Reg D . . .

refers to Regulation D of the federal Securities and Exchange Commission (SEC), which sets out certain "safe harbor" exemptions to the 33 Act’s registration requirements. These safe harbors have clearly delineated requirements that enable companies to safely sell their shares in private or limited placements without conducting public offerings. Because of their specificity, Reg D exemptions are easier to rely on than the general private placement exemption contained in Section 4(2) of the 33 Act. Whenever possible, one or more of the exemptions spelled out in Reg D should be followed.

The provisions of Reg D are set forth in six rules, the last three of which contain the exemptions. Because of their importance, each of the rules is summarized below.

Rule 501. Rule 501 provides the method of calculating the number of purchasers who can be involved in sales conducted under the exemptions in Rules 505 and 506 and defines the term "accredited investor" as it is used in Reg D. Under circumstances spelled out in Reg D, sales to these accredited investors can be made without counting them toward the maximum number of allowable investors under the exemption. The accredited investor category consists of persons who fall within, or who the issuing company reasonably believes fall within, one of the categories summarized below.

• A director, executive officer or general partner of the issuing company or a director, executive officer or general partner of a general partner of the issuing company.
  

• A natural person whose net worth (individual or jointly with his spouse) exceeds $1 million.
  

• A person who has had individual income of over $200,000 or joint income with his spouse of over $300,000 during each of the last two years and reasonably expects to maintain those minimum income levels in the coming year.
  

• A qualified bank, savings and loan association, or insurance company.
  

• A corporation, partnership or business trust with at least $5 million in assets that was not formed for the purpose of acquiring the offered.
  

• A private business development company that meets the definition contained in the Investment Advisers Act of 1940.
  

• A 501(C)(3) charitable organization with at least $5 million in assets.
  

• Employee benefit plans subject to ERISA that have either a plan fiduciary that is a bank, insurance company or registered investment adviser or total assets of at least $5 million.
  

• A non-business trust with at least $5 million in assets, which is directed by a "sophisticated" person (as defined in Rule 506).
  

• An entity in which all of the equity owners are accredited investors.

Rule 502. Rule 502 describes general conditions that must be met to secure a Reg D exemption. The rule deals with integration, information disclosure, the manner of conducting offerings, and resale limitations.

Integration

The SEC will not integrate (or combine) sales made more than six months prior to or after a Reg D offering so long as within such period the issuing company makes no offers or sales of a same or similar class of securities (other than under certain employee benefit plans).

Information Required

Rule 502(b) provides that no prescribed information need be furnished for offers and sales of up to $1 million under its Rule 504 exemption or where such sales are made only to accredited investors under the Rule 505 and 506 exemptions. For offers above $1 million that include non-accredited investors, the type and degree of disclosure is linked to the size and nature of the offering under Rules 505 and 506. If the offering involves both accredited and non-accredited investors, the issuing company must distribute the information to all investors.

The amount and type of financial and non-financial reporting required varies depending on the size of the offering. Different requirements apply to offerings up to $2 million, between $2 million and $7.5 million and above $7.5 million. Offerings of up to $2 million require disclosure of the type required Item 310 of Regulation S-B. Those between $2 million and $7.5 million require distribution of the kind of information called for in Part I of Registration Form SB-2. If Form SB-2 is unavailable (e.g., if the issuer is a reporting company), the company must supply the kind of information "required in Part I of a registration statement filed under the 33 Act on the form the issuer would be entitled to use." (For most companies this will be Registration Form S-1.) Companies offering more than $7.5 million worth of securities must supply information of the type required in Part I of a registration statement.

Manner of Offering Limitations

Rule 502(c) provides that, with the exception of offerings under Rule 504, the issuing company or anyone acting on its behalf may not publicly solicit or generally advertise in connection with any offer.

Resale Limitations

Rule 502(d) requires issuers to exercise reasonable care in determining that purchasers of their securities are not engaging in illegal private resales. The reasonable care required by the rule includes (but is not limited to)

• Making a reasonable inquiry into whether the purchaser is acquiring the securities for himself or another.
  

• Providing written disclosure to each purchaser prior to sale that the securities are not registered under the 33 Act and cannot be resold unless registered or exempted.
  

• Placing a legend on the stock certificate stating that the securities represented by the certificate have not been registered under the 33 Act and setting forth the restrictions imposed on the transferability of those securities.

Rule 503. This rule requires a written notice of sale to be filed on Form D. The issuing company must file five copies of the form within fifteen days after the first sale in order to receive a Reg D exemption. (Some states require filing before the first sale.)

Rule 504. Rule 504 provides an exemption for issuing companies that are not reporting companies or investment companies. The exemption applies to sales of up to $1 million in securities made during a twelve-month period. Rule 504 permits issuers to make general advertisements and solicitations in connection with an offering. The Rule requires the filing of a timely notice on Form D but the availability of the exemption is not contingent upon filing of the notice.

Rule 505. Rule 505 allows an exemption for offers and sales of securities up to $5 million, subject to offsets for certain types of sales occurring within the past twelve months and throughout the Rule 505 offering. The issuing company, which cannot be an investment company, must meet the disclosure requirements set forth in Rule 502, as well as the offer and resale provisions in Rules 502(c) and (d). Although there may be an unlimited number of accredited investors, Rule 505 requires that the issuer reasonably believe that it has sold securities to no more than thirty-five non-accredited purchasers.

Rule 506. This rule provides an exemption for limited offers and sales of securities without regard to the dollar amount of the offering. Like Rule 505, it limits the number of non-accredited purchasers to thirty-five. Unlike Rule 505, however, Rule 506 requires that non-accredited investors (either alone or with their "purchaser representative") be "sophisticated" before they can purchase company securities. The language of the sophistication requirement reads as follows:

Each purchaser who is not an accredited investor either alone or with his purchaser representative(s) has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that such purchaser comes within this description.

Summary of Reg D. The safe harbor exemptions contained in Reg D are nonexclusive. That is, companies that rely on them need not rely on them exclusively. They may also rely on other exemptions, such as the general 4(2) private placement exemption, to avoid the 33 Act’s registration requirements. Nonetheless, because their detailed requirements make them the safest way for companies to obtain a registration exemption, they should be used whenever possible, even in financings to a single venture capitalist.

The Reg D exemptions do not relieve a company or its management from the need to comply with the provisions of the securities laws in the states in which they offer or sell securities. Also, they do not exempt a company from the federal and state antifraud provisions, such as the 33 Act’s Rule 10b5. The antifraud provisions make it necessary for issuing companies to disclose or make available to offerees material information about the issuing company and the offering even in offerings conducted under exemptions that do not require the disclosure of any prescribed information. Failure to comply with state blue sky laws or the antifraud provisions of the federal and state securities laws can impose serious liabilities on a company and its management. It can even impair a company’s ability to raise money in the future.

Because of the complexity of the federal and state securities laws and the severity of the penalties for failure to comply with those laws, a company should consult experienced counsel before offering or selling any of its securities. Only a qualified professional can assure management that the company’s security offering has been conducted in a manner that will not create significant liabilities for the company and its management. See: Blue Sky Laws, Going Public, Integration, Investment Reps, Investors, IPOs (Initial Public Offerings), Private Placements, Restricted Securities, 10b5, 33 Act.