Regulation D

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Regulation D (also known as Reg D) is a regulation of the U.S. Securities and Exchange Commission (the "SEC"), and is also a term for an investment strategy, mostly associated with hedge funds, based upon that regulation. It also affects individual savings and money market accounts with banks and credit unions, and any other person or entity that wants to sell "securities." It provides a "safe harbor" from the general requirement that all offerings of securities be registered with the SEC, and also exempts certain offerings which total under $5,000,000 from the SEC's registration requirement. It is found at in Title 17 of the Code of Federal Regulations, part 230, Sections 501 through 508. The legal citation is 17 C.F.R. §230.501 et seq.

Contents

[edit] Overview

Regulation D is a set of rules which, if followed, allows an issuer (i.e., the person offering securities for sale) to sell securities without registering them with the SEC. Rule 501 contains definitions that apply to the rest of Regulation D. Rule 502 contains the general conditions that must be met to take advantage of the exemptions under Regulation D. Generally speaking, these conditions are (1) that all sales within a certain time period that are part of the same Reg D offering must be "integrated" (i.e., treated as one offering), (2) information and disclosures must be provided, (3) there must be no "general solicitation", and (4) that the securities being sold contain restrictions on their resale. Rule 503 requires issuer to file a Form D with the SEC when they make an offering under Regulation D.

In Rules 504 and 505, Regulation D implements §3(b) of the Securities Act of 1933 (also referred to as the '33 Act), which allows the SEC to exempt issuances of under $5,000,000 from registration. It also provides (in Rule 506) a "safe harbor" under §4(2) of the '33 Act (which says that non-public offerings are exempt from the registration requirement). In other words, if an issuer complies with the requirements of Rule 506, they can rest assured that their offering is "non-public," and thus that it is exempt from registration.

Rule 507 penalizes issuers who do not file the Form D, as required by Rule 503. Rule 508 provides the guidelines under which the SEC enforces Regulation D against issuers.

For certain persons and entities called "accredited investors," (generally this includes banks, certain other organizations, and people making more than $200,000 per year or with a net worth of over $1,000,000), Regulation D exempts certain offerings of equity from many of the regulatory requirements that impose costs upon standard public offerings. A Reg D offering is intended to make access to the capital markets possible for small companies that could not otherwise bear those costs.

[edit] Exemptions

Regulation D establishes three exemptions from Securities Act registration.

[edit] Rule 504

Rule 504 provides an exemption for the offer and sale of up to $1,000,000 of securities in a 12-month period. The company may use this exemption so long as it is not a blank check company and is not subject to Exchange Act reporting requirements. Like the other Regulation D exemptions, it may not involve use public solicitation or advertising to market the securities, and purchasers receive "restricted" securities, meaning that they may not sell the securities without registration or an applicable exemption.

This exemption may be used for a public offering for which investors will receive freely tradable securities under the following circumstances:

  • The offering is registered exclusively in one or more states that require a publicly filed registration statement and delivery of a substantive disclosure document to investors;
  • The registration and sale takes place in a state that requires registration and disclosure delivery, and the buyer is in a state without those requirements, so long as the disclosure documents mandated by the state in which you registered to all purchasers are delivered; or
  • The securities are sold exclusively according to state law exemptions that permit general solicitation and advertising and you are selling only to accredited investors. However, accredited investors are only needed when sold exclusively with state law exemptions on solicitation.

[edit] Rule 505

Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, securities may be sold to an unlimited number of "accredited investors" and up to 35 other persons who do not need to satisfy the sophistication or wealth standards associated with other exemptions. Purchasers must buy for investment only, and not for resale. The issued securities are restricted, in that the investors may not sell for at least a year without registering the transaction. General solicitation or advertising to sell the securities is not allowed.

Financial statement requirements applicable to this type of offering:

  • Financial statements need to be certified by an independent public accountant;
  • If a company other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the company's balance sheet, to be dated within 120 days of the start of the offering, must be audited; and
  • Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish audited financial statements prepared under the federal income tax laws.

[edit] Rule 506

A company that satisfies the following standards may qualify for an exemption under this rule:

  • Can raise an unlimited amount of capital;
  • Does not use general solicitation or advertising to market the securities;
  • Sale of securities can be to an unlimited number of accredited investors and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated - that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment;
  • Seller must be available to answer questions by prospective purchasers;
  • Financial statement requirements as for Rule 505; and
  • Purchasers receive restricted securities, which may not be freely traded in the secondary market after the offering.

[edit] Accredited Investor Exemption

Section 4(6) of the '33 Act exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million and no public solicitation or advertising is made. However, Regulation D does not address the offering of securities under this section of the '33 Act.

[edit] Investment Strategy

As a hedge fund strategy, Reg. D refers to investment in micro- and small-capitalization public companies that are raising money in private capital markets. Often these securities are hedged by way of a look-back provision or a convertibility option with a floating exercise price.