Regulation D (Reg D) is a set of exemptions to the registration requirement of the Securities Act of 1933. Through Reg D, issuers and sponsors can privately raise capital without having to register their securities with the SEC.
When Regulation D was first established, Rule 506 was a single exemption. However, the JOBS Act added a new section to Rule 506 in 2013. 506(b) retained all of the same requirements as the original, while 506(c) opened up the opportunity to market offerings to investors outside of an issuer's immediate network.
Below are some of the differences between the two rules:
|General Solicitation?||No. Issuers must have a pre-existing relationship with all investors.||Yes. Issuers may openly market their offering to any accredited investor.|
|Investor Requirements?||Accredited investors, plus up to 35
|Accredited investors only.|
|Investor Verification?||Issuers may rely on investor self-certification.||Issuers must verify that investors are accredited.|
|Document Disclosure?||Must provide non-accredited investors with disclosure documents.||No disclosure documents required.|
While Regulation D offerings are exempt from registration with the SEC, both the SEC and the various states require filings providing notice that an offering is occurring. The SEC requires an issuer to file notice on Form D within 15 days of the date of first sale of a Reg D security on the SEC's Edgar System.
Form D contains basic information about the offering and the issuer, including industry, whether a broker-dealer is involved, and the amount being raised. In addition, for each state into which the security is sold, the issuer must file a notice filing within 15 days of the first sale in that state. The majority of states use an online database to allow electronic filing. Additionally, with this notice filing, the states require the issuer to pay a filing fee, usually between $100-$500.
The biggest difference between the 506(b) and 506(c) exemptions in Reg D is the ability to use general solicitation to market and sell securities to new investors. Prior to the JOBS Act in 2013, issuers were restricted to selling securities within their personal networks. This significantly limited the ability for newly established companies or companies located outside of major population centers to raise capital successfully. Since the SEC created 506(c), issuers taking advantage of the new exemption have been able to market their offerings online, vastly expanding their possible reach. Issuers in certain industries, such as commercial real estate, have utilized general solicitation to great advantage.
While marketing and advertising tactics are allowed under general solicitation, it should be noted that unless your employees fall under the issuer exemption, any actual selling of securities must be done by representatives of a registered broker-dealer.
Both Reg D 506(b) and 506(c) require most if not all investors to be accredited. Accredited investor rules were put in place to ensure that investors were sophisticated and financially stable enough to risk their invested capital on private, non-registered investment opportunities.
Investors can meet the requirements for accredited status based on either high annual income or high net worth.
Below are the specific criteria for each:
|Annual Income Requirement||$200,000||$300,000|
|Net Worth Requirement
(excluding primary residence)
While not the case with 506(b), issuers of Reg D 506(c) offerings are required to take reasonable steps to verify the accreditation of investors. Verification is usually done through a registered broker-dealer in order to mitigate regulatory risk and – in the case of a comparatively large amount of investors – bring efficiency to the process.
The accredited investor rule has become a controversial topic among issuers and regulators. The rule was created in the 1980s, when less than 2% of US households met the requirements. Since then, inflation has increased that number to over 10% as of 2013. Some think the outdated rule should be eliminated entirely and replaced with a sophistication test that would allow lower net worth individuals with requisite financial knowledge access to such investments.
Including Foreign Investors
There is no prohibition against bringing foreign investors (“non-U.S. persons”) into a Regulation D, Rule 506 offering. However, the offering documents will need to include additional clauses regarding eligibility of non-U.S. persons to invest and the risks of including non-U.S. persons in a U.S. private securities offering.
Many developed countries have securities laws similar to those in the United States, which may include solicitation prohibitions, registration requirements, or translation of offering documents into the local language, etc. A local securities attorney should review any securities offering that will be made in a foreign country before it is presented to their residents to ensure that it complies with their securities laws. For this reason alone, it may be impractical to make a single offering available to investors from multiple foreign countries.
For issuers, launching a successful Reg D offering can be an expensive and time-consuming endeavor. The cost will differ depending on the offering, but some factors to consider include legal fees, offering administration and subscription, and regulatory compliance on both a federal and state level.
Law firms provide a number of valuable services for issuers of private capital, including formation of private placement memoranda (PPM), subscription agreements, operating agreements, advice on offering structure, and required regulatory filings.
Offering Administration and Subscription
A Reg D raise requires that you capture certain information about investors, get their signatures on the requisite documentation, and collect payment. This can be especially burdensome if you have a high volume of investors or are completing these tasks without the assistance of technology. And communication with investors does not end once your offering is funded. You’ll need to maintain frequent correspondence, sending them management updates, distribution notices, K-1s, financials, and more.
Federal Regulatory Compliance
Issuers of Reg D offerings have specific requirements to maintain compliance with federal securities laws. Proper communication with investors, complying with anti-fraud provisions of the Securities and Exchange Act, including bad actor checks, maintaining books and records, and verifying investor accreditations are just a few examples.
Blue Sky Laws
In addition to federal securities laws, issuers must comply with state securities laws in any state in which securities are being sold. These state securities laws are called Blue Sky laws. While you do not need to complete a full registration in each state when taking advantage of the Reg D exemption, state regulators continue to have the authority to punish issuers for any sort of fraudulent activity in their state. You should be familiar (or have good counsel that is familiar) with the blue sky laws in any state in which you plan to sell securities, as well as your home state. In most states, failure to file on time, or at all, can result in a fine or even harsher punishments. State regulators may require you to return the funds raised or impose sanctions that prevent you from raising capital in the future.
Regulation D offerings account for a large segment of the capital raising market, with $1.7 trillion in transaction volume across 40 thousand offerings in 2017. This was up considerably from the $1.3 trillion in 2016.
Form D data from 2016 indicates that the Reg D market is largely comprised of pooled investment funds, but also consists of a significant number of offerings across industries such as technology, real estate, healthcare, and oil and gas, among others.
Large markets such as New York, San Francisco, Boston, and Chicago have the highest concentration of Form D Filings. However, the distributed access to capital and investment opportunities via online private placements has helped bring about some prominent “middleweights” in a number of diverse markets, including Houston, TX, Vancouver, WA, and Raleigh, NC.