The Section 4(2) Exemption

The private placement plays an important role in a variety of contexts. The principal role, perhaps, is to provide financing for established companies through a placement made primarily, if not exclusively, to institutional investors, such as insurance companies, pension funds, and the like. Such placements are often handled by investment banking firms receiving, as in the case of a public offering, a commission for their efforts in placing the securities. At the other end of the spectrum, a private placement may be the means by which a start-up company raises its initial capital, often with a view to defraying the costs of undertaking a public offering. Private placements also are relied upon in the issuance of securities by a company in connection with business combinations and isolated asset acquisitions for stock.

In all of the situations described, reliance may be placed on the exemption from registration of securities provided for by Section 4(2) of the Securities Act for transactions not involving a public offering. The availability of the exemption depends in large part upon the administrative and judicial gloss derived from more than 40 years of interpretation. The Commission has also adopted Rule 506 as a private placement “safe harbor” to those complying with all its terms and conditions. Our focus is on Rule 506 and Regulation D, of which it is a part.

The 1954 decision of the Supreme Court in Ralston Purina established the basic principle that the private offering exemption is available only for an offering made exclusively to persons able to fend for themselves.[1] The ability to fend for oneself in this context depends on (1) access to the same kind of information as that which would be included in a registration statement and (2) sophistication of the offerees. A public offering in this view does not depend upon whether the offerees are few or many, and in theory it is possible that an offering to a single person may constitute a public offering.

Although the staff of the Commission, with some judicial support, insisted at times that access to the required information necessitates some type of insider relationship,[2] it seems apparent that the access requirement can be satisfied by economic bargaining power as well.[3] On occasion, the courts have required that the offerees have exceptional business experience or the equivalent level of sophistication.[4] A party claiming the exemption has the burden of proof to establish its availability.[5]

Overview of the Exemptions

Rule 506 replaced Rule 146 as the safe harbor rule for private placements. Since the exemption has been integrated with other exemptions into Regulation D, it is no longer convenient to discuss it as an aspect of Section 4(2), although that section remains the conceptual basis for the exemption. Rule 506 is discussed in the context of Regulation D below.

The Securities Act registration provisions are all pervasive in the sense that Section 5(a) makes it unlawful to use the means or instrumentalities of interstate commerce or the mails to sell unregistered securities. The provision is not as draconian, however, as it appears since there are a number of exemptions from the provisions of Section 5. The most significant exemptions with respect to securities offered by the issuer are (1) the private offering exemption provided for by Section 4(2) of the Securities Act, (2) the intrastate exemption embodied in Section 3(a)(11), (3) the conditional exemptions adopted by the Commission pursuant to its authority to exempt offerings not exceeding $5 million under Section 3(b) of the Securities Act, and (4) the exemption provided by Section 4(6) of the Securities Act for offerings not exceeding $5 million made exclusively to accredited investors. The Commission in March of 1982 integrated several exemptions it had adopted under various numbers that are now obsolete into a single integrated Regulation D. Although Regulation D was prompted by concerns over the efficacy of the “exemptions as they relate to the capital formation needs of small businesses,” some aspects of the Regulation are of potential utility to all issuers.

The Rule 504 and 505 exemptions both rely on the Commission’s authority under Section 3(b) to adopt conditional exemptions for offerings not exceeding $5 million. Rule 506, on the other hand, is predicated on the Commission’s general rulemaking authority and transactions under the Rule are deemed to be transactions that are not public offerings for the purpose of the Section 4(2) exemption. The National Securities Markets Improvement Act of 1996 (NSMIA) extended the Commission’s authority to adopt rules or regulations exempting offerings from the registration or other provisions of the Securities Act that it deems necessary or appropriate in accordance with the public interest or protection of investors. See Securities Act § 28. The Commission, however, has relied on it only to a limited extent in expanding the availability of the exemptions.

An expanded Regulation A exemption and the Section 3(a)(11) exemption supplemented by Rule 147 also remain as alternatives. See Part 15. The Rule 701 exemption for certain type of employee offerings also may available. There is also a Section 4(6) exemption supplemented by Rule 215 that overlaps with Rule 506 ad 505 exemptions and essentially is redundant.

Rule 504 Offerings

Rule 504 subject to qualifications noted below is available to any issuer that is not subject to the reporting requirements of Sections 13 or 15(d) of the Exchange Act and that is not an investment company. The exemption is available irrespective of the issuer’s legal structure (i.e., it may be a corporation, partnership, venture, trust or other entity) or line of business and irrespective of the total number of offerees or purchasers. The exemption, however, is not available for an offering by a Rule 419 blank check company, a defined term that we do not pursue other than say avoid being involved in such offerings. The aggregate offering price of securities sold in reliance on Rule 504 can not exceed $1 million during any 12 month period. Rule 504 offerings do not have to conform to the Regulation D disclosure provisions applicable to Rule 506 and 505 offerings.

If reliance is made on what we refer to as the Rule 504 public offering path, Rule 502(c) of Regulation D[6] (precluding general solicitations or general advertising) and Rule 502(d)[7] (limiting resales and resulting in purchasers acquiring restricted stock), are not applicable. In order for the exemption to be available in this context, however, the offering must be registered and sold in states that require the use of a disclosure document. Further, regardless of the path chosen, the exemption is not from the anti-fraud provisions of the securities laws, and all purchasers should be provided such information as may be necessary to avoid false or misleading statements of material facts. Several states have adopted a version of SCOR (Small Company Offering Registration) as propounded by the North American Securties Administrators Association (NASAA), which can be used for Rule 504 offerings. Overview of SCOR  (Form U-7). SCOR Form U-7  Instructions for Using Form U-7..

Sales under Rule 504 may be made to an unlimited number of purchasers. There is no requirement that the purchasers meet any suitability or sophistication requirement. If, however, the securities are sold by a broker-dealer and are penny stocks under the Penny Stock Suitability Rule (Rule 15g-9), the suitability requirements of that Rule would be applicable and the procedures established by that Rule would have to be complied with. Rule 15g-9 can be avoided at this stage by using an offering price of $5.00 or more. Rule 503 is applicable to a Rule 504 offering; hence, five copies of Form D should be filed with the Securities and Exchange Commission no later than 15 days after the first sale. The failure to file is not a condition to the availability of the exemption, but under Rule 507, in the event of a failure to file, the Commission could obtain an order enjoining the offering because of the failure to file the Form D in which event the exemption would be unavailable.

There are three divergent paths that a Rule 504 offering can take. Under path 1, the offering must comply with an applicable state exemption that limits sales to accredited investors as defined by Rule 501(a) of Regulation D.[8] In that event Rule 504 would not require a disclosure document, preclude a general solicitation or require restrictions on resale. Under the NASAA Model Accredited Investor exemption, however, the issuer must reasonably believe that the securities are being purchased for investment,[9] and the type of publicity that can be given to the offering is limited. Under path 2 (the public offering path), as discussed above, if the securities are registered in a state(s) that requires filing and delivery to investors of a “substantive disclosure document” prior to the sale of the securities and sold exclusively in such state(s) in compliance with such disclosure requirements, neither Rule 502(c) or (d) are applicable.[10] Under those circumstances, the issuer within Rule 504 quantitative limitations can make a public offering, deliver the state disclosure document and the securities purchased are not restricted securities. Under path 3, the securities can also be offered in states that do not provide for the registration of the securities or the use of a disclosure document provided they are registered in a state that does and that disclosure document is use in the states that do not provide for registration.[11] This latter alternative, however, is available only in states that do not provide for registration and the Commission notes in the Release adopting the amendments to Rule 504 that the Commission understands this provision would be applicable only to offerings made in New York and the District of Columbia.[12] Although New York does not generally require registration of a securities offerings, its broker-dealer registration provisions may be applicable and compliance with those provisions are not a simple matter.  NASAA Form to Apply for Accredited Investor Excmption.

Rule 504 is likely to be relied upon to do a public offering by a company that does not expect to be traded on Nasdaq or listed on an exchange. The possibility of doing an offering limited to accredited investors under an applicable appropriate state exemption overlaps with the Rule 506 exemption which would permit raising a greater amount of money in an offering made exclusively to accredited investors without the use of a disclosure document. The advantage of the 504 exemption is that it would not be subject to the restriction on general solicitation provided the state exemption does not limit it. The Uniform Model Accredited Exemption, however, limits to some extent the manner in which the offering can be publicized. See Colorado--Model Accredited Investor Exemption

Accredited Investors

We look at the accredited investor definition primarily in connection with Rule 506 and 505 offering as it is in that context it has its greater significance, but as noted above it also plays a role with respect to one of the paths available under Rule 504. Rule 501(a)(1) covers a wide range of institutional investors including any bank; any savings and loan association;  any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934;  any insurance company as defined in section 2(13) of the Act;  any investment company registered under the Investment Company Act of 1940. Rule 501(a)(3) includes nonprofit tax-exempt organizations with $5 million or more in total assets as accredited investors and also accredits corporations, partnerships, or business trusts with total assets of $5 million or more, provided that such entities have not been formed solely for the purpose of purchasing securities offered pursuant to Regulation D. Rule 501(a) (4) includes any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer. Natural persons who individually or jointly with their spouse have a net worth of $1 million are accredited investors under Rule 501(a)(5) or under Rule 501(a)(6)) natural persons who individually have an income in excess of $200,000 for the two most recent years with an expectation of such income in the current year or natural persons who have joint income with their spouse for such time periods in excess of $300,000. Rule 501(a)(7) accredits trusts (other than business trusts which are included under 501(a)(3)) that: (a) have total assets in excess of $5 million, (b) have not been formed for the specific purpose of acquiring the securities offered, and (c) are directed by a sophisticated person as described in Rule 506. A trust with less than $5 million in assets may be accredited derivatively if the trustee is a bank, savings and loan, or similar institution deemed an accredited investor under Rule 501(a)(1) with respect to purchases made in a fiduciary capacity.

An employee benefit plan within the meaning of ERISA is an accredited investor if the investment decision is made by a plan fiduciary as defined by that Act and is either “a bank, savings and loan association, insurance company, or registered investment adviser,” or if the plan has total assets in excess of $5 million. Employee benefit plans established by states, their political subdivisions, agencies and instrumentalities are on the same footing as employee plans which are subject to ERISA. A self-directed plan in which investment decisions are made solely by persons that are accredited investors is an accredited investor.

All accredited investor categories are significant in terms of a large private placement by an established company or a private company with a significant operating history. Seed money in the historical sense, however, is likely to come from the officer and director category [(a)(4)]; natural persons that can meet the net worth [(a)(5)] or the net income [(a)(6)] categories, or venture capitalist corporation or other legal entity with in excess of $5 million in total assets [(a)(3) category].

Accredited purchasers do not have to be counted for purposes of determining the 35-purchaser limitations of Rule 505 or 506. Rule 501(e)(1)(iv). If sales made pursuant to Rule 505 or 506 are exclusively to accredited investors, and in an offering pursuant to Rule 4(6) (which can be made only to accredited purchasers), no specified disclosure document has to be used. Rule 502(b)(1).

The Rule 505 and 506 Exemptions

The Rule 505 and Rule 506 exemptions are substantially identical except in the following respects:

(1)  The Rule 505 offering cannot exceed $5 million in a 12-month period. A Rule 506 offering can be unlimited in amount.

(2)  Any issuer (including an investment company) can utilize the Rule 506 exemption. There is no disqualification because of prior conduct of persons affiliated with the issuer or a party receiving commissions in connection with the offering. Rule 505 exemption is not available if the issuer or underwriter or persons associated with them are subject to the disqualification (bad boy) provisions set forth in Rule 262 of Regulation A, which is incorporated into Rule 505.

(3)  The 35 nonaccredited purchasers of a Rule 506 offering (but not a 505 offering), either alone or with the assistance of a purchaser representative, must have sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment. Rule 506(b)(2). This is the principal difference between the two rules and the main incentive for utilizing Rule 505. The Rule 506 sophistication requirement described above is applied solely to purchasers and not to offerees (Rule 506(b)(2)(ii)). Note that both Rule 505 and 506 are limited to 35 purchasers, but for the purpose of making this calculation an accredited investor is not a purchaser. See Rule 501(e).

