Private Placements And Exempt Offerings
The Securities Act of 1933 (“Securities Act”) requires that every offer and sale of securities either be registered with the SEC or be exempt from registration.
Offering exemptions are found in Sections 3 and 4 of the Securities Act. Section 3 exempts certain classes of securities (for example, government-backed securities or short-term notes) and certain transactions (for example, Section 3(a)(9) exchanges of one security for another). Section 4 contains all transactional exemptions, including Section 4(a)(2), which is the statutory basis for Regulation D and its Sections 4(a)(2) and 506(c). The requirements to rely on exemptions vary from the type of company making the offering (private or public, U.S. or not, investment companies), the offering amount, the manner of offering (solicitation allowable or not), the bad actor rules, the type of investor (accredited) and the amount and type of disclosure required. In general, the greater the ability to sell to nonaccredited investors, the more offering requirements are imposed.
In recent years, the scope of exemptions has evolved stemming from the JOBS Act of 2012, which broke Rule 506 into two exemptions, 506(b) and 506(c), and created the current Regulation A/A+ and Regulation Crowdfunding. The FAST Act, signed into law in December 2015, added Rule 4(a)(7) for re-sales to accredited investors. The Economic Growth Act of 2018 mandated certain changes to Regulation A, including allowing its use by SEC reporting companies, and to Rule 701 for employee stock option plans for private companies. Also relatively recently, the SEC eliminated the never-used Rule 505, expanded the offering limits for Rule 504 and modified the intrastate offering structure.
The most commonly used exempt offerings are Rules 506(b) and 506(c) of Regulation D. Section 4(a)(2) of the Securities Act exempts transactions by an issuer not involving a public offering from the Act’s registration requirements. Section 4(a)(2) does not limit the amount a company can raise or the amount any investor can invest. Rule 506 is a “safe harbor” promulgated under Section 4(a)(2). If all the requirements of Rule 506 are complied with, then the exemption under Section 4(a)(2) would likewise be complied with.
Rule 506 is bifurcated into two separate offering exemptions. Rule 506(b) allows offers and sales to an unlimited number of accredited investors and up to 35 unaccredited investors – provided, however, that if any unaccredited investors are included in the offering, certain delineated disclosures, including an audited balance sheet and financial statements, must be provided to potential investors. Rule 506(b) prohibits the use of any general solicitation or advertising in association with the offering. Rule 506(c) allows for general solicitation and advertising; however, all sales must be strictly made to accredited investors and the company has an additional burden of verifying such accredited status. In a 506(c) offering, it is not enough for the investor to check a box confirming that they are accredited, as it is with a 506(b) offering.
One of the reasons that Rule 506 is the most commonly used is that it preempts state law. That is, as long as the requirements of Rule 506 are adhered to, a company needs only make notice filings in the individual states it offers or sells securities in. Many other exempt offerings do not preempt state law. When a company must review and comply with individual state statutes, the cost of capital increases exponentially.
Regardless of the exempt offering being relied upon, it is extremely important that all of the legal requirements are complied with. Failure to comply with the requirements can lead to:
- State and federal regulatory actions
- Shareholder lawsuits
- Requirements to offer rescission to existing shareholders
- Monetary penalties
- Reputational damage
- A judgment that results in the company being a statutory bad actor, thus prohibiting the ability to rely on most exempt offerings in the future and thus cutting off third-party capital sources
- Criminal repercussions
Navigate These Complex Requirements With Our Help
Exempt offerings come with complex and stringent regulatory standards. Because of this, companies must make sure they collaborate with the right lawyers with the right experience. Schedule an initial consultation with us today by calling 877-541-3263 or emailing us through our contact form.