31. What are the general information disclosure requirements for companies seeking an exemption from registration?
The perfection of an exemption does not completely relieve an issuer’s disclosure requirements. The disclosure document that is generally used by businesses perfecting a registration exemption is the “private placement memorandum” (PPM). The issuer must disclose to potential investors at the time of the offer or prior to the business accepting any offer of investment funds. The PPM is very similar to the prospectus and is similarly demanding in its disclosure requirement. The PPM requirement requires extensive work and effort to prepare, but it is far less burdensome to the business than registering the issuance.
Types of Disclosure
Securities law breaks down the disclosure requirements for issuers of securities based upon the type of investor or purchaser of the securities. The relevant disclosure provision governing issuances is Rule 502(b)(2). It requires that issuers provide both financial and non-financial information. The company is required to provide the equivalent information as is required under SEC Form 1-A. It is important to note that the information disclosure or delivery requirements set forth in Rule 502(b) are only applicable to offerings under certain exemptions. Offerings to accredited investors do not require furnishing information.
• Example: Offerings under Rules 505 and 506 have to provide extensive information to non-accredited investors, while offerings under Rule 504 do not.
• Note: The issuer must always comply with state and federal anti-fraud laws, such as section 11(a), 12(a) and (b), and 10(b) under the ’33 Act. Information that is factually untrue or misleading in any form runs the risk of violating one of these provisions. Generally, if the issuer is not a company that routinely provides reports to the SEC under Sections 13 or 15(d) of the Securities Exchange Act of 1934, it must furnish the following information to the purchaser of the securities.
Non-financial information required by Rule 502(b) includes: the management team; the industry; the type and characteristics of the securities offered; any third-party facilitators in the offering process; and the risks involved in the type of security being offered. More precisely, the required information is listed in Part 1 of the registration statement that the business would be required to use, absent the applicable exemption. This information is deemed necessary to allow the investor to make an informed decision about whether to undertake the investment.
• Note: There is some flexibility in this disclosure requirement, as the introductory language in Rule 502(b)(2)(i) requires the issuer to furnish the specified information “to the extent material to an understanding of the issuer, its business, and the securities being offered.”
Financial information about the business must be disclosed via the financial statements of the business. The extent of disclosure, which can be extremely detailed, depends on the size of the offering. The greater the dollar value the more extensive the disclosure requirements. The amount of required financial information varies between issuances below $2 million, between $2 million and $7.5 million, and above $7.5 million. Generally, the variation is the amount of financial data of the company and whether that information must be audited and certified by the company executives. The information requirement serves to provide the investor with information that may not be available because the business is not required to register the information with the SEC.
• Discussion: Why do you think the information disclosure requirements vary between accredited and non-accredited investors? Why do you think the rules separate the requirements for financial and non-financial disclosures? Why do you think the amount of issuance matters with regards to the amount of information required to be disclosed to investors?
• Practice Question: ABC Corp is attempting to sell securities pursuant to an exemption under Rule 506(c). ABC Corp wonders what actions it should take to remain within the confines of Rule 506(c). Can you explain the types of disclosures that ABC Corp must make?