Rule 505 can, except as otherwise noted below, be utilized for an issuer offering by any issuer including, among others, oil and gas companies, limited partnerships and foreign issuers. It cannot be used by an issuer which is an investment company (Rule 505(a)) or issuers disqualified because of certain prior conduct of persons affiliated with the issuer or a party receiving commissions in connection with the offering. Rule 505(b)(2)(iii). The disqualifications are identical to those applicable to the use of Regulation A. An issuer can offer $5 million under the Rule in any 12-month period (Rule 505(b)(2)(i)). The exemption is available to reporting and non-reporting issuers and is not contingent upon being current in filing Exchange Act reports.

An issuer cannot raise more than $5 million pursuant to Rule 505 during a 12-month period.. Included is the aggregate offering price of the securities being offered pursuant to the Rule, the aggregate offering price of securities sold during the preceding 12 months and during the offering in reliance on a Section 3(b) exemption (Rule 504, 505, and Regulation A), or securities sold during the same period in violation of the registration provisions. Rule 505(b)(2)(i). Securities sold in reliance on the Rule 506 exemption are not included provided integration of the Rule 506 and 505 offerings can be avoided. This may be particularly important with respect to securities sold in reliance on Rule 506 to officers and directors on organization of the corporation. Although such persons are accredited investors and, hence, not included in determining the 35-person limitation, sales to accredited investors have to be included in determining the $5 million limitation; it is, accordingly, important to either take such sales into account or be reasonably certain that such sales are not integrated with the Rule 505 offering.

A Rule 505 offering can be made to an unlimited number of offerees provided there is no general solicitation or advertising. Such an offering can involve an unlimited number of accredited purchasers as well as 35 nonaccredited purchasers. Rule 505(b)(2)(ii). The nonaccredited purchasers do not have to meet any sophistication or suitability requirements.  In calculating the number of nonaccredited purchasers for purposes of Rule 505 or 506, a corporation, partnership or other entity is counted as one purchaser unless it is organized for the specific purpose of acquiring the securities being offered in which event each beneficial owner of securities of the entity is counted. Rule 501(e)(2). If a corporation or other entity is not considered a single purchaser because it was formed for the purpose of buying the securities, the provisions of Rule 501(e) excluding certain purchasers, such as a spouse of a purchaser, are applicable in determining the number of purchasers represented by the shareholders (or other interest owners) in the entity. A relative, spouse or relative of the spouse of a purchaser who has the same principal residence as the purchaser, and trusts, estates, and entities in which the purchaser and such related persons own collectively more than 50 percent of the beneficial (equity) interest are deemed one person in determining the 35-person limitation. Rule 501(e)(1). The disclosure requirements are discussed  below.

Restrictions on Resale

All securities issued pursuant to the Rule 505 and 506 exemptions must be acquired by the purchaser without a view to distribution, must be restricted as to resale and the issuer must exercise reasonable care to prevent such resales. Rule 502(d) specifies a number of steps which may be taken (but since, the 1989 amendments are no longer the exclusive means) to establish reasonable care including appropriate disclosure to the purchaser of the restricted nature of the securities and the use of a legend on the stock certificate setting forth the restrictions on transfer. The legend typically states in substance that the securities covered by the certificate have not been registered and can be resold only if registered or an exemption from registration is available. The non-exclusive nature of these provisions is to keep them from being a condition to the availability of the exemption; issuers would, nonetheless, be well advised to follow them. Rule 144 includes securities issued pursuant to Rules 505 and 506 within the definition of “restricted securities” and Rule 144 is the route generally relied upon to resell such securities after compliance with the conditions of the Rule. See BELOW.

Disclosure--Introduction

Under amended Rule 502(b) no disclosure document has to be delivered to accredited investors even if there are nonaccredited investors. This has broad implications, but one specific result of this amendment is that if no disclosure document is used because the offering is intended to be solely to accredited investors and there inadvertently is one or more nonaccredited investors, the exemption, under Rule 508 would not be lost as to accredited investors. See BELOW. The Regulation D Rule 505 and 506 exemptions require the delivery of a private placement memorandum to all non-accredited purchasers. In the case of a reporting issuer, this essentially involves delivering copies of appropriate Exchange Act filings. The private placement memorandum, however, in the case of a non-reporting issuer in many respects is a prospectus without the benefit of review by the Commission’s staff. The private placement memorandum is to be delivered to the purchaser “a reasonable time prior to the sale of the securities” and is to include prescribed information “to the extent material to an understanding of the issuer, its business and the securities being offered.” The information to be included by a non-reporting issuer is divided between non-financial information and financial statement information. The required financial statement information depends upon the size of the offering; the non-financial statement information depends upon the eligibility of the issuer to use various disclosure formats under the integrated disclosure systems.

Disclosure--Reporting Company

A reporting company would ordinarily furnish the annual report to shareholders for the most recent fiscal year, information contained in the most recent proxy statement, and any Form 10-Q or Form 8-K filed since the distribution of the annual report to shareholders. In addition, a copy of the most recent Form 10-K must be furnished if requested in writing. The issuer may, rather than furnishing the annual report to shareholders and the proxy statement, furnish the Form 10-K, a registration statement on Form S-1 or a registration statement under the Exchange Act on Form 10, whichever is the most recent. A reporting company must also furnish a brief description of the securities being offered, the use of proceeds from the offering, and any material changes not reflected in one of the documents furnished. Rule 502(b)(2)(ii)(C). See Rule 502(b).

Non-Reporting Company — Non-Financial Statement Disclosure

 Rule 502(b) provides f the non-reporting issuer is eligible to use Regulation A, it is to use Regulation A level non-financial statement disclosure based on Part II of Form 1-A. If it is not eligible to use Regulation A level disclosure, then it is to include the Part 1 (prospectus) information called for under the registration form that the issuer would be entitled to use if the offering were a registered one. Although it is not clear in this respect we are going to make a few assumptions. Identifying non-reporting issuers that are “eligible to use Regulation A” is not an easy task. Regulation A is available for U.S. and Canadian issuers with their principal place of business in the United States or Canada that are not reporting issuers and that are not investment companies. “Blank check” companies, defined as companies in the development stage with no specific business plan or purpose or a business plan to merge with an unidentified company or companies, are ineligible for Regulation A. Beyond that issuers may be disqualified from using Regulation A under the “bad boy” provisions, including prior “misconduct” by persons associated with the issuer and underwriter. There is also a quantitative limitation on the availability of Regulation A and although it leads to some curious situations it appears clear that it is not  to be taken into account in determining eligibility to use Regulation A for this purpose. In particular, literally it results in allowing a larger offering to be made using Regulation A disclosure than Form S-1 disclosure.

Release (33-6996, Apr, 28, 1993, 1993 WL 132095) in which the  Rule 506/505 disclosure was adopted states: “Historically, the information required to be delivered to non-accredited investors in connection with offerings under Rules 505 or 506 depended upon the dollar amount offered. In its Small Business Initiative, however, the Commission...shifted the eligibility criteria for streamlined offering documents from the amount being offered to the size of the issuer. The non-financial statement requirements of Rule 502 have been amended to reflect this revised eligibility criteria” Subsequently, the same Release states as follows: “As amended today, the non-financial statement informational requirements in Rule 502 depend upon the issuer's eligibility to use a particular registration statement form or Regulation A. The dollar amount of the particular offering is no longer determinative.” The Release in which small business issuers became obsolete and the new smaller reporting company regimen was introduced does not change the non-financial information required and referenced in the earlier Release.

What this overlooks is (1) a company that would not be a smaller reporting company because of its revenues (over $50 million) may be a non-reporting company and eligible insofar as I can determine to use Regulation A and, hence, Regulation A disclosure. A Google, for example, prior to going public under this hypothesis could make a $100 million private placement relying on Rule 506 and use Regulation A non-financial disclosure. On the other hand a smaller reporting company that had previously registered a modest size offering and, hence, is a reporting company could not use Regulation A disclosure.  The alternatives available to a non-reporting company (Rule 502(b)(2)(i)(A)) are modified by the introductory clause “furnish…to the extent material to an understanding of the issuer, its business and the securities being offered.” On that basis, arguably Regulation A disclosure would not be appropriate for a non-reporting company that would not be a smaller reporting company because it has revenues in excess of $50 million.

A corporate issuer selling securities pursuant to Regulation A has three choices regarding preparation of the narrative disclosure portion of the Offering Circular. First, a corporate issuer may use "Model A," which is a replication of the Form U-7 registration form adopted by the North American Securities Administrators Association in 1989 as a model registration form for small corporate offerings. NASAA, however revised the Form U-7 on September 28, 1999 and the page to the links to the revised Form includes the following notation:

NASAA revised the Form U-7, Disclosure Document on September 28, 1999. The revised Form U-7 has not been adopted by the Securities and Exchange Commission for use as the disclosure document in connection with Regulation A. If you intend to qualify your offering of securities under SEC Regulation A using Model A as the disclosure document, you may be required to use Form U-7, Small Corporate Offering Registration, adopted April 29, 1989.

Second, corporate or other issuers may furnish the information specified in Model B of Part II of Form 1-A. Finally, as a third alternative corporate or other issuers mau use Form S-1 with the election to use the smaller reporting company disclosures built into Regulation S-K except as to financial statements which may comply with Part F/S of Form 1-A. The election to use Part I of Form S-1 as the disclosure vehicle does not differ except as to financial statements from disclosure of smaller business companies registering securities on Form S-1.

The disclosure required by Model A is as extensive or more so than the information called for under the other formats, but is to be presented in a question and answer, "fill in the blank" format, which has not been the form of traditional corporate financing disclosure documents in the United States. The required disclosure includes a number of familiar categories of items, including risk factors; business and properties; offering price factors; use of proceeds; capitalization; description of securities; plan of distribution; dividends, distributions and redemptions; officers and key personnel; directors; principal stockholders; management relationships; transactions and remuneration; litigation; and federal tax matters. Although the required disclosures are thorough, there may be some advantages for inexperienced preparers due to the "fill in the blank," short-answer format. Model A to some extent serves as a checklist that guides one through the disclosure process on a step-by-step basis and may be less intimidating to the uninitiated preparer of securities law disclosure documents.

Model B in a number of areas is somewhat less than would be required if the issuer followed the Form S-1 scaled disclosure for a smaller reporting company. We assume, particularly in view of the fact that the Form U-7 information called for no longer conforms with the NASAA revised Form U-7, now dated that most issuers will uitilize Model B for preparing the offering statement. Model B requires  (Form 1-A, Model B, Item 6) an extensive description of the business for the past five years (or such shorter period in existence). Model B calls for the location of principal plants and other property, and if the issuer's ownership is less than 100 percent a description of the limitations on its ownership, including any encumbrances. Model B requires a description of the issuer's plan of operations for the next twelve months, but only if it has formulated such a plan. If it has not, it must explain why it was unable to do so. It must also state whether the offering will satisfy its cash requirements and whether it will be necessary to raise additional funds within the next six months. Model B does not require an MD&A. Model A calls for management's discussion and analysis of a number of specified factors, including profit margins; trends in operating results, and, if operating at a loss, the causes of underlying losses from operations and what steps the company has taken or will take to address them.

Model B has a $50,000 transaction (or series of related transactions) threshold before disclosure is required of transactions with management. Model B lumps together promoters with the other insiders and requires that transactions with such persons be disclosed if the issuer was organized within the past three years. The promoter transactions that have to be described, are limited to those that occurred within the past two years or are currently proposed. Model B requires, as to any transaction required to be described that involves the purchase or sale of assets, that the cost to the purchaser be set forth, and if the seller acquired it within two years prior to the transaction, the cost to the seller.

Model B requires a tabular presentation for each class of equity securities of any person or group known to the issuer to be the beneficial owner of more than 10 percent of the class, and for each director and nominee setting forth the amount of shares owned and percent of the class, and for the three highest paid persons who are officers and directors.

