Preparing and completing a private offering of securities in compliance with federal and state securities laws can be a daunting task. There are many pitfalls along the way. We have listed below our top list of the headaches we have encountered in practicing in this area over the years.
Explaining securities laws to clients. Federal and state laws are obtuse and opaque. Clients frequently do not fully understand them. My primary goal is to make sure that the client understands the basics outlined below:
All offerings of securities require state and federal registration, absent an exemption.
- The term “security” is broadly defined.
- Registration is impractical and expensive for small offerings.
- Exemption generally involves keeping the offering “private”.
- Exemption does not shield the issuer from liability for fraud.
- Regulation D is one of the primary federal exemptions.
- Investors must be given access to all material information regarding the offering.
Complying with the ban on general solicitation. Regulation D is comprised of Rules 501 through 508 and includes three exemptions from registration under the Securities Act. The three exemptions are contained in Rules 504, 505, and 506. Rules 501 and 502 contain definitions and conditions for these three exemptions. Both Rule 505 and Rule 506 offerings are subject to Rule 502(c)’s restriction on general solicitation and general advertisement. Specifically, Rule 502(c) provides that “neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising.” The terms “general solicitation” and “general advertising” are not defined in Rule 502(c). Rule 502(c) does, however, state that soliciting investors through “(1) any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; [or] (2) any seminar or meeting whose attendees may have been invited by any general solicitation or general advertising” would constitute general solicitation or advertising. Beyond that there is a considerable amount of SEC interpretive material and case law that discuss the problem of general solicitation.
The SEC has stated that determining whether a particular action constitutes a general solicitation is always a product of individual facts and circumstances. In evaluating potential instances of general solicitation, the SEC has focused on the relationship between the solicitor and the potential investor and determined that a general solicitation is not present when there is a “substantive” and “pre-existing” relationship between an issuer, or its broker-dealer, and the offerees. While the SEC expressed in several no-action letters that this type of relationship is not the only way to show the absence of general solicitation, the SEC has not issued any guidance on any other way to evaluate a potential general solicitation. Therefore, the relevant inquiry in determining whether a particular communication constitutes a general solicitation is whether the relationship between the issuer/broker dealer and the offeree is substantive and pre-existing. Issuers often find this approach to be too restrictive when raising capital so there is frequently pressure to exceed the acceptable limits on general solicitation. We have to counsel clients against broad dissemination of offering material. To avoid inadvertent violations we also recommend that issuers take some or all of the following steps:
- Pre-number the offering books.
- Maintain a list of all offerees.
- Designate a very limited number of company representatives who are authorized to disseminate information.
- Document the basis for believing that offerees are accredited investors.
- Obtain confidentiality and non-disclosure agreements prior to dissemination of offering materials.
- Either engage a registered broker/dealer or document the substantive, pre-existing relationship between the issuer and each offeree.
- Avoid the use of unregistered intermediaries such as “finders” (see discussion below).
Integration. Issuers attempting to evade the limitations of the various offering exemptions may be tempted to make a series of sales over a short period of time and claim each sale is a separate offering. The courts and the SEC address this problem through the doctrine of “integration” – taking the purportedly separate offerings and combining (or “integrating”) them into one offering to test compliance with limits on offering amounts and number of purchasers. Regulation D summarizes the factors used to determine whether a series of offers will be integrated, as follows:
(a) whether the sales are part of a single plan of financing;
(b) whether the sales involve issuance of the same class of securities;
(c) whether the sales have been made at or about the same time;
(d) whether the same type of consideration is being received; and
(e) whether the sales are made for the same general purpose.
Regulation D provides a “safe harbor” for offerings made under its conditions at least six months apart from one another. If two offerings occur close in time and do not satisfy the safe harbor, the integration analysis will be a facts and circumstances determination, and it may be difficult to achieve complete certainty that the private offering exemption remains available.
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