In the United States under the Securities Act of 1933 any offer to sell securities must be registered with Securities and Exchange Commission (SEC) or meet certain qualifications to exempt them from such registration. Regulation D (Reg D) contains the rules providing exemption from registration requirements allowing smaller companies to offer and sell securities without the having to register them with SEC. Reg D allows companies to obtain funds faster and avoid costs of registration which many small companies could not bear.
The SEC earlier placed many restrictions upon private placement transaction. Those restriction referred to type and limited number of investors, solicitation and reselling of securities. Regulation D was adopted in 1982 and has been revised several time since then. It has various rules prescribing qualifications needed to meet exemption from registration requirements, numbered 501 to 508.
Rule 501 contains contains definitions that apply to the rest of Reg D offerings. Rule 502 contains general conditions that must be meet in order to be qualified for exemption. Rule 503 requires issuers to electronically file a form D with the SEC which is linked with the Rule 507 that penalizes issuers who don’t file the form D. Rule 508 provides guidelines under which the SEC enforces Reg D against issuers. Rules 504, 505, 506 describe three different types of exempt offerings and set guidelines covering the amount of offered stock, number and type of investors.
Rule 504
Rule 504 provides an exemption for the offer and sale of up to $1,000,000 of securities in a 12-month period. The company may use this exemption so long as it is not a blank check company and is not subject to Exchange Act of 1934 reporting requirements. General offering and solicitations are permitted under Rule 504 as long as they are restricted to accredited investors. The issuer need not restrict purchaser’s right to resell securities.
Rule 504 allows companies to sell securities that are not restricted if one of the following conditions is met:
The offering is registered exclusively in one or more states that require a publicly filed registration statement and delivery of a substantive disclosure document to investors;
The registration and sale takes place in a state that requires registration and disclosure delivery, and the buyer is in a state without those requirements, so long as the disclosure documents mandated by the state in which you registered to all purchasers are delivered; or
The securities are sold exclusively according to state law exemptions that permit general solicitation and advertising and you are selling only to accredited investors. However, accredited investors are only needed when sold exclusively with state law exemptions on solicitation.
The SEC is currently seeking comments on a proposal to increase the cap for Rule 504 offerings from $1,000,000 to $5,000,000.
Rule 505
Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, securities may be sold to an unlimited number of “accredited investors” and up to 35 “unaccredited investors” who do not need to satisfy the sophistication or wealth standards associated with other exemptions. Purchasers must buy for investment only, and not for resale. The issued securities are restricted, in that the investors may not sell for at least two years without registering the transaction. General solicitation or advertising to sell the securities is not allowed. Under Regulation D, Rule 505, the SEC must be notified within 15 days after the first sale of the offering.
Financial statement requirements applicable to this type of offering:
Financial statements need to be certified by an independent public accountant;
If a company other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the company’s balance sheet, to be dated within 120 days of the start of the offering, must be audited; and
Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish audited financial statements prepared under the federal income tax laws.
Rule 506
A company that satisfies the following standards may qualify for an exemption under this rule:
Can raise an unlimited amount of capital;
Seller must be available to answer questions by prospective purchasers;
Financial statement requirements as for Rule 505; and
Purchasers receive restricted securities, which may not be freely traded in the secondary market after the offering.
The rule is split into two options based on whether the issuer will engage in general solicitation or advertising to market the securities.
If the issuer will not use general solicitation or advertising to market the securities then the sale of securities can be issued under Rule 506(b) to an unlimited number of accredited investors and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated – that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.
In July 2013, the SEC issued new regulations as required by 2012 Jumpstart Our Business Startups Act. These new regulations add Rule 506(c) to allow general solicitation and advertising for a private placement offering. However, in a Rule 506(c) private offering all of the purchasers must be accredited investors and the issuer must take reasonable steps to determine that the purchaser is an accredited investor.
Accredited investor exemption
Section 4(5) of the ’33 Act exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million and no public solicitation or advertising is made. However, Regulation D does not address the offering of securities under this section of the ’33 Act. This definition is also used in defining the size of investment allowed under Regulation A.
