Understanding Securities Law
The business professional's guide to securities laws
Roadmap to a Reg. D Private Placement
Your initial task is to select which of the rules, 504, 505 or 506, you want to utilize for your placement. In order to do that, you must first understand how Reg. D works.
What you can and cannot do in a Reg. D offering
Rule 502 is the guts of Regulation D. It tells you:
Limitations on the number of investors
Rules 505 and 506 limit the number of investors to 35 investors who are not “Accredited Investors.” Rule 504 does not have this limitation. However, state “Blue Sky” laws effectively impose the same limitations even if you choose a Rule 504 Private Placement.
To make this count accurately and assure you don’t violate Reg. D by going over the number of allowed investors, you must understand what an Accredited Investor is:
There are other types of investors that are also excluded in the count, most often any relative, spouse or relative of the spouse of a purchaser who has the same principal residence as the purchaser.
How do you know if an investor in your placement is accredited? You ask. All investors in your Reg. D Private Placement must fill out a Subscription Agreement. In the Subscription Agreement, you ask the Investor to make representations confirm Accredited Investor status.
Subscription Agreements generally contain other items, including:
General Advertising and Solicitation
Rule 502 (c) concerning limitations on manner of offering provides that [except as provided in Rule 504(b)(1) – but more on this below], neither the your company nor any person acting on your behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:
So what is “general advertising and solicitation?” Like Mr. Justice Stewart’s definition of pornography, I know it when I see it. The SEC will not tell you anything more than is in the Rule.
So why can’t you solicit investors on the internet for your private placement? The Rule was written before the days of the internet, or the word “internet” would have appeared in the first bullet point. If you have a website, do not mention anywhere on the site you are doing a Private Placement and for sure do not post your Private Placement Memorandum or a link to your Private Placement Memorandum on your website.
Beyond the specifics above, it gets fuzzy. One important factor is a pre-existing relationship with the investors you contact. Do you already know them personally or through business? But be careful. If you have 1,000 customers or subscribers with whom you have a business relationship, can you solicit all 1,000 of them? NO. The number of potential investors is so large that this would constitute general advertising and solicitation. Is there an absolute number that we can give you. Unfortunately NO. The best advice is to get advice from an experienced securities law professional before you do any solicitation.
Integration of Multiple Private Placements
If you conduct multiple private placements, you run the risk that the SEC will say that what you thought were multiple, separate Private Placements were really one big Private Placement. The SEC integrates, or combines, the multiple Private Placements.
Why is this a problem? As described below, each of the Rules 504, 504 and 506 have various limitations, such as the limitation on the number of Non-Accredited investors. If you cannot have more than 35 Non-Accredited investors, and in your first Private Placement you had 30 and in your second Private Placement you had another 30, and the SEC integrated these two Placements, you would have busted the Reg. D exemption and broken federal securities laws.
The SEC provides you with a very subjective test for integration, as follows:
Do not rely on these factors as they almost never work. Instead, rely on the following “bright line” test in the Rule:
Offers and sales that are made more than six months before the start of a Regulation D offering or are made more than six months after completion of a Regulation D offering will not be considered part of that Regulation D offering, so long as during those six month periods there are no offers or sales of securities by or for the issuer that are of the same or a similar class as those offered or sold under Regulation D, other than those offers or sales of securities under an employee benefit plan.
To avoid busting the Reg. D exemption, make sure the last sale in your first Private Placement is more than six months before your first offer to sell in your second Private Placement.
Integration of Regulation D Private Placements and Public Offerings
There is one other aspect of the doctrine of Integration that is critical if you conduct a Private Placement followed within 6 months by a public offering, including a Selling Stockholder Registration Statement described above. This is a common method used to obtain a Ticker Symbol on the OTCBB or higher exchange. The bright line test is not available. So an integration of the Private Placement and the Public Offering will bust the exemption for the Private Placement.
However, there is another SEC Rule that provides additional protection, but only if your Private Placement was done under Rule 506. This is Rule 152 that provides:
The phrase "transactions by an issuer not involving any public offering" in Section 4(2) shall be deemed to apply to transactions not involving any public offering at the time of said transactions although subsequently thereto the issuer decides to make a public offering and/or files a registration statement.
This means that even if your Placement ends within six months of the date of filing your registration statement, you will not have the two integrated, but only if the Placement was done under Rule 506. Why? Rule 504 and 505, like Regulation A described above, are exemptions based not upon Section 4(2) but instead upon Section 3(b). This makes Rule 152 unavailable for Reg. D 504 and 505 Placements followed within six months by the filing of a Registration Statement.
Selecting the Right Rule
Although there are common aspects of all three Rules, there are also important differences:
Rule 504 -- Exemption for Limited Offerings and Sales of Securities Not Exceeding $1,000,000
You cannot use Rule 504 if you are an SEC reporting company or if you are a blank check shell company.
The aggregate offering price for an offering of securities under Rule 504 cannot exceed $1,000,000, less the aggregate offering price for all securities sold within the twelve months before the start of and during the offering of securities under this Rule 504, in reliance on any exemption under section 3(b), or in violation of section 5(a) of the Securities Act.
The disclosure information in the Private Placement Memorandum is same kind of information as would be required in Part II of Form 1-A for Regulation A.