The general information relating to officers, directors, and key personnel under Model B requires, the names, ages, positions and offices to be listed for all directors, executive officers, nominees and significant employees together with a brief description of each such person's business experience during the past five years. Model B also requires disclosure of any family relationship among such persons (other than key personnel). Model B calls for disclosure, if material to the evaluation of the ability or integrity of executive officers, directors, nominees, promoters or control persons, and if occurring during the past five years, of a petition under the Bankruptcy Act or state insolvency law and conviction in a criminal proceeding.

Under Model B compensation has to be set forth for each of the three highest paid persons who are officers or directors and for the officers and directors as a group during the last fiscal year. The number of persons in the group must be set forth, without naming them. "If either the Model A or Model B alternative is followed, none of the compensation tables required by Item 402 of Regulation S-K. Model B requires disclosure for the named officers and directors of the capacities in which the compensation was received and the amount of aggregate remuneration paid each such person for the last fiscal year. The information relating to officers and directors as a group is in terms of aggregate remuneration of the group.

Model B does not call for the extensive information relating to options and SARs that is now required as part of the executive compensation disclosures under Regulation S-K. Rather, as part of the security holdings section, it calls for a relatively simple table showing, for the named officers and for the officers and directors as a group, the title and amount of securities held as options, warrants, or rights, the exercise price, and the exercise date of same.

Form S-1 disclosure including scaled disclosure choices of a smaller reporting company is discussed at PART 12 No express provision is made for determining whether the issuer is a smaller reporting company for purpose of Regulation A or Rules 505 or 506. We assume that it will be in a manner similar to a registered offering or if the issuer (and we are talking about non-reporting company) has no float on whether its revenues are less than $50 million. Regulation S-K, Item 10(f)(1)(iii), 17 C.F.R. § 229.10(f)(1)(iii).

Non-Reporting Company — Financial Statement Disclosure

The required financial statements for non-reporting companies is specified by Rule 502 (b). In the case of non-reporting issuers, the financial statements for offerings up to $2 million are to include "[t]he information required in Article 8 of Regulation S-X ... except that only the issuer's balance sheet, which shall be dated within 120 days of the start of the offering, must be audited. These are the financial statements that have to be filed by a smaller reporting company except as to the audit requirements.. The financial statement disclosure for offerings between $2 million and $7.5 million are those that a smaller reporting company would file on Form S-1 which also are those required by Article 8 of Regulation S-X. If the  issuer "cannot obtain audited financial statements without unreasonable effort or expense, then only the issuer's balance sheet, which shall be dated within 120 days of the start of the offering, must be audited If the offering exceeds $7.5 million, which would have to be a Rule 506 offering, the financial states  that would be required if the securities were registered on the Form that would be appropriate for the  offerings. If the company would be a smaller reporting company; presumably it could use Article 8 financial statements. Otherwise it would the Article 3 of Regulation S-X financial statements.

Other Disclosure

The issuer in Rule 505 and 506 offerings must afford all purchasers a reasonable time prior to purchase the opportunity to ask questions and receive answers from the issuer’s representatives and to obtain additional information necessary to verify the accuracy of the information furnished if it can be obtained without unreasonable effort or expense. Query, however, if no information is furnished to accredited investors whether they must be afforded such an opportunity since in that event there is nothing to verify. Whatever may be the appropriate construction, the issuer should afford accredited investors such an opportunity, particularly, if there has been no other disclosure in order to avoid violations of the anti-fraud provisions of the Securities Acts.

The issuer must prior to purchase furnish a nonaccredited purchaser a brief description in writing of any written information furnished to an accredited investor and, upon written request, furnish such information prior to purchase to the nonaccredited purchaser.

There is no prescribed time (except in the course of the offer and a reasonable time before the sale) at which the required disclo­sure document must be delivered under Rule 505 or 506. Accord­ingly, the issuer may use a summary document at the outset of the offering provided a disclosure document meeting all of the re­quirements of Regulation D is delivered a reasonable time prior to the sale. Regulation D permits the use of “free writing” without it being accompanied or preceded by the required disclosure document provided the appropriate disclosure document is delivered prior to the sale. An issuer is not required to furnish the exhibits that would accompany a registration statement, but must identify the content of those exhibits and make them available to investors on request. Rule 502(b)(2)(iii). The staff has construed this provision so that issuers are required, for example, to have legal opinions prepared to the extent they would be required in a registration statement (opinion of legality, tax opinions, etc.), not to be included in the Regulation D document (unless the issuer elects to do so), but in order to list such opinions and make them available on request.[13] This forces the issuer, for example, to have a tax opinion with respect to any rep­resentations made in the disclosure document relating to material tax consequences even though those tax consequences may be well established.

No General Solicitation or General Advertising

The Rule 505 and 506 exemptions preclude general solicitation or advertising. The staff has taken a very strict view of what constitutes a general solicitation, requiring in most instances a pre-existing relationship of some type between the solicitor and the offeree solicited. The practical impact is to preclude issuers or smaller underwriters from reaching out for qualified investors, but allowing national investment banking firms with a large clientele to be virtually free of any restriction in this regard. There also have been some fine lines drawn allowing brokerage firms to establish the necessary pre-existing relationship by soliciting a relationship with prospective private offering placees provided no specific private placement is offered in connection therewith. The Commission has relaxed the general solicitation restriction for reporting issuers and certain foreign issuers to allow the issuer to distribute a “general announcement” of an offering that contains, among other things, the basic terms of the offering and a brief statement of the manner and purpose of the offering.[14] The Commission has sought public comment concerning the possibility of allowing general solicitations in all offerings made in reliance upon Rule 505 and Rule 506 of Regulation D. The policy reason supporting the Commission’s exploration of this subject is that the “inability to reach out broadly to find possible qualified investors for Regulation D exempt offerings hampers the utility of the exemption and may raise the costs to companies of trying to do these exempt offerings. . . .”[15] The Commission has not followed up on this initiative. The Commission, under specified circumstances has allowed the Internet to be used to make a Rule 506 offering without running afoul of the limitations on general solicitations and advertising. See .BELOW.

The California Exemption

An interesting aspect of the Commission’s awareness of the problems with the restrictions on solicitations of qualified investors with whom the solicitor does not have a pre-existing relationship is that it came to the Commission attention as the result of a variation to the Regulation D exemption adopted by the State of California under its blue-sky law. California enacted an additional counterpart exemption for offers and sales of securities that is similar to Regulation D, but broader in that, among other things, it permits general solicitation within certain parameters. The restrictions on general solicitation under existing lore, however, would have made the Regulation D exemption unavailable for the offering. The Commission impressed with California’s formulation, proposed for public comment in June 1995 its own exemption, Rule 1001, to exempt offerings of up to $5 million that satisfy the conditions of the California exemption and adopted the exemption on May 1, 1996.

The California exemption is limited to certain issuers with a specified California nexus. Rule 1001 does not, itself, extend a federal exemption to issuers that do not, for failure to satisfy the California nexus or otherwise, qualify for the California exemption. However, the Commission did offer to adopt a federal exemption for each state that enacts an exemption corresponding to the California exemption. Significantly, the California exemption allows the issuer and its agent to make a general solicitation, within certain parameters. A “general announcement” of the proposed offering may be published by written document, provided it sets forth certain required information and does not set forth other information, beyond a category of permitted, discretionary disclosures. The announcement may contain, inter alia, the price of the security to be issued and a brief description of the issuer’s business. The exemption permits the solicitation of a response provided it is made in the following format: “For more complete information about (Name of Issuer) and (Full Title of Security), send for additional information from (Name and Address) by sending this coupon or calling (Telephone Number).” No sales can be made, no commitments to purchase accepted, no money accepted, until five business days after delivery of a disclosure statement and subscription information to the prospective purchaser.

The federal exemption, Rule 1001, is limited to $5 million per offering, including the securities sold in the offering pursuant to the exemption and any other exemption. Thus the sales made in California in reliance on the exemption could be combined with sales made elsewhere in reliance on another exemption (e.g., Rule 505), but the offering could not exceed $5 million. The proposing release noted that the $5 million limit applies on an “offering by offering” basis, which differs from the approach taken by other rules adopted under section 3(b) of the Act, which use an annual dollar limitation. Securities sold pursuant to Rule 1001 are “restricted securities” under the Act. No other state has excepted the Commission’s invitation to adopt a similar exemption.

Filing

The availability of all Regulation D exemptions is dependent upon the filing of five copies of a Form D with the Commission no later than 15 days after the first sale of securities pursuant to one of the exemptions. No periodic or final Form D has to be filed thereafter. At least one copy of the Form D has to be manually signed by a person duly authorized by the issuer and must contain an undertaking to furnish to the Commission upon written request the disclosure document furnished to any purchaser who is not an accredited investor. Supplemental periodic filings are not required except, if the offering continues for a substantial period of time, or it otherwise becomes apparent that the information in the Form D is inaccurate, there may be a need to file an amendment to correct the information in the Form D. The filing requirement is not a condition to the availability of the exemption. Under Rule 507, if the issuer fails to timely file a Form D, the Commission can obtain an order from a court of competent jurisdiction directing a filing, and, once such an order is issued, the exemption under Regulation D is no longer available to the issuer for future transactions. The disqualification can be waived upon a showing of good cause by the issuer that the exemption should not be denied. This appears to be a cumbersome method for limiting the consequences of late filings, but has the virtue that the failure to file does not impact the underwriter and a private action cannot be based on sales made prior to the issuance of a court order.

Rule 508 and Insignificant Failure Penalties to Comply

The Regulation D exemption to be available required compliance with all the terms and conditions of Rules 501 through 503 and of the specific Rule (504, 505, or 506) upon which reliance is being placed. Rule 508 provides that failure to comply with a condition or requirement of the rule will not result in a loss of the exemption as to any specific offer or sale if the person relying on the exemption demonstrates that (1) such condition or requirement was not directly intended to protect the complaining party, (2) the failure to comply was “insignificant to the offering as a whole,” and (3) a good faith and reasonable attempt was made to comply. Specifically, Rule 508 provides that failure to comply with the dollar limitations of Rules 504 and 505; the number of purchasers limitations of Rules 505 and 506, and the limitations, to the extent applicable, on general solicitations or general advertising, “shall be deemed to be significant to the offering as a whole.” Rule 508 also provides that nothing in the Rule excuses the failure to comply in an action brought by the Commission.

The person relying on the exemption has to show as to any individual purchaser that the failure to comply related to a term, condition or requirement of the exemption not intended for the protection of the particular individual. For example, if reliance is placed on Rule 506, the sale to a nonsophisticated purchaser would not preclude the person from relying on the exemption to rely on Rule 508 as a defense in an action brought by sophisticated purchasers. Although general solicitations are always significant to the offering as a whole, the adopting Release stresses that whether there is a general solicitation “must always be determined in the context of the particular facts and circumstances of each case.” Although a prior existing relationship may have some relevance to a general solicitation, such prior relationship is not the only means by which the absence of general solicitation can be established. Accordingly, if the offering is structured so as to limit solicitations to persons with whom the issuer or the agent have a prior relationship, but inadvertently the offer is made to a person without such a relationship, it would not necessarily constitute a general solicitation.83 That issue would have to be determined first; if it is determined, however, that there was a general solicitation, Rule 508 would not be available.

Rule 135(c)

Rule 135(c) permits any company that files reports pursuant to §§ 13(a) or 15(d) of the Exchange Act or a foreign issuer exempt from registration under the Exchange Act pursuant to Rule 12g3-2(b) to make a limited public announcement that it is making or proposes to make an unregistered offering of securities. The announcement must state that the securities are not registered and cannot be sold in the United States absent registration or an applicable exemption. The notice may in addition contain no more than (a) the name of the issuer, (b) title, amount, basic terms, time of offering, amount being offered by selling shareholders, if any, (c) a brief statement of the manner and purpose of the offering without naming the underwriters, any statement or legend required by state or foreign law or administrative authority. In the case of rights offerings, exchange offerings, and offerings to employees, certain additional specified information may be included. The announcement may take the form of a news release, written communication directed to security holders or employees, or other published statements. A copy must be furnished the Commission under cover of Form 8-K or 6-K, as appropriate, or in accordance with Rule 12g3-2(b) for companies relying on that exemptive section. See attached EXAMPLE.

