Regulation D, Rule 506(b), the Most Commonly Used Exemption
A securities offering exempt from registration is sometimes referred to as a private placement, unregistered offering, or exempt offering. Generally speaking, exempt offerings are not subject to some of the laws and regulations that are designed to protect investors, such as the comprehensive disclosure requirements that apply to registered offerings. Rule 506 promulgated under Regulation D is the exemption used for more than 90 percent of all exempt offerings in the United States.[1] It should be noted that Rule 506 offerings, like all Regulation D offerings, are “conditional exemptions” from registration. This means that the issuer must show compliance with the conditions of the rule in order for their securities offering to enjoy an exemption. There are now two types of exemptions available under Rule 506.
Rule 506(b) is an exemption for limited offers and sales without regard to the dollar amount to be raised.[2] Specifically, offers and sales of securities by an issuer are exempt from the registration requirement as long as the company:
- does not use general solicitation or advertising (e.g., any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio,[3] as well as other uses of publicly available media, such as unrestricted web sites[4]);
- sells its securities to an unlimited number of “accredited investors” and up to 35 non-accredited investors;
- gives non-accredited investors disclosure documents that are generally the same as those used in registered offerings, as well as any information it provides to accredited investors;
- is available to answer questions by prospective purchasers; and
- provides certain financial statements.[5]
Of note, “accredited investor” means certain institutional buyers (e.g., banks), certain insiders (e.g., director, executive officer, or general partner of the issuer), or any person whose individual net worth is over $1,000,000 (excluding their primary residence) or who had an individual income over $200,000 (or joint income in excess of $300,000 with his or her spouse) in the two most recent years, among others.[6] In other words, these are purchasers who, by virtue of their wealth, are presumed to have the ability to fend for themselves. Rule 506(b) also requires non-accredited investors to have knowledge and experience in financial and business matters that he or she is capable of evaluating the merits and risks of the prospective investment.[7] The reason for these requirements is to ensure that all purchasers, regardless of their net wealth or income, are sophisticated enough to understand that they are investing in an unregistered offering and can protect their own interests. Interestingly enough, although the rule allows for the participation of non-accredited investors, the SEC estimates that non-accredited investors purchased securities in only about 11% of the Rule 506 offerings conducted between 2009 and 2012.[8] This may be due to the requirement that non-accredited investors be provided disclosure documents that are generally the same as those used in registered offerings, which makes compliance with the rule significantly more burdensome.
There are several benefits of Rule 506 offerings. First of all, there are no limits on the offering amount, so both small and large issuers can take advantage of the exemption. Second, there are no specific required disclosures; the company can decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws and the company provides the same information to non-accredited investors.[9] Last, but not least, Rule 506 offerings are exempt from state securities requirements. The issuer still has to file Form D with the SEC (and possibly with states), which is a simple notice of sales.[10] There may be some state fees associated with such filings, which are usually fairly nominal in amount. Purchasers of Rule 506 securities also need to be aware of the limitations on resale; they are restricted securities and cannot be resold without registration or an applicable exemption.[11] This is why issuers sometimes place a legend on the certificate or other document that the securities have not been registered, and are restricted. Importantly, Regulation D exempts transactions from the registration requirements only, but not from the antifraud, civil liability, or other provisions of the federal securities laws.[12]
In our next post, we will discuss the new Rule 506(c) under Title II of the JOBS Act.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
About the Author
So-Eun Lee – So-Eun Lee is an associate attorney in the New York office of The R. Shawn McBride Law Office, P.L.L.C. She concentrates her practice on business law. So-Eun can be contacted at: (347) 921-0173 or [email protected]. Her profile is available on www.mcbrideattorneys.com.
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C. which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: 407-517-0064; [email protected], or www.mcbrideattorneys.com.
[1] Robert Robins, Practical Implications of the JOBS Act Changes to Private Placements: Rule 506(c), Crowdfunding, and Reg A+, http://www.pillsburylaw.com/siteFiles/Publications/WhitePaperOct2014CorporateandSecuritiesPracticalImplicationsoftheJOBSActChanges.pdf (last visited Apr. 15, 2015) (internal citation omitted).
[2] See generally 17 C.F.R. § 230.506(b).
[3] Id. § 230.502(c).
[4] 65 Fed. Reg. 25,843, 25,851–52 (May 4, 2000).
[5] SEC, Rule 506 of Regulation D, http://www.sec.gov/answers/rule506.htm (last visited Apr. 7, 2015).
[6] 17 C.F.R. § 230.501(a).
[7] Id. § 230.506(b).
[8] 78 Fed. Reg. 44,771, 44,792 (July 24, 2013).
[9] Robins, supra n.2, at 2.
[10] 17 C.F.R. § 230.503.
[11] Id. § 505(b).
[12] Id. § 500.