Securities Act Registration Exemptions

Regulation D• Limits: $ size, # and type of investors• Restrictions: marketing, resales• Requirements: disclosure, SEC filing

(last updated 25 Feb 13)

What are the stakes?

Compare §4(2) exemption to Reg D …

Statute Section 3(b) Safe harbor

§4(2) Rule 504 Rule 505 Rule 506

Issuer Any issuerNo 34 Act, inv cos, blank ch

No inv cos, “bad boys”

Any issuer***

$$ limits None$1 MM

(12 months)$5 MM

(12 months)None

MarketingNo offers to “unqualified”

No general solicitations*

No general solicitations

No general solicitations

# of investors No limits No limits35 non-

accredited***35 non-

accredited***

Type of investorOnly “qualified

investors”No limits

Accredited / non-accred

Accredited / non-accred**

Disclosure“access”

(sliding scale)None

Only to non-accredited

Only to non-accredited

ResalesOnly to “qualified

investors”“restricted”* “restricted” “restricted”

SEC filingNone

(until file RS)Yes Yes Yes

* N/A – if offering state-registered or subject to state exemption for accredited investors** Non-accredited must be sophisticated or have purchaser rep*** amended by Dodd-Frank

§ 4(2) Exempted transactions

The provisions of section 5 shall not apply to … transactions by an issuer not involving any public offering.

________________________________

§ 3(b) Additional exemptions

The Commission may … by its rules and regulations … add any class of securities to the securities exempted as provided in this section, if it finds that the enforcement of this title … is not necessary … by reason of the small amount involved or the limited character of the public offering … [up to] $5,000,000.

Edward F. Greene

• JD, Harvard (1966) • Law professor (avoid military draft);

private practice in NYC (1966-1979)• Director, SEC Div Corp Finance

(1979-1981)• General Counsel, SEC (1981-1982)• Partner, Cleary Gottlieb Steen &

Hamilton (1982 to 2004 – DC, Tokyo, London)  

• First licensed foreign lawyer to practice law (Japan, 1987)

• General Counsel, Citigroup Institutional Clients (2004 – 2009)

• Partner, Cleary Gottlieb Steen & Hamilton

And the Reg D details …(9 hypotheticals)

#1 (overview/disclosure)

E-B Corp., a mail-order furniture retailer, wants to expand its business to the Internet.  It will need $3 million in new capital. 

First Lynch Securities, the company’s investment banker, has identified 30 investors interested in investing – many out-of-state millionaires.   Each will buy $100,000 of E-B stock – total $3 million.  Structure an offering without a formal disclosure document / audited financials.

Consider -- • dollar limits• number of investors • type of investor • disclosure requirements

Statute Section 3(b) Safe harbor

§4(2) Rule 504 Rule 505 Rule 506

Issuer Any issuerNo rep or inv cos, blank ch

No inv cos, “bad boys”

Any issuer *** (no “bad boy”)

$$ limits None$1 MM

(12 months)$5 MM

(12 months)None

MarketingNo offers to “unqualified”

No general solicitations *

No general solicitations

Varies

****

# of investors No limits No limits35 non-

accredited35 non-

accredited ***

Type of investorOnly “qualified

investors”No limits

Accredited / non-accred

Accredited / non-accred **

Disclosure“access”

(sliding scale)None

To non-accredited

To non-accredited

ResalesOnly to “qualified

investors”“restricted”

*“restricted” “restricted”

SEC filingNone

(until file RS)Yes Yes Yes

* N/A – if offering state-registered or subject to state exemption for accredited investors** Non-accredited must be sophisticated or have purchaser rep*** amended by Dodd-Frank / **** amended by JOBS Act

#2 (accredited investor)

Who is accredited? So what? Rule 501

1. Ivan, a home builder, will have his bank buy the stock.  See Rule 501(a)(1).  

2. Iris, E-B's VP for sales, has no investment experience.  See Rule 501(a)(1) / Rule 501(f)

3. Imelda, who owns a $1.3 million collection of shoes.  See Rule 501(a)(5) [and intro].

4. A VC firm with $4 million in assets.  See Rule 501(a)(2).  Compare to 501(a)(3).

5. A state pension fund, with assets of $30 million, run by yahoo.  See Rule 501(a)(1).

6. A "dink" couple:  each with income last year of $160,000.  See Rule 501(a)(6).

7. First Lynch fails to get documentation on the "dink" couple.  See Rule 501(a)(1) [intro].

#3 (general solicitation)