Proposed Rule 507 Exemption and other Changes to Regulation D Forthcoming

The Commission on August 3, 2007 proposed a number of significant revisions to Regulation D Rule 505 and 506 exemptions. The proposal includes a new Rule 507 exemption for offers and sales to newly defined “large accredited investors” that would allows a general solicitation within certain limits.[1] Rule 507 as proposed would include the following features::

(1)   The offering would not be limited in amount

(2)   The offering could be made only to new category of large accredited investors

(3)   A limited general solicitation could be made by way of newspaper and/or internet advertising

(4)   Restricted stock acquired by investors could be resold pursuant to liberalized Rule 144 discussed above

(5)   There would be no specified disclosure required other than the anti-fraud restrictions

(6)   States would be preempted from requiring registration under the blue sky laws, except as to a notification filing.

Both Rule 507 exempt securities and the present Rule 506 exemption will benefit from the liberalized Rule 144 exemption discussed below. Securities sold pursuant to Rule 506 can be sold to unlimited number of accredited investors in an unlimited amount without the use of prescribed solicitation material provided confined to accredited investors. Rule 506 offerings, however, are subject to the restrictions on general solicitations and will not have the benefit of the limited general solicitation to be allowed under proposed Rule 507.

Rule 507 as proposed would require the issuer to comply with the Regulation D limitations on general solicitations[2] subject to the following major exception. The issuer could publish in written form an announcement of a proposed offering that prominently states that sales will be made to large accredited investors only; no money or other consideration is being solicited or will be accepted through the announcement;  the securities have not been registered with or approved by the U.S. Securities and Exchange Commission and are being offered and sold pursuant to an exemption from registration.[3] The announcement may appear in newspapers and/ or on the Internet, but may not be made by radio or broadcast.[4]

The announcement also may contain, but no more than, the following optional information: (1) the name and address of the issuer; (2) the name, type, number, price and aggregate amount of securities being offered and a brief description of the securities; (3) a description of what “large accredited investor” means; (4) any suitability standards and minimum investment requirements for prospective purchasers in the offering; (5) a brief description of the business of the issuer in 25 or fewer words; and (6) the name, postal or email address and telephone number of a person to contact for additional information.[5] The Commission stated in the Proposing Release it thought the exemption appropriate in view of “the general increased sophistication and financial literacy of investors in today’s markets, coupled with the advantages of modern communication technologies.”[6] The announcement may be part of the offering process, which is not the case with Rule 135c notices.[7] The publication of a general announcement in accordance with Rule 507 would not preclude resales pursuant to Rule 144A,[8] provided a Rule 144A exemption is otherwise available..

The issuer could provide to prospective purchasers information in addition to the announcement described immediately above only if the issuer reasonably believes that the prospective purchaser is a large accredited investor.[9] Information may be delivered to prospective purchasers through an electronic database that is restricted to large accredited investors.[10] We assume, for example, that, after receiving a response to its limited general solicitation and determining that the responder is a large accredited investor, providing the responder a password that can be used to access a password limited website with general information and updates. There, of course, is nothing to preclude maintaining email access to and with large accredited investors to solicit and affirm commitments to purchase the offered securities.

Securities sold to large accredited investors in compliance with Rule 507 would be “covered securities” within the meaning of Section 18 of the Securities Act by reason of Section 18(b)(3) of the Act and Rule 146(c), which limit state regulation as provided in section 18 of the Act.[11] Large accredited investors would be deemed “qualified purchasers” for purposes of Section 18(b)(3) of the Securities Act, the result of which would be the preemption of state securities law.[12] Specifically, Rule 146 would be amended to provide that, for purposes of Section 18(b)(3), the term “qualified purchaser” will mean any large accredited investor with respect to a sale under Rule 507.[13] The proposed rule would not prohibit a state from imposing notice filing requirements substantially similar to “those imposed by the Commission for transactions with such investors.”[14]

The issuer would not be required to provide any specific information to purchasers under Rule 502(b), although it would be required to comply with applicable requirements under the antifraud provisions of the securities laws.[15] Securities acquired in a transaction under Rule 507 would be restricted securities for purposes of Rule 144; the issuer would have to exercise reasonable care to assure that the purchasers are not “underwriters” under the Securities Act.[16] The issuer would be required to file a Form D.[17] Pooled investment vehicles that rely upon Section 3(c)(1) or 3(c)(7) of the Investment Company Act would be precluded from selling securities in reliance upon Rule 507.[18] Rule 507 was proposed pursuant to Section 28 rather than 4(2) of the Act, and offerings under Rule 507 would be considered “limited” rather than “private” offerings.

Separately, the Commission on June 29, 2007 proposed rules designed to simplify and restructure Form D and mandate electronic filing of the Form through an online filing system.[19] The Commission on December 11, 2007 announced the adoption of amendments as to the content of the Form D in connection with Regulation D exempt offerings and steps being taken toward requiring that the Form D be filed electronically.[20] The Commission, however, as this issue of SFCLR had not adopted the formal rules implementing the Form D revisions and mandatory electronic filings. We are dependent in large part upon the Press Release as to the content of the Form D amendments. Our focus is on the electronic filings of Form D.

Form D filings presently are made on paper, but the Commission’s EDGAR database reflects the filing of Form Ds by reporting companies with the date of filing and the Document Control Number. The latter permits with some effort and expense obtaining access or copies of the filing. The electronic filings when made would be made via the Internet on the Commission’s website, but not part of the EDGAR system. What is contemplated is described by the press release as follows:

The phase-in period for Form D electronic filing will begin on Sept. 15, 2008. Electronic filing will become mandatory on March 16, 2009. The information will be filed through an online filing system that would be accessible from any computer with Internet access, will capture and tag data items and will make the filed information available on the Commission's Web site in a format that can be viewed in an easy-to-read format.

The expectation is “that this will eventually facilitate one-stop filing of both federal and state Form D notices and substantially reduce filing burdens of smaller companies.” The Press Release summarizes the amendments as to the content of the Form D, as follows:  “Specific revisions will include, among other changes,

·   requiring filers to identify all issuers in a multiple-issuer offering; 

·   deleting the current requirement to identify as "related persons" owners of 10 percent or more of a class of equity securities; 

·   replacing the current requirement to provide a business description with a requirement to provide industry group information from a pre-established list; 

·   requiring revenue range information for operating companies and net asset value information for hedge funds (subject to an option to decline to disclose); 

·   requiring reporting the date of first sale; 

·   specifying that material mistakes of fact or errors in a previously filed Form D require an amendment and when changes in a previously filed Form D or the passage of time require amendments; 

·   requiring that amendments contain current information in response to all information requirements; 

·   revising the minimum investment amount disclosure requirement to specify that it relates to outside investors only; 

·   replacing the current requirement to disclose information on a wide variety of expense and use of proceeds items with a requirement to disclose expenses only as to amounts paid for sales commissions and, separately stated, finders' fees and disclose use of proceeds only as to the amount of gross proceeds used or proposed to be used for payments to related persons; and 

·   permitting a limited amount of free writing to the extent necessary to clarify responses.

The changes in information requirements will become effective on Sept. 15, 2008.”

Under State Blue Sky Laws

Substantially all of the states also register securities. It is, therefore, necessary to find a counterpart state exemption or to consider the necessity of registering the securities in the states in which the offering is being made. States to varying degrees have exemptions compatible with federal exemptions except in areas in which reliance is being placed primarily on state registration such as the federal exemption for intrastate offerings and Rule 504 public offerings. The task has been simplified greatly by NSMIA, which preempts state registration of securities for certain federally exempt offerings and in particular Rule 506 offerings. The preemption, however, is a limited one as states may still require a notice filing, payment of filing fees, and filing of a consent to service of process. Further, the preemption is not applicable to a Rule 505 offering, which is another reason to comply with Rule 506 rather than 505 if practicable. Several states also have a version of the Uniform Limited Offering Exemption (ULOE) which to a large degree with some variation as to Rule 505 offerings is compatible with the Rule 505 and 506 exemptions. The exemption has bad boy provisions, which are irrelevant as to a 506 offering as state registration is preempted as noted above pursuant to NSMIA. See Georgia ULOE. Some have suitability and sophistication requirements, which makes it incompatible with most Rule 505 offerings. See Illinois ULOE.

Liberalizing Rule 144

The federal securities laws are designed to compel registration not only when securities are sold by a company, but also when a substantial block of stock is sold by a person (affiliate) controlling a company. In addition, securities issued in an exempt transaction generally cannot be resold publicly unless registered. The Securities Act restrictions on the public resale of shares issued in exempt transactions and on the sale publicly of shares by an affiliate are controlled through the Section 2(a)(11) definition of the term “underwriter.” Since a person is a statutory underwriter if he purchases shares from an issuer (which for this purpose under the last sentence o Section 2(a)(11) includes a person who controls the issuer) with a view to public distribution, the usual Section 4(1) trading exemption for transactions not involving an “issuer or underwriter” is generally unavailable for the public sale of shares by a controlling person or for the resale of shares issued initially in an exempt transaction. For almost  40 years after the adoption of the '33 Act, whether one was an underwriter in this context depended upon whether he purchased shares from the issuer or a person controlling the issuer for investment, as distinguished from public distribution. Investment intent, however, proved to be an elusive concept and, on April 15, 1972, Rule 144 became effective. It sets forth the circumstances under which and the extent to which affiliates (controlling persons of a company) and/or persons acquiring shares from a company issued in reliance on the Regulation D exemption or private offering  can sell such shares publicly without registration. Rule 144 could  only be utilized with respect to securities of companies that were  reporting companies or which make Rule 15c2-11-type information generally available to market makers and shareholders. Rule 144(c).

The Commission on November 15, 2007 adopted major amendments to Rules 144 and 145, the Adopting Release was published on December 6, 2006,[1] and the amendments became effective February 15, 2008. Although bundled with the scaled disclosure system for smaller reporting companies, the amendments are applicable to all companies. Rule 144 is applicable to the resale of securities acquired in exempt transactions from the issuer or an affiliate of the issuer and that are restricted securities as defined by Rule 144(a)(3).[2] This includes securities acquired in transactions exempt pursuant to Section 4(2)[3] as not involving a public offering; securities issued pursuant to the Rule 505 and 506 Regulation D exemptions, securities acquired in Rule 144A exempt transactions. It is also applicable to securities offered offshore in reliance on Regulation S that are resold in the United State.[4]  

Rule 144 provides in effect that one acquiring securities from an issuer or an affiliate is not deemed a Section 2(11) underwriter for purpose of the Section 4(1) exemption if securities are resold in compliance with the rule. Securities acquired from an affiliate as well as from an issuer are drawn into the equation as the last sentence of Section 2(11) defines an underwriter to include persons who acquire securities from an affiliate of an issuer with a view to distribution.[5] The revisions reduce the Rule 144 holding periods to six months or one year and eliminate other conditions of Rule 144 for many transactions. Non-affiliates of reporting issuers are now able to resell freely when the six-month holding period is satisfied, without compliance with the other conditions provided the issuer satisfies the current public information requirements.. The Rule 144(k) “free resale” provisions for non-affiliates in effect are reduced to six months for non-affiliates. The manner of sale requirements are eliminated for all debt securities and the filing of Form 144 does not apply to resales by non-affiliates.

The Adopting Release includes the following helpful table, which summarizes the impact of the amendments to Rule 144.

