A private placement is a sale of securities to pre-selected investors and institutions rather than on the open market. It is often used as an alternative to an initial public offering (IPO) for a company seeking to raise capital for expansion. Under the Securities Act of 1933 (Securities Act), any offer or sale of securities must either be registered under the Securities Act or qualify for an exemption from the Securities Act’s registration requirements. Issuers often use Regulation D under Section 4(a)(2) of the Securities Act to exempt their private placements.
Regulation D contains three safe harbors: Rule 504, Rule 506(b), and Rule 506(c). These safe harbors allow issuers to offer and sell their securities without having to register the transaction with the Securities and Exchange Commission (SEC) under the Securities Act. However, it is important to note that the issuer will still need to comply with state securities laws in the states in which it offers or sells its securities.
Complying with the federal and state requirements relating to Regulation D can be a complicated process; and failing to comply with applicable requirements can have serious ramifications for the issuer and individuals selling the securities. Our experienced attorneys can help navigate you through the process and avoid costly pitfalls. Please contact our office and speak with one of our corporate and securities attorneys for more information. A brief summary of Regulation D and the safe harbors it offers is below.
General
- Though not always required, it is generally a best practice to provide each investor with a private placement memorandum (PPM).
- A PPM is a document that describes the issuer selling the securities, the terms of the offering, and the risks of the investment, and other matters relevant to the investor’s investment in the issuer.
- Providing a PPM to investors, even when not technically required, helps to avoid the possibility of misleading investors or triggering the anti-fraud provisions of federal or state securities laws.
- A PPM may not be required or beneficial if the issuer is already subject to the SEC’s reporting requirements under section 13 or 15(d) of the Securities and Exchange Act of 1934 (Exchange Act).
- An issuer relying on a Regulation D safe harbor must file a Form D with the SEC no later than 15 days after the first sale of any of the offered securities.
- Form D is a relatively simple form used for disclosing information about the offering, including the amount and value of the securities sold, whether broker-dealers are used, and the states where the securities are offered and sold.
- Filing a Form D requires the issuer of the securities to have SEC access codes. If you do not already have SEC access codes, our office can help acquire them for you.
- It is important to note that some states require state filings (separate from Form D) to be submitted prior to any offer or sale of securities. As such, issuers should consult with an attorney and have a general plan for the offering ready prior to commencing any offering of securities under Regulation D.
- The particular safe harbor available under Regulation D depends, in part, on whether or not the securities are being offered to “accredited investors.”
- Accredited investors are investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings.
- Accredited investors include banks, insurance companies, brokers, trusts, and persons who satisfy at least one requirement regarding their income, net worth, asset size, governance status, or professional experience.
Rule 504
- Rule 504 of Regulation D exempts from federal registration the offer and sale of up to $10 million of securities in a 12-month period.
- Issuers must comply with state securities laws and regulations in the states in which securities are offered or sold. This may include registering (i) the issuer, (ii) the individuals offering the securities, and/or (iii) the offered securities with state securities agencies, unless one or more exemptions are available.
- Generally, public solicitation is not allowed and the sellers must have a pre-existing relationship with potential investors. There are, however, exceptions to this rule (for example, if the issuer uses a state registration exemption that requires registration, public filing and delivery to investors of a PPM or other disclosure document).
- The following companies are not eligible to use Rule 504:
- Issuers subject to the SEC’s reporting requirements under the Exchange Act;
- Investment companies;
- Shell companies; and
- Issuers disqualified under Rule 504’s “bad actor” disqualification provisions.
Rule 506(b)
- Rule 506(b) of Regulation D exempts from registration the offer and sale of securities worth an unlimited amount of money and to an unlimited number of accredited investors. However, Rule 506(b) offerings are subject to the following requirements:
- No general solicitation or advertising can be used to market the securities, so the sellers must have pre-existing relationships with potential investors.
- Securities may not be sold to more than 35 non-accredited investors in any 90-day period.
- All non-accredited investors, either alone or with one or more representatives, must meet the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment.
- If non-accredited investors are participating in the offering, the issuer:
- Must give each non-accredited investor a PPM and any other information provided to accredited investors;
- Must give each non-accredited investor certain financial statement information; and
- Must be available to answer questions from prospective non-accredited investors.
- Rule 506(b) provides a federal preemption from state registration and qualification, but the states still have authority to require notice filings and collect state fees.
- Rule 506(b) offerings are subject to “bad actor” disqualification provisions.
Rule 506(c)
- Rule 506(c) of Regulation D exempts from registration the offer and sale of securities worth an unlimited amount of money and to an unlimited number of accredited investors.
- Rule 506(c) permits issuers to broadly solicit and generally advertise an offering, provided that:
- All purchasers in the offering are accredited investors; and
- The issuer takes reasonable steps to verify purchasers’ accredited investor status;
- Verifying the accredited investor status of purchasers for 506(c) offerings is important because, if any purchaser is found to be a non-accredited investor after the fact, (i) the offering would be categorized as a Rule 506(b) offering, (ii) the issuer would lose the ability to conduct general solicitation, and, (iii) if general solicitation was already conducted, the sellers could be liable for violating the provisions of Rule 506(b).
- Rule 506(c) provides a federal preemption from state registration and qualification under Rule 506(c), but the states still have authority to require notice filings and collect state fees.
- Rule 506(c) offerings are subject to “bad actor” disqualification provisions.
Disclaimer
Austin Legal Group, APC (ALG) does not make any representations or warranties, expressed or implied, as to the accuracy, completeness or fitness for a particular purpose of this or any article. This article is meant for general informational purposes only and should not be construed as, and does not constitute, legal advice. No one should take any action regarding the information in this article without first seeking the advice of an attorney. This article does not create an attorney-client relationship. No attorney-client relationship will exist with ALG or any attorney affiliated with it unless a written contract is signed by all parties and any conditions in such contract are satisfied. Please reach out to Gina M. Austin, Esq. by phone at (619) 924-9600 or by email at gaustin@austinlegalgroup.com for more information.