E-B continues with its Rule 506 offering. E-B plans to mail out a cover letter, an offering circular and a reply card to the following potential investors. But it will only sell to accredited investors. See Rule 502(c)  

1. All North Carolina physicians and lawyers with a full-time practice.

2. All chief executives of companies (38 of them) who are members of the NC Furniture Manufacturing Association.

#4 (prior relationship)

E-B hires First Lynch Securities, a registered broker-dealer, to sell the offering.   FL mails an offering circular to the following See Rule 502(c))  

1. FL’s customers who had indicated prior interest in mail-order investments.

2. FL sends a questionnaire to physicians and lawyers with a full-time practice in North Carolina.  The questionnaire asks them to indicate their investment background, wealth, interest in start-up investments. FL then mails the E-B investment package to some.

3. FL sends its customers a newsletter which describes E-B's and others' offerings.

#5 (Reg D coverage)

Tom Paine sells a newsletter to accountants and tax attorneys who advise investor clients.  Tom interviews start-up company officials and analyzes their disclosure documents; he rates and compares these start-up investments.  See Rule 502(c).

#6 (aggregation/integration)

Consider the following sequences.  See Rule 502(a)

• On March 1 E-B sells $10 million in stock to 50 purchasers in an intrastate offering.  On April 1 the company sells $5 million under Rule 505 to 30 purchasers, many of whom are out-of-state residents. Problems?

• On January 1 the company begins a Rule 505 offering.  It sells the final $5 million on April 1.  When can the company begin another Reg D offering?

• The company did not sell stock last year.  On January 1 it begins a Rule 505 offering, which it completes in June 1 after selling $4.5 million.  On May 1 it begins a Rule 504 offering, and it sells $750,000. Problems?

#7 (mistakes)

E-B completes a $7 million offering under Rule 506 to ten investors – all accredited individual and institutional investors. 

Two wealthy individuals were recruited through cold calls and have no pre-existing relationship to the company or its underwriter. 

Some of the big pension funds that purchased now want to rescind.  Can they?  See Rule 508

#8 (personal rep)

You use Rule 506.  Imelda (whose “shoe” collection is worth less than $1 million) wants to invest as a non-accredited investor, but she needs some investment help. She turns to George, an experienced investment adviser.  

• George is an officer of E-B, and he tells Imelda of his position and his conflicting interests.  See Rule 501(h)(1), (h)(4).

• George has no prior relationship with E-B or with Imelda, but he is planning to buy stock in the private placement.  See Rule 501(h)(4).

#9 (Form D)

You use Rule 506.  What do you have to file? If you don’t?

• Name / juris / type• Principal place / industry• Related person• Revenue ranges • Exemption claimed • Offering info – when, what, how

much, for what• Non-accredited investors• Sales commissions – what, who

What else if it’s a reporting company?

Regulation A

Section 4(2) Section 3(b) - Safe harbor

Rule 506 Rule 504 Rule 505 Reg A

Issuer Any issuer***No 34 Act, inv cos, blank ch

No inv cos, “bad boys”

No ‘34 Act, “bad boys”

$$ limits None$1 MM

(12 months)$5 MM

(12 months)$5 MM****

(12 months)

MarketingNo general solicitations

No general solicitations*

No general solicitations

“test waters”

# of investors35 non-

accredited***No limits

35 non-accredited***

No limits

Type of investorAccredited / non-

accred**No limits

Accredited / non-accred

No limits

DisclosureOnly to non-accredited

NoneOnly to non-accredited

Offer circular (unaudited)

Resales “restricted” “restricted”* “restricted” None

SEC filing Yes Yes Yes Yes

* N/A – if offering state-registered or subject to state exemption for accredited investors** Non-accredited must be sophisticated or have purchaser rep*** amended by Dodd-Frank // **** JOBS Act increases to $50 million

The end

Hypothetical #xx

Edgar B has many potential investors -- perhaps more than 35.  How many non-accredited investors are there in the following cases?  

1. Investors Henry and Wilma are married.  Neither is an accredited investor.  Each invests in the company.  See Rule 501(e)(1).  

2. Henry and Wilma are married, and they live together. Henry is an accredited director of the company.  Wilma is not accredited.  Each invests in the company.  See Rule 501(e)(1).  Does Wilma get required disclosure and must she have a purchaser rep?  See Note to Rule 501(e).

3. Bubba and Sissy are brother and sister, and live in different states.  Neither is an accredited investor.  Each owns 50% of corporation Combined Investments, Inc.  Bubba, Sissy and Combined all invest in the company.  See Rule 501(e)(2).

Corp

Bubba Sissy