)) provides a “safe harbor” under Section 4(a)(2). Keep in mind, however, an exemption at the federal level does not necessarily eliminate the obligation to comply with state “blue sky” laws in all circumstances. Federal preemption depends upon the exemption relied upon.
A quick history lesson: Going back nearly 25 years, as a result of a lack of uniformity in state securities laws and associated burden on capital-raising transactions, in October 1996, the National Securities Markets Improvement Act of 1996 (“NSMIA”) was enacted into law. The NSMIA amended Section 18 of the Securities Act to preempt state blue sky registration and review of specified securities and offerings. These preempted securities are called “covered securities.” The NSMIA list of “covered securities” includes securities issued in Rule 506(b) offerings, except that a state may still require a notice filing and payment of a notice fee.
The SEC’s website has a handy table which illustrates whether offerings are potentially subject to state registration or qualification under the Securities Act:
|Securities Act Exemption||Under the Securities Act, is the offering potentially subject to state registration or qualification?|
|Regulation A – Tier 1||Yes|
|Regulation A – Tier 2||No|
|Rules 147 and 147A||Yes|
As further stated on the SEC’s website, “[f]or the offerings that are potentially subject to state registration or qualification, each state’s securities laws have their own separate registration requirements and exemptions to registration requirements. Even if the offering is not subject to state registration or qualification, there may still be state notice filing requirements and fees.”
Issuers take note: On October 26, 2016, the Commission repealed Rule 505. Hence, this exemption is no longer available, although some issuers still mistakenly rely upon this exemption.
Over the next few installments of this series, we will more closely examine applicable federal securities regulations, including Section 4(a)(2) and Rules 506(b) and (c), as well as certain state blue sky laws governing exemptions to registration at the state level.