To help combat cost and complexity, the SEC introduced registration exemptions. Essentially, there are workarounds for the regulation process in many instances. Regulation D of the Securities Act of 1933 is the oldest securities registration exemption with the newer Rule 506 B and Rule 506c, which traditionally covered roughly 99% of offerings.
There are three exemptions set forth in Regulation D which are based upon the amount of the offering:
- Rule 504 – offerings not exceeding $10,000,000 but subject to State law;
- Rule 506(b) – unlimited offerings to accredited investors and up to 35 sophisticated but unaccredited investors; and
- Rule 506(c) – unlimited offerings to verified accredited investors ; and
Rule 504 Exemption
The Rule 504 Exemption is available only to an Issuer that is not (1) a SEC reporting company (i.e., the Issuer is not subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “1934 Act”); (2) an investment company; or (3) a “Shell Company” (i.e., a development stage company that either has no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisitions with an unidentified company or companies or other entity).
The Rule 504 Exemption is available only for offerings that do not exceed $10,000,000, less the aggregate offering price for all securities sold by the Issuer within the 12 months before the start of and during the offering in reliance on any exemption under Section 3(b) under the 1933 Act.
The Rule 504 Exemption does not impose a limit on the number of investors who purchase the securities. However, securities offerings under Rule 504 generally have to abide by state regulations wherein Rule 506 offerings are exempt from State registration regulations. Since Rule 504 offerings require separate exemptions or registrations on a state by state basis, it can often be cost prohibitive if dealing with investors in multiple states. We often use Rule 504 when an offering is intrastate, meaning that all investors are residents of a single state. When an offering is intrastate, each state securities division have the only supervisory jurisdiction for intrastate offerings. This means that the SEC will generally not become involved except in criminal circumstances.
Many states have “self exercising” securities exemptions for smaller offerings to limited numbers of investors. This is important information to know whether any state registrations, filings or fees are due for Reg D Rule 504 or intra-state securities offerings. The review must be completed on a state by state basis where each investor resides.
Under 506 B, business owners and investors are able to raise an unlimited amount of money. However, there’s no public solicitation allowed. In other words, the people that you raise money from must have already been in your personal or professional network. Logging into Facebook and Instagram to find strangers to invest in your deal is not allowed. This is certainly a downside, and it’s only one of them.
Rule 506 B of Regulation D is considered a “safe harbor” exemption under Section 4(a)(2) of the Securities Act of 1933. Section 4(a)(2) of the Securities Act exempts from registration transactions by an issuer not involving any public offering. It provides objective standards that a company can rely on to meet the Section 4(a)(2) exemption requirements. Companies conducting an offering under Rule 506(b) can raise an unlimited amount of money and sell securities to an unlimited number of accredited investors. An offering under Rule 506(b), however, is subject to the following requirements:
- no general solicitation or advertising to market the securities
- securities may not be sold to more than 35 non-accredited investors (all non-accredited investors, either alone or with a purchaser representative, 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 company conducting the offering:
- must give any non-accredited investors disclosure documents that generally contain the same type of information as provided in Regulation A offerings (the company is not required to provide specified disclosure documents to accredited investors, but, if it does provide information to accredited investors, it must also make this information available to the non-accredited investors as well)
- must give any non-accredited investors financial statement information specified in Regulation D506 and
- should be available to answer questions from prospective purchasers who are non-accredited investors
506 C is another popular registration exemption option. Like 506 B, this provision allows for an unlimited amount of fundraising. It also allows general solicitation (i.e., advertising), which 506 B does not. In other words, you can seek investors out through Facebook and other social media outlets – strangers are welcome.
However, there’s a catch. Where 506 B allows you to bring in some sophisticated, unaccredited investors, 506 C strictly prohibits it. So, you are completely locked into that small percentage of Americans who are considered “accredited.”
Rule 506 C permits issuers to broadly solicit and generally advertise an offering, provided that:
- all purchasers in the offering are accredited investors
- the issuer takes reasonable steps to verify purchasers’ accredited investor status and
- certain other conditions in Regulation D are satisfied
Purchasers in Rule 506(b) or Rule 506(c) offerings receive “restricted securities.” A company must file a notice with the Commission on Form D within 15 days after the first sale of securities in the offering. Although the Securities Act provides a federal preemption from state registration and qualification under Rule 506(b), the states still have the authority to require notice filings and collect state fees.