In order to sell securities in compliance with U.S. federal securities, companies must either register the securities with the Securities and Exchange Commission (SEC) or qualify for an exemption from registration. Unregistered securities are sold in private placement transactions. Private placement offerings can generally occur more quickly than registered underwritten offerings.
One safe harbor from registration that is commonly used is Section 4(a)(2) under the Securities Act of 1933 (Securities Act). Another such exemption is Regulation D under the Securities Act.
Regulation D provides an exemption for smaller companies to sell unregistered securities in a private placement transaction. Two securities rules under Regulation D, Rule 504 and Rule 506, can be relied upon by investors if they meet certain criteria. An SEC filing called a Form D must be promptly filed to provide the public with notice about the offering of exempt securities.
In order to rely on the Rule 504 safe harbor, a company cannot sell more than $10 million of securities in a 12-month period. Securities issued under Rule 504 are generally restricted securities. Securities issued pursuant to Rule 504 can be sold to both accredited and non-accredited investors, and there is no limit on the total number of investors that can participate in the offering. An accredited investor is defined under Rule 501 of Regulation D as an individual or entity meeting certain wealth thresholds. For an individual to qualify as an accredited investor, they must have a net worth of over $1 million excluding their primary residence.
The Rule 506 exemption under Regulation D is more frequently relied upon. Unlike Rule 504, offerings under Rule 506 are not subject to a dollar amount limit. There are two exemptions under Rule 506—the Rule 506(b) exemption and the Rule 506(c) exemption.
A company relying upon the Rule 506(b) safe harbor is permitted to sell securities to an unlimited number of accredited investors, but to no more than 35 non-accredited investors. The non-accredited investors must be financially sophisticated, meaning they must have knowledge and experience with evaluating the financial risks of prospective investments.
A company relying upon the Rule 506(c) safe harbor is only permitted to sell securities to accredited investors. Furthermore, the issuer is required to take reasonable steps to verify the accredited status of investors. This generally involves obtaining a written confirmation or certification from each investor of their accredited investor status. Both Rule 506(b) and Rule 506(c) offerings are not subject to state blue sky laws. In other words, the federal securities laws preempt the state blue sky laws.
When offering securities pursuant to Regulation D, investors must file a Form D with the SEC to report basic information about the offering. The Form D must be filed within 15 days of a sale of securities. The information that must be disclosed on a Form D includes the issuer’s name and address, the issuer’s size and industry, the offering and sales amount, the duration of the securities offering, the type of securities offered, the name of any recipient of sales compensation in connection with the offering, and the amount of gross proceeds from the offering.
