Federal Securities Lawyer and Founding Attorney of Oberheiden P.C., Dr. Nick Oberheiden, answers FAQs about private placements under Regulation D.
In the U.S., companies generally must register securities offerings with the U.S. Securities and Exchange Commission (SEC). However, several exemptions exist, including two common ones under Regulation D. While Regulation D offers a streamlined alternative to the lengthy and costly registration process, these offerings still demand a carefully planned approach and strict adherence to compliance.
There are many things that company owners and executives should know about Regulation D. Here are some answers to some of the most frequently asked questions.
What Is the Purpose of Regulation D?
Regulation D, created by the SEC under the Securities Act of 1933, provides exemptions from registration requirements, allowing certain companies to offer and sell securities and access capital markets without full SEC registration.
Is Regulation D Still in Effect?
Yes, Regulation D remains in effect. It's important to distinguish this from the Federal Reserve's Regulation D, which deals with bank reserves and was amended in 2020. The SEC's Regulation D concerning securities offerings is a separate set of rules.
What Types of Securities Can Be Offered Under Regulation D?
Companies do not have to go through SEC registration to sell securities. In some cases, they can use Regulation D to avoid the process. Regulation D can be used for a variety of private placement offerings, including:
- Stock options
- Bonds and other debt instruments
- Convertible instruments
- Tokenized offerings
- Other investment contracts
When is Regulation D a Suitable Option for Companies?
Whether a company should use Regulation D depends on the specifics of its securities offering. Companies commonly utilize Rule 504 or Rule 506 within Regulation D, though other exemptions exist. Ideal scenarios for using Reg D include raising capital from accredited investors, seeking private placements, engaging in faster and less expensive offerings, and maintaining confidentiality of fundraising efforts.
What Distinguishes Rule 504 from Rule 506?
Rule 504 and Rule 506 offer different avenues for unregistered securities offerings under Regulation D. Rule 504 limits offerings to $10 million within a 12-month period. Rule 506 has no such limit, making it attractive for larger capital raises, but comes with its own set of restrictions, often involving sales to accredited investors.
Who Qualifies as an "Accredited Investor"?
Regulation D defines accredited investors based on specific criteria. Individuals can qualify based on net worth (over $1 million excluding primary residence) or income ($200,000 annually, or $300,000 with a spouse/partner, for the past two years with an expectation of similar income in the current year). This restriction exists to safeguard less sophisticated investors who may lack the expertise to fully assess the risks associated with these investments. Certain investment professionals and other entities with experience and knowledge on financial and business matters also qualify. Rule 506(c) outlines methods for verifying accredited investor status.
How Does One Execute a Regulation D Private Placement?
A Regulation D private placement begins with choosing between Rule 504 and Rule 506. Rule 506 offers two options: sales to accredited investors and up to 35 non-accredited investors, or sales exclusively to accredited investors with general solicitation permitted. Once the chosen path is determined, the necessary documentation, including a private placement memorandum (PPM) and subscription agreement, must be prepared.
Are There Alternatives to Regulation D Private Placements?
Yes, while Regulation D is common, alternatives exist. These include private placements under Section 4(a)(2) of the Securities Act of 1933 and Regulation A+ (a "mini-IPO"). Strategic planning regarding fund use and future capital raising needs is important in selecting the best option.
How Does Regulation D Differ from Rule 144A?
Regulation D governs the issuance of unregistered securities, while Rule 144A facilitates the resale of unregistered securities among qualified institutional buyers. Rule 144A is not an alternative to a Regulation D offering. It addresses a different stage in the securities lifecycle.
Does the SEC Supervise Regulation D Offerings?
The SEC has enforcement power over Regulation D compliance. While not every private placement is scrutinized, the SEC acts on reported federal securities laws violations. Investor complaints often trigger SEC involvement.
Is Registration Required for a Regulation D Offering?
No, Regulation D offerings are exempt from SEC registration. This is a key benefit of Reg D. However, Form D must be filed with the SEC after the first Regulation D offering, and compliance with state securities laws is also required.
Is a PPM Mandatory in a Regulation D Offering?
While not explicitly mandated by Regulation D, a PPM (or similar document) is essential. It provides material information to potential investors, establishing compliance and fulfilling investor expectations. The SEC also expects to see a PPM (or equivalent) during compliance reviews.
Is a Subscription Agreement Required?
Although not specifically required by Regulation D, a subscription agreement is standard practice. It's a legally binding contract outlining the terms of the securities issuance, complementing the PPM's disclosure function.
What Are the Consequences of Regulation D Violations?
Violating Regulation D (e.g., exceeding the Rule 504 limit or selling to non-accredited investors under Rule 506(c)) can result in administrative and civil penalties from the SEC. Willful violations may lead to criminal prosecution. Penalties can include fines, offering prohibitions, and even criminal charges.
Can Investors Sue for Regulation D Violations?
Yes, investors can sue for Regulation D violations, potentially triggering SEC action. Beyond Regulation D, investors may also pursue claims for fraud and other violations. Meeting the technical requirements of Regulation D does not eliminate all potential liability.
What is the Initial Step in a Reg D Offering?
The first step is consulting with a securities lawyer experienced in Regulation D offerings. They can provide guidance, tailor documentation (PPM, financial statements, subscription agreement, etc.), and ensure compliance throughout the process.
Learn More About Regulation D to Decide If It’s Right for Your Company
Regulation D offers a valuable pathway for companies to raise capital privately, bypassing the complexities of full SEC registration. However, navigating its rules and nuances is difficult. Understanding the distinctions between Rule 504 and 506, the definition of accredited investors, and the importance of proper documentation like PPMs and subscription agreements is paramount. While Regulation D provides exemptions, compliance remains essential. Violations can lead to significant penalties, emphasizing the need for expert guidance.
