Chapter 4 - § 4.5 • REGULATION D, RULES 501-508

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§ 4.5 • REGULATION D, RULES 501-508

Regulation D was adopted on March 8, 1982.35 As adopted, it replaced former Rules 146, 240, and 242. Regulation D also created a safe harbor for private offerings. The adopting release and the preliminary notes to Regulation D specifically advise that Regulation D does not preclude reliance on a statutory exemption as well.

• Rules 501-503, 507, and 508 are general, definitional rules.
• Rule 504, adopted under § 3(b)(1), replaced Rule 240 for offerings of small amounts of $5,000,000 or less that the SEC believes do not warrant federal regulation.36
• Rule 505 (also adopted under § 3(b)(1)) replaced Rule 242. Rule 505 is very similar to Rule 506. Rule 505 was eliminated in 2017 and is no longer available.37
• Rule 506 (adopted under § 4(a)(2)) replaced Rule 146 and now consists of two different exemptions — 506(b) (the traditional private placement) and 506(c) (an accredited-investor only offering that can be publicly advertised).

§ 4.5.1Regulation D — Preliminary Notes

Note 1 makes it clear that Regulation D is a transactional exemption. Regulation D only exempts offers and sales of securities from the registration requirements of § 5 of the 1933 Act. Regulation D does not exempt any offer or sale of a security from the anti-fraud requirements or the civil liability provisions of the 1933 or 1934 Acts.

Note 1 also makes it clear that the offeror must provide purchasers with all "material information." This is consistent with the law relating to exemptions other than Regulation D — see, for example, Wright v. National Warranty Co. L.P.,38 in which material information was withheld from an inside investor. The court found that a cause of action existed notwithstanding the investor's status as an insider.

Note 2 reiterates that compliance with Regulation D only exempts transactions from § 5 of the 1933 Act; all offers and sales must also comply with applicable state law.

Note 3 states that attempted compliance with Regulation D does not act as an exclusive election. Other exemptions may also be available.

Note 4 states that the Regulation D exemptions are only available to issuers — these exemptions are not available to other persons selling restricted stock.

Note 5 makes it clear that Regulation D can be used for business combinations that involve the sale of a security under Rule 145 or otherwise.

Note 6 provides that Regulation D is not available for a transaction or chain of transactions which, although in technical compliance with the rules, are part of a plan or scheme to avoid the registration requirements of the 1933 Act.

Finally, Note 7 says that Regulation S is generally applicable for offers and sales of securities made outside the United States.

§ 4.5.2—Rule 501 Definitions

Rule 501(a) defines an accredited investor to include certain banks, 501(c)(3) organizations, and trusts with assets in excess of $5 million; officers, directors, and general partners of the issuer; individuals with a net worth (individual or joint) in excess of $1 million (excluding the value of the person's primary residence39 ) or who have a net income in excess of $200,000 in each of the two most recent fiscal years (or $300,000, if joint), and expect reaching the same level in the current year; and entities in which all of the equity owners are accredited.40

Rule 501 also defines the terms "affiliate," "aggregate offering price," "business combination" (by reference to Rule 145(a)), "calculation of number of purchasers," "executive officer," "issuer," and "purchaser representative." A "purchaser representative" cannot be an affiliate of the issuer, must be sophisticated, and must be acknowledged (in writing) by the purchaser as his or her representative.

§ 4.5.3—Rule 502

Rule 502 sets forth a number of concepts that apply throughout Regulation D. Among these is the concept of "integration of offerings." When offerings are "integrated," they are combined together for the purposes of determining whether an exemption from the registration requirements may be available. In most cases, when offerings are "integrated," the claimed exemption may no longer be available, resulting in a violation of the registration requirements.

Rule 502(a) provides a safe harbor for offers and sales that occur six months or more before commencement of the next offering and after conclusion of the previous offering. Offerings ending before or commencing after the safe harbor periods will not be integrated into the offering. This leads to a number of questions, however:

• When is the commencement of an offering? Does it occur at the time of preparation of the offering circular? The occurrence of preliminary discussions with prospective investors? The delivery of first offering circular to a prospective investor?
• Equally complex is the determination of the completion date of an offering. Does "completion" occur when the last investment is received? When the offering escrow account closes and the proceeds are disbursed? How is completion of an offering determined when payments are to be received over a period of time?