Previously under Rule 144 restricted securities could not be resold unless held for one year from the date of acquisition of the securities from the issuer or from an affiliate of the issuer in reliance on Rule 144, including all of its conditions.[6] Under Rule 144(k) a person that was not an affiliate and had not been an affiliate for at least three months and held the securities for two years could resell the securities without compliance with any other conditions of the rule. The prior 144(k) holding period relating to non-affiliates that have been such for at least 90 days is in effect by the amendments reduced to a six month holding period after which if the issuer is a reporting company and has been such for at least 90 days the holder can resell in reliance on Rule 144 subject only to the condition that the issuer meets the current information requirement.[7] If the securities are held for one year, there no longer is a condition as to current information with respect to resales by a person that is not an affiliate and has not been an affiliate for a period of at least 3 months.[8] This is a dramatic liberalization of the resale of restricted securities by non-affiliates. In the case of companies that are not reporting companies (or have not been for the preceding 90 days) restricted securities under similar circumstances must be held for one year, but after one year can be resold without restriction and subject to none of the Rule 144 conditions.[9] This in part is accomplished by the simple expedient of providing  non-affiliates are subject only to the conditions outlined above. Conditions relating to the volume of securities that can be sold; the manner of sale, or the filing of a Form D are not applicable once the holding period(s) are satisfied..

Affiliates also benefit by the same shorter holding periods, but remain subject to significant conditions. The holding periods are identical for affiliates and persons that are not affiliates—six months with respect to securities of a reporting company[10] and one year in the case of an issuer that is not a reporting company (or has not been a reporting company for the 90 days preceding the sale).[11]. Whether selling after the six month holding period or after the one year holding period, affiliates and persons selling for affiliates are subject to the same conditions[12] including the following: (a) current public information,[13] (b) volume limitations,[14] (c) manner of sale (equity securities),[15] and (d) filing of Form 144[16] (subject to  revised thresholds[17]). The revised thresholds of Rule 144(h) require the filing of a Form 144 only if as amended requires a Form 144 to be filed only if the amount to be sold during any three month period exceeds 5,000 shares or other units or if have an aggregate sales price of in excess of $50,000. Previously, the threshold was 500 shares or aggregate sales price in excess of $10,000. The manner of sale restrictions are not applicable to debt securities,[18] or if sold for an estate or beneficiary of an estate provided the estate or beneficiary, as applicable is not an affiliate of the issuer.[19]

The Commission also revised Rule 145(c) so that affiliates of an acquired company except in the case of a shell company are no longer deemed to be underwriters and to conform the holding periods of Rule 145(d) to those of the revised Rule 144. This is good news for affiliates of acquired companies in corporate combinations who will not be affiliates of the acquired company. Theretofore under Rule 145(c), an affiliate of an acquired company was deemed an underwriter with respect to the shares acquired in the corporate combination and had to rely on Rule 145(d) to resell the shares. Rule 145(d) essentially imposed the current information, volume of sales and manner of sale provisions of Rule 144.

Who will use Rule 144 and how?

Only the passage of some time will provide a definitive answer. The revisions to Rule 144, however, should encourage the use of exempt private and Regulation D Rule 506 offerings by reporting companies as it should reduce the discount that typically is involved in connection with exempt offerings because of the lack of liquidity. It also may reduce the reliance on PIPEs exempt financing by reporting companies as the period after which securities may be resold under Rule 144 may not be significantly longer than that involved in preparing the registration statement and review by the staff. Contrary wise, issuers and/or underwriters may be encouraged to impose via the underwriting agreement their own restrictions on the resale of securities held by non-affiliates, and, perhaps, others, to keep it from impacting the market price within a short time frame after the public offering. The real concern may be non-affiliates as the company in connection with its initial public offering is likely to become a reporting company and many non-affiliates may have held there shares for six months. The current reporting requirements are satisfied if the company has been a reporting company for a period of 90 days and has filed all reports (other than Form 8-Ks) during the preceding 12 months or such shorter period that it was required to file reports.[20] Within 90 days of the public offering, non-affiliates that have held restricted securities for six months could sell securities without restriction as to amount and without filing a Form 144.

The shares of some reporting companies trade on the electronic pink sheets often because they have been delisted from a stock exchange for the failure to file ’34 Act reports generally because of the extended time required to restate financial statements because of some unseemly event such as the backdating of stock options.[21] Rule 144 as revised permits non-affiliates to resell the securities in reliance on Rule 144 after a holding period of six month provided the company is in compliance with the current information requirements of Rule 144(c). Rule 144(c) requires in the case of a reporting company that it filed all reports required under the Exchange Act for the period of 12 months preceding the sale in reliance on Rule 144. As to restricted securities held by non-affiliates of a reporting company for a period of one year, however, Rule 144 is available as non-affiliates (assuming they have been such for 90 days) without regard to the conditions of Rule 144(c).[22] There are also some reporting companies that are not delinquent in their ’34 Act filings that trade on the pink sheets and/or the Over the Counter Bulletin Board (OTCBB). In that situation, non-affiliates that have held restricted securities for six month could trade their shares on the OTCBB and/or the pink sheets if a broker-dealer(s) has elected to make a market in the security. In the case of a non-reporting company, restricted securities can be resold if held for a period of one year by non-affiliates without regard to other conditions of Rule 144 provided a market is available, which, if it exists, is likely o be the electronic pink sheets. These undoubtedly are unintended consequences, but there are a number of companies that are determined to remain private by relying on exempt offerings and a market developing for the security and they are likely to welcome the liberalized Rule 144.

Securities issued pursuant to the Rule 701 exemption also benefit from the Rule 701 which, subject to the conditions of the exemption, exempts from Securities Act registration securities issued pursuant to a written compensatory employee benefit plan or written contract by a non-reporting company.[23] An employee benefit plan includes any purchase, savings, option, bonus, stock appreciation, profit sharing, thrift, incentive, pension, or similar plan. The participants in the plan (or party to the contract) must be employees, directors, general partners, trustees (if a business trust), officers, consultants, or advisers. In the case of consultants and advisers, however, the plan (or contract) must not be for services rendered in connection with capital raising activities. The plan or the contract setting forth the arrangement must be in writing and a copy must be given to the employee. The exemption is only available to companies that are not investment companies and that are not reporting companies under the Exchange Act. Companies that have not gone public often as a prelude to going public adopt employee compensatory plans (including those pertaining to officers and directors), often involving the issuance of stock options, in reliance on the Rule 701 exemption.

The exemption is available only to the securities offered or sold by the issuer, which means the employee must find another exemption for their resale. Rule 701, however, provides a framework for their resale. Such securities are deemed restricted securities as defined by Rule 144.[24] Until the company becomes a reporting company (typically by going public), recipients of the stock options absent restrictions in the stock option plan may resell them (or more likely the underlying securities) in reliance on Rule 144 as Rule 701 expressly provides that securities issued pursuant to this section are deemed to be ‘restricted securities’ as defined in Rule 144.”[25] After a holding period of one year, non-affiliates may resell the securities without regard to the other conditions of Rule 144[26]. This assumes, however, that there is a market for the securities, which, if it exists, is likely to be the electronic pink sheets.

We noted above the compensatory employee benefit plans are often adopted in reliance on Rule 701 by companies that contemplate in the not too distant future going public and at the same time registering the common stock under the Exchange Act. The company going public and listing on a U.S. stock exchange must register the securities under the ’34 Act, but even if the security is not listed on an exchange and not registered under the Exchange Act, Section 15(d) of the Exchange Act requires the company that has registered securities under the “33 Act to file ’34 Act reports.[27] Prior to the amendment of Rule 701[28] previously provided that 90 days after the company became a reporting company that the Rule 701 securities could be resold  pursuant to Rule 144 by persons who are not affiliates without compliance with the provisions of Rule 144(c) (current information) (d) (holding period), (e) (amount of securities sold) and (h) (filing of Form 144). This provision was amended at the same time as Rule 144 to delete (e) and (h) since they are no longer necessary as they would not be applicable in any event to resales by non-affiliates in reliance on Rule 144. Accordingly, it appears that 90 days after the company becomes a reporting company, non-affiliates that acquired the security in reliance on the Rule 701 exemption could resell them without regard to the period the securities are sold or even if the company had failed to file a ’34 Act report.

We reiterate, that the resale of securities issued in reliance on Rule 701 as discussed above assumes that there are no restrictions on resales in the agreement covering the issuance of the securities and that there is a market for the security. Further, Rule 701 has limitations on the amount of securities that can be sold in reliance on the exemption. We do not pursue those limitations, but generally they preclude reliance on the exemption for sales during any 12 month period exceeding the greater of $1 million or 15% of the total assets of the issuer.[29]

There is also what is sometimes referred to as a Section 4(1½) exemption involving securities issued in an exempt transaction or securities sold by an affiliate. What these transactions may have in common is the resale (by the purchaser of exempt securities from the issuer or affiliate or by the affiliate) of the securities in what is essentially a private placement. The Section 4(2) exemption for transactions not involving a public offering is not available since it exempts only transactions by an issuer. Gilligan Will held that one purchasing securities from an issuer is not an underwriter for purposes of Section 4(1) if he resells the securities in transactions that would meet the Ralston Purina concept of a Section 4(2) transaction as he did not purchase the securities with a view to distribution. The term “distribution” in this context is synonymous with a “public offering.” To meet the Ralston Purina criteria, the purchasers in the resale (1) must be sophisticated and (2) must have access to the same information as would be available if the securities were registered. The combination of Section 4(1) and 4(2) in this manner is often referred to as the Section 4(1½) exemption. Although the person who acquired the securities in an exempt transaction [or from an affiliate] may by such sale evidence an initial intent to acquire them for resale, s/he is not an underwriter since they were not acquired with a view to distribution if acquired with a view to reselling them to persons meeting the Section 4(2) criteria.  Securities sold in such transactions are deemed restricted securities for purposes of Rule 144. The sale of securities in such transactions does not, however, start a new holding period for the purchaser can in effect tack the holding period of the person from whom the securities were acquired provided such person is not an affiliate. See Rule 144(d).

Registered Secondary Distributions

To the extent an affiliate or a person who acquired shares in a nonpublic offering publicly offers shares beyond the confines of Rule 144, the shares must be registered absent another appropriate exemption. Since only the company can register shares, it is essential in this context that persons acquiring shares in an exempt transaction obtain a contractual commitment from the company to register the shares for public sale. Assuming that the company is prepared to file a registration statement, the registration process is not significantly different in connection with such secondary distributions, except in the following respects. If the issuer has been a reporting company for one year, generally, Form S-3 will be available for a secondary distribution.. Form S-3 registration essentially consists of incorporating certain Exchange Act filings by reference, hence, it is a relatively simple form of registration with a minimal disclosure document. See Part 12.

Rule 144A--Interrelationship of Rule 144Aand Rule 144

Rule 144A in one sense is a logical extension of our discussion of exempt offerings.. Although conceptually it is not an exemption for the issuer, under certain circumstances it can be utilized to effect a private placement. Rule 144A, however, conceptually deals primarily with the resale of securities issued in exempt transactions and sequentially it supplements Rule 144. The private placement market in the United States is a large one and Rule 144A has contributed significantly to its growth. Rule 144A is intended to provide an efficient, liquid market among large (securities portfolios in excess of $100 million) institutional investors for securities issued in exempt offerings or in offshore distributions made in reliance on Regulation S. Rule 144A as adopted is applicable primarily to straight debt securities not traded on a U.S. exchange or Nasdaq and to securities of foreign issuers, the primary markets for which are outside the United States that are offered privately to megainstitutional investors. The NASD has created the PORTAL Market (hereinafter sometimes referred to as PORTAL), a computerized, screen-based quotation, trading, settlement, and clearing system for securities sold in reliance on Rule 144A. We do not pursue Rule 144A other to make you aware of its existence. For most reporting U.S. issuers, the definition of eligible securities limits the Rule 144A market to straight debt securities not traded on an exchange. Rule 144A does not provide an exemption for an issuer engaged in a private placement. See Rule 144A(d)(3). Nonetheless, it is designed to facilitate a specific type of private placement of an eligible security which would ordinarily be a debt security of a U.S. issuer and could be an equity security of a foreign issuer traded in an offshore market (provided not traded on a U.S. exchange or Nasdaq). Such a private placement involves the purchase of the eligible securities by a dealer in reliance on the Section 4(2) exemption for transactions not involving a public offering and the resale of the securities to qualified institutional buyers in reliance on Rule 144A. We do not pursue this type of private placement in depth as it has limited utility in the context of a U.S. issuer going public. See Securities Law Handbook s 10:17. PRIVATE PLACEMENTS UNDER RULE 144A

Exemption for Employee Benefit Plans of Nonreporting Companies--Rule 701 Exemption

The Commission has facilitated in a number of ways compliance with the registration provisions of the Securities Act in connection with the issuance of securities to employees and the resale of such securities by employees acquiring shares pursuant to an employee benefit plan of an employer which is a reporting company.[16] The Commission in 1988 adopted Rule 701 which, subject to the conditions of the exemption, exempts from Securities Act registration securities issued pursuant to a written compensatory employee benefit plan or written contract by a nonreporting company.[17] An employee benefit plan includes any purchase, savings, option, bonus, stock appreciation, profit sharing, thrift, incentive, pension, or similar plan. The participants in the plan (or party to the con­tract) must be employees, directors, general partners, trustees (if a business trust), officers, consultants, or advisers. In the case of consultants and advisers, however, the plan (or contract) must not be for services rendered in connection with capital raising activi­ties. The plan or the contract setting forth the arrangement must be in writing and a copy must be given to the employee. The exemption is available with respect to plans that require an employee contribution (otherwise, such an ex­emption would not be needed since there generally is no sale in the absence of a contribution by an employee)[18] such as options. The exemption is only available to companies which are not investment companies and which are not reporting companies under the Exchange Act.

