Regulation D, Rule 506
As you can see, the overwhelming popularity of Rule 506 is largely the result of preemption of state securities laws. In fact, an analysis of Regulation D offerings based on approximately 27,000 Form Ds filed between September 15, 2008 and October 18, 2010 shows that even transactions with smaller offering amounts, for which Rule 504 or Rule 505 were specifically designed, overwhelmingly elected to use Rule 506.[1]
Imagine, for example, a small business that proposes to raise $1 million by offering its securities in three states.[2] In a Rule 504 offering, on one hand, the issuer must meet the registration requirements in each of the three states in which it offers its securities, facing three distinct sets of rules and the residual risk that it might inadvertently fail to meet the requirements of one of the states (or federally), generating significant potential liability.[3] In a Rule 506 offering, on the other hand, the issuer need not worry about the state requirements, but it faces the additional burdens of providing prescribed disclosures to purchasers and ensuring that sales are made only up to 35 unaccredited, qualified investors, which would significantly complicate a Rule 506 offering and raise transaction costs.[4] These additional requirements of Rule 506, however, are taken care of if the offering is limited to accredited investors, as the rule imposes no specific disclosure in connection with sales to accredited investors (though some disclosure documents will still be advisable in almost all cases for liability protection purposes).[5] Thus, issuers could rationally conclude that a Rule 506 offering limited to accredited investors would involve overall lower transaction costs than Rule 504 or Rule 505 offerings.[6] Indeed, roughly 80% of all offerings in size range that would qualify for Rule 504 and Rule 505 are made under Rule 506 and limited to accredited investors.[7]
As one commentator points out, this appears to be an unintended outcome of how Regulation D evolved: Rules 504, 505, and 506 were adopted to strike the appropriate balance between capital formation and investor protection, hence the increasing level of protective measures based on the offering amount, to make it easier for small businesses to raise capital.[8] But the burden of compliance with state securities laws seems to outweigh any benefits to be gained from such relative simplicity, forcing small business that otherwise would be more suited for Rule 504 or Rule 505 offerings to opt for Rule 506.
This post was a part of a multi-post blog series on other exemptions under Regulation D and the overwhelming popularity of Rule 506. You can find the other posts by searching our blogs at www.mcbrideattorneys.com. If you have any questions about the content of this blog series or other issues not discussed here, please contact us.
If you have any questions about the content of this blog series or other securities law issues not discussed here, please contact us.
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.
Steps have been taken to verify the contents of this article prior to publication. However, readers should not, and may not, rely on this article. Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.
About the Author
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] Rutherford B. Campbell, Jr., The Wreck of Regulation D: The Unintended (and Bad) Outcomes for the SEC’s Crown Jewel Exemptions, Ohio State Entrepreneurial Bus. Law Journal, Vol. 7.2 (2012), at 295.
[2] Id. at 302.
[3] Id.
[4] Id. at 303.
[5] Id.
[6] Id.
[7] Id.
[8] See generally id.