Introduction to Regulation D

In this article I give a brief overview of federal Regulation D.  Regulation D is the primary exemption that issuers use for private, limited offerings of securities (also called private placements).

I intend this article as a brief introduction only.  I narrow down to more detail in other articles – for example, I discuss at much greater length the advertising and solicitation limitations of Regulation D in other articles.  Consider also taking a step back for a bird’s eye view of private offerings – see my articles “Introduction to the Federal Exemptions” or “Introduction to Private Offerings.”

Regulation D consists of Rules 501 through 508.  Rules 501 and 502 give definitions and general terms and conditions, including some of the concepts discussed below, i.e. accredited investors, disclosure requirements, limitations on advertising and solicitation, and integration.  Rule 503 requires the filing of a notice on Form D.  Rules 504, 505 and 506 contain the specific exemptions that issuers actually use under Regulation D.  Rule 507 enforces the Form D filing requirement.  Rule 508 relates to defective offerings.

Rule 504 – Offerings up to $1 Million.

Rule 504 permits an issuer (other than an investment company or an Exchange Act reporting company) to sell up to $1 million of its securities during a 12-month period.  Rule 504 does not restrict the number of investors, nor does it require a disclosure document.  Rule 504 does prohibit general advertising and solicitation, however.

Rule 505 – Offerings up to $5 Million.

Rule 505 permits an issuer to sell up to $5 million in securities during a 12-month period. 

Rule 505 permits sales to an unlimited number of accredited investors and to 35 unaccredited investors.  In most other respects, Rule 505 is similar to Rule 506 (next).

Rule 506 – Offerings Beyond $5 Million.

Rule 506 permits an unlimited dollar amount of sales to an unlimited number of accredited investors and to 35 unaccredited investors.  Rule 506 requires that the issuer deliver statutory disclosure documents to unaccredited investors, but not accredited investors.

Rule 506 contains a number of other restrictions (as do Rules 504 and 505), which I will address next.  These restrictions are the heart of any Regulation D analysis.

Accredited Investors.

Rules 505 and 506 distinguish between accredited and unaccredited investors – the issuer may sell to an unlimited number of accredited investors but only up to 35 unaccredited investors.  The definition of accredited investor is given in Rule 501(a).  Accredited investors include directors, executive officers and general partners of the issuer, a natural person whose net worth is at least $1 million, and a natural person with income over $200,000 in each of the last two years or joint income with that person’s spouse over $300,000 in each of those years and who reasonably expects to reach the same income level in the current year. 

Disclosure Requirements.

Rules 505 and 506 (not 504) require the issuer to make statutory disclosures to unaccredited investors.  The law contains detailed requirements for the content and format of the disclosures.  The disclosures include financial and non-financial information.  The scope of disclosure is dependent on the nature of the issuer and the amount of the offering. 

The disclosure requirement can be very costly to issuers, both in terms of the issuer’s time and resources, and the costs of lawyers and accountants in preparing the disclosures.  For this reason, issuers should consider selling only to accredited investors to avoid the statutory disclosure requirement.

No General Advertisements. 

All of Rules 504, 505 and 506 prohibit the issuer from selling securities through any general solicitation or advertising.  It is for this reason that we call these offerings “private placements” or “private offerings.”  The essence of the exemption is private sales, not public sales.

The SEC requires that the issuer have a substantive relationship with each investor before offering securities to the investor.  The issuer must know each investor well enough to ensure that the investment is suitable to the investor.  The issuer may not use any advertisement, article, notice or other communication in any newspaper, TV or similar media, or any seminar where attendees have been invited by any general solicitation or advertising.  This is because in all these cases, the issuer solicits the public-at-large. 

In my experience, issuers run afoul of this requirement in Regulation D more than any other term or condition.  Even though an issuer might find these legal limitations to be overly restrictive, it still must comply with the law.  Ignorance or disapproval of the law is no excuse for noncompliance.

Integration.

The doctrine of integration applies to all offerings under Rule 504, 505 and 506. With integration, the SEC or a court combines two or more offerings into one offering. 

Usually integration applies if an issuer conducts multiple offerings where all of the offerings are part of the same scheme of financing.  For example, an issuer might try to avoid Rule 506’s limitation to 35 unaccredited investors by using two offerings, the first to 34 unaccredited investors and the second to 33 unaccredited investors.  If integration applies, the issuer is deemed to have made one offering to 67 unaccredited investors.  The result is that the issuer is left without an exemption and in violation of securities laws.  Clearly, issuers should protect their offerings from being integrated.

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This article only gives a brief introduction to Regulation D.  I strongly urge you to get competent legal, accounting and tax counsel when you offer securities. 

Call me to schedule a legal consultation: 510-796-9144