The exemption is available only to the securities offered or sold by the issuer, which means the employee must find another ex­emption for their resale. The exemption, however, provides a framework for their resale. Such securities are to be deemed restricted securities as defined by Rule 144, which means resales must be in compliance with the registration provisions or an appli­cable exemption. Therefore, the securities can be resold pursuant to a registration statement, in a private transaction (a so-called Sec­tion 4(1½) exemption),[19] or pursuant to Rule 144. Rule 144 re­quires a one-year holding period, and at the end of that period securities can be resold within the quantitative limitations of Rule 144(d), but only if there is a market for them permitting compli­ance with Rule 144(f) and (g) as to the manner of sale and only if the public information provisions of Rule 144(c) are complied with.[20] If the securities were held for two years, they could be resold without regard to any of these limitations under the provisions of Rule 144(k) by persons who are not affiliates. See ABOVE. If, however, the issuer becomes a reporting company, 90 days thereafter a per­son who is not an affiliate can resell the securities under Rule 144 without regard to the holding period, quantitative limitations, Form 144 filing requirements, or the public information requirements of the rule.[21] Rule 701(c)(3. The emasculated version of Rule 144 in effect merely re­quires compliance with the manner of sale provisions of the rule. An affiliate, 90 days after the issuer becomes a reporting com­pany, must continue to comply with all the provisions of Rule 144 except for the holding period.[22] .

Rule 701--Quantitative Limitations and Required Disclosure

In 1999, the Commission adopted amendments to Rule 701.[23] The Commission’s review appears to have been prompted in part by the National Securities Markets Improvement Act of 1996 (“NSMIA”), the legislative history of which suggests that key Congressional committees desired the Commission to increase the $5 million ceiling currently contained in Rule 701.[24] Prior to the 1999 amendments, the aggregate offering price of securities of the issuer offered in reliance on Rule 701, together with securities of the issuer sold in the preceding 12 months in reliance upon such rule, could not exceed $5 million.[25] In Release 7645, the Commission removed the $5 million ceiling on aggregate offers and sales and replaced it with a limitation on aggregate sales price or amount sold in any consecutive 12-month period based upon the greatest of $1 million, 15 percent of the company’s assets, or 15 percent of the outstanding securities of the class. Specifically, as amended, Rule 701(d) provides as follows:

Offers. Any amount of securities may be offered in reliance on this section. However, for purposes of this section, sales of securities underlying options must be counted as sales on the date of the option grant.

Sales. The aggregate sales price or amount of securities sold in reliance on this section during any consecutive 12-month period, shall not exceed the greatest of the following:

1.       $1,000,000;

2.       15 percent of the total assets of the issuer (or of the issuer’s parent if the issuer is a wholly owned subsidiary and the securities represent obligations that the parent fully and unconditionally guarantees) measured at the issuer’s most recent balance sheet date (if no older than its last fiscal year end); or

3.       15 percent of the outstanding amount of the class of securities being offered and sold in reliance on this section, measured at the issuer’s most recent balance sheet date (if no older than its last fiscal year end).

The regulation is not a model of clarity, but what it is saying is that for purpose of determining the limitation the grant of the options is deemed a sale of the underlying security on the date of the grant and at the exercise price on that date. To this extent, but only to this extent, offers are taken into account since they are deemed sales whether or not the options are ever exercised.[26] The Commission also was of the view that its central focus should be not on an absolute dollar threshold for sales, “but rather how the amount compares to the size of the company and its capital base.”[27] The Commission has made it clear that: “[a]mounts of securities sold in reliance upon [Rule 701] do not affect amounts that may be sold in reliance on other exemptions, and amounts of securities sold in reliance on other exemptions do not affect amounts that may be sold in reliance upon this section.”[28] Thus, by way of example, amounts of securities sold pursuant to Rule 701 do not affect amounts that may be sold in reliance upon Rules 504-505 of Regulation D, and amounts sold pursuant to Rules 504-505 do not affect amounts sold pursuant to Rule 701.

The disclosure requirements apply only if the aggregate sales price or amount of securities sold during any consecutive 12-month period exceed $5 million. Subject to that qualification, an issuer relying upon Rule 701 is required to provide to investors, a reasonable period of time prior to sale,[29] (1) a copy of the plan or contract; (2) a copy of the summary plan description required by ERISA or, if the plan is not subject to ERISA, a summary of the material terms of the plans; (3) information concerning risks associated with the securities sold; and (4) financial statements required by Part F/S of Form 1-A as of a date no more than 180 days prior to sale.[30] Although financial statements do not have to be audited unless the issuer otherwise has audited statements available, they must be prepared in accordance with GAAP. Since the issuer may not be able to determine in advance of each 12-month period the sales that will take place under the employee benefit plan(s), it should err on the side of caution and make the required disclosures if there is a possibility that sales will exceed the $5 million limitation as if it does the exemption would no longer be available.

Although reliance can be placed on Rule 701 in connection with securities issued to a consultant or an adviser in compliance with the requirements of the Rule, there are two limitations applicable to those transactions that are not applicable to other eligible recipients. The consultants and advisers must render bona fide services, which services are not in connection with capital raising activities.[31] In addition, the consultants and advisers must be natural persons, and the services must not directly or indirectly promote or maintain a market for the issuer’s securities.[32] Unlike employees, the services rendered by a consultant or an adviser in exchange for securities are considered part of the consideration for the securities, and the value of those services is included in the offering price.[33]

Private Placements on the Internet

The Commission has published several interpretive releases setting forth its views on electronic media and the Internet.[34] In the first of these releases,[35] the Commission briefly addressed the relationship between Internet offers and private placements. The Commission gave the example of a company that intended to raise capital through a private placement under Rule 506 of Regulation D. The Company placed offering materials on its web site. The web site required “various information” from a person attempting to view the offering materials.[36] The Commission concluded that it would be inappropriate to do so as it would constitute a general solicitation or advertising and as such is precluded by Rule 502(c) of Regulation D.[37]

In a 1996 no‑action letter,[38] the staff considered whether the posting of notices of private offerings and private offering materials on a password-protected web page constitutes a “general solicitation” within the meaning of Regulation D. IPONET established a home page and other linked pages on the web, with a section entitled “Accredited Investor.” A person could become registered as an “Accredited Investor” by completing an on‑line questionnaire relating to that person’s status as an accredited investor within the meaning of Rule 501 of Regulation D or a sophisticated investor within the meaning of Rule 506 of Regulation D. A registered broker-dealer would verify the reported information. An investor qualified as an Accredited Investor would be given a password which would give the investor access to a password-protected page on the web site. This would enable the investor to access information about private offerings. Neither IPONET nor the broker-dealer would be affiliated with the issuer at the time of the private offering. Accredited investors would only be allowed to participate in private offerings posted on IPONET after the investor registered with IPONET as an accredited investor “and then only after a sufficient time has elapsed between the IPONET member’s registration as an Accredited Investor and the inception of a private offering so that the registration as an Accredited Investor is not deemed to be a solicitation for a particular private offering.”[39]

IPONET relied upon a previous, “pre-electronic” no‑action letter where the staff allowed the circulation by a registered broker-dealer of questionnaires to prospective accredited investors to evaluate eligibility to purchase in private offerings without the circulation of such questionnaires being deemed a general solicitation for purposes of Regulation D.[40] IPONET argued that its proposed procedure was indistinguishable from Shaine except that its distribution of the questionnaire and subsequent distribution of private offering materials would be by electronic rather than paper means. Since the broker-dealer “will be soliciting questionnaires for Accredited Investors and will be distributing information on private offerings electronically that it could otherwise properly do by paper, the posting of private offerings in a password-protected page of IPONET would not involve general solicitation” within the meaning of Regulation D.[41] The staff granted the no‑action letter, noting particularly that the invitation to complete the questionnaire and the questionnaire would be generic in nature and would not refer to a specific offering; the password-protected page would become available to an investor only if and after the broker-dealer determined that an investor were qualified; and an investor could only purchase securities that are posted on the site subsequent to the investor’s registration with IPONET as an accredited investor.[42]

The staff took a similar position in Lamp Technologies, Inc.[43] which involved the posting of information by hedge fund managers on a web site administered by Lamp. The hedge fund managers would determine the information regarding the fund (e.g., information about the fund, offering memoranda, and performance-related information) that was put on the site. The procedure for soliciting subscribers would parallel that used in IPONET: subscribers would be pre-qualified as accredited investors and given a password necessary to access the site. The principal distinction between the two no‑action letters is that in IPONET, investors were only given the right to participate in transactions posted after the investor’s registration as an accredited investor, whereas Lamp imposed a waiting period after qualification that would apply before an investor could purchase securities of a posted hedge fund. The staff responded that “the qualification of accredited investors in the manner described and the posting of a notice concerning a private fund on a web site that is password-protected and accessible only to subscribers who are pre-determined by Lamp to be Accredited Investors would not involve a ‘general solicitation’ or ‘general advertising’ within the meaning of Rule 502(c) of Securities Act Regulation D.”[44] The staff also took the position that the posting of hedge fund information on the web site under the circumstances described would not constitute a “public offering” within the meaning of Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. Finally, the staff concluded that an investment advisor that posted only private fund information on the site would not be “holding itself out generally to the public” as an investment advisor within the meaning of Section 203(b)(3) of the Investment Advisors Act.[45]

In March 1998, BankAmerica reportedly managed an international private placement on the Internet, a $150 million senior note offering for Newbridge Networks Corp of Canada.[46] “The tool BankAmerica used to facilitate the on‑line deal was IntraPlace, a system from New York-based IntraLinks, Inc. that was customized for the private placement market.”[47] The Internet site reportedly is password-protected and is used “to transmit information between broker and customer, and to work out documentation and legal issues; pricing and allocation are done separately.”[48]

