1975, March, Pg. 483. Rule 146 and Colorado Private Offerings by Issuers.

• Author: by David R. Johnson

4 Colo.Law. 483

Colorado Lawyer

1975.

1975, March, Pg. 483.

Rule 146 and Colorado Private Offerings by Issuers

483Vol. 4, No. 3, Pg. 483Rule 146 and Colorado Private Offerings by Issuersby David R. JohnsonA so-called "safe harbor" has been constructed by the Securities and Exchange Commission for issuers to offer and sell securities privately without registration. Rule 146,(fn1) which became effective for offerings commencing on or after June 10, 1974, states a number of conditions and stipulates that if an offering is made by an issuer in accordance with all the conditions the offers and sales would be "transactions not involving any public offering" within § 4(2) of the Securities Act of 1933(fn2) and exempt from the federal registration requirement in § 5. Like § 4(2), the rule applies only to issuers and does not apply to resales by holders of outstanding securities.

Every proposal to raise capital which contemplates any form of solicitation should first be analyzed to determine whether the interest to be offered is a "security."(fn3) A result of the continuing evolution of the word "security" is that more types of transactions are being found to fall within the scope of the federal and state securities laws, including their registration requirements.(fn4) If the capital-raising effort is likely to involve the offer and sale of a security, its issuer must set a course at the outset to be able to proceed with the offering without violating the registration requirements. At the same time, the issuer and related persons must consider the applications of the broker-dealer and salesmen licensing requirements under the federal and state securities laws.(fn5) The antifraud provisions,(fn6) of course, pervade every offering and must be given constant attention throughout the course of an offering. While these licensing requirements and the antifraud provisions are beyond the scope of this article, compliance with them is as important as compliance with the securities registration requirements. The sanctions for violations of these various requirements are quite similar.

Even an innocent violation of either the federal or state registration requirement can have devastating consequences for an issuer. The issuer becomes liable to each purchaser for the full amount of the purchase price, less any income received on the securities, upon their tender or for damages if the purchaser no longer owns the securities.(fn7) If the value of the securities declines for any reason, all except the benevolent purchasers are likely to enforce their claims for rescission or damages. The mere existence of such contingent liabilities,

484in the absence of actual claims, can severely interfere with or even destroy the business operations of an issuer. In order not to mislead in violation of the antifraud provisions, the issuer generally must disclose the contingent liabilities in its financial statements. Major lenders will be reluctant to make additional capital available if other investors have easy access to the issuer's existing capital base. Other offerings of securities may be impossible so long as the issuer is subject to substantial contingent liabilities. Careful attention to the securities laws whenever an offer or sale of securities is made by an issuer will prevent many possible problems.Assuming that the security to be offered is not among the special classes exempt from registration under § 3(a), the choices available to the issuer to deal with the registration requirement in the 1933 Act are (i) to use Rule 146 or the vague standards of the traditional private offering exemption under § 4(2), (ii) to use Rule 147(fn8) or the traditional rules of the intrastate offering exemption under § 3(a)(11), (iii) to use Rule 240(fn9), recently adopted by the SEC pursuant to Section 3(b), (iv) to file a notification pursuant to Regulation A (or an offering sheet pursuant to Regulation B for fractional undivided interests in oil and gas rights) for an exemption under § 3(b) or (v) to register in compliance with § 5. Rule 240, which is effective as of March 15, 1975, carves out another exemption under § 3(b) for issuers other than investment companies with securities beneficially owned by not more than 100 persons before and after a sale to permit them to make unregistered sales of securities in an aggregate amount up to $100,000 during any 12-month period. Rule 240 prohibits any general advertising and any payment of sales commissions but, in sharp contrast with Rule 146, it does not impose qualification standards for either offerees or purchasers. With one exception, Rule 240 requires the filing once each calendar year of notices of sales after they occur.

For any particular capital-raising effort, the optimum selection from the list of choices will be determined by the type of security to be offered, the nature and size of the group of potential investors, the period of time available to raise the capital, the amount of money needed and the availability of funds to pay the offering expenses. In these respects, Rule 146 seems to have its fair share of advantages and disadvantages as a capital-raising tool. The rule is neither wholly useless, as some complain, nor a panacea, as some may have naively hoped.

Without attempting to explore every little cove in Rule 146, this article reviews only the basic conditions of the rule and suggests some potential problems which an issuer may confront. Following that review of Rule 146, this article investigates the private offering exemption under Colorado law and considers the similarities and dissimilarities between the conditions of Rule 146 and the standards for that state exemption.

The Relationship between § 4(2) and Rule 146Rule 146 is the progeny of § 4(2) of the 1933 Act. The statute exempts from the federal registration requirement "any transaction by an issuer not involving any public offering." Setting Rule 146 aside, the outer boundaries of this traditional § 4(2) exemption must be divined from court opinions(fn10) and SEC pronouncements(fn11) which, in vague and sometimes conflicting terms, purport to interpret the statutory language. Out of this confusion, certain factors can be isolated. Limiting the number of offerees seems to be important, but staying below any particular number is not alone sufficient to establish the traditional § 4(2) exemption. Restricting offers and sales to sophisticated persons (whatever that means) is important, but not alone sufficient. Making available to each offeree the same types of information that would be included in a registration statement seems to be advisable, but not sufficient. Obtaining investment letters from each purchaser is customary, but not enough. Placing restrictive legends on certificates

485486and issuing stop-transfer instructions are essential precautions, but more is needed. What combination of these factors or others will establish the traditional § 4(2) exemption has never been settled with any certainty, and issuers that have proceeded in reliance upon the traditional § 4(2) exemption have necessarily done so without adequate guidelines in the law. Now Rule 146 states one combination of conditions which, if all are satisfied, will establish the exemption. The rule should help some issuers for some types of offerings.The SEC asserts that Rule 146 is not the exclusive basis for determining whether the § 4(2) exemption is available to an issuer for a particular offering. "[P]ersons may continue to rely on the Section 4(2) exemption [other than Rule 146] by complying with the relevant administrative and judicial interpretations in effect at the time of the transaction."(fn12) It is common speculation, however, that the conditions in Rule 146, by the continuing process of administrative and judicial interpretation, will flow into the vacuum which surrounds the traditional § 4(2) exemption so that the statutory exemption apart from the rule will gradually disappear.

Rule 146 ConditionsThe mode of operation of Rule 146 is set by paragraph (b), which provides in effect that offers and sales of securities by an issuer "shall be deemed to be transactions not involving any public offering within the meaning of Section 4(2)" if they are part of an "offering" made in accordance with all the conditions of the rule. Many of the conditions are couched in language which has had no prior usage in connection with the 1933 Act. Certain conditions must be satisfied in a prescribed sequence. Other conditions require absolute precision in draftsmanship. The text of the rule, and its accompanying SEC release, should be referred to time and time again before and during the course of an offering. Evidence of compliance with every condition of the rule should be carefully preserved so that months or years later the issuer can prove compliance if its claim of the exemption is challenged by either the SEC or a disgruntled investor.

Any discussion of Rule 146 must begin with a consideration of what constitutes an "offering." All the individual offers and sales which comprise a single Rule 146 offering must satisfy the conditions of the rule. Finding the criteria to determine which individual offers and sales must be integrated and viewed as parts of a single offering is a nagging problem. The question frequently arises. For example, in Colorado a real estate developer may organize a series of limited partnerships, with the developer serving as the...