PRIVATE OFFERING EXEMPTIONS FROM REGISTRATION: RULE 506(b)

As was discussed in a previous blog post, the most common exemptions from registration used in private offerings are the following:

· Section 4(a)(2);

· Rule 504 under Regulation D;

· Rule 506(b) under Regulation D;

· Rule 506(c) under Regulation D;

· Rule 701;

· Regulation S;

· Regulation A (Reg. A+); and

· Regulation Crowdfunding.

What is Regulation D?

Regulation D (Reg. D) contains the Rules 504, 505, and 506, which provide exemptions from the registration requirements of the Securities and Exchange Commission (the “SEC”).

What is the Rule 506(b) exemption used in private offerings?

Rule 506(b) of Regulation D is an exemption from the registration requirements of the SEC for issuers and is considered a “safe harbor” under Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”). A “safe harbor” provides objective standards an issuer can rely upon in order to comply with Section 4(a)(2).

What are the benefits and downsides of using a Rule 506(b) exemption in a private offering?

The benefits to using a Rule 506(b) exemption in a private offering are as follows:

· No limit on private offering amount;

· No limit on private offering duration;

· Unlimited amount of “accredited investors” and up to 35 “non-accredited investors” in the private offering;

· No disclosure requirements for “accredited investors” in the private offering (although 10b-5 under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), still applies);

· Exemption pre-empts federal law; no state compliance required for private offering (besides notice filing and fee payment); and

· Limited filing requirement following private offering (Form D).

The downsides to using a Rule 506(b) exemption in a private offering are as follows:

· Maximum of 35 “non-accredited investors” allowed in the private offering;

· All “non-accredited investors,” either alone or with 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 private offering;

· All “non-accredited investors” in the private offering must be provided disclosure documents that generally contain the same type of information as provided in a registered offering (including financial disclosures);

· General solicitation and general advertising of the private offering are not allowed;

· Bad actor disqualification applicable in private offerings; and

· The securities sold in the private offering will be restricted securities, which means they may not be resold, without registration with the SEC, for up to 12 months.

What is an “accredited investor” in a private offering?

For individuals in a private offering, an “accredited investor” is anyone who 1) earned income exceeding $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year; or 2) has a net worth over $1,000,000, either alone or together with a spouse (excluding the value of the primary residence). For entities in a private offering, an “accredited investor,” generally, 1) has total assets in excess of $5,000,000; or 2) any entity in which all of the equity owners are “accredited investors.”

What is Rule 10b-5 under the Exchange Act?

Although, under Rule 506(b) and other exemptions from registration, there is no disclosure requirement in the private offering, Rule 10b-5 under the Exchange Act still applies making it unlawful for the issuer or its representatives, in the connection with the purchase or sale of any security: (a) to employ any device, scheme, or artifice to defraud, (b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.

The decision whether to commence a private offering, including the preparation of required disclosures and federal and state compliance, can be complicated and difficult. Business Legal Advisors, LLC has over seven years of experience assisting companies with private offerings from preparing for the private offering to the completion of a successful offering.