On April 28, 2000, the Commission issued its third Interpretative Release relating to the Use of Electronic Media,[49] one aspect of which dealt with on-line offerings. That aspect of the Release that dealt with public offerings is discussed at Part 7. The Interpretative Release also alluded to private placements and Rule 506 offerings being done on-line and raised some question about the scope of the prior no-action letters. The big issue in connection with private placements and Rule 506 offerings being done on the Internet is conforming with the Rule 502(c) condition precluding any form of “general solicitation.”[50] Interpretative Release III focuses on the significance of the role of the broker-dealer in making the determination that the applicant is an accredited or sophisticated investor. “Generally,” the Release states,” staff interpretations of whether a ‘pre‑existing, substantive relationship’ exists have been limited to procedures established by broker-dealers in connection with their customers. This is because traditional broker-dealer relationships require that a broker-dealer deal fairly with, and make suitable recommendations to, customers, and, thus, implies that a substantive relationship exists between the broker-dealer and its customers.”[51] Consistent with prior Commission statements, “there may be facts and circumstances in which a third party, other than a registered broker-dealer, could establish a ‘pre‑existing, substantive relationship’ sufficient to avoid a ‘general solicitation.’”[52] But don’t rely on the no-action letter in Lamp Technologies, discussed above, in this context, the Release warns: “We understand that securities lawyers may have interpreted staff responses to Lamp Technologies, Inc. as extending the ‘pre‑existing, substantive relationship’ doctrine to solicitations conducted by third parties other than a registered broker-dealer. . . . We disagree.”[53]

Lamp Technologies was in the business, among other things, of maintaining web sites and was not a broker-dealer or affiliated with a broker-dealer.[54] It proposed to create a web site and in connection therewith to list certain issuers offering securities pursuant to Rule 506 and to include information concerning the issuers including offering memoranda.[55] Lamp proposed to pre-qualify subscribers to its site as accredited investors based on a questionnaire generic in nature. Qualified subscribers would receive a password giving them access to information on the site. Subscribers would have to agree not to invest in any issuer that posted information on the site for at least 30 days after the subscriber qualified. The Division of Corporation Finance agreed that the prescribed procedures would not be deemed to constitute a general solicitation within the meaning of Rule 502(c). It relied on the same three factors referenced in the IPONET letter and the use of a 30-day waiting period in lieu of denying access to offerings already posted. In the original request the letter also noted the subscribers would have to meet both the definition of an accredited investor and “qualified eligible participant” (“QEP”) under CFTC Rule 4.7 (essentially an accredited investor which has at least a $2 million investment portfolio). Subscribers also would have to pay a substantial fee. A year later, Lamp requested the staff to reaffirm its prior position notwithstanding it was no longer requiring that subscribers be a QEP and no longer was requiring a subscription fee. The Division of Corporation Finance did not “object to the proposed modifications” and saw “no reason to alter its previous grant of no-action relief pursuant to the Original Response.”[56]

Why is this not a relaxation of the general requirement alluded to that the ersatz pre-existing substantive relationship involve a broker-dealer? The reasons offered by Interpretative Release III relate to the facts that the above description of the request and no-action letter omitted. The issuers posting information on the Lamp site were hedge funds relying on the exemption from registration under the Investment Company Act pursuant to Section 3(c)(1) or Section 3(c)(7) of that Act. The Lamp letter, the Release asserts, is applicable “solely in the context of offerings by private hedge funds.”[57] There is nothing in the Lamp response letter that attached significance to the fact the issuers were private hedge funds and the Release does not attempt to deal with why that should make a difference. If limited to § 3(c)(7) private hedge funds that might make a difference as a condition to that exemption from the Investment Company Act is that the outstanding securities be owned exclusively by “qualified persons” and the fund is not making a public offering. For a natural person to be a qualified person s/he must “own[] $5 million or more in investments as defined by the Commission.” The Section 3(c)(1) exemption on the other hand requires only that the company not be owned beneficially by more than 100 persons and not be making or proposing to make a public offering. That a number of companies posting on the Lamp site were in that category is evidenced by the fact that it dropped the requirement that subscribers be QEPs (minimum $2 million portfolio). Private hedge funds have to qualify with the limitations on private offerings twice over — (1) to have an exemption under the Investment Company Act, and (2) to have an exemption for the offering of its securities under the Securities Act. What else separates out a hedge fund from other issuers? The hedge funds to post information on the Lamp site had to have an investment adviser either registered under the Investment Advisers Act or exempt from registration under Section 203(b)(3) of that Act. The exemption is for investment advisers who have less than 15 clients and do not hold themselves out to the general public as investment advisers. The latter proviso elicited a request for and receipt of a no-action response from the Division of Investment Management that the posting of information on the site by companies with an exempt investment adviser would not be a holding out the investment adviser to the public for this purpose. Should this make a difference and why? The Lamp requests for a no-action letter also went to some length to suggest that its site would attract primarily professional investors, but why this would be the case once the substantial subscription fee was dispensed with is not entirely clear and is not referred to in the staff response.[58] Although not alluded to, given the 100 beneficial owner limitation on the § 3(c)(1) exemption, the funds posting on the site and seeking investors in most instances were likely to require a large minimum investment, but again that is not the basis cited in the staff response.

The no-action letters permitting the creation of a pre-existing relationship through a pre-subscription qualification procedure from Bateman Eichler[59] on have insisted that investors cannot be qualified in this manner for a pending offering. IPONET followed this pattern literally and Lamp Technologies was allowed an in-between position of no purchases for 30 days after qualification because the hedge funds were represented to be open for purchase only annually or quarterly. Interpretative Release III, in referring to IPONET, does stress this factor, stating: “Additionally, a prospective investor could purchase securities only in offerings that were posted on the restricted web site after the investor had been qualified by the affiliated broker-dealer as an accredited or sophisticated investor and had opened an account with the broker-dealer.”[60] Emphasis in original.

Interpretative Release III not only takes issue with any attempt to extend Lamp Technologies, but says in substance that a number of private placements taking place on the Internet may be in violation of Section 5, stating:[61]

We understand that some entities have engaged in practices that deviate substantially from the facts in the IPONET interpretive letter. Specifically, third‑party service providers who are neither registered broker‑dealers nor affiliated with registered broker‑dealers have established web sites that generally invite prospective investors to qualify as accredited or sophisticated as a prelude to participation, on an access-restricted basis, in limited or private offerings transmitted on those web sites. Moreover, some non-broker-dealer web site operators are not even requiring prospective investors to complete questionnaires providing information needed to form a reasonable belief regarding their accreditation or sophistication. Instead, these web sites permit interested persons to certify themselves as accredited or sophisticated merely by checking a box.

These web sites, particularly those allowing for self-accreditation, raise significant concerns as to whether the offerings that they facilitate involve general solicitations.

The IPONET and Lamp no-action letters both declined to express a view as to whether the procedures establish a “reasonable belief” that the investors are accredited or sophisticated. A footnote to Interpretative Release III notes “[t]hese web sites would also call into question the ability of an issuer to form a reasonable belief, before sale, as to the qualification of the purchaser.”[62] This presumably is not a problem if in fact the purchaser is an accredited investor or sophisticated, as appropriate. The “reasonable belief” is a fall-back defense in the event a purchaser(s) is not an accredited or sophisticated.

In sum, an issuer can destroy the private placement exemption by posting its private offering materials on the Internet. A broker-dealer, however, can pre-qualify accredited investors and thereafter make available subsequent Rule 506 offerings by making the materials available on its Internet site that can be accessed and downloaded using a password only by such pre-qualified accredited investors. The extent to which a third party that is not a broker-dealer can pre-qualify accredited investors and thereby establish a pre-existing relationship is an open one and challenged by the Interpretative Release.

Whether a consequent of Interp III or otherwise, private placements have virtually disappeared from the Internet. WR Hambrecht appears to be doing some, but this author has been unable to figure out what it is doing and the exemption being relied upon. I suspect it has something to do with hedge funds and attempts to rely on certain exemptions from registration under the investment company act; but for various reasons that are beyond the scope of this course it does not fit. Go to the Hambrecht website and see if you can figure it out. Harris Direct is also purporting to do private placements on line involving hedge funds and private equity funds among others involving mega minimum investments and presumably relying on some type of exempt offering exemption. Take a Look. If you look at completed alternative investments there are none available at this time, which suggests they aren't doing many if any.

Rule 504 and Rule 1001 Offerings on the Internet

The big issue in connection with private placements being done on the Internet is conforming with the Rule 502(c) condition precluding any form of “general solicitation.”[63] Although not discussed in Interpretative Release III, it may be useful to note two exemptions to which there are no limitations on general solicitations. Rule 504(b)(1)(iii) exempts and excludes from the provisions of Rule 502(c) offerings made within the quantitative limitations ($1 million during any 12-month period), provided made exclusively in accordance with state exemptions that permit general solicitations “so long as sales are made only to ‘accredited investors’” as defined by Regulation D.[64] Several states have adopted a version of the NASAA Model Accredited Investor Exemption for sales made exclusively to persons “the issuer reasonably believes are accredited investors” as defined by Regulation D.[65] The Model Exemption permits a general announcement of the offering if appropriately limited that states “sales will only be made to accredited investors.”[66] The general announcement may include information that goes beyond the prescribed information if “delivered through an electronic database that is restricted to persons who have been prequalified as accredited investors.”[67] A Rule 504 public offering can also be done online if the offering is limited to residents of the states in which the offering is registered, such states require the use of a substantive disclosure document, and the disclosure document is available online..SEE ABOVE.

Similarly, Rule 1001 exempts offerings not exceeding $5 million made in conformity with Section 25102(n) of the California Corporation Code and other provisions of the Rule.[68] The other relevant provision is to the effect that such securities are to be deemed restricted securities as defined by Rule 144. The California exemption is limited to certain issuers with a specified California nexus.[69] The offering has to be limited to a category of investors similar to the accredited investor concept and others meeting somewhat lesser net worth or annual income thresholds provided such investors “can be reasonably assumed to have the capacity to protect his or her interests in connection with the transaction.”[70] The exemption permits general solicitations within certain parameters. A “general announcement” of the proposed offering may be published by written document, provided it sets forth certain required information and does not set forth other information, beyond a category of permitted, discretionary disclosures.[71] The announcement may contain, inter alia, the price of the security to be issued and a brief description of the issuer’s business. The exemption permits the solicitation of a response provided it is made in the following format: “For more complete information about (Name of Issuer) and (Full Title of Security), send for additional information from (Name and Address) by sending this coupon or calling (Telephone Number).”[72] No sales can be made, no commitments to purchase accepted, no money accepted, until five business days after delivery of a disclosure statement and subscription information to the prospective purchaser.[73] SEE ABOVE.

Offerings were being made on the Internet with and without the assistance of a third party by companies relying on the Rule 504 exemption described above and on the California exemption. The qualification as accredited (or qualified California) investors was done online and upon qualification those deemed accredited (or qualified) are provided access to the offering material. Since there is no restriction on general solicitation, the immediate access in such offerings to offering materials does not pose the problem it may pose in connection with Rule 506 offerings. The adequacy of the procedures to identify accredited investors, however, remains the same issue that exists with respect to online Rule 506 offerings. The author has been unable to find any recent offering being done in this manner.

Integration ― Regulation D Safe Harbor

The Regulation D exemptions share the same general integra­tion concepts and the same safe harbor provision. Rule 502(a). The question of integration is important in a number of different contexts with respect to the exemptions including (1) determination of the 35 non­accredited purchasers of Rule 505 and 506 offerings, (2) in deter­mining the $1,000,000 limitation of the Rule 504 exemption, and (3) in determining whether securities of the same single issue are offered and sold exclusively to accredited investors. The integra­tion concept determines the extent to which a series of 506 exempt offerings can be made, the extent to which 505 exempt offerings can be separated from 506 exempt offerings. Under the usual folk­lore incorporated into Rule 502(a), integration is a question of fact determined in the light of the extent the following factors (with no specification as to weight or numbers) set forth in the Rule are applicable: (a) a single plan of financing, (b) the same type of con­sideration, (c) sales made at about the same time, (d) the same class of securities, and (e) sales are made for the same general pur­pose. Under the safe harbor provision of Rule 502(a), sales made more than six months before the Regulation D exempt offering and those made more than six months after the completion of a Regu­lation D offering are not deemed integrated with the Regulation D offering if during the appropriate six-month period no sales of secu­rities of the same or similar class were made other than pursu­ant to certain employee benefit plans. Thus, a Rule 506 offering could be made to 35 nonaccredited purchasers, followed by a similar Rule 506 offering six months later, if no securities of the same class were sold during the interval, and be within the safe harbor provision. Successive Rule 505 offerings could be made in the same manner, but such offerings would have to be combined for purposes of determining the $5 million limitation. On the other hand, Rule 505 and 506 offerings could be made with a six-month interval between them under similar circumstances without inte­grating the two for purposes of the 35 nonaccredited investor limi­tation and/or the $5 million limitation of Rule 505.

