Under federal securities laws, a business or investment company may not offer or sell securities (raise business capital) unless the offering has been registered with the Securities and Exchange Commission (SEC) or unless an exemption from registration is available. A securities offering exempt from registration with the SEC is sometimes referred to as a private placement offering or an unregistered offering. Private placement offerings generally include the following exemptions: (1) Section 4(a)(2) of the U.S. Securities Act of 1933 Act ("the 1933 Act"); and (2) Regulation D put into effect and enforced by the SEC. Section 4(a)(2) exempts from registration transactions by a business or investment company involving sophisticated investors, which may include non-accredited investors. However, this blog will focus solely on private placement offerings under Regulation D ("Reg D"), including those that fall under Section 3(b)(1) (Rule 504) and Section 4(b) (Rule 506(c)) of the Securities Act of 1933.
What is Regulation D, and how does it apply?
Regulation D (“Reg D”) is a SEC regulation that allows businesses to sell unregistered securities offerings to investors in order to raise business capital. Regulation D specifically includes SEC rules—Rules 504 and 506—two exemptions often relied upon to sell securities as private placement or unregistered offerings. The business or investment company selling the securities is commonly referred to as the “issuer.” Each rule has specific requirements that the issuer must meet.
Rule 504 of Reg D exempts from registration the offer and sale of securities of up to $10 million in a 12-month period. Prior to this recent change in March 2021, issuers conducting a Rule 504 offer from 2017-2021 could only raise up to $5 million from investors and even less than that back in 2015 (only up to $1 million).
Issuers’ Rule 504 Requirements
By default, issuers relying on the Rule 504 Reg D exemption are not allowed to generally solicit or publicly advertise their offerings to investors. Likewise, investors of this offering may resell their shares or interests in the business to other investors only after holding on to their shares for at least one year, except where one of the following situations occur:
1. the issuer offers and sells the securities exclusively in one or more States that
require registration, public filing, and delivery to investors of a substantive
disclosure document before sale;
Issuers of Reg D offers often provide a disclosure document called a private placement memorandum ("PPM") that introduces the investment and discloses material information about the securities offering and the issuer. A PPM should comply with both State and federal securities laws. Although good practice, a PPM is not required nor is it necessary to file such with the SEC. Instead, the SEC requires issuers of Reg D offers to file a disclosure form titled Form D no later than 15 days after the first sale of securities or an agreement to sell. Form D requires brief information about the issuer, its management, and promoters, as well as the offering itself. In addition to Form D, the SEC requires issuers to comply with the federal rule against fraud, misrepresentation, and omission Rule 10b-5). To comply with this rule, an issuer of a Reg D offering should provide full disclosure to prospective investors in the form of a PPM or another document that describes the particular risk factors of the offer.
2. the issuer offers and sells the securities in one or more States that do not
require registration, public filing, and delivery of a disclosure document before
sale, so long as: (A) the securities have been registered in at least one other State
that provides for such registration, public filing, and delivery before sale; (B) the
issuer offers and sells securities in that other State; and (C) the issuer delivers the
disclosure documents to all purchasers in that State(s); or
3. the issuer offers and sells the securities exclusively in a State that allows general
solicitation and advertising, so long as sales are made only to accredited
Lastly, an issuer of a Rule 504 offer must also comply with State securities laws in every State in which its securities are offered or sold. This State compliance requirement can make Rule 504 offers costly. As such, these offers are best for regional investment (investors from 1-4 States).
Under Rule 506(b), businesses and investment companies may raise an unlimited amount of capital from investors. However, these issuers may not use general solicitation or public advertising to obtain these investors. Furthermore, issuers of Rule 506(b) offers may only raise business capital from up to 35 non-accredited investors who also need to be financially sophisticated. Nonetheless, these same issuers can raise money from an unlimited number of accredited investors.
Accredited investors are presumed to have financial sophistication. However, this presumption does not exist for non-accredited investors. Instead, an issuer must show that the non-accredited investors are sophisticated (specific expertise or knowledge of the business or industry) or otherwise have a purchaser representative who satisfies the "sophisticated investor" criteria or who the issuer reasonably believes satisfies this criterion. Lastly, the Rule 506(b) exemption preempts State securities laws. Still, some States may require these issuers to make notice filings and pay filing fees, and the SEC requires a Form D filing
Unlike Rule 506(b), Rule 506(c) permits issuers to raise an unlimited amount of money through general solicitation and public advertising. However, these issuers may only sell to or receive investment dollars from accredited investors.
Issuers’ Rule 506(c) Requirements
1. Issuers of Rule 506(c) offers must take reasonable steps to verify that investors
are accredited. This includes obtaining financial information such as bank
statements, tax returns, or written verifications from the investors’ attorney,
accountant, financial advisor, or broker confirming such status.
2. Like Rule 504 and Rule 506(b), issuers of Rule 506(c) offers are also required to
file a Form D within 15 days after the first sale to investors. However, unlike Rule
504 issuers, Rule 506(c) issuers are not required to comply with State securities
laws. Notwithstanding this State preemption, issuers of Rule 506(c) offers will
have to comply with State anti-fraud laws and pay State filing fees just like issuers
of Rule 506(b) offers.
Although a PPM or some other mandated disclosure form is not required for Reg D offers, it is essential for issuers of Reg D offers to provide investors with all necessary information so that they may make informed investment decisions. In fact, issuers relying on Rules 506(c) and 506(b) are actually required to provide non-accredited investors an opportunity to ask questions regarding the investment. Furthermore, any information provided to prospective investors must be accurate and an issuer must not omit any material facts regarding the offer. Otherwise, the issuer risks a claim of fraud or misrepresentation and enforcement action by the SEC.
Eliminate the Risk of Raising Capital with Reg D
Reg D provides issuers with a relatively cost-effective opportunity to raise business capital from investors. However, Reg D offers can be risky for issuers if they are not implemented in accordance with the appropriate Reg D rules, requirements, and necessary investor education. Therefore, issuers of prospective Reg D offers should consult with a corporate securities attorney before launching their offers. Eliminate your risk and exposure to potential SEC violations by scheduling a consultation with us today!
*co-authored by Elizabeth L. Carter, Esq., Managing Attorney