Corporate Finance & Securities

Securities Registration and Private Placement Exemptions

Last week we talked about the securities registration requirements for public offerings. This week we’re taking a look at the registration exemptions.

Some Background on Securities Registration Exemptions
Under the Securities Act of 1933 (the ’33 Act), a private securities offering is exempt from the registration statement and prospectus requirements of public securities offerings. Section 4(2) of the ’33 Act provides that the registration requirements “shall not apply to transactions by an issuer not involving any public offering.” Shockingly (if you’re not familiar with federal regulations), the terms “public” and “private” are not defined in the ’33 Act.

In general, an offering is considered to be private when the number of offerees and ultimate purchasers is relatively small, the investment is prudent in the light of the investor’s financial condition, and the investor or someone acting on its behalf has been provided with information similar to that required to be set forth in a Registration Statement. The SEC’s administrative regulations relating to non-public offerings of securities are set forth in the Commission’s Regulation D.

Details of Section 4(2) of ’33 Act – Private Offering Exemption
Section 4(2) of the Securities Act exempts from registration “transactions by an issuer not involving any public offering.”
To qualify for this exemption, the purchasers of the securities must:
(1) have enough knowledge and experience in finance and business matters to evaluate the risks and merits of the investment (the “sophisticated investor”), or be able to bear the investment’s economic risk;
(2) have access to the type of information normally provided in a prospectus; and
(3) agree not to resell or distribute the securities to the public.

Restriction on Public Solicitation and General Advertising
Additionally those seeking exemption under 4(2) may not use any form of public solicitation or general advertising in connection with the offering.

The precise limits of this private offering exemption are uncertain. As the number of purchasers increases and their relationship to the company and its management becomes more remote, it is more difficult to show that the transaction qualifies for the exemption. You should know that if you offer securities to even one person who does not meet the necessary conditions, the entire offering may be in violation of the ’33 Act.

Regulation D
Regulation D contains the rules providing exemptions from the registration requirements, allowing some companies to offer and sell their securities without registering the securities with the SEC. A Regulation D offering is intended to make access to the capital markets possible for companies that could not otherwise afford the costs of registering securities.

While companies using a Regulation D exemption do not have to register their securities and usually do not have to file reports with the SEC, they do have to file a Form D after they first sell their securities. Form D is a simple form that requires disclosure of the names and addresses of the company’s executive officers and stock promoters.

Rule 504

Rule 504 provides companies with an exemption from the registration requirements provided that the following conditions are satisfied:

Maximum Offering: Under Rule 504 issuers may raise up to $1,000,000 in a 12 month period
Maximum Number of Purchasers: There is no limit to the number of purchasers.
Resale of Stock:  Rule 504 allows companies to sell securities that are not restricted if one of the following applies:
(1) 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;
(2) 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
(3) 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 (see definition of “accredited investors” in the “Nitty Gritty Details” section below) are only needed when sold exclusively with state law exemptions on solicitation.
Disclosure of Information to Purchasers: There are no specific disclosure delivery requirements, but as the SEC website points out, “a company should take care to provide sufficient information to investors to avoid violating the antifraud provisions of the securities laws. This means that any information a company provides to investors must be free from false or misleading statements. Similarly, a company should not exclude any information if the omission makes what is provided to investors false or misleading.”
Solicitation and Advertising:  General offering and solicitations are permitted under Rule 504 as long as they are restricted to accredited investors.

Rule 505

Rule 505 provides companies with an exemption from the registration requirements provided that the following conditions are satisfied:

Maximum Offering: Under Rule 505 issuers may raise up to $5,000,000 in a 12 month period.
Maximum Number of Purchasers: Securities may be sold to an unlimited number of accredited investors and up to 35 unaccredited investors.
Resale of Stock:  The issued securities are restricted, in that the investors may not sell for at least two years without registering the transaction.
Disclosure of Information to Purchasers: Rule 505 allows companies to decide what information to give to accredited investors. But companies must give non-accredited investors disclosure documents that generally are equivalent to those used in registered offerings. If a company provides information to accredited investors, it must make this information available to non-accredited investors as well. The company must also be available to answer questions by prospective purchasers.
Additionally, the following financial statement requirements are applicable to this type of offering:
(1) Financial statements need to be certified by an independent public accountant;
(2) 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
(3) 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.
Solicitation and Advertising:  General solicitation or advertising to sell the securities is not allowed.

Rule 506

Rule 506 provides companies with an exemption from the registration requriements provided that the following conditions are satisfied:

Maximum Offering: Under 506 issuers can raise an unlimited amount of capital.
Maximum Number of Purchasers: Sale of securities can be to an unlimited number of accredited investors and up to 35 other purchasers. However, unlike Rule 505, all non-accredited investors, 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.
Resale of Stock:  Purchasers receive restricted securities, which may not be freely traded in the secondary market after the offering.
Disclosure of Information to Purchasers: Same as under Rule 505 (see above).
Solicitation and Advertising:  General solicitation or advertising to sell the securities is not allowed.

Here’s a visual recap of this information:

The Nitty Gritty Details in Rules 501-503

Rule 501

Rule 501 contains definitions that apply to Rules 504, 505, and 506.

Accredited Investor

501 defines an accredited investor as:
(1) a bank, insurance company, registered investment company, business development company, or small business investment company;
(2) an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
(3) a charitable organization, corporation, or partnership with assets exceeding $5 million; (4) a director, executive officer, or general partner of the company selling the securities;
(5) a business in which all the equity owners are accredited investors;
(6) a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase-note that this has recently been amended to exclude the value of one’s home;
(7) a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
(8) a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

Calculation of Number of Purchasers

For purposes of calculating the number of purchasers under Rule 505(b) and Rule 506(b) only, the following shall apply:
The following purchasers shall be excluded:
1. Any relative, spouse or relative of the spouse of a purchaser who has the same principal residence as the purchaser;
2. Any trust or estate in which a purchaser and any of the persons related to him as specified in paragraph (e)(1)(i) or (e)(1)(iii) of this section collectively have more than 50 percent of the beneficial interest (excluding contingent interests);
3. Any corporation or other organization of which a purchaser and any of the persons related to him as specified in paragraph (e)(1)(i) or (e)(1)(ii) of this section collectively are beneficial owners of more than 50 percent of the equity securities (excluding directors’ qualifying shares) or equity interests; and
(4) Any accredited investor.

A corporation, partnership or other entity shall be counted as one purchaser. If, however, that entity is organized for the specific purpose of acquiring the securities offered and is not an accredited investor under paragraph (a)8 of this section, then each beneficial owner of equity securities or equity interests in the entity shall count as a separate purchaser for all provisions of Regulation D, except to the extent provided in paragraph (e)1 of this section.

A non-contributory employee benefit plan within the meaning of Title I of the Employee Retirement Income Security Act of 1974 shall be counted as one purchaser where the trustee makes all investment decisions for the plan.

Rule 502

Rule 502 contains the general conditions that must be met to take advantage of the exemptions under Regulation D. Generally speaking, these conditions are (1) that all sales within a certain time period that are part of the same Reg D offering must be “integrated”, meaning they must be treated as one offering, (2) information and disclosures must be provided, (3) there must be no “general solicitation”, and (4) that the securities being sold contain restrictions on their resale.

Rule 503

Rule 503 requires issuers to file a Form D with the SEC when they make an offering under Regulation D.


Kyle Hulten

When I'm not in the office I enjoy cooking, gardening, and watching my toddler son explore his little universe.