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What is Regulation D and Why is it Important?
Navigating the Complex SEC Rules for Investing
SEC Registration or Exemption? A Crucial Decision for Companies
Any company raising investor capital in the United States must either
(1) register its securities offering under the Securities Act of 1933 (the “Securities Act”) with the Securities and Exchange Commission (“SEC”)
(2) seek and rely upon an applicable exemption from registration with the SEC.
One such exemption from registration is Section 4(a)(2) of the Securities Act broadly providing that no public offering was involved within the meaning of the Securities Act; such an exempted offering is often referred to as a “private placement.”
However, in addition to the federal regulations, each state in the U.S. has its own securities act and associated exemptions from registration with state regulatory bodies, each, in turn, varying by degrees from their federal counterparts. Over time, all of this variation led to a great deal of confusion. All of that confusion ultimately led to the adoption of the SEC’s Regulation D (“Reg D”) to provide a national safe harbor exemption that preempted some aspects of state securities regulation.
Reg D: An Alternative to Registration
Generally speaking, Reg D allows a given company, if it satisfies certain conditions and restrictions, to raise equity capital for the company by selling the company’s securities without being required to register the company’s equity offering with the SEC. Registering an equity offering is, for any company, a complex and costly process – typically prohibitively so for smaller businesses. Properly complied with, Reg D gives “safe harbor” to private placements in the form of an exemption from SEC registration and some state regulation as noted above.
Reg D itself is composed of various rules having their own conditions and restrictions (such as Rules 504, 505, 506(b), and 506(c)). It’s important to note that it limits investor participation, for all practical purposes, to those classified within Reg D as “accredited investors.”
Accredited investors include high-net-worth individuals, institutional investors, and others. Reg D’s accredited investor classification is intended to permit the Reg D exemptions from registration (and relaxed investor disclosure requirements) only in situations in which investor participants are deemed to have a critical mass of financial sophistication sufficient for them to understand and manage the considerable risks associated with investments that have not gone through the rigorous registration process. That limits the playing field to a smaller pool of investors.
Deciphering the Rules and Regulations
Even if an issuer company and its principals want to take advantage of an applicable safe harbor Reg D exemption, they must still provide the proper framework and disclosure documentation to investors. To the extent any investors are not “accredited investors,” then additional requirements and restrictions would apply. To confirm the issuer company’s reliance on the Reg D safe harbor in any private placement transaction (which is particularly necessary in the context of state securities regulation), the issuer company must complete a document known as a “Form D,” which must be filed electronically with the SEC within fifteen (15) days after the first sale of securities in the private placement.
For companies seeking to raise capital such as startups, commercial real estate developments, and emerging businesses, entrepreneurs and developers should be aware that navigating the intricacies of Regulation D can be complex.
Experienced securities attorneys can advise and structure the fundraising transaction or offering protocol in a manner complying with Reg D and applicable state law. Any misstep by issuers or company principals could lead to potential federal and state civil and/or criminal penalties, invalidation of the private placement exemption, and rescission of the offering.