The financial statements are in general the same as a registered offering, except that only the issuer's balance sheet, which shall be dated within 120 days of the start of the offering, must be audited.
The following is the most misunderstood, and probably the most abused, aspect of Rule 504:
Everyone fell in love with 504:
Everyone conveniently forgot:
Investment intent; resales. The issuer reasonably believes that all purchasers are purchasing for investment and not with the view to or for sale in connection with a distribution of the security. Any resale of a security sold in reliance on this [all Accredited Investor] exemption within 12 months of sale shall be presumed to be with a view to distribution and not for investment, except a resale pursuant to a registration statement effective under the Texas Securities Act, §7, or to an accredited investor pursuant to an exemption available under the Texas Securities Act or Board rules. This means the stock sold under this exemption may not be resold for 12 months. Thus, although the stock is free trading under Rule 504, it is not free trading under Texas law and thus may not be deemed free trading for a FINRA 211 filing or any other purpose.
Rule 505 -- Exemption for Limited Offers and Sales of Securities Not Exceeding $5,000,000
A Rule 505 private placement is for offerings that do not exceed $5,000,000, less the aggregate offering price for all securities sold within the twelve months before the start of and during the offering of securities under this Rule 505 or in violation of section 5(a) of the Act.
The following general rules of Reg. D apply:
In addition, the following limitation on number of purchasers applies:
The same information required to be disclosed in a Private Placement Memorandum under Rule 504 is required in a Rule 505 Private Placement Memorandum, except with respect to financial statement if you the offering is for more than $2,000,000, the financial statement information required in Form S-1 for smaller reporting companies is required, subject to the following: If you cannot obtain audited financial statements without unreasonable effort or expense, then only the your balance sheet, which shall be dated within 120 days of the start of the offering, must be audited.
Rule 506 -- Exemption for Limited Offers and Sales without Regard to Dollar Amount of Offering
Rule 506 private placements can be for any amount.
The same restrictions that apply in Rule 505 placements apply in Rule 506 placements, as follows:
The following general rules of Reg. D apply:
The same disclosure information and financial statements required be included in a Private Placement Memorandum in Rule 505 placements apply in Rule 506 placements.
The most important factor in selecting which Rule to use is not found in Reg. D.
Instead, it is related to the fact that you must also comply with state laws when selling your Private Placement, as discussed in detail below.
The easiest private placements to clear under state Blue Sky Laws is a 506 placement. This is because the National Securities Markets Improvement Act of 1996, called NSMIA contains significant provisions that preempt state blue sky registration and review of Rule 506 offerings. However, even if you are doing a Rule 506 placement, you must file a Form D and in most cases a uniform service of process, called Form U-2, and pay a filing fee, which varies from state to state.
Rule 504 and 505 Private Placements may be subject to review on their merits or otherwise be more difficult to clear in the states.
Many practitioners advise their clients to use Rule 506 for this reason.
You’re not quite done yet
There are several other things you must do to assure your Reg. D Private Placement does not violate the law:
Filing of Notice of Sales
You must file with the SEC a notice of sales containing the information required by for each new offering of securities no later than 15 calendar days after the first sale of securities in the offering, unless the end of that period falls on a Saturday, Sunday or holiday, in which case the due date would be the first business day following.
You must file an amendment to a previously filed notice of sales on Form D for an offering if any information in a previously filed Form D needs to be corrected.
Previously, you could only file a Form D in paper format. Now, the Form D must be filed with the Commission in electronic format on the SEC’s EDGAR system.
Every notice of sales on Form D must be signed by a person duly authorized by the issuer.
Make sure you aren’t subject to the disqualifying provision relating to exemptions under Rule 504, Rule 505 and Rule 506
This is a limited “bad boy” disqualification in Regulation D. No exemption under Rule 504, Rule 505 or Rule 506 shall be available for an issuer if such issuer, any of its predecessors or affiliates have been subject to any order, judgment, or decree of any court of competent jurisdiction temporarily, preliminary or permanently enjoining such person for failure to comply with Rule 503 requiring the filing of a Form D.
If you screw up, but only a little, you could still be saved: Insignificant Deviations from a Term, Condition or Requirement of Regulation D
This is the so called innocent and immaterial, or “I and I” savings provision of Reg. D.
It provides that a failure to comply with a term, condition or requirement of Rule 504, Rule 505 or Rule 506 will not result in the loss of the exemption from the requirements of section 5 of the Act for any offer or sale to a particular individual or entity, if the person relying on the exemption shows:
The failure to comply did not pertain to a term, condition or requirement directly intended to protect that particular individual or entity; and
The failure to comply was insignificant with respect to the offering as a whole, provided that any failure to comply with paragraph (c) of Rule 502, paragraph (b)(2) of Rule 504, paragraph (b)(2)(i) and paragraph(b)(2)(ii) of Rule 505 and paragraph (b)(2)(i) of Rule 506 shall be deemed to be significant to the offering as a whole; and
A good faith and reasonable attempt was made to comply with all applicable terms, conditions and requirements of Rule 504, Rule 505 or Rule 506.
Thus, for example, the innocent failure to timely file a Form D will not blow the whole Reg. D exemption.
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