The Federal Securities Laws provide for a Private Offering Exemption under Section 4(2) of the Securities Act of 1933 (the Act). This provision exempts transactions by a company not involving any public offering from having to meet the registration provisions of the Act. The Securities Exchange Commission has issued Regulation D under Section 4(2). Regulation D provides an additional exemption for transactions in which a company offers or sells securities.
Regulation D sets out the requirements that the company must meet for the sale of the security to be exempt. It creates three specific exemptions, based on the aggregate price of the offering: (1) Rule 504 covers an offering of securities for a total of $1,000,000 or less; (2) if the total offering price does not exceed $5,000,000, the offering may qualify under the Rule 505 exemption, if there are 35 or fewer purchasers other than accredited investors; and (3) Rule 506 may be available if the offerings is for more than $5,000,000, so long as the purchasers include accredited investors and no more than 35 unaccredited purchasers who are experienced and knowledgeable.
Regulation D requires that all offerings be of a limited nature and that each satisfies the general conditions of Regulation D. Regulation D requires that the company must notify the SEC of the offering within certain time limits by filing a Form D. The failure to meet the notice filing requirements will result in the loss of the exemption.
The determination of the offering price depends on whether separate sales of securities are part of the same offering, that is, whether they are “integrated”. The following factors determine whether offers and sales are integrated under Regulation D: whether the sales (1) are part of a single plan of financing; (2) involve issuing the same class of securities; (3) have been made at or about the same time; (4) involve receiving the same type of consideration; and (5) are made for the same general purpose. Nevertheless, any offer or sale of securities that takes place more than six months before the start of a Regulation D offering, or more than six months after the completion of the offering, will not be integrated if the company made no offers or sales of a similar class of securities as those offered under Regulation D during those six-month periods.
To qualify for a Regulation D exemption under Rules 505 or 506, the securities may not be offered or sold through any form of general solicitation or advertising. In addition, securities sold under Regulation D may not be resold unless they are registered under the Securities Act of 1933 or the sale qualifies for an independent registration exemption. As part of the restriction on resales, the company must make a reasonable inquiry to determine if the purchaser is acquiring the security for investment purposes or for resale to other persons. Before each sale, the company must also give each purchaser a written disclosure of the unregistered status of the security and the transfer restrictions on resale. Each share certificate must contain a legend that sets forth the unregistered status and the transfer restrictions on the securities.
Under Rules 505 and 506, specific disclosures must be made to each purchaser, unless sales are made only to accredited investors. The regulations prescribe different disclosures based on the size of the offering. At a reasonable time before purchase, the company must also give any purchaser an opportunity to ask questions and receive answers concerning the terms and conditions of the offering, and to obtain additional information necessary to verify the accuracy of the information furnished, if the information can be obtained by the company without unreasonable effort or expense. Under the requirements of the Act, all companies have an obligation to avoid material omissions and misstatements of fact, including any who offer securities under Regulation D.
Under the Rule 504 exemption, an offer or sale of no more than $1,000,000 of securities may be exempt if it meets certain requirements, including the Rules 501 and 502 restrictions dealing with the manner of sale. Rule 504 contains definitions and standards for determining the aggregate sales price and whether offerings are integrated. The $1,000,000 aggregate offering price maximum for a Rule 504 offering is reduced by the aggregate offering price for all unregistered securities sold within 12 months before the start of, and during the offering of, securities under Rule 504. Unregistered securities include those sold in reliance on any exemption under Section 3(b) or sold in violation of section 5(a) of the Act.
Under Rule 505, an offer or sale can be exempt if: (1) it is made by a company that is not an investment company; (2) it does not exceed an aggregate offering price of $5,000,000, less the aggregate offering price for all unregistered securities sold under any exemption of Section 3(b) or in violation of Section 5(a) of the Securities Act of 1933 within the 12 months before the start of and during the offering of securities; and (3) the company reasonably believes that there are no more than 35 purchasers of the securities in the integrated offering.
In calculating the number of purchasers, a corporation, partnership, or other entity not organized for the specific purpose of acquiring the offered securities is counted as one purchaser. Persons classified as accredited investors usually are the largest group of purchasers excluded from the purchaser calculation. There are many categories of accredited investors, including certain institutional investors, private business development companies, and tax-exempt organizations. Directors, executive officers, and general partners of the company are accredited investors, as are individuals having a net worth in excess of specified amounts, and individuals who have had and expect to continue to have income in excess of specified amounts.
Under the Rule 506 exemption, an offer or sale of securities is exempt if (1) it exceeds $5,000,000, reduced by the total offering price for all unregistered securities sold under the Section 3(b) exemption or in violation of Section 5(a) of the Act within 12 months before the start of and during the offering; (2) the company reasonably believes that there are no more than 35 unaccredited purchasers of the securities in the offering; and (3) the company provides the information required by Regulation D and reasonably believes that each unaccredited investor has sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment. This requirement of sufficient business experience and knowledge can be satisfied if the purchaser has a representative who is capable of evaluating the merits and risks of the investment and who otherwise meets all of the requirements of Regulation D.
Under Regulation D, an “accredited investor” includes certain corporate insiders such as directors and executive officers, as well as any natural person whose individual net worth at the time of the offering is more than $1 million and any natural person whose individual income in each of the two most recent years was more than $200,000, or joint income with that person's spouse was in excess of $300,000 in each of these years, and who reasonably expects an income in the current year of that level.
Please see the following articles for additional information: Federal Intrastate Securities Exemption, Federal Securities Aspects of a Stock Option Grant, Texas Exemption for Employee Stock Option and Similar Plans, Texas Uniform Limited Offering Exemption, Texas Intrastate Exemption, Texas Limited Offering Exemptions.
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