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The offer and sale of securities in the
United States is regulated by the
federal Securities and Exchange
Commission (SEC) and by each state
under what are commonly known as the
blue sky laws. Every offer or sale of
a security must be registered with the
federal and appropriate state agency
unless the offering is subject to an
exemption from registration.
Registration is very time consuming and
expensive process that typically
involves conducting a public offering
through underwriters and the preparation
of a prospectus. Registration should be
avoided by early-stage start-ups, by
issuing stock pursuant to an exemption
from registration. Anti-fraud rules
apply to all transactions involving the
exchange of securities, whether or not
the offering is exempt from registration
under federal or state law.
Anti-fraud rules require that the
persons offering securities disclose any
material information about the business.
Material information is anything that
a reasonable investor would want to know
prior to making an investment decision.
Promoters of
securities offerings should be careful
to comply with state and federal
broker-dealer registration
requirements.
Intrastate Offering Exemption
Section 3(a)(11) of the Securities Act
provides an "intrastate offering
exemption" from the registration
requirements of the federal securities
laws with respect to securities issued
to investors within a single state. To
qualify for the intrastate offering
exemption, the issuing company must:
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Be incorporated in the state
where it is offering the
securities; |
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Carry out a significant amount
of its business in that state;
and |
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Make offers and sales only to
residents of that state.
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There is no monetary limit on the
offering or the number of purchasers. If
any of the securities are offered or
sold to a single non-resident, the
exemption may be lost. Thus it is
critical to determine and document the
residence of each offeree
by means of an investor suitability
questionnaire. If a purchaser
resells any of the unregistered
securities to a person who resides
outside the state within a period of
approximately nine months the entire
transaction, including the original
sales, may violate the Securities Act.
Accordingly, the securities issued under
this exemption should be treated as
restricted securities and should bear a
legend to that effect.
Private Offering Exemptions under
Regulation D.
Rule 505. This rule exempts
certain offerings from the registration
requirements of the federal securities
laws when the issuing company:
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Does not sell more than $5
million of its securities in any
12-month period; |
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Sells the securities to an
unlimited number of "accredited
investors" and up to 35 other
persons (who do not have to meet
any sophistication or
suitability requirements);
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Informs purchasers that they are
acquiring "restricted"
securities, (i.e, the securities
cannot be sold for at least a
year without being registered);
and |
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Does not use general
solicitation or advertising to
sell the securities.
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Accredited Investors.
For purposes of Rule 505
and Rule 506, discussed below, an
"accredited investor" is:
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A
bank, insurance company,
registered investment company,
business development company, or
small business investment
company; |
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An employee benefit plan, within
the meaning of the Employee
Retirement Income Security Act,
if a bank, insurance company, or
registered investment adviser
makes the investment decisions,
or if the plan has total assets
in excess of $5 million; |
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A
charitable organization,
corporation or partnership with
assets exceeding $5 million;
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A
director, executive officer, or
general partner of the company
selling the securities;
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A
business in which all the equity
owners are accredited investors; |
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A
natural person with a net worth
of at least $1 million;
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A
natural person with income
exceeding $200,000 in each of
the two most recent years or
joint income with a spouse
exceeding $300,000 for those
years and a reasonable
expectation of the same income
level in the current year; or
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A
trust with assets of at least $5
million, not formed to acquire
the securities offered, and
whose purchases are directed by
a sophisticated person.
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Rule 505. Rule 505
allows companies to decide what
information to give to accredited
investors, so long as it does not
violate the antifraud prohibitions of
the federal securities laws. But
companies must give non-accredited
investors disclosure documents that
generally are the same as those used in
registered offerings, including
financials (i.e. a private placement
memorandum). The company must also be
available to answer questions by
prospective purchasers.
Issuing companies using the Rule 505
exemption do not have to register their
securities and usually do not have to
file reports with the SEC. However, such
companies must file as "Form D" upon
selling their securities. Form D is a
brief notice that includes the names and
addresses of the company's owners and
stock promoters.
Rule 506.
Rule 506 of Regulation D is
considered a "safe harbor" for the
private offering exemption. Companies
using the Rule 506 exemption can raise
an unlimited amount of money. This safe
harbor is available if the following
standards are met:
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The issuing company cannot use
general solicitation or
advertising to market the
securities; |
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The
issuing company may sell its securities
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;
Issuing companies must decide what
information to give to accredited
investors, so long as it does not
violate the antifraud prohibitions of
the federal securities laws. Issuing
companies must give non-accredited
investors disclosure documents that are
generally the same as those used in
registered offerings (i.e., a private
placement memorandum). |
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The issuing
company must be available to
answer questions by prospective
purchasers; Financial
statement requirements;
and |
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Purchasers receive "restricted"
securities, meaning that the
securities cannot be sold for at
least a year without registering
them. |
As with the Rule 505 exemption, issuing
companies using the Rule 506 exemption
do not have to register their securities
and usually do not have to file reports
with the SEC. However, such companies
must also file a "Form D" upon selling
their securities, just as with Rule 505.
CONTACT US
To speak to an
attorney about
the legal issues related to a private
placement of securities, please contact
us
here, or call
713.650.9700.
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