If other offers or sales occur within the six-month time period, the factors in the Note to Rule 502(a) should be considered to determine if integration will result. If offerings are integrated:

1) The offerings may exceed the permissible number of purchasers (resulting in Rules 505 and/or 506 possibly not being available).
2) The offerings may exceed the allowed aggregate offering price (resulting in Rules 504 and/or 505 not being available).

§ 4.5.4Information Requirements

If an issuer sells securities to any purchaser that is not an accredited investor, the issuer must furnish specified information to the offerees. When an issuer supplies information to non-accredited investors, it should supply the same information to accredited investors.

Rule 504 does not require that any specific information be delivered to offerees or purchasers. However, any information the issuer chooses to give in a Rule 504 offering must be accurate and complete in all material respects. In considering the disclosure that should be made to investors in a Rule 504 offering, Preliminary Note 1 to Regulation D should be considered:

Issuers are reminded of their obligation to provide such further material information, if any, as may be necessary to make the information required under this regulation, in light of the circumstances under which it is furnished, not misleading.

Information requirements ("disclosure requirements") under Rules 505 and 506 when non-accredited investors are involved follow the same requirements.41

• If the issuer is not a public company, it must furnish the same information as would be furnished in an appropriate registration statement; financial information may be modified from that required in the registration statement form or Regulation A offering circular. In addition, there is a provision that may eliminate the need for audited financial statements if financial statements cannot be prepared without unreasonable effort or expense; financial statements arguably can be eliminated totally if not "material," but does counsel really want to make that judgment?
• If the issuer is already a public company, it can satisfy the information requirements with all appropriate 1934 Act reports together with a short disclosure of the material aspects of the offering.

Rule 502(b)(2)(iii) specifically requires that exhibits "required to be filed with the [SEC] as a part of a registration statement" be available to investors receiving Regulation D disclosure, including any legal opinions that would be required.42

The issuer must also give the purchasers the opportunity to ask questions and receive answers concerning the terms and conditions of the offering and to obtain any additional information that the issuer possesses or can acquire without unreasonable effort or expense.

The offering memorandum, when properly prepared, will provide protection for the persons selling the securities against unjustifiable reliance by purchasers on other statements inconsistent with the offering memorandum. In Zobrist v. Coal-X, Inc.,43 knowledge of the information contained in the offering memorandum was imputed to the plaintiff even though he testified that he never read the offering memorandum. In First Lincoln Holdings, Inc. v. Equitable Life Assurance Society of the United States,44 the Second Circuit reaffirmed that fraud claims were properly dismissed when the court found that no reasonable investor could have relied on the allegedly fraudulent oral representations, which were directly contradicted by written documents.

In Carr v. CIGNA Securities, Inc.,45 an investor lost his entire investment in limited partnership interests when a salesman had assured the investor that the investment risks were low. The investor acknowledged receiving a disclosure memorandum that he did not read because the salesman assured him it was "boilerplate." The Seventh Circuit affirmed the trial court's dismissal of the claims.46

In another case, the court ruled that meaningful caveats were sufficient to protect an issuer from liability on a private placement memorandum. In Mercury Air Group Inc. v. Perez,47 the private offering memorandum had described the proposed use of proceeds, but concluded by cautioning that "actual expenditures may vary substantially from these estimates, and the Company may find it necessary or advisable to reallocate the net proceeds, . . . or to use portions thereof for other purposes." The court concluded that a reasonable investor "could not have read this portion of the POM without realizing that Jet USA might use the proceeds for expenses not listed therein." The court found that the statements did, in fact, "bespeak caution of precisely the risk" complained of by the plaintiff, and dismissed the complaint.

In Wamser v. J.E. Liss Inc.,48 the court found that accurate disclosure in a private...

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