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What are “Regulation D exemptions”?
Regulation D is the most commonly used set of exemptions for private placement. It consists of Rules 501-508 of the ’33 Act. In addition to several statutory exemptions from registration, the SEC adopted Regulation D to provide “safe harbors” for issuers of securities. These exemptions are referred to as safe harbors because compliance with these rules will provide for an exemption from the standard disclosure requirements. Unlike the statutory exemptions, such as Section 4(a)(2) or Section 4(a)(5), failure to achieve or perfect an exemption is not completely detrimental to the validity of the securities offering. Rather, if the validity of the issuance under a Regulation D rule is challenged, the issuer can then attempt to assert a statutory exemption for the issuance. As such, Regulation D provides a safe harbor for pursing an exemption and leaves open other possibilities for seeking exemption if somehow the offering runs afoul of the Regulation D exemptions.
• Note: The statutory authority for exemptions under Regulation D are found in Sections 3 and 4. Pursuant to this authority, the SEC used its quasi-legislative authority as an administrative agency to pass these exemption rules.
Regulation D, Rule-Based Exemptions
Regulation D, rules 501, 502 and 503 provide definitions and conditions for the applicable exemptions. Rules 504, 505 and 506, are the substantive exemptions. Rules 507 and 508 lay out the consequences for failing to comply with the requirements of an individual exemption. Taken together, these rules provide for the most commonly employed exemptions to securities registration requirements.
• Note: Each of the rule-based exemptions are discussed in detail below. It is important, however, to remember that the general provisions of Rules 501- 503 apply to each exemption.
Limitations of Regulation D
• Issuer Protections – A notable limitation of Regulation D safe harbor provisions is that they only provide exemptions for the issuers of the securities during the original issuance of the security. The rules do not exempt individuals who later sell those same securities to third parties.
⁃ Note: This restriction is quite important, as some securities sold to equity investors are “restricted” and limit the investor’s ability to resell. The importance of this limitation will be become apparent as we review the available exemptions.
• General Solicitation – Another important limitation is the restriction on the ability to make offers to sell securities to individuals. Many Regulation D exemptions prohibit issuers from soliciting investors to purchase the securities.
⁃ Note: The ability to solicit investors by making offers to sell securities is dependent upon the assumed knowledge and personal wealth of the investor.
• Accredited & Sophisticated Investors – Some exemptions limit the ability to sell securities to a certain number of “accredited investors” or “sophisticated investors”. Accredited investors are individuals with a net worth (not counting their primary residence) of more than $1 million or an annual income of more than $200,000 or institutions (such as banks and insurance companies). A sophisticated investor is an individual who has sufficient knowledge or experience to assess the risks of an offering themselves.
⁃ Note: A sophisticated investor may also be an accredited investor and vice versa. However, it is possible that one may not qualify as the other.
• Discussion: Why do you think the SEC decided to offer rule-based exemptions as safe harbors for the statutory exemptions? Do you think that offering additional protections to issuers against challenges by purchasers is a good thing? Why or why not?
• Practice Questions: What are the primary rules under regulation D? What are the rule-based exemptions from registration of securities and how do these rules relate to the statutory authorizations?