Integration of Subsequent Public Offering

On its face, Rule 502(a) requires that integration be applied retroactively so as to combine a registered public offering with a prior exempt Regulation D offering so as to destroy the availability of the exemption if there is not a hiatus of six months between the completion of a Rule 505 or 506 offering and commencement of the registered offering. Further, the safe harbor is not available if securities of the same class are offered or sold during that six-month period. Since offers to buy may be solicited once a registra­tion statement is filed, the filing of the registration statement within the six-month period literally makes the safe harbor un­available. The Division of Corporation Finance announced in a no-action letter, without much fanfare, that retroactive integration is not applicable under appropriate circumstances in the context of private offerings (including a Rule 506 offering) followed by a registered offering.[74] It did so notwithstanding a long-standing ad­ministrative policy to decline requests for no-action letters relating to integration issues. Although not mentioned in counsel’s request for a no-action letter, which relied on the general criteria set forth in the Note to Rule 502(a) and in Securities Act Release 4552,[75] the staff relied on Rule 152 which was initially adopted March 2, 1935.[76] Since the integration of Rule 506 offerings not within the Rule 502(a) safe harbor is part of a broader complex of integration issues, it is discussed in that context.. Rule 502(a) with its six-month interlude, however, is the only alternative to avoid integration of Rule 505 offerings with a subsequent registered offering. The Rule 502(a) alternative, therefore, should not be overlooked if reliance is being placed on Rule 505.

Completed Private Placement Followed by Registered Offering — Herein of Verticom

The Commission on January 26, 2001 adopted Rule 155,[77] which provides an integration safe harbor for an abandoned private offering followed by a registered offering and the converse of an abandoned registered offering followed by a private offering. But the integration of private and registered offerings is not only about abandoned offerings, it is also about the integration of a successful private offering followed by a registered offering. To understand any of it, we have to know something about integration in the context of Section 5 of the Securities Act. For convenience of exposition we limit our discussion to what we need to know about integration as it relates to the integration of private and public offerings. The Commission recognized the need for an integration safe harbor in some contexts as early as March 2 1935, when it adopted Rule 152.[78] Rule 152 continues to play an important role, although not necessarily what the Commission envisioned in 1935. It provides in substance that the Section 4(2) exemption for transactions not involving a public offering is not lost for sales made pursuant to that exemption if the issuer subsequently determines to make a public offering. What we need to know about integration for our immediate purpose was conveniently brought together in Rule 502(a) of Regulation D. Rule 502(a) is applicable to all Regulation D offerings (including those made pursuant to Rule 504 and 505) and is considered in that context ABOVE and we do not outline it further here.

Although not the subject of Rule 155, for most issuers the more important situation is that in which a Rule 506 offering is to be completed and shortly thereafter (less than six months) is to be followed by a public offering registered under the Securities Act. The answer is found in the staff’s interpretation of a Rule that long preceded Rule 155, Rule 152 provides that a transaction not involving a public of­fering at the time it is made is within Section 4(2), and hence ex­empt, “although subsequently thereto the issuer decides to make a public offering and/or files a registration statement.” Rule 152 clearly is applicable to the aborted private offering, but is it appli­cable to a private offering followed by a registered public offering when the issuer intended at the time of the private offering to fol­low it with a registered public offering? If the words of Rule 152 are given their plain meaning, under such circumstances the issuer didn’t “subsequently . . . decide to make a public offering.” In Verticom[79] the request for a no-action letter acknowledged that the is­suer contemplated two distinct phases of financing, one private and the other public, but it argued, the two phases were separate and distinct plans of financing and, hence, not integrated under the general integration concepts. The staff responded as follows:

[N]otwithstanding Verticom contemplation of a registered public offering at the time of the Placement, the Placement need not be integrated with the later registered public offering. In ar­riving at this position we have not addressed your arguments based on Rel. 33-4552, but instead are relying on the view that under Rule 152 the filing of a registration statement following an offering otherwise exempt under Section 4(2) does not viti­ate the exemption under Section 4(2).

Given the staff interpretation, contemplating a subsequent pub­lic offering is not the equivalent of deciding, and one for purposes of Rule 152 subsequently decides to make a public offering not­withstanding the fact that it was contemplated at the time of the private offering. This was good news to issuers that frequently en­gage in bridge financing preliminary to undertaking a registered public offering. It has never made much sense to integrate an offer­ing made in compliance with Rule 506 or Section 4(2) followed by a registered offering. The objectives of the securities laws ap­pear to be realized if the criteria for the private offering exemption have been met with respect to sales made in reliance on such ex­emption and a registration statement is in effect for sales made to the public. The interpretation, however, is limited since Rule 152 is applicable only to offerings made pursuant to Section 4(2) based on Section 4(2). The staff subsequently expressed the view that Rule 152 under Verticom is applicable to a Rule 506 offering to be followed by a registered offering,[80] a Rule 506 offering to be followed by a Regulation E offering,[81] and a Rule 506 offering to be followed by a public offering by a bank exempt under Section 3(a)(2) of the Securities Act.[82] Since Rule 506 is based on Section 4(2), this is consistent with Verticom. Rule 152, however, is not available for an offering exempt under Rule 504 or 505, both of which are based on Section 3(b) of the Securities Act, or on Section 3(a)(11) followed by a subsequent public offering, including a subsequent registered public offering.[83] The staff has given a no-action letter in respect of what was technically a Rule 505 exempt offering to be followed by a registered public offering, but the Rule 505 offering also conformed to the requirements of Rule 506 and was characterized as a Rule 505 offering because one of the states in which the offering was made incorporated Rule 505, but not 506, into its counterpart Regulation D exemption.[84] The staff emphasized that, in reaching this position, it was relying on the opinion of counsel that the exempt offering satisfied the requirements of Rule 506. See Immune Response No-Action Letter.

The Aircraft Carrier Release proposed to amend Rule 152 in a manner consistent with Verticom. Specifically, amended Rule 152(a)(1)-(2) would have provided that a completed private offering would not be deemed integrated with a subsequent registered offering provided the registration statement was not filed before the private offering was completed. It would also have provided that securities issued in a completed private offering could be registered for resale provided not issued to an affiliate or a broker-dealer.[85] A private offering would be deemed completed when all securities have been paid for or all subscribers are unconditionally obligated to pay for the securities with one qualification. The obligation to pay could have been contingent provided the purchase price was fixed, the obligation to pay was not contingent upon the market price of the security at or around the time of the registered offering, and the condition was not subject to the direct or indirect control of any purchaser. When Rule 155 was adopted in January of 2001, it specifically, as discussed below, adopted with modification other amendments to Rule 152 proposed in the Aircraft Carrier Release, but it did not adopt proposed Rule 152(a). The Adopting Release, however, noted as to the area covered by proposed Rule 152(a) that “[b]ecause we are not adopting those proposed amendments, Rule 152 and related staff interpretations as to when a private offering is deemed ‘completed’ are unaffected.”[86] This suggests that Verticom and related staff interpretations remain the defacto law in the area of completed private offerings followed by a registered offering.

Abandoned Private Placement Followed by Registering Offering and Converse

We do not discuss other by this reference that Rule 155(b) provides a safe harbor for an abandoned private offering followed by a registered offering. Rule 155(c) provides a safe harbor for an abandoned registered offering followed by a private offering. The Rule 155(b) safe harbor is largely a non-event. Why would you commence with a private offering and abandon it in lieu of a registered offering; particularly, if it appears that you cannot complete the private offering. A registered offering frequently follows a completed private offering; particularly, by start-up companies that get their start with venture or other private capital and follow in some instances shortly thereafter with a registered public offering. It is reassuring to know as discussed above that Rule 152 and the Verticom interpretation are not affected by the adoption of Rule 155. Going from an unsuccessful private offering to a registered public offering, however, ordinarily makes little sense, although there may be changes in the market situation that on rare occasions makes it possible. What the Commission appears to have had primarily in mind is using it as a means of testing the market for a public offering. We do not pursue, however, because of time limitations and its limited utility.

To be in a position to rely upon Rule 155(c) and to make a private offering following an abandoned registered offering will take less planning and is much more likely to be utilized than Rule 155(b). In an IPO, and to a lesser extent follow-on offering, the underwriter will probably make the decision whether to abandon the offering before the registration statement goes effective and, in any event, before any sales are confirmed. An IPO typically is abandoned because the marketing effort during the so-called waiting period after the filing of the registration statement indicates the underwriter cannot complete the offering — at least at the price and the number of shares the issuer insists be included. The entire institutional arrangement for a firm underwriting is designed to assure that there is no binding underwriting agreement until completion of the marketing effort.[87] If the issue cannot be marketed, there will be no underwriting agreement and no shares sold. If the registered offering is withdrawn, absent Rule 155(c), the issuer has now engaged in a general solicitation and any private offering is likely to be deemed integrated absent a six-month waiting period. The private offering might be structured in a manner that under the five so-called general integration principles it is not deemed integrated with the unsuccessful registered offering, although this generally is not a reliable alternative. If Rule 155(c) is not available, the issuer attempting to do a private offering after the withdrawal of a registered offering has to rely on such an alternative or wait the six months to avail itself of the Rule 502(a) safe harbor. Rule 155 expressly provides that it is a “non-exclusive safe harbor from integration of registered and public offerings.”[88]

The adopting Release explained the interrelationship of Rule 155(c) and amendments to the Rules relating to the withdrawal of registration statements and the offset of filing fees as follows:[89]

New Rule 155 also provides an integration safe harbor that will permit an issuer that started a registered offering to withdraw the registration statement before any securities are sold and then begin a private offering. To use the safe harbor, the issuer and any person acting on its behalf will need to wait 30 days after the effective date of withdrawal of the registration statement before commencing the private offering. The issuer must provide each offeree in the private offering with information concerning withdrawal of the registration statement, the fact that the private offering is unregistered and the legal implications of its unregistered status. In addition, any disclosure document used in the private offering must disclose any changes in the issuer’s business or financial condition that occurred after the issuer filed the registration statement that are material to the investment decision in the private offering.

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In order for the Rule 155(c) safe-harbor to be applicable, the private offering must conform with the definition of a private offering utilized by the rule,[90] and the following additional conditions must be complied with.

1. No securities are sold pursuant to the registered offering.[91]

2. The registration statement has been withdrawn in accordance with Rule 477.[92] Rule 477 provides an incentive in this context for the issuer to file an application for withdrawal prior to the effective date of the registration statement. An application to withdraw requires the consent of the Commission.[93] Rule 477 provides that a pre-effective application to withdraw the entire offering will be deemed granted as of the date the application is filed unless the Commission within 15 calendar days notifies the issuer that its application has been denied.[94] If the application is filed after the registration statement becomes effective it will not be deemed granted until the Commission consents to the withdrawal.[95]

3. The date of grant of the withdrawal plays an important role as a condition of the safe harbor is that the private offering not be commenced until 30 calendar days after the effective date of the withdrawal.[96]

4. The issuer must notify each offeree in the private offering (a) the securities are not registered, (b) the securities are restricted securities and can be resold only if registered or pursuant to an exemption, (c) purchasers cannot assert a Section 11 private action, (d) a registration statement for the abandoned offering was filed and withdrawn together with the effective date of the withdrawal.[97] If a disclosure document is used in the private offering, it must disclose any changes in the issuer’s business or financial condition that occurred after the issuer filed the registration statement that would be material to the private offerees.[98]

If the registration statement is withdrawn to satisfy the condition of Rule 155(c), the registrant may offset the amount of registration fee paid against the registration fee under any future Securities Act registration statement(s) filed within five years from the initial filing date of the withdrawn registration statement. Such offset can also be taken if not otherwise used by a successor of the registrant, any majority owned subsidiary, or by a parent owning more than 50 percent of the registrant’s voting securities.[99]