|Arbitration||Hedge Funds||Mutual Funds||Investors||Brokers||Advisers||CorpFin||IPO||Compliance|
By Mark J. Astarita, Esq.
Investment Adviser's Legal and Compliance Guide
Recent SEC Filings
The term "private placement" as used in this text refers to the offer and sale of any security by a brokerage firm not involving a public offering. Private offerings are not the subject of a registration statement filed with the SEC under the 1933 Act. Private placements are done in reliance upon Sections 3(b) or 4(2) of the 1933 Act as construed or under Regulation D as promulgated by the SEC, or both. Regulation D, promulgated in 1982, sets forth certain guidelines for compliance with the Private Offering Exemption. Any registered representative who are involved in the private placement process are expected to have a working familiarity with Regulation D.
To qualify as a private placement, an offering by an issuer must meet either the requirement of Sections 3(b) or 4(2) of the 1933 Act as developed through SEC interpretation and court decisions or must follow the conditions set out under Regulation D of the 1933 Act. Persons claiming the exemption from the 1933 Act carry the burden of proving that its activities came within that exemption.
OverviewRegulation D is a series of six rules, Rules 501-506, establishing three transactional exemptions from the registration requirements of the 1933 Act.
Rules 501-503 set forth definitions, terms and conditions that apply generally throughout the Regulation. Specific exemptions are set out in Rules 504-506.
Rule 504 applies to transactions in which no more than $1,000,000 of securities are sold in any consecutive twelve-month period. Rule 504 imposes no ceiling on the number of investors, permits the payment of commissions, and imposes no restrictions on the manner of offering or resale of securities. Further, Rule 504 does not prescribe specific disclosure requirements. Generally, the intent of Rule 504 is to shift the obligation of regulating very small offerings to state "Blue Sky" administrators, though the offerings continue to be subject to federal anti-fraud provisions and civil liability provisions of the Exchange Act.
Rule 505 applies to transactions in which not more than $5,000,000 of securities is sold in any consecutive twelve-month period. Sales to thirty-five "non-accredited" investors and to an unlimited number of accredited investors are permitted. An issuer under Rule 505 may not use any general solicitation or general advertising to sell its securities.
Rule 506 has no dollar limitation of the offering. Rule 506 is available to all issuers for offerings sold to not more than thirty-five non-accredited purchasers and an unlimited number of accredited investors. Rule 506, however, unlike 504 and 505, requires an issuer to make a subjective determination that at the time of acquisition of the investment each non-accredited purchaser meets a certain sophistication standard, either individually or in conjunction with a "Purchaser Representative." Like Rule 505, Rule 506 prohibits any general solicitation or general advertising.
"Accredited Investor" is defined in Rule 501(a). The principal categories of accredited investors are as follows:
Section 201(a) of the JOBS Act required the SEC to remove the general solicitation prohibition under Rule 506, in the situations where all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that the purchasers are accredited investors.
In September 2013, the SEC adopted paragraph (c) of Rule 506. Under Rule 506(c), issuers can offer securities through means of general solicitation, provided that:
Issuers wishing to engage in general solicitation take "reasonable steps" to verify the accredited investor status of purchasers. Rule 506(c) sets forth a principles-based method of verification which requires an objective determination by the issuer (or those acting on its behalf) as to whether the steps taken are "reasonable" in the context of the particular facts and circumstances of each purchaser and transaction. Among the factors that an issuer should consider under this principles-based method are: "
In addition to this flexible, principles-based method, Rule 506(c) includes a non-exclusive list of verification methods that issuers may use, but are not required to use, when seeking greater certainty that they satisfy the verification requirement with respect to natural person purchasers. This non-exclusive list of verification methods consists of: Rule 506(b) remains unchanged following the adoption of Rule 506(c) and continues to be available for issuers that wish to conduct a Rule 506 offering without the use of general solicitation or that do not wish to limit sales of securities in the offering to accredited investors.
Additional Compliance Considerations Under Regulation DThe SEC has pointed out the following regarding Regulation D:
Form DNotices, on Form D, are due within fifteen days after the first sale of securities in an offering under Regulation D. It will be prepared by Issuer's counsel.
Private Placement of Restricted Securities Outside Regulation D
Private Placement Offering Memorandum
To meet the requirement of Regulation D or the requirements of Section 4(2) of the 1933 Act (the private placement exemption), the issuer is almost always required to make extensive disclosures regarding the nature, character and risk factors relating to an offering. The disclosure document often is labeled "Offering Memorandum" or given a similar title, which, in the normal course, is based upon information provided to counsel to the issuer. While a properly executed private placement is exempt from the registration provisions (i.e. Section 5 of the 1933 Act) of the federal securities laws, the transaction (and the disclosures made or a lack thereof) is subject to the anti-fraud provisions. If the offering memorandum is a particular private placement turns out to be materially misleading in terms of disclosures which have been made (or which should have been made), the broker-dealer and its principals may be deemed to have violated or aided or abetted violations of the anti-fraud provisions of the federal securities laws.
Unfortunately, because of the nature of a private offering, those looking to review an offering memorandum for educational purposes will have a very difficult time finding one. We did manage to locate a sample, and have it on line - sample private placement memorandum. Another source that we have found is Hedge Fund Disclosure Documents Line by Line: A User's Guide to Private Placement Memoranda for Funds Formed as Limited Liability Companies While a hedge fund PPM is slightly different than a "traditional" PPM, the book will give the reader a great deal of insight into the contents of a private placement memorandum.
Supplementary or Corrective MaterialDuring the course of private placement activities on a particular issue, or prior to the closing, it may become necessary to update or correct information supplied in the private placement memorandum as originally prepared. The corrected information must be brought to the attention of the offerees by means of a cover or transmittal letter which describes the changes or additions. Depending upon the information transmitted, reconfirmation of an investors desire to invest may be required. The files maintained with respect to a particular offering must contain a record of what has been done. Prior to closing an offering, meaning the acceptance of investors in a transaction, a brokerage firm Principal must verify that all such amendments have been sent to all subscribing offerees and that the files are accurate and complete.
Offeree Access To InformationIn most private placement offering memoranda, it is stated that the memorandum has been prepared by counsel to the issuer (i.e., the corporation) from documents which have been provided by representatives of the issuer. Offerees are invited to meet with representatives of the issuer to make an independent investigation and verification of the matters disclosed in the offering memorandum. Courts, reviewing private placements when challenged, weigh investor access to underlying information about the transaction very heavily in the determination of whether there has been compliance with the private placement exemption. The brokerage firm's designated Principal should obtain a commitment from the Issuer that potential purchasers and their representatives shall be given access to underlying information about the transaction if they desire to pursue such information. The fact that information is available to offerees should be specifically disclosed to the offerees at a conspicuous point in the offering documents.
PRIVATE PLACEMENT OFFERING PROCESS
Offering Commencement and TerminationThe commencement date of private offerings is fixed generally at the date of the availability of the approved offering documents, for distribution to sales personnel.
The termination date for a private offering is dependent on the type of offering being made. An "all or nothing" offering contains, by its terms, a fixed or defined date for the termination of the offering. A "best efforts" offering may have an indeterminate termination period meaning that the offering continues until the full number of Securities is placed and the subscribers are formally accepted by both the issuer (or a duly authorized representative) and by a Principal of the brokerage firm.
The sales objectives in a best efforts offering, of course, is that all securities will be placed with suitable investors. However, short of all securities being placed, it is required that a minimum amount of money need be raised which shall be sufficient, after the funding of all of the organizational and offering expenses, and giving consideration to the fixed contractual obligations of the issuer, without changing the nature of the investment called for by the general terms of the offering. The issuer may be given the option of funding required issuer obligations by the making of loans or deferral of fees. In such a case where the issuer funds financial requirements prior to the placement of all of the securities, it is the obligation of the brokerage firm to assure itself that appropriate disclosure to all offerees (and subscribers) be made and to assure itself that